

Ask HN: Equity for first hire? - rgba

A startup with four technical founders and a great deal of potential is in the process of closing series A at a $25-30 million valuation.<p>A potential first hire currently makes $190k. He would bring significant value and take a leadership role as an engineer. What's appropriate equity if he's making $115k pay?
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onlawschool
As a starting point, it may be helpful to think about the equity stake that
would be required in order to offer the potential employee compensation
equivalent to that which he currently receives.

To that end, I did a quick back-of-the-envelope-style calculation that you can
find here:
[https://docs.google.com/spreadsheet/ccc?key=0AgLVLMvTOJ8ldDl...](https://docs.google.com/spreadsheet/ccc?key=0AgLVLMvTOJ8ldDlsUWRucHlsZ3p3WVpmWlhBeERoWGc&hl=en_US)

In my model, I assumed that he would receive a 5% raise in salary each year at
either job. I assumed an 8% discount rate for his current salary, a 12%
discount rate for his salary at your company, and a 25% discount rate for his
equity cashout, which I assumed he would receive at the end of year 7. I also
assumed that the growth rate for your firm's valuation would be 20% in year 1
and would decrease at a constant rate of 2% per year.

Under these assumptions, an equity stake around about 4.5% would yield a $2.56
Million payment when he sells his stake at the end of year 7. The net present
value (NPV) of this one-time payment would be equal to $536,302 today. Taken
together with his salary payments, the NPV of his total compensation package
in this scenario over 7 years would be equal to the $1.13 Million NPV of his
salary payments from his current job.

You can download the spreadsheet and can play around with the various
assumptions that I made. The greater the risk associated with a particular
stream of cashflows, the higher the discount rate should be.

Adjustments to these assumptions can have a significant impact on the NPV of
the payments. For example, if we set the discount rate for his salary payments
at your company to 16% and the discount rate for his equity cashout to 30%,
then the equivalent equity stake would be more like 6.64%.

If you are able to make some reasonably accurate discount rate assumptions and
valuation growth assumptions, then you should be able to get a reasonably good
% equity stake that would compensate him for the decrease in salary.

From there, you might consider adjusting the offered equity stake upward...
the spreadsheet will give you the equity stake that would presumably make him
indifferent between choosing to stay at his current job or joining your team -
In order to persuade him to join you, you want to be able to make him a better
offer than that which he currently has.

~~~
willpower101
I'm loving this. Thanks for sharing!

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onlawschool
Finally, I'd also like to note that, given the proximity of this hire to your
series A funding, you may want to consider the tax implications involved in
granting an equity stake to an employee.

If the company is valued at $30 million, then granting a new hire 10% of the
stock in the company might be viewed as a taxable event by the IRS. In that
case, your employee might find himself responsible for paying taxes on $3
million in income. You don't want to wind up with an employee who owes
$750,000 to the IRS and can't pay it.

Consulting with a qualified attorney will be invaluable in structuring this
transaction in order to avoid this sort of problem. With a valuation of
$25-$30 million, you really must seek legal counsel in this matter before
moving forward. With that much money on the line, you really can't afford NOT
to have a good attorney on your side when you are putting together this deal.

 _Note: I am not a licensed attorney and this is not legal advice. Please seek
the advice of qualified legal counsel._

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onlawschool
Also, you may want to consider including vesting provisions in the new hire's
compensation agreement.
[http://en.wikipedia.org/wiki/Vesting#Ownership_in_startup_co...](http://en.wikipedia.org/wiki/Vesting#Ownership_in_startup_companies)

If you decide to offer an 8% equity stake, then you might, for example, want a
2% stake to vest each year for 4 years.

~~~
willpower101
Agreed. Always vest non founders. Don't get stuck with a non-preforming
shareholder a few years from now.

~~~
ig1
You should vest founders too.

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ig1
Out of curiosity: didn't this issue come up when you were negotiating your
series a ?

I was under the assumption that it's typical for a series a term sheet to
create an employee options pool pre-investment (to avoid dilution of the VCs),
which would therefore require you to have a plan for how much equity you plan
to give employees.

~~~
rgba
You're assuming I'm not the potential employee. :)

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glimcat
IMO the level of involvement in IP generation, in determining the business's
direction, and the degree to which you need this specific person are more
relevant to equity vs. treating it as direct compensation.

