This is also for your first employee. You may live or die based on the work this person does, and more importantly they may be accepting extraordinary risk (if your runway is less than 6 months, say). The same rules do not apply to employee #3.
Finally, if you don't pay the person, or if you pay them bare subsistence wages (say, $20-30k) and they're senior talent, you've introduced an additional level of risk, and you should pay a premium for that. However, there may be better ways to compensate that risk; for instance, you can defer salary at a premium rate.
A really important thing to remember about employee options is that employees don't know how to value them. You need to be really engaged with the strategic course of the business (not just the product: the business and its future cash flows) to really grok what options mean in rational terms. This is a good reason not to grant huge amounts to early employees; it costs you dearly and doesn't make them much happier.
I've been in companies where my shares had dramatic legal rights, and where I had access to financials. I guess I liked that at the time, but to be honest, I didn't care. However, I have friends who have quit companies because they saw financials and got a warped idea of how much their time was worth, so doing that has downsides too.
Around '98, my company was me plus 8 employees. I was pushing hard to turn our model from a "consulting with a product model" to a full on product and platform business. This required taking some risks with our client base to enable us to invest in product R&D to make it ready for general consumption. We ended up with one client that year. They were a big-mother of a client and gave us access to a product strategy and acquisition if we pulled the job off. I became pushy with my client as we weren't getting to where I wanted to be quick enough. I finally lost my cool one day and the client told me he was through, get lost. This was going to cost him easily 20x what he had already paid to cut ties as his core product depended on us. But he was pissed off and I was pissed off and he could afford the big loss.
That same day, I went into the office after the client meeting and sat everyone down and told them our bleak outlook: we had enough payroll for 3 more months. The next day, each employee came to me individually and offered to work for free. Each one had a different story as to how long they could go without pay; 2 told me to quit paying them immediately.
They all acted like founders and I think its because I treated them like it.
This model probably doesn't scale well. But its an experience I'll never forget.
your parent post could also be sound. it depends on the philosophies of those hiring.
It shouldn't be possible for them to buy shares at a price attractive to both founders/investors & employees.
Personally, I'd ask for 5% and might be willing to take 4%. Otherwise, there are startups that will pay market salaries at 0.7% with way less personal risk involved.
I'm apparently saying the same thing the Mint founder said, for what it's worth.
I think it is a bit different here.
Also, the first employee may not be more important than your second CEO, but he should certainly not be outranked by post-funding VPs.
Should your first employee be outranked by a post-funding exec? Well, Twitter hired Dick Costolo. You need some pretty amazing Django chops to "outrank" him.
There are exceptions, I got a tiny part of google because I was there (briefly) very early and that paid off nicely. And there are other examples of non-founders doing well, where "well" means life changing amounts of money (measured in millions).
But people need to keep in mind that those are exceptions, not the rule.
Most non-founders end up with what amounts to a nice bonus, a year or two's salary.
Unless I'm mistaken this question was sort of "what's normal for this situation?".
What's normal varies but not by much. 5% is high. I agree with tptacek, 5% is what you give the 2nd CEO (which is a different topic, that's usually 5% wasted because that CEO will probably drive your company out of business. Anyone remember the Pepsi guy running Apple?). .5-1.5% sounds about right for the first engineering hire.
Remember, you can always give out more stock but it is close to impossible to take it back.
Otherwise, I've seen two methods of valuing startup equity offers:
1. Options are worth nothing, until they are worth something.
2. Options are worth their face value times the probability you will meet that face value. Example: 2% equity of a startup targeting a $100M exit, with a 1% probability of hitting that exit = (2% * 100M) * 1% = $20,000.
I agree with other commenters that a chance at "life-changing money" is usually required for higher-risk situations like being a first employee. So that's the real test, not a fixed percentage.
Also remember this is an early round, and that 4-5% will get diluted a lot as you take more venture. So it's not really comparable to what a future CEO might get.
Start at 2% and increase by 1% for every $10k under market your paying in salary.
I'm happy to give 5% in equity to a top-notch engineer who is taking a 30% pay cut.
Ask for founder level equity and founder level control (both over the business idea and the technical implementation: non-technical "managers" have a nasty tendency to make horrible technical decisions for "business reasons" -- think being forced to use "enterprise" software vs. open source alternatives, e.g. ASP.NET + SQL Server or Oracle + EJB).
If they say no, move on. There are thousands of early stage start-ups. Being a the most technical person in company of "business guys" sucks for an employee and brings no benefits associated with being in technology start-up (a greater freedom to choose technologies to work with, a chance to pursue fascinating problems rather than build CRUD screens for sales people).
On the other hand, if you're working for a large software/Internet company (or high growth, late stage tech start-up) you can at least be sure that your manager is technical and on your side. What rational reason is there, then, to choose to be the first engineer in an already established company (given your equity will likely end up being worthless)? There could be exceptions: if the company broke into an entirely new market (product has to be "good enough" vs. high quality), or if the founders gave you absolute freedom to choose the technology (e.g. letting you use Haskell and Erlang if you so wish), but generally the scenario is "I'm a business guy with a super-duper idea and I want an engineer to build it for me in two weeks, in PHP".
To the "business guys": any technical guy who accepts this situation isn't a "gold mine". He either doesn't know his own worth (and thus can't know your products' worth), is inexperienced (won't be able to build a product that would be a fit most market) or has nowhere else to go (can't build a good product for you). If he is competent, experienced and confident, he may simply be looking to take/explore your idea and then build a much better version of it himself (e.g. what Zuckerberg did with Winkelvoss brothers)
Assuming this engineer is fairly valuable to your startup due to the non-technical co-founders, you might have to give up more than normal (0.5-1.5% equity). I don't have a number in mind, but I'd be interested in hearing other people's thoughts on this.
His first engineer got ~$50K + 2% IIRC.
I should note, we are never addicted to outside money. We try to bootstap as much as possible and plan always to make it without taking in funds which may prove costly or hard to get. In other words, we always try to manage our cash carefully and not take VC or angel fund unless absolutely necessary.