Allocating equity - equal cash investment - unequal time investment

I am getting involved in a small start up - we have been discussing (3 partners) this for a few months and now is time to get everything settled.

We originally discussed a certain time allocation 4 -4 - 2.5 days a week and agreed to allocate extra salary to cover the differential (but this is on the books in year 1 we won't actually take the salary.)

My partners have decided that we all need to up our commitment to 4-5 days and pretty much out voted me. After lots of debating I am sure that for personal reasons (I am much younger and have much more family risk) I can't commit to the time they want and don't much like the role that they want me to do in the extra time.

I put a counter proposal on the table - I would restrict my role to my real value add in the business - roughly 1 day per week and add some cash to cover a guy to to the grunt work that I am opting out of. In addition I would stay an equal partner on the initial investment needed - this is real money not a few bucks here and there.

My partners value my contribution and would like me to stay in - they want me to take less equity for same investment. I feel this is unfair (discussed on this blog site) & think that the solution is to buy the guy for grunt work.

My "partners" are upset as this very low balls their time and of course they have both investment and time risk involved. They correctly state that in year 1 this biz is all risk - if we make it through 12-18months we are probably on our way to doing very well - so they need to be rewarded for taking an unfair amount of risk in their time whilst I hedge my bets in salaried work.

I am looking for a "reasonable" solution - not asking for favors and will (sadly) walk away if needed.....

What determines equity? - equal & substantial cash investment or time invested in year 1 - most other discussions seem to relate to recognising effort on low cash investment - here the cash is fairly substantial and up front to establish the company

Thanks!

Equity Founders Agreement Investment Partnerships

asked Nov 24 '11 at 20:53

Goldenone
21 points

Get up to $750K in working capital to finance your business: Clarify Capital Business Loans

2 Answers

I founded a startup in which the early "founders" worked different amount and also made cash contributions in the 5-10K range. I'm not sure how much cash investment you are referring to, but here are some thoughts:

Loan: Treat the cash investment as a loan to the company. I've also used this approach. The money in was a loan and once we had enough to pay us back and comfortably sustain the business for several months, we repaid the loan. This approach is simple and can work well.
Sweat Equity : This is about valuing founders' time. We used an approach where we created an hourly rates based on the opportunity cost - sweat equity. We used the same hourly rate for everyone since we all had similar levels of experience. Let's say everyone's hourly rate would be $25/hour. Then you can assign value to your time based on that hourly rate. If the other's are working 4x your time for a period of a week (40 hours for simplicity) then you would owe the company for 30 hours ($750) for that week. In our case we kept equity even and just had the non-full time founder pay to level up. It would be very difficult to assign different levels of equity with this approach since that would require you to value your company.
Only Full-time Founders : According to Joel Spolsky, founder of StackExchange, a part-time founder shouldn't get equity, excerpted below:

What if one of the founders doesn't work full time on the company? Then they're not a founder. In my book nobody who is not working full
time counts as a founder. Anyone who holds on to their day job gets a
salary or IOUs, but not equity. If they hang onto that day job until
the VC puts in funding and then comes to work for the company full
time, they didn't take nearly as much risk and they deserve to receive
equity along with the first layer of employees

You can read Joel's entire answer here Lastly, no matter what option you choose, vesting is a must. Typically 4-5 years with a 1 year cliff is standard. Meaning that anyone who quits before year 1 gets nothing. After year 1, each person gets a little more monthly until the 4-5 years is up. This typically assumes full-time work going forward.

answered Nov 27 '11 at 18:33

Bkparikh
610 points

Thanks - the issue here is that we are all committing a lot of cash - so that Joel's approach isnt correct (IMHO) as it is a huge risk in its own way - for the same reason calling it loan and not equity is also not working. The top up salary idea works I think – Goldenone 13 years ago
Thks - the issue here is that we are all committing a lot of cash - so that Joel's approach isnt correct (IMHO) as cash is a huge risk in its own way - for same reason calling it loan and not equity is also not working. The top up wage works I think - I was trying to build a model that said controlling equity would be split based on cash - but that salary in yr 1 could be 2nd round of equity based on hrs - so I maintain equal partnership in decisions but they would get more for their risk & sweat. But I suspect that this would be much too damaging for me over several years if very successful. – Goldenone 13 years ago

The situation your discribing is you becoming an investor not a founder. (mainly devoting money not time) That means that no your not necessarily entitled to an equal share. You need to agree on a fair percentage based on the amount of investment and the current value of the business. The problem here is valuing an early startup is very hard. I suggest you ask your partners what capital lump sum is x percentage worth.

On a separate note, I would urge you to quit your current job and go in full time. It sounds like you have some cash so could use some of that as a safety net. Your partners seem to want another founder rather than an investor and you will be much more involved in the business if you take that leap.

Good luck whichever way you choose!

answered Dec 27 '11 at 20:27

Tom Squires
1,047 points

Thx Tom! Update - I tried to build a minor partnership formula - 20% equity & 20% of total time committed leaving them with 40% each in both equity & time - seemed reasonable to me. (I was forced to split my time into direct time & time with an employee doing v low level stuff.) Sadly this didn't work - they got into a complex analysis where the bottom line was we can only work with each doing exactly 33% - not unreasonable as you noted they decided they really want a FT Founder. So my solution isn't appropriate in this case. Looking at risk/reward/my bank account I was forced to bow out. – Goldenone 13 years ago