How much equity should I give these people?

We're two co founders, I'm the tech, he is the business end.

We want to bring on a graphic designer (since the stuff we've gotten 2/3 times on Guru.com was awful). We currently have begun raising capital yet, since we're bootstrapping and we're considering paying them in a small amount of equity. How much equity for a graphic designer? We also want to bring in another business guy (count would = 2) to help support marketing/PR/etc. We would see this guy (if all works out) as possibly a COO eventually. How much is a good amount upfront? My business partner and I are currently doing 50/50, bootstrapping. We're NOT profitable yet, since I'm developing the product.

This is a tough question. The approach that I've seen used most often is calculation of "sweat equity." I'll go through an example in the steps below.

1. You look at the opportunity cost of each potential employee - what salary are they giving up by coming to work for you. For the sake of example, let's say the designer would have earned 7K/month.
2. Think of the lost salary of the designer as an investment in your business. For instance, to hire the designer, you would have to pay him roughly 7K/month (as stated in the example above.) Let's say he'll be working for free for 12 months. So he is basically be a 84K investment in your company.
3. Calculate your valuation in 3 and 5 years. Most investors want to see a 3x return in 3 years and a 10x return in 5 years. So let's say your company will be worth 3M in 3 years and 10M in 5 years, then you could say you are worth 1M now. Obviously, these numbers are pretty big guesses (and don't really make logical sense) but they help you frame your problem.
4. Calculate the equity. So if the designer is making a 84K investment, and you estimate that you are worth 1M now then he would get about 8.4%. Obviously, you would still want to apply a standard vesting agreement - something like 4 years with a 1 year cliff (he gets nothing if he quits before the year is up and he vests monthly after that getting the full amount at the end of 4 years). And when you get investment you would level him up on salary and possibly add some equity if you can't get him to full salary.

The biggest variables in this approach are:

• Employee's "lost" salary by working for you
• Length of time working for free
• Current valuation

This approach is not perfect but it's a general framework that I've seen used before. You can obviously tweak it as necessary. Also, it's good to have the valuation discussion early so you can set the vision of how big you are trying to grow.

When you aren't paying the employee it becomes difficult to go with industry standard equity arrangements.