How to structure startup equity / shareholding between co-founders and developer

A partner and I have been working through a business idea centered around a website & mobile app. We've worked through the conceptualisation, version 1 designs, research and some very basic proof of concept functional demos.

We're at the stage now where we require a developer to assist with getting a production version of the product out. Either outsourcing or taking on a developer as an equity partner.

We've approached a friend who is a developer to come on board. He is very keen to join as an equity partner and happy to work on this basis.

Our question now is how to structure the equity split. As the initial co-founders we have agreed on a 50-50 split.

How much should we offer the developer or would he be entitled to?

We both have other full time commitments and neither will be drawing a salary. We each bring different resources to the table, e.g. design skills on one side and beneficial business relationships on the other, with each of us having input on the product development and scope.

We've used the Co-founders Equity Calculator tool (http://foundrs.com/ ) which suggests a 44-44-12 split between the two co-founders and then developer. Of course this may not be accurate but it seems more weight is giving to partners who's responsibilities revolve around business/product development and the marketing side of things.

My partner and I will both be very actively involved from a business development side of things along with product marketing, sales and management of the development process.

Apart from a split based on time / effort input from each side what other factors should be taken into account and importantly how should a weighting be attached to each?

Ask yourself how much work you and your partner do, and how much work your developer friend will do. Can you get your business moving without your developer? Do you have the ability to hire someone without offering an equity split? If you are dependent upon this person, offering them 12% of the equity may come across as a bit of a slap in the face. It is tempting as an "original" founder to want to keep a bigger piece of the pie; the idea was yours, after all. But don't diminish the value that your developer friend may bring to the table. If you can honestly say that you and your current partner will be doing more work, putting in more hours and more effort overall, then try and negotiate an inequal split (40-40-20 is less insulting). However, if this person is going to be working just as hard and going to be just as passionate about it as you, then they deserve an equal split.

It sounds like the confusion is partly arising because there are two types of equity.

First is equity given to key team members to encourage and reward future contributions; this typically vests over four years for full-time team members and ten years for half-time team members (so if people don't contribute in the future as expected they lose the shares). This is the kind which will be calculated on the co-founders equity calculator.

The second is equity which is sold for cash. This vests 100% immediately, because it is for cash contributed to the business today at the market price of the shares.

People often confuse the two when they have a cash expense (e.g., paying an outsourced programmer) and they come to an arrangement whereby they effectively pay cash at the market rate for the service on condition that the recipient then reinvests the cash in buying their shares.

At the extreme, you could offer equity to your cleaners, who will bring zero long-term value to your business (hence would get zero via the foundrs.com calculator), but who have actually delivered a valuable service today that you would have paid cash for.

Note: your cleaners in the case above will owe business/income tax on the cash received, even though they reinvested all the cash into your shares. Always make sure you remember this when you are dealing with this kind of transaction. Of course, if you haven't sold any of your shares to a third party for real cash yet, you have some flexibility here because nobody can say what your shares are worth. So it sounds like you are dealing with someone who delivers a service that is important today (cash equity), but who won't bring a lot of value to the long term (vesting equity). In the ideal case, you would figure out what your business is worth today, what their services are worth, and offer them a corresponding amount of shares to vest as they do the work. However, it's a real argument to say what your business is worth.

There are two solutions that can work here. You may do a mix of both.

First: set up appropriate vesting. Though you and your partner deserve 44% of the shares, you are currently working full-time elsewhere ... so you should be vesting over a 10-20 year period if you are working 10-20 hours per week. The programmer may only deserve 12% of the shares, but he may be working full-time right now, so his shares would vest over 4 years. So in terms of vested shares, he will own much more than 12% right now (closer to 30%).

Second: sell some of your shares for cash to an external investor. You can then pay your programmer a mix of cash (e.g., at 50% of the developer's market rate) plus equity. It sounds a lot nicer to have an early employee's share of the company (e.g., 6%) if you are being paid for your time as an employee when the founders aren't being paid.