Goldmine on Salary and Equity

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This article is authored by Sameer Guglani, Partner, Morpheus Venture Partners and can be found on his blog: http://www.guglanisam.me/. This post is a goldmine of knowledge on "Salary and Equity".

To go the article, click here

For readers convenience, I am publishing it here. All credit to Sameer!!!!!

In the beginning of a startup there are just the founders. They do all the work - making / selling / admin / HR / cleaning / finance - everything. With their enormous passion and never ending energy they start moving the wheel. They make the product / launch it / get some traction / start getting some orders and so on. Once the work load increases to a point there is need for more hands & heads. Since they have launched / been covered / have made progress - less people look down upon them and some even show interest in working with them. Through their efforts they manage to find some passionate guys ready to come on board. (Read here about What to look for in startup interviews?). So far so good. Now comes the tricky part. What should be the salary and equity for the new team members?



Salary

You need to find folks who are ready to work for much lower than market salary. Folks who value the other things they will get much more than money, things like - learn lot of cool stuff / work on hard problems / have loads of fun / work with uber smart folks / etc
To begin with it’s great if they agree to work for "survival salary" for a year or until the company either raises money or starts earning enough to pay him / her more than survival salary
Look for people who lead a fairly simple / bootstrapped lifestyle and don't have too many commitments. Specially stay away from folks with housing loans
I think INR 15-25K a month is a good range to think about
When you make the salary commitments you should ensure that you have enough cash to take care of overall expenses for next 10-12 months or more
Budget for other expenses like - Computer / Phone / Work area / misc expenses for each employee
If you can hire people who bring their own laptop - that is a bonus


Equity

Equity should be decided depending on
Stage of the company
Potential impact on the employee on the future of the company
How much cut is the guy taking on the cash side (this should be compensated)
A good thumb rule is to think 5 years in future
Assume that your company is acquired for a reasonable amount
Calculate the return which that guy will get via sale of equity
Now estimate the market salary of the guy 5 years from today
If in the 5th year he can make 5-6 times his annual salary via the equity sale - its a decent deal / anything higher is off course better for him
Read PG's excellent article on how much equity is the right equity
Overall you should designate a certain number of unallocated shares as the ESOP pool. These shares are not yet issued but have been allocated as employee stock - to be issued overtime
Typically startups keep 20% as employee stock option pool
Vesting Schedule
Equity offered to startup employees is not just for joining but for long term contribution to the company
Hence you pro-rate the equity over this period of time called "Vesting Period"
Normally this period is 4 years. But in special cases it can be brought down to 3 years
You also need to think about the minimum period the person should work for the company for making a decent contribution
This is called "Cliff" and is normally 1 year. You can be flexible on the duration but its strongly recommended that you have the cliff in the arrangement
If the employee leaves (or is asked to leave) before completion of the cliff period he / she will not get any equity in the company
So lets say you plan to hire a guy X for following terms
Equity - 4%
Vesting Period - 4 years
Cliff - 1 year
This means that you will give X 4% equity for working in the company for 4 years. But you expect him to stay for minimum 1 year
Let’s say 4% translates to 4800 shares
Total vesting duration in months is 48 months
Every month that X stays with the company he becomes owner of 1/ 48th of 4800 shares - which is 100 shares
Now the cliff kicks in, X needs to complete the cliff period of 12 months to receive any shares
So if he stays for 13 months, number of shares = (4800/48) *13 = 1300
But if he stays for 11 months, he gets ZERO shares - since he did not complete the cliff period
Additional equity
In some case companies give additional equity to employees later on as a performance bonus or as part of promotion
Each equity grant should have separate vesting schedule
Share price
In most cases startup employees are only expected to pay the face value of the shares and even that is reimbursed in some form
But at later stages companies calculate the share price with the help of their CA and offer the shares the employee for a heavy discount or subsidy
Paperwork / Agreements
Setting up a formal ESOP plan with help of a good lawyer would be too expensive for a bootstrapped startup - hence it’s a good idea to do that after you raise series A or start making decent amount of revenues
For a bootstrapped startup, you should mention the amount of equity and details of vesting schedule in the employment agreement
At the time of issuing shares you enter into share subscription agreement with the employee - where he / she only needs to pay the face value of the shares
Deciding later
In many cases people like each other and start working together without finalizing the equity %
Leaving it totally open could be a bad idea - since expectations could be totally mismatched and that could become a big headache
If you do want to defer the decision on the number, make sure that you discuss
Exact time after which equity will be decided
Range in which the equity will fall
Your expectations from the employee
Best way is to start with a firm number slightly on the lower side and if things turn out good you can always grant more equity
Ankur raised a point while reviewing the draft of this post that some times the employee will ask you back the question - Why are you guys keeping 95% and giving me only 5%? Obviously guy is not able appreciate to or realize the difference in the contribution of a Founder and an early employee. Here are some of those reasons, which quite often remain invisible to the employees:

Founders take the maximum risk while starting a company
They quit their job not to join an existing setup but they quit with nothing in hand
The startups are literally created in heads of the founders - its their DNA that the startup carries - they have the maximum impact on its outcome and the equity should reflect that
The initial days are the hardest for every startup and there is very little to show - so at that point almost no one wants to join them - during that period its the founders alone who toil and create - employees mostly come later
An employee has the flexibility to leave the job whenever they want and move on to a new job. Founders don't have that option - they need to stay with the company thru thick and thin. (In theory they can also shutdown or leave - but in practice its very difficult)
Founders also make the initial capital investment in the company and add more capital in most cases / they max out the credit cards / bring personal laptops / run office from there home / bring stuff from home to run the office and many such contributions
Founders work for zero salary for quite a long time
Founders normally setup ESOP of 20% out of which other employees are also given equity grants - so they are really are not keeping 95%
Most employees want to do specialized jobs around their core area and stick to it - so that they continue to build their job career. Founders do not have any such choice - irrespective of their backgrounds - founders need to work in every department and do what ever it takes to keep things moving and it also involves junior most jobs like - bank work / cleaning / delivering orders / making tea / pretty much every thing
A founder's career and reputation is attached to the outcome of the venture / he is the one who worries the most / looses the most sleep - the buck stops at him
As a founder -If you find a guy who can match you to a certain extent in above listed aspects - you should surely give him more equity or even bring him on board as a founder. One of portolio founders did this very recently - brought a guy as first employee with 9% equity / found that the guy can bring a lot more value and invited him to join as a co-founder with same amount equity as the first founder
As a founder - its also important that you draw the line at the right place. If you find someone really good for a particular role, but they bring no additional value and this person expects a much higher equity than what seems fair - Dont worry about it - just let them go. If they can not respect your contribution - they are anyway a wrong hire
As a potential employee - if you don't see founders with the kind of commitment and qualities mentioned above - don't join the startup

This article is authored by Sameer Guglani, Partner, Morpheus Venture Partners and can be found on his blog: http://www.guglanisam.me/. This post is a goldmine of knowledge on "Salary and Equity".

To go the article, click here

For readers convenience, I am publishing it here. All credit to Sameer!!!!!

In the beginning of a startup there are just the founders. They do all the work - making / selling / admin / HR / cleaning / finance - everything. With their enormous passion and never ending energy they start moving the wheel. They make the product / launch it / get some traction / start getting some orders and so on. Once the work load increases to a point there is need for more hands & heads. Since they have launched / been covered / have made progress - less people look down upon them and some even show interest in working with them. Through their efforts they manage to find some passionate guys ready to come on board. (Read here about What to look for in startup interviews?). So far so good. Now comes the tricky part. What should be the salary and equity for the new team members?



Salary

You need to find folks who are ready to work for much lower than market salary. Folks who value the other things they will get much more than money, things like - learn lot of cool stuff / work on hard problems / have loads of fun / work with uber smart folks / etc
To begin with it’s great if they agree to work for "survival salary" for a year or until the company either raises money or starts earning enough to pay him / her more than survival salary
Look for people who lead a fairly simple / bootstrapped lifestyle and don't have too many commitments. Specially stay away from folks with housing loans
I think INR 15-25K a month is a good range to think about
When you make the salary commitments you should ensure that you have enough cash to take care of overall expenses for next 10-12 months or more
Budget for other expenses like - Computer / Phone / Work area / misc expenses for each employee
If you can hire people who bring their own laptop - that is a bonus


Equity

Equity should be decided depending on
Stage of the company
Potential impact on the employee on the future of the company
How much cut is the guy taking on the cash side (this should be compensated)
A good thumb rule is to think 5 years in future
Assume that your company is acquired for a reasonable amount
Calculate the return which that guy will get via sale of equity
Now estimate the market salary of the guy 5 years from today
If in the 5th year he can make 5-6 times his annual salary via the equity sale - its a decent deal / anything higher is off course better for him
Read PG's excellent article on how much equity is the right equity
Overall you should designate a certain number of unallocated shares as the ESOP pool. These shares are not yet issued but have been allocated as employee stock - to be issued overtime
Typically startups keep 20% as employee stock option pool
Vesting Schedule
Equity offered to startup employees is not just for joining but for long term contribution to the company
Hence you pro-rate the equity over this period of time called "Vesting Period"
Normally this period is 4 years. But in special cases it can be brought down to 3 years
You also need to think about the minimum period the person should work for the company for making a decent contribution
This is called "Cliff" and is normally 1 year. You can be flexible on the duration but its strongly recommended that you have the cliff in the arrangement
If the employee leaves (or is asked to leave) before completion of the cliff period he / she will not get any equity in the company
So lets say you plan to hire a guy X for following terms
Equity - 4%
Vesting Period - 4 years
Cliff - 1 year
This means that you will give X 4% equity for working in the company for 4 years. But you expect him to stay for minimum 1 year
Let’s say 4% translates to 4800 shares
Total vesting duration in months is 48 months
Every month that X stays with the company he becomes owner of 1/ 48th of 4800 shares - which is 100 shares
Now the cliff kicks in, X needs to complete the cliff period of 12 months to receive any shares
So if he stays for 13 months, number of shares = (4800/48) *13 = 1300
But if he stays for 11 months, he gets ZERO shares - since he did not complete the cliff period
Additional equity
In some case companies give additional equity to employees later on as a performance bonus or as part of promotion
Each equity grant should have separate vesting schedule
Share price
In most cases startup employees are only expected to pay the face value of the shares and even that is reimbursed in some form
But at later stages companies calculate the share price with the help of their CA and offer the shares the employee for a heavy discount or subsidy
Paperwork / Agreements
Setting up a formal ESOP plan with help of a good lawyer would be too expensive for a bootstrapped startup - hence it’s a good idea to do that after you raise series A or start making decent amount of revenues
For a bootstrapped startup, you should mention the amount of equity and details of vesting schedule in the employment agreement
At the time of issuing shares you enter into share subscription agreement with the employee - where he / she only needs to pay the face value of the shares
Deciding later
In many cases people like each other and start working together without finalizing the equity %
Leaving it totally open could be a bad idea - since expectations could be totally mismatched and that could become a big headache
If you do want to defer the decision on the number, make sure that you discuss
Exact time after which equity will be decided
Range in which the equity will fall
Your expectations from the employee
Best way is to start with a firm number slightly on the lower side and if things turn out good you can always grant more equity
Ankur raised a point while reviewing the draft of this post that some times the employee will ask you back the question - Why are you guys keeping 95% and giving me only 5%? Obviously guy is not able appreciate to or realize the difference in the contribution of a Founder and an early employee. Here are some of those reasons, which quite often remain invisible to the employees:

Founders take the maximum risk while starting a company
They quit their job not to join an existing setup but they quit with nothing in hand
The startups are literally created in heads of the founders - its their DNA that the startup carries - they have the maximum impact on its outcome and the equity should reflect that
The initial days are the hardest for every startup and there is very little to show - so at that point almost no one wants to join them - during that period its the founders alone who toil and create - employees mostly come later
An employee has the flexibility to leave the job whenever they want and move on to a new job. Founders don't have that option - they need to stay with the company thru thick and thin. (In theory they can also shutdown or leave - but in practice its very difficult)
Founders also make the initial capital investment in the company and add more capital in most cases / they max out the credit cards / bring personal laptops / run office from there home / bring stuff from home to run the office and many such contributions
Founders work for zero salary for quite a long time
Founders normally setup ESOP of 20% out of which other employees are also given equity grants - so they are really are not keeping 95%
Most employees want to do specialized jobs around their core area and stick to it - so that they continue to build their job career. Founders do not have any such choice - irrespective of their backgrounds - founders need to work in every department and do what ever it takes to keep things moving and it also involves junior most jobs like - bank work / cleaning / delivering orders / making tea / pretty much every thing
A founder's career and reputation is attached to the outcome of the venture / he is the one who worries the most / looses the most sleep - the buck stops at him
As a founder -If you find a guy who can match you to a certain extent in above listed aspects - you should surely give him more equity or even bring him on board as a founder. One of portolio founders did this very recently - brought a guy as first employee with 9% equity / found that the guy can bring a lot more value and invited him to join as a co-founder with same amount equity as the first founder
As a founder - its also important that you draw the line at the right place. If you find someone really good for a particular role, but they bring no additional value and this person expects a much higher equity than what seems fair - Dont worry about it - just let them go. If they can not respect your contribution - they are anyway a wrong hire
As a potential employee - if you don't see founders with the kind of commitment and qualities mentioned above - don't join the startup

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