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Compensation question

Hi guys,

I wanted to some advice on a compensation question. I am about to bring on
an algorithm developer for a 3 month part time project, with the potential
of hiring him full-time if we get funded and the working relationship goes
smoothly.

What is an appropriate compensation model for him? Can I just offer equity?
If so, how much? What about a mix of equity and fixed fee? Vesting?

Please chime in and let me know your thoughts!

Cheers,
Chandra
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Chandra L. Jacobs, Global MBA 2012
therestlessr...@gmail.com                   Phone: (703) 785-0621

Thunderbird School of Global Management
#1 "International" Full-time MBA (U.S. News & World Report 2013)

"Borders frequented by trade seldom need soldiers."

22 Replies

Craig Green
0
0
Craig Green Entrepreneur
E-commerce Consultant

Here's a straight cut'n'paste from my MBA course on equity in entrepreneurship -- I think it covers things well. My feeling is that, in this case, you should pay cash to your 3 month developer. If you feel the mix is so great that you want him to be part of the team, then change the deal later. Look at it form his point of view -- what amount of a $0 in value entity does he want to take? If I was him, I'd ask for a LOT (5%??), which seems extreme. Pay cash now for services.

Explain the logic of share allocation to stakeholders: shares are for resources which add value.

Have a clear outline of the vision (defines where we are going), strategy (defines what resources we need) and performance milestones (measures value of contribution). Generate a common understanding that venture is unlikely to develop in exactly the way perceived at start-up and therefore some flexibility needs to be built into share allocation.

Have a shareholders? agreement: rules, new issues, sales of shares, conflict of interests and performance milestones.

The mechanism of allocating shares entails the following decisions:

Agree an initial equity allocation for the idea, for example 20% (would make sense if 2% of revenue = 20% of profits and if the profit margin is 10%).

The remaining shares (80%) are allocated for implementation.

Cost everything (no free hours) and define cost to breakeven.

Allocate shares on the basis of who will cover these costs.

Define performance milestones and agree ability to replace a person and their share position.

An example of this mechanism in practice:

20% allocated for the idea: founders Joe & Susan at 10% each.

Suppose 2 years to break even where cost to breakeven is ?500k.

With 80% allocated for implementation this implies ?6.25k for 1%.

Joe agrees to look after operations for two years at ?50k agreed salary per annum.

He offers to self fund and in return gets allocated 100/6.25 = 16% equity available at 0 (4%), 6 (4%) and 12 (8%) months.

Joemakesamessofthingsandneedstoreplacedaftersixmonthsso he keeps 14% (10% + 4%) and the remaining 12% can be allocated to find a replacement with no dilution for remaining shareholders.

In summary:

Make sure everyone understands the logic of share allocation and why it is fair.

Outline the vision/strategy and agree the implementation and share mechanism up front.

Define performance yardsticks before you start ? ask people to set their own yardsticks!

Use a shareholders agreement ? business fallouts can be acrimonious.

As far as possible, use cash as the only currency for resource contribution ? not free hours.

On Nov 15, 2012, at 10:06 AM, Chandra Jacobs wrote:

Nick Pontacoloni
1
0
Nick Pontacoloni Entrepreneur
Online Media Sales and Marketing

Hi Chandra,

I would recommend two things.

1) Don't give up equity if you can afford to pay cash.  Most developers
I've worked with actually won't work for equity.  They are offered ideas
from friends, family and peers on a consistent basis and most experienced
developers have learned not to work for the potential to be paid in the
future.  It can also result in a lack of enthusiasm and you may find
yourself with many delays.

2) If you do offer equity, make sure it is rolling/vesting based on key
milestones that are explicitly defined and mutually agreed upon up front.

Having done this a couple of times to certain degrees of success and
failure, your best bet is to try and pay a "Project Fee."  Ideally would be
1/3 up front, 1/3 at a certain milestone and 1/3 upon completion.   Some of
the better developers, in my opinion, won't work on a Project Fee basis,
because they can't accurately predict the number of hours it will take.

Another option if you are short on cash may be Convertible Notes, but again
you run the risk of people working for "free" and not completing projects
on time. In order to accurately calculate Fees, you may try to back into a
mutually agreed upon hourly rate based on the specific tasks that make up
the project.

What ever you decided to do, make sure you are very clear and upfront on
tasks, milestones and timelines.  Project management is an essential skill
at this stage and its important to find non-monetary ways to inspire and
motivate.

Nick

Jessica Alter
0
0
Jessica Alter Entrepreneur • Advisor
Entrepreneur & Advisor

chiming in as actually doing a similar arrangement with someone right now...
1. Compensation - the answer is a mix of a) what you can afford b) what they will accept and c) the longer-term goal.  Re a - if they won't work for equity you have your answer and if you are cash strapped you also have you answer. Re c) is this really a one-time skill you need or a trial-period to see if you like working together? If the former then set up additional incentive to keep them involved - even as an advisor. You can turn them into employee shares and back date their vesting if they join later. If the latter, then cash is better for someone that isn't going to stay involved with the company but of course, see a and b.
2. vesting - if you do offer equity it should vest monthly for a contractor - assuming that's a large part of their compensation. Doesn't make sense to vest them over several years if the situation is that they are swooping in and swooping out.

hope that helps,
JA
On Nov 15, 2012, at 10:06 AM, Chandra Jacobs wrote:

Jia Jiang
0
0
Jia Jiang Entrepreneur
Entrepreneur, Author and Keynote Speaker Who Turns Rejection On Its Head

As I wrote about it in jest here, the startup scenes seems to be dominated by guys in their 20's.

My question is, how old is everyone? If you are over 30, do you feel old?

Jia Jiang
Company: hooplus.com
Blog: entresting.com
Twitter: @jiajiang
j...@souplus.com

Joshua Butner
1
0
Joshua Butner Entrepreneur
Founder / Partner at Vulk

I'm 31 (and a half :-) and don't feel old. The only time i start to feel
old is when people start talking about new "college talent." But then I
realize I'm more experienced (and as a result, most likely better) than
them.
On Nov 15, 2012 12:49 PM, "Jia Jiang" <j...@souplus.com> wrote:

Hayden Tay
0
0
Hayden Tay Entrepreneur
Marketing and Customer Success Manager at ChargeSpot Wireless Power

That's quite a false illusion. Just like the real world, the entrepreneur
scene can be quite heterogeneous in terms of age.

There are several articles out there discussing age and enterpreneurs -
this is one:
http://neilperkin.typepad.com/only_dead_fish/2012/02/is-the-average-a...

Research published a couple of years
ago<http://www.kauffman.org/uploadedFiles/kiea_042709.pdf> by

> the Kauffman Foundation showed that the number of company founders older
> than 50 was double the number of founders younger than 25, and the number
> of founders over the age of 60 was twice the number of founders under the
> age of 20.

Jason Crawford
0
0
Jason Crawford Entrepreneur
Co-Founder & CEO at Fieldbook

I'm 33. Started my first company when I was 30. Plan to start at least one
more in the future.

Amazon was started when Bezos was I think 37. Netscape, Intel, Adobe,
Zynga, and many others had founders over 40:
http://www.quora.com/What-successful-Silicon-Valley-companies-were-st...

I wrote about the topic here: "Peak age for entrepreneurship: who cares?"
http://jasoncrawford.org/2012/02/peak-age-for-entrepreneurship-who-ca...

The age thing is classic Silicon Valley pattern-recognition?founders are
typically young. The problem with that, as Andrew Chen has pointed out, is
that we're all looking for exceptional outcomes, not typical
ones<http://andrewchen.co/2012/03/08/how-sheep-like-behavior-breeds-innova...>
.

So, as I said in that blog post, don't worry about it. Just go out and
pursue your vision.

-Jason

Olivier Suritz
0
0
Olivier Suritz Entrepreneur
Software Engineer at Google

I suppose this one was worth a Reply All:

I'm 31... and yeah I feel "old" compared to the rest of the founder's
scene. Especially since our product targets users that typically aren't in
their 20's so they don't necessarily "get it".

I also feel more constrained because I'm married and have a mortgage to
pay... compared to a lot of founders that I know that still live with their
parents. Responsibilities aren't the same ;)

Kristin Pierce Fitch
0
0
Kristin Pierce Fitch Entrepreneur
Co-Founder ZiggityZoom Media-Online & Mobile Ed Tech- Content & Games- Business Educator & Mentor, Author, Speaker

I think the obvious startup founders are 18-25 but there are so many
startups across the country who are founded by those in the 25-45 and up
range. I think those over 25 have experiences that often help them make
better decisions, and this is the talent I believe more people need to pay
attention to.  Also, I am mid to late 30s and a female.  I guess either
could make me feel old or the minority but it does not.  I look for like
minded people with similar interests (and talent).

Kristin

Kristin Fitch (Virginia Beach, VA)
ZiggityZoom.com

Brian Karas
0
0
Brian Karas Entrepreneur • Advisor

I'm closer to 40 than 30 at this point, but started my first company in my mid-20's.

I don't consider the overall "startup scene" to be dominated by people in their 20's, but I would say that a large number of the 1 or 2-man web-app type things seem to be primarily the output of that demographic.

In any case, I certainly do not feel "old", if anything I think that the mid-20's folks are often perceived as "young"...

On Nov 15, 2012, at 1:49 PM, Jia Jiang wrote:

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