Another great post. I would also caution founders to be careful of not accounting for their time and investment from day one. I know you covered this, Dharmesh, but I will say that most investors will readily and easily "forget" the amount of investment you've put in when their money follows.
One possible tactic to use here is to actually make a loan to the company (treated as debt) and pay some salary to yourself from that. The debt can then be carried on the books and paid when cash is available, or converted to preferred equity when then financing occurs.
Hold it. Let's think about this. You are lending after tax dollars to the company. Then you are paying yourself a taxable salary with that money. And when the company pays you back, the interest to you is taxable. The capital pay-in idea sounds better. This is the kind of decision you should run by your accountant and when appropriate lawyer BEFORE acting. Even if they charge by the hour and just concur with your thinking, it's worth it for peace of mind.
When paying startup team members, I've found that there are two golden rules:
1) Avoid no-man's land... pay either 75% of FMV or pay nothing at all. The goal is get the team member focused on the value of the stock, not the salary. My experience suggests that paying people at say 25% of FMV usually winds up focusing the team member on salary which creates resentment on both sides.
2) Be consistent and lead by example. If the co-founders aren't willing to work for below FMV and they have the largest slice of the pie, how can they really expect employees that don't share as heavily in the upside to make these sacrafices?
Thanks for the comments.
Wil: I agree. Keeping track of this stuff is critical. Common rookie mistake to not track the details and account for them.
Richard: Agree with the point on taxation. This is definitely worth the time and money to get a CPA and/or tax attorney involved.
Andrew: I'm totally with you on leading by example. The article was really targeted at founder compensation (not employee compensation), and there are definitely differences.
One more thought with regard to taxation occurred to me.
The corporate tax rate is generally lower than the applicable individual rate, so when possible you want to legally avoid transfering tax liabilities from the corporation to the individual, and insofar as possible and allowed, you want to avoid double taxation; i.e., money comes into the corp, and it pays tax and pays the net out in salaries, on which the individual has to pay tax. Considerations like this can impact whether you want to file as an LLC or a true corporation (usually an S-Corp since a C-Corp carries with it a lot of onerous additional requirements). An accountant's advice is key in these matters, but you have to get it before you commit to action.
Your website is such a great resource for someone like me who is new to the startup world. You have done a great job so far building what has become an encyclopedia of startup tips. During these early stages of Xobni we have come to Onstartups.com for a lot of answers. The only thing I would like to see more of are specific stories from startups you have been involved with in the past.
A very nice article. It will help me a lot as I am in the process of laying the foundation of my start up ActivMOBS. Thanks.
I have a hypothetical for you guys.
Two gentle start a project 4 years ago. They put a tremendous amount of work into in regards to research, and developing a business model at a tremendous personal expense to both of them plus they were successful getting through all the government red tape. The natural resource required for the project went up to an Expression of Interest from the government and they made a submittal for the resource and it looks as though they are the winning Proponent.
5 months ago they asked another gentleman to join their founders group and whereas he had more experience as a CEO in larger Corps. than either of the other two founders did they thought it best for him to take over a CEO. The 3 them done the Proposal for the Expression of Interest.
Three of them signed a Founders Agreement giving them 3 equal shares of the company pre-investor.
Now the new CEO is insisting that the two original founders give up more of their founder’s shares to compensate him as CEO before they take on investors. Even though the two original founders have put much more time and personal expense into the project than the new CEO did.
My question is:
Should his CEO compensation package be done now (pre-investor) or after investors are taken on???
Should the new CEO get more founders shares than the original founders?? If so, what amount is fair??
Any commitments would be appreciated.
Great bolg and very helpful information!! Woudl appreciate receiving comments on the following :
I am a tech person without any startup experience. I have an invention and partly developed technology (with patents filed) that has a promising market. I am planning to partner with someone with start-up experience, preferably an ex-CEO, to start a company and seek venture capital to commercialize the technology. I am assuming that my new partner will be a co-founder of the company. What is the split in company ownership for such situations? I have been working on this technology for the past three years and assuming that I should have major share of the company. Also, when we get new personnel involved, do we give them company shares? I am currently interviewing candidates for the partner and will appreciate any feedback on this.
This is a great article.
But i have a doubt. I an trying to get a start up from Angel Investors. So my question is how should i decide the debt/equiy ratio for my startup, assuming that i ask for 100% funding from the investors how much equity should they be offered?
Since they are giving 100% funding, should they be given 100% equity?