Co-founding a startup without the proper regulation of equity shares is a bitter experience. I've had it - never again! It resulted in continuous boardroom rows, loss of trust and even ruining friendships. That’s something you want to avoid when starting a business, right?
When I was starting Y-Productive, this experience inspired an early creative decision to establish an "everybody can be a co-founder" equality principle. We used a "Dynamic Equity Split" (DES) approach to achieve that. It has worked out for us surprisingly well!
The main idea is to take into account and recalculate our shares every month. We count it by each co-founder’s monthly contribution. It's calculated in either the investment of money or effort (aka Sweat Equity). That’s what we call the Dynamic Equity Split scheme. Each co-founder continually earns shares, the number of which depends on the contribution to the business. The more you do or contribute in cash, the more shares you earn. In the second part of the article, I share some actual calculations and formulae that will come in handy should you wish to understand and implement a similar scheme for your team.
DES (aka Slicing Pie) idea was first proposed by Mike Moyer - check his Slicing Pie website. Slicing Pie’s value proposition is a “perfectly fair equity split”.
We in Y-Productive see it from a different angle:
“DES enables our culture of full transparency and equality. It’s the platform without which bootstrapping won’t be a feasible idea for us.”
We have had a lot of people come and go, but we haven't experienced any of the typical problems normally experienced with upfront equity agreements.
What do you feel when you start your relationship with co-founders?
For me it was always starting on a high - everybody was on the top of the world, we believed that our startup idea was a gold mine and our customers would love us. Usually at the inception everything is more than fine. Your hands just itch to start making progress!
It doesn't feel like the right time to pause and start talking about unpleasant things like:
As a result of starting with high expectations you just agree on a fixed equity share and move along. That becomes a real pain in the future. Hard questions that you haven't answered at the beginning are becoming much harder to solve as you move ahead. Remember, there won't be a better and easier situation in the future anymore. The state of things will only become more complicated, you'll face more challenges and you'll have more complaints about your co-founder's behavior.
Agreeing the level of an equity share is another aspect which will add fuel to the fire. Wise people in the startup industry say that the startup should be the most important venture of a founder's life, but everyone defines the meaning of"most important" in his own way. All of us have family, friends, and numerous other duties that negatively impact our time invested in the business.
The ultimate question here is "Will you be happy with your or your co-founder's share in 6 months? A year from now?"
As a startup evolves we are all going to change significantly. Had you asked me at the inception of Y-Productive I would have said that I would never be writing blog posts.
I hate writing and each word extracted from me was a real pain once I started writing. On top of this I am doing marketing, copywriting, UI/UX, customer support, software architecture, administration and cleaning :)
My point here is that you and your co-founders are not going to be the same. The issue is that people tend to react to challenges of any given situation in a different way. I've seen a lot of startup co-founders who tended to concentrate only on their specific area of responsibility and comfort level, however their startup's current situation may have required of them that they become a marketer, for example. Would you be happy with your co-founder's duties and equity in such a case?
If you think that a good solution to the aforementioned challenges of early equity allocation is to postpone an equity decision, the answer, again, is “Hardly so”.
A year has passed, you and your co-founders are finishing a hard week and plan to go out for a drink. Your startup is generating a little business, you have your first customers who are pretty much happy with your product or service. You and your co-founders go out for a first celebration dinner at a good restaurant. You proudly hand over to the waiter your new and shiny corporate credit card. But wait... you haven't agreed on shares. Of course, you made enough money for a dinner, but in the not too distant future you are going to make a lot more of it. So whose money are you spending right now?
That's the moment of truth, that's the last moment when you can come to an agreement. You should probably have dealt with this even earlier. Chances are that’s your last dinner as trustworthy partners. When real money comes into a discussion, dirty politics and invisible boxing are inevitable if you haven’t agreed about the rules of the game!
A lot of us have been there. I’ve been there. I don’t want to put myself in such a situation anymore. Here's what I came up with when founding Y-Productive.
Dynamic Equity Split changed the whole bootstrapping approach at Y-Productive. When the whole team is engaged in the funding, be it through hours of work or money invested, they start to care about the outcome.
In our team, people can trade off parts of their salary or invest additional work hours in exchange for an increased company share on a monthly or regular basis. The motivation for it depends on each individual. Whether they want to earn more in the future or offer something free to the current team budget for business needs, DES allows a choice of options for every team member. It makes business development more personal. It’s flexible and helps us adjust to problems without wasting time, being focused on solving problems instead of internal fights.
At any moment, people know that their efforts will be rewarded. Everyone in Y-Productive has a personal interest to make our venture succeed, because everyone can earn a share. It is the best motivation for a team you can ever imagine.
Let’s provide an example which mimics our DES calculations. For the sake of simplicity the personas are made up, the figures are real. Here is a typical situation…
Andrew, CEO and John, CTO come up with a great idea and decide to create yet another startup called SoulBeat. They have little savings from their previous corporate jobs where they were colleagues and liked working with each other a lot. They agree to allocate around 10k USD each to grow the business in the future, but they will not pay themselves salaries from this money. They also agree to use Dynamic Equity Split and they’ve heard that guys from Y-Productive have had a great success with it. Great start!
Btw, here is the link to Google Sheet where you may learn in detail all tables shown below.
Now Andrew and John need to agree about Theoretic Base Salary (THB) which is their market rate. THB reflects the difference in their skillset and experience. Basically, THB is the most important and usually the only variable in the whole Dynamic Equity Split which needs to be agreed with each partner joining a venture. So, Andrew and John agree to 4800$ and 3200$ respectively.
The guys agreed to convert their monthly THB to an hourly rate as they had forecast that they would not always be 100% dedicated to the startup. That’s actually what happened to Andrew in November when his son was born and therefore he was able to dedicate only 80 hours per month to the startup. John was OK with this scenario as the formula accounted for this and he was able to increase the company’s share. A nice arrangement for both to keep up the good work.
Things went well and in December Carlos, senior software developer, whom Andrew and John knew well, decided to join the startup on a part-time basis. Carlos didn’t want to quit his current job because of money concerns. He didn’t know yet how much time he would be able to dedicate to the startup - a pretty common situation, right? Andrew and John knew that Carlos was the key element to their success and they decided to start working with him anyway. A foot in the door!
The issue with Andrew’s paternity leave and Carlos’s part-time involvement inspired them to add more motivation leverages into the DES scheme. They added multipliers. Basically, a multiplier is the way to boost one’s earning of points. Let’s check their case:
So, the guys decided that if a partner works more than 80 hours per month, then he is sufficiently committed to the startup and should be rewarded with more equity points. That’s why in December John and Carlos, having worked 160 and 80 hours respectively, get their points with x4 multiplier. Despite Andrew seats a CEO position with the highest salary in company, he was still busy as a parent and worked only for 70 hours in a whole month - which converts to 4200 points.
Why so low, almost like Carlos`? Because the company is still on the founding stage and the participation in its development is vital. Compare the commitment of his co-founder John, who worked twice more than Andrew. Taking a part of Andrew`s share seems fair at this point, isn’t it?
Please note, that this is a basic set of rules. We love DES because it allows any additional changes. For instance, if you’re concerned with the possibility of people trying to cheat the system and work out your shares on the later stages, you can implement the rule of safe amount of equity. Once achieved, this minimum percentage belongs to its owner and cannot be taken back. It’s up for you to decide what exact set of rules fits your team best - who knows best if not you?
In Y-Productive, we can impeach any corrupt by the rule of majority. One opinion equals one vote no matter how much of equity anyone has. This how equality works for us as the co-founders.
Let’s return to Andrew and Co. What Andrew could do in this situation to secure his amount of 52,9% shares? He can do the math and compensate his absence by injecting money in company`s development.
Let’s see how money investment and salary combines with time in DES system.
Carlos had great fun working together with Andrew and John in December and decided to quit his other job starting from January. A new life starting from the onset of the New Year! But the money was still an issue for Carlos and he wanted to be sure he would earn at least a living wage.
Andrew and John decided to pay Carlos 1000 USD monthly in order to cover his basic cost of living. The formula for equity points when a partner receives a salary from his equity is the following:
"Equity Points" =("Hourly Rate" x "Worked Hours" - "Salary Paid") x "Multiplier"
Carlos committed to join the startup full-time, but how should the commitment multiplier be used in the case of salary? Partners tweaked the formula for a multiplier to make it more fair:
If ("Hourly Rate" x "Worked Hours" - "Salary Paid") / "Hourly Rate" >= 80, then "Multiplier" =4
Read it the following way: Carlos worked 80 hours in January and got paid for them with 1000 USD of cash, another 80 hours he was paid with equity points with multiplier x4 (committed partner multiplier).
Here is the equity table:
Money for Carlos’ salary won’t appear out of nowhere. Money is invested by Andrew and John. This should be taken into account. Here is the improved equity table for January which accounts for the cash investment:
You may ask why the cash multiplier is x8. Think about a miserable startup success rate. Think about the importance of money at the very beginning when you desperately need to pay for all kinds of software etc. Think about potential partners like Carlos who need money to cover their basic cost of living.
Money is extremely important at the inception phase. We think it is twice as important as invested time. Of course, you may come to a different agreement with your partners.
In this article using the example I covered the formulae that regulate equity sharing at Y-Productive. In “Poor, Hungry and Creative” I described the way I and my partners arrived at this solution. Of course, when you start a company it’s not enough just to agree on an equity formula. We have a collection of rules that regulate the way we make decisions and that define what we do in case of fire.
In the next article I will cover our experience with the following:
If you missed the link to our DES formulae and table here it is.
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