Is it fair for founders to own about 100% of a startup while employee #1 only owns a few percent? Are founders 10-1000x more valuable than employees?

The answers are

  1. Yes, it is fair.
  2. Value doesn’t matter, timing does.

In fact, many employees get better equity deals than the founders. There are two cases.

1. The founders are not intrinsically fundable

When the founders start the company, it is worth approximately $0. So their equity is worth $0.

Let’s say the founders work for 6 months, make progress, and then raise money at a $10M post. Then employee #1 joins and gets 1% of the company. So his shares are worth $100,000.

So each founder got $0 of stock when he joined the business. The employee got $100,000 of stock when he joined the business.

Every employee that joins the business gets more stock than the founders did. Not in shares, or as a percentage of the company. But in the only metric that really matters, the dollar value of stock at the time the employee joins.

That’s why some people say that anyone who joins a company before they raise money is a founder. In other words, anyone who joins the company before the stock has value to a third party, is considered to be a founder.

2. The founders are intrinsically fundable

Some founders can raise money with nothing to show other than their smiling faces.

Let’s say the founders raise money at a $10M post-money, simultaneous with founding the company. In this case, the market is valuing the founders’ contribution at $10M.

Then the company identifies employee #1 and tries to hire her. The company will have to compete with every company in the world for that employee, and therefore the market, not the company, is setting the employee’s compensation.

Continued in Part 2.

Addendum

Measuring your stock in dollars is not at odds with measuring your stock in percentages. They’re just different views on the same data. If you’re an employee at Facebook and the stock price is monotonically increasing, look at the dollar value of your stock. If you’re joining a company today and you’re trying to figure out what you get if the company sells for $100M, use percentages.

(Note: This is the first time I’m testing this argument. Be gentle.)

Topics Employees · Valuation

30 comments · Show

  • Marshall Yount

    Not only that, but the founders risk profile is immeasurably higher. Founders commonly work their asses off in the early days for zero cash compensation. Even more importantly, founders put a lifetime’s accrual of personal credibility at risk, when they beg for those critical first investment dollars. Everyone loses their job when a startup company implodes, but the founders are the ones considered at fault.

    • John

      Marshall,

      I definitely agree with that perspective and from a high level its really a simple statement. A founder pours heart, soul, time and probably personal asset into getting his/her company off the ground, and the emotional toll can be heavy. Employees on the other hand, while possibly upset that a company has failed are not likely to be as personally invested.

      It also tends to be the founder who will walk through fire for the well being of the company, whereas an employee is definitely less likely to be as dedicated.

  • Alex Murphy

    Nivi,

    I like the way you structured this. A company at inception is worth nothing, because 100% of the value comes from execution.

    However, I don’t agree with the mark of whether or not you are a cofounder being determined by whether or not you have taken money from a 3rd party. Plenty of businesses grow and succeed without ever taking money from a 3rd party.

    I think whether or not you are a cofounder has everything to do with the transition point from idea to an idea that is being executed on. That doesn’t mean you have to be there from the first minute, but you need to be there in the beginning. There isn’t really a hard and fast rule to this, and it will certainly vary from industry to industry, but in the web universe I think the line in the sand is somewhere near the development of a product road map. Now, some companies don’t have a product road map, so it is not a perfect test, but if there is an idea of what the prototype looks like, what you think the alpha and beta products look like, and you have a good sense of what the final product could look like, and you have started to build … then you are past the stage of founding the company. From that point forward, everyone is an early employee of sorts; maybe a new title like founding employee. These team members are critical and help evolve the business, perhaps in a way that looks nothing like the ideas that the original founders originally had.

    So, to the original question, are the founders worth 1000x the employees, it depends. The people that are worth the most are the ones that execute. Since founders (by my definition above) are the ones that are executing on an idea, they are the ones that are the most valuable. As the company evolves, others will come in that will execute and they will be rewarded along the way as well.

    • Kate

      I think this is an excellent post, particularly this comment, “A company at inception is worth nothing, because 100% of the value comes from execution.”

      I’ve started several companies of varying size and quite frankly, everyones a founder until the company demonstrates tangible value to a third party. Jostling for position when the project is worth $0 does nothing more than tell you that you’re starting this company for the wrong reasons and your team is going to experience issues down the road.

      Founders can also be 1000x less valuable than employees, particularly when the company reaches a certain level of growth and requires a battle tested CEO for example. I’ve seen founders refuse to get out of the driving seat due to ego, much to the detriment of the business and its goals.

  • rama

    I happen to run my startup for almost a year without no employee, and then after 1 year i did ok (financially) and i decided to hire a few guys (salary + stock). So 1 employee later i raised money from investors and starts recruiting, does that make the guy i hired as co-founder?

    I personally don’t think so but would like to hear more.

    • Effetti

      Rama ~ I’m personally not a fan of titles as they tend to obscure the actual promises that an individual can and does make to the outside world.

      But I digress.

      My suggestion would be to look at the contribution your employee provided to the overall idea and business model you are now running with. If that contribution is substantial, then a co-founder title could be warranted. If not, then I would go with a more functional title that is consistent with the promises they can hold when and if needed.

      Hope that helps…

  • Nik Souris

    The math is simple and straight forward but the reality is that it comes down to the specifics of the venture and as you point out “timing”. And even then it doesn’t always work out, e.g. a great sales person may sell their way into a sweetheart deal and if they are truly that great they probably will have undersold themselves on the value they deliver.

    Bottom line is early stage hiring needs to be equitable but more importantly for the venture the hire must have passion and chemistry – which really end up being priceless. That’s why key hires are key and the earlier in the venture’s life the bigger the percentage and the higher the stakes.

  • Tim

    That’s why some people say that anyone who joins a company before they raise money is a founder. In other words, anyone who joins the company before the stock has value to a third party, is considered to be a founder.

    The latter statement is always true, though the former isn’t necessarily true. The founders may bootstrap the company and begin earning revenue before any employees join. Those employees would certainly not be considered founders, even if a third-party investment occurs later.

  • Carlos T

    I agree. The percentage does not matter. What matters is revenue, & P/E at liquidity. By focusing on hitting those EPS targets upon reaching a liquidity event, the stock price will take care of itself.

    If an employee is given 500,000 shares (say 1%) at the seed stage, those shares are probably only worth $0.10 to $0.30 each. If they work really hard for a couple of years, and drive the price up to $10.00 then the percentage they own doesn’t really matter. They walk away with $5m. A $5m payout for a few years work is fair in my opinion.

    Just my opinion. I could be wrong.

  • Effetti

    I would offer that fair is a relative assessment and valuation attempts before revenue ( actual paying customers ) is a complete waste of time.

    Assuming you’re referring to founders who are officers and directors in a formalized corporate structure ~ then these people have ALL the risk ~ a point easily forgotten, or not even understood by those that come later.

    Also, assuming that you’re referring to employees as people who are getting paid to provide their services ~ founders often forgo paychecks to get things built and keep the ball rolling.

    Funding is the antithesis and should NOT be considered the holy grail that it is. For businesses to be successful they need paying customers NOT investors. In the rare situations where funding is necessary it should be considered the ticket to the game NOT success. The purpose of funding is to increase market penetration.

    Valuation conversations based on last investment in is a pure and absolute fantasy. Facebook ( who actually has good revenue per head ) included. Some say that 1 venture in 10,000 returns anything to investors. So, the focus needs to be on paying customers. Subscribers of free services don’t count. Just try buying food, clothes, a car, or a house with “valuation” documentation and you will soon see that cash flow is king.

    @EFFETTI

  • janice

    Buy low, sell high. If you believe in that, then the founders get a much better deal. Another thing you might have overlooked is control, as in; the person with the most shares has the most control. The use of leverage is something else that seems missing in this topic.

    It’s interesting you bring up the idea of fairness. Why do you think it’s important?

    Business is amoral, if you don’t like it, then go join a non-profit.

    • Effetti

      Janice ~ The person with the most shares doesn’t always have control. Right ? Control really depends on the relationship of any one person’s shares with the size of the pool of outstanding shares.

      Love your question about fairness !…

    • Brett Welch

      Janice, i think you’re missing the point a little – fairness is important to your potential employees. Both during the hiring process and later down the road when they’re working somewhere else. Reputation matters.

      If you want to build a strong team you want the team to feel like they’ve gotten a fair deal when joining you AND when leaving you. If they feel like they’ve been screwed it’ll effect their work, your reputation and your outcome.

      In any case, business is not necessarily amoral and neither are non-profits necessarily morally driven :)

  • NOR

    You mix up economics and morale.
    The market, i.e., competition affects the price of manpower.
    You can work 25h/day and get low pay if you are easily replaceable by 1000000 people who also need to pay their flats and food. That said, the price of manpower differs from the value of his final product; The just exchange between founder and employee is: manpower for its actual market(!) price as wage. The employer finally acquires the value of the product (surplus). This has nothing to do who is more worth than the other in moral terms. If this question would be valid: your low paid cleaning ladies. There is no production possible within a trash montain.

  • bob pasker

    I was cofounder of a fairly successful company and product ($10s of billions of revenue since inception), and also cofounder of a flop.

    There are plenty of early employees who have used “founder” in some way to describe their position in the first, yet none of the early employees of the second company have done so.

    Kennedy said “victory has 100 fathers and defeat is an orphan.”

    that being said, the only people who are founders are those who sign the founders documents, such as these:
    http://www.orrick.com/practices/corporate/emergingCompanies/startup/forms_founders_stock.asp

  • Ian

    The idea that 100% of the value comes form execution assumes that ideas have no value. Our patent system is based on a different assumption, and from experience some ideas are worth a lot more than other.

    Coming up with an exciting idea for a business is part of the execution and inventors and founders who achieve this are creating value before implementation or execution.

    It would be nice and tidy if it were so black and white, but it’s not quite this simple.

  • Gavan Woolery

    IMHO, point #1 is not entirely valid. Founders do not get $0 of stock when they start up the company. If it is done properly, the company is immediately given a valuation, even if it would not sell for that much (or anything at all) during its inception. If you want to avoid arguments and haggling, every founder should immediately be aware of what share they have in the company, how their shares will be diluted over time and/or what shares are allocated to sell to investors and give employees. Not always, but very often, the startup continues to carry no real market value until a significant user base or revenue stream is acquired (i.e., the software and work put into it might be worth something in theory, but it is worth nothing unless someone actually wants to acquire them or they are independently making money).

    Now, on to my second point:
    I have worked for a startup where my shares were worth virtually nothing, but it did not matter since I made out alright after the acquisition regardless. I worked very hard and made a good deal of money only my second year out of college. Had that not been the case, our founders’ reputations could have been hurt. What follows is my personal philosophy:

    In a small company, founders should be worth, at most, 10x more than their employees. If you want the employee to work hard, and more importantly, contribute great ideas to the company, they have to be inspired to create value. They will do this if they have a meaningful stake in the company. Unless the startup is very well funded, employees are earning peanuts, so their risk (invested time) should be worth the reward (significant stock). If you want to scoop inexperienced college grads up who will do anything for a job, this works in some cases, but very often these people cannot create as much value as an experienced person, and can even detract from the value or damage the product. Sometimes it is better to hire fewer, higher quality employees who have real incentive and stake in the product. Small startups should be as flat as possible, as most founders will generally agree.

  • Roland Tritsch

    “Are founders 10x more valuable than employees?”

    If they can make people that are 10x better than they are, join and stay: YES!!!

  • Jonathan

    The reality is that value is all a matter of perspective, and it depends on the situation. Value and timing do (and should) come into play.

    In my case, my co-founder and I came up with the idea, developed it, funded it and put in a tremendous amount of time and energy to get it off the ground.

    We’ve yet to hire F/T employee #1, but a number of other folks have helped to make the company successful. I’m a big believer in motivating and rewarding people financially, but in this specific case, I feel that the founders absolutely deserve the lion’s share of the equity.

    Let’s take the other extreme in a hypothetical case. Let’s say that my partner and I had hired an employee early on. The business model was in question and this employee helped to pivot the company and ultimately make it successful through their strong contributions (whatever they were). It was clear that without their involvement, the company might never have been successful. Based on this, I feel personally that the new hire would warrant an equity stake roughly equivalent to their contribution.

    Therein lies the rub though. What do the founders feel this person’s contribution is worth vs. what the employee feels? Are they in line or at odds with each other? Like most things in life, it becomes a negotiation.

    In a successful negotiation, both sides walk away feeling whole. More often than not though, the outcome is not optimal for one side in their opinion. This may or may not affect the future of the company (if one or more parties decide to leave because they are unsatisfied).

    Timing, personalities, finances, negotiating skills and many other factors come into play. I’ve presented two extremes here, but most situations probably fall somewhere in the middle.

    The original question was interesting, but it attempts to over-simplify a very complex dynamic of startups and compensation.

  • Nick Sullivan

    Let’s see – a site geared towards founders — talking about how founders deserve more than employees — commented on by dozens of founders who have spent a lot of mental energy justifying why they deserve more stock than employees.

    Does anyone else see the blatant bias here? I hope that no one considers this a fair, balanced, well reasoned argument for this topic.

    I’ve been a founder twice, and an employee 4 times. Founders are greedy, and they use logic as mentioned in this article to justify how they deserve far more stock. They are the ones in the position of power, so employees begrudingly take it.

    IMO, the % of stock should be directly related to the % of contribution that person brings to the company. This typically means that founders deserve more, because their commitment, sacrifice and contribution level is higher.

    If founders stopped having this 100x attitude, maybe they can could get *founder quality employees* to join their cause.

    • Sean

      Nick, I agree with you here. Being a 2x founder and 2x employee, in my experience I have seen that founder’s are generally too greedy in dividing up the pie to new employees. This is, in a large part, why they frustratingly can’t find “founder quality employees” to take the deal. 1% for employee number one (vested after four years) seems like a pretty shit deal to me. As a creative entrepreneur, to me that feels like enslaving your life for four years for peanuts.

  • Antone Johnson

    I’m as committed to equity (in the “fairness” sense of the word) as anyone as a matter of principle. That said, there is always a large amount of luck and timing involved in any gains on equity. In working with and for many tech startups over the past 15 years, I’ve witnessed many examples of ordinary folks being “hit by the lucky bus” and realizing large financial gains (e.g., the proverbial “millionaire secretaries” from the ’90s dot-com boom), as well as many others valiantly working their butts off for years without much in the way of equity value.

    The key point I like to emphasize is that if the company does great, everyone will do just fine in an exit, provide they are vested. (Ask any early Google employee.) It is true that senior executives and founders get orders of magnitude more equity than rank-and-file employees. That’s also the case for cash compensation in the world of larger, more mature companies; regardless of individual views on the subject, this kind of differential wasn’t invented by the tech startup community.

  • Tristan Kromer

    While I’m happy to see VH writing about equity issues again, this post seems a bit…well…not up to pre-Angel List post standard.

    Discussing the fairness of equity splits in startup without once using the word ‘risk’ in the article seems like more than an oversight.

    Founders take on more risk, so they get more reward.

    It’s not the only reason founders get more equity, but it’s certainly relevant to the discussion. There’s obviously a host of other issues you could discuss, but that seems like the minimum.

    If you’re going to bring up the issue, I think you should have a thorough discussion.

  • Non Disclosable

    Nice post Nivi. I like the explanation.
    I don’t know much about the ecosystem in the valley, but here in India founders are Infinite times valuable than employ.
    After working with few start-ups here, I realized that the employ stock option is not exist in reality. Stock options are offered to employ verbally (off the record) and generally get denied later.

  • Fred

    I agree, percentages are important.

  • Pavan

    This article kind of makes it a little bit more attractive to join a start up rather than start one, but at the same time, equity is only worth what someone is willing to pay for it. So yes the employee is getting a better deal than the founder did when the founder came up with the idea, but at the same time the founder is trading equity in the Company for the talent of the employee.

    As a start up founder, I truly believe talent is more important than anything. It’s more important than money and equity. Because talent is ultimately what’s behind what makes equity worth money.

    I think i’m just rambling on, but recently my Partner and I decided to give our Team Lead equity and base pay (even though we’re bootstrapped), and I think it’s the best decision we’ve made.

    At a start up, founders need to foster an environment where talented employees can blossom and be diligent.

  • Siddharth

    How do you justify a scenario where a founder starts with nothing but an idea when employee one is hired. I understand that ideas are invaluable but without implementation its just another idea. Is the founder worth that much more even then? Curious?

  • Halloo

    I’m not sure I understand the argument. If employee #1 is a superstar with a track record, they can, and often do, receive more stock options eventually than say, a “founder.”

    The term “founder” to me, is just another title for people to hide behind or find refuge in If you kick @ss, you don’t care what you’re called, and you’re going to ask what you’re worth, regardless of when you came in.

    There are also a lot of “Founders,” whose only contribution is that they were there before some others, but played little role in getting the company to success.

  • Charles

    A founder can also be defined as anyone who joins a company and gets equity in the company but no salary.