I recently read one article about compensation in early stage ventures. One of my friends is planning to invest in a startup where he is one the four partners of which two of them will be running the show while the other two will be just investors. The proposed equity structure is 25 percent each for the pure-investors in return for 35 percent investment (each) while the two guys who would run the show are putting in 15 percent of the money for a 25% stake (each). This means they are getting 10% extra as sweat equity. Interestingly, both of these folks would work for full salary in the new company (no salary cut).
Is this a good arrangement? In my view the managing promoters don’t deserve any sweat equity upfront as they are working for full salary. I would say that all four should have equity proportional to their percentage investment.
My friend wants to know what would be the best equity structure for this company with 2 working and 2 non-working promoters assuming that the working promoters take market compensation.
- Software As A Service: Is India ready for it yet? - September 25, 2008
- Sweat equity in new ventures - October 28, 2007
Given the current economic situation (globally and not just in India) raising capital is a lesser challenge as compared to getting the right talent for executing ideas. Hence the premium for the guys bringing execution to the table. Also from a career progression persepective, success or failure of the startup might determine/impact their future career prospects (in case of failure and assuming they still need a job as a career) hence the reward-risk premium.
Thanks everyone for your feedback. I really appreciate it.
I would write about what my friend did after I hear from him.
Beginner, yes the math is right.
Great question. You’d still want to give a slightly higher % to the managing partners if
1. They are taking a career risk (even if they are earning same as market, its possible that if the venture is shut down in 2 years and they go out, they won’t get a promoted level; they’ll probably start at the same level. Thus they are losing “2 years of seniority”. This factor is irrelevant in most markets, but not in India!)
2. If you are going for VC later, the VCs may want the managing guys to have slightly higher, from an incentive perspective.
Of course, the delta portion of the manging guys should vest over 4 years. And of course, everyone dilutes pro rata for any stock options allocated to other employees.
Hi Shyam,
I was looking at my response and felt maybe it was not easily understandable. So thought I would use my lunch break to do this. Here’s how I feel it could be structured for a win-win:
Equity at Start of Venture
Silent Promoter 1: 35% – 35,000 shares
Silent Promoter 2: 35% – 35,000 shares
Management 1: 15% – 15,000 shares
Management 2: 15% – 15,000 shares
Stock Option Grant for Management 1: x,000 shares vesting over 3 years, hurdle of 18 months
Stock Option Grant for Management 2: y,000 shares vesting over 3 years, hurdle of 18 months
Equity in 1 years time
Silent Promoter 1 – 35,000 shares
Silent Promoter 2: – 35,000 shares
Management 1: – 15,000 shares
Management 2: – 15,000 shares
Stock Option Grant for Management 1: x,000 shares at par vesting over 3 years, hurdle of 18 months
Stock Option Grant for Management 2: y,000 shares at par vesting over 3 years, hurdle of 18 months
Second Stock Option Grant for Management 1: a,000 shares at new valuation vesting over 3 years, hurdle of 18 months
Second Stock Option Grant for Management 2: b,000 shares at new valuation vesting over 3 years, hurdle of 18 months
The reason I feel this is the best way to structure this is so that management is kept in their jobs for some time and secondly in case there is a need to replace managers, there is room for options to the new team.