As a software developer I’ve been involved in a number of equity conversations over my career. Mostly what you’ll run into is dreamers with no experience asking you to work for free while they waste your time. Occasionally you’ll encounter a real business person who is worth talking to. It is thrilling to negotiate for equity – simultaneously weighing the adventure, challenge, and potential reward of a new job. Beware, it is a literal “shark tank” in this area of business and you’ll need a lot more than this blog post to guide you!
Below I’ll share some of my perspectives as the “tech person” being recruited into a startup with equity as part of the compensation package.
Disclaimer – I am not a lawyer and this is not legal advice. The information in this post comes from personal experiences and those shared by my colleagues. Examples provided have been anonymized and generalized into a work of fiction.
What is Equity:
Impulse Power vs Warp Power and the allure of equity:
Selling your time is like traveling at impulse power, great for short trips around the solar system.
Owning a substantial chunk of equity is like having warp power. Only warp power can take you to other star systems you can only dream of (eg, getting really rich).
I was once told “Equity is a funny thing.” and I agree with that.
Equity is ownership in a company. It has “value” but it acts more like red matter from Star Trek than regular money. Your job will be to help grow that value. With equity you can’t easily tap into it, transfer it, or even get rid of it. That is until an exit event where the company gets sold and all owners tap into the value at once.
Equity can also be valuable in a different way if you are the majority owner. Majority ownership provides control which gives you access to the company’s cash flow, hiring and firing decisions, and total freedom. Being in the position of a majority owner generally requires you to start the business and put in your own money. This is much riskier up front, but the potential rewards are much higher too.
How much equity can you expect?
There are Founders and Later Hires:
If you are coming in at the very beginning of the company you can get a lot of equity and possibly control but don’t expect to get paid right away.
If you are coming in as a later hire you can get a decent wage and a little equity (anywhere from a few percent to a fraction of a percent). Typically that equity will vest over a number of years (you have to stick around to earn it).
Working for a ‘Minority’ share:
A minority share is ownership that doesn’t offer control, typically anything less than 50%. When you are working for someone else who is funding the project, you will be a minority owner.
Working for free?
If you are going to build it for free, ask for at least 51% equity, or 100% of the voting stock and 50% of the common stock.
Equity changes with time:
If you don’t have control, expect to get diluted along the way. New shares will be issued, making your shares less valuable.
Watch out for bad people:
I’d say about half of the self proclaimed entrepreneurs I’ve met were good people and the other half were narcissistic sociopaths.
If you get in bed with a scum bag….
For a software developer / co-founder CTO to get anything positive out of startup equity everything has to go perfect. So much of that is completely out of your hands. Plus there is the chance you are being lied to by a sociopath Founder-CEO. So even if things do go perfectly for the company you may still get crumbs and an unfavorable legal position. Scam artists tend to blow all their money quickly, funneling it into cars, drugs, and the next scam. That makes recovery problematic assuming you can even find them.
They drink their own kool aid….
Some startup founders get so obsessed with their idea it becomes dangerous. At first nobody else believes in them or their idea. Constant rejection is psychologically taxing. So they invent a persona to carry on. This can get out of control. In a few cases I’ve seen startup founders justify breaking their word, screwing over their customers, and treating people like trash (me included) all for the sake of the company’s mission. Watch out for being asked to do their dirty work.
Operating a fledgling startup isn’t a license to lie to people, be unethical, or act like you are above the law.
Tips for checking out potential co-founders / startup employers:
- Weed out the dreamers by asking what their budget is, what their time commitment is, what their plans are for dealing with competition.
- Watch how they treat others, someday they will treat you the same.
- In the United States – check out their UCC filings. These are state level publicly registered debts. These kinds of debts are important in bankruptcy.
- See if they are operating any other businesses.
- Check their residence and see if the purchase date, location, etc lines up with their story.
- Check their social media presence, do a google search, etc look for any red flags.
- Ask who their attorney is. If they don’t have one, they have failed the test.
- Other names will likely come up in your searches, perform similar lookups on their “known associates”.
Understand what Control and Profit are:
If your partner buys a Tesla with company funds, do you get to drive it?
Control directly translates to personal enrichment even if the company is struggling and taking on debt.
Let’s say you own 20% and your partner owns 80%. Your partner (who has control) can lease a Tesla on company money and keep the car all to themselves. Even though you have 1/5th of the stock you don’t get to drive it. You don’t even get the spare tire! All you can do is look at it with contempt. In fact, you can be fired by your “partner” at any time since they have control.
Profits are not for minority owners:
Perhaps your agreement clearly says if the company makes a “profit” this year you are entitled to 25% of it! When it comes to zeroing out profit for tax purposes consider how useful control is. Your partner may decide it is essential to now have a yacht for entertaining prospective customers, to hire their family members, and to give themselves a raise, etc, etc. There goes all the profit. This may mean the end of your relationship with them, but what do they care, they now have the money to easily replace you.
Navigating the “shark tank” of equity for software development:
Kinds of crappy offers out there:
- 1.3% vesting over 4 years, starting salary $900/month.
- This is below minimum wage which is illegal.
- Anything below 5% should command a market salary, in exchange for the career risk the software developer is taking on by accepting the assignment!
- 20% equity for developer, 80% equity for CEO/founder, no wages
- Developer is allowed to freelance 12 hours/week on the side to pay their bills. Wow that’s really generous.
- Due to possibility of dilution and lack of control this arrangement leaves nothing but crumbs on the table for the developer.
- What if the CEO/founder gets bored or loses focus or hires their stupid nephew who “knows computers”? The software developer cannot recover their investment!
- Zero pay and no paperwork, just come and “be a part of the madness”. WTF!!!
- Developer was asked to join as a “co-founder” and contribute $24k to a company which had a launch pending in 4 weeks. Turns out the splash page had been there for months, and after 6 weeks nothing changed. This was a scam.
You have two choices when evaluating an offer:
- Get your own lawyer to review the documents. It is worth every penny (provided you set limits and expectations up front). I’ve found when negotiating, saying “my lawyer is asking for X” is much more credible and likely to be accepted than simply saying “I would like X”.
- Sign the paperwork blindly and risk that years later you’ll suddenly get screwed out of something you love and poured countless hours into.
Avoid complex deals:
I used to think creativity was useful to apply everywhere, including legal agreements.
What I have learned is when it comes to business arrangements, keep it simple and stay with established patterns. If the agreement needs to be out of the ordinary then there is probably something else majorly wrong with the situation.
Use an LLC or incorporate:
I’ve casually used the term “partner” in this post, but you never want to be in a “legal partnership” which means joint liability in the eyes of the law. In a “legal partnership”, if your partner wrecks the Tesla, say smashing it into a liquor store, you are liable for the damages too.
Always do business through a LLC (limited liability company) or other corporate entity that provides personal protection. LLCs are easy to create online at the Secretary of State’s office for your state without a lawyer.
Then when a project goes sour, you are not a “partner” who is jointly liable for the debts.
Use each LLC once and never again (like kleenex, use and throw away). This is because the problems of any past venture will continue to follow the LLC.
This basic step will easily and cheaply insulate you from most of the problems of a failed venture. Doing business through a LLC means everything you sign should be as “joe developer LLC” and all paychecks, etc. should read the same.
- Founder’s Dilemma general info about company formation, equity
- E-Myth Revisited general information about working for others vs in a business you create
- Finding Success in Failure – Lucas Carlson by a software developer turned entrepreneur
I hope you enjoyed this post. If you have a horror story related to startup equity that you’d like to share please contact me or leave a comment below.