Founding Employee Compensation

Posted on September 4, 2015

One of the most common questions I get from new founders is how they should compensate their first employee.  We call your first set of employees “founding employees” because although they are not officially considered founders they are joining the company at an extremely early stage and sharing much of the risk with the founders.  On top of that, these new employees will be critical to the success (or failure) of your company so ensuring they are bought in for the long haul is critical.

Determining compensation is particularly problematic for founding employees because of two major issues – founders are cash poor and they want to ensure the employee has “skin in the game” with equity ownership.  But how much equity ownership and how much cash?  What if the startup cannot afford to pay the employee their market rate?  Then how much equity should they receive to make up for that?

We have adopted a rule of thumb at Velocity that has served us well over the years based on feedback from Dan Martell way back in 2012.

In a perfect world, the startup would pay their employee market salary and 1% equity in the company.  In the case where the startup cannot pay market salary OR the employee is willing to accept less than market salary we suggest that for every $10,000 in salary given up by the employee they should receive an additional 1% in equity.

For example:
Market Salary ~$70,000
Equity 1%
Reduced Salary ~30,000
Equity 5%
No Salary $0
Equity 8%

This provides the employee with complete control over the levers between equity and cash compensation up to the maximum cash available from the startup.  I would suggest that the equity should have a one year probation period (typically referred to as a “cliff”) where the employee gets nothing if they leave within the first year.  The equity should also vest or be given to the employee split over a 4 year period typically monthly.  That is, after month 12 the employee would have 25% of their equity and each subsequent month would receive an additional ~2% for the next 36 months.

Be careful with the No Salary rule because if you are successful (and I sure hope you are!) then you will eventually pay that employee a salary and it will be difficult to change this equity amount in the future.

There are a number of other rules of thumb out there (grunt equity being another famous one) but we find that the sheer simplicity of this model makes it very appealing to startup founders and their new employees.

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