How to compensate sweat equity?

[OpenWebU]

I had several would-be technical co-founders. They ended up quitting after putting in only a month - 3 months of work in exchange for equity. In most cases, they delivered some but not all that they promised. The agreements were done on a handshake.

I worked on the project for 10 months full time and am bringing the product to the finishing line. And, I invested in all of the business expenses, including hiring contractors overseas to complete the work.

So, my question: how do I give equity compensation to the tech folks who worked for sweat equity that is fair?

I don't think they are any longer founders so out of what pool of stock would I compensate them when I incorporate?

Any rules of thumb would be appreciated. I'm also looking into equity consultants so any referrals would be great. Thanks.

[pg]

The upper bound is e(m/48), where e is the amount of equity they'd have gotten if they stuck around, and m is the number of months they worked.

[pelle]

I like that.

Using that we could work out a similar formula for project or time based equity.

Lets say you agree that a developer gets say %5 (e) for building the first prototype. Assuming developer only gets the project half built he gets half of e(completion percentage) 2.5%.

The difficulty here are the same though as in normal fixed price, namely that of scope change and creep. This is in particularly a problem with startups, where you should be changing scope and direction all the time.

A possibly better way could be to work out an time based deal based on how much a founder would get.

Lets say programmer A and B are both of equal skill level:

A agrees to work fulltime as a founder receives 10% (e) complete with regular vesting over 4 years.

B can not for whatever reason offer to work fulltime but would like a similar deal only with hourly vesting. As there isn't a normal 1 year cliff we probably want to reduce e to maybe half of what A is making so lets put e to 5% as a example. This would of course all be for personal negotiation.

Lets assume 4 years is equal to 8000 hours. He is vested using a variation of pg's formula e(hours/8000). So if he only ended up doing 100 hours during the life of the project his share would be 0.0625%.

Thoughts?

[pg]

Remember, though, that e(m/48) is an upper bound. It's not by accident that the usual plan for vesting is to have a 1-year cliff.

Also, 4 years is probably more than 8000 hours in a startup...

[pelle]

Thats a very good question. I myself would like to hear what others are doing.

Some conventional wisdom would probably say that they shouldn't receive anything, but I don't think thats contractually fair and it looks like you don't either.

Did you have any agreement about percentages before you got started?

As you yourself concluded I agree that retrospectively they should be treated as if they were consultants.

As consultants almost by definition aren't going to be working on your project for a longer time, I would think less shares than a non paid employee, but a project milestone based vesting period.

I've known one startup that had a group of 10-20 equity consultants. Everyone got to vote for I think it was 3 other people as who deserved more. The consultant equity pool was thereafter split according to this. It's certainly interesting, but not necessarily totally fair.

If we could work out a best practice, I'd be willing to workout an example contract template for this over on http://agree2.com

[ScottWhigham]

Have you spoken to them about what their expectations are? You might be dealing with people who say, "Nah - I don't expect anything. You did all the work - good luck!"

Giving uninterested folks equity now could really be regretted later. What sort of grant are you going to give them? I've seen agreements in which the minority stockholder(s) had to agree to any deal that would dilute their percent ownership. That can kill a company since any investment would dilute common stock.

Just be careful doing this. I would talk with each one and work out separate deals with each if I could, even if it meant paying them a monthly amount over a two year period. I hate to pay out of pocket but I'd hate to give out equity for non-contribution even more.

[prakash]

This is exactly why there is a 1 year cliff when it comes to equity.