[n72]

"Don't resolve these problems with shares. Instead, just keep a ledger of how much you paid each of the founders, and if someone goes without salary, give them an IOU."

The IOU solution is not a good one:

1. Not taking salary when a startup starts is basically a very risky loan. An IOU simply doesn't take into account the risk involved.

2. This is not symmetrical to how investors are treated. In both cases there is an investment in the company which can be measured in terms of dollars. In the case of the employee he is only getting an IOU, but in the case of the investor, he is getting shares. I don't see any reason why these should be treated differently.

[tptacek]

So don't use a dollar-for-dollar IOU. You can pay interest.

What you're trying to avoid is bringing company valuation into totally mundane cash flow problems like "who pays for plane tickets to first customer meeting".

It's a sign of very bad founding team cohesion when the founders look at each other as negotiating adversaries. Founders should prefer solutions that have a quick and intuitive sense of fairness over technical solutions that attempt to ensure fairness.

[pan69]

Honest question, what happens to IOU's when the company fails? E.g. in the described scenario, one founder takes a salary and the other takes IOU's (+ 5% interest). The founder with the salary took less risk but still received 50% of the shares (even though they are worth zero when the company failed).

[tptacek]

They're zeroed out.

[YokoZar]

Perhaps more specifically, in a liquidation the IOU-holder is a creditor in line behind others (but ahead of common stock-holder)

[chasing]

I've heard advice that giving up salary like this should be considered equivalent to investing seed money. If you get $50k for your first year with the company and I get no money, treat that as if I gave the company $50k and work things out like that.

This is probably a bit more complicated in practice, but seems fair on the face.

Curious what other folks think.

[tptacek]

You're mixing valuation into mundane cash-flow problems, and also letting arbitrary circumstance help determine equity allocation; however you chop it up when the cofounder ponies up for plane tickets or whatnot, it'll seem fair at the time and a lot less fair after every member of the team has broken their backs getting the business off the ground.

Reasonable people can disagree on this point, but one thing that YC has said for years now that rings perfectly true to me: cofounder disputes can kill a company more abruptly than almost anything else. Rig your startup to minimize the possibility of resentment; you'll need all the unimpeded communications capacity you can get to resolve the problems that will arise intrinsically from your business.

[n72]

I'm curious what you would recommend to the me of five years ago (this sounds like a challenge, but it really isn't — I'm genuinely interested in your take.)

I started with three other guys on day 1 of a startup. They had money to put into the startup from a previous venture. I didn't but took 50% pay cut to lengthen the runway, as it were. After 9 months the company was almost out of money. I worked for free for 3 months after which we got the product off the ground. (They paid themselves during this time from the little money the company had left.) Two years later we had a very successful exit. For the fact that I worked at 50% paycut and worked for free, I demanded equity. Had I taken an IOU I would have missed out on a significant payday. The money which I didn't take from the company was just as important as they money they put in: without either one we would never have had time to release the product.

[tptacek]

If the upside of investing 50% of your pay was significant, the upside from your allocation as a cofounder should have been far more significant in a successful exit. To me, the delta between a paid off IOU and a return on equity purchased with a pay cut sounds like cheap insurance. But I don't know enough about your situation to say.

Reasonable people can disagree; I'm invested only in the idea of giving 50/50+IOU its fullest, fairest hearing.

[greggman]

I'm curious why you see these 2 things as different.

Situation #1. 2 founders, one investor. 2 founders quit their jobs, have no money in the back. Investor invests $1 million. Money is used to buy equipment, rent office space, play living wages, hire contractors.

Situation #2. 2 founders, one has $1 million, the other has nothing. Money is used similarly.

It seems like the founder contributing $1 million in the 2nd case should get all the same considerations as the investor in the 1st case.

In other words.

    2 founders
    founder #1 1/2
    founder #2 1/2

    2 founders, 1 investor
    founder #1 1/3
    founder #2 1/3
    investor   1/3

which seems like it should lead to

    2 founders only one of which investing

    non-investing founder  1/3
    investing founder      2/3s (1/3 for being a founder, 1/3 for investing)

I know it's not that easy but I can't see any reasonable way to resolve this. The founder who contributes no cash will likely feel like a 2nd class founder because there's no reasonable way they can own half the company. They can agree they both get the same number of shares but then that makes the founder who contributed the money feel like he took all the risk and got nothing for it.

Off the top of my head, one possible way to resolve it might be to let the founder contributing cash to vest quicker. So day one 25% of his shares have vested and he starts vest 2% a month immediately. That means in 3 years he'll have 100% of his shares where as the founder contributing no cash will require 4 years to vest at which point they'll be equal 50/50?

Of course arguably that's still not quite fair to the founder that contributed cash because his deal is not as good as if he was split into 2 people, founder and investor.

[tptacek]

If we were talking about a million dollars, I wouldn't see things differently from you. Of course, if your founder role at a startup exists at the pleasure of someone paying your salary, rent, and expenses, you're not really a founder, are you? You're an employee. Whatever control you have on paper, the funding founder trumps with their bank account.

[1stop]

If one founder bank rolls the entire enterprise, then they are the only founder, as the is no "risk" to the others (i.e they are getting paid from a known source of income).

I thought this discussion revolved around forgoing a salary, not bringing in initial investment. They are distinctly different.

founders should be distinct from investors in my opinion, I realise beggers can't be choosers, but it feels like you are going to argue a lot over how much that initial investment is worth vs how much the initial effort was worth, and probably fail because of it.

[brudgers]

Suppose Ben has $1,000,000 to invest in a startup and Patrick has zero dollars to invest.

If Ben goes it alone, he believes he stands a 40% chance of a $3,000,000 exit.

If Ben cofounds with Patrick he believes he stands a 10% chance of a $50,000,000 exit.

Why is Ben better off economically just giving Patrick half the equity despite his lack of cash?

Forget the math, if one founder takes issue with another founder's getting rich off the company, then there's a problem that may be deep enough to prevent both of you from becoming rich.

[tptacek]

The nightmare of having to first value 1MM worth of shares on day one of a company, and then have to value Patrick's immediately intangible contribution to the company, both of which involve absurdly difficult predictions, is why you're better off not trying to resolve things between founders with shares. Or, at any rate, this is I think the point Joel Spolsky is trying to make. Reasonable people can &c &c &c.

The $1MM in vs. $0 in situation sounds like a nightmare all its own, though. Has anyone here been in a situation like that? How did it work out?

[brudgers]

Wasn't there a significant disparity in capital investment between Clark and Andreessen at NetScape?

[msandford]

Cashflow is cashflow is cashflow, it doesn't matter if it's more cash in or less cash out. They're mathematically equivalent.

When pursuing a startup cashflow is the biggest problem of all, you're bleeding out and trying to staunch the flow. Someone plugging a hole is just as valuable as someone providing a pint.

[tptacek]

All sorts of things cofounders do for each other have value. The best measure of a cofounder relationship is the tacit assumption that they have each others' back.

Again, the issues here are simple: dragging valuation into day-to-day operational discussions turns those discussions into negotiations, which I think isn't good for cohesion.

Reasonable people can disagree.

[msandford]

I completely agree that dragging valuation into day-to-day operations is a very bad idea. You're quite right about that.

Let's say that you and I go in together for some startup. Neither of us has the $50k in the bank to pitch in immediately so that we're equal investors in the company as well as equal cofounders. But let's say that due to a book you published some time ago you're bringing in $4k/mo in royalties which is enough to pay the bills. And because I don't have the option to go without a salary, we get some seed funding to the tune of $100k so we can pay me a small salary and afford whatever mundane things we need to get going.

I would argue that as long as we agree to both pay ourselves $4k/mo until things really get going, and you just happen to be able to pay yourself that $4k/mo for the next year out of your royalties that is a $48k (or perhaps a bit more due to interest) investment. Sure it's not all delivered at the time of the seed round but it's all pledged by that time. So long as you don't start demanding a salary before the year is up (i.e. you make good on your investment) I think it makes sense for you to get some additional equity as a result.

If you disagree I'd really like to hear the particulars. You've written before that one shouldn't mix up the day-to-day with valuation, but if it's a one-time thing at the beginning it seems more like an investment and less of an ongoing negotiation.

[1stop]

But your company has no value, so how many shares does your 100k salary buy? Do you compare that with other investors? What if you have no other investors?

If it were me, I'd force the founder to take the salary before I gave them more equity.