It has been 3 weeks since I landed in Chile. The environment has been great. Being away from an environment of friends & relatives with 'rich' salaries, and being with 200+ other entrepreneurs who are in the same boat as you helps, I guess. And that just proves the fact that 'it is all a state of the mind'.
Coming to the subject of this post, one question most of us seem to be grappling with is, 'How do we select partners/key employees and most importantly, how do we share equity with them?'
I worked with 5 sets of partners in my 9.5 year entrepreneurial career so far. The first lasted only 3 months, the second one - only 2 years in spite of working with friends I knew for years, and the 3rd - 2 years until we had to close down the business. The 4th and 5th are going strong and we are close to finishing our 3rd year. I learnt quite a bit from these, the most important thing being that 'it is all about being on the same page, always'.
Some key lessons:
(thanks to Steve Sherlock for whipping me into action after more than a year!)
- Be very careful working with someone who says that money is not important to them, and that they are working to 'learn' or 'for the satisfaction'. This philosophy is for interns or not-so-serious guys, and not business partners
- The others won't always be as passionate about the venture as you will be, no matter how much they promise. If someone indeed proves this wrong consistently for a year or two, give them additional equity
- Exit, non-compete and IP clauses should never ever be ignored
- Never give away anything for free, even if you can. Let them earn it or they will never value it
- Never get in an equity partner for something a freelancer / part-timer / consultant can do
- Do not be desperate. Be prepared to lose an opportunity than giving into the pressures and regretting later
- Do not hire / give equity to a key employee without having multiple interviews, a 3rd party give its opinion on the candidate and giving trial tasks to prove his/her worth
- Promise performance based cash bonus or salary hikes (but only from profits or working capital) than promising equity. Equity is something to be earned by working really really hard
- Always ensure that a decent salary is paid to the key employee (never less than 50-60% of their market value) so that they do not keep looking for greener pastures. If you cannot pay that much, it means that you do not need a specialist at that moment and that one of the founders can do that work for a while
- Never hand over equity in one shot. Tie up portions of the promised equity to concrete deliverables as well as the duration (minimum 1-2 years) of the association
- Before handing over equity, ask yourself - what if he/she reaches the preliminary targets and earn, say 2-3% equity, but quit after that? What if he/she quits to join a rival or start on his/her own?
My 5-step process of giving out equity:
Step 1: Allocate a % for the idea & concept development, say 5%. This depends on the complexity of the concept - concepts with solid IP / higher entry barriers for competition cost more.
Step 2: Allocate sweat equity for the founders. Say there are 2 founders, a CEO and a CTO - 25-30% each. Always calculate such that the founders hold more than 51% equity together, even after they have to dilute it to raise angel investment (in the future)
Step 3: Calculate the investment needed to start and running for a year. Allocate an equity to whoever invests this. Ensure that sweat equity is valued more than money. Do not allocate more than 5-7% for 50,000 USD
Step 4: I identify the other key roles for your business (digital marketing? sales? legal? finance? operations? etc.) and allocate an equity to each based on their importance. Say, you need digital marketing for your app or sales for a physical product you developed - 6-8%, based on which stage the venture is in and how much salary the key employee is compromising on to join you.
Step 5: Always set aside a small % (say, 2) for stock options for future key (but, junior) employees, and 1-2% for industry experts to mentor/advise.
A few key points to discuss before hiring a key employee (even if he/she is your best friend):
It is all about effective communication and building mutual trust, only that.
- How you like the concept? What do you think of the potential?
- What is your vision for the venture?
- What does your family think of this opportunity/risk?
- Would you invest if you had the money? How much?
- Would you be getting your hands dirty, or are you interested in a supervisory role (for senior candidates)
- How tough/easy would it be to get back to the start-up mode, from the corporate world where the pressures are relatively less (where applicable)
- What exactly are your expectations (financial and otherwise)? What is the minimum monthly pay you need? To what extent can you compromise on this, in return to a promise of equity? Can your show us the pay slips of your last job?
- How long can you give the venture a shot? How much time can you spend on it per day & per week? Do you work on Saturdays and Sundays?
- Your relevant skills for this venture? How diverse can you get? How good are you at multi-tasking?
- Do you have any other consulting / freelance / part-time assignments?
- What if we are not able to hit the revenue targets after a year, and we cannot give you a hike?
- During tough times, would you be willing to take a pay cut? To what extent?
- Disputes / difference of opinion are bound to come up. How do we resolve them?
- How do we take decisions, review progress and what are the boundary lines we need to draw for our respective roles?
- Would you prefer selling the venture if someone offers us a few million dollar now, or would you want to stick with it till it is worth a billion dollars?
- Would you call yourself diplomatic, or are you frank and open?
- Are you an extrovert or an introvert?
- Can you take intense negative feedback? And can you analyse and give intense feed back to others?
- Are you a follower or a leader? Can you co-exist with other leaders with equally strong thoughts? Any example from your previous jobs?
- What are your industry contacts?
- Can you hire? Can you fire? Did you do these before?
- What if we have to part ways? How can we avoid that situation? And how do we do that without hard feelings?
- What are the Qs you have for us reg. the venture and our association?
Remember -
- The right answers to these depend on your business. Most often, there are no right / wrong answers. Asking these questions will let you know how the proposed candidate thinks and if he/she is on the same page as you.
- These are just HR points. You will have to do an equally exhaustive technical interview and assign some trial tasks as well. If you are not an expert and cannot do this, get an expert friend to help you out.
- Summarize all key points in an email at any cost. Store it carefully.
- Always put down deliverables, promises of financials, growth, equity, T&C, etc. on paper.
- Be safe than sorry. This is your career / passion and you should not risk it. But, do not get paranoid.
Hope this helps! If you want to discuss your situation or have specific examples, write to sasihere@gmail.com
