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FAQs | Management

Sweat Equity

Q1: What's the best way to handle "equity for work" allocations? Should it be shares for hours worked, or an amount of shares with each level of position?

The following answers all have one thing in common: be careful when handling equity for work share allocations.

  • I'm against "equity for work" allocations. Change that to "equity for results" or "equity for risk" and it might be easier to work out. [Anne Crossman, Good]
  • Equity for work sounds like a recipe for disaster. If you don't have the equity sorted out on day one, many problems will arise in six months. The major milestones for a startup are achieving key objectives such as a demo, funding, and first customer. Hours worked is too fuzzy an objective, and may lead to people just hanging out, not working, and not solving any of the major problems. Further, the concept of a rewarding a "hero" on the team is also very subjective.

    Don't defer the issue of stock allocation. The decision will be even more difficult down the road six or twelve months when the company actually has some value. I recommend you set a firm allocation on day one, with certain adjustments made for easily defined milestones. The adjustments should be minor, more like a bonus plan for executives. For example, if the CEO has a bonus plan that kicks in if revenues increase by 20%, and they only increase by 19%, he gets no bonus. It does not matter how hard he worked, as he is expected to work hard. It's no different in a start up. If you make people work for a shot a greater equity, you will probably end up with lawsuits and fist fights. Make them work because they committed to something.

    My other advice is to make equity vest over time so that the early drop-outs can be more easily removed from the equation. And those who stay longer are rewarded accordingly. [Eric Eisenhower,]

  • We faced the same issue at Women's Connection Online. Initially the two partners did not take salaries and divided the equity with consideration given to the length of time I had already put in (three years) developing the company.

    In looking at our needs pre-funding, we believed a PR person was critical in order to build traffic and credibility for the Web site. We hired a PR person who agreed to consult on a part-time basis for stock options and salary later. We had a technical consultant as well who received stock options in lieu of payment.

    Post first round funding, we were able to hire a team and pay salaries. We still can't pay "big company" salaries, but we've incented the team with stock options and continue to increase their options as bonuses. The commitment to the company and the potential upside of the options has proven to be a real attraction in hiring for us.

    Pre-funding, equity was a good way for us to get the most critical members of the team. Post funding, it still is, but at a lesser amount in addition to salaries. You may be able to get key members of the team for equity only for a while, but reality is most of the team will need the security of salaries in the near future.

    We also believe in vesting at higher percentages with more tenure. One quarter of the options offered at WCO vest after the first year of employment, and monthly thereafter up to four years. [Susan DeFife,]

  • The 'shares for hours worked' approach has some flaws that can show up later to upset the apple cart. Presuming you have an honor system for counting hours is one thing, some people count hours in their favor, leaving others on the short end of the stick. And some people can reap tremendous results for relatively few hours of effort, while take longer to produce anything.

    Doling out shares up front in equal portions, with one portion set aside as a bonus pool can work. At predetermined intervals, say quarterly, the team members score their own and the others performance and use the total scores to divvy up the quarter's bonus shares.

    There are some legal issues of which to be aware. For example, shares cannot be distributed based on some future measure. In other words, if John, a team member promises to work 500 hours in the coming year and Mary promises to work 300 hours in the coming year, distributing 5000 shares to John and 3000 shares to Mary based on the promise of future work is not legal (as I understand it). [Roger W. Davis,]

Q2: How can you value stock options? Do you set an arbitrary value, say, $5.00 per share with 100,000 shares issued? What is the procedure if you all need to issue another 100,000 shares to cover the equity requirements of a V.C.? I assume the holders of issued shares get to vote their respective shares on the funding plan?

  • You can set your valuation, but the only thing that matters is what the market will bear (what investors will pay).

    Before going out for investment capital, we incorporated with 5,000 shares at a price of a penny a piece. Valuation was set with the first round of funding, new stock issued, and price per share determined (valuation divided by number of shares) -- and, yes, it did go up!). After the second round of funding, new shares were issued, and new valuation set (and it went up again. At this point, you're hoping the dilutive impact isn't too great and hope your new stock price takes care of that (but, again, it's what the market will bear). [Susan DeFife,]

  • There's a break point that affects incorporation fees in Maryland. When I incorporated I thought it would be a good idea to have a large number of shares available so I incorporated with 100,000 shares authorized at a par value of $.10. I've actually issued only 10 shares, which I own. If I need to distribute equity, I have lots of unissued shares to play with and can issue myself more to maintain the percentage ownership I want. [Seth Grimes,]


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