How Much Equity Should I Give My First Employee?

This article was originally posted on Quora.com, but I liked it so I republished it here…

Don’t give him any equity. Just pay him a fair salary and keep the equity for yourself. However, if you can’t afford to pay him a salary you will have to give him equity. There is a way to figure out exactly how much you each deserve using the Slicing Pie method (aka Grunt Fund), here is how you would get started:

All employees, including you, shouldstart with no equity and earn it over time (I realize that at this point you probably own 100%, but here is how you give it away). Resist, at all costs, the temptation to keep a big chunk of equity for yourself. If you do, it will probably backfire and cause irreparable harm to your team dynamic. Founder’s do this all the time, but most companies fail and this (greedy founders) is one of the causes. Here is how to figure out what each person deserves:

1. Figure out opportunity costs for you and for the employee. This would be the amount of money you would be willing to accept for the same type of work if you were going to take a salary instead of equity. This is your fair market rate.
2. Subtract any cash payments from the company
3. Multiply the number times two (2). This recognizes the inherent risk associated with working for a startup company. It will also protect you from each other later down the road (more later).
4. Divide the number by 2,000. This is roughly the number of working hours in a year. This number is your hourly rate, expressed in “Slices“. It provides a relative measure of your respective contributions.
5. Track the hours you work.
6. Multiply hours worked times the slices per hour. This will tell you how many slices you have at any given time.

Your share is equal to the your number of slices divided by all the slices contributed by everybody. His share is equal to his number of slices divided by all the slices. The model is dynamic so it changes over time as more contributions are made. This makes sure it stays fair.

You can calculate slices for any input. Simply take it’s fair market value, subtract cash payments, then multiply by two for non-cash contributions (like time, royalties on ideas, commissions on sales, etc). For out-of-pocket costs and cash contributions you multiply by four because it’s harder to come up with cash than it is to come up with time (for most people).

If he quits or gets fired for cause he would lose his slices, this protects the company from decisions the employee makes that negatively impact the business.

If you fire him for no reason, or otherwise “push” him out,he keeps his slices. If you want them back you would have to buy him out at $1 per slice if you had the money. This protects the employee from decisions the company makes that have a negative impact on his future. The multiplier compensates him for his risk.

This is an oversimplification, I provide detailed instructions on how this work on my site: Equity Splits at Stanford University

I’ve also written a book on this topic, Slicing Pie, you can get a free sample on my site too.

Good luck!