Comrades in arms

Turning an idea into a business requires resources, the most important of which, and potentially hardest to find, are human resources. These resources can include employees, contractors, mentors, investors, and fellow entrepreneurs. Starting out, you probably care most about people who can work directly on helping turn your idea into reality. These resources will typically fall into one of three categories:

  1. Co-founders
  2. Employees
  3. Contractors

It’s important to realise that co-founders, employees and contractors are very different types of people, whose needs / wants and capabilities may be vastly different. However, getting this mix of people right is extremely important because it is the quality of the people, and their working relationship, that will ultimately underpin the success of your startup.

Let’s begin with co-founders. Co-founders are typically people who have complementary skills, experience and expertise that is crucial to the success of your startup. They will be the hardest people to find and a good one is worth their weight in gold. Outside of their key skills, expertise and experience you need to be intellectually, emotionally and philosophically compatible with your co-founder as you may end up spending an awful lot of time with them.

Co-founders, by definition, share in the risk and rewards of building and running a startup and need to be passionate, committed, and resilient. If co-founders sound like special people, that’s because they are. You should take your time finding and vetting any potential co-founder. It is important to realise that as co-founders they are likely to want and need a sizeable equity stake. It is for this reason that you should only offer co-founder status to those people truly able to offer skills, expertise and experience to help build and grow your idea to make it a reality.

In the case of there were three co-founders (including myself) who split equity equally — this was a reflection of the fact there was equal risk taken and relatively equal contribution of unpaid work.

Most, if not all, other skills and expertise that you need to grow your business will come in the form of employees or contractors. In Australia, there is an important legal differentiation between contractors and employees which is important to consider. For what follows I will refer to an employee as someone who works in your business and is part of your business, whereas a contractor is running their own business and typically is engaged by your business to perform a specific set of duties, perhaps over a prescribed timeframe.

While contractors might seem ideal, in that they represent a significantly reduced administrative burden over employees, I have found that contractors are best when hired to complete a specific, non-core task for the business. By non-core I mean anything that isn’t part of the core intellectual property or technology that the business is seeking to commercialise. This could include graphic design, legal or financial advice, or other professional services that support your core business.

In the case of I used three sets of contractors to try and build the core IP and each time it failed — costing time, money and effort. In each case, it failed for different reasons but the underlying problem was that contractors try to maximise their profit. They typically achieve this by minimising the time they spend on your project, sometimes, and I experienced this first-hand, by seriously cutting corners. It is also worth realising that in the dynamic world of startups where customer requirements are often subject to change, using contractors is likely to become very costly once additional charges for changing the scope and timing of work are levied. Finally, it is really import that you understand contractors are not personally invested in your business. This is a just a job for them.

This brings us to employees. Employees are the heart of any startup, and bring important skills, expertise and experience to the business. Importantly, by being in the business it is possible to leverage both their explicit (i.e. formal or codified) and tacit knowledge. Tacit knowledge is knowledge that is often difficult to transfer to another person, and thus capturing tacit knowledge, in the form of your employees, is vital to building and sustaining corporate knowledge.

Employees are typically after a job that pays reliably and are often not willing or able to accommodate the risk that you as the co-founder are taking. That being said it is typical for employees in a startup to have access to equity, often through some form of employee share ownership scheme (ESOP). In Australia, providing equity to non-founders is complicated by the significant taxation impediments created by tax office regulations. My dislike of this situation could fill an entire blog post, and probably will at some point in the future.

Aside from the complications of actually issuing the equity to employees, you still need to determine what is a fair percentage of equity ownership for an employee. There is no magic formula for equity ownership, though a google search will reveal many potential calculation methodologies. As a general rule I tend to find that for employees paid at or near the market rate, who have a well defined role, with concrete milestones can expect to receive equity between 0.5 – 5% of the business. These positions, including relatively senior ‘C’ level positions, are not exposed to greater equity because the idea has been formed prior to their involvement and their risk profile is relatively low.

If you compare the equity given to co-founders and employees you will see that equity follows risk taken and sweat contributed, more or less evenly. For me, lesser considerations then include the impact of the equity split on the working relationship, the overall structure of the share registry and any other factors. In saying all of this, I don’t think there is a perfect way to split equity and with high quality people I err on the side of egalitarianism (for co-founders) and generosity (for employees) as it makes for a far simpler discussion, and ultimately a more stable and productive working environment as everyone has proper buy in to the company.

I will conclude with a couple of important points that I have learnt the hard way in previous ventures. Finding good people to work with is one of the big challenges of growing a startup so, for what it’s worth, take your time meeting and vetting people before you formally begin working together. Once you decide to work with one or more people, make it formal. Everything seems great until it isn’t, so getting the formal arrangements sorted out up front is always easiest.

On the equity situation, I think it is important to avoid small equity percentages (<1%) unless it is part of a structured employee share scheme because investors are typically looking for a ‘clean’ share registry and it will be off-putting to them to see:

  1. Lots of small shareholders.
  2. Shareholders who are no longer involved in the business. (This is a major one and relates to making sure you properly vet people before granting them equity.)

Having great co-founders and staff is a joy and makes the startup experience all the more enjoyable. Like any relationship you should expect there to be ups and downs and having a working relationship based on mutual respect and a willingness to be upfront and communicative will make these tough periods easier to navigate. There is no such thing as a one-person, billion-dollar company so finding people who are willing to work with you is crucial. Good luck with the search.

photo credit: Kalexanderson via photopin cc

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