Last week I was talking to an entrepreneur and he asked about equity compensation for late co-founders. Late co-founders are senior team members given the co-founder title after the company has already been started. Also called a junior co-founder, these people are key recruits early in the life of the business. Once a late co-founder has been engaged and is interested, inevitability the topic of compensation and equity comes up.
Here are some initial compensation questions to answer for a late co-founder:
- What was their W-2 compensation (or equivalent) for the last two years?
- What’s the cash component of the compensation in this new co-founder role?
- What is the company worth now based on the last (or next financing round)?
- What will the company be worth in three years (subjective!)?
- What’s the equity target value multiplier for taking the risk (e.g. by joining as a co-founder, how much should the equity hopefully be worth in three years to take a pay cut)?
Now, let’s run through a hypothetical scenario:
- Average W-2 compensation for the last two years of $150,000
- Cash compensation as a co-founder of $100,000/year
- Company valued at $5M in the last round
- Plan to be valued at $50M in three years (10x increase from today)
- 50x multiplier for each $1 of cash pay cut (e.g. make $1,000 less, get $50,000 in equity)
- Formula: $50,000 pay cut times 50x multiplier = $2,500,000 of year three equity, which equals 5% of the company’s overall equity (assumes a $50M valuation)
Of course, this doesn’t take into account items like salary increases to get to market rate and other potential compensation enhancements. This also only looks out three years for the valuation — if everything goes well, the equity will appreciate even more dramatically in future years.
Equity for a late co-founder is always a subjective negotiation. This example provides a framework for thinking through different elements and coming up with a value based on a combination of pay cut and future company valuation.