Ask HN: Unorthodox Equity Arrangement?
Hi all,
I’ll soon be joining a small 1yo startup as the CTO and the CEO suggested the following equity arrangement:
- 3y vesting period, 3% per year - If I leave the company on the 4th year, the percentage will start reducing linearly until the 10th year, going down to a minimum of 5% (unless there is an exit event).
Keep in mind the following:
- We’re both first-timers in these roles (CEO / CTO). - He’s not coming from the business world. - We’ve known each other since forever and he’s not trying to screw me over; we are honest with each other on what we do or don’t know and this is definitely something we are not knowledgeable about. His reasoning is that the work between year 4 and 10 may be way more significant than the one we’ll do together in the next 3 years and that 9% is too generous to be given away in 3 years.
1. Is this pattern something you’ve heard before? If yes, how is this type of arrangement called? 2. Does it make sense? Any questions I should raise with him?
Thank you in advance. These terms seem to presume that you should stay for ten years or more because 9% of the company in 3 years will be worth less than 5% in ten years, i.e. an extremely successful growth pattern. This is not only more recklessly optimistic than usual: it's unfair to you because you are giving your shares to your cofounders in exchange for, apparently, nothing. I agree mostly. Motivation is most likely that this is how the person thinks a business person is supposed to act rather than personally directed bad behavior or general sociopathology. Many people don't have good role models because they have only worked crappy jobs. But, the real red flags for me are that the person has focused on dividing the equity in some strange way rather than making sales and has concocted something that is antithetical to long term employee retention. I mean if year four is a bad year, it's not just that the bonus will be smaller, but also that the employee will lose equity at exactly the moment when it grinding it out is needed. I think there is a large moral brown area of bad faith and deliberate exploitation of weak people between fair but greedy terms (e.g. me 20% you 5% because according to me my work is more valuable), which can result from excesses of businesslike aggressive attitude, and antisocial criminal intent (e.g. if I can make you sign this and that, when you are no longer necessary I'll then be able to sue you to get your shares, your back salary and imaginary damages). In my opinion taking away shares falls in a rather bad part of this spectrum because, even if no further tricks are intended, it's something that can only be proposed to someone who's known to be gullible and submissive, by someone who isn't their friend. Since the OP seems unable to treat this outrageous proposal as the red flag it is, it might be useful for them to frame their equity arrangement as a problem of "friend retention": friends shouldn't exploit friends, not even if they drown them in bullshit and they leverage personal feelings. It is clear you are only trying to help - and honestly, thank you for that - but it is also clear (to me) you are making too many assumptions about us and our backgrounds. Simply put, we are both pretty decent engineers in our domains but also clueless re: how to structure a business. And it doesn't help that startup wisdom is very limited where we are now based. The reason why it didn't sound like a red flag is that I'm not a founder, market fit has already been established, and google results suggest that 5% is a great deal in such cases. So the potential of going up to 9% sounds even greater to me. My unknown unknowns are more than my known unknowns though, hence the post. The described terms appear to be a red flag because there doesn't seem to be any good reason to reduce your quota of the company after a peak at three years: you are going to have a large share of almost nothing, then if everything goes well a smaller share of a thriving company. It is clearly not in your interest, so it must be in your friend's interest. To avoid giving away your equity for nothing you could just accumulate shares progressively and your friend could be entitled (or even obliged) to buy some of them at a guaranteed high price. How, and how badly, your friends will fail you is an unknown unknown and unknown unknowns are a reason to design contracts for the worst case and write them in the most robust and comprehensive way; if you are clueless about how to structure a business, hire a lawyer (and I mean your lawyer, not your friend's one). Everything you don't analyze, discuss and specify is a risk. For example, what happens if after two year you need to stop working there? Are you going to get shares or options? Options to buy, to sell or both? At what price and with what taxation? With the same schedule as others, or with divergent incentives? What happens if the company is bought? Do you have proper limited liability? In what situations more shares or more options would cause you to spend more? That is a great answer, thank you so much!
ROTFL; if your mindset is that your cofounders might be "too generous" you are already being screwed. > We’ve known each other since forever and he’s not trying to screw me over