Editor’s note: Serial entrepreneur and investor David Gardner, who is general partner of Cary-based Cofounders Capital, will be writing columns about the business of startups for WRAL TechWire.

CARY – I remember a mentor telling me once that very few people ever got rich working for salary. He was emphatic.

“You’ve got to work for equity or you will just be stuck on a treadmill for most of your life.”

There are only two ways to get equity in a promising new venture. You can either buy it with cash or trade your services for it over time. Entrepreneurs often think that they get founder’s equity for having an idea but in fact an idea by itself is worthless.

It is all of the hard work that propels that idea into a successful venture that creates value. This is why investors typically require founder to vest their equity over time as they provide their services.   

This structure keeps everything fair.

I’ve seen situations where one founder left the venture after a few months while the other stayed and worked for years at a below-market salary. Had we not vested their equity over time both of these founders would have owned the same amount of their company even though only one had made most of the sacrifices.

Who should get sweat equity?

When climbing the face of the mountain dealing with the uncertainties and stress of building a new venture I always wanted to be surrounded by a team of owners rather than hirelings. The stock option pool is a portion of a company’s equity that is set aside to allot to employee’s and others as an incentive for their services.

I encourage early stage founders to make sure all of their employees have at least some equity. This creates a culture of ownership. As everyone works hard and they see the value of their equity increasing, options help to foster a team atmosphere and they serve as a retention tool as employees have to stay for their entire vesting period in order to get all of their equity. 

I can’t describe how good it feels the day you sell your venture and get to walk around the office handing out checks to everyone who helped you make that day possible.

Some members of the team are more impactful and harder to find than others and as such tend to be granted more ownership opportunity as part of their compensation package. Startups are always short on working capital. Because money is very expensive early on in a venture, founders tend to raise as little capital as is necessary to get them to their next valuation inflection point where they can raise more capital at a higher valuation. 

For this reason, they tend to pay below-market salaries while being much more generous with stock options as a way to make up the difference.

How to measure sweat equity?

How much sweat equity should a person get for their services? I’ve always considered this a simple math problem.   Beyond token amounts, meaningful amounts of equity should always be valued in terms of dollars. If a new hire’s market salary is around $100K and that person agrees to work for your startup for $75K then that employee should earn $25K worth of equity at the most recent round valuation or fair market value of the company.

Startups are always running out of money and raising additional rounds so there is usually a fairly recent market valuation president to use.

I’ve always counseled students, job candidates and my own daughter to take as little salary as possible in exchange for as much equity as possible in every early-stage employment situation. Sometimes that equity might become worthless but it can also be life-changing.   If you do this enough times eventually you are going to have a big hit.

When should your sweat equity vest?

Options are usually granted on a vesting schedule over three to four years but if you are trading real salary dollars for your equity then I believe the amount of sweat equity vested each month should be at the same rate as your foregone salary. For example, if you are trading $12K off of our annual market salary in exchange for $12K worth of stock options then your stock options should vest $1,000 each month i.e. at the same rate your paycheck is short each month.

I believe that employee compensation should be an annual agreement. Performance should be evaluated and a new compensation plan put in place each year.

If you find yourself back at your market salary the second year then it is reasonable to expect that no new meaningful stock options would be granted but if you are still asked to work at a discounted salary then more options should be granted proportionately.

Negotiating with equity

I encourage startup founders to try to find employees that are risk-takers and willing to gamble some of their compensation for equity. I have found these workers/co-owners to be the most tenacious and passionate about pushing the venture forward.

Better to give them your equity then to take money from a passive investor so you can immediately pay your team full market salaries.

When deciding the right ratio of equity to salary to offer a potential new hire these amounts will vary. Different people have different minimal income requirements.

Some value ownership greatly while others discount its value altogether.   Take the time to understand the compensation package that fits each person’s needs and don’t waste significant ownership on hires that don’t value it. 

Bio: David Gardner

Founder, Investor and General Partner, Cofounders Capital

David Gardner is a serial entrepreneur, writer, adviser and very early stage investor with nearly thirty years of experience in creating and building software technology companies.

Before founding Cofounders Capital he was the Triangle’s most active and involved angel investor with over $7M personally deployed in early stage ventures. As an adviser, David spent all of his time working as a full-time unpaid coach and mentor to startup companies usually in the software space.

As an entrepreneur, David has been the founder or cofounder of multiple successful companies in the Triangle including PeopleClick which was purchased for $100M and Report2Web which sold for $12M in less than eleven months from inception. He has demonstrated a record for consistency across multiple industries and markets with six successful exits in a row.

As a senior executive, David served as a Vice President for Compuware, a billion dollar Fortune 1000 corporation, after it acquired ProviderLink, a healthcare communications exchange he founded.

As a writer and thought leader, David is author of a popular book on entrepreneurship called, The StartUp Hats. He has published many articles and forward thinking white papers on technical, marketing and managerial topics. David founded and launched the first hosted software-as-a- service enterprise application in NC long before the SaaS model was recognized as a viable architecture or best practice.

As a lifelong learner, David is constantly researching new technologies and challenging traditional ways of thinking. In addition to several years of full time computer science and business related post graduate studies at NCSU, he holds degrees in Music and Philosophy with a post graduate concentration in theology and dead languages.

What drives David today is his passionate for helping smart, coachable first-time entrepreneurs, watching them succeed and witnessing their life-changing exits.

Source: Cofounders Capital