One of the most crucial decisions founders must make is how to distribute equity among the key team members. While founders and investors often take center stage, the allocation of equity to founding engineers is equally significant. Founding engineers play a pivotal role in transforming ideas into functioning products, often shouldering a substantial share of the early technical burden.
This article dives deep into the critical question: How much equity should a founding engineer get?
Understanding the Role of a Founding Engineer
A founding engineer is typically the first engineer brought into a startup and often the first employee. This role is usually part of the founding team, though not necessarily an original founder. The distinction is crucial because it influences the equity received and salary structure. A founding engineer generally receives less equity compared to actual founders but can enjoy a higher salary.
Being a founding engineer involves wearing multiple hats and contributing in various ways beyond coding. Primary responsibilities include building Minimum Viable Products (MVPs) to test the startup's market hypotheses. Additional tasks may involve customer support, interviewing potential hires, product design, and even contributing to pitch decks. Often, a founding engineer also takes on product management responsibilities, as early-stage startups usually lack dedicated product managers.
Moreover, founding engineers heavily influence the company's cultural foundation. Their personality and decisions impact future hires and the overall company culture. The ideal founding engineer is proficient in building MVPs quickly and is adaptable to changes, often foregoing attachment to their work due to the volatile nature of startups.
Example: A founding engineer may earn anywhere from 50-80% of the salary of their big-tech counterparts but can receive up to 2% or more ownership of the startup. This equity compensation comes with significant risks due to the high possibility of startup failure. However, the potential for significant financial upside exists if the startup succeeds.
Standard Equity Distribution Practices
Equity distribution in startups is a nuanced process influenced by various factors, including market standards, experience, and the specific role within the startup. Common practices and norms vary, but understanding these can provide a baseline for negotiations and expectations.
Market Insights
According to market data from Pave, the equity range for a senior software engineer (with approximately 5-8 years of experience) can be from ~0.50% to 1.75%. The exact percentage often depends on several factors, including the individual's experience, the total number of shares, and the stage of the company. For example, engineers from FAANG companies may prioritize equity over cash, leading to different negotiation strategies.
Example Market Offers:
50th percentile: $175k cash, 0.50% equity.
75th percentile: $200k cash, 0.85% equity.
90th percentile: $220k cash, 1.50% equity.
Factors Influencing Equity Distribution
Experience and Seniority: The more experienced and senior the engineer, the higher the equity stake they might negotiate.
Role and Responsibilities: The specific contributions and responsibilities of the engineer play a crucial role in determining equity. Those involved in core product development and pivotal technical decisions may receive more equity.
Market Comparisons: Benchmarks from similar roles and companies provide guidance. Industry reports, salary guides, and equity distribution surveys can offer valuable insights.
Risk and Commitment: The level of risk and commitment required from the engineer, especially in the early stages, influences equity allocation. Higher risk often justifies a higher equity stake.
Negotiation and Trade-offs: Balancing cash compensation with equity is a common trade-off. Engineers might accept lower salaries in exchange for higher equity, depending on their risk tolerance and financial situation.
How to Negotiate Equity as a Founding Engineer
Negotiating equity requires a strategic approach. Here are some tips for founding engineers:
Understand Market Standards: Research market standards for equity in similar roles and companies. Use tools like Pave's compensation data and equity calculators.
Assess Company Valuation: Understand the startup's valuation and future growth potential. Equity in a higher-valued company might be worth negotiating for even if it’s a smaller percentage.
Balance Cash and Equity: Determine your risk tolerance and financial needs. Be willing to trade-off cash compensation for equity if you believe in the startup’s long-term success.
Seek Professional Advice: Consider consulting with legal and financial advisors to understand the implications of equity offers and ensure fair agreements.
Legal and Financial Considerations
Understanding the legal and financial aspects of equity allocation is crucial:
Legal Agreements: Ensure all equity agreements are documented and legally binding. This includes outlining vesting schedules, cliff periods, and any performance-based contingencies.
Tax Implications: Consult with tax experts to understand the tax implications of receiving equity, especially regarding stock options and RSUs.
Vesting and Dilution: Regularly review the equity structure to manage dilution and ensure that vesting schedules are being followed.
Best Practices for Founders and Startups
Transparency and Fairness: Establish transparent and fair equity distribution policies. This helps in maintaining trust and motivation among the team.
Regular Reviews: Conduct regular reviews of equity distribution based on the company’s growth and changes in roles and contributions.
Clear Communication: Keep open lines of communication with all stakeholders about equity and ownership changes.
Utilize Tools: Leverage equity calculators and professional advice to facilitate fair and informed equity distributions.
Conclusion
Equity allocation is a critical component of startup success. Founding engineers play a vital role in building the foundation of a startup, and fair equity distribution reflects their contributions and commitment. By understanding market standards, negotiating effectively, and managing legal and financial aspects, both founders and engineers can ensure equitable and motivating equity arrangements.
