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In my earlier venture attempts, the scenario was something like 3 guys, each of whom would get 33.3%. I found out soon that this was silly because as soon as one of us lost interest, he could do nothing and still reap 33.3% of the reward.

What is the smart way to compensate co-founders and employees? The things I have to offer are equity in the company and money (as I get it). (Anything else?) But I also want to maintain enough control over the equity that I don't have to give away all of my equity when it's time to bring in investors.

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What's wrong with vesting - tied to some defined activity/productivity, etc? – TimJ♦ Jan 7 '11 at 17:24
Just found a really good article on establishing the value of equity that you give away to employees. – John Berryman Feb 25 '11 at 1:24

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That's a typical situation that you can avoid easily following some best practices. I suggest you to read Venture Hacks and AVC's MBA Mondays that have covered this topic in detail.

In brief:

Shares must never be assigned upfront. Every founder will vest his share over 3 or 4 years.

Reserve a share pool for consultants, advisors, future partners. You don't need to assign all the shares, reserve 30% of them for future use. You can even use them to further compensate cofounders who did exceptional work.

Set clear deliverables. It must be very clear what every cofounder or employee is supposed to do, and what results he's supposed to bring. That's particularly true for non-technical founders (business development, sales, marketing) that often refuse the idea to have clear deliverables; trying to sell, or trying to attract customers is not a deliverable: sell 100 licenses over a month, set up 50 customer meetings in 6 months, attract 1000 signups per day are clear deliverables.

Once you have clear deliverables, it's easier to prove/disprove if a cofounder/employee is performing adequately.

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Early on (with a different venture) I made the mistake of assigning shares upfront. When anyone wants to leave, it's unspeakably demotivating for the remaining people who will work their butts off and only get the same reward that the person who left had. Also, how can you attract an investor when a large chunk in already tied up in some deadbeat. Ah... you live you learn. – John Berryman Jan 8 '11 at 23:54
Also... I knew about VentureHacks, but AVC's MBA Mondays is new... excellent site it seems. – John Berryman Jan 9 '11 at 0:05
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There are two ways to deal with the above situation, founders restricted stock and stock options/Restricted Stock Units (RSUs)

Founders Restricted Stock This is where you give stock to the founders outright, but tell them that if they leave before a certain amount of time (called "vesting period") they will lose the stock. If you had done this in the example above, the founder who left would have received nothing, or only a portion of the stock.

Stock Options/Restricted Stock Units This is what you typically give employees. There is also a vesting period, usually 3-4 years with a certain amount vesting each year. The primary difference is that with founders restricted stock, they actually get it, but can forfeit their right to it later on. Stock options, on the other hand, gives you a right to purchase the stock. Restricted Stock Units only gives you the right to the stock after the vesting period is done.

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