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  1. Is it common to issue equity to CEO as Preferred stock but other co-founders as Common stock?

  2. When setting up a 20% employee pool, it is common to have terms that the unissued equity will be issued back to the CEO only, not co-founders, not angel investor?

  3. What are the advantages in setting up a employee pool, I knew some prefer not setting it up at all?

Thanks.

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Why do you want to reinvent the wheel? Especially point 2 sounds very unusual. Why don't you focus instead on building a successful business? – Alain Raynaud Jul 24 '11 at 18:59
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do me a favor -- next time split this up in separate questions? For now it's OK but in the future it's easier to answer one question at a time. Thanks. – Joel Spolsky♦ Jul 25 '11 at 2:43

2 Answers

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  1. No; it doesn't even make sense to give the CEO preferred stock. The "preference" in preferred stock is usually a liquidation preference, giving the holder of the stock the right to get 100% of their investment back before anyone else takes a dime. This makes sense for an investor that has put in money. As the CEO has not put in money, it doesn't make sense. Of course, if the CEO is also an investor, they would have some preferred shares as a part of that investment. But founders stock and employee option stock is almost always common.

  2. No. That's bizarre and sounds rather unfair, unless there are special circumstances which I don't understand in your particular case.

  3. You set up an employee pool so that you can issue employee stock options. Because those options have value, you will be able to pay your employees less (all else being equal) and you will be able to attract the type of talent that wants the excitement of working at a startup with the possibility of a large payday if the company is acquired or goes public.

The pros and cons of the size of the employee option pool are rather subtle and are discussed in detail at VentureHacks. I won't go into the details here; suffice it to say that during a fundraising, the option pool comes entirely out of the common shareholders' stake, but if you have to enlarge the option pool later, it is dilutive to both the common and preferred. Therefore common shareholders prefer as small as possible of an option pool, thinking that if they need to enlarge it later, the preferred shareholders should pay up, while the preferred shareholders prefer as large an option pool as possible, knowing that they don't have to pay with equity now, but if anything is left over unissued in the option pool, they will benefit.

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Joel, thanks for your tips. 1. We have 3 founders, one is fulltime and while others are parttime, we all put money into the startup, but I am not sure if the fulltime CEO should take preferred stock. 2. I read the Paul Gram's article(paulgraham.com/startupfunding.html), it said ...eave 20% as an options pool for later employees (but they set things up so that they can issue this stock to themselves if they get bought early and most is still unissued Thanks for your help. – Howard Jul 25 '11 at 9:11
up vote 1 down vote

To answer your questions:

  1. No.
  2. No.
  3. An employee pool is the only way to reduce their dilution as you get more rounds of funding.

If you are worried the CEO keeping a stake in the company, then you can add something to their employee contract that they get a certain percentage of the company. That way, the evaluations are worked our properly and the stock can be issued accordingly.

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So for the option pool, it means I don't need to think about it before external investors give us money for the funding? – Howard Jul 25 '11 at 9:47
You should think about the option pool beforehand since that will affect your overall stock pool for investors. Any investor will want to see an option pool for employees -- it's just good practice and the right thing to do. In the beginning, you typically give founders share to your first employees and set aside some options for new employees. – Jarie Bolander Jul 25 '11 at 12:27
So you think we should setup the pool from day1? Thanks. – Howard Jul 25 '11 at 14:54
I think that would be wise to have a line item for it. Most VC will ask you your pre-money with and without the option pool so they can calculate post-money with the option pool. It's good practice to have it already thought about. – Jarie Bolander Jul 25 '11 at 15:18

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