Many wanted to know how it works. The calculator is quite simple. Let me start with an old tale: a repairman is called to a huge factory to fix a major problem. After walking around for a while, he finally settles on one screw, tightens it, and declares his job done. Indeed, the factory now works like a charm, but the manager refuses to pay the large fee. After all, it was only one screw, how hard could it be? True, responds the repairman. The trick wasn’t to fix one screw, it was figuring out which one to fix.

That’s how the calculator works: it asks very few questions, but each one is crucially important to your startup’s success. There are countless peripheral questions and details, but they are not critical. The trick in designing the calculator was removing those.

I lost track of how many founders I talked to about equity split, but it may be approaching or above 100 by now. Including several cases where, after our discussion, a co-founder was terminated. Having an impartial person listen to you and repeat what you said with the filter of common sense is valuable, if sometimes unpleasant.

From all those discussions, over the last two years, I started detecting patterns. Many questions didn’t matter. A few did. Eventually, I wrote the calculator to see if I could automate what I was doing manually.

I must conclude with a caveat: of course the calculator is far from perfect. For starters, it has no pretention to be precise, if it’s 5% off it’s already amazing. It is not meant to be the definitive equity split you then tell your co-founders, as if written in stone. Rather, it’s a great way to start a discussion with your co-founders. If you don’t like the results, then ask yourself why the calculator gives such a different result. Possibly, someone’s contribution to the success of your startups is not properly reflected in the questions. Why is that? It could be that your situation is unique, or that you somehow have a co-founder onboard who shouldn’t be there, but is the friend of a friend, or you feel some personal obligation to them.

For now, the calculator assumes that all founders have started more or less at the same time, doesn’t take into account cash investments. It also works best for web consumer startups where graphic design is not critical to the success.

Feedback absolutely welcome! If you tried it, what worked, what didn’t?

Q: I just met someone who looks like a potential co-founder for me. What should I ask to tell if he is the right co-founder for me?

A: It’s actually quite simple. Good co-founders are all about doing, not talking. So here’s the one-month plan to find out.

Week 1

Meet for coffee and pitch your idea in more details. Does the other person want to meet again that same week? That’s a good sign. At coffee meeting #2, expect the other person to contribute some ideas. If he just shows up but offers no twist on your project, something is wrong. It means he hasn’t obsessed about it.

Week 2

By week 2, you should be brainstorming and exchanging random thoughts on instant messenger. That’s when you settle on a first goal together.

Week 3 & 4

The rest of the first month, you actually work on accomplishing whatever milestone you came up with.

At the end of the first month, you know if you have a co-founder or not. If you do, bring them on board with equity (don’t forget vesting).

Decision Point

Common mistakes I have seen too often: at the end of the first month, no work was done, but you heard plenty of very convincing excuses. It’s so tempting to be nice and give the other person the benefit of the doubt.

Don’t.

You’ll become more and more miserable over many months before you eventually pull the trigger, and it will be very painful for everyone. Just don’t.

It works because they force you to use YCombinator’s standard terms, just as if this was Ron Conway investing. So the investors know they are dealing with professional startups and receive all their usual protections: a board seat, preferred shares and so on. But since everything is codified and standardized, we avoid the exhorbitant legal fees (often north of $25K), which really hurt when raising small chunks of money.

Being able to use this service allowed us to continuously raise money. In effect, it’s as if we could IPO for free every time we needed more cash for operations. The need to go through VCs as gatekeeper pretty much disappeared.

It’s pretty cool!

And it’s also a fantasy. Such a site doesn’t exist yet. Partly because it would be illegal in the US of course (you can’t offer equity for sale to the public, and reporting requirements when you have a large number of shareholders are prohibitive). Partly because building a healthy market, where both sellers (the startups) and buyers (the angels) behave properly, free of scams, is not so easy.

Do you know a way to make StartupIPOs.com? If so, please do it, for all startups’ sakes!

Here’s how you do it in one tweet:

@joe I expect this co-founder position to be worth ~30% equity. My goal is to incorporate in about a month, let’s see how it goes by then.

Really, that’s all there is to it. Now if you are curious to know why this is the right way to do it, read on.

You must commit to a number upfront

You need to make the potential co-founder a promise. Something tangible that clearly spells out how much of the company they’ll be getting. You can’t avoid a discussion with a specific number. Am I getting 30% or 5%? That makes a huge difference. By putting it in “writing” (a tweet), you are giving enough rope for the co-founder to sue you if you completely abuse the situation.

You’d be amazed by how many startups I coach that tell me they haven’t discussed equity split yet, although they have been coding along for 6 months or more… The longer you wait to have that discussion, the worse it gets. Be upfront.

You need a way out

Frankly, you should not sign a definitive co-founder agreement with someone you haven’t work with yet. In my experience (confirmed by talking to many entrepreneurs facing the same situation), it takes about a month to know whether it’s going to work out or not. So work together informally for a month, and decide then. Follow your instincts. If after one month, the only contribution of the co-founder are excuses and delay, just stop, don’t try to save the situation and hope that it will get better. It doesn’t.

You need to be fair

While you committed in writing to an equity split, a tweet is clearly not as strong as a legal contract, so in case where the relationship doesn’t work out, there is no additional paperwork needed.

But if you ripped-off the co-founder, the tweet gives them a (small) basis for a lawsuit. So it forces you to do the right thing. It’s a good trade-off, fair for both sides, without getting all lawyerly.

After the one month, if everyone is happy and super-excited about the startup, incorporate. That will make the tweet official. That’s it!

PS: did I mention that if you construe this post as legal advice, you deserve the mess you’ll get into? Of course you should talk to a real lawyer. Just do your own research as well.

I’ll happily take comments from lawyers and others about whether this approach is sound or not.

His gut feeling was that as the main developer, he of course should keep most of the revenue.

There are two ways to approach this question. You should use both. If they lead you to similar numbers, you have your answer. If not, something is wrong and you need to understand why before you proceed with a revenue sharing deal.

Be Realistic About Who Needs Who

Everyone tends to have a high opinion of their work. That’s a problem when trying to reach a fair deal.

As a developer, you know how tough it is to write good code. To you, English writing doesn’t seem like a big deal – although you are not willing to do it yourself.

Well, the writer on the other side thinks the same way. It all goes down to negotiations and who can walk away from the deal.

Ask yourself this question: if the writer was to quit when the first version of the app is out, would it be a problem or not? Or will you need them to stay around and improve the product?

This is the key question that tells you the difference between a co-founder and a contractor.

Obviously co-founders deserve a significant amount of shares. Contractors want to be paid, but they can be replaced.

Be realistic about the fact that you indeed need a good writer. Your app’s quality may depend on it.

At the car dealership, you must be willing to walk out three times to get a good deal. Equity negotiations work the same way, except that once you reach a deal, you need to actually spend time with the other person. So you can’t burn bridges.

Discounted Value of Future Revenue

The second exercise is to look at the potential income and check whether it’s in line with compensation. If the writer is expected to put about a month of work full-time and you offer 1% of an app that may make $20,000, that’s a total compensation of $200 for the month. It just doesn’t compute.

No need to go back to business school and run a fancy analysis about discounted values and risk factors, but it’s clear that anyone who works for revenue share is taking a risk. So even the $200 above is a best case scenario.

In reality, there is a possibility that the app never makes it to the market, so the writer makes $0. The app could do ok and generate a few thousand dollars. The writers makes less than $20 (the price of a dinner).

The Number

So what is the right number? In the case of that developer, the amount of work expected of the writer was significant (a month, probably more with updates, changes and what-not). The job was more that of a co-founder, not a hired gun. My recommendation: anywhere from 25% to 40%.

What do you think? Is that the right number? Is too much or too little?

Many of you asked us for a more flexible way to add co-founders early on and offer more flexibility on the allocation of shares, since you haven’t always found all your co-founders by the time you have your initial idea.

Therefore, creating a Fair Project is now split in two parts. First, you setup your project, with a very simple one-page form. At that stage, all you really need is a name and some idea of what you want to build.

You can leave your project in that stage for as long as you want. You an start adding co-founders from friends you know, advertise your project to the rest of our community, and also crowdsource your idea by gathering feedback.

During that setup phase, you can freely add or remove co-founders and modify the share allocation as many times as you want until you are happy with the results.

Invite Co-Founder

Edit Shares Split

Once you have settled on a founding team, you activate the project. That’s when each co-founder has to agree to the deal by approving the Software Bill of Rights. From then on, co-founders can start contributing, write code, and so on. Everyone is protected legally. As before, you can grow your project and bring more contributors on board.

We hope this improvement will make it even easier than before to start working on apps, even if you haven’t found a team yet.

As always, feel free to send us feedback and requests for more improvements.

This is the more negative side of vesting – to protect. You’re probably familiar with this. But the other side of vesting – to motivate is also very important.

The value of a startup is more in its potential than in its reality. It is the hard work of a group that transforms that potential into something that has real value. The key ingredient in the process is the team: a core group of people that works on the problem for a long time. It can take a while to go from an idea to satisfied customers and income. And you can’t afford to keep bringing in new people to finish what others started. You need a team that will stick together to build a great site and keep generating quality content for a blog. Or who will design, build, test and maintain a winning software product.

One way to get people to stay for a while is to motivate them financially to do so. The most popular scheme used, in Silicon Valley startup culture, is vesting to reward over the long run. Most people are familiar with how option vesting or 401K matching works. Your employer gives you a reward, but you can’t take it home right now; you have to work for a fixed number of years before it is completely yours.

All Fair Projects have this mechanism built in. You can assign a fraction of the profits and the decision making to someone. But if they leave before fully vested, they must give back a part of their share. The standard vesting period in high-tech companies is 4 years. This means that after one year, 1/4 (one quarter) of the reward is yours to keep and nobody can take it away. Such a long vesting period makes sense for a business, but it might not make sense for your project. It depends on how long it takes to develop it, and how long you want people to stick around. A two year vesting period, for example, might be appropriate for bloggers.

Vesting is good for everybody involved. You can work confidently because all your colleagues are also incentivized to stay for a long time. If somebody could walk away and still receive 30% of the future profits, they have a smaller incentive to stay.

Also, humans are competitive by nature and also value fairness. We don’t mind being poor, so long as everyone is poorer than we are. In the same way, nobody likes to know that they have to work for 2 years to get what somebody else will get after 2 months. Which is why everyone in a Fair Project vests over the same amount of time.

Finally, without vesting you might be much more weary of adding new members to your project. Vesting limits the risk of trying new members. That is, you can add new members but if they do not become productive members, the group can vote them out. This is never an easy decision (so make sure you’re bringing the right people, a subject we will discuss in a future blog entry!) but at least you know that there is a mechanism to do so without the person who left still benefiting as if they had stayed.

My Page, My Ads

A popular view is that each blogger should be paid for the pages they write. Essentially, if you wrote the entry, the ads on that page are yours. It makes sense and is easy to understand. If you write great content, you are immediately rewarded.

This approach has a drawback: there is no feeling of being on the same team. You are not building a destination site together. You could almost wonder why bloggers would team up this way, since for all practical purposes, it looks like a collection of separate blogs.

Who Pays The Editors?

Taking your blog to the next level requires more than individual bloggers. Look at TechCrunch’s staff. Not everyone is a writer, but I’m sure that each is needed for a reason.

For instance, the role of a good editor is critical: shortening blog posts, forcing authors to go to the point quickly, removing spelling and grammatical mistakes, etc. Such functions are performed for all blog entries and increase the value of the site as a whole.

Hybrid Approach

Some revenue sharing of the entire site’s content thus becomes necessary. You know that at FairSoftware we are biased toward equity-based revenue sharing. If you think of your blog as a company, then it makes sense that you pay the writers from the pool of money that is coming in.

It’s smart, so of course you will pay the best writers more. But you recognize that there is some human side to the decision of who gets what. Done well, it can be extremely motivating and fair. Left to machines and pageview counters, you run the risk of people gaming the system.

Do you think a hybrid approach would be in order, a compromise between getting paid for your pages but also receiving some share of what others on the same site are generating?