A frequent topic of conversation came up: the misunderstood entrepreneur. When you start a startup, even your own family doesn’t understand why you didn’t keep a “real job.”

It is extremely frustrating.

Entrepreneurs try to reason with the rest of the clueless world. They use logical arguments, explain the upside of stock-options, or how the freedom they now enjoy is worth more than the salary they gave up.

It doesn’t work.

Your mother still doesn’t get it. After one more long argument, she sheepishly asks if maybe you need money.

One day I found how to settle the discussion: “I’m OK, Mon. I bought a Porsche.”

That worked like a charm. No more concerns for my future. True story(*).

(*) minor details have been modified to protect the innocent

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?

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.