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Division of Startup Equity For Pirates

Tuesday, September 16, 2014

Daily Standup

How it normally works

We’ve been thinking about equity this week — and the problems there in. Lets invent a hypothetical SEO firm called Pirates Incorporated. No... that’s not techie enough. How about we call them, PyrateSpace. Better. Now we’ll need a Founder / CEO to start. Shortly after that, other first hires join up (assuming they’re not already there at the moment of inception.) They do what they can, for as long as they can. But inevitably, they’ll need a full staff of developers and a staff to manage those developers.

It’s a startup. As such, everyone there works really hard, really long hours. There’s camaraderie: ping pong tables, lots of drinking, and seemingly endless amounts of free cereal. Eventually there is great success. Early traction leads to more traction. Traction leads to lots of early and well respected VC. Respected VC leads to an couple incredible funding rounds. And now it’s time to exit. Luckily, the investor class doesn’t understands their product too well — but it looks like there’s a boatload of monitizable elements. Their company is then sold to a multinational, which has more money than innovation, for 100 million dollars.

Here’s the question: Where does all that money go? In most cases, it largely goes to the CEO and the early-in crowd. Which is great for them. They all get a crazy amount of money. The grunts on the ground (a group I’ll be calling “the Crew” — the development team, the marketing department, HR, etc.) have to be satisfied with whatever is left for them when it’s finally their turn at the bar.

This is a problem. Mostly because there’s little incentive in this model for the crew. They get a job, work it for 22 months, 60 hours a week, then upon exit are given an insultingly small bonus and shown the door. Their hard work made someone else rich. Do this a few times and the whole startup culture starts to loose its appeal for the crew. They end up abandoning startups all together and start looking for a larger, and more reliable paycheck at one of those aforementioned multinationals. Their experience goes with them out of the startup ecosystem, and the whole ecosystem suffers.

A Lesson From Pirates

Objectively, living on a boat at sea in the 19th century must have been awful. Death from cannon fire, storms, or infectious diseases awaited you. Your only luxuries were hard tack dinners and watered down rum. So why do it? Simple. It payed well. Whether you worked as a pirate, privateer, or in the Royal Navy the economic model was similar: chase down enemy allied merchant ships, take them as a prize, then take everything in their hold and sell it.

They had the similar division of equity problem. Obviously the Captain was in charge. His good decisions and leadership brought success or failure. But he wouldn’t have gotten very far without the crew. There were many iterations of Prize Money distribution. I’ll take a mid 19th century formula for simplicity.

All winnings were divided by eights. The Captain was allotted 2/8ths. 1/8th was divided among the next down the chain of command (the Leftenants, Sailing Master, Captain of Marines.) Another eight was divided among the warrant officers (lesser officers like carpenter, boatswain, gunner, purser, etc.) The remaining 4/8ths was divided among the crew (junior warrant and petty officers, crew.)

It would look like this: 1/8 Captain 1/8 Command Officers 1/8 Warrant Officers 4/8 Crew

Lets apply these numbers to our startup. Let’s just say, for fantasy’s simplicity, that the 100M needs to be divided just among those in the room and it’s a company of 53 people. There is a CEO, a C-Suite of 4, 12 Department Heads, and 36 everybody else (developers, marketing, HR, etc.) Divided the historical Naval way it would look like this:

1/8 CEO ($25 million) 1/8 C-Suite ($3.13 million per person) 1/8 Department heads ($1.04 million per person) 4/8 Crew ($347,000 per person)

Even the most lowly at this startup gets to leave with a nice healthy chunk of change. It’s not a bad way to end your employment. Moreover, you’re back in line to try it again. No more startup brain drain.

Also, you get to tell people that your startup’s fiscal model is based on 19th century pirating. Which is a pretty cool thing to mention at bars.

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