Chris Dixon

If you want to work in venture capital focusing on internet/software companies, or start one of those companies, or work as an employee in any role at one of those companies, there is only one undergraduate major you should consider:  computer science.*

I’m not saying you need a computer science degree, but I am saying it’s incredibly helpful to know computer science.  Lots of great computer scientists are self taught. But almost all of them started coding in their teens.  If you are a coder already and want to spend your college years majoring in something else for the heck of it, great.  I spent my whole childhood coding, and worked during college as a programmer, so decided to major in Philosophy because I thought it was interesting.

Why is it so much better to learn computer science in college (or before)?  Because after college it’s very hard to find the time and discipline to teach yourself coding.  On the other hand, it’s pretty easy to pick up business skills, economics and all sorts of other skills on the job or in grad school.

Why is a computer science degree so important to VC and startups?  I would estimate in about half the conversations I have at my own startup, with tech founders, and with venture capitalists, there is a moment in the conversation when we start getting technical.  Sometimes someone will even ask “Are you technical?” before starting down a topic.  The non-technical people in the room just sit there like we are speaking Greek.

It’s a shame that student enrollment in computer science is in decline.  The thinking apparently is that computer programming is increasingly moving overseas.  What these students fail to realize is you don’t need to be a professional coder all your life to find computer science an incredibly valuable major.

* There is a whole separate world of VC and startups in energy and healthcare.  In those areas I’d recommend analogous technical undergraduate majors.

I’ve gotten some emails recently from readers of this blog with questions about early stage startups.  I’m sorry if I haven’t responded to all of them yet.  I’m happy to try to answer questions but would generally prefer to do them on the blog so they can be shared/discussed.

Here’s one I got recently:

So you’re joining a startup as one of the first, or the first, non-founding members.  At the moment, the company generates little or even no revenue, but they do have a working first version of their product and a few early users.  To this point the company has been surviving on a modest amount of “friends and family” capital, which has largely been used to support the founders as they built the company and their product.  The founders, however, are convinced that a significant investment is imminent and you will be receiving a reasonable salary in short order.  They are equally certain that their product and their plan is ready to take off.

Determining a fair equity grant at this time is tricky enough; there seem to be far fewer established norms and guidelines for determining compensation in a pre-investment startup than there are following such a milestone.  To further complicate this situation, fast forward 6, 9, even 12 months into the future.  That “imminent” investment has not yet materialized and you have yet to receive any salary (though perhaps the founders have continued to subsidize themselves from the earlier friends and family investment).  The original product has been slow to build traction.  The product has undergone significant upgrades, and one or more new products have been developed, all with your input and assistance.

At this time, both sides decide to sit down and more formally address the issue of your equity grant, but by now the boundaries of your role have become even more blurred than when you first joined the startup.  To be sure, you are not one of the founders, but it seems the founders were not as far along as they believed when they brought you in.  Of course both sides are still likely to overvalue their contributions, so what guidelines and norms can you and the founders possibly look to in order to reach a fair and reasonable agreement on your equity grant?

Honestly, I’m not sure my top worry would be my equity grant at this point.  If I understand correctly, you’ve been working for a year with no written equity grant, no salary, for a company that has gotten little traction, and for founders who were way overly optimistic about their chances of raising money…? (perhaps even misleadingly so?)  I guess if you really love the vision or have no other options then you stay, but otherwise I’d recommend looking for a new job.  At an absolute minimum you should be given an option grant in writing ASAP, and I think that given your sacrifice and the uncertainty of raising any money beyond friends and family that grant should be significant.  If your skills are as important to the company’s as the founders, I’d say it should be at or around founder level.

I worked for a startup once where my equity grant wasn’t in writing.  Needless to say, when the company was sold, I got nothing.  Always, always get your equity grant in writing. Quality entrepreneurs will simply give you your grant in writing without you even needing to ask.

/* aggregate_options_strike_price = your options strike price per share * number of shares you own
company sale price is 1) if private transaction: amount paid by acquirer plus any funds in startup returned to investors,  2) if IPO = market capitalization.
note: if you assume all financings were 1x preferred, investor preferences == total amount of money the company has raised
to do:  add condition for participating preferred, graph various scenarios

*/

function my_exit_payout(  company_sale_price, your_percent_ownership, your_aggregate_options_strike_price, investor_preferences, investors_ownership_percent)
{

if (investors_ownership_percent * company_sale_price < investor_preferences) investor_converts=FALSE;
else investor_converts=TRUE;

if (investor_converts) return your_percent_ownership * company_sale_price – your_aggregate_options_strike_price;
else {
common_stock_proceeds = company_sale_price – investors_preferences.
your_percent_common = your_percent_ownership / ( 1 – investor_ownership_percent );
return common_stock_proceeds * your_percent_common – your_aggregate_options_strike_price;
}

}

The one number you should know about your equity grant is the percent of the company you are being granted (in options, shares, whatever – it doesn’t matter – just the % matters).

Number of shares:  meaningless.

Price of shares:  meaningless.

Percent of the outstanding option pool:  meaningless.

Your equity in relation to other employees:  meaningless.

Strike price of options: meaningless.

The only thing that matters in terms of your equity when you join a startup is what percent of the company they are giving you.  If management tells you the number of shares and not the total shares outstanding so you can’t compute the percent you own – don’t join the company! They are dishonest and are tricking you and will trick you again many times.

I find it really depressing how often employees, especially engineers who are so smart about other mathematical issues, don’t get this.  I felt forced to post this after talking to a friend today who told me about how a prominent NYC startup has been telling hires the number of shares they are granted but won’t tell them the percent those shares represented (“it is company policy”), or the number you need to compute the percent – the total outstanding shares.  It’s really amazing people are getting away with this simple and incredibly cynical trick.

I’ve seen many companies “split the stock” 10-1 so that instead of, say, 10M shares there are 100M shares outstanding so the absolute number of shares granted sounds really big to naive hires who don’t understand that all that matters is the percent they own.

I think every engineering school in the country should have a week-long course on the basics of the capitalization of startups.  There are other things that matter too, but far less (like the number of preferences outstanding).   I’ll try to write about these other things in later posts.

Engineers – here’s how equity is paid out in a normal company sale/IPO (assuming a “good” outcome – in the downside cases it’s more complicated as investors have preferences which act like a max() function).  You get the percent you own multiplied times the price the company was sold for (or the market cap after IPO).  That is why percent ownership is the only equity number that matters.  Don’t work for someone who tells you otherwise or won’t tell you what percent you own.

One things I’ve noticed over the years is that equity grants given to new employees soon after Series A financings are generally a bad deal for those employees on a risk/reward basis.  (By a Series A financing I’m referring the first round of funding by VCs, where the amount raised is roughly $2M or more).

Here’s how equity is often granted from the very beginning of a company’s formation:

1. Founders decide on mostly equal split over beers.  It’s all just scribbles on a napkin at this point so equity flows freely.

2. In the cold light of day, founders renegotiate, with some founders possibly getting (significantly) more than others.

3. Employees who join pre-funding get reasonably big equity grants.

4. Series A financing occurs.

5. Suddenly equity grants to new employees are sliced an order of magnitude or more from what they were prior to Series A.

(Also, toss in there along the way one founder gets disgruntled and leaves – see founder vesting).

The problem is a Series A financing usually de-risks the company far less than the equity grants drop.  If I had to graph this in a totally unscientific way it would be like this (for successful companies – as represented by the green line going straight up):

Why do the equity grants drop so much after initial VC financings?

1) There are well established norms for post VC equity grants.  Going against them generates a lot of resistence from VCs.  By way of example, here are directionally accurate although probably 2x what I have typically seen post Series A.

2) Compounding this, after a financing the founders probably just got finished arguing for a smaller option pool to reduce their dilution, and it’s seems very hypocritical after that to argue for greater-than-standard equity grants.

3) The company now has an arms length valuation, probably in the multi-millions of dollars.  Suddenly 1% is worth “real money.”

The best time to join a company is at the very beginning – to found or co-found the company.  The second best time is to join before venture financing.  The third best time is when the company has started to ramp sales/traction – at that point your equity grant will be small but at least the company will have a much higher likelihood for success.  The worst time, from my experience, is right after initial (Series A) VC funding.

The flip side of this argument is after the company raises venture financing, an employee is more likely to get a “market” cash salary.  Personally I’d rather see people get bigger option grants post Series A and sub-market (or better yet subsistence) cash salaries – until the company is cash flow positive.  This is pretty much the opposite of Wall Street’s compensation schemes.  To me, as a principle, that means it’s probably a good idea..

A friend asked me recently if I knew of any good guidelines for dividing up equity between founders, and specifically what to do in the case when a co-founder provides seed capital.

The truth is I don’t know of any great guidelines – this is seems to me a very case-by-case decison.

Obviously the main consideration should be the relative importance of each founder to the future prospects of the venture.  And, as in any negotiation, the alternatives each person has will also factor in.

Probably way too many founders divide things evenly just to avoid a difficult conversation.  Most likely, this will lead to a difficult conversation down the road (or worse).

(As an aside – you should also figure out titles early on.  When founders say “we are co-CEOs” or “we don’t have titles” that more often than not means there is a big fight looming.  Startups are little dictatorships for good reason.)

One thing I’ve also noticed is people tend to overvalue past contributions (coming up with the idea, spending time developing it, building a prototype, etc) and undervalue future contributions.  Remember that an equity grant is typically for the next 4 years of work (hence 4 years of vesting).  Imagine yourself 2 years from now after working day and night, and ask yourself in that situation if the split still seems fair.

Another consideration is if one founder has had greater career success and will therefore significantly improve the odds of getting financed at an attractive valuation.  One way to figure out how much this is worth is to estimate how much having that founder increases your valuation at the next financing and then, say, split the difference.  So if having her means you can raise $2M by giving away 30% of your company instead of 40% of your company, let that founder have an extra 5%.

If one founder had the idea for the company, it is sometimes reasonable to give that person additional equity.  If that idea involves a bona fide technology breakthrough, they could be entitled to considerably more equity, say 10-20% (or you may have to give some of that to a university or other IP owner). But if the idea is more abstract and doesn’t have real IP behind it (“User generated X” “A marketplace for Y”) that should only earn a few extra points of equity, if any.

If one founder is providing seed capital, assuming there are no other investors involved, the best way to do this is a simple interest bearing (say 5% annual rate), non-convertible loan to the company. I did this once and just had my partner write an IOU on a single sheet of paper, without using lawyers.  When you raise further money the best thing is to have that loan convert into equity at the same terms as the rest of the investors (it looks a somewhat bad to investors to take their fresh capital and pay it right out to a founder – unless the founder is in dire financial straights).

The reason you want to avoid granting equity for a founder’s seed capital is 1) it would cost a lot more in legal fees and 2) you would have to come up with a valuation without a 3rd party, arms length offer.

If there are multiple seed investors, including non-founders, things get more complicated and you might have to resort to a convertible note or full blown equity round.

A frequent question entrepreneurs have when they are just starting their company is:  how secretive should I be about my idea?  My answer:  you should talk about it to almost anyone who will listen.  This includes investors, entrepreneurs, people who work in similar areas, friends, people on the street, the bartender, etc.

There are lots of benefits to talking to people.  You’ll get suggestions for improvements.  You’ll discover flaws and hopefully correct them.   You’ll learn a lot more about the sector/industry.  You’ll learn about competitive products that exist or are being built.  You’ll gauge people’s excitement level for the product and for various features.  You’ll refine your sales and investor pitch.  You might even discover your idea is a bad idea and save yourself years of hitting your head against the wall.

In terms of the risk of someone stealing your idea, there are at best a handful of people in the world who might actually drop everything and copy your idea.

First of all, most people will probably think your idea is stupid.  This does not mean your idea is stupid.  In fact, if everyone loves your idea, I might be worried that it’s not forward thinking enough.

People at large related companies almost always think they have already built or are in the process of building all the good ideas – so your idea is either something they are already building (which is a good thing to discover early) or else they will dismiss it as a bad idea.  (I have a personal diligence rule that when speaking to people at large companies, the facts that they tell you are very useful but their opinions about startup ideas no more valuable than any other smart person’s opinions).

In terms of speaking to other entrepreneurs, the vast majority are already working on something and are highly unlikely to drop everything and copy you.  Even if they are in the idea generation phase, high integrity entrepreneurs wouldn’t copy your idea anyways.

VC’s will either not like your idea, or else like it and possibly want to fund you.  They vastly prefer funding an existing team than taking an idea and building a team.  The one risk is if they have entrepreneurs they are working with in a similar area (see next paragraph).  Most VCs have enough integrity to disclose this and let you decide how much detail to go into.

The handful of people in the world who might copy your idea are entrepreneurs just starting up with a very similar idea.  You can probably just explicitly avoid these people, although by talking to lots of people your ideas will likely seep through to them.

Even if your idea gets in the wrong hands, they will probably just get the high level “elevator pitch” which isn’t worth much anyways. Hopefully by that time you’ve developed the idea much further and in much greater detail – by talking to as many people as possible.

A note about NDAs:  1) almost no experienced entrepreneurs/VCs will sign them (in fact, you asking them too is widely considered a sign of inexperience), 2) It’s not clear they have any real value – are you really going to spend years suing someone who signed an NDA?  I’ve personally never heard of it happening.

Joining a startup is far less risky than most people seem to think.  In fact, I don’t know if anyone has ever studied this systematically, but I would bet that people who join startups have greater job security than people who join large companies, and certainly have better risk-adjusted returns.

Here’s why:

- Big companies aren’t as stable as you think:  I graduated business school 6 years ago.  Very few people in my class created or joined startups, instead opting for “safe” companies like… Bear Stearns, Lehman Brothers, Ford, hedge funds that no longer exist, etc.  Meanwhile, everyone I know who went the startup route has had job security and been successful – in some cases spectacularly so.

- Big companies aren’t loyal to employees:  When there are cuts at big companies, they tend to just use a hacksaw and not consider how loyal you’ve been or how hard you worked.  The people who survive are often the ones who happen to be in certain favored divisions or are good at playing politics.

On the flip side:

- Startups that have financing pay pretty well:  If the startup you found or join is VC backed, you usually make market or near-market wages (in addition to the potential upside you get with equity).   Even if things go south you will probably have broken even financially and learned valuable skills.

- Startups tend to be much more loyal to employees:  For example, in the recent downturn I know of a number of startups where management took pay cuts (in some cases took their pay to zero) before laying anyone off.  Experienced startup managers know how devastating layoffs can be to morale and to their own reputation and tend to avoid them at all costs.  Moreover, even when there are layoffs they tend to be based on merit and loyalty.

- When you join a startup, you are also joining a network –  You aren’t just joining a company – you are joining a network of employees and investors who – regardless of the fate of the startup you join – will inevitably go on to do interesting and successful ventures.  If you impress them, they will bring you along.  I know of many cases where startups failed but employees went on to flourish at the founders’ next startup or another company their VCs invested in.

In short, just because startups tend to fail more than big companies doesn’t mean joining a startup is riskier than joining a big company.

The most important term in a startup term sheet that no one seems to think carefully about is founder vesting.   There are two key points about vesting:

1) All startup employees – including founders! – should vest over 4 years from their start date (with a one year “cliff”).  When I used to work in VC I can’t tell you how many companies I saw where some random former founder who was long gone from the company and was only there for some short period of time owned some big chunk of the company.  Not only is this just plain unfair, it also means there is a lot less room for giving equity to employees and for raising new capital.  Even if you are founding a company with your best friend – actually, especially if you are founding a company with your best friend – everyone should have vesting.   If you have a lawyer who tells you otherwise, get a new lawyer.

2) Founders should always have acceleration on change of control!  In particular, you should have full acceleration on “double trigger” (company is acquired and you are fired).  In addition you should have partial acceleration on “single trigger” (company is acquired and you remain at company).  I prefer a structure where you accelerate such that you have N months remaining (N=12 is a good number).  This gives the acquirer comfort that the key people will be around for a reasonable period of time but also lets the founders get the equity they deserve without spending years and years at the acquirer.  Consider the scenario where your company gets acquired 1 year after founding and you have 3 years of vesting remaining.   Suppose further that you just aren’t a big company type and leave after 1 year.  In that case you would forgo half your equity.  It’s always surprising to me how much time founders spending focusing on valuation that might change their ownership by a few points when vesting acceleration (albeit under certain circumstances – but I have seen this happen) can have a far larger impact on their ultimate equity ownership.

Tom Pinckney was VP Engineering and co-founder of SiteAdvisor (along with me and Doug Wyatt) up through and beyond SiteAdvisor’s acquisition by McAfee. Tom sometimes gets asked by friends who are starting internet companies what to look for in potential VP Engineering hires, so we thought it might be helpful to put Tom’s thoughts down in writing here. (In addition to being co-founder and VP Engineering at three VC-backed startups, Tom has a BS & MS from MIT in Computer Science). Here are Tom’s thoughts:

This is based on my experience with very early stage Internet companies. I’m sure if I were building an ethernet switch I’d want someone different. But if I were building a website, whether for consumers or other businesses, this is what I’d look for.

Note that we think of the VP Engineering role (as opposed to the CTO) as the person who makes software that gets built on schedule, on budget, in a reliable, scalable way etc. You might also want a CTO at your company to think of big, creative ideas but often those people aren’t good VP Engineers.

Technical Skills

1) They are comfortable with web-speed development — release every week, ok to have minor bugs on the site vs never getting a release out etc. You don’t have any users right now so you can afford a few bugs. In six months you will have users and then you can start worrying more about having more process.

2) They are not overly process oriented — you’re not building the space shuttle so don’t need to spend three months designing the next release. You do need to know how the big pieces of the problem will interact with each other and what the overall system architecture will be. No Gantt chart experts, non-techy people managers, or high level big company guys who haven’t been hands on in years.

3) They are someone who can architect the system, understands how to test/QA a site, what IT needs to do to keep the site running fast and reliably. They need enough technical expertise in all areas to see how each person’s work affects other people’s work, what it’s inputs and outputs are, see how each piece fits into the rest of the system, judge trade-offs being made, estimate complexity, timelines etc.

Make sure they can talk in intimate detail and have opinions about all of this. How should the DB clustering work? What exactly were the test scripts checking and how did they get written so that as the software changed all the scripts didn’t have to get thrown out? That sort of thing.

4) They have experience using open source technologies such as MySQL, Apache, Java/Python, Linux etc. I’d avoid people who want to use MS
technologies since you have to pay a lot for it and most of the kids these days want to work on the open source stuff.

5) They are someone who can code and wants to code on day one and could even build the first version of the system, but understands that by day 365 they won’t be coding any more. You’re not so big that you can afford anyone who just manages in the early days.

6) They can architect the system in a way that developers can build your project with maximal parallelism and so that computers can run it with maximum parallelism so that you can scale to the millions of users, terabytes of data, or whatever it is you need to do.

7) They should prefer the simple to the Baroque. Most simple, reliable and quick-to-build systems can also be built as a complicated, slow, bug-laden piece of software too. Every line of software that doesn’t exist because of your simple design is a line that has no bugs, can’t slow the system down, and won’t take time for new developers to understand. Can they talk about how they design things to be simple, what they gave up to make the system simple, etc?

Personal Skills

1) Watch out for people that seem dogmatic about unreasonable things (”Anyone who uses Postgres instead of MySQL is an idiot” etc etc) (Note, see my comment above about anyone that uses Windows technologies being an idiot).

2) Watch out for empire builders or people who need lots of resources. Do they believe they can build anything with a couple of great guys or have they never worked with a few great people before? Do they want to hire a large over-seas staff because everyone else is doing it and it will look good on their resume? Do they know so little about things that they need lots of expensive tools or consultants?

3) They should be outgoing, fun, intense people. No one likes to work for a low energy introvert. Ask them why they want to manage instead of coding. See if they are an engineer who got promoted into management because they wanted the higher pay but really would be happier just coding all day and not interacting with people. A lot of people aren’t into managing but end up doing it for the money. Or maybe they are an ego maniac that needs to be in control since otherwise no one pays attention to them?

4) Are they really excited about technology, do they do techy things in their spare time, etc? Do they talk about how they programmed for fun in high school or wax poetic about the cool game they wrote back in the day?

5) Most technical hiring is about convincing engineers that your problems are the best to work on and that the rest of the team are super smart people, so your VP Eng will have to be able to pitch this.

6) The ideal VP Eng could build most parts of the system themselves, but they’re self-confident enough to work with people better then themselves too.

7) They should be hungry to step up and prove themselves. Ideally they have been a tech lead or had some managerial exposure already, but are
eager to step up and build something even bigger then they’ve been responsible for so far.

Where do you find someone that has these qualities?

Unfortunately, there’s not one good answer. I’ve seen people have good luck by having a recruiter target specific companies. Your personal network is obviously the ideal way so that you can get trusted references. If you have outside investors, their network might be useful too. We’ve had basically no luck using job boards like Monster and Hotjobs.

I think it’s hard for people with no technical background to interview a VP Engineering candidate. If you don’t have a technical background, have someone technical (if not someone full time at your company, perhaps an advisor or board member) interview with the candidate as well.