A few months ago, I wrote a nuanced post detailing the phenomenon of startups who get people to work for them for free. In How To Get Free Labor for Your Startup, I walked through the typical ways that founders delay proper compensation in the early days to give their startup some much-needed runway.
Working for free is a common practice and even a necessary one at that. Most truly new ideas need true believers to get them into an executable state, let alone a revenue generating state. We entrepreneurs are gamblers in that sense, willing to put our time, money, and effort into a dream in the hopes that the payoff will return on that investment exponentially.
That only becomes a problem when we start asking others to share that risk, especially those folks who aren’t co-founders.
I’ve been burned before, as an employee and as a co-founder. More than once. So in that same post, I also warned heavily against doing free labor wrong, and how a lack of transparency and a lack of timeline in a company’s early compensation plan can lead to disaster for both the employer and the employee.
Those warnings need to be louder.
When Everyone Starts Suing
To drive the point home of how worst-case-scenario free labor can get, last week I got an email via my website that opened with this question:
Am I able to sue a start up that just kept making me promises and doesn't seem to be coming through?
The author, whom I’ll call “Fred,” had been working for the startup for over a year with no compensation whatsoever, just promises of a healthy full-time salary and a small bit of equity… someday. Fred was planning on leaving, but felt like he was owed something for a year of unfulfilled promises.
First let me clarify how bullshit that deal is. Founders should never wave that kind of carrot for that long to any employee who isn’t a co-founder.
Then, let me state the obvious. Unless there is some kind of contract detailing the promise, chances are slim-to-none that Fred is going to see anything.
Make no mistake, there are all sorts of legal ramifications when creating a company, from who gets what-sized piece of the initial pie to patent trolls coming after you when you exit.
Fred needs an attorney, or more specifically, Fred needed an attorney a a year ago. If you’re starting a company, cofounding a company, or going to work for a startup that isn’t offering a traditional compensation plan with a fully documented employee equity offering, you need to sign something, and you need to run it past an attorney before you sign it.
Spend the money now to save the heartbreak later.
The Co-founder Caveat
Here’s where I start explaining the “Unless…” part of the title of this post.
There are indeed times when you should work for free, whether that’s co-founding a company, joining a very early startup, or just doing business for a promising client. It’s risk, and startups need to take risk. You just need to go into that risk with eyes wide open.
There are two boxes you need to check before you get too deep into any kind of free labor: 1) What’s the reward? 2) What’s the timeline?
The only time you might want to skip checking those boxes is if you’re a co-founder. Being a co-founder of a company comes with a very vague sense of reward and timeline, so no one is going to have any answers to those questions that early. But you still need documentation. So before we talk about employees, let’s first talk about equity for co-founders.
For us entrepreneurs, there’s nothing more exhilarating than falling into a great idea that has a chance to become a great product or great company. These ventures usually start out as hobbies, or projects, or even conversations, sometimes over drinks.
There’s nothing wrong with collaborating with someone you trust on a fun new thing that could be a big thing. But at some point, one of you has to raise their hand and start talking about who owns what and who is going to do what.
This shouldn’t happen too early, because a lot of great ideas are killed by the territorial nature of ownership. But before too much money starts going out or coming in, there should at least be a document that parses out ownership of the venture and the vesting timeline of that ownership, preferably drawn up by an attorney. At the very least, the loose partnership should evolve into a corporation or LLC.
Employee equity is a crazy thing, in that it’s something every startup hands out even though everyone involved knows that its value can’t be determined other than the fact that its current value is nothing.
Equity is usually offered as a make good for a less-than-desirable early salary — again, this is a necessary evil to give the startup as much runway as possible so that it can reach a revenue level where it can start paying competitively. Once that happens, the equity then becomes what it was meant to become: A reward for taking on risk.
That said, a less-then-desirable salary shouldn’t mean NO salary.
When a startup starts hiring rank-and-file employees and comping with all or mostly equity, it’s probably not a great idea for that startup to be hiring employees in the first place. It usually means the CEO is flying by the seat of his or her pants. It also might mean that there’s a lot of early equity being thrown around, and it’s all going to get diluted to next to nothing if the company raises money or hires even more employees.
It happens, and like I said, it’s often necessary and it can be very valuable under the right circumstances.
Regardless, the promise of equity should never be just a promise. Because of its nature as a valuable thing that has no present value, equity can and should be accounted for from day one. There should be a cap table and legal documents defining what employee options mean, how much they’re worth, and when they vest.
If Fred didn’t get those documents, Fred has no equity. Fred has a promise. Never work for promises. No exceptions.
Salary is a different story because writing IOUs for salary is even more worthless than granting options for equity.
There is rarely a time when talent at a startup is going to be paid what they’re worth. Money is scarce in startup, because it always comes from one of two sources: Outside investment, which expects an outsized return, or early revenue, which is always less than what it takes to be able to afford growth.
You can think of early employees at a startup as investors as well, paying for their options with deferred salary or straight up underpayment for their worth.
So yeah, you should probably ask to see a table for this as well.
It’s OK to work for a deferred or reduced salary provided you have something in writing that states what the initial salary is going to be, what the full salary is going to be, and a timeline of the steps in between. The timeline should be milestone-based, so there is no question as to when the new levels kick in. For example, when the company reaches $1 million in revenue or when the company closes a Series A investment.
A contract like this won’t prevent malfeasance, but it will make it harder to hide the fact that the startup is not growing as quickly as the founders are leading everyone to believe, which is probably exactly what is happening to Fred. It also forces company leadership into a growth plan. Surprisingly, this is a step many startups skip, especially those conceived by friends over a few drinks.
How Long Is Too Long?
So how much time should pass before a startup employee gets paid for their output? I can’t give you an exact answer, but I can tell you that what you’re watching for is stagnation.
If the company flounders and fails, the answer is clear. If the company hits its marks and milestones, the answer should also be clear, especially if the employee has the proper paperwork in place as described above.
If the company is treading water, always on the verge of that first big windfall moment that’s going to propel it to the next level, then it comes down to a matter of belief.
Do you believe in the company?
Do you believe in the product?
Do you believe in the leadership?
Those are the three reasons you decided to work for free in the first place. If any of those answers flips to “no,” sleep on it, and if it’s still “no,” it’s time to take action.
You don’t necessarily need to walk, but you may need some kind of sweetener to take on what has become decidedly more risk. This could come in the form of a partial payout on deferred salary, a slightly larger chunk of equity, or some other benefit to keep you on board.
Just keep in mind, those kinds of things are just going to make the runway shorter and the struggle to get to revenue harder. And the glow of those benefits rarely last. Be careful that you’re not just sliding into the same trap.