Rethinking Founding Engineer Equity

The status quo for Founding Engineer compensation is broken. It’s unfair, outdated, and doesn’t work for founders or engineers.

A startup starts with the founders doing all the work. The founders write all the code and they talk to all the customers. If the startup is doing well, there is more coding and talking to do than the hours in the day, and you need to hire some help. This help will almost always be a technical hire.

The job title “Founding Engineer” was invented to describe this role. It is kinda-sorta like a founder, but not a founder. You do similar work to a founder, but a little bit less. You take on similar risk to the founder, but a little bit less.

This is all fine, except for one part. These roles offer similar compensation to the founders, except it’s a whole lot less.

Similar risk for 50x less reward?

The exact numbers vary, but the typical equity grants for founding engineers are in the range of 0.5% to 2%. You can get a sense for it if you scan YC’s job board. Getting 1% is typical, and it comes with a one year cliff and a four year vest. These grants are given to the first one or two engineering hires, and many of these companies have YC as their first and only investor.

Assuming two founders and a 7% stake by YC, the founders retain 48.5% equity. That means their stake is anywhere from 25x to 80x larger than the Founding Engineer’s stake.

To illustrate this in dollar terms, consider an acquihire exit. At 1% of $10 million, the acquihire nets the Founding Engineer around $100,000, enough to buy a nice Tesla. Meanwhile, the founders net $4.8 million, enough to buy a house in Palo Alto, a small yacht, and two nice Teslas.

The founders certainly took on more risk, but not 80 times more. The risk reward ratio is completely out of proportion, and it's profoundly unfair to the Founding Engineer.

When liquidity?

Even if you ignore the reward proportions, there’s another problem with startup equity: liquidity.

Most startups put a one year cliff on your vesting, which means if you work there for 11 months and 29 days, you don’t get any equity at all.

But even once you start vesting, there’s another problem: you can’t sell your equity. There are no market makers for a typical startup's equity, which means there are no buyers and no sellers. You could try a second market deal, but even for Series A startups those markets are slow. Good luck trying to sell pre-seed shares.

Even mature startups have thin liquidity. When I worked at 23andMe, we had a once a year liquidity event, and you had to sell a large number of shares with high fees. If you missed the event, you had to wait a whole year before you could sell again.

Many VCs will tell you this is for “long term alignment” and to “maintain incentives.” It’s all shenanigans. These are the exact same VCs that happily jumped into failed crypto projects for short term gains (or cashed out successful crypto pumps by dumping on retail). Don’t believe their lies. With VCs, it’s “long term alignment” for you, and “cash now” for them.

Who this works for

This equity model works in some situations. It works in when the founders are bringing 50x more value than the Founding Engineer, for example:

• Famous founder. If your startup has a famous founder like Sam Altman or Elon Musk, the equity is instantly valuable. A Sam Altman type brings so much weight to a startup that the absolute worst failure case is a $100 million exit. The best case for normal founders is the worst case for a famous founder.
  
  
• Brand name investors. If your startup has brand name investors like YC or a16z, it puts a floor on the exit value of your startup. If you fail, you are very likely to get acquired for a decent amount by virtue of your connections. Additionally, these brand names bring a little bit of guaranteed success, especially for B2B startups.
  
  
• Proven hypergrowth. If your startup is experiencing hypergrowth, like growing revenue by 2x monthly, then it has been de-risked substantially. At this point, you’re no longer an early stage startup, you are hiring regular engineers, not “Founding Engineers.”
  
  

If one of these applies to your startup, then you are justified in offering 50x lower equity to founding engineers. But if you are in the vast majority of startups that do not fall in these buckets, your equity offering is out of line with the risk-reward for a Founding Engineer.

Who this doesn’t work for

This equity model does not work for tiny, no-name startups, like FetchFox.

Here at FetchFox, we very much want to hire great engineers. Our goal is to build a super reliable, easy to use system on top of two super unreliable, flakey systems: LLMs and proxies. This is hard. We run into subtle errors and difficult to reproduce bugs. We are competing against larger teams with more funding and huge incumbents. We need engineers who can frame problems well, figure out leveraged solutions, make good tradeoffs, apply both intuition and empiricism, and quickly write high quality code.

The great engineers we want to hire are always in demand, and they are super rare. They have the option to work at FetchFox, or they have the option to work at OpenAI for the same salary. When they see a 1% equity offer, conventional wisdom tells them to discount it down to zero after accounting for risk and time horizon. Meanwhile, the 0.005% equity offer from OpenAI will buy them a nice house in Palo Alto.

There are intangible benefits to working at an early stage startup like FetchFox: perhaps you want to own an entire component of the project, perhaps you enjoy the early stage startup experience, or perhaps you just like the vibe of the team. But these intangible benefits are stacked against the very tangible realities of cash compensation and exit liquidity.

A 10x better model for Founding Engineer compensation

FetchFox is inventing a new model for Founding Engineer compensation. Our goal is to solve the problems with the current model from above: disproportionate stake, and improbable liquidity.

First, we are dramatically increasing the stake that Founding Engineers receive. Generally we offer between 5% stake on the low end to 25% or more on the high end to the first few engineering hires. There is some tradeoff here with cash compensation. We believe this is a much more fair range that accounts for the risk and expected contribution for Founding Engineers.

Second, we are changing the vesting structure. We do have a vesting system, but you begin vesting your stake almost immediately upon joining the company. We do not have a one year cliff, and your stake does not expire if you leave the company.

Third, and most significant, we do not offer equity stakes using conventional instruments. We do not offer stock or options or equity in the traditional sense. Instead, we offer a crypto token. This is a utility token that will be deployed under the ERC-20 standard, and live on the Ethereum blockchain. It will be set up so that if the product does well, the price of the token goes up, and if the product does badly, the price of the token goes down. You can read more about the details of the token in a sister article.

Finally, the founders and employees get exactly the same crypto token. Only difference is that the founders get a larger allocation of that token. In my case, I am taking $0 salary at FetchFox and my entire upside and compensation is through the token that me and Founding Engineers are getting.

As far as I know, very very few, if any, startups outside the crypto space use tokens for employee compensation. I believe this is out of habit, not rational analysis, and I predict that in the future, many many startups outside the crypto space will use tokens for employee compensation.

Using a crypto token gives our employees a very important, 10x improvement over traditional stock grants. A crypto token enables continuous, 24/7 liquidity within the first months of the startup's life. No more waiting for a liquidity event that is contingent on the founders needs: you can sell anytime from day one.

Due to the unique structure of crypto AMM’s, any crypto token has infinite depth. Yes, infinite depth. A crypto AMM can absorb a token sale of any size, any time, zero sweat. It might not be at a price you like, but the option is there. If you haven’t read about them, I highly recommend learning about the math and intuition behind crypto AMM curves.

What crypto AMM’s offer is better than the liquidity you get at a brand name startup (it comes a few times a year at best), better than you get on second markets (which have high fees and takes weeks to close), and even better than the gold standard of an IPO (these are closed on weekends, and have nasty employee lockout periods).

Tradeoffs mean it's also 10x worse

While I strongly believe that a crypto token is a 10x better model for early stage startups, there are downsides. Any innovation that is 10x better in some dimension is 10x worse in another. Let's consider some of the downsides of the crypto token model.

First, granting a large amount of equity creates a signalling problem. If all the other startups are giving 1%, and FetchFox is giving up to 25%, does that mean FetchFox is a worthless company? It doesn’t, but many people will conclude it is.

Second, early stage startups are very volatile, and small cap crypto tokens are also volatile. Combine these two and you get volatility squared. This may create upset employees who could see their token grant values go up or down an order of magnitude overnight.

Finally, there is still a reputation risk associated with crypto. Mentioning crypto will set off alarm bells for some people, and it will often derail conversations because of its association with all manner of scammers.

Fortunately, these downsides are a necessary and worthwhile tradeoff. They are mostly related to perceptions (or misperceptions), and much of the impact can be mitigated by managing expectations. And remember that a startup should make a small group of people very happy. It should not make everyone mildly ok.

It’s not for everyone, but maybe it's for you

I recently told the CEO of a recruiting agency about this compensation model. She told me that if you even mention crypto, more than half your engineering candidates will immediately say “no” to your company. The word triggers people, and many will wonder if you’re trying to pull some kind of get rich quick scheme. Even rational people will decide the risk model is not for them, or they don’t want to be guinea pigs on a new compensation model.

However, we don’t need to hire lots of people here at FetchFox. We just need a handful of really great engineers. I am betting there is a niche group of great engineers who will view this compensation as a huge big positive, and be excited to join us.

If that describes you, please email marcell@fetchfoxai.com to chat about joining the team.

— Marcell Ortutay, Founder/CEO, FetchFox