Ask HN: How do I manage equity and dilution in a lifestyle business?
I think the way it works in most startups is that you agree to an equity
split, and if one founder leaves, the company dies or you buy him
out and that's that.

The thing is, I run a lifestyle business. I've pretty much poured
all my resources for the last five years into the thing. I'm fairly
dedicated; I'm not saying I'd never give up, but I think I've already
gone beyond what could be expected of any right thinking person.

Things are going fairly well now; I mean, it is a growing market
segment with lots of investor interest, and I seem to have developed
something of a reputation. I've got an office and an employee
now (not a misclassified contractor; I'm doing it right.) and
I've got far more customer demand than I can meet at the moment.
I mean, it's not a big business, by any means; but it's more than
a hobby and there's a chance it will become something that will
return significantly more than what a bay area sysadmin can get.

If you can read my tone above, I have very strong feelings of
pride and ownership. I feel pretty uncomfortable cutting in
someone on ownership who will likely leave the company long before
I will. The problem with simply buying people out as they leave
is that if I had the cash, I'd pay them in cash to begin with
rather than screwing with equity.

Up until now, I've just been paying people cash. This has necessitated
a policy of finding people with potential who are new and training,
or finding people who are undervalued by the market for other reasons.
It has worked out fairly well for me; I like training, and I think
I'm pretty good at spotting people with potential. The crappy economy
means that lately I've been able to keep people longer than they normally
stick around.

The thing of it is, I know some people who are very good
who make fairly good money on the open market who are interested
in working for me. I'm certain that hiring these people could
make my company much stronger, but the kind of cash I can offer is
just not going to cut it, not without a pretty good shot of equity.

Take, for example, a hypothetical person I want to hire who is
worth $130K in salary and benefits on the open market (around here,
that's a competent programmer, but nothing unusual.) Say I can afford
to pay $30K a year so they can cover rent; After a year, I've
got a $100K shortfall. Assuming my company was only worth $200K
(my company is worth more, but not a lot more. ISPs go foraround a years revenue plus value of any hardware, so we're not
talking emerging social network level price to earnings ratios.)
if I was to be fair, I'd give that person half the company.

Now, I understand that most startups won't give an employee
more than 5%, no matter how little the company is worth or how
much the employee is worth... I don't think that 5% of a $200K
company plus thirty grand is going to get me a years work from
a $130K person. This whole thought experiment is an experiment
in being fair, and 5% is obviously not fair in that case.

If I give someone half the equity and the company grows at a
realistic (rather than an explosive) rate, unless they are as
excited as staying on and working for free as I am (and I don't expect
that from a rational person.) it's pretty much over. I have a
choice between continuing to work for free on the startup, with
all the downsides of working for someone else and none of the upside,
and getting a real job with an immediate 400% pay raise.

Now, if growth exploded, that'd be fine. we'd all be happy
and rich. The problem is, what if we only boost the company
by another $100K? I'm now stuck with half of a $300K company;
$50K poorer than I was last year, and now to move my own personal
net worth by a buck, I've gotta make the company $2 more valuable.

User maxawaytoolong pretty much sums it up for me:

"You just described how most startups end up. Even yc funded
startups that flop have to close up shop and the founders go
back to work at Facebook or whatever. There aren't any easy
answers to your questions."

the thing is, in the likely case of a reasonable growth curve, I
want the option of not shutting down.

There is precedent for this; I know several funded but unprofitable
startups that have been funded and unprofitable for years. They
keep going back for more funding, and because they have a very
compelling product, they get that funding.

Now, each time they go out for another round of funding, their
old investors are diluted by the new shares created to sell to
new investors. Old investors let this happen because otherwise
the company would just die, and it's better to have a smaller part
of something than a larger part of nothing, and the newer investors,
well, they feel that just maybe, the company will take off without
needing another round.

What if I could apply this same process to people who invest labor
rather than dollars?

My thought is that every 6-12 months or so, we simulate another round
of funding. First, we'd figure the difference between market rate
and what people actually got paid (I'm pretty sure I could do this
with anyone I'd be willing to work with... if it was a problem, we
could agree on those figures at the beginning of the term.)

We dilute all current stock by the amount of additional money we'd need to
pay everyone market rate, and distribute the new shares based on the
difference between a person's market value and the cash they actually
got paid. (Obviously, we'd need to agree on 'market rate' and a formula
for calculating the value of the company ahead of time, but I think
these are small things.)

This would mean that every six months, anyone who was not working would
get diluted a little bit more.