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Employee Equity (2014)

blog.samaltman.com

88 pointswilliswee74 comments

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I work for a top-5 YC investment (by current valuation) and none of the things Sam discusses are true of our company:

-Employee equity is much lower than his recommendations.

-We have 90 days to exercise options.

-They refused to tell me what percentage my equity represented when I applied.

-They refused to tell me information about burn rate/money in the bank when I applied.

I still took the job, because money was not a primary motivating factor, but it is disappointing to see one of the most successful YC investments fit none of his criteria. He goes so far as to warn readers to "be very suspect of any startup" that doesn't provide this information. I understand that Sam does not personally control what decisions YC portfolio companies make on these topics, but I certainly hope that he guides them strongly towards the recommendations he has made here.

> They refused to tell me what percentage my equity represented when I applied.

Did they tell you how much the equity was worth? You could take the latest round they raised and divide by that.

If it's a top-5 YC company, I assume it's relatively older. This post is probably based on thinking and lessons learned over the last few years - why would he have needed to write it if older YC companies didn't have the bad structures?

It is crazy that this stuff that was well down and discussed on HN itself over the years was somehow unknown to YC. When I was a startup employee noob five years ago I learned all the advice of this article, from reading HN.

+1 can vouch I have had similar problems with YC companies, though not as bad as mentioned here. I think it's important to remember YC companies are totally free to ignore the advice of YC, especially if they believe (perhaps mistakenly) that they'll succeed doing so.

That said, I've had still had very positive experiences with other YC companies.

So I've been looking at startup jobs on AngelList lately and came across many postings claiming to give "significant" equity. And then I scroll up and usually see something along the lines of 0.1%-0.2%.

Now I'm not exactly an expert on the intricacies of employee stock options, but simple math indicates that 0.1%-0.2% translates into 1-2 million for a billion dollar company.

Sure, 1-2 million is a decent amount of money, but that's before taking into account factors like dilution and opportunity costs of the associated golden handcuffs. The chances for a given startup to grow to a billion dollars is minuscule to begin with, and working at an established tech company could easily net you that same 1-2 million within a few years with none of the risks. And considering that the founders' equity will be worth hundreds of millions for that same billion dollar company, calling 1-2 million significant just feels downright condescending.

You have to look at the 0.2% in relation to the salary that they offer. And, many companies do allow you to negotiate the salary vs options trade-off.

>And, many companies do allow you to negotiate the salary vs options trade-off.

That's definitely true in principle. But in practice, it might not be a great idea.

I actually tried to negotiate the salary vs options tradeoff recently, and I feel it didn't end well because even though I tried to be as objective as possible, the fact that I didn't want equity might have given the impression that I didn't really believe in the startup (which was true, since I really didn't believe they had any chance of becoming a billion dollar company, but it's not the kind of impression you'd want to leave if you want the job).

So, the process worked. The company finds people who have the most interest in the company's success, within the set of hirable candidates

Aka, people they can rip off the easiest. I m not saying they can't do this, but I want more people to not agree, because it's a bad deal and makes the market worse off for employees.

You can be interested in the company's success without being delusional about the limits of its potential for success.

> You have to look at the 0.2% in relation to the salary that they offer

I disagree. Salary is a real thing that you can use today. Options at a start-up? Some studies indicate that start-up failure is at 90% within the first 3 years. This means those options, 90% of the time, don't mean anything. They're literally useless.

The other 10% of the time? Depending on percentage, dilution and exit (IPO? Sale? Neither?) it's still difficult to get a return on those options in any reasonable timeframe.

In my opinion you should NEVER sacrifice salary for options UNLESS it's an established company where you can see how to get your money out of those options. There is a TON of competition out there for talent, if a company wants a quality candidate they will pay for one.

I agree, but unfortunately that's not how it works. All founders believe that they can succeed. Every VC believes that their investment is going to become the next billion dollar company, etc. Ideally, options are the icing on cake, but the reality is that most companies use options as a way to reduce their immediate expenses - for start-ups, cash is like oxygen. Most start-ups die not because of their competition, but they run out of money.

What study is that?

In any case, success is (mostly) not rolling a dice. Good planning, strategy, skill, and past experience make a huge difference.

I doubt 10% chance of success is the best you can do.

And by co-incidence, I was ranting about the same thing on Twitter https://twitter.com/HashNuke/status/670118075841187841

0.1% is hardly anything to make it worth a pay cut to take risks.

As for more equity: founders have a qualitatively different risk profile than employees. I've been running my startup for over two years, and I am the lowest paid person on our team. I have to defer having a family and can't enjoy the things that my employees enjoy. I also can't ask my employees to work harder than me, which means I have to work harder than everyone else. A couple of times I had to cover payroll with my credit card and would have been bankrupt if we didn't pull through. If things get tough an employee can jump ship at anytime, while I will be going down with the ship. And at the end, if I'm lucky I end up with 5-15% of the company. I'm not complaining, this is what I signed up for, but employees can be very well compensated in today's market prior to equity upside.

Allow me to disagree slightly with this, in the cast of early (number less than, say, 10) employees. My (hard-earned) experience here is as the first engineering hire, functioning as engineering lead.

We have the same (maybe even worse!) risk profile: we are being paid below market rates (because small startup), we probably don't have healthcare or benefits (because small startup), we have the majority of the burden in terms of actual leadership (because we probably have been hired with the explicit intent of having us grow the team, tech, or sales). We don't get the glory or good press that the founders do (because we're just employees, lol). We don't get the same access or transparency to the business decisions (because we're not founders).

If the business folds for the founders, they shut it down, walk away, and maybe have to file some bankruptcy. In exchange, they get to join The Magical Founders Club, wherein they can parlay their experience into speaking engagements, recruiting for new gigs, senior-level business and tech positions (regardless of skill), and funding from investors.

When the startup folds for early employees (or exits in such a way only the founders are taken care of), the result is whatever personal harm comes of stress and health issues (if not taken care of b/c of bad benefits), the net loss of however much time spent working at below market prices, potentially no portfolio work (because a lot of companies are shitty about NDAs and proprietary software), and so on.

For third or forth wave employees, sure, it's just another round of job hunting. For the first folks who actually had to build the business, well, it can really suck.

EDIT:

A minor elaboration...Micheal O'Church in an essay made an interesting claim that the founders and employees are no longer considered in the same class, compared with the 90s.

My observation has been that founders will merrily maintain three orders of magnitude of equity while doing very little more than their first few hires. In fact, they may be doing less work, because they are inexperienced and spend time doing the wrong things because they don't know any better and are senior enough they feel they can ignore advice.

If you are the eng or sales lead at a startup, you can blog and tweet and sprinkle the magic founder dust on yourself. There is no Office of Dust Control .

Nope. But the level of interest you'll draw is substantially lower. You can also declare yourself a celebrity of some other kind -- there is no Office of Celebrity Control. But similarly, it doesn't work as well.

Couldn't agree more. It's the same for business / marketing / sales folks too.

This incentivizes people to be founders, because first employees get a terrible deal (comparatively).

It's odd that we reward people that "simply started the company" to such a great extent. Especially since "starting a company" is not the difficult part.

If by market rate, you mean $250k per year at Google, then yes, most startups will pay below market rate, but it's a competitive market for talent and it's very hard for startups to attract good talent. You need a generous compensation package and a compelling mission.

Everyone on my team makes 2x - 3x what I make, and I'm three years into my startup. I wouldn't expect a non-founder to assume that same burden. Moreover, if we fail I'll have no savings, I'll likely have gone bankrupt trying to save the company, and that Magical Founders Club you speak of really only exists for founders who built a successful company and had an exit for their investors.

You also mentioned stress and health issues. I'm not sure why founders would be immune to that. They should have it far far worse. Heavy is the head that wears the crown.

You'd be amazed at the number of companies in the Midwest that balk at paying devs above 65K, even for senior level work.

As for your company--if you fail and it wipes out your savings, that was your choice as a founder. There is no golden rule saying you need spend anything more than what is necessary to file bankruptcy. There's a reason it's called a limited-liability corporation.

And yes, being a founder isn't easy (did that, flamed out, f--- would not recommend on amazon), but at the same time the sort of stress is quite different than the ongoing exploitation and powerlessness that you can find as an early employee faced with misbehaving founders. At least as a founder you have some degree of control.

Great writeup - I recently had the opportunity to join a startup as an early employee and ended up turning it down (by way of asking for "too much equity"). Every time I read comments like this, it only reinforces my decision.

I don't mean to sound disparaging, but I assumed that the modern funding landscape would have changed all that - with the right level of investment one should not have those horrors. Additionally what market signals does "barely covers payroll" say to prospective employees?

There are (say) two Startup profiles - grow steady and go for the moon. I would assume Inwoukd not go for the moon unless outside investors had covered my ass. Otherwise all this bad things would be a huge risk for me.

I am not a risk taker it is obvious, but if you have the right idea, a good team, then all that is needed is time ? Is this not actually true?

Initial VC and follow-ons, statistically, are not as easy as headlines make it seem.

Likewise, for "organic", key is to remember that growth is crucial to a startup ("grow or die") vs. small business, and at early stages, the step function around big salaries sucks.

Ex 1: SaaS where growth seems on nice trajectory so you hire up on sales (~3mo warmup to effectiveness), yet maybe Google switches algorithms and your marketing funnel dies.

Ex 2: Enterprise where you hire up for a big customer who then flakes out.

You could choose not to grow, but that's arguably riskier.

I'm not saying it is easier, just that if capital wants to invest it needs to do so at a price the founders will accept - and it seems there is far more capital than founders (with good ideas / teams). Which means the price goes up.

As someone with arguably both, and the same with my peers, not really. Difference between easier and easy.

This is an old post. It's worth noting that 10/20/30/40 grants did not work (duh!!) and companies (at least the smart ones) have moved away from them. It's also worth noting 83b / early exercise is very common now (hurray!) and can essentially double the value of the equity to the employee (only if they can take advantage of it). ISOs are very toxic.

One last piece of advice if you're trying to value the equity in an offer: keep in mind IPOs usually require share prices >= $10 and reverse splits are a favored tool to make that happen.

What was the problem with 10/20/30/40 grants and what kind of vesting schedule is used instead?

10/20/30/40 is insane without double trigger. There's already enough stories of people being pushed out of their stock.

The value a super-early employee provides is disproportionately in the first couple years, so backweighting it is quite unfair. Even if the employee is in for the long haul, the company may find it economical to terminate before the compensation increases.

Uniform vesting (1 year cliff, 25% per year) is typical. Some companies (startups and post-IPO) were doing non-uniform vesting in part because the company's valuation was rapidly soaring (and in some cases crashed shortly thereafter). Some did this for refresher grants. The evidence I've seen is that it doesn't help with retention. Well, maybe it helped retain certain execs implementing the programs...

"As an aside, some companies now write in a repurchase right on vested shares at the current common price when an employee leaves. It’s fine if the company wants to offer to repurchase the shares, but it’s horrible for the company to be able to demand this."

Which companies are those (and who are their advisors/investors/etc.) so I can never work there, or with them? Seriously, fuck everything about that.

The only problematic aspect of this proposal is not pushing for faster vesting. Slow vesting creates an adverse incentive for managers and founders; and in the absence of any right to suspend them, removes the only leverage that employees have today: departure.

Why options at all? At startup valuations is the cost that great?

According to the Buffett worldview (I think) Actual shares align shareholders interests, unlike option grants, in later stage companies.

To my mind options are a free and usually worthless offer. But actual shares have a value and significance, not for their monetary worth, but the actual ownership.

I must admit I am hazy on the details of options - but then as I am a profile of typical early employee perhaps that's also the point

Early stage shares are illiquid paper money that you have to pay taxes on (or the cash-poor startup does). The higher the valuation, the more you / the startup forks over up front. Options skip that: you only pay if and when things go well, in which case you don't mind. If things fail, you only pay in lost time. They're way more employee friendly.

But that seems a failure of the tax system (tax on a asset worth less than the tax is silly). And illiquid should not be the issue surely. We don't want the employees selling the shares - but we do want them as part owners.

These days Inwoukd assume my right to an option could be tradeable, even securitisable.

Startups can't fix the tax system.

Options are the right to buy shares at a frozen (& cheap) price. Incentives are aligned because, if the employee helps make the company more valuable, the share value goes up, and they get to walk away with the difference. (A slight oddity is that technically their value needs to go up to be worth exercising, but because of how they get valued -- ~20% of price early VCs pay ~ as soon as VCs would make money, so would anybody owning options.)

Independent of my desires for reform around taxes and illiquidity, offers should be made in terms of the current system, not a make believe one.

You may want to read up on this stuff, esp. if you want to work in startups..

So the existence of, if not the acceptance of, forums like equidateinc.com that do run secondary markets in stock options, to me seem a good thing. They mark options as more liquid.

One thing that strikes me about all this is that if capital is and remains much easier to access, then the risk of entrepreneurship is diminished, and the reward to founders seems likely to drop too - presumably being shared more with early employees?

Taxes.

At least in the US, if a company with a non-zero valuation grants actual stock to an employee, income tax is due at the time of grant on the difference between what the employee paid and what the stock is "worth" (I'm assuming the employee files an "83(b) election" -- if not then it's even worse).

There are only two ways out: either charge the employee the current "fair market value" of the stock (which can be very expensive on day 1) or the employee has to pay taxes on grant (which can also be very expensive on day 1).

By contrast, if you grant ISO options, $0 is due in taxes at grant. $0 is due when it vests. Taxes only become relevant when an employee decides whether or not to exercise. As Altman discusses, there's an argument to be made that it should be 10 years after quitting rather than 90 days after quitting, but either way it gives the employee a lot more information about whether this is a good company or not.

So the big issue is determining worth of the stock. Which suggests that while the investment points are interesting, a genuine market in startup shares would be a better way to value them. What are the legal hurdles to either direct trading in shares in next-Facebook or in trading instruments that represent the options an employee receives?

I am a fan of open markets and exchanges so this seems a good idea at solving price discovery (is squares recent IPO should not have been such a surprise if there was a market pricing its employees options)

I think it's unfortunate that he doesn't go into greater detail on the "considerable problems" posed by employees selling their options (or similar transactions). From the simple perspective of fair dealing with employees, it seems obvious that employees should be able to do with what they've earned as they will, so there must be some legal reason that this is inconvenient. If he actually thinks that the incentive argument is strong enough to override the moral argument I would be skeptical, but would love to hear a fully fleshed out argument, given that employers could instead change vesting schedules if they think employees don't actually deserve to own those shares at those times.

Shareholders have rights to information, increases paperwork and such. Also, can be forced to release financials to the public once you have 500: http://www.businessinsider.com/rule-12g5-1b3-or-how-facebook...

While convertible notes and SAFE documents have made seed stage financing much more streamlined and straightforward, employee equity is still a hot mess in terms of the legal, financial and tax difficulties that only present themselves after it's too late.

The biggest issue IMO are those scenarios when private, completely illiquid stock gets taxed as ordinary income. There should be a way to pay the tax with the same shares, though counting on the IRS becoming "flexible" is probably a longshot.

While I agree with the other points mentioned, that is one the largest and most painful when it presents itself. I do think there's also an opportunity for companies to be creative about exercising mechanics as well.

>Option pools are complete fiction; boards can increase them whenever they want. It should never be used as a reason for not making a grant.

Is this true? I had one startup say they couldn't increase the equity portion of an offer because they'd have to go to the board and the amount of equity they had available was already set. Didn't heard a word about dilution there. Haven't heard what the other stories were/are yet.

Both are true. (Generally) The percentage of equity dedicated to ESOP is fixed unless the board has a good reason to change it. Since increasing the ESOP causes dilution, it would be hard to argue for an increase just to hire a single employee.

However, some dilution can be good for everyone. Wealthfront and others have described such a plan:

https://blog.wealthfront.com/the-right-way-to-grant-equity-t...

Thank you for the informative reply. Have an upvote!

"""it would be hard to argue for an increase just to hire a single employee."""

For a lot of tech startups hiring a single employee is actually a big enough deal in most cases to try and argue for it (imo)

Sorry, most boards and most companies don't value employees that highly, which is why this post and discussion are still happening. YC companies are outliers and boards at YC companies are more likely to be better informed and closer to the employees of the business.

For most boards and investors, they will focus on the numbers on the spreadsheet unless the potential hire is quite exceptional.

> Since increasing the ESOP causes dilution, it would be hard to argue for an increase just to hire a single employee

A reason why it is important to choose your investors carefully. A smart diligent investor, should be ok with sacrificing some equity to hire a very good employee who can add immense value to the company.

The period (typically just 30-90 days) for exercising the options is the most unfair of the lot. Most of my friends who left, say, after 3-years, simply were not in a place to exercise their options because of the financial implications. People leave for various reasons, and it's extremely unfair for someone to be in this position after 2-3 years. I wish more companies would adopt the 10-year exercising period.

Has anyone been thinking about or seen analyses on the potential changes to tax treatment of stock options for start-ups in Canada under the new government?

http://www.lexology.com/library/detail.aspx?g=86190d96-b169-...

This is why I have mixed feelings about the Liberal party.

I voted for them because I agree with their platform in principle (i.e. invest in infrastructure, take global warming seriously, help the middle class prosper), but between this and reverting of the TFSA contribution limits, their actual policies makes me a bit nervous about their definition of middle class. What definition of middle class consists of people who can't benefit from being able to save and invest 4.5k more per year or from working at a startup with low pay in hopes for a better quality of life down the line from equities?

I've got mixed feelings about the TFSA as well. I think they are easier to understand than RRSPs and thus easier for people to use. But I have this nagging suspicion that the $10k/year would forgo too much revenue down the line. Though maybe I'm too optimistic about how much use TFSAs would get and what kind of growth they would see (assuming no "IRA-stuffing" equivalent).

The thing is, basically by definition, no one who is middle class (aside from perhaps upper, upper middle class) maxes out both their TFSA and RRSP. Even with the reduced TFSA limit, that's 18% of income plus $5500 per year. So really all a lower TFSA means is that more RRSP needs to be used to get the same sheltered space.

The TFSA certainly has advantages: flexibility being the biggest one. No bookkeeping, put money in whenever, and take it out with minimal restriction (aside from waiting until Jan. 1 to re-contribute). That said, as long as you invest the tax refund you get from contributing to the RRSP (or even better, file a T1213 so you don't pay those taxes in the first place), the RRSP is arguably a better retirement savings vehicle for most people (ie anyone who expects to be in a lower tax bracket in retirement than while they are contributing). Also, the lack of flexibility makes it more likely that the money will still be there in retirement.

The TFSA is great, and selfishly I'd love to keep the extra space. I have to agree though that it (the larger size, not necessarily the TFSA in general) disproportionately benefits the wealthy, and that government revenue would be better spent elsewhere.

This post got me interested in the actual statistics of what income range the middle class represents in Canada, and I found an early 2015 Macleans article [1] listing the following statistics:

- Lowest 20% individual income is 18717 and below

- Highest 20% individual income is 55498 and above

That definitely brought some perspective to my view on this issue. I guess my views on what qualified as a middle class income was pretty heavily skewed towards my own salary range. Now I definitely agree with the conclusions made by you and the Liberal party regarding the TFSA contribution limits.

[1] http://www.macleans.ca/economy/money-economy/are-you-in-the-...

That's why politicians love to cater to the middle class, right? Almost everyone self-identifies that way.

Edit: Ha, wrote that before clicking through to your link, which leads off with the same point in almost identical wording.

Interesting numbers in general too. Thanks!

The last startup I worked at had a small flock of employees that hit the 4 year mark this year. Unfortunately, most of them didn't do any sort of early exercise so they paid taxes on the difference after they exercised.

The only thing that saved a few of them is that the company offered a buyback program so they were able to flip some (all, in some cases) of their shares to cover the exercise and the taxes.

Great idea Sam. I assume going forward you will be asking for less equity for your LPs.

Quite frankly there is a need for a third party (an honest broker) that come handle all this on behalf of employees, along with salary, benefits, 401k, and other related financial matters.

When people cannot balance their checkbooks, and cannot make simple financial planning for the next 6 months, how are they to understand these seemingly complex structures.

UNLESS SOFTWARE.

What you are describing sounds like a trade union and collective agreements.

Not a "trade union"; a "professional association," like the AMA or ADA.

A guild.

Don't call it that. The idea is to avoid words like "union" or "guild" that arouse suspicion. Professional associations like the AMA and ADA fly under the anti-union radar.

Whatever we call it, it will have to be a new thing. What exists right now in the UK is the BCS who are a laughing stock among any practitioner. Even the respected professional associations such as the IMechE barely look out for the interests of their members, not compared to the BMA at any rate.

Not necessarily. Example: Lawyers are not a union, but I can hire one for my divorce. Developers are not a union, but I can hire one to build my application. Accountants are not a union, but I can hire one to do my taxes.

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