The Right Way to Grant Equity to Your Employees
firstround.com
firstround.com
Sorry, guys, but equity doesn't pay the bills. Furthermore, it's delayed and potential gratification. First, there's generally a 1 year cliff, which means I'm effectively taking a salary hit for 1 year for no good reason (unless you matched my original salary). So like I said, equity is not a replacement for salary. Second, your company may be valued at $400M, but my options are worthless until you get acquired, sell, or IPO.
You're basically saying "I'll give you X salary and I'll also give you Y pieces of paper that will hopefully be worth Z dollars in the future, but I can't promise anything."
IMO, equity should be treated as a benefit along the same lines as free lunches or vacation days. It should be a bonus. If you offer me X salary and Y equity, then X should be enough to pay my bills and Y should be enough to incentivize me work my ass off for you.
My two cents, anyway.
Back when our startup was like 2 people and barely ramen profitable, as much as we wanted to, there was no way we could pay market rate for some of our early hires without going out of business before we got any traction. Those hires made a risk vs. reward decision to take a temporary cut in salary in return for a larger amount of equity. Now that we are bigger and stabler, we have raised all their salaries to above market.
Perhaps this is what you were saying as well, but I find that many people demonize any startup that offers below market salaries in return for higher equity. In many cases, it's not because they want to - it's because they have to.
We didn't represent it like that at all. We were very upfront that we just don't have the money to pay them today what they expect, but we believe that this is a good market and we have the right team to become successful. Also that we understand that this is a huge risk they're taking, and so we will reward that with much higher equity. Some people were ok with it, some weren't and passed on our offer, and we fully respected that.
I'd happily take a pay cut to work for a startup that I believed in, but there is a lower limit that I can feasibly accept before I'm living paycheck to paycheck again, and that's just a miserable place to be, imo.
It shouldn't strike you as strange. You're expecting those young, single founders with few living expenses to empathize with people who aren't in their situation. What experience have they had that would allow them to do so?
(Not saying that you guys didn’t offer people enough equity, rather that I’ve seen many stories of startups not offering nearly enough to justify the risk and below-market salary.)
I.e., if my current salary is 100K and I have 50K in equity vesting between now and next November, and you offer me 90K and 250K in total equity, then I have to decide whether it's worth taking a 10K salary cut AND giving up 50K over the next year. The fact that you're offering me 250K in equity is actually going to wind up being equal to what I'm making now (250K - 50K = 200K, 200K / 4 = 50K/year), and the salary is actually lower! It's a net loss for me! So unless I really believe in your company and I really want to leave my current job, it's just probably not enough. And it's your job to either convince me that it's worth the loss or offer me more.
And that's assuming your equity is actually worth anything. Given the number of startups that fail, it's a huge risk to take for something that's only theoretically equal to what I currently actually earn.
So like I said, equity should be a bonus, not a replacement for salary. But to be fair, like nairteashop said, some people have different appetite for risk and are at different stages in life, so maybe the excitement of moving to a new company is enough to justify that.
Anyway, I agree. You either need to beat my salary or beat the equity, but you can't offer me a lower salary and then offer equity and call it comparable, because you're not only offering me something, but you're asking me to give up stuff I already earned. You're asking me to walk away from free money. It's your job to convince me to do that, not to tell me I'm a moron for doing something completely logical.
Also, you say "… that's assuming your equity is actually worth anything" but doesn't that assumption also apply to the equity you're currently vesting?
The companies that are offering me jobs with lower salary and equity are not public, have no viable exit strategy in the near future, and therefore their equity is virtually worthless. There's a potential that it will be worth the equity at my current company, but the likelihood of that is low. That makes the risk high, so in order for me to justify leaving my currently vesting/cashable stock on the table, you have to offer me something I can't get right now, whether that's a higher salary, more equity, or something else.
It's not entirely a money issue. If I really, really believe in your company or I really, really hate my current job, I could more easily be persuaded to leave my current job. I'm fairly content where I am, though, so that's hard.
Since the EV of most startup equity is zero they should be treated as such. Doing a good job is irrelevant to the EV of your equity.
At this point one should be looking either at solid financials or a twitter like ability to command a great valuation.
I think Square and Dropbox both have solid rev models and valuations, my guess is that both would experience a liquidity event in the next 5 years.
They offer you a salary of X and equity of Y, and then you can say that you hoped more for Z for salary. Of course a startup with a million or two in a bank can't pay you like Facebook or Google could but they can give more equity than any of them. If your needs and the startups offer don't match, don't work there.
(I guess it's mostly this even a possible problem in SF since most companies in other places or parts of the world, don't really give out equity for employees.)
And you're right: their needs and my needs didn't match, so I declined. That's just business. Nothing personal. :)
Agreed with your post entirely, though potential is a very optimistic word to use there... "unlikely" might be better.
"Second, your company may be valued at $400M, but my options are worthless until you get acquired, sell, or IPO."
Assuming we are talking about common stock options they might even be worthless after any of those 3 things happens, depending upon factors outside of your control like dilution.
Those guys typically have a good nest egg already, which makes larger equity / smaller salary package reasonable, and has a side effect of telling VCs a story of how low burn-rate (and therefore efficient) your startup is.
As the company grows, so does the need for implementers, who are motivated by salary as well as chance at equity, but mainly by salary.
So for you the salary component has no impact on whether you work hard for your employer or not? That's simply the cost of doing business from your perspective?
I come from the fuck you pay me school of equity.
Now the startups's got Paulie as a partner. Any problems, he goes to Paulie. Trouble with the bill? He can go to Paulie. Trouble with the cops, deliveries, Tommy, he can call Paulie. But now the guy's gotta come up with Paulie's money every week, no matter what. Business bad? "Fuck you, pay me." Oh, you had a fire? "Fuck you, pay me." Place got hit by lightning, huh? "Fuck you, pay me."
That said, I also don't care about business strategy, blah blah blah, that's up to the founders, I'm happy to add my 2cents but as a professional my job is to implement their vision. Not play venture capitalist with my time rather than my money.
Think about it, HN gets 5% for 20K, if you make $100 an hour, that's 200 hours. Imagine the typical first employee, 1-2% with a 4 year vest, that's over 8000 hours (assuming an 8 hour day, let alone the typical death march), and it's doubtful you'd come even close to $100 an hour. If you're working for equity you're paying close to 100 times the price for a much shittier class of shares.
Now on the otherhand if you take a convertible note at $20K and the founders can't raise anymore, just call your loan and grab the IP, or break even on the aquihire.
I agree, I work for a salary and generally discount equity but the lack of monetary incentive doesn't mean I'm not in the game. I've always offered my opinion on business strategy and the best way to accomplish goals and I hope other early employees do the same.
Just because many tech startups and their employees engage in this equity charade doesn't mean that it is or should be considered a defining characteristic of a "startup."
A professional needs domain knowledge even if he's not particularly fussed with the whole run-your-own-company thing.
I work for a start up that's almost entirely bootstrapped. Certainly no VC or "professional" investment.
When we formed our company, we specifically stated automatic vesting for specific employees so they knew they were guaranteed money during the trigger event - whether they were still with the company or not. Those numbers are low, but it gives them faith we're not going to screw them over.
(As of the time of this comment, the title starts off "One Way..." instead of "The Right Way..." You might disagree with the article's assertion that this is the right way. But a different subject is misrepresenting the article.)
On the flip side, we have useless titles like "Pencil".
When equity is liquid, ongoing grants are akin to bonuses. At early-stage startups, however, the attractiveness of ongoing grants to employees ultimately depends on the perceived value of those grants. If a path to liquidity is not clear and employees are not certain that the company's traction is producing meaningful appreciation of their existing equity, ongoing grants are unlikely to be very compelling.
In short, I think it's a mistake for earlier-stage startups to treat equity as a retention tool. It can be an effective recruiting tool in some circumstances, but unless your company is a rocket ship that is going to reach the moon soon, which most early-stage startups are not, focusing too much on equity as part of the compensation package can easily hurt retention because most of the experienced and savvy employees know how to keep score.
IMO there's exactly one key to my good fortune: the company founders made the decision to be generous with the amount of stock/options they granted. They weren't trying to lowball people.
That's the bottom line, you need founders who want to "do the right thing" for their employees. Unfortunately I don't know how you (without doing a lot of due-diligence by asking around) join a company with "honest" founders. It's almost axiomatic that startups try to screw "the little people" out of any stock rewards, even if the company is successful. I was lucky.
- Don't put call options on employee stock.
And something I wish that companies would start doing:
- Don't make vested options expire soon after the end of employment. Don't force people to take big tax hits just to buy the stock that they have earned.
That's counter to one of the main goals of a good equity comp plan - retention. If a company goes out of it's way to ensure that LEAVING the company is painless and of low cost to the employee, retention would suffer.
This is a big difference between aligning incentives and retroactively punishing behavior you don't like.
These tension between these two points of view is the source of the consternation in this area.
The big difference here is the company is practically non-liquid and the employee is already taking a risk in working for that startup. I feel the 1 year vesting cliff alone is enough to evaluate if an employee is worthwhile and you should give the employee the full value of the vested stock compensation. Not add more gotchas to make the worth of the options even worse. If the company shares were liquid, then I wouldn't care as much.
Often over a few years you get the situation where the strike price is a good chunk over the FMV price and taxes are somewhat prohibitive compared to the probability that a liquidity event would happen. It makes the shares an actual net negative in total compensation and as a result, the open secret in the bay area is that most people don't actually exercise their stock options when they leave their companies. You get things like the ESO fund popping up in response taking a good cut of your compensation because you didn't want to pay some employees to do 20 hours of extra work a year.
Anyway overall, to an experienced employee who has stock option experience, it just makes your compensation package even less attractive and them less likely to work with you. If you show that you are willing to do this relatively minor & cheap thing, it will increase trust and make your company more attractive to work for, especially if your a non liquid company. I would really consider this as an early stage startup as a recruiting technique. This stuff is usually hidden in contracts, so I would bring up this feature of your company early on explaining the logic behind it.
How would you do that exactly? Even if you take advantage of SEC's rule permitting a private company to have 2,000 shareholders, the moment you convert those options to stock units (either restricted or open), they've got a brand new tax problem.
At least with ISO exercise you can juggle AMT taxation vs income taxation, RSUs or SUs are just straight bottom-line income.
What different tax problems would they have with people exercising later? How is it different from employees exercising their stock after vesting?
Unless your saying the entire structure is made to give people an incentive to not actually take their stock if they leave the company before a liquidity event to help avoid that 2000 shareholder stock limit?
What I'm talking about is mainly about non-liquid companies. The problems mostly go away with liquid companies.
http://www.mystockoptions.com/faq/index.cfm/catID/36274DB1-D...
When I can actually sell the options, then the price of about %5 extra in taxes (short term vs long term capital gains) is small compared to the taxation paperwork and paying for stock that has a good chance of being worthless.
If a company is liquid or soon to be liquid when I start working for them, then the extra bonus treatment of ISOs is fine and I understand putting that limit inside there, because the stock isn't worthless and I can sell it when I leave the company.
But, my stock options have no vesting period. They expire, and I lose them entirely, should I ever leave the company. This is the same deal everybody got. I've never really understood why they were done this way, it seems rather unusual?
It's always felt like a hook, an ugly way to retain people who've already been there a long time. I've been working with the company for 3 years now, but if I left tomorrow, I'd have no equity to show for it.
Does anyone else have stock options like this? Is it normal?
Number of shares is meaningless, you can take the number of shares and the FMV of each share (they have to give you that else you can't pay taxes) and get an idea of where you are. You can do the same pre and post financing.
I do not know if they have to tell you how many shares there are or how many have been allocated. If you exercise you may gain access to additional information as a share holder, but I don't know the specifics of how that works.
Options are fun and you should negotiate for them, but never compromise on cash. They can't take away cash, but they can effectively render your options worthless if they wish.
It's my understanding that generally when you raise more funding, your shares are diluted. Let's say before there were 100,000 shares, and you had 500 of them. Well, now there are 120,000 shares and you still only have 500 of them, so instead of having options for 0.5% of the company, you have options for .4% of the company. They don't really want you to know that the equity you were promised up front is now worth less than it was before, so that's why they hemmed and hawed.
You can't expect blood from a stone when it comes to ISOs. As long as the dilution is fair WRT to the valuation and number of new shares issued/allocated I don't see the problem and good leadership would explain it as such.
The flip side is that if employees are diluted badly enough they will leave. Employers know this and walk the line of doing the bare minimum they think they have to do to get the people they care about to stay.
I guess in my case, I don't know how the second round dilution arrangement will affect me.
First I would suggest you bring up your concerns clearly and make sure you understand why they won't tell you. Give them a chance to explain. If the company is 30 people you should be able to drop by the CEOs office and ask. Like I said they may not be saying anything because the financing is not final.
Alternatively if they are not cooperative.
Go in tomorrow and ask to exercise your vested options. At this point they have no choice but to tell you the FMV of those options. Don't exercise them, or do that is a separate topic and you have to watch out for tax liability.
Do it again after the financing finishes. The FMV of your shares will change. If it is significantly lower the options may not be worth your time.
They can't avoid telling you the FMV of the shares you have because you need to know to calculate your tax liability for the spread between the strike price and the current FMV.
Think of it like any other investment. If it isn't gaining in value it's not worth your time. If the FMV of your shares is say 4/5s of what you had before financing you did well. If it is 1/9 you got screwed or your company is doing very poorly (although why would anyone invest in it then...) In the middle it is more complicated.
If your company is healthy and not taking on a large amount of money for growth the FMV of your shares might actually increase despite the dilution.
If the company is doing poorly, people are going to look around regardless of equity.
Investors and employees make much more money by increasing the size of the pie rather than their share of the pie.
Percentage-wise the new grants will be smaller but could theoretically match the (estimated) dollar value of the original grant, if they are considered based on the time each was granted. Obviously, the new hire grant will be worth much more than the evergreen grant at the time the evergreen grant is given. But the employee is now taking much less risk than they did when they joined, which is covered here:
The best part is that, as your company grows, you always grant stock in proportion to what is fair today rather than in proportion to their original grant.
It's a bad system that doesn't serve either side well and the only reason it hasn't blown up into a real issue is because cash is cheap enough right now that most of the deals I'm seeing amount to something like "within 20% of market wage + an insultingly small amount of equity".
I have no pretensions that the ideas I have are any good, feasible or even legal but I think it's at least worthwhile thinking and experimenting with models that serve the needs of both sides better.
Problem: Options are basically impossible to price (and are undervalued). If it costs me as an employer $100K to offer an options package but the employee only perceives it to be worth $10K, then it becomes a major problem using it as a hiring incentive. The problem is that standard option contracts are basically impossible to price. I like to think I'm relatively sophisticated at finance and I've worked through the options packages of a bunch of my friends and I always end up throwing my hands up in the air and declaring that I have no idea how to even approximate a fair price.
What most people far less sophisticated (aka most engineers) do is price on the underlying asset. eg: 4% of a company worth 1M vesting over 4 years equals $4000 of forgone salary (aka: not that exciting). In reality, basic options theory states that an option is always worth more than the underlying asset and the difference is directly dependent on the volatility of the underlying asset. On the flip side, liquidation preferences, dilution, acquihiring and the like drastically depress the value of an option. These two combined make pricing options a black art.
Solution: Think about it, nowhere else in the startup world do we make locked in 4 year contracts, why would you do it with employees? Would you sign a 4 year office lease? Would you commit to a fixed bill for EC2 4 years down the road? Startups are all about paying a premium for flexibility, I'd much rather offer 2% vesting over 1 year than 4% vesting over 4 and I wager employees would value it higher as well. Alternatively, get rid of linear vesting and implement something like 40%/30%/20%/10%. This at least makes refresher grants meaningful rather than a pitiful joke when put against existing options.
Problem: There are huge discontinuities in the standard vesting. At 1 year, your effective net worth suddenly takes a huge jump upwards and at 4 years, your effective salary takes a huge jump downwards (even accounting for refresher grants). These discontinuities are ruinous to employee loyalty. People are pretty lazy, they usually prefer a pretty good job to the effort of finding a better one. But 1 year cliffs and 4 year cliffs are just enough of a nudge to put people casually on the market.
Solution: Get rid of the 1 year cliff. The ostensible reason given for the cliff is that companies don't want to reward employees who don't work out. But you've already paid them a bunch of salary and spent the time hiring and training them!
If the concern is that you don't want them added to the shareholder limit, instead what might be a more elegant solution is that, anytime during the first year, if you leave for any reason, the company has the option to force you to sell back your shares for say, 2x the strike price. For example, say you're made an offer for 1000 shares per month at a $1 strike price and it ends up not working out in 4 months. The company has the option of either letting you keep 4000 shares or paying you $8000 to void the shares. This seems like a way better way to keep all the incentives aligned rather than blunt force cliffs.
Problem: It's easy to give people additional options but hard, and possibly illegal to take options away. On the surface, this seems like a win for employees. But like laws that make it harder to fire people, the perverse incentives make companies more conservative and make it worse for employees. A company that makes a mistake and offers a salary that is too high for an employee's value can at least attempt to re-negotiate and drop the salary. A company that makes a mistake on equity has no choice but to either live with it or fire the employee.
Solution: Making equity grants re-negotiable opens up a can of worms as Zynga discovered. Who knows? I don't have any great ideas about this.
Problem: Standard share grants are a shitty way to compensate for forgone income. Say you're a cash strapped startup and an engineer is willing to work for you as employee #1 for $12K instead of his usual 120K. How much is that worth in equity? It's hard to say since you don't know how long the income is forgone for. You could raise a Series A tomorrow and bump his salary back up to 100K, you could struggle to raise for a year while he gamely hangs on. Is that worth 1%? 4%? 15%? Who knows?
Solution: Agree on two vesting schedules that get switched over automatically upon hitting certain goals. eg: Agree to pay 1K & vest 1% for every month while bootstrapped which gets automatically switched over to 10K & 0.05% monthly upon raising $1M.
I'm not saying these solutions are necessarily good and I'm sure there's a dozen things I haven't taken into account. But these are all real problems I've seen that have caused real equity negotiations to fall apart.
An option is always worth less than the underlying asset.
When was that written? 1985? Meaningful equity? "Meaningful" starts at 0.3/N (pre-dilution) where N is the number of employees. Anyway, equity is an awful model. Profit-sharing is better. Go here: http://michaelochurch.wordpress.com/2013/03/26/gervais-macle...
If I ever build a company, I'll use profit-sharing (at much more generous levels) instead of equity, except for people who are truly partner-level. Trying to convince non-partners to think of themselves as more in order to extract more from them is just dishonest.
But the engineering tradition that spawned Silicon Valley was much more egalitarian than traditional corporate culture.
No, those supposedly stodgy corporate cultures (see: banks) are actually a lot more egalitarian. In banks and normal companies, your boss is a social equal, just more experienced, more valuable on account of being longer with the organization, and perhaps luckier than you are. In these VC-funded startups, founders (much less the unapproachable gods called "investors") are simply better than you. That's why they got introduced to partners at VC funds and you're lucky to get a reply from an associate.
No company would ever pay the 27-year-old VP/HR 10 times the salary of the 35-year-old programmer. You might see 1.5x, especially if the programmer is a bad negotiator (or female). But that's common with VC-istan equity. When it matters, VC-istan equity exacerbates the shit out of inequality because the executives are getting paid 10-100x as much as the workers (when no one would tolerate more than a 1.5-2x difference in salaries).
the Wealthfront Equity Plan should result in approximately 3.5% to 5% annual dilution assuming no executives need to be hired
Investor infusions dilute everyone, of course; but if employees are getting diluted for fucking executives then you, sir, are a fucking asshole and deserve to lose all the talent you have.
Honestly, this product (yes, this is a product pitch, not a real article) looks like a complex solution to a simple problem: the equity model in Silicon Valley is broken and actually very un-egalitarian in practice (look at house prices out there). Equity should be substantial but for genuine partner-level people only (and most people shouldn't, and won't want to be, partners). Everyone else should get substantial profit-sharing that can pay off like equity-- in fact, most get bonuses much larger than they get under the VC-istan system that awards mediocre one-time bonuses-- but (a) isn't persistent if the person leaves, and (b) doesn't come with all the nastiness (tax, regulation) of owning an illiquid security.
how else would this work? all new option grants dilute all current stock and option holders.