Startup Equity: In Conclusion (Part 14 of a 14 part series)

Stickman Startup In ConclusionIt feels odd to be wrapping up this series on Startup Equity. I started the series almost six-months ago, and although I have written around 10,000 words, I still have nearly endless things that we can discuss.

My goal was to provide some insight into the variations, complexity, power and hurdles that come along with equity compensation focused specifically on startups and other private companies. The information available is often too unreliable, too high level and too inconsistent to be useful. I hope this series has given readers multiple different perspectives and can provide the start for better conversations, better plan designs, and more successful companies. I am going to follow through on the suggestions from readers and colleagues that I turn the series into an ebook. If you are interested in getting a copy of the ebook, please shoot me an email (dwalter@performensation.com).

  1. You should know that determining grant size can be a challenge and that traditional techniques used for cash compensation do not translate well to the more variable nature of equity compensation. Using more refined methods can create much better results. 1
  2. You should know that NO ONE agrees on the value of equity compensation. Not ever. But, that’s OK as long as each party communicates the reasoning for their valuation. 2
  3. I hope you a have better understanding of the concerns of Venture Capital firms and similar early investors. Also, that you can better explain your case for equity and how it can drive their goals as well as yours. 3
  4. You should have a better understanding of how to use equity as your currency. You must also be willing to embrace your equity uniqueness, and why you shouldn’t put too much focus on comparisons to other companies (especially publicly traded) 4
  5. You may be able to evaluate better when you can accomplish your equity compensation goals with only a synthetic instrument. Sometimes polyester can outperform silk. Knowing when and how is the key. 5
  6. You should have a better grasp of when it makes sense to give additional equity grants and when it may be a recipe for failure. Most importantly, you should be clear that other companies’, entrepreneurs’, or thought-leaders’ formulaic methods or proven processes are unlikely to work perfectly for your company.6
  7. You should be fully aware of the MOST COMMON MISTAKE startups make when using equity compensation. 7
  8. You should be confident that your employees don’t understand their equity compensation any better than politicians understand the Internet. 8
  9. You should know that the variables that have the most impact at startups are Vesting, Termination Rules and Change in Control provisions. If you get these right for your goals and timeline, you are more than halfway to success. 9
  10. Performance-based equity shouldn’t be that scary to you. Yes, there is more to it than time-based equity, but it can be far more effective at getting you to your destination. 10
  11. Staying private and using equity compensation in a world obsessed with IPOs should no longer seem crazy. Equity compensation is very a useful tool and can even offer significant design advantages if you are willing to explore the possibilities. 11
  12. Hopefully, you know more about the evolution of cash pay and equity compensation levels over the past decade or two. Equity may no longer give you the savings that it once did, but that can offset by its long-term competitiveness. 12
  13. You may better understand more technical issues like Rights of First Refusal, Tag Along Rights and Drag Along Rights. Not everyone goes public, and not everyone stays at your company forever. Proper planning and documentation can lead to less stress and angst. 13

You will notice that I have touched on some of the more commonly covered topics like accounting and taxation issues. I have barely talked about things like ISOs and NonQuals. And, I haven’t gotten into the final 12-18 months in the run-up to IPO. There are at least one hundred other topics that tend to only come up in very specific conversations, but I think the foundation has been laid and hope that you will share any other specific topics that you may want me to cover in the future. Thanks, and I hope you will come back and read my future articles whether or not they cover startup issues.

Startup Equity: Three Crucial Variables (Part 9 of an n part series)

stickman startup three crucial thingsStartup equity has approximately a gazillion moving parts. But three of these variables are far more important than all of the others. These three components are what make your plan uniquely yours. They are the things that require real thought. They are also the elements that are most commonly viewed as “plug-and-play” in the world of startups.

  1. Vesting Schedule

Stock options are grants with four-year vesting schedules. Everyone knows this. RSUs have a three-year schedule. Everyone knows this as well. However, while these are the most common vesting schedules, they are not as “standard” or as scientific as you may think.

The truth about vesting is a bit more complex. Vesting should align with expected employment cycles and potential company objectives (time and performance.) If four years fit this bill, then great! If not, you should consider something(s) different. Two years may be right or maybe seven years makes sense. You may even need more than one vesting schedule depending on the level of participant and the goals for that job. Your vesting schedule is a key competitive differentiator. Doing the same thing as everyone else puts you at a disadvantage unless you are the absolute best in your industry.

  1. Termination Rules

If you die, you get one year to exercise. If you leave while still in good standing, you get 30 days or three months. Unvested options and RSUs expire immediately. Again, this is common knowledge but it is not based on facts.

A small number of companies have started granting equity that does not expire. While this is a generous offer, the likelihood that it will result in running out of grantable shares is far too high for most companies. But, you may want to look at longer periods for key positions, or termination rules that align with the tenure of an individual. If someone has been with you for eight years, they may deserve more leeway than a new hire. There is no easy answer that works, only easy answers that don’t.

  1. Change-in-Control and Related Liquidity

Things are less standard in this area. Should vesting accelerate? What should expire? What the heck qualifies as a “change-in-control?” Accelerating vesting sounds great, but it may limit a company’s ability to show value. If critical positions have no “stickiness” then acquirers may offer less in return for the risk of losing key players. Acceleration of RSUs may result in income and taxes at times when participants cannot afford it. On the other hand, acceleration may be a great negotiation tool for participants in key positions.

All of this may lead you to “inspire” people to stick around after the transaction via continued vesting or earn-out periods. This can be effective, but may backfire if the time to transaction has already been extensive. One solution may be to build in performance criteria that trigger acceleration only if the value of the company exceeds a certain level. Properly designed and communicated, this can provide targeted motivation that drives those most responsible for achieving this value.

The emerging fourth member of the big three is performance conditions. Ten years ago these were seldom seen at startups. Now they are still uncommon, but commonly requested. We will cover this topic in an up coming post.

Take a look at your plan and agreements. How “vanilla” are your vesting, termination and change-in-control provisions? More importantly, why? Don’t sell your company short on such a big component of your pay and motivation package. Minor differences in these three areas can have a major impact on your ability to hire, motivate and keep your best talent.

Startup Equity: No. They Don’t Get It. (Part 8 of an n part series)

stickman they dont get itDuring a recent presentation I did for industry professionals, an attendee claimed that his employees didn’t need additional education on their equity compensation because they worked in tech and “already understood” these plans. I pointed out that he was mistaken. I stated that most, and perhaps nearly all, employees misunderstand, or do not even try and understand, their stock-based compensation. This is especially true for startups.

Check out a site like Quora, or attend a Technology or Human Resources conference. The questions about stock options, restricted stock units, dilution, values, taxation and more are wide-ranging and numerous. For almost 30 years, equity compensation and startups have been a ubiquitous combination. This long-term relationship has lead us to believe that people not only value equity, but they also understand its value. They don’t.

Stock options became popular before internet browsers existed for ordinary people. And, like the internet, stock options are a mystery to nearly everyone who benefits from them. Are they a series of tubes*? Did Al Gore invent them? Why is there a vesting schedule? Why is it always four years? (It’s not.) Are they better than cash and most importantly, when will they make you a millionaire?

If you are granting equity prepare for this simple fact: Your staff will not “get” how their awards work if you don’t take the time to educate them. For many companies, this is part of a weird secret goal. If people don’t understand their equity, then they are free to invent whatever cockamamie value they wish. People motivating themselves on a dream is sweet for a while, but the truth always makes itself known eventually.

If your staff doesn’t understand their equity, then you are probably going through a lot of pain for very little gain. Equity compensation beyond Series A usually requires convincing your investors to accept additional dilution. If your company is like most, by the time your company has an IPO or is acquired, these requests for shares can become battles that stall far more important strategic and tactical decisions. If the return on your equity compensation is random or the value is not understood, then you may be fighting for nothing.

Equity compensation is likely the most complicated way for an average employee to make money. That being said, it is not difficult to ensure that your staff understands, at the minimum, the following:

  • How their grants work (basic features, timing, mechanics, and risks)
  • Why equity is used (in addition to, or instead of, cash)
  • How to determine a potential value of an award
  • The workings of the value exchange between investors, founders, management and employees

No matter how vanilla your plan is, no matter how many other startups your employees have worked for, they don’t get it. Not without help. Not without facts. Not without reminders. And, not without effort. If you haven’t already started your education process, the time to start is now. If you’re not sure where to start, ask in the comments, and I will gladly point the way.

%-#-$ – Startup Equity: It’s Enough to Make You Swear!

untitled7Figuring out the right amount of equity compensation at startups is a challenge. How much should I grant? How big should the grant be? How should I size the grant relative to base pay? Investors, boards, executives, HR and compensation departments at start-ups have conflicts over these questions all the time. In the past I have written about the 11 Reasons Your Equity Compensation Survey Data is Wrong. This article focuses on three common ways to determine equity at startups regardless of your survey source.

% Percentage of FD Outstanding Shares

This is where most companies start. The first 10 or 20 key players at a start-up are Continue reading

OMG! You Were Right All Along!

untitled11Remember that time you spent weeks modeling a new incentive plan only to have it shot down? They explained that any goals needed to be based on RESULTS! You maintained that the reason interim goals were included, was to ensure that success could be achieved and communicated throughout the process.

Remember that other time you explained to your managers that they needed to have frequent conversations on the new pay for performance program? And, when it didn’t work they told you Continue reading

Applying Pixar’s “22 Rules of Storytelling” to Pay

untitledWhat do ‘Up’, ‘Cars’, ‘Inside Out’, ‘Monsters, Inc’, ‘Ratatouille’, ‘Toy Story 3’, ‘The Incredibles’, ‘Finding Nemo’, ‘Toy Story’ and ‘WALL-E’ have in common? First, they are 10 of the best animated movies made by Pixar. Second, they all follow Pixar’s “22 Rules of Storytelling.” As it turns out, these rules adapt well to the world of compensation plans and philosophy. Continue reading

Are Your Pay Plans Just New Hire “Click Bait”?

untitled5“You won’t believe what this star from the ‘80’s look like now!” “The best banana bread EVER!” “This great trend is your next haircut!”

It happens to everyone. We see the headline and click through to see the interesting pictures or stories. When the new page opens up (and we get past the explosion of ads) we find nothing surprising, new or even interesting. In fact, we are disappointed and annoyed that we were fooled again. Before you stop reading, you should know that this is exactly what many of our compensation programs are doing during the recruitment process.

Attract, Motivate, Retain (and hopefully Engage). This is the mantra of Continue reading

FABulous Pay Improves Talent Acquisition

untitledHow are great salespeople able to seamlessly turn every one of your concerns into a demonstration of the prowess of their product? Are they really just that convincing or is there some type of method to their success? The best salespeople personalize every discussion. The trick is years of practicing a simple process until it has become part of how to explain everything. Your recruiters, staffing professionals and talent acquisition stars can do the same with your compensation plans (and you can easily help them).

The key in the absolutely fabulous method is the F.A.B.

F = Features

A = Advantages

B = Benefits Continue reading

When the Chef Visits Your Table

untitledSales compensation is an uncomfortable area for many compensation professionals. Many of us have never been professional sales people. Many of us don’t have the technical modeling expertise to flesh out these plans. The plans don’t operate the same way as most incentive plans. Sales people do not react to pay programs the same way as most other employees. Sales managers often are simply great sales people who have been put in charge of similar, but less great, sales people. Often we are tasked with supporting or communicating a plan when we have had little interaction during the fact finding and design phases. With all the being said, let’s talk about sales comp!

I recently spoke to a company that is Continue reading

Why is it SO DIFFICULT to Get Equity Amounts Right?

6a0134836082f8970c01bb08f49b59970d-200wiLet me start this by saying that there is little new in this post. If you have been a senior compensation professional during a market downturn, this should sound familiar. If you have not had this exciting and seldom pleasant experience, buckle up and let’s go!

The main selling point of equity compensation is that it provides unequaled compensatory upside through its extreme variability, while allowing a Continue reading