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: What About Performance? (Part 10 of an n part series)

Stickman Startup Performance Dashboard“But, how do I make sure that the person is a great performer before I am forced to give them equity?”

This question gets asked by nearly every Founder, Investor or Compensation Committee Member very early in the development of an equity compensation plan. Sometimes it is expressed more genuinely as, “I don’t want to give away part of my company to someone who hasn’t carried their fair share.” Either way, the concern is valid. Sometimes the answer is very simple, and sometimes it is not.

Your equity compensation plan should be aligned with Continue reading

Do founders with a16z funding agree with Scott Kupor’s post on employee options?

Question (Orig. on Quora):

Do founders with a16z funding agree with Scott Kupor’s post on employee options?

The Lack of Options for (Startup Employees’) Options

Answer (by Dan Walter):

Scott’s answer is a great start to a discussion that has been needed for a long time. The lock step approach to equity compensation that is followed by most startups is not founded in any science, so it is right to question things.

But, extending the post termination exercise period to the full life of the grant is not sustainable. Most of the equity at startups is given the the first 20 (maybe 50) employees. This doesn’t leave much for any else to begin with. Without having the ability to recycle stock options (and other forms of equity compensation) companies would quickly end up with nothing to grant at all.

The accounting rules and lack of cash make it difficult, but not impossible, for the company to provide cash at the time someone leaves. It is also counterintuitive to give leavers money when those who stay cannot get money.

More successful (read profitable or very well funded) companies are looking at creating some type of market for employees and ex-employees to get out from under some of their equity. As these techniques mature I think we will see more companies extend the post termination exercise period to a length long enough to allow people to participate in the next private round of liquidity. This would probably be more fair and reduce the overhang that is a problem for any long-term pre-IPO company. It is a big problem even when the only people holding equity are employees.

I think you may also see growing use of options that have lives much shorter than ten years. These may be linked to cash incentive programs that are designed to drive exercise and hold transaction, once again reducing the burden on lower paid staff members.

Also, options were never meant to be a guarantee or direct replacement for cash. They were intended to be a reward for the commitment to the long-term success, while remaining a fairly inexpensive tool for companies. They were also designed to inspire long-term holding (hence the periods associated with Incentive Stock Options).

If a company plans to be successful with a relatively small number employees (let’s say less than 250) then long-term post-termination periods may be viable. If they company requires a larger staff, or a significant number of senior players, the “10 year exercise period” is likely to drive as many or more problems as the current vanilla solutions.

The key is this: Equity compensation is both very flexible and very complex. Companies tend to follow the leader because 1) Their lawyers like to follow plans that have already been tested in court, 2) Investors like to use plans that fit easily into their pre-made financial models, 3) Consultants often choose the easiest path to approval rather than the best path to success, 4) Companies can get a vanilla plan created much cheaper than a more “bespoke” plan that may work better, 5) Internal HR, Compensation and other related professionals seldom have deep expertise in the design elements of these programs and must therefore simply trust that those giving advice actually know what they’re talking about. There are, of course, additional reasons to follow the leader, but, like building a company, following the leader is seldom the best path to success.

LinkedIn, Microsoft and “Stock-based Compensation”

I just had someone send me an article titled “REASON BEHIND THE MICROSOFT-LINKEDIN DEAL”. The premise behind that article is that stock-based compensation (the accounting term for this piece of the compensation pie) was a major driver behind LinkedIn’s decision to be acquired by Microsoft. LinkedIn did use stock-based compensation more heavily than many companies, but that alone would not be a good reason to desire an acquisition at a value significantly less than the 52 week high. Stock-based compensation includes virtually any type of pay where the individual gets ownership in the company at some discount to the value and it is eventually owned in full by them. In order for stock-based compensation to factor into the decision at all, there would need to be Continue reading

How Will The New Overtime Rules Affect You?

34899216_l (2)Is your mind already racing about how the new overtime regulations will affect your company? The media is buzzing about today’s release of the U.S. Department of Labor’s new rules regarding overtime pay.  The recent DOL publication highlights the following changes: Continue reading

What happens to employee unvested stock options upon acquisition?

Question (Orig. on Quora):

Let say I’ve received 1% over 4 years. At the end of the second year we get acquired. Now I have 0.5% in my hands. What’s happens next, assuming I continue working at the acquiring company?

Do I still get stock options of the ‘old’ company for the next two year?
Does the old company even have stocks of it’s own now that it’s been acquired?
Do I switch to getting options of the new company?
How will the value of the options I get be determined?

Many companies may sell for tens of millions and be worth close to nothing after a few months, be dissolved by the acquirer etc. I’m wondering how may my unvested stock option keep their value.

Answer (by Dan Walter):

Generally the basic for how this is handled will be described in your Plan document and your award agreement.  Here are three things to look for.

  1. Unvested portion will be assumed. – This means the acquiring company will “convert” your old grant into a new grant of roughly the same value (taking the intrinsic value of your old awards and converting them into shares at the new company’s price) and at least the same terms. You will receive updated information. Your exercise price may change. Your vesting will likely be the same, or earlier.
  2. Unvested portion will be cashed out. – This means that the company does not want to carry your equity, or may not be able to carry it (legal issues, etc…).  They will cash out any unvested equity compensation at the then current value (*Be aware that this may be $0.00). You will have income and associated taxes at the time of payment.
  3. Unvested portion will be cancelled/forfeited. – While it isn’t common, some companies set up plans so that unvested amounts simply “go away” at the time of CIC. The company is not required to provide a replacement or payment (although many do provide something)

It is critical that you read and understand your agreement paperwork.  There are many moving parts.  There are many things that may seem logical or even possible.  This area of compensation is still somewhat of the Wild West, so you need to do your homework.   This is especially true in environments where IPOs are less likely that corporate transactions like mergers and acquisitions.

Parental Leave in San Francisco: Another Pay-Related Reason to Hire Baby Boomers

hand and baby feet-sq (2)San Francisco just became the first city in the US to ensure 100% paid leave for new parents. This covers both mothers and/or fathers. This new rule is effective January 1, 2017 for employers with more than 50 employees. Companies with between 20 and 49 employees have until January 1, 2018. While this is a great thing, is it just another reason to avoid hiring Millennials? Perhaps this is all a conspiracy to improve the long-term retention of baby boomers.

55% of parental pay was already covered by a statewide initiative. Companies will be responsible for Continue reading

What are current (2016) best practices for employee stock option programs for US pre-IPO startups?

Question: (org. on Quora)

Answer (by Dan Walter)

Hi Alex.  Thanks for the A2a.  And thanks to Shriram Bhashyam for also recommending me.
The first thing to clarify is the difference between “best practices” and most common practices. In the realm of equity compensation the most common practices are seldom the best. I will try and cover a bit of both.
“Early Stage” has also become a term of art in many cases. In this case I will write from the perspective of a company who may have up to a medium sized B Round. Your company may certainly fall into a different category.
Lastly, before I get into details, please realize that essential ANY equity compensation data is wrong at some fundamental level. Since you are unlikely to know how another company has designed their plan, what their investors expectations are, what the releasing timeline and potential value at the time of liquidity and whether the liquidity event is focused on IPO or acquisition (*and a series of other potential factors), you may be comparing apples to hotdogs, or plastic cups. (A list of the 11 reasons your equity compensation data is wrong)
The most common practices in the Silicon Valley (another assumption I am making, since these rules may not apply to you if you are located elsewhere) have been generally boxed in by VCs over the past couple of decades. The VC sway on startups is so strong that many companies (and many VCs) don’t realize that there may be other ways.  In summary:

Continue reading

Sam Reeve to Cover 4 topics at BLR Thrive 2016!

Performensation is pleased to announce that Sam Reeve, Performensation’s Executive Vice President of Consulting Services, will be presenting on four topics at the BLR Thrive 2016 annual conference, May 12-13, 2016 in Las Vegas!

Sam is a well-regarded compensation leader with broad and deep experience across many industries and virtually every size of company. Come to Las Vegas and spend a little one on one time learning more from Sam.

Sam’s presentations will cover:

The Cutting Edge of Compensation: Critical Trends of 2016 and Beyond

Selling the C-Suite on Your Compensation Plan: Secrets to Securing Executive Buy-In

Total Rewards Tactics for Motivating the Multigenerational Workforce

Sales Compensation Strategies for Retaining Selling Stars

 

When will the new 2016 GPS Stock Options become available to view?

Question: (org. on Quora)

When will the new 2016 GPS Stock Options become available to view?

Answer (by Dan Walter)

The updated 2016 version of the GPS Stock Options document was released yesterday, January 27, 2016, in draft format (GPS options DRAFT.pdf), and is currently available for Public Comment through February 17, 2016. The final publication, which will include public comment, is expected to be available towards the end of March 2016. Please take a look and provide your feedback. Additional details can be found at:  https://www.scu.edu/business/cepi/gpsproject/public-comment/