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 (

  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: You’re Coming With Me, or maybe NOT (Part 13 in an n part series)

Stickman Startup Drag Along Tag AlongWe’ve covered a lot of ground in this series, but there is always more when it comes to equity compensation. Sharing ownership can be messy and participating in a liquidity event can be even messier. Companies, majority shareholders, and minority shareholders have defined tools to help avoid some of this messiness. Three of the most important provisions to consider in a startup equity plan are 1) Rights of first refusal, 2) Tag along rights and 3) Drag along rights. Often these are defined in your lawyer’s boilerplate document and never addressed during the design and approval phases of your plan.

1) Rights of First Refusal:

These are designed to protect the company from unwanted shareholders. They can be the bane of, or boon to, employees and other equity plan participants. The most basic form allows the company to buy shares from a potential seller for the same terms and conditions offered by a third party prospective purchaser. If someone wants to cash out, finds someone willing to buy their shares, and is not otherwise prohibited from selling their shares, they must first offer the shares to the company for purchase. If the company decides not to buy, the third-party can become a shareholder.

Rights of first refusal can be designed to allow the company to buy back shares at the most recent valuation price instead of the price offered by the third-party. This can ensure that the company is not “held over a barrel” by a seller who has found someone who passionately wants to become and owner and is willing to pay top dollar. This can be upsetting to a seller who has not read their agreement. This is especially true when the “investor value” far exceeds the value the company currently deems reasonable pursuant to a valid valuation.

Very few companies WANT a shareholder they do not know or with whom they are not on friendly terms. Most companies will exercise their right. But, what if they can’t? Not every company has the cash to buy back shares on a whim. Savvy equity holders can use this to their advantage by timing their potential sale to occur when the company is cash poor. It is critical that a company consider every possibility before simply signing off on a basic equity compensation plan.

2) Tag Along Rights

These are designed to protect minority shareholders. Imagine a majority shareholder decides to sell their shares. Imagine also that you are employee #5 and have purchased and held your shares for a while. When the majority shareholder sells, a tag along right ensures that the minority shareholder(s) can sell an equal percentage of their shares at the same price. If you are the minority shareholder, this can be huge. It helps ensure that the control and value of the company isn’t sold out from underneath you, especially if the purchaser is someone with whom you may disagree.

3) Drag Along Rights

These are designed to give additional power to majority shareholders. In many cases, a potential acquirer will balk at having to negotiate individual terms with minority shareholders. A well-designed, “drag along right” allows the majority shareholder to require minority shareholders (often equity compensation plan participants) to sell a pro rata portion of their shares to the acquirer for the same price, terms, and conditions as agreed to by the majority shareholder. This can be especially powerful if someone is looking to acquire 100% of a company. Negotiating with only the majority holder while guaranteeing the participation of every shareholder can smooth the process considerably. It also gives the majority shareholder significantly more negotiating power.

Lacking control of future transactions makes everyone a bit uneasy. Everyone should know whether they can leave the party, join the party or be forced to shut down the party. Building your equity compensation program to reflect your potential future transactions is a way to ensure all parties are treated in a way that can be both expected and relatively conflict-free. Most companies and plan participants do not pay attention to these details until the conflict has already started.

Startup Equity: But Can’t I Pay Less Cash? (Part 12 in an n part series)

Stickman Startup Cash ValueThis series of articles has covered a lot of ground, but this particular article touches on a critical component that we have not really discussed. When equity first began to be used in Silicon Valley, prior to the boom of the late-1980’s, the goal was getting senior players to have some skin in the game. This is still a major objective of equity.

As the stock market took off in the late 1980’s and flew through the 1990’s, equity became a cheap replacement for cash. The accounting rules ensured equity barely touched companies’ books. The stock market ensured that equity delivered far more, far faster that any form cash compensation. These high growth companies were able to keep cash pay low. This allowed the to easily compete for talent against large mature companies. This is no longer the case.

Many things have changed since the 1990’s. When it comes to equity compensation, the biggest change is that you only see lower cash pay at the earliest of startups. Far more Angel and Venture Capital money is being spent on staff than in the past. This means that less is going to research and development, or larger investments are required to build companies with no better potential than those in the past.

Remember that the accepted “value” of startups is based on recent investment rounds. Very few consider that a far great percentage of these investment rounds is being spent on staff than ever before. In fact, below the very top roles, we see very little differentiation in pay between public and private companies. The startup discount no longer exists for most industries.

What does this mean if you are an executive, HR leader of compensation professional? First, you need to budget the essentially the same base pay, and perhaps cash short-term incentives regardless of whether you have just finished your B-Round or your IPO. Second it means you need to be far better at using equity intelligently and efficiently. You can no longer throw a basic equity plan out there and expect to also get away with sub-par salaries.

Add to all of this the rapidly changing workplace and experience. Companies are spreading out more quickly. Employees at all levels are looking for more workplace (and time) flexibility. Housing prices are skyrocketing in nearly every location where equity compensation is a strong component of total rewards. The fundamental equation has changed and companies, and their leaders, must learn and adapt. They must understand that the bargain garage-based startup is far different when a garage now costs $1 Million.

So, in answer to the question: “How much less can I may my employees if I also give them reasonable equity?” If you are a typical startup, equity will not give you any direct cash savings. Of course, if you are in any industry where equity is uncommon it may still have some capability to reduce cash pay, but those industries are becoming increasingly rare.

The next pieces of this series will touch upon some of the most technical equity issues that are often not included in terms of compensation. These include: Call and Put Rights, Drag Along and Tag Along Rights and Rights of First Refusal. Let me know what else interests you in the space as I am wrapping up this series in the not so distant future.

Startup Equity: Staying Private in a Public World (Part 11 in an n part series)

Stickman Startup Private CoIt is readily accepted that an IPO is Nirvana to a startup. Of course, a fantabulous acquisition will also work in a pinch. Most startups design their equity plans around one or both of these possibilities. The events increasingly trigger vesting events, earn-out periods, house purchases and early retirements. But, what if you want to build something far longer-term? What if you only want to grow, make money and accomplish some important goal? Do equity plans even work for these companies?

The short answer is, they can. The better answer is they ABSOLUTELY can, as long as you and the person designing your plan know what they are doing. A surprising number of companies with no intention of trading publicly have successful equity compensation programs. We’ll stay away from the wonky technical details in this post and focus on some of the things that can help make your program successful.

Privately held companies vary in size far more than publicly held companies. How you should handle the issues varies widely depending on your company’s size, profitability and growth expectations. Many of the issues I have discussed in earlier posts (1, 2, 3, 4, 5, 6, 7, 8, 9, 10) and will discuss in future posts, apply whether or not you intend to eventually have an IPO or get acquired by a publicly traded company. Feel free to go back and read some of those articles to get reacquainted.

Common Types of Private Companies and Considerations for Equity

  1. Mega-Super-Giant Company

These are technically not startups, so I will keep this brief. These are the companies that often dwarf publicly traded companies. They can be found in almost any industry. They may have tens of thousands of employees or more. Sometimes they even have to file reports with the SEC due to having so many shareholders.

These companies may use equity plans in a manner similar to public companies. The biggest difference is that there isn’t a broad group of outside investors who can fund future employee transactions. This means that these companies may make a market in their stock, offer equity that settled only in cash, or more recently, offer programs that are funded through pre-approved private investors.

  1. Profitable High-Growth Companies

These companies are in the enviable position of making money. They don’t need money from investors to thrive. They are in many “old school” industries, but they can also be found in tech, biotech and other industries that typically look to VC or PE money to grow.

A surprising number of startups are profitable. These companies have very little reason to tap into other people’s money, whether private or public investors. Because of this, they have far more freedom to design their plans to meet their specific needs. They don’t worry about how the “next round” will dilute people. They seldom worry about getting the approval for new share allocations. They have a broad range of options.

But, they do not have outside investors to fund transactions. They must still compete for talent with companies with more traditional plans. Success drives their growth but also is throttled by current and future needs for investment. In short, they can’t simply rollout a typical plan and hope it will work.

They do, however, have interesting opportunities in plan design. Some may offer a regular or occasional dividend or dividend equivalent payments to their equity plan participants. This allows people to extract some value, without needing to wait for an “event.” They may settle all awards in cash or add in performance metrics that would otherwise be difficult with outside investors looking over your shoulder. They often have vesting schedules that are far shorter or longer than their less profitable or more typical competitors.

The main ingredient in their successful equity plans is playing to their unique key strength. Real money. Their profitability drives their valuations. The profitability provides funding for employee transactions. Their profitability allows employees to feel there is less risk in equity. But, in a world of unicorns, it requires a LOT of money to compete for the absolute best talent.

  1. Family-Owned, Professional Services, etc.

These companies have often been around for decades. They know how to operate in their space. Growth is always an objective, but often not the most important goal. They have well-established company cultures and often focus on excellence before innovation.

Historically it’s has been unusual for these companies to broadly share real equity. It is more common for real equity to be reserved for a relative few at the top of the company and offer synthetic equity or no equity to the lower ranks. This paradigm is starting to shift. Professional services firms are offering more techy-style products and solutions. Family businesses are being taken over by a new generation of leaders dealing with a new type of worker. These companies are looking at things as if they are a startup with a brand new lease on life. They are exploring equity because it has become a ubiquitous element in current total reward programs.

Outside of these three types of private companies is a wild kingdom of others. There are as many potential solutions as there are business models. The point is this: Equity isn’t only for tech startups and an IPO is not the perfect goal for every company. Staying private is a path that can allow companies to compete for talent in unexpected ways. Don’t limit yourself to the rules that must be followed by companies who require outside funding.

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 the strategic needs, executable capabilities and cultural strength of your company. Clearly identifying these in any company can be tough. At a startup, it can be nearly impossible. That doesn’t mean it shouldn’t be done. Startups are used to the concept of impossible.

Performance conditions can be incorporated into nearly any type of equity, but the easiest tool is Restricted Stock Units (RSUs). Performance conditions can impact all the following: whether someone gets an award, the size of the award, the timing of vesting and the amount of vesting. This article is a bit too short to cover the details, but we can cover the key points.

What are good performance conditions for equity? Most companies want to reward results, but results in a startup are notoriously hard to predict. What will your revenue be in three or four years? How about EBITDA? What is the correct margin number and how can you predict a relatively accurate estimate of how you will get there? These are all hard, but there are more far more challenging questions.

When will you “pivot” and who will you become? Who else is building something similar and how much better or worse is their team and execution? What will your second and third round of investors want to see from you? How will those hurdles conflict with or support the goals already in place? These are impossible to predict; therefore, performance equity plan needs to be avoided or designed to evolve.


Rather than focusing on the specific results associated with each metric, focus on what will need to be accomplished to drive success in each metric.

  • You want revenue to hit a certain number? Then, you better make sure that the product is viable and ready on time. You also need to make sure that your go to market strategy is as bulletproof as possible. Your sales people need to have the tools and marketing collateral to be successful. This list goes on.
  • You want the company value to increase by X%. You need to be willing to squash passion projects and focus on the things that your valuation professional says will increase your multiple. Your need to hone your investor pitch deck to get that extra bit of value out of each new funding round. You better be prepared to navigate your market as it sways and spins over the years.

The unpredictable nature of the issues above is why stock options, remain so popular. They have a single metric which is stock price. The have a single goal to take the stock higher in the future than it is today. They are just and fairly elegant. They can also be a crude tool for a nuanced topic. And, adding performance conditions to something that already has a stock price hurdle can end up in “hitting your performance goals” while having the stock price flat or down due to market conditions, operational errors or any number of other things.

RSUs require no stock price hurdle to create value (therefore investors increasing dislike RSUs.) But, they are far less dilutive than stock options (therefore investors increasing love RSUs.) When you add in performance conditions that can help modulate unexpected great performance and provide a softer landing to unintended underperformance (within reason), you give yourself and investors something that may be far better for your company and employees than anything else.

Of course, it takes a bit more time and effort to create, manage and evolve a plan like this. But in an age where investors are more careful and potential values are more fantastical than ever before, performance-based equity may be the solution to the question that nearly everyone has when they start their exploration process.

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: 409A vs Investor Value (part 2 of an n part series)

untitledfWe have all seen the headlines, “XYZ receives $100M in funding at a $3B valuation.” We seldom see the “other” valuation showing the same company is worth $350M. For publicly-traded companies, value is determined by investors working as a group in a real-time market. They are generally purchasing the same kind of stock. Values are based on a combination of publicly disclosed information, supercool computer models and gut feel. But in the world of the pre-IPO start-ups, values take on a life of their own.

Investors in startups are buying stock with more risk and more upside potential. Companies only sell stock to investors on Continue reading

%-#-$ – 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

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:

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