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.

Could the stock options or RSUs you receive from a “unicorn” startup be diluted?

Question (Orig. on Quora):

Of course the rsu’s can be worth nothing if the company implodes, but other than the company simply failing, is it possible for my stock to become worthless?

Answer (by Dan Walter):

Sure. Imagine the company goes through a down round financing. Imagine the new investors put a structure in place that ensures they receive their full value if the company is sold below a given price. If the company is eventually sold below this price then all of the value of the company would be paid to the latest investors and nothing to the holders of employee equity.

This is just a super simple hypothetical but I can bet that some people on Quora have real horror stories about similar transactions.

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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If a start-up terminated an employee, is it required to allow them to exercise the relative portion of their stock option grant that is yet vested?

Question: (org. on Quora)

Answer (by Dan Walter)

This is a fairly common question. The short answer is no. But, it depends.
The first thing you should turn to is your grant agreement.  This will explain things like vesting schedules (generally when you can beging exercising stock options, or when you gain access to the stock or cash underlying things like. RSUs.  The vesting schedules may also require that a change in control or IPO take place before any vesting is finalized.
Your agreement is also the most common place to see the details on post-termination grace periods.  This is what may allow you to exercise any vested amounts after you  leave. The rules for these are usually different depending on the type of termination.  Example:  Death or Permanent Disability may give you 6 months or a year, termination without cause may give you 30 days or three months, but being fired or “terminated for cause” often results in an immediate forfeiture of anything vested.  Anything unvested usually is cancelled the date of termination, regardless of the reason.
If your vesting schedule allows exercises and your termination grace period allows exercises, they may still be additional restrictions that would keep you from exercising.  Some of these may be defined in your agreement.  Others may be found in the plan document.
You need to ask the company to put in writing their reasons for not allowing you to exercise.  And you need to do this quickly.  If there is a grace period you don;t want to mess around with the grant after that expires.  If the company is on the edge of a transaction like an acquisition, you don;t want to have to learn a new set of people and rules.

Equity Compensation Triage Assessment (Stock Options on Precipice Part 2)

6a0134836082f8970c01b7c8140d49970b-200wiThe first article in this “Stock Options on the Precipice” series covered some of the main issues that are currently impacting employee stock options (check it out here). This article will discuss some of the paths you might take if you are having stock option concerns. For many executives, human resources and compensation professionals, this may be the first time to experience the trials and tribulations of stock options. For others, the questions below and the assessment process may be a new way of addressing this issue.

Luckily, Continue reading