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 Continue reading

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 Continue reading

Startup Equity: The Most Common Mistake (Part 7 of an n part series)

untitledHere is my 2017 gift to you. I truly believe that equity compensation helped build the technology industry, and therefore the world as we know it. But, an unfortunate number of startups make the same error when using this complex and powerful tool that drive corporate success.

If you browse the internet, ask entrepreneurs or receive guidance from someone at a VC firm, you will get similar answers when asking about equity awards for the first twenty, or so, employees. This information, while accurate at a generic level, is likely to be incorrect for your specific circumstances.

The answer looks a bit like this. Outside of the founders, the C-level hires should each get Continue reading

Startup Equity: Isn’t It Refreshing? (maybe not) – (Part 6 of an n part series)

untitledThe historically long periods between the startup and “big event” for companies has given rise to many issues that were never considered when stock options and other equity tools first became the preferred startup incentive tool. Among these unplanned issues are things like:

  • Wealth inequality between the first 20 employees and employee 5,000 or 12,000 or more
  • Grants expire when the company has not yet made its move to IPO
  • 409A Valuations
  • Dilution and burn rate issues long before IPO
  • Grants becoming stale
  • Downward movement in stock prices
  • (Ugh, this list can take the maximum 800 words allowed for this post)

This post we will discuss the controversial issue of “refreshing” grants for long-term employees. To clarify, these are not grants for promotions or company-wide performance. These are equity compensation awards that are given simply because Continue reading

Startup Equity: Synthetic Equity or Sharing Without Sharing (Part 5 of an n part series)

untitled4When you hear “equity compensation” and startups, you immediately think of stock options. More recently RSUs (restricted stock units that settle in company stock) have also been popular. But, what if you aren’t the “sharing” type? Or what if your company doesn’t have stock? LLCs are a good example. How does your business compete when it doesn’t have access to the same tools? Synthetic equity is becoming an increasingly popular answer.

Synthetic equity refers to any type of incentive plan where the value delivered to participants fluctuates based on the value of the enterprise. For corporations, the most common tools are Continue reading

Startup Equity: Comparing Your “Currency” to a Competitor’s (Part 4 of an n part series)

untitledComparing base bay is relatively easy, equity not so much. A dollar is a dollar. And, if a dollar isn’t a dollar (let’s say it’s a Franc), there are published exchange rates to help convert values. But, with equity compensation, the base currency is your stock, and its value is not easily translated (or even agreed upon). This fundamental disconnect is one of the most challenging issues faced by anyone dealing with equity compensation at a start-up.

Let’s start with the oversimplified example above. There are exchange rates from dollars to francs, but they are not as consistent as the prices available for Continue reading

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

Evolving Equity Like It’s a Flying Machine

untitled3Other professionals in HR, compensation and investing frequently ask why I am so passionate about changing the way companies use equity compensation. They point out that the majority of companies follow the same path and many companies (as well as many individuals) have been very successful with the current paradigm (see below for a quick summary). Why mess with something that seems to work at least some of the time?

I ask you to consider the 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.