
We need to rethink employee compensation - katm
http://www.aaronkharris.com/we-need-to-rethink-employee-compensation
======
Jemaclus
In this market, I tend to think of options as incentives, and not as
replacements for salary. Salary gets me in the door and work hard, great
people and culture make me want to be there and evangelize, and options
incentivize me to work my ass off. (I'd work my ass off without options, but
the options really make it easy to say "I will do everything in my power to
make this succeed" instead of "I'd rather go spend time with my friends
tonight").

To put it a slightly different way, I can't pay my rent with options. You can
offer me all the options in the world, but my landlord doesn't accept them as
payment. Therefore, you cannot simply exchange salary for equity.

I received an offer from a company a year or two ago, and they offered me a
salary almost 50% below my then-current salary, and then some equity. When I
tried to negotiate on salary, the CEO berated me for ignoring the equity. The
problem is that as far as equity is concerned, it's worth $0 until you exit.
There's a _potential_ for millions, but my lottery ticket is also worth
potentially millions of dollars. My landlord won't accept my lottery ticket as
payment.

Long story short, Aaron is correct: startups need to rethink the whole equity
component. It's valuable -- but it's not valuable in the same way that salary
is, especially in today's market.

~~~
drivingmenuts
I tend to think of options as worthless, until they vest. Which is too far in
the future to count on.

Pay me money. That's actually useful.

~~~
pbreit
Yeah, but no one ever got rich off salary.

~~~
MCRed
I've made more money investing in stocks and options than I have from options.
Over 20 years as an employee (so excluding time as a founder) my returns from
investments is 2-3X the return from startup stock options.

And that's as only a part time investor. I like sure things (like I knew in
2001 from an understanding of economics that there would be a housing bubble
and that it would eventually burst. I was never able to buy CDOs against the
market, but I did profit from it until 2007 when things got crazy and I got
out of the market-- a year early but I'll take it.)

I suspect most people can't do this... but they can buy a house or two in up
and coming areas, and put extra salary into that. Rent one out, get your
mortgage paid by your tenants and you're building a real estate empire...
slowly, but it can make you rich.

~~~
ryandrake
But that's not "getting rich off of salary". That's gambling on the stock
market. Sure, there are plenty of people who hit that jackpot too, but let's
not lump that together with the idea that 9-5 salary is a way to get rich.

~~~
MCRed
Investing in the stock market is not a game of chance. You may lack the skill
or discipline to engage in that activity, and that's fine, don't do it, put
your time elsewhere, such as the real estate method I described.

Calling it gambling, however, is dishonest, and is popular among those who
want to use that characterization to serve the purpose of denying people the
opportunity to invest. For instance, despite working in startups for 20 years,
regulations prevent me from being an angel investor (though it seems its
common in california to simply ignore those regulations) ... because people
like you think that I shouldn't be allowed to decide where to invest my money.
Yet I could go to Las Vegas and blow $100k in a weekend.

So, no, it's not gambling. It's investing. And shame on you for saying
otherwise.

~~~
ryandrake
"People like me"? I think you're reading way into my comment. I don't care
what you do with your money, it's yours.

Gambling is defined as "an enterprise undertaken or attempted with a risk of
loss and a chance of profit or success." That's exactly what people do when
they buy a stock or invest in a start-up. They just go to sites like E-trade
and Schwab to do it rather than PokerStars. Unless you know of some risk-free
stock where chance is not a factor (I'm all ears).

------
birken
Another really important, highly negative, combination of these factors is if
you want to leave the company.

If the company is public, then you can essentially leave whenever you want,
exercise the options and sell the stock to pay the costs (exercise price +
taxes).

But if the company is private, you have to pay the exercise price + applicable
taxes (which can exist even if you only have theoretical gains) yourself,
without the ability to hedge your risk and sell the still illiquid stock. If
you have ISO stock options, you have 90 days after you leave (or are fired) to
figure this out or lose the stock options altogether.

So if you are joining a company with the following combination of elements:

1) High exercise price (the math is: # of options * exercise price... is this
a lot of money or not)

2) ISO stock options or the stock option plan gives you limited time to
exercise after you leave

3) No reliable system to sell the private stock

Then you should add in a further discount on the stock options, because there
may be situations where you cannot afford to reap the benefits of the options
if you leave (or are fired) before there is reliable liquidity for the stock.

~~~
dschwartz88
Just a heads up, the 90 day out clauses are usually put in there by the
company lawyers. The only rule the IRS has is that ISO options flip to NSO
after 90 days[0].

Take a look at the Pinterest options plan[1], where Pinterest actually gives
you 7 years from when you leave to exercise. Your ISO options just flip to NSO
after 90 days.

[0]
[http://www.mystockoptions.com/faq/index.cfm/catID/36274DB1-D...](http://www.mystockoptions.com/faq/index.cfm/catID/36274DB1-D3C4-4D93-B57E8FA2916B9477/objectID/F1E4EDF6-2B05-452D-9AFD3FB64A55AE1E)
[1] [http://fortune.com/2015/03/23/pinterest-employee-
taxes/](http://fortune.com/2015/03/23/pinterest-employee-taxes/)

~~~
kentonv
The ISO -> NSO switch can have severe tax consequences for the employee. Even
if your company doesn't expire your options in 90 days, consider exercising
within 90 days anyway (and talk to a tax lawyer, etc.).

One not-as-obvious reason why companies are reluctant to set long expiration
dates on options is because it means former employees take up space in the cap
table even if they have no intention of ever exercising that option. The
company essentially has to treat those shares as having been purchased,
without having received any cash for said purchase. Cap table cruft can make
it harder to negotiate subsequent funding rounds.

~~~
scurvy
Oh noes! Don't disrupt the almighty cap table with a few peons worth of
shares!

Please. These are discounted to zero by anyone worth a salt.

------
ChuckMcM
I am not sure I understand Aaron's point in this.

Is it "We should pay people more?"

But isn't that really a question of whether or not you can find people who
will work for the salary your offering? If you can't you raise what your
willing to pay until you find someone who will right?

Or is it "We should make options always remunerative?"

In which case they aren't really options are they? They are just salary so why
not just switch to a fixed + variable salary system like so many folks do.
Heck you could even go all pay to perform like sales folks have been paid for
ages, "Get this code done, you get paid, don't you don't." I personally don't
think that incents the best choices but it can motivate.

If you want to write into your corporate by laws that every round of funding
includes a 10% of the shares in the funding must come from employees common
stock, and you always divide by 'n' (the number of employees that want to
participate) the amount of stock they can contribute, well that is ok, except
your converting common to preferred in that case and the SEC is going to ask a
lot of questions about that.

There is the perception that founders of unicorns are rich, but trust me, they
aren't, what they are is "rich on paper" and when they can't raise any more
money and they are running out of cash on hand, the founders stock is going to
be worth just as much as the employee's stock, which is near 0. So it will all
even out. There are a lot of people who were working in the Bay Area during
the 90s (and I'm one of them) that were multi-millionaires on paper at some
point, and that same paper because worthless sometime later before it could be
converted into cash. Did I "lose" 12 million dollars? No, of course not. I
never _had_ 12 million dollars, what I had was a concatenation of increasingly
improbable if statements which if the 'true' path was followed to the end,
could be converted into $12M. Since not all of those if statements resolved
true, the actual result was about $83,000. Lots and lots of people had the
same sort of experience.

Aaron, if you're reading, what problem are you trying to solve?

~~~
damoncali
I think it's more along the lines of "the old way we used to value and award
options/equity isn't very compelling for employees these days. We need to
think of better ways to give employees ownership."

That's a real problem for people trying to start a company without a lot of
cash. If it's to be useful as compensation, equity should be valuable, but
it's not because the payout is so uncertain and so far away. Throw in terms
that leave multiple opportunities to kiss the whole payoff goodbye just
because of life (or worse yet, get screwed over by the IRS), and it's no
wonder employees don't particularly value equity.

Typical option agreements are not terribly effective, so you may as well just
pay cash unless there is a better way to distribute ownership in today's
environment.

It's not a simple problem to solve. Saying "give more equity" doesn't really
do it if the problem is that the likelihood of seeing a payout is too small.
And making the payout more certain is not easy.

~~~
ChuckMcM
If that is the problem, to make it more compelling, then you're simply
advocating a pay raise.

Equity is called compensation but anyone who is working at their second
startup should understand that calling that is misleading at best. Since the
average tenure at the 'first startup' is about 2 years, consider it a 'masters
program' in learning about what is and what is not compensation.

So if you're going to take equity in lieu of cash you need to understand how
to compute the expected value of equity. And in early stage companies its
almost always zero. In an acqui-hire sort of situation it is zero and your
retention package is based entirely how important you are to making the
eventual use of the technology successful. Doesn't matter if your a founder or
not, if you're not useful you get nothing, if you are you get something.

But lets step back and ask the question again, if "equity" is the deciding
factor in your decision as an employee to join a startup, then you are clearly
doing it wrong. If you want equity to mean something, join a company that is
already publicly traded, then those ISO options or RSU have real dollar value
that you can compute using Black-Sholes or any other method. Stock in a pre-
series B startup exactly equivalent to the collected wishful thinking of the
founders and investors. And all of them know that if they get their money back
they will count themselves lucky.

What is broken then is not how we compensate people coming into startups, it
is the misconceptions they have about how startups work, and the fundamental
fact that "stock in a startup" is even on the list of things they want. All
you can ever ask for is interesting work, people that are fun to work with,
and enough salary to pay the bills and put money into a 401k. If you have all
of those as an employee than any stock you get that happens to become valuable
is all bonus.

~~~
damoncali
A pay raise would do it. But actual money is hard to come by in an
unprofitable high growth company. What is really desirable is a way to
distribute equity in a way that is not so complex from a legal and taxation
stand point, is manageable for employers, and is understandable by employees
without a finance degree. That's a pretty hard problem, and the shift in exit
patterns over the last 10 years has made it even more difficult.

The realization of the ideal that you can just get a percentage of the company
for putting in your time working hard is largely elusive. I think that is the
problem to solve. I'm not terribly optimistic there is a way to solve it
outside of "don't give as much equity since nobody wants it", but I like to
think there are smarter folks out there who can come up with something.

------
arbitrage314
I've made this point before, but since it's a bit relevant here, I'll make it
again (sorry to repeat):

If you're primarily interested in making money, or if you love the startup but
not the compensation, you should NOT work at that startup.

If you're a good developer, you can get a better deal by working at an
established company and simply investing. This has been true for every startup
offer I've ever seen. Ever.

I've considered lots of startup jobs because I believed strongly in the
companies. Every single time, however, I was able to get a larger chunk of the
company by keeping my current job and simply investing.

To give an example, my current job pays about $250k, and one year, I invested
$100k of that into a startup, leaving me with ~$150k of salary. This $150k +
startup equity was a better deal than the startup was offering in both salary
and equity. Plus, equity bought as an investor is much less tax toxic than
equity options received as an employee of a startup.

On the other hand, most people who work at startups aren't interested in
money. If that's you, that's totally cool! I wish I could care less sometimes.

~~~
reinhardt
> most people who work at startups aren't interested in money.

That's a bold assertion, bolder than "most people who work at startups usually
don't get to have competing offers for $250k to pass up"

~~~
arbitrage314
Even if your competing offer is ~$150k, it still makes sense to not work at
the startup ALMOST every time (given that you are trying to maximize money--
most are not). I've seen a few exceptions, but startup offers are usually that
bad.

Also, based on my convsations with literally hundreds of startup engineers, I
have seen three trends:

1\. They care very little about how much they are getting paid due to being
passionate about their work (awesome!)

2\. If they do care about money, they are under the false belief that their
startup options are worth more than than that startup's investors were willing
to pay for them in the secondary market (i.e., the price of a nearby round)

3\. They are almost always talented enough to get a high-paying job somewhere
else

------
kabdib
Treat options as wastepaper. They're lottery tickets. If they are worth
something someday, then great, good job.

But you can pour yourself into a company heart and soul, one with options and
one without, with exactly the same outcome: Zero. And to a large degree the
outcome is not only not under your control, it is often under the control of
predatory entities who do not want you to realize any return.

As an employee, get a competitive salary because the chances verge on
certainty that those options will be worth zero, no matter how hard you work
and no matter how much you think your contributions will move the needle.

The equation is different for honest-true-and-blue founders. But for a worker
bee, sure, make a show that options are interesting to you, but don't trade
them for cash compensation, it's a bad deal for you.

------
dotBen
Interesting article but it fails to mention a significant source of liquidity
for startup shares _(both currently and historically)_ :

Acquisition by a publicly traded company.

IPO isn't the only way to obtain liquidity, but what's interesting is just
like companies are shunning IPO they are also shunning acquisition.

We don't normally get to know about failed acquisition offers but Snapchat's
$3bn offer by Facebook is a great case in point. A few years ago practically
no one would have turned down that kind of offer, which would have also
created a liquidity event for everyone currently employed at Snapchat. Various
factors today mean someone like Evan Siegel was prepared to turn that down.

I'd love to see more discussion about that as much as the IPO market itself.

~~~
paulpauper
exactly..fundamentals will always trump liquidity

------
arielweisberg
Equity, unlike salary, can be crammed (dilution not correlated to valuation or
investment) away to an arbitrary degree at each funding event. Surprising not
to see this mentioned.

Every time you see a small company change CEOs you are probably seeing all the
employees who have been there since the beginning crammed away into
nothingness so the new CEO can get his 6%. The old CEO and execs won't walk
away with nothing so it comes out of the share of the rest of the employees.

I can tell when a company I have worked at is going to get a new CEO because I
get a notice in the mail telling me that my ownership has been further crammed
away into nothingness. This happens months before the actual handoff.

Options at a small company are definitely not in your favor. Options at a pre-
IPO company might be a different story, but pre-IPO you can get a real salary
and the options just bump your income up a bit.

Interesting things happen after you exercise. From now on I will always
exercise one share once I reach the first cliff.

------
bcheung
My thoughts on options are pretty much identical except I would say
"worthless" no "worth less".

I would also add that with an option position you are most likely giving up a
higher salary and the opportunity cost that comes with it.

An extra 30K each year invested at 5% in 5 years is worth more than 200K lump
sum in 5 years (200K discounted at 5% for 5 years is $157K).

You also have to factor in the probability of an exit. I just multiply the
probability by the expected future amount. So 10% chance of exit in 5 years
with a predicted equity position of $1M I would only count it as $100K.
Discount it for 5 years and it is even worse: $78K.

Of course you also have to factor in taxes. If you are already in a high
bracket and in CA you are going to be paying 9.3 CA + 28 Fed + 6.2 FICA =
43.5%. So more salary is pretty much worth half as much. You might have to
worry about AMT as well.

Of course with a capital gains, assuming you exercised more than a year ago
(possibly earlier with ISO options) then you will be taxed at only 15%.

But you have also given up that cash and the associated opportunity cost. In
effect, instead of a "free" lottery ticket taxed at 43.5% you now bought an
expensive lottery ticket, for the option (hehe) of only being taxed at 15%.

I'm on my 3rd startup and have equity in all of them and have yet to see a
single penny.

Honestly with tax brackets that high, and the chance of getting any equity so
small, I'm more tempted to start a business on the side that can be taxed
separately than try for a higher paying job.

The way I pick a company to work at now is more based on what kind of personal
and career growth it will offer, and also how much I will like working there.

~~~
gkop
It's even worse: California also taxes capital gains (as income!).

~~~
bcheung
Wow. I'm surprised I didn't know that. Thanks for mentioning it. Definitely
another nail in the coffin for early exercising.

------
dsinsky
One of the big issues here is that once employees start selling common stock,
the strike price of the options can no longer be set at a large discount to
the latest valuation as it can when the only transactions are the preferred
stock shares that are sold when the company raises money from VCs.

One of the most attractive things about employee stock options is that the
strike price is often set at 30-40% of the valuation of the latest financing
round. So a company that just raised (preferred) money at a $500m valuation
can give their employees options with strike prices around $200m or less.
Therefore, the employee can believe that they have a "locked-in" gain day
one.*

If employees sold their common shares at anywhere near fair value at the same
time the company was raising the round, they would likely sell at a price
between $400m-$500m a very slight discount to the preferred shares. Any future
option grants given would have to have a strike price reflective of these
recent common-stock transactions, and companies would no longer be able to use
the low strike prices of options to attract employees.

Obviously, this is just one trade-off among many and in no way means that
companies shouldn't allow more sales of employee common stock over time, but
its worth understanding the many reasons companies currently are resistant to
doing so as much as individual employees would like.

*Obviously, common shares should be priced at a discount to preferred shares but almost everyone I've talked to in the VC/startup community believes that the 60-70% discount applied is extremely generous as it implies that up 60-70% of the value the VCs investment is in downside protection (ie the debt-like element) rather than upside potential (ie the equity-like element), a pretty nonsensical amount for a high-risk, asset-light VC investment.

~~~
scurvy
You're discounting the value of preferred stock vs common stock. Funding
rounds sell different series of preferred stock. The relationship from common
to preferred stock is loose at best, despite what any 409a "valuation expert"
claims.

------
CodeMage
> _The first is a founder pledge that they will do everything in their power
> to let common holders sell into secondary markets above a certain valuation_

And that is where any company, big or small, would lose me. I've been burned
too many times by all kinds of people -- from co-worker to VP -- promising to
do "everything in their power" to do this or that. Weasel words like those are
worth nothing at all.

~~~
numbsafari
Agreed. If "everything in their power" doesn't extend to writing it into the
contract, then they are already lying to you.

------
marssaxman
Options are just a fancy lottery ticket. I have learned to consider their
value as $0 when evaluating a prospective employer's compensation offer; they
have lost all incentive power.

~~~
balls187
Financially speaking, that is the most prudent thing to do.

------
bcg1
The premise should be simple I think... pay people competitively with actual
money for the work they are actually doing right now. If there is a chance
their work could lead to a huge paypay... then give them a claim to a sliver
of that payday. Don't cross the streams.

------
StillBored
I would like to see someone actually attempt to quantify the chance a random
employee (that comes in post series A) at a random startup actually cashes out
more than a years salary from stock options.

Everyone would like to think that working their ass off at some start-up
increases the chance of being in the big leagues, but I just have never seen
it personally happen.

I've spent 15+ years working at small companies/startups, and I have yet to
see options that actually resulted in a fraction of what my salary was. I also
don't personally know anyone that hit the big time either.

So, do it because you love it and are happy with your current situation, not
because you think your going to hit the lottery. I have now twice in my life
created products that sold well, and made everyone enough money to live off.
But never have I ever even been near a situation where I created a product
that made tens of billions. And frankly I don't know anyone who has done that.
The few millions a product got sold for here or there, wasn't enough to put
even $100k in any single persons pocket.

------
joeblau
I was going to write a blog post about this as well from the employee said
based on a some quotes from Marc Andreessen. I just listened to an interview
where Dan Primack interviewed Marc Andreessen and Marc made some really good
points about timelines for public and private companies. Marc said:

> the time frame for how public companies think and how they are able to
> invest has shortened dramatically and correspondently the time frame for how
> private companies can think has elongated. [1]

> they (investors) tell the public company give us the money back this quarter
> and they tell the private company "no problem, go for ten years"

After I listened, I wondered why a talented employee would want to stay at
private company that is going to take 10+ years to IPO?

[1] - [https://soundcloud.com/a16z/a16z-podcast-taking-the-pulse-
of...](https://soundcloud.com/a16z/a16z-podcast-taking-the-pulse-of-vc-and-
tech-dan-primack-interviews-marc-andreessen#t=1:45)

------
randomname2
"They note that the average time to IPO is now 11 years vs. 4 in 99, and that
the overall number of tech IPOs is plummeting as privately funded companies
raise huge late stage private rounds instead."

What part do the increased regulatory requirements for public companies play
in this? Might this be one of the unintended consequences of Sarbanes-Oxley?

~~~
tonnesoffun
Yes definitely. Increased regulatory requests means it takes longer and costs
more to go public.

The Emerging Growth Company Act (EGC) helps this somewhat: companies with <
$1b in revenue have less reporting requirements if they file to go public.
Most VC-backed companies that do an IPO will leverage this.

Clearly, the benefit of staying private (and still being able to raise $100M+
rounds) outweighs the consequences of illiquidity for employees....at least in
the eyes of the founders and management.

------
Animats
This is for the special case of options in successful startups, a problem
which affects well under 1% of the workforce.

Nobody is going public because borrowing is so cheap, resulting in round after
round of leveraged private equity. This may change when the Fed starts
cranking up interest rates around the end of this year.

Also, the new JOBS act rules for small IPOs are now in effect. So far, nobody
seems to have done much with them, but that's now an option for companies at
the point they need a follow-on round.

------
ninjakeyboard
In my experience, you might see a startup get bought once or twice in your
career. It happened to me. While it has been amazing for both my career and my
income, I have not seen anyone around me get a dime from equity. If you get
bought, it's probably not going to make you rich - if anything, you might get
a bit of dough, get into a great shop, and have to make some utterly
disturbing choices like pick up and relocate. This week. Do it go or you're
out of a job.

------
sytelus
I think lot of these idiosyncrasy stems for arcane SEC rules like 500
investors and restrictions on IPOs. Startups and tech community should lobby
to change all these. Why can't we have full fledged public exchange where
anyone, any startup can come in and sell its stock with no restrictions at
all. If people want to buy in to their vision, sure let them be. Lot of rules
around IPO and SEC are placed to protect the general public from fraud and
prevent their confidence evaporate from investments. But let's say if you
build an exchange called "High Risk Securities Exchange" and let anyone list
themselves, publish their stocks and allow anyone buy or trade them as they
like then lot of artificial artifacts we see today will be gone. These kind of
trading exchanges can live side by side of conventional public exchanges.

One thing we need to understand is that starups most likely won't have money
to pay same amount as their established counter parts. All they have is their
vision to sell and that means options must remain critical part of their
offerings. If IPOs are fizzling and employees don't get rewarded for the risks
they took then ultimately existence of startups itself is at risk.

~~~
nstart
I think what we need to understand is that we shouldn't underestimate how
naive people are when it comes to the chance of going home 'big', and how
exploitative big companies can be of such naivete. Imagine big company X,
listing a shady company Y (no official connections to company x though) which
has a few employees and some very vague hocus pocus documents discussing their
promise. Y gets a few googly eyed people who don't do their homework to buy
in, by selling stock owned by X. Stock prices go up naturally, and then when
all the stock is done, big company X closes up Y (discard office premises etc
but keep the legal entity) and move on to their next similar venture. Money is
laundered back into X's bank accounts and the thieves come out on top yet
again.

It's not like the current system stops people from being gamed, but any of
these types of systems are bound to be exploited by the "evils". Cartels are
formed in the shadows, markets are manipulated. I love the idea of a public
market as an official process, but I'm not sure if it can be done without the
system becoming polluted.

------
bane
Options should be thought by employees as a future bonus based on performance
- a "thanks for sticking around when there was lots of hard work to do".
Meaning your salary should be market rate and not lowered in exchange for
options.

It's been a while, and I can't find it right now, but somebody once put
together an analysis of average employee payout for companies with exits that
valued the price of the options above their strike price (meaning they were
actually worth something). My memory is hazy, but they found that a tiny
fraction of employees managed to make something under $20k per year worked out
of their options. And many of them were working under market rates for their
services meaning the financial outcome, the years of belt-tightened living,
and missed opportunities came out to something like under $10k extra
compensation per year worked.

On the flip side, I know from personal experience, you can learn more in
startups than in more traditional businesses, and so the experience you gain
might be worth more to you over a career than any specific financial
compensation.

Basically go into startups as an employee expecting to learn, but don't expect
a big pay out. If you get one, count yourself lucky and enjoy.

------
dkasper
> companies need to standardize their secondary sale and options repurchase
> practices

I realize this is somewhat trolling, but like Benedict Evans joked in the
recent a16z podcast on this topic traditionally that's a process called...
IPOing.

[http://a16z.com/2015/06/17/a16z-podcast-the-rise-of-the-
quas...](http://a16z.com/2015/06/17/a16z-podcast-the-rise-of-the-quasi-ipo/)

------
inspectahdeck
The third point here seems wrong to me:

>The third reason for why individual options are probably worth less now than
they used to be is that both employer and employee need to account for the
fact that the time until IPO or liquidity is longer than it used to be. This
is a big issue. To get the true value of offered comp, employees need to add
their offered salary to the present value of the options offered. When
calculating that, the further out the payout, the less it is worth today

This assumes a constant payout, which defeats the purpose of options. If there
were a set date and set payout, the company should just offer cash bonuses or
similar.

The value of an option _increases_ the further the expiration date is [0]. He
even says:

>You can be pretty sure that a company currently worth $10mm won't be worth
$1b in 3 months, so you have a reasonable band of expectation.

Sure, but it might be in 5 years. You're granted an option as a bet that it
might grow that big by the time you cash out - not to lock in some set amount
of compensation 3 months from now.

Maybe I'm missing his point. Sure, employee compensation might need to be
rethought - but not because options are a bad tool. Companies grant options at
an early stage _because_ of the long time horizon and high volatility [1].
That's what makes them valuable. If you want your compensation to be liquid
and predictable, you should probably just ask for more cash.

[0]
[https://en.wikipedia.org/wiki/Option_time_value](https://en.wikipedia.org/wiki/Option_time_value)
[1]
[https://en.wikipedia.org/wiki/Black%E2%80%93Scholes_model](https://en.wikipedia.org/wiki/Black%E2%80%93Scholes_model)

------
probablycorey
Has anyone used a service like
[https://www.equidateinc.com](https://www.equidateinc.com). They help you
"sell" the right to buy your stock options to a third party. From their site:

> Traditional stock sales are time consuming, expensive, and clutter a
> company's cap table. Now it's easier: the Equidate contract transfers the
> economic upside and downside of your shares without actually selling them.
> It honors all exisiting transfer restrictions on your stock, and your
> identity is kept private throughout the entire process.

> The contracts Equidate has designed have aspects similar to both a
> derivative contract and a asset-backed loan. The result allows an investor
> to purchase the rights now to the economic upside/downside of a share now,
> without going through the complications of adding additional shareholders to
> the company's cap table or the hassles of a secondary stock transaction,
> postponing any transfer of shares until the company is ready.

~~~
rsamvit
Equidate founder here! Feel free to email me directly at samvit@.. if you have
any questions

------
jmalicki
Public companies have already rethought this. They give equity compensation in
RSUs (i.e. options with a strike price of 0), rather than options with a
strike price at the current valuation.

With RSUs, you are rewarded for meeting high expectations. With options, you
are only rewarded if you dramatically beat already very high expectations.

------
shawnee_
_If IPOs are getting significantly delayed and are potentially at risk of not
happening at all,[1] we need to change how compensation is structured._

Not sure that this is the best opening argument here. With things like the
JOBS Act passing, Reg A+ and such getting off the ground, my hypothesis is
that we'll see an acceleration in the rate at which companies are able to get
to the IPO stage. If anything, in the short / near-term future, we'll see an
_increase_ in value of paper. The whole point of offering equity to
shareholders and stakeholders is to have people (ownership theory) who are
rooting for and/or willing to work toward group success.

The problem, of course, is that executives at far too many companies use
equity like a dangling carrot... demanding more than reasonable time for even
a basic ROI for the people whose risks are the riskiest (early employees).

------
ig1
There are other solutions:

1) The company could offer to buy back options at market rate.

2) The company's current investors could offer to buy equity from employees.
The majority of investors returns come from a small number of portfolio
companies, for those companies that are doing well the investors want a bigger
stake even if it comes in as secondary.

3) Companies could appoint designated investors who could buy secondary stock
from employees. Successful companies typically have over-subscribed rounds,
companies could allow those investors who they like but couldn't get into the
round to buy employee stock.

The general reason (2) and (3) don't happen is that individual employees don't
have that much stock and the overhead involved makes it not worthwhile. But
potentially there could be a solution which involves bundling together stock
into meaningful amounts.

~~~
dsjoerg
A blend of 2) and 3) would be 4), options-holders get right of first refusal
on stock sales with a valuation >$X

------
avz
Options and equity are financial instruments. Like mortgage, but with
different rules.

With a mortgage, you're buying a present house with your future income.
Presumably because you cannot afford to pay for it in cash right now.

With options, the startup is compensating you for your present work with a
future share of ownership of the company you're helping to build. Presumably
because it cannot afford the risk of accepting the fixed expense of your
salary right now.

It's hard to tell whether the author is right that the current compensation
structure needs to change. The real question is: are there potential employees
around the labour market who accept the risk and prefer the potentially large
future bounty over fixed income at present?

------
onion2k
_The first is a founder pledge that they will do everything in their power to
let common holders sell into secondary markets above a certain valuation, say,
$500mm._

How many VC backed startups get to that sort of valuation without going
public? At the $1bn mark, globally, there are 98[1]. I imagine it's possible
there are 50 times that number at $0.5bn, but that's still a pretty small
number out of all the startups there are. To fix compensation we need things
that are going to move the needle even for relatively small companies.

[1] [http://graphics.wsj.com/billion-dollar-
club/](http://graphics.wsj.com/billion-dollar-club/)

------
11thEarlOfMar
I'd consider tossing profit sharing into the compensation package. Not instead
of, but in addition to. The 'CFO' could commit a (minor) portion of profit to
profit sharing, perhaps on a tiered basis. Add that into the package, and the
employees have a bridge between their (below market?) salary and in-money
options that gets more cash in their pocket as the company starts to succeed.
I'd even go so far as to say that motivating employees to strive towards a
profitable business structure is a more pure motivator than equity.

Does anyone have experience with this approach?

------
brudgers
Salary is the only hedge employees get that is congruent to the liquidation
preference preferred stock provides passive investment. It is increasingly
important because capital is finding 1x liquidation preference in a startup
investment a reasonable alternative to parking cash in near zero interest rate
bonds. The same institutional investors who used to buy IP's can now provide
capital directly and the beneficial outcome gap between passive capital and
employee equity is increasingly wide.

------
mjbellantoni
As a hiring manager I have found that this adjustment already started
occurring about two years ago.

Firstly, the market for technical talent is so competitive right now, that
cash is an easy way to compete for people and salaries have been driven up.

More importantly, people have become far more sophisticated about options and
what a payoff is likely to look like. Ten years ago I would never be asked a
question like "how many shares are there outstanding on a fully diluted basis"
but now I hear it essentially all the time.

edit: grammar

------
bcheung
One thing that would increase the value of options, at least to me, is if you
have Series A options that can be sold to investors at Series B or C.

Why is it that this is never an option (pun intended)?

------
westoque
>> Thank you for writing this. Start-up comp is effed. I'm 30 and have worked
at a few start-ups that didn't make it, thus the cut I was taking in salary
never turned into anything better. I had to cut my losses at this point in
life and head to a public company that was able to pay me a lot more, plus
signing bonus, plus stock options that had real value, plus restricted stocks.
Maybe I just got lucky. But my expectations now are well above what I've been
given in the past.

This.

------
nhangen
What about the increase in shares being sold in the private markets, and
during financing rounds? Wouldn't that help make up some of the opportunity
lost by staying private?

------
exelius
There's a simple solution here: make employee options liquid during major
fundraising events. So when you close your round B/C/etc, give employees 30
days or so to exercise their options at the pre-money valuation. If you're
nervous about employees exiting too early, pick a high valuation (say, $50M)
and the option exercise clause doesn't kick in until then (at that point
dilution shouldn't be an issue).

------
dj_doh
I'm probably going to get a lot of negative comments. I've a simple theory for
compensation. First, pay me salary and bonus for my work that I deserve in a
given market, for a set of skills and experiences I'll be bringing in. And
second, give me stocks for the risk I'm taking on a nobody inc. 9 out of 10
companies or hiring managers don't give a second thought about failed startups
and its stories.

------
leopoldo
How crazy would it be to say something along the lines of: "OK, I'll accept
your offer but I want to be paid for overtime, and have [some] freedom to work
in personal projects/consulting (as long as they don't expose 'trade' secrets
from the company)"

It's like saying, I'll take your low pay + stocks but you will also be risking
that I start making more money on my own and leave.

------
rdlecler1
Founder here. Not sure what you're talking about. Talented people are
expecting healthy salaries in this market and decent chunks of equity. I'm the
least paid person on our team, take significant risk ( if the ship goes down I
go down with it ) and I have just 6x more equity upside than our top
compensated employee (who makes 3x my salary now).

------
danielweber
I was at a startup company where an employee wanted to sell his stock and had
a buyer, and the company said "no, if you want to do your own sale, you will
need to hire an auditor in your own dime to determine the value, and we won't
let your auditor see the books."

And this company was _above average_ in not pulling dirty tricks.

------
bcheung
Another thing that would make the options worth more (less of a risk) is if
the company started making a profit they started issuing dividends.

This is not likely to happen though because the company is going to be focused
on growth and then an exit and they can't grow as fast if they are paying out
their profits instead of reinvesting them.

------
normloman
Profit sharing.

~~~
dhimes
Agree.
[http://blogs.balsamiq.com/team/2011/09/12/profitsharing/](http://blogs.balsamiq.com/team/2011/09/12/profitsharing/)

------
balls187
If you believe that options are worthless and will always be worthless, aren't
you tacitly saying you believe the company is worthless and will always remain
that way?

So why are you even working at that company to begin with?

Is it because people are fatigued by having their options amount to nothing?

~~~
rconti
No, TFA outlined the reasons that options may not become liquid even if the
company is successful.

------
gnorsot
In some situations startups just don't have enough money to offer and the only
thing that they could give is stocks. In those cases it is a matter of
negotiating bigger cut of options to compensate for small salary.

~~~
wmeredith
It doesn't matter if it's a bigger cut of zero. That's the problem.

------
paulpauper
I don't mean to sound too dismissive, but this article is bunkum. SO I guess
by the author's logic, Michael Bloomberg's net worth is zero because Bloomberg
LP never went public? The private market is illiquid, but fundamentals will
always trump liquidity. If you own equity, that equity - assuming there is no
dilution or deterioration in the fundamentals of the underlying business - is
wealth. Employee stock options are a different matter, but deep in the money
options are essentially as good as partial ownership. it may be harder to
assess valuation in a private market, but it's done nonetheless.

~~~
fredkbloggs
Mr. Bloomberg's privately held equity undoubtedly makes distributions to its
shareholders. Stock that does not pay dividends and is unlikely ever to do so
is not wealth; it's just a piece of paper. And if you cannot legally sell it
to someone else, it's effectively worthless as there is no way to convert it
into something of value. The exception is if you have a majority of the voting
rights, but that's not what this article is about.

~~~
001sky
There are many liquidity events that are not in the set of 'IPO' events. But
the issue remains that liquidity is a core element of asset value. Many later
stage financing events can be structured to provide limited liquidity to
founders and early investors; the issue is that this may not help all
employees equally. The IPO is useful in this case.

------
brightball
Something to keep in mind...there is nothing standing in the way of you
negotiating your own compensation package.

------
dk8996
Well. I stoped read after the first paragraph. The time line for startup to
IPO is getting shorter.

------
justizin
"When shares can only be sold in private transactions on secondary markets,
and, increasingly can only be sold with the consent of the company, the
options are actually worth less."

There's no space in the middle of "worthless" ;)

~~~
stephengillie
In economics, you often deal with situations where an asset has devalued below
another asset's value. The first asset still has value, but relatively less
than the second.

This is different from an asset which has zero value. Some economists enjoy
the wordplay of "worth less" (first meaning) vs "worthless" (second meaning)

In this instance, it looks like the article is describing how increasing
controls further devalues the options.

Edit: For instance, if the company decides on each attempt if you're allowed
to exercise the option, you might value it at 25% of the stock price, or
lower. Even moreso, you can't be certain that the company will still exist
when your options can be traded for cash, which should devalue the options
even more in your perspective.

It should be the net same as if you're working for someone, and they paid you
with an IOU for 1% of the money they might win from a lottery ticket. So the
value might be infinitesimally small, but not zero.

~~~
fredkbloggs
The point here is that due to the factors the author noted (and probably
others), the perceived value of options in nonpublic companies is now low
enough that many (most?) candidates/employees no longer consider it relevant.
I happen to agree with that choice, regardless of whether the expected value
to the employee of the options is actually zero or just some very small
number. We can debate the true ev of an option, we can apply various formulae
to attempt to compute it, and we can each agree to devalue various
restrictions differently according to our own preferences. But I think we can
probably agree that in many if not most situations, the value of the options
to the employee is too small to affect the decisions that employee is going to
make. It doesn't matter whether that value is zero or $50 or $5000, it matters
only that it's too small to be material.

To the extent that this is a problem for founders/owners, it's largely of
their own making. It seems like it should be easy enough to correct if they
want to, but they will have to give up many if not all of the wildly favorable
(to them) terms and/or give up more equity to their employees to do it. The
alternatives all involve paying more cash, which is probably the right answer
for everyone anyway; it's disappointing that the author didn't even seriously
discuss the possibility of simply paying higher salaries in lieu of equity.
Apparently that's simply taboo.

~~~
damoncali
_it 's disappointing that the author didn't even seriously discuss the
possibility of simply paying higher salaries in lieu of equity. Apparently
that's simply taboo._

I think most people would like that, but options can be created out of thin
air, while money cannot.

------
AdieuToLogic
I read the article, based on the title, thinking "I wonder what the author is
going to address regarding employee compensation." Was it addressing
performance? Or perhaps socially valuable contributions which have been
traditionally under-compensated (such as teaching)?

No. It was bemoaning how stock options offered to employees by a corporation
might, _might_ , be "worth less" when restricted sale is applicable.

Just so we are all on the same page, here is the definition of "stock option"
as provided by Merriam-Webster:

> 2 : a right granted by a corporation to officers or employees as a form of
> compensation that allows purchase of corporate stock at a fixed price
> usually within a specified period (source: [http://www.merriam-
> webster.com/dictionary/stock%20option](http://www.merriam-
> webster.com/dictionary/stock%20option))

The article then went into great depth skillfully supporting the author's
thesis, done from the perspective of a partner at Y Combinator. All well and
good, but what wages do "other people" make?

According to here:

[http://www.census.gov/newsroom/releases/archives/income_weal...](http://www.census.gov/newsroom/releases/archives/income_wealth/cb11-157.html)

The median household income in 2010 was $49,445 USD. The census does not
mention stock options, though I think it reasonable to assume most US workers
do not receive such consideration.

Within this thread, "MCRed" shared their experience with stock options:

> Over many years as an employee for startups, I was employee number 24 of a
> $30M cash acquisition exit. The result was 6 figures, but just. Effectively
> it was a year's salary.

Since "MCRed" states the options were worth "a year's salary", it is safe to
state that "MCRed" made at least $100,000 USD per year.

And "varelse" writes:

> Given that a seasoned and in-demand engineer can make anywhere from $250K to
> $500K annually working for a big co, without a 3-letter title and 3-letter
> title equity, there seems little incentive to accept $150K or less and ~0.5%
> or less equity.

All of this leads to this simple, direct, question: how much do you think
people outside of "tech" make in _their_ jobs? Based on the median household
income quoted above, the likelyhood is _1 /5 to 1/10_ what "varelse" estimates
(which I think is high nationwide) and minimally _1 /2_ what "MCRed" was once
_given_ above and beyond a paycheck for at least the same amount.

We, _all of us in tech_ , need a reality check. There are literally _millions_
of people in the US along (not including 6.5+ billion other people in the
world) which do not come close to "just" the base salary many of us enjoy. And
before anyone says "but the market demand...", I say be honest with yourself.

And yet many are boo-hoo'ing over "gee, I didn't get Even More(TM)!"

I tell ya what. Stop by the Walgreen's on Market and 9th (IIRC) in San
Francisco and ask someone working there whether or not their stock options
offerred to them when hired was worth it for making $50,000 USD less per year.
For bonus points, present the same question to the Uber driver dropping you
off.

PS: "MCRed" and "varelse" are only two representative examples. Other
statements in this thread would serve equally well and I bear no malice toward
either "MCRed" or "varelse."

~~~
Retra
Who are you making that argument to? If your company is making absurd profits,
you should be tap into it as an employee. Comparing your earning to people
elsewhere isn't going to mean anything unless the money is there as well. And
saying "Oh, but other people don't make any money" doesn't mean that they
_shouldn 't_ make money. Or that people in the tech sector developing the
social tools and economic methods to make for fairer compensation wouldn't
also apply elsewhere.

You're not going to convince people that they should except peanuts from a
multi-billion dollar industry because "there are starving children in
Africa(TM)." That's not a progressive argument.

~~~
AdieuToLogic
> Who are you making that argument to?

The commentary is meant for all, which is why I posted it on its own and not
in response to a particular person. This is also why I said "'MCRed' and
'varelse' are only two representative examples. Other statements in this
thread would serve equally well and I bear no malice toward either 'MCRed' or
'varelse.'"

My intent was to give a different perspective to a person reading it.

> If your company is making absurd profits, you should be tap into it as an
> employee.

No, a company which employs a person agrees to remunerate the employee at the
rate agreed upon by both parties. The amount of profit a company makes is only
relevant to this in the context of how long the employee's check(s) will cash.

> You're not going to convince people that they should except peanuts from a
> multi-billion dollar industry because "there are starving children in
> Africa(TM)." That's not a progressive argument.

This is a straw man[1] as I said _nothing_ about convincing people to accept
"peanuts from a multi-billion dollar industry." What I _did_ say is that
people in tech (myself included) need to have perspective that not everyone
makes the kind of money we make. Ignoring this leads to situations such as the
rally in SoMa last month entitled "evict techies" and other similar
expressions of resentment.

Feel free to ignore this perspective, me, or anything anyone else says or
does. It matters not to me. Based on the reception my original post has
received, it looks like I need to learn to do the same.

1 -
[https://en.wikipedia.org/wiki/Straw_man](https://en.wikipedia.org/wiki/Straw_man)

------
anon3_
The whole concept of options as something to supplement salary is bullshit. It
essentially means that as an employee, you're hedging the risk and taking a
lower salary for it.

In addition to you taking the risk of that option, even in the most optimistic
outcomes for the company, your shares could have been watered down in various
ways.

You could work for a startup for a year and get fired early on and receive no
options.

The whole thing is a employees getting ripped off. We keep telling ourselves
there's a rose garden after we get X.

I recommend the book "How to stop worrying and start living" by Dale Carnegie.

------
paulhauggis
You can say it's over, but since there always seems to be a never-ending
supply of young workers that think they are going to win the startup lottery.

Companies won't start offering it until workers stop accepting it.

A similar parallel is the gaming industry.

------
acaloiar
Not to discount the OP's points, but this smells like the tech industry
equivalent of your worst Facebook friend—the one with a penchant for selfies
with Starbucks skinny vanilla lattes—hashtagging an inane event with
"whitepeopleproblems".

