
The Right Way to Grant Equity to Your Employees - ca98am79
http://firstround.com/article/The-Right-Way-to-Grant-Equity-to-Your-Employees
======
Jemaclus
The best part about this is that it describes equity as what it should be: an
incentive to do a great job. The problem that I see with most startups
(especially in SF) is that they treat equity as a replacement for salary.

Sorry, guys, but equity doesn't pay the bills. Furthermore, it's _delayed_ and
_potential_ gratification. First, there's generally a 1 year cliff, which
means I'm effectively taking a salary hit for 1 year for no good reason
(unless you matched my original salary). So like I said, equity is not a
replacement for salary. Second, your company may be valued at $400M, but my
options are worth _less_ until you get acquired, sell, or IPO.

You're basically saying "I'll give you X salary and I'll also give you Y
pieces of paper that will hopefully be worth Z dollars in the future, but I
can't promise anything."

IMO, equity should be treated as a benefit along the same lines as free
lunches or vacation days. It should be a bonus. If you offer me X salary and Y
equity, then X should be enough to pay my bills and Y should be enough to
incentivize me work my ass off for you.

My two cents, anyway.

~~~
nairteashop
I agree with you that a _well-funded_ company has no excuse for offering a
below-market salary and make up the difference with equity. But for early
stage startups that have no money, this is something that you don't have much
control over.

Back when our startup was like 2 people and barely ramen profitable, as much
as we wanted to, there was no way we could pay market rate for some of our
early hires without going out of business before we got any traction. Those
hires made a risk vs. reward decision to take a _temporary_ cut in salary in
return for a larger amount of equity. Now that we are bigger and stabler, we
have raised all their salaries to above market.

Perhaps this is what you were saying as well, but I find that many people
demonize any startup that offers below market salaries in return for higher
equity. In many cases, it's not because they want to - it's because they have
to.

~~~
Jemaclus
Sure, I think that's a fair assessment. I've just gotten a few offers where
they offer SIGNIFICANTLY below market rate and offer a lot of equity, and when
I counter, they get upset. That's frustrating.

I'd happily take a pay cut to work for a startup that I believed in, but there
is a lower limit that I can feasibly accept before I'm living paycheck to
paycheck again, and that's just a miserable place to be, imo.

~~~
judk
Any one who gets upset during salary negotiation is either trying to scam you
or not emotionally mature enough to run a business. Either way, walk away.

~~~
Jemaclus
Agreed. That's exactly what I did. :)

------
fleitz
I collect equity bi-weekly when I use a portion of my earnings to invest in
various companies (most of whom make actual... you know, money):

I come from the fuck you pay me school of equity.

Now the startups's got Paulie as a partner. Any problems, he goes to Paulie.
Trouble with the bill? He can go to Paulie. Trouble with the cops, deliveries,
Tommy, he can call Paulie. But now the guy's gotta come up with Paulie's money
every week, no matter what. Business bad? "Fuck you, pay me." Oh, you had a
fire? "Fuck you, pay me." Place got hit by lightning, huh? "Fuck you, pay me."

That said, I also don't care about business strategy, blah blah blah, that's
up to the founders, I'm happy to add my 2cents but as a professional my job is
to implement their vision. Not play venture capitalist with my time rather
than my money.

Think about it, HN gets 5% for 20K, if you make $100 an hour, that's 200
hours. Imagine the typical first employee, 1-2% with a 4 year vest, that's
over 8000 hours (assuming an 8 hour day, let alone the typical death march),
and it's doubtful you'd come even close to $100 an hour. If you're working for
equity you're paying close to 100 times the price for a much shittier class of
shares.

Now on the otherhand if you take a convertible note at $20K and the founders
can't raise anymore, just call your loan and grab the IP, or break even on the
aquihire.

~~~
joelthelion
I wouldn't hire you.

~~~
fleitz
That's ok I probably wouldn't accept your offer.

------
edgesrazor
One thing I don't see mentioned frequently when articles talk about equity is
the concept of trigger events in regards to vested shares. Equity is a great
motivator, and is terrific for rewarding (or even keeping employees) but most
strategies don't cover vesting and trigger events. I've seen several excellent
employees at another job get completely screwed because they were given
equity, but their shares didn't vest until a specific trigger event (such as a
buyout or a VC investment). The contract stated the employee had to be working
at the company during the trigger event, so the easiest way to save money was
to fire those people right before it happened. Not here during the trigger
event? No vested shares and therefor no money for you. It's a terrible
strategy and quite immoral, but not illegal, so I encourage anyone who is
contemplating taking shares in addition to (or in lieu of) pay, make them be
very specific about the trigger events, and more importantly - if there's any
amount of those shares that are automatically vested on Day 1.

When we formed our company, we specifically stated automatic vesting for
specific employees so they knew they were guaranteed money during the trigger
event - whether they were still with the company or not. Those numbers are
low, but it gives them faith we're not going to screw them over.

~~~
prostoalex
The "in it to win it" is a typical structure for a private equity, but not for
venture-funded software startups. Was your friends' company venture-funded?

~~~
edgesrazor
They were self-funded for about 3-4 years, then received a cash infusion from
a private equity firm (the first trigger event), then were sold to a much
larger VC a few years later. That's when the firings started taking place.

------
btilly
This is one of the cases where the title of the article is better than the
title chosen on HN. Because the entire article is really about why this is
_The Right_ Way to Grant Equity to Your Employees.

(As of the time of this comment, the title starts off "One Way..." instead of
"The Right Way..." You might disagree with the article's assertion that this
is the right way. But a different subject is misrepresenting the article.)

~~~
biot
I'm sure the change was made because "The Right Way..." falls under the
"gratuitous adjective" clause in the guidelines, no different than if it said
"The #1 Way...".

~~~
kevinpet
One Weird Trick Successful Startups Use to Grant Equity

------
7Figures2Commas
A distinction needs to be made between illiquid equity at early-stage startups
and liquid equity at publicly-traded companies or companies that are well on
their way to liquidity. What makes sense at Equinix, Juniper Networks and
Opsware, all publicly-traded or acquired companies, may make little sense at
an early-stage startup.

When equity is liquid, ongoing grants are akin to bonuses. At early-stage
startups, however, the attractiveness of ongoing grants to employees
ultimately depends on the perceived value of those grants. If a path to
liquidity is not clear and employees are not certain that the company's
traction is producing meaningful appreciation of their existing equity,
ongoing grants are unlikely to be very compelling.

In short, I think it's a mistake for earlier-stage startups to treat equity as
a retention tool. It can be an effective recruiting tool in some
circumstances, but unless your company is a rocket ship that is going to reach
the moon soon, which most early-stage startups are not, focusing too much on
equity as part of the compensation package can easily hurt retention because
most of the experienced and savvy employees know how to keep score.

~~~
kevinpet
I don't think Andy's point is that equity is a strong retention tool. It's
that when people stop vesting, then it's almost active encouragement to go
look elsewhere.

~~~
fleitz
It's a strong retention tool as long as your employees aren't acting as
rational agents.

------
PhantomGremlin
I've been very lucky to have received equity from three different startups (as
an early employee, not as a founder). In each case the company went public or
was acquired by a public company. In each case my equity was _meaningful_ in
comparison to the salary I received.

IMO there's exactly _one_ key to my good fortune: the company founders made
the decision to be _generous_ with the amount of stock/options they granted.
They weren't trying to lowball people.

That's the bottom line, you need founders who want to "do the right thing" for
their employees. Unfortunately I don't know how you (without doing a lot of
due-diligence by asking around) join a company with "honest" founders. It's
almost axiomatic that startups try to screw "the little people" out of any
stock rewards, even if the company is successful. I was lucky.

------
mahyarm
I want to add one more thing, doesn't happen often, but happens often enough:

\- Don't put call options on employee stock.

And something I wish that companies would start doing:

\- Don't make vested options expire soon after the end of employment. Don't
force people to take big tax hits just to buy the stock that they have earned.

~~~
djrogers
"And something I wish that companies would start doing: \- Don't make vested
options expire soon after the end of employment. Don't force people to take
big tax hits just to buy the stock that they have earned."

That's counter to one of the main goals of a good equity comp plan -
retention. If a company goes out of it's way to ensure that LEAVING the
company is painless and of low cost to the employee, retention would suffer.

~~~
asolove
But the plan should be structured so that what you earn is in line with the
benefit you provide to the company. Making it arbitrarily harder to benefit
from what you've already earned is unnecessarily cruel.

This is a big difference between aligning incentives and retroactively
punishing behavior you don't like.

~~~
harryh
Have you earned your equity just because you put in the time, or have you
earned it when you get to the finish line (when the stock is able to be traded
for actual $)?

These tension between these two points of view is the source of the
consternation in this area.

------
stickydink
Every time I read about this, I'm reminded how out of the ordinary my stock
options appear to be. I was granted an amount of stock options after ~1 year
at the company. They represented about the average % of the total pool that
I'd expected. Our company has about 20 employees, 3 founders, no execs. I'm
the #1 employee, in terms of salary.

But, my stock options have no vesting period. They expire, and I lose them
entirely, should I ever leave the company. This is the same deal everybody
got. I've never really understood why they were done this way, it seems rather
unusual?

It's always felt like a hook, an ugly way to retain people who've already been
there a long time. I've been working with the company for 3 years now, but if
I left tomorrow, I'd have no equity to show for it.

Does anyone else have stock options like this? Is it normal?

~~~
mjmahone17
That sounds dysfunctional, not at all normal. You've given a ton of power to
your employer, with no position for you to have any recourse. This sort of
plan actually incentivizes the board to fire all current employees, especially
those with the most "promised" equity. I can't imagine ever agreeing to a
situation like that, unless I could confidently say that, assuming I got no
equity (which likely will be the case), it's still a better deal than my
alternatives.

------
emp25
General options question: I was hired after the first round of funding and
given x0,000 options along the way (three years in so far). We're just now
closing our second round. I was curious about the valuation and number of
options/shares issued so I could have a ballpark idea of the value of my
options. When I asked at a company meeting, the founders hemmed and hawed
about it and ultimately wouldn't say. The round hasn't closed yet. Are these
numbers typically kept secret? Is there a reason whey they're tight-lipped?
Our headcount is 20-30 and I'm just a developer.

~~~
Jemaclus
Disclaimer: I'm not super versed on this kind of thing, so this is just what I
understand.

It's my understanding that generally when you raise more funding, your shares
are diluted. Let's say before there were 100,000 shares, and you had 500 of
them. Well, now there are 120,000 shares and you still only have 500 of them,
so instead of having options for 0.5% of the company, you have options for .4%
of the company. They don't really want you to know that the equity you were
promised up front is now worth less than it was before, so that's why they
hemmed and hawed.

~~~
arielweisberg
IMO dilution is not a bad thing. The company is worth more after it takes
money and that money is going to fuel growth that will hopefully offset the
dilution. If it doesn't well the shares weren't worth that much anyways.

You can't expect blood from a stone when it comes to ISOs. As long as the
dilution is fair WRT to the valuation and number of new shares
issued/allocated I don't see the problem and good leadership would explain it
as such.

The flip side is that if employees are diluted badly enough they will leave.
Employers know this and walk the line of doing the bare minimum they think
they have to do to get the people they care about to stay.

~~~
emp25
"if employees are diluted badly enough they will leave"

I guess in my case, I don't know how the second round dilution arrangement
will affect me.

~~~
arielweisberg
Disclaimer, I am not an expert, but I did stay at a Holiday Inn Express last
night.

First I would suggest you bring up your concerns clearly and make sure you
understand why they won't tell you. Give them a chance to explain. If the
company is 30 people you should be able to drop by the CEOs office and ask.
Like I said they may not be saying anything because the financing is not
final.

Alternatively if they are not cooperative.

Go in tomorrow and ask to exercise your vested options. At this point they
have no choice but to tell you the FMV of those options. Don't exercise them,
or do that is a separate topic and you have to watch out for tax liability.

Do it again after the financing finishes. The FMV of your shares will change.
If it is significantly lower the options may not be worth your time.

They can't avoid telling you the FMV of the shares you have because you need
to know to calculate your tax liability for the spread between the strike
price and the current FMV.

Think of it like any other investment. If it isn't gaining in value it's not
worth your time. If the FMV of your shares is say 4/5s of what you had before
financing you did well. If it is 1/9 you got screwed or your company is doing
very poorly (although why would anyone invest in it then...) In the middle it
is more complicated.

If your company is healthy and not taking on a large amount of money for
growth the FMV of your shares might actually increase despite the dilution.

~~~
emp25
Thanks for the info Ariel. I'll have another talk with the CEO, maybe in
private this time.

------
johnrob
There's a catch 22 here though. If the company does well, the new hire equity
amount will drop because the stock is more valuable, and thus the evergreen
grant will pale in comparison to the employee's earlier grants. Should the
evergreen grant be relative to the original grant?

If the company is doing poorly, people are going to look around regardless of
equity.

~~~
resu_nimda
I think he covers that here:

 _Investors and employees make much more money by increasing the size of the
pie rather than their share of the pie._

Percentage-wise the new grants will be smaller but could theoretically match
the (estimated) dollar value of the original grant, if they are considered
based on the time each was granted. Obviously, the new hire grant will be
worth much more than the evergreen grant at the time the evergreen grant is
given. But the employee is now taking much less risk than they did when they
joined, which is covered here:

 _The best part is that, as your company grows, you always grant stock in
proportion to what is fair today rather than in proportion to their original
grant._

------
polskibus
There's a good book on the subject, albeit with completely opposite point of
view - the equity has spoiled management and made them care less about the big
picture and instead moved the focus to managing expectations.

[http://rogerlmartin.com/lets-read/fixing-the-
game](http://rogerlmartin.com/lets-read/fixing-the-game)

------
shalmanese
Having been on both sides of the negotiation table, I'm increasingly of the
opinion that the standard model of granting equity (linear vesting over 4
years with a 1 year cliff) is deeply and fundamentally broken and the only
reason anyone ever sticks with it is due to tradition and a fear that any
attempt to tinker will uncover how deeply broken it is.

It's a bad system that doesn't serve either side well and the only reason it
hasn't blown up into a real issue is because cash is cheap enough right now
that most of the deals I'm seeing amount to something like "within 20% of
market wage + an insultingly small amount of equity".

I have no pretensions that the ideas I have are any good, feasible or even
legal but I think it's at least worthwhile thinking and experimenting with
models that serve the needs of both sides better.

Problem: Options are basically impossible to price (and are undervalued). If
it costs me as an employer $100K to offer an options package but the employee
only perceives it to be worth $10K, then it becomes a major problem using it
as a hiring incentive. The problem is that standard option contracts are
basically impossible to price. I like to think I'm relatively sophisticated at
finance and I've worked through the options packages of a bunch of my friends
and I always end up throwing my hands up in the air and declaring that I have
no idea how to even approximate a fair price.

What most people far less sophisticated (aka most engineers) do is price on
the underlying asset. eg: 4% of a company worth 1M vesting over 4 years equals
$4000 of forgone salary (aka: not that exciting). In reality, basic options
theory states that an option is always worth more than the underlying asset
and the difference is directly dependent on the volatility of the underlying
asset. On the flip side, liquidation preferences, dilution, acquihiring and
the like drastically depress the value of an option. These two combined make
pricing options a black art.

Solution: Think about it, nowhere else in the startup world do we make locked
in 4 year contracts, why would you do it with employees? Would you sign a 4
year office lease? Would you commit to a fixed bill for EC2 4 years down the
road? Startups are all about paying a premium for flexibility, I'd much rather
offer 2% vesting over 1 year than 4% vesting over 4 and I wager employees
would value it higher as well. Alternatively, get rid of linear vesting and
implement something like 40%/30%/20%/10%. This at least makes refresher grants
meaningful rather than a pitiful joke when put against existing options.

Problem: There are huge discontinuities in the standard vesting. At 1 year,
your effective net worth suddenly takes a huge jump upwards and at 4 years,
your effective salary takes a huge jump downwards (even accounting for
refresher grants). These discontinuities are ruinous to employee loyalty.
People are pretty lazy, they usually prefer a pretty good job to the effort of
finding a better one. But 1 year cliffs and 4 year cliffs are just enough of a
nudge to put people casually on the market.

Solution: Get rid of the 1 year cliff. The ostensible reason given for the
cliff is that companies don't want to reward employees who don't work out. But
you've already paid them a bunch of salary and spent the time hiring and
training them!

If the concern is that you don't want them added to the shareholder limit,
instead what might be a more elegant solution is that, anytime during the
first year, if you leave for any reason, the company has the option to force
you to sell back your shares for say, 2x the strike price. For example, say
you're made an offer for 1000 shares per month at a $1 strike price and it
ends up not working out in 4 months. The company has the option of either
letting you keep 4000 shares or paying you $8000 to void the shares. This
seems like a way better way to keep all the incentives aligned rather than
blunt force cliffs.

Problem: It's easy to give people additional options but hard, and possibly
illegal to take options away. On the surface, this seems like a win for
employees. But like laws that make it harder to fire people, the perverse
incentives make companies more conservative and make it worse for employees. A
company that makes a mistake and offers a salary that is too high for an
employee's value can at least attempt to re-negotiate and drop the salary. A
company that makes a mistake on equity has no choice but to either live with
it or fire the employee.

Solution: Making equity grants re-negotiable opens up a can of worms as Zynga
discovered. Who knows? I don't have any great ideas about this.

Problem: Standard share grants are a shitty way to compensate for forgone
income. Say you're a cash strapped startup and an engineer is willing to work
for you as employee #1 for $12K instead of his usual 120K. How much is that
worth in equity? It's hard to say since you don't know how long the income is
forgone for. You could raise a Series A tomorrow and bump his salary back up
to 100K, you could struggle to raise for a year while he gamely hangs on. Is
that worth 1%? 4%? 15%? Who knows?

Solution: Agree on two vesting schedules that get switched over automatically
upon hitting certain goals. eg: Agree to pay 1K & vest 1% for every month
while bootstrapped which gets automatically switched over to 10K & 0.05%
monthly upon raising $1M.

I'm not saying these solutions are necessarily good and I'm sure there's a
dozen things I haven't taken into account. But these are all real problems
I've seen that have caused real equity negotiations to fall apart.

~~~
applecore
_> In reality, basic options theory states that an option is always worth more
than the underlying asset..._

An option is always worth _less_ than the underlying asset.

------
michaelochurch
_The defining difference between Silicon Valley companies and almost every
other industry in the U.S. is the virtually universal practice among tech
companies of distributing meaningful equity (usually in the form of stock
options) to ordinary employees._

When was that written? 1985? _Meaningful_ equity? "Meaningful" starts at 0.3/N
(pre-dilution) where N is the number of employees. Anyway, equity is an awful
model. Profit-sharing is better. Go here:
[http://michaelochurch.wordpress.com/2013/03/26/gervais-
macle...](http://michaelochurch.wordpress.com/2013/03/26/gervais-
macleod-17-building-the-future-and-financing-lifestyle-businesses/)

If I ever build a company, I'll use profit-sharing (at much more generous
levels) instead of equity, except for people who are truly partner-level.
Trying to convince non-partners to think of themselves as more in order to
extract more from them is just dishonest.

 _But the engineering tradition that spawned Silicon Valley was much more
egalitarian than traditional corporate culture._

No, those supposedly stodgy corporate cultures (see: banks) are actually a lot
more egalitarian. In banks and normal companies, your boss is a social equal,
just more experienced, more valuable on account of being longer with the
organization, and perhaps luckier than you are. In these VC-funded startups,
founders (much less the unapproachable gods called "investors") are simply
_better than you_. That's why they got introduced to partners at VC funds and
you're lucky to get a reply from an associate.

No company would ever pay the 27-year-old VP/HR 10 times the salary of the
35-year-old programmer. You _might_ see 1.5x, especially if the programmer is
a bad negotiator (or female). But that's common with VC-istan equity. When it
matters, VC-istan equity exacerbates the shit out of inequality because the
executives are getting paid 10-100x as much as the workers (when no one would
tolerate more than a 1.5-2x difference in salaries).

 _the Wealthfront Equity Plan should result in approximately 3.5% to 5% annual
dilution assuming no executives need to be hired_

Investor infusions dilute everyone, of course; but if employees are getting
diluted for fucking _executives_ then you, sir, are a fucking asshole and
deserve to lose all the talent you have.

Honestly, this product (yes, this is a product pitch, not a real article)
looks like a complex solution to a simple problem: the equity model in Silicon
Valley is broken and actually very un-egalitarian in practice (look at house
prices out there). Equity should be substantial but for genuine partner-level
people only (and most people shouldn't, and won't want to be, partners).
Everyone else should get substantial profit-sharing that can pay off like
equity-- in fact, most get bonuses much larger than they get under the VC-
istan system that awards mediocre one-time bonuses-- but (a) isn't persistent
if the person leaves, and (b) doesn't come with all the nastiness (tax,
regulation) of owning an illiquid security.

~~~
jalonso510
"if employees are getting diluted for fucking executives then you, sir, are a
fucking asshole and deserve to lose all the talent you have."

how else would this work? all new option grants dilute all current stock and
option holders.

~~~
michaelochurch
Employee equity usually comes out of a pool that has already been set aside.

