
Employee Equity: Too Little? - arnauddri
http://avc.com/2014/04/employee-equity-too-little/
======
tptacek
The other problem with large equity grants to employees is that employees
discount them irrationally, why by "irrationally" I mean things like "by
trying to value them without doing the math or research". Employees are
usually at a sharp disadvantage when it comes to valuing equity, which means
that when you allocate it to employees, you're paying a premium to do that.

My sense of it is, it's good to give generous equity to keep the team's skin
in the game, so that the ups and downs of the business are meaningful to
everyone. And, key team members that really _want_ equity and are willing to
do the work to value it, also good. But pro-forma "competitive" equity grants?
Pay cash instead.

Incidentally, the odds that the "best" engineers getting 10% of startups at
signup are _actually the best developers_ is, I don't know, something like 𝛆.

~~~
adambenayoun
This.

What I find help with it is give them as much information as possible and be
there to answer any question they may have.

If you're giving away generous stock option grants you want to make sure they
are as educated as possible about their value as opposed to some companies
where they'll be secretive about the actual outstanding shares issued and
other preferences that could hurt employees grants when a liquidation happens.

Additionally for people who may not value option stocks like you do (as a
founder or early team member), we usually offer generous equity grant but also
allow employees to swap some of them for a higher pay.

I think employees are grateful when given the ability to pick more pay or more
options.

It allows them to put a price tag on these stock options which make these more
valuable and tangible.

------
claudiusd
Stop taking advice about equity from VCs. If you've ever read a term sheet or
a SPA, then you know that VCs have a huge incentive to encourage founders to
increase the size of their option pools: your typical term sheet requires the
existing shareholders to take the dilution of the option pool rather than the
investors. Because of this, the bigger your option pool is the lower your
price-per-share becomes, and as such the investor gets a bigger cut. It
requires founders to budget their option pool up front and divvy it up
carefully until the next round of funding. These terms ENCOURAGE founders to
keep their option grants tight.

Sam Altman and others need to put their money where their mouths are - if you
want bigger option pools for employees then remove this clause from your term
sheets and encourage other investors to do the same. If you think that more
employee equity is good for business, then give us more flexibility with the
option pool and share the dilution with us. Don't blame us when the real
change starts with you.

~~~
tptacek
The option pool issue is obviously a hot button here, but remember that Sam
Altman's commentary on it ends with "Option pools are complete fiction; boards
can increase them whenever they want. It should never be used as a reason for
not making a grant.".

~~~
claudiusd
I do agree with him on that, but ask any founder if they feel like that's a
real option. Any VC pre-closing will certainly give the impression that it is
not.

~~~
malandrew
Unless YC goes out on a limb here and starts pushing to make it a condition
for getting face-time with YC companies on demo day.

IANAL, I would expect it's collusion if the startups get together and start
agreeing to terms they will accept collectively. But if instead YC, a single
entity, uses entrance into its demo day event, as a bargaining chip that can
change the conversation around term sheets for the entire industry.

i.e. make this rule: Every investor YC allows into demo day may only offer
term sheets that does not require the size of the option pool to be raised
until after closing the financing. Instead the size of the equity pool will be
negotiated after funding closes and will be based on the amount of dilution
both the founders and employees and the VCs think okay with relative to the
benefit they receive from a larger pool.

Individual YC companies would still be free to engage with investors outside
and after the demo day event and take the less favorable terms where the
option pool is negotiated ahead of time.

------
balls187
"Let’s say that you want to hire a top software engineer and are competing
with equity grant offers from Facebook and Google where the value of the grant
is $1mm. If you have a current valuation on your company of $10mm, then you
have to offer 10% of the company to compete for that engineer. I am not saying
the engineer isn’t worth it."

I totally disagree here.

I don't think you compete with Facebook on comp in this manner. Facebook stock
is as good as cash. Stock at a ~A/post A company isn't. Even if you say you'll
give this employee $1mil worth of stock, there is a high likelihood that stock
isn't going to be worth it.

Don't go after Facebook's top engineers trying to compete with comp until you
have the resources to get them, take the money ball approach and find talented
people who aren't having the world thrown at them yet, and lure those people
away.

~~~
potatolicious
Or... find people worth less than $1mm. It's strange that people even talk
about recruiting top (and I mean _top_ ) engineers when I can count on one
hand the number of startups I've ever seen that'd justify that kind of talent
(think John Carmack level).

The vast majority of startups are business process improvements (think AirBnb,
think Uber) where there's no freaking way you'd really need a Carmack on your
team.

I disagree with the point about finding talented but under-recognized people.
I've seen companies do this, and in this market they _will_ get discovered,
it's only a matter of time - and the switching cost of jobs right now is
nearly zero. If you're going to lure ridiculously undervalued people away,
only to continue to undervalue them (just not as badly), you're going to get a
_lot_ of attrition.

~~~
balls187
> I disagree with the point about finding talented but under-recognized
> people....If you're going to lure ridiculously undervalued people away, only
> to continue to undervalue them

I agree with this point, though I don't think that not-offering them 10% of
your company is undervaluing them.

I'd like to believe that most people who are undervalued at BigCo's are
because they either lack the self-promoting skills, or haven't yet found the
right environment to be successful.

~~~
potatolicious
> _" though I don't think that not-offering them 10% of your company is
> undervaluing them."_

I didn't say anything about 10% ;)

This may or may not be what you're suggesting, but I've seen this time and
time again in NYC - find someone with talent making $45K in the Midwest and
dazzle them with visions of the Big City and... $80K. I've heard of the same
things happening in SF as well.

These guys never stay put, once they're in your local talent pool the
recruiters will set upon them like sharks. It'll be a few months at most
before someone comes in with a price adjustment on your engineer's services.

In this market, with a supply this short, any arbitrage opportunity is going
to be highly temporary.

~~~
hapless
The big problem with recruiting out of the Midwest is that nearly anyone with
a marketable skill in the Midwest has stayed there by choice.

It's not as if Midwestern engineers are unaware that working on the coast is
an _option_. It is almost certainly an option considered and rejected. .

------
7Figures2Commas
> Let’s say that you want to hire a top software engineer and are competing
> with equity grant offers from Facebook and Google where the value of the
> grant is $1mm. If you have a current valuation on your company of $10mm,
> then you have to offer 10% of the company to compete for that engineer. I am
> not saying the engineer isn’t worth it. She is.

1\. Facebook and Google are publicly-traded. $1 million in equity at a
publicly-traded company is _not_ the same as an equity grant at a startup that
is theoretically worth $1 million based on the valuation given to the startup
by venture capitalists in its last round. The startup's equity might never be
liquid and it's far more vulnerable.

2\. Most startups do _not_ have to compete with Facebook and Google on
compensation. Most of them can't really afford to. The truth of the matter is
that as a startup, if you can't get folks excited about working for you
without matching the dollars offered by the richest tech companies, there's
something wrong with your value proposition or you're trying to recruit the
wrong people.

3\. What's the difference between a "top software engineer" and a "software
engineer"? Different companies have different needs. This idea that all
startups need the best of the best (i.e. the person who Facebook and Google
are battling for) and that you can't put a limit on the worth of an engineer
("I am not saying the engineer isn’t worth it") is ridiculous.

------
kenjackson
Fred seems to ignore that it costs less to create a viable company now. Hence
the amount they _need_ to raise from VCs is smaller. In the past I may have
needed $30m from VCs, now I need $5m.

Additionally, as hapless notes, the cost of good engineers is the price of
business. You could flip it the other way and say that VCs should pony up the
$30m and founders give the engineer $1m signing bonus with market wages and no
equity. But I think founders would be more squeamish about that then giving up
equity that really has little cash value 90% of the time.

BTW, I've never seen a non-founder engineer get 10%. Maybe it happens, but I
think its still pretty rare.

------
chasing
I find it weird that the only discussion about this seems to be coming from
the founder/VC side of things.

Any offer has two sides. The one who offers and the one who accepts (or
declines). And I feel like employees need to fully understand what they're
getting themselves into. Then they can decide whether what they're being
offered is worth it.

The last time I was offered a chunk of equity to work with a start-up, I ran
the math and decided it wasn't enough to compete with other opportunities. The
start-up wouldn't agree to raise the equity to a point I was comfortable with,
so I walked and went on to other projects.

If more employees negotiated -- and negotiated seriously from a place of
knowing both their value and the value of the offer -- I feel like we'd
quickly get a better sense of how much equity is fair.

~~~
malandrew
As someone who was once a founder (failure) and is now the first engineering
hire at a funded startup and plans on founding something after my current gig,
the issues Sam raised that are most concerning to me are all the other issues
besides the size of the grant. Don't get me wrong, I wish the grants were
higher, but all the other issues are more pressing since they increase the
utility of the small percentage I earned without diluting anyone else. Solving
those issues that increase the utility of a good limited in supply and makes
the valuation of that good far less nebulous makes it much easier to more
accurately determine the amount of equity an employee demands/receives.

Getting a bigger percentage with unfavorable terms that might be used to limit
how much upside I can get or nullify the upside entirely matters far more.

I would prefer terms:

* where the exercise window is long (10 years)

* where the employees and the founders have the same conditions in funding rounds or acquisitions. i.e. equal dilution. equal opportunity to take money off the table if that is an option. same triggers (double, single).

* protection against liquidation preferences (honestly this shouldn't even be a thing)

* restricted stock instead of options, with a bonus to cover the tax on it for the year it was issued that is paid out either on the 12th month when the cliff is reached or when taxes on it are due, whichever comes first.

Beyond that, a change in tax treatment for these illiquid assets would be
awesome.

------
mjmahone17
If we take this article down the "slippery slope" it proposes, you'd end up
with 8 people in the company owning ~80% of the total equity, with the
"founder" only owning ~15-20%. But why this is a negative thing for the
company is still up in the air: at that point, you might as well have a
partnership, like consultancies, law firms or advertising agencies. There's no
inherent reason a partnership couldn't make the next LinkedIn or Oculus Rift.

~~~
tptacek
That's about where founders land now, isn't it?

~~~
mjmahone17
Yes, but it seems like with much less say than they would have if they were a
partner, as opposed to just 15% shareholders.

------
hapless
If it costs you 10% of your company to attract a top engineer, and it's not
worth that much to you, you're going to make do with less than the top
engineers. At best, you will be recruiting people not smart enough to ask
important questions about equity.

Fred Wilson seems to be suggesting that founders should indeed hire second-
rate candidates if it means they get to keep more of the pie. Maybe he's
right.

------
fingerprinter
This is dumb. There are at least three sides the equity equation: founders,
VCs/investors and employees.

I notice that only two are considered "variable" in this article: founder and
employee.

The fact is, VCs/Investors are becoming less needed than they were 10-20 years
ago. Why wouldn't it be logical for their stake to take a hit for the money
they put in?

~~~
tptacek
Because at the margin, of the three parties we're discussing, the investors
have the least market pressure. For all the talk of valuation bubbles, top-
tier VC firms still fund one company for every ten-twenty-thirty? companies
they meet with.

~~~
fingerprinter
That just tells me that VCs should be taking less. The fact remains that Fred
only looked at two options; either the founder stake goes down or the employee
pool does.

A third option also exists...Investor total share goes down. I personally
believe we will see this more in the future.

~~~
tptacek
The VCs are going to take what the market will bear, is my point.

------
zacharycohn
"...companies make very large grants to early employees and that ends up
hurting the founder’s stake..."

Isn't that the point? That early employees are worth more than they've
historically been compensated?

------
brudgers
[Preface: My assumption is that Altman is thinking about greater employee
equity as something which will create value in YC's portfolio companies. I
take it as a given that YC now has sufficient data points to perform
regression analysis on this sort of thing among their portfolio companies (and
perhaps others outside their portfolio), and that Altman's attention has been
drawn by some trend in YC's data and the possibility of increasing YC's rates
of return.]

I doubt Altman is trying to make life easier for VC's like Wilson. My sense is
that YC's business model is oriented to disrupt the traditional VC model and
more closely align the interests of investors with those of people at the
company. Pretty much every financial innovation YC has made has had the effect
of pushing the transfer of power from the people working at the company to
those providing capital further and further down the road - from YC's taking
common stock, to connecting companies with Angels, to convertible note
financing, each move has been toward getting capital into companies without
payment always being made in board seats.

YC's stated goal is to invest in people over ideas, while founders may be the
first order investment, the employees of the companies they fund are still a
critical part of that bet. Thinking on the bigger horizon, more equity for
employees favors founders whose ability to get things done is less dependent
on total control, which almost certainly correlates with the sort of
leadership that benefits big companies - and big companies are the outliers
that YC is looking for.

To put it another way, a CEO who has experience building consensus among
principle and minority shareholders is better prepared to deal with the
diverse and competing ownership interests that exist after a company has taken
VC.

At least that's my theory of the day.

------
rch
> I am not saying the engineer isn't worth it. She is. I am just pointing out
> how dilutive employee equity is becoming in silicon valley.

Maybe this reflects the fact that it's so much easier to get by with less
early capital these days. Those early employees are simply worth
proportionally more to a startup than they might have been 5-7 years ago.

------
adambenayoun
I am a bit disappointed no one actually addressed* an issue that every founder
has to deal with when raising series A: the option pool (it's true most start
with a small option pool long before series A but the friction start during
series A fundraising).

Most (if not all) VCs require the option pool to be formed before the series A
transaction is completed and usually push for a very high option pool to avoid
granting more options and dilute themselves in case the option pool is not big
enough.

This conflict of interest lead founders to fight the VC to form the smallest
option pool possible while VCs want the biggest one. And the non-sense is that
most of that option pool will be granted to employees that will be hired after
series A.

*Sam Altman actually wrote a short note but didn't expand on it and I think it's a shame.

------
caseyf7
I would like to see more evidence of employees getting too much equity. What I
see more often is the VCs getting the large option pool and then the founders
try to issue as few options as possible to protect themselves from the
dilution the large option pool created for them.

------
gavanwoolery
I've been on both ends of the spectrum - as an employee who got very little
equity and as a founder who had to distribute it. All I can say is that you
don't fully appreciate the worth of equity until it is your own that you are
giving away (and I consider myself a relatively generous guy). :)

------
malandrew
I'm wondering why we don't make the vesting of the grant variable as well. Why
four years?

Why not allow an employee to negotiate for double the chunk for double the
length of the grant? That's far more desirable than getting 4 years worth,
arriving at year 4 realizing you've succeeded in building a company of true
value only to discover that the amount you are re-upped is now at a strike
price far greater (that you are responsible for achieving). i.e. you are
punished for succeeding if you stay long enough to get re-upped.

