One things I’ve noticed over the years is that equity grants given to new employees soon after Series A financings are generally a bad deal for those employees on a risk/reward basis. (By a Series A financing I’m referring the first round of funding by VCs, where the amount raised is roughly $2M or more).
Here’s how equity is often granted from the very beginning of a company’s formation:
1. Founders decide on mostly equal split over beers. It’s all just scribbles on a napkin at this point so equity flows freely.
2. In the cold light of day, founders renegotiate, with some founders possibly getting (significantly) more than others.
3. Employees who join pre-funding get reasonably big equity grants.
4. Series A financing occurs.
5. Suddenly equity grants to new employees are sliced an order of magnitude or more from what they were prior to Series A.
(Also, toss in there along the way one founder gets disgruntled and leaves – see founder vesting).
The problem is a Series A financing usually de-risks the company far less than the equity grants drop. If I had to graph this in a totally unscientific way it would be like this (for successful companies – as represented by the green line going straight up):
Why do the equity grants drop so much after initial VC financings?
1) There are well established norms for post VC equity grants. Going against them generates a lot of resistence from VCs. By way of example, here are directionally accurate although probably 2x what I have typically seen post Series A.
2) Compounding this, after a financing the founders probably just got finished arguing for a smaller option pool to reduce their dilution, and it’s seems very hypocritical after that to argue for greater-than-standard equity grants.
3) The company now has an arms length valuation, probably in the multi-millions of dollars. Suddenly 1% is worth “real money.”
The best time to join a company is at the very beginning – to found or co-found the company. The second best time is to join before venture financing. The third best time is when the company has started to ramp sales/traction – at that point your equity grant will be small but at least the company will have a much higher likelihood for success. The worst time, from my experience, is right after initial (Series A) VC funding.
The flip side of this argument is after the company raises venture financing, an employee is more likely to get a “market” cash salary. Personally I’d rather see people get bigger option grants post Series A and sub-market (or better yet subsistence) cash salaries – until the company is cash flow positive. This is pretty much the opposite of Wall Street’s compensation schemes. To me, as a principle, that means it’s probably a good idea..