Your reaction is spot on. Chris Dixon has a great post (http://cdixon.org/2009/08/27/the-one-number-you-should-know-about-your-equity-grant/) on exactly this subject. Excerpt: “I felt forced to post this after talking to a friend today who told me abo…

I am going to join an internet start-up next month pre-funding.
Currently the brief status is:

2 founders spent 1+ yr bootstrapping
4 fresh out of college engineers made offers to join mid-this month.

They are giving final touches to their product's working demo for 1st round VC funding hoping for a $2M+.

I am 6 yrs experienced and going in for an Architect role.
I am going on a 75% pay-cut, since till now the company is funded by founders' own pocket. But i have planned things and i am out of “safe company” mode and prepared to WORK in startup mode.

They haven't yet formulated their final offer to me but What kind of equity should i be looking at in % terms ?

Your input on this will be highly beneficial for me.

Thanks !
MG

Don’t play games if you expect to find smart people that will work for the best growth/profitability of your business.

Love the succinctness of this post, certainly after reading posts and comments for the past few hours .

My 2 cents:

For an employee, I think price per share captures enough information. You are basically telling your employees: You get a salary plus bonus. Bonus is in the form of options. This year, you get 10,000 options at $5 (ignore strike price for simplicity). That’s worth $50,000 today. It may increase as the company does better (partly your responsibility…as a valued team member) or it may decrease if we all mess up (down round or business failure). See it as a non guaranteed bonus. The only thing that is guaranteed is salary. That’s the whole concept of thinking of options NOT as a lottery ticket but as compensation. The following year, the company will grant you more options.

What more does the employee need to know? I think if you are asking them to think about % stake from the beginning you are encouraging them to think about lottery ticket payouts rather than the merits of the job/career itself.

I agree with you even though I don’t always practice what I preach for the simple reason that this transparency can sometimes create cultural issues internally.

In my experience, developers discuss their compensation openly. I may have individual team members with very different option %s based on when they joined primarily.

When you know your colleague has 3x more upside than you that affects your daily motivation.

I know that most option grants don’t generated the incentives we hope for as managers and most staff don’t drink the kool aid and think they’ll get rich, so we need to fix it. And so, you’re right to bring this up. I just do worry about the effect this level of transparency has on team morale.

How much time will you spend educating people on why its a good thing that post the next funding round their % went down?

I’m going to stop now, because the more I write, the more I think you’re bang on (i.e. if everyone knows and sees their personal dilution, it can be motivating so everyone pushes harder to keep things capital efficient).

Thus endeth this Monday morning stream of consciousness.

Let’s look at two ways that a company could communicate the value of options to an employee. To keep it simple, let’s ignore the amount the employee will have to pay to purchase the shares, let’s just look at gross value.

Option 1:
Current share price: $10
Number of options granted: 10,000
Current value of option grant: $100,000

Value increases as current share price increases. If there’s a 2:1 split, the share price drops to $5.

Option 2:
Company’s current market value: $10,000,000
Total shares outstanding: 1,000,000
Current share price: $10
Number of options granted: 10,000
% ownership: 1%
Current value of option grant: $100,000

Value increases as the company’s market value increases.

These are two different ways of describing the same thing, neither is deceiving. In the first example subsequent dilution is communicated through the share price, in the second through shares outstanding. Either calculation will catch it. If you believe that Option 1 is deceiving, you’d have to believe that they’re equally deceiving.

The only difference is that Option 1 is slightly easier to understand. I think it’s simpler math – not deception – that causes companies to communicate it this way.

But your point is taken that share quantity is meaningless in isolation.

And we should encourage our employees to think about careers and ot getting rich quick off their 1st or 2nd startup (particuarly when they are non-founders)

If you have CEO/VC experience you know full well everyone on the management/VC side of the table talks about option grants in % terms – why do you think we should then switch into another metric that no insiders use and seems only to exist to make the grant sound more favorable?

I’d agree that all that other information is valuable for the employee as well. But in my mind if management won’t reveal outstanding shares or % they are slimy and shouldn’t be trusted.

In theory what you are saying makes sense but you are encouraging something which will lead non-senior employees into a very confusing situation. Most options get offered to non-senior employees and I would suggest that your advice will cause more problems than it will solve.

Examples:

What is the right % for these employees to have? How do I compare a % in one company to what my friend got at another company? How do I adjust for the stage of the company? What employee knows how to negotiate that?

There is no way for them to anchor this around something tangible.

Having been on both sides of this negotiation I feel that as a member of Senior management it is better to negotiate a % because on a dollar basis it always sounds like too high an amount. However, as a junior employee who will receive a fraction of a %, how do you know what to ask for?

Partial Solution: There is a way to anchor this for a company which has recently raised money (as long as there are not large preferences) which is to use the most recent fund-raising price per share as an implied market valuation. Assuming that investors are smart and weren’t duped by management into over-paying, then there is a good chance that a future exit will be at a premium to this.

So actually what I would encourage employees to find out is:
- How many options
- Exercise price
- Price per share paid by the investors
- Did they get any liquidation preferences
- When the investors paid this e.g. pre / post a bubble
- Research the investors i.e. are they likely to have set the price correctly
- Check to see if the management are trustworthy.

This has the added advantage of being translatable into actual dollars paid in options when combined with the vesting schedule. It also automatically adjusts as the value of the company goes up i.e. I get fewer shares which are worth more. In % terms it is impossible to know how to adjust the % as a company gets more valuable.

Overall I think your advice is very misleading and knowing your % provides you no extra information unless you are somehow negotiating the deal based on %.

So there needs to be a greater emphasis placed on the career growth as opposed to the job. Working at Hunch or AnyClip or any of the startups represented in this discussion brings good and bad things. We need to really be transparent about all of that and when we are we retain the people we want most.

Why slag the Venture Hacks?

Before you join a company, you should ask “What are my options worth?” and “What percentage of the company do my options represent on a fully diluted basis?” See http://venturehacks.com/articles/job-offer

We also say that you should “focus on your share price” because the share price and # of shares are the atomic components of a cap table. See http://venturehacks.com/articles/job-offer

In an effort to write punchy articles that grab people’s attention, we tend to over-simplify the conversation:

“The one number you should know about your equity grant” (that’s you)

“Most people think [percentage ownership] is important—it’s not.” (that’s me)

If you’re going to join a company, you should ask a lot of questions, including the percent of the company you’re being granted. Then evaluate the answer in context. For example, later stage companies will give you a smaller percentage of the company.

The sad fact is that you are not going to get rich off options unless you strap onto a one-in-a-million Google-type rocket ship. Even if you are a C-level guy who comes in relatively early and the company is pretty darn successful, the math isn’t all that compelling. Your options represent 1.0% after all the dilution; sell company for $500 million; ignoring exercise price and any funky venture terms, you get $5 million pre-tax; depending on how/when you exercised, holding period, your state of residence and tax rates in effect at the time, you may end up with $3 million in the bank. A nice chunk of change to be sure, but not enough to buy that house in the Hamptons and live a life of leisure among the hedge fund guys.

I am sure things are different in the heart of Silicon Valley, but in my experience, once you are past the raw start-up phase, options are almost never that critical in a non-management hiring process. This may be the real reason that prospective employees don’t ask what percentage of the company their options would represent. The prospective employee just does not attribute that much value to them. Further, once you are beyond 10-15 employees, many people don’t even ask what the number of options they will get will be, let alone what they represent as a fully-diluted percentage of the company. It is a fair question to ask whether companies that are at this stage should be issuing options at all given the administrative costs of doing so.

The other thing that I would point out is that if you are going to educate your employees on how to value their options, you need to give them an overview of the relevant tax provisions. Depending on the individual’s situation, the AMT can pretty much kill the incremental value of an ISO versus a non-qual unless the employee can afford to exercise them before the “bargain purchase” amount gets large (which is rare, particularly given the low wages that the options supposedly offset). So, it is often the case that you are either paying ordinary income tax or AMT on the most of the gain. Just about nobody pays attention to that, even those who know that their x,000 options represent 0.yy% of the company.

Anyone who wants to join a startup and has the options as their most important reason for doing so probably should be screened out in the interview process. I want people who want to work in a dynamic environment where they can do things they couldn’t do at a more established company and everything they do matters to the business.

I believe that knowing what percentage of the company your shares represent is the most important number because, when the company matures and, hopefully, either goes public or gets sold to a much larger company with deep pockets, the number that is going to matter will be the total money the company gets sold for. Then, and only then, will the value of each share be computed by using the number of outstanding shares. Obviously, if there is a special provision that says that preferred stocks get special treatment, the commoners will get even less.

The point I would like to make is that you often get an offer along the lines “you get paid less in salary, but you get shares/stock options to compensate. These shares/stock options have the potential to be extremely valuable in the future.” In other words, you are being asked to accept a lower salary in exchange for the potential of selling your equity in the future.

Knowing your likely percentage after dilution in 3, 5 years, or more, down the road is obviously tricky, but one can estimate this number by evaluating the best case scenario (the worst case is that the startup won’t be successful and your shares will be worth 0.) Take the percentage as of the moment you join and assume no dilution at all. Then, estimate what this startup could sell for in the future (use numbers of recent success stories) and figure out your best case payout. Now, take this number divide by the number of years you expect to have to wait before cashing out. Compare this number to the loss of income working for this startup compared to what you could get working for an established company and see if you are willing to take the risk. And remember, this is your best case scenario. You should probably correct this number by dividing it by 2 or 3 to take into account probable dilution. I won’t get into the details of “opportunity cost” and taxes as this would complicate the whole calculation beyond what this discussion is about.

My personal experience is that it is usually not worth the risk, unless you are out of college and have minimal cost of living and can afford a low salary in exchange for a future pay out -or- you are in the founder/executive team and have preferred stocks that guarantee a minimum payout. The commoner will probably simply catch up on their loss of income due to lower wages but they won’t be able to retire…

Also, if someone tries to sell you an offer with something like “we are going to offer you X shares/stock options currently worth $Y based on our latest financing round” be extremely careful. These shares/options are actually worth $0 because they are not liquid and you probably cannot sell them to anybody else.

Now, if you are an entrepreneur, working as a commoner in someone else’s startup in order to build your chops so that in 5 or 10 years from now, you start your own company, that is probably worth it. Know what you are getting into and what your motivation is.

I think the more important/less convoluted point to be made in all this is Aaron’s. I think the REAL dis-service that management does is to give young startup employees the impression that they will get *rich* from working with them. I had this happen time after time, when I was interviewing with prominent VC-backed startups, and it befuddled me. Most FOUNDERS don’t get as rich as they think they might, after taking vc money, let alone startup employees (even in what appear to be successful exits); it’s astounding to me that this “carrot” is paraded around to potential employees. I’ve had CEOs with big-name venture capital experience tell me how “I may never have to work again” after joining xyz corp.; simply worthless.

I think the two biggest motivating factors that went into choosing my current place of employment were:

1) Learning enough to feel comfortable being a founder myself: this was/is my REAL motivation for working at a startup. I have no delusions of getting rich as a startup employee; I am where I am to advance my career, and to learn more than I could anywhere else, so that I can ultimately be comfortable leading the helm, at another company. This was the primary driver in choosing my current employer; however, very few people emphasized this.

2) Being made whole: my all in-comp, if I weren’t @ a startup and in my prior profession, would probably be no less than 3x what my salary is now (roughly). I think that with a moderately reasonable exit, I could make this back. This is somewhat important to me; maybe it shouldn’t be. But it’s nice to think that I might be able to make up my *immediate* financial opportunity cost, if things go at least reasonably decently.

I think #1 is much more important than #2, but ultimately, I think these are the 2 points founders should focus on, when hiring employees; aggrandizing the opportunity to be some kind of “lottery ticket” is the real trickery IMHO.

I think there is a broader issue here about the importance of equity compensation in startups and how its valued.

It raise many, many issues.

1. Few employees of a Venture-Financed company receive anywhere close to 1% of a company’s stock. Typically 1% goes to senior level execs who are non-founders.

Given that there are very few large exits these days numbers significantly smaller than 1% are unlikely to make non-founding employees spectacularly wealthy. Even at mature Zappos with its 700MM exit, how many people there made $1mm on the transaction? I have to be believe that number is fewer than 10 outside of founders. How many employees had .1% of YouTube post Sequoia financing and got liquid with their Google stock at that time? It couldn’t have been too many.

Equity compensation became a huge, huge part of the system in the late 90s when billion dollar market caps were plentiful and companies hired dozens of employees early in their trajectory because the IPO market was so open.

Things have changed and expectations need to be managed. In my opinion, few employees are going to see massively life changing events from their startup efforts. To be sure, founders and top executives could and will make millions if companies sell for exit north of $250mm. M

Most startup employees need to realize they are on a journey and that in addition to making a few hundred thousand dollars on a good outcome they are learning how to become more senior at the next company. Real wealth creation will take founding, seniority, or staggeringly large exits.

Good entrepreneurs and CEO should be preparing their people for careers beyond the current startup.

Focusing too much on the stock price is a classic amateur mistake. There’s no way to have any idea what the common stock price will be without knowing all the info that Chris (and others) talk about.