Options and Offer Letters

A CEO of one of our portfolio companies sent me a question about process in making offers and equity grants. I sent him a reply. And I thought, “this reply is a blog post”. So here is the reply with the specifics redacted. I hope folks will find this useful.

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It is a Board’s responsibility to approve all option grants. Most boards do this at the start of the Board Meeting. It is usually just a formality, but it is good governance to do that.

The management team obviously can’t wait for the Board Meetings to make offers. So most companies make offers that are contingent on board approval, but that approval is assumed that it is going to be there. Otherwise the management will be in a tough spot having made a promise they can’t keep.

What I generally suggest is that management have a standard options grant. It could be as simple as “everyone gets at least 1000 shares when they join, important role players get 5000 shares, directors get 10,000 shares, software engineers get 10,000 shares, senior software engineers get 20,000 shares, VPs get 50,000 shares. C level gets 100,000 shares”

I just made that up. You should make one that makes sense to you.

Then you get the Board to sign off on the standard grants. Then you can make offers with standard grants in them knowing that they will be approved.

If you want to go wildly off the standard grant for a special situation (relo, super star, etc), just shoot the board an email and get buy-in before making the offer. You will still want to get formal approval at the next Board Meeting.

I also suggest building an options budget. To do this you take your standard grant schedule, and then map it to your hiring and retention plan (I suggest granting options to current employees every two years as part of a retention plan) and then you will have an options budget for the next few years. That is a great thing to have.

For many of you, this is all obvious stuff. But you would be surprised how confusing all of this is to many entrepreneurs. So I figured I would put it out there.

Counting The Hits

Venture Capital is a hits business. All of the returns come from the top cohort of investments. So figuring out how many “hits” there are over a given time period turns out to be a useful exercise.

Aileen Lee posted her attempt to do that on TechCrunch a while back. I countered with a post of my own on the topic.

Those two posts started William Mougayar on a long process to figure out what the right number is. This week he published his findings.

William has found 235 global “tech” companies that were started since 2000 that have gone on to be valued at north of $250mm.

I think William’s efforts are the most exhaustive I’ve seen to date but I don’t think the list is anywhere near complete, particularly for the $250mm to $1bn cohort.

I pointed him to three or four of our portfolio companies that are carrying valuations north of $250mm that he did not have on his list. And I am sure there are many more like that out there.

My guess is an exhaustive list of global tech companies founded since 2000 that have gone on to be valued at north of $250mm would be 400-500 companies and possibly more.

It is very unusual for a company to get to $250mm in valuation in a year or two so you would not have many companies started since 2010 on this list, yet.

So if we take my guess and divide by ten years, that means there are 40-50 global tech companies started a year that go on to be worth $250mm or more.

That feels about right to me. Let’s help William compile that list. Leave him comments on his post or this post suggesting companies he has left out.

CrowdRise

Yesterday the news broke about our most recent investment, CrowdRise. I wrote a bit about it yesterday on usv.com. I thought I’d add some thoughts here as well.

Many of our best investments came to us over time. We did not invest the first time we met them, or the second, or the third. CloudFlare was like that, SoundCloud was like that, Behance was like that. Zynga was like that. FeedBurner was like that. And CrowdRise was like that. I told the story of how I met them in 2010 and we did not invest until 2014 in the usv.com post yesterday. Many things, like wine, get better over time. And when you wait on them, these companies often turn out to be great investments.

Another thing about this investment that feels right is the domain. We have been early and consistent investors in crowdfunding at USV. We like everything about this category of company. We like the democratizing aspects of a true marketplace model. We like that it supports discovery, curation, and personal connections between funders and fundees. We like that we have become recognized domain experts and have been able to invest in some of the very best companies in this sector. It was our early expertise in this sector that led to our first meeting with CrowdRise back in 2010. If you go deep on a sector that you really like, it pays dividends, again and again.

But the thing that feels most right about CrowdRise is the impact that this company and their service has on the world. Yesterday, runners in the Boston Marathon raised over $25mm on CrowdRise. If you click on that link you can see the runners, the charities, and the teams that collectively made up that massive expression of generosity. These are not fatcats donating millions to their favorite cause (which is totally fine by me!). This is everybody giving 10s and 20s in a scale that adds up to $25mm+. This will happen again at the NYC Marathon, The Ironman Triathalon, and a many other events that will take place this year.

While events drive a lot of giving, they are not everything that happens on CrowdRise. As regular readers of AVC know, we have been raising money for CSNYC on CrowdRise. If you feel generous today and want to support expanding CS education in the NYC public schools, please head over to CrowdRise and support our cause.

Everyone on CrowdRise has a profile. Here is mine. It does not show individual gifts, but it does show the fundraisers I have run on CrowdRise. Over time, I hope and expect that these profiles will live up to Edward Norton’s vision that he shared with TechCrunch yesterday:

“‘Facebook’ is who I am as defined by my social life; ‘Linkedin,’ is who I am as defined by my [business] life; and ‘CrowdRise’ is who I am as defined by my activist life,” 

If you are active on CrowdRise, I would encourage you to fill out a profile for yourself and start doing online fundraisers for your favorite causes. It’s both efficient and fun. And that’s a powerful combination.

Valuations?

I just listened to this podcast with Marc Andreessen, Chris Dixon, and Benedict Evans. And since the post I was going to write today is now delayed until tomorrow, I will simply run the podcast as my post of the day. Lot’s of great stuff in here. I particularly liked the bit (about 17.5 mins in) where Marc says “there’s no public market bet on bitcoin, there’s no public market bet on crowdfunding, etc, etc”.  We’ve got those bets and I hope we can share them with the public markets someday :)

Employee Equity: Too Little?

Sam Altman, who is now running YC, has a good post on employee equity that has been making the rounds this weekend.

He makes four observations about employee equity:

- employees don’t get enough

- the requirement to exercise quickly upon leaving is painful

- the tax treatment of options is closer to salary than stock

- companies don’t tell employees enough about their stock and related information

I generally agree with the latter three points. But I am not sold on the first point. We have seen some of our portfolio companies make very large grants to early employees and that ends up hurting the founder’s stake because investors factor all of the shares that have been issued into the valuation they offer.

This issue is getting particularly visible in silicon valley where the value of a top software engineer has risen considerably in recent years. 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. I am just pointing out how dilutive employee equity is becoming in silicon valley. We are seeing similar things happening in NYC and I imagine they are happening elsewhere.

Since I started in VC, the percentage of a company that non-founder employees owned was always in the 15-20% range after the team is fully built out. In recent years, I have seen that number creep up to the 20-25% range and if you extrapolate current trends out a few years, it could easily be 30%.

So I guess what I am saying is that this is a market we are participating in. And this market is becoming very competitive and a lot more transparent. The benefits of both of those things are accruing to the employees and they are getting more and more equity as a result. Sam may be looking in the rear view mirror with this first assertion. I think like many things, the market will take care of this problem. It already is.

Video Of The Week: The Gotham Gal on TWIST

Last summer, The Gotham Gal went on Jason Calacanis’ show, This Week In Startups. I had never watched it until this morning. It’s fun to see two people who know each other well (they worked together in the late 90s) do a conversation. It’s an hour long but there is some good stuff in here.

Feature Friday: Comedy On SoundCloud

Where is the next Howard Stern going to emerge? I don’t think it will be terrestrial or satellite radio. I think its more likely that he or she will emerge from a place like our portfolio company SoundCloud. There is a ton of comedy on SoundCloud and its growing very fast. But discovery has been a problem.

In the most recent Android release, SoundCloud has introduced some very nice discovery features. These features also exist on the web and will be coming to iOS soon. Since the way we most likely want to listen to the next Howard Stern is by bluetoothing our phone to our car when we are driving to and from work, I will show you how to listen to comedy on SoundCloud using the Android app flow. It is very similar on the web.

First, you open up the app menu by tapping on the upper left of the app and get this:

soundcloud menu

 

 

Next you click on Explore to get this:

soundcloud genres

 

Then you select Comedy to get this:

soundcloud comedy

 

Each of these “cards” represents a potential new Howard Stern show. You select one and start listening. If you find one you really like, you can follow in SoundCloud and get the next show right in your feed.

If you are driving to and from work and are looking for something good to listen to, I’d strongly recommend checking out some of these comedy shows on SoundCloud. They are great.

Traces – A Group Show For Young Artists

It always makes me happy to see my daughter Emily send a tweet, my son Josh repost a song on SoundCloud, and my daughter Jessica post something to her Tumblr. They aren’t always so keen to use the services we back at USV, but they do come around to them from time to time.

But I think the biggest kick I got in this area was a few weeks ago when Jessica and three friends launched this Kickstarter.

It was funded quickly, over the course of a weekend, and they don’t need more money so if you are in the giving mood today, you might want to find another project to back.

If you live in NYC, you might want to attend the show. It will be at the Gowanus Loft in Brooklyn on June 6th, 7th, and 8th. The opening will be the evening of the 6th.

Although I have funded many projects on Kickstarter over the years, I have never made one. It was enlightening to watch Jessica and her friends Lenora, Zoe, and Lolita go through the process of defining and explaining their project, making a video, and scoping out the rewards. I gave them some advice here and there, mostly on the rewards which are great btw, and also on setting up Amazon payments. I came away with an appreciation for what a project creator goes through in making a Kickstarter. And of course, I experienced the thrill of pushing it out and the joy of seeing it funded.

I’ve said this many times on this blog, but I will say it again. Kickstarter is an iconic example of what makes the Internet so awesome. I am proud to be an investor and I am equally proud to be the father of a Kickstarter project creator.

The Difference Between Large Funds and Small Funds

I have always been a “small fund” oriented investor. Both models work if executed well, but they are different.

With small funds, you only need to find a few good ideas a year to get behind. That is true in hedge funds, private equity, venture capital, and probably many other asset classes.

With large funds, you need to get behind every good idea every year.

There are some investors out there than can execute the large fund model. I imagine you can list them and so can I. But there aren’t many who can.

There are many investors out there that can execute the small fund model. You can do it with a geographic focus. You can do it with a sector focus. You just need to know a few things really well and then select the best among what you know and ignore everything else.

That is essentially what we do at USV. Because we only manage funds in the $150mm to $200mm range, we only need to invest in 6-10 new companies a year and we only need a third of them to work. So that means 2-3 good investments a year and we are doing well. Given how much opportunity is out there, 2-3 good ones a year is doable. Even if we miss on lots of great opportunities.

I don’t lose a lot of sleep over missing good deals. We can afford to do that.

But imagine if you had a $1bn fund to invest. Then you’d need 10-20 good investments a year. If good investments are defined as billion dollar exits or better, then that would require getting a meaningful percentage of them. Maybe you would need to get 33% to 50% of all good deals every year. I couldn’t sleep if I had to do that.  Because I know I couldn’t do that sustainably. Very few can.

Cryptography

So much of what interests me and consumes the tech industry these days relates to Cryptography, and in particularly public key cryptography. The list would include Heartbleed, NSA spying on citizens, and of course, Bitcoin and Blockhains.

And yet, when I hear people talk about Cryptography or when I read about Cryptography, my eyes tend to glaze over because I never studied Cryptography and am a self taught coder.

So I need to fix this. I want to bone up on Cryptography. Where should I start and what should I read?