Reblog: Employee Equity: How Much
This may be the most popular AVC post of all time based on the amount of traffic it gets month after month after month. I think I may rewrite it at some point because while I still believe the basic ideas here are correct, some of the math has changed due to market pressures and it deserves a rewrite. With that caveat, here it is.
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The most common comment in the long and complicated MBA Mondays series on Employee Equity is the question of how much equity should you grant when you make a hire. I am going to try to address that question in this post.
First, a caveat. For your first key hires, three, five, maybe as much as ten, you will probably not be able to use any kind of formula. Getting someone to join your dream before it is much of anything is an art not a science. And the amount of equity you need to grant to accomplish these hires is also an art and most certainly not a science. However, a rule of thumb for those first few hires is that you will be granting them in terms of points of equity (ie 1%, 2%, 5%, 10%). To be clear, these are hires we are talking about, not co-founders. Co-founders are an entirely different discussion and I am not talking about them in this post.
Once you have assembled a core team that is operating the business, you need to move from art to science in terms of granting employee equity. And most importantly you need to move away from points of equity to the dollar value of equity. Giving out equity in terms of points is very expensive and you need to move away from it as soon as it is reasonable to do so.
We have developed a formula that we like to use for this purpose. I got this formula from a big compensation consulting firm. We hired them to advise a company I was on the board of that was going public a long time ago. I’ve modified it in a few places to simplify it. But it is based on a common practive in compensation consulting. And it is based on the dollar value of equity.
The first thing you do is you figure out how valuable your company is (we call this “best value”). This is NOT your 409a valuation (we call that “fair value”). This “best value” can be the valuation on the last round of financing. Or it can be a recent offer to buy your company that you turned down. Or it can be the discounted value of future cash flows. Or it can be a public market comp analysis. Whatever approach you use, it should be the value of your company that you would sell or finance your business at right now. Let’s say the number is $25mm. This is an important data point for this effort. The other important data point is the number of fully diluted shares. Let’s say that is 10mm shares outstanding.
The second thing you do is break up your org chart into brackets. There is no bracket for the CEO and COO. Grants for CEOs and COOs should and will be made by the Board. The first bracket is the senior management team; the CFO, Chief Revenue Officer/VP Sales, Chief Marketing Officer/VP Marketing, Chief Product Officer/VP Product, CTO, VP Eng, Chief People Officer/VP HR, General Counsel, and anyone else on the senior team. The second bracket is Director level managers and key people (engineering and design superstars for sure). The third bracket are employees who are in the key functions like engineering, product, marketing, etc. And the fourth bracket are employees who are not in key functions. This could include reception, clerical employees, etc.
When you have the brackets set up, you put a multiplier next to them. There are no hard and fast rules on multipliers. You can also have many more brackets than four. I am sticking with four brackets to make this post simple. Here are our default brackets:
NOTE: The numbers below are as of 2010. They have moved a lot since then. The Senior Team numbers have moved the most. I would not recommend using these numbers or you will be below market with your employee equity grants.
Senior Team: 0.5x
Director Level: 0.25x
Key Functions: 0.1x
All Others: 0.05x
Then you multiply the employee’s base salary by the multiplier to get to a dollar value of equity. Let’s say your VP Product is making $175k per year. Then the dollar value of equity you offer them is 0.5 x $175k, which is equal to $87.5k. Let’s say a director level product person is making $125k. Then the dollar value of equity you offer them is 0.25 x $125k which is equal to $31.25k.
Then you divide the dollar value of equity by the “best value” of your business and multiply the result by the number of fully diluted shares outstanding to get the grant amount. We said that the business was worth $25mm and there are 10mm shares outstanding. So the VP Product gets an equity grant of ((87.5k/25mm) * 10mm) which is 35k shares. And the the director level product person gets an equity grant of ((31.25k/25mm) *10mm) which is 12.5k shares.
Another, possibly simpler, way to do this is to use the current share price. You get that by dividing the best value of your company ($25mm) by the fully diluted shares outstanding (10mm). In this case, it would be $2.50 per share. Then you simply divide the dollar value of equity by the current share price. You’ll get the same numbers and it is easier to explain and understand.
The key thing is to communicate the equity grant in dollar values, not in percentage of the company. Startups should be able to dramatically increase the value of their equity over the four years a stock grant vests. We expect our companies to be able to increase in value three to five times over a four year period. So a grant with a value of $125k could be worth $400k to $600k over the time period it vests. And of course, there is always the possiblilty of a breakout that increases 10x over that time. Talking about grants in dollar values emphasizes that equity aligns interests around increasing the value of the company and makes it tangible to the employees.
When you are doing retention grants, I like to use the same formula but divide the dollar value of the retention grant by two to reflect that they are being made every two years. That means the the unvested equity at the time of the retention grant should be roughly equal to the dollar value of unvested equity at the time of the initial grant.
We have a very sophisticated spreadsheet that Andrew Parker built that lays all of this out for current employees and future hires. We share it with our portfolio companies but I do not want to post it here because it is very complicated and requires someone to hand hold the users. And this blog doesn’t come with end user support.
I hope this methodology makes sense to all of you and helps answer the question of “how much?”. Issuing equity to employees does not have to be an art form, particularly once the company has grown into a real business and is scaling up. Using a methodology, whether it is this one or some other one, is a good practice to promote fairness and rigor in a very important part of the compensation scheme.
Comments (Archived):
Nice post – you make step A (hit $25m valuation) sound so easy!! Give a shout when you hit Portugal – my girlfriend is from there and I’ve got plenty of recommendations for Lisbon, Faro, Porto or Algarve.
.but, but,… it’s Apple day.
This might be the most popular AVC post of all time, but it’s not the iWatch. You can’t upstage Tim Cook, can you ;-)#timingiseverything
Tim Cook? Does he? iWatch? Is someone watching something? Who’s this Tim guy? I’m supposed to know him? What”s he do? Does he write code?
He dabbles in tech
That iWatch is pretty cool, isn’t it. Like they trumped every other device so far that was a watch, wallet, fitness thing, all with a single product. It has its own special purpose chips in there, and that’s a tough thing to compete with, from a technology perspective. They really nailed the user experience/interaction too.Maybe that will be the first mobile “i” product Fred might buy. I can’t see Fred resisting to not buy an iWatch.
Yes, it is very cool. But it requires an iPhone. I know he has one to try stuff out on, but not sure this will put him over the edge and make it his everyday phone.But I think it might just convert a lot of people.
I wasn’t sure if it required an iPhone for *everything* it did. Will have to dig into that. I know certain functions paired with the iPhone. Someone will write an Android App that pairs to an iWatch. Watch 🙂
but not sure this will put him over the edge and make it his everyday phone.I think it will and it should.If Fred believes there is opportunity in designing apps for the apple watch and the eco system that evolves around it then in order to understand it it and invest in it it will be necessary to own an iwatch and use it. Seems to be more beneficial than whether some android phone has a particular feature that you like.I mean geez if I could make more money I’d give up many products that I actually prefer personally in my day to day use.
fitness thingI got a big laugh out of the “fitness thing” part of the video.The entire concept of thinking that there is some magic to keeping active and exercising rather than just keeping active and exercising just shows how lame people are. Not to mention that every single person in the video was young and in uber good shape and good looking. As if they are the people with “the problem”.Here’s a thought. Stop (not you btw) trying to focus on numbers, goals and all of that and just follow the simple guidelines of eating in moderation and exercising on most days. Continually, without injuring yourself so you can keep doing it every day almost every day. [1] Getting sleep is actually just as important. Sleep helps with appetite control.Anyway all of that fitness tracking is to me a gimmick that is not needed if you have a reasonable amount of discipline and will power.[1] Which means it’s a priority over other things it’s #1 on the list not #4 after “I have to take the kids to soccer practice” or “I have to go to the supermarket” or “I promised to call my friend who I haven’t spoken to in 6 weeks”.
The $75B and growing weight loss business in the US I guess proves your wrong on this 😉
Not really. Fact is there are many things that people spend money on and that doesn’t in itself mean they have to in order to achieve some goal. Keeping your weight in check, for most people [1] is possible as long as they get rid of their food addiction and the general concept of using food for pleasure. Or eating in excess because something tastes so good.Besides I didn’t say there wasn’t money to be made in the weight loss industry. There is. I’d cash in if I had a good idea (I’ve been told by 3 physicians by the way that I should write an book on what I do.)For the record I figured out a long time ago things such that if I kept the laser printer in the next room instead of next to my desk (which I could do) it would force me to get up every time I print something and that would be good. My point being I don’t need to track that and know that I do it 50 times per day or whatever. And I don’t need to know what my heart rate is so I can constantly increase it. I’m not running a contest I’m just trying to stay fit. And I don’t need to count calories I know that certain foods in certain quantities are “to much”. And so on. It’s all “gross” things to me not “micro managing”.Separately it doesn’t surprise me that people go for this type of thing. Everyone is looking for the magic bullet and “the answer”.[1] I’m not talking either about people who actually have some metabolic or health related reason that they are heavy and may need some plan of action or are sedentary. I’m talking about a group of people that exist today that didn’t exist, say 60 years ago (and I don’t mean they were working on farms either) and that use and worship food as a mechanism to gain pleasure and make themselves happy.
I thought it would be a motivator. It’s not an answer, but a little reminder.
No, no, no, there’s no way you can be correct! Instead, clearly, we have now made a major discovery in archeology, anthropology, evolution, and current high tech: As we can see now, certainly way back there necessarily they had to have had things much like, maybe still more advanced than, an iWatch! Else all our ancestors would have died off from lack of smart eating and smart exercise!Besides, as we high tech entrepreneurs have been told too often already, “whatever idea you have and/or whatever you are working on, you are not the first, and someone else is doing the same or has already been there, done that, and gotten the T-shirt.”!Sorry, Apple, you can’t be the first and must have been cooked!Then, to extrapolate, smart eating and exercise clearly are not the only crucial necessary conditions for our ancestors having been successful. Right, you guessed it! Gee, did you ever guess it!There was also sex, the most important necessary condition of them all!Sooooo, way back there necessarily they had an iSex device so that they could be successful, and that’s the only reason we are here!Sooooo, wake up, Apple, time for your next, huge product breakthrough — the iSex product! And, Google, Microsoft, Samsung, even Intel, AMD, LG, RIM, Nokia, and Motorola, here’s your unique chance — win the race to be first with the best iSex! The human race is counting on you! And, how about Bull, that is, something from France — Oo la la, from the unique, unchallenged, world-class experts!And, just think about the opportunities in media and accessories! Or, what could be more appropriate, an apple and iSex; not just a coincidence!
I think it is a sad underachievement for apple.it pales in comparison to the Android watches and the iphony6 blah barely makes it to the 2012 nexus specs.
And … i am not an apple hater, i love my macbook, just not impressed … and there is nothing like goog maps on my droid
funny i can’t stand goog maps. i prefer apple maps.good thing we have apple and android, just like we have venus and mars 🙂
well…let’s revisit that statement, say 3 months after they start shipping it.
I will buy one when it matches Johnny Soko’s watch. For the uninitiated, look from around 10 seconds in this video http://www.youtube.com/watc…
ha
i wrote a post about thathttp://avc.com/2014/07/the-…
yeah, but that was pre- Apple Watch.it does a lot more than “I don’t think the ability to see notifications and calls coming in on my wrist instead of my phone will change that.”I was pretty close to your viewpoint, and haven’t worn a watch for at least 7 years, but now I can’t wait to get an Apple Watch because of the many functions it will have. I think it represents a paradigm shift.
not me
Interesting from a branding PoV, this is actually not an “i” product.It’s Apple Watch, like Apple TV. It signals something, more than grouping it together with Apple TV, it feels like a gentle break with the last 15 years.And on with the new.
yes. i agree.
Actually, I’m surprised they called it “watch”. The watch function is maybe 1% of the whole thing. Why didn’t they call it “Apple wrist device” or something less about the watch, but more about the digital connectivity.
I don’t know, maybe just like the iPhone is not a phone?But it’s easier for people to accept something familiar.The only familiar thing about the iPhone at launch was its form factor (phone form factor) and that, among a lot of other things, it could place phone calls.Their marketing was flawless.And now we have this new thing which is not really a watch at all, but its form factor, and the use patterns it encourages are reminiscent of actual watches.We are used to discuss GUI metaphors (desktop, buttons, menus) but we’re not very used to discuss UX metaphors (this can be used as a watch).I think it’s a very powerful concept, and I would like to see more people doing that.What do you think?
Actually it’s called the Apple Watch, not the iWatch…Were you iWatching?
iWasn’t
iKnow
Apparently the original post was athttp://avc.com/2010/11/empl…It has a lot of comments.
FWIW I’m nonplussed about Apple’s product launch, so I’m hanging out here.Maybe it’s a good time to post that spreadsheet Andrew Parker made, with enough warnings and caveat notices added?I’m curious and would like to learn more.
Would love to play with that spreadsheet too…
I read this post and thought….hmmm, this should keep people from joining a startup in the Employee#10 to Employee#100 slots.#SingleDigitEmployeesBankTheJack
I’d be curious to hear how these would change given the current environment. When I applied them 2 years ago, I was a little more generous on the ratios. I was thinking of a range more than an absolute ratio.
Explain why if you had a startup you would be less generous with equity for key people today please.
I said I was more generous. Did you mean “more” or “less” generous?
I thought you said you were more generous then as in 2 years ago.Not getting this I’m afraid.
He did.He said he was more generous 2 years ago which implies he is less generous today. You want to know why he is less generous today which is a good question.Seems he is saying there is a reason to be less generous today meaning something has changed which is what you want to know.Probably not the reason but I would imagine that assuming there is more of a supply of people today wanting to work for “startups” consequently by supply and demand in theory you could be “less generous” all else equal.
nooooo. I was more generous than the ratios that Fred suggested. That’s all.
I was saying I was more generous than the ratios that Fred suggested.
You should have been a lawyer my friend.
Why?
He only applied it once, it was 2 years ago, and he was more generous than the ratios above. You should not have been a lawyer my friend.
;)5 years of M & A, I am pretty good at contract law.
It would be really interesting to cross-reference this with an analysis of job posts on Angelist (could use CrunchBase as basis for equity, locale as basis for salary)
Does the exercise price of the options play into this formula at all?
Very interesting read. But I am wondering what happens when an employee joins a startup taking a salary haircut and wishes to be compensated by equity (that’s the kind of long term thinking and commitment one would like). Since the formula is based on comp, should one take last drawn comp as a proxy?
Fred – a rewrite would be awesome! I have visited and revisited the original post in the past.
How does this measure up? http://technbiz.blogspot.co…
Slightly confused.I’m assuming this all equates to an initial “at the money” grant…and thus the real value is the spread between now and three years or so down the road when the company increases in value?So..if you’re talking in terms of $ value vs percentage of the business…the stock really has no value at the time of grant because its “at the money” and if that is so…then discussing its value at time of grant is kinda mis-leading no?Am I on the right track here?
posts like this one are why I follow Fred’s blog
I just made a calculator app that does the Fred Wilson method (above) automatically, sans spreadsheet:http://startupequity.io (100% free)
While at first this approach might seem reasonable, in my book it is not, for two main reasons. First, the whole idea of providing equity as a part of total compensation package is IMHO to establish a partial correlation between startup’s performance and employees’ compensation. Second, and complementary to the above, equity should be an additional stimulus for employees’ best efforts and optimal performance (additional to belief in a startup’s idea and corresponding enthusiasm). As we see, the approach, suggested in the post, does not satisfy these criteria (as it links employees’ equity compensation package not to company’s performance, roughly measured in its valuation, but to their salaries, which aren’t performance-based by definition).I think that this is not a good approach not only from a startup’s employees’ perspective, but, even despite clear focus on minimizing employees’ equity pool for the benefit of founders and investors, from founders’ and investors’ perspective, as it might backfire later in loss of enthusiasm, damaged company culture and even talent loss, which, in turn, might be much more costly than the perceived economy in equity.