Some Thoughts On Equity Compensation

A hallmark of startup companies, the tech sector more broadly, and certainly our portfolio companies, is that they include equity in their compensation packages for their employees, often all employees.

If you work for a tech company, chances are good that you will get options as part of your compensation package.

I have written extensively on this topic over the years and even published a framework for issuing equity to employees on this blog.

That framework is now out of date as the market has moved (up in case you were wondering) and I need to update it. It’s a project and we are working on it at USV but I can’t promise it any time soon.

A few years ago I met with a very successful entrepreneur who built his company outside of the tech sector. When I asked him about equity compensation he said to me “You people in tech are crazy. I pay my employees handsomely in cash and I keep all of the equity for myself.”

I’ve thought about that comment a lot in the years since. I grew up in the business doing things a certain way and never questioned it until that moment.

The truth is that equity comp has its disadvantages. You can’t pay your rent or take a vacation with your options. They might be worthless if the company fails or is sold in a fire sale. You have to pay taxes when you exercise and if you can’t sell the underlying stock that can be painful. If you leave and can’t exercise, you could lose the equity.

And it is hard to compare two competing equity packages if you have two (or more) competing offers. Companies often purposely make it hard to understand the equity they are offering you. But even if they give you everything you need to know to value the equity, you still need to make assumptions about the future value of the equity to value it and nobody has a crystal ball.

For all of these reasons, many employees don’t really value the equity and they often don’t understand it either. But they understand the cash part of their compensation and know how to value that.

For companies, the equity they grant their employees is costly. Annual dilution can be as high as 5% per year just for employee compensation. We work hard with our portfolio companies to keep this dilution as reasonable as possible but I have never seen it, regardless of stage, much lower than 2% per year. Compound that over ten years and you can see what happens.

And companies have to expense the cost of issuing equity to their employees on their income/loss statements and the amounts can be massive when the companies get to be large publicly traded companies.

This recorded cost on the income statement is not theoretical. If you bought back as much stock as you issue to employees every year, something I strongly recommend to companies that have the cash flow to do it, the expense in terms of cash is very real.

So this issue of employee equity, whether to include it in your comp packages, for whom, and how employees should value it, if at all, is a big fucking deal for our industry.

And yet we treat it like something that is non negotiable, like it is part of the ten commandments of tech companies handed down by God to the Hewlett Packard founders eighty years ago when they were starting their company.

I don’t have any specific recommendations to make on this topic except that Boards should be thinking way more deeply and creatively about this issue than we are. We should be confronting the true cost of this practice and asking ourselves if it is best for our employees, and if so, which ones, and if it is best for our companies and our shareholders.

The answers to those questions is not definitively yes for all employees and all companies. As the unnamed entrepreneur who got me thinking about this proves.

#Uncategorized

Comments (Archived):

  1. Matt Zagaja

    As a government employee we (I) face a similar issue with our pensions. I have been spending a lot of time trying to figure out how to value my pension if at all. The swing is huge. If I decide to stay in government service for 30 years and the pension pays out at the terms as they exist today, the replacement cost (additional salary I’d have to make to have a similar level of retirement savings from a defined countribution plan) is $55,000 pre-tax dollars. If I leave state service before the 10 year minimum vesting period then the pension is actually a net 11% decrease in my salary (we have to contribute 11% towards the pension and I’d get nothing in return if I fail to vest).The hard part is predicting the future. The pension does not pay out today so unfortunately I cannot use part of this $55,000 of value to fund the purchase of a condo, which would be nice to do. I am forced to rent. Even worse than equity I cannot sell any part of my future penison on a secondary market or borrow against it (at least not until I vest in 9 more years). The legal landscape and fiscal condition of government also means that the pension might actually pay out a percentage of what it is rated at (in a worst case scenario pensions in Central Falls, RI were cut 50%).Ultimately this is all a question of individual circumstances and economics. In comp packages that are less than $100K I imagine that more base salary is highly valuable to an individual employee to pay rent/mortgage, student loans, etc. over equity, but in comp packages that are hitting $200K equity is just getting you closer to that yacht purchase.

    1. LE

      If I leave state service before the 10 year minimum vesting period then the pension is actually a net 11% decrease in my salary (we have to contribute 11% towards the pension and I’d get nothing in return if I fail to vest).This is an easy one for me. You are wasting the best years of your life by tying yourself up for 10 years at a government job no less. 11% decrease in salary and golden handcuffs to boot?

      1. Adam Sher

        The impact of a government job can be widespread and personally meaningful. For example, if you work for the Federal Reserve system, your research and analysis will affect the entire country. The money usually isn’t there but maybe it’s about more than the money.

  2. awaldstein

    i wonder Fred whether this has changed.When I started the only way to get liquidity was getting acquired or going public and the equity piece of comp was less important and more standardized.With secondary markets and liquidity happening way in front of profitability this is changing,’With some gigs in the crypto world, different again.One rule doesn’t fit all of anything much any longer.

  3. LE

    “You people in tech are crazy. I pay my employees handsomely in cash and I keep all of the equity for myself.”In a business that I was in I will never forget an employee that I hired that wanted to be on the path of ownership literally 3 months after I hired him. He was really good and he solved a large amount of problems that we had at the time. But I really didn’t like his personality (he was to emotional and even had a bit of an anger problem) and for that and other reasons I didn’t want him as a partner. So I told him I would pay him more money but equity was off the table forever. Forget about it not going to happen. [1] [2]Later of course I sold the company (it is still operating today) and after about 2 years with the new owners he moved on and started his own company and all is well. And I got to keep 100% of the money that I sold the company for (no investors; was about 20 employees).[1] Later I gave him a percentage of the profits. So he would go around and tell people when they asked him if he was the owner (because he kind of looked the part and was in on all meetings) that he had ‘an ownership interest’. However I controlled exactly that number and it was net profit which obviously I controlled and calculated. I felt it was fair to do this because he had backed me into a corner in an unfair way (no discussion of any ownership in the hiring phase).[2] In today’s dollars I just did the conversion and he was making $160k per year roughly by the time I sold the business. Plus benefits.

    1. creative group

      LE:Based upon your narration we would agree with you in principle regarding your course of action regarding this invaluable employee who knew his value. You compensated him also after you cashed out.The issue (squeeze) being devised is nothing altruistic. Just sit and think about the great Angel Investors and VC’s who started out via generous options. Now they are sitting in the cat seat the funnel of same opportunity is being closed. Appears to have more to do with the writing on the wall regarding ICO with companies using their brains.Really! If employees of start-up’s instrumental in their success are now being told we will offer you 20K more to forgo possible millions tell them to kick rocks.You get paid what you are worth is becoming a myth in this new business model. Don’t accept inequity period!Captain Obvious!#UNEQUIVOCALLYUNAPOLOGETICALLYINDEPENDENT

  4. LE

    One thing is probably certain. It’s my guess that startup equity compensation packages in general favor younger people and disadvantage older employees. So it’s also a way to control the age of the workforce. You don’t have to tell someone you won’t hire them for age. You just modulate it with the pay structure.

  5. BillMcNeely

    I think startups, especially those outside the major hubs, have to understand you can’t pay HS kid wages AND/OR give zero equity for knowledge workers

    1. cavepainting

      Equity is a great way to compensate for the risk that employees take in an unproven, uncertain venture.But.. equity awards need to be managed with a lot of thought and care. It is not something to give away mindlessly and at all times. It is also not something to hoard only for founders and investors.The right balance at any time is a function of the risk in the venture, its level of capitalization, expected and actual contributions of the employee, and what is needed to attract the best people.All employees are not the same, and all companies are not the same. Even the same company is different at different points in time. The role of equity also has to vary according to each situation.However.. it still needs to be driven by some core principles of fairness and equitable treatment. If two employees who join at the same time and have equivalent contributions, they should be treated equally.The board, CEO, and founders need to constantly think through the equity policy. It needs more proactive management and consideration than setting aside an options pool and creating an initial policy for option grants.

      1. Robert Jamie Munro

        It doesn’t compensate employees, it increases their risk. What would compensate employees is some sort of insurance or bond so that if the company folds, they still get paid for some period of time afterwards.Being compensated with equity means that if the company folds, not only do you lose your job, you also lose your life savings.

        1. CJ

          Sounds like a modern version of a pension.

        2. cavepainting

          If an employee seeks such insurance. an early stage startup is not the place for him. “Compensating for risk” in startups means there is high upside if things go well. If things do not work out, everyone loses money including investors and founders.

      2. joesmoe

        Every key employee within the first 10 who sticks through with the venture for years until sale should enjoy at least a 1%-2% stake in total ownership of the company.If you think this is too much, then you are exploiting them or not being honest about how crucial their level of work was to making the enterprise succeed in the first place.This is doubly true since even with higher salaries, employees in startups will always have demands placed on them that FAR exceed the normal demands of most jobs.

  6. PhilipSugar

    I have thought a lot about this over the last 30 years. At my one company we gave tons of options. I can remember a specific person that was really bitter when we got bought for a good amount of money but they didn’t make “retirement money”. Then at another we paid above market rates but when we sold I know somebody was bitter that they didn’t make “retirement money”I have said the key to keeping people is to make them never want to leave. So this will sound strange.I like having a policy where people know and expect if the business is doing well their quarterly bonus is based on:1. Company Performance2. Pay3. TenureNow I have debated about declaring that number but deferring it for a year.Doesn’t quite seem fair, but it would mean if you left you would lose 4 quarters of bonuses and that could be a really good number.And last thing you don’t want a yearly bonus or to tie pay raises to reviews or you will get an exodus all at one time. If people want to leave (haven’t lost one in over a decade) you want to see it happen quickly.

    1. kidmercury

      yeah at one company i worked at they ran a company performance + individual performance = annual bonus formula. bonus given in march. headcount in april 10-15% lower. mass exodus can be highly dysfunctional.

      1. CJ

        I bet those employees that left didn’t know where they stood throughout the year. Not 100% but enough to put money on it. That’s the problem with review-based systems, they happen once a year and no one ever knows where they stand until it’s time to hand out checks.I’d do reviews quarterly and offer a bonus to any low-performers who want to leave now. It’s contingent on staying long enough to find and train their replacement. We’ll let them resign gracefully, throw them a party, etc… but you gotta go.Spread out the hit over the year instead of all at once. Tie the bonus to tenure, individual performance and company performance and it filters out those who might try and take advantage. There just isn’t a lot of transparency in being an employee nowadays and it’s to the detriment of everyone involved. Open up the process and treat everyone like the adults that they are.

        1. PhilipSugar

          I’d agree but the you gotta go means you gotta go now. You don’t want to tie reviews to raises. You do reviews and you do raises. Could be one person gets a worse review but their contribution is so much more than a person with another. See comment above.

          1. CJ

            I can see this, but you have to figure out a way to make it predictable. I was going to use the word fair but it’s not the right one, it doesn’t have to be fair from this standpoint, it has to be predictable. Not all employees are created the same so not all comp will be either but the employee should know how they’re generating that comp so that they can improve it, etc.I can also see your point about ‘go now’. You really don’t want that person screwing up the culture. If you’re willing to get bought up, leave now and don’t touch anything on the way out.

          2. PhilipSugar

            Here is my point. Sure people get paid differently. Sales differently, than support, different than admin, different than executives.People can deal with that (or if they can’t too fucking bad)But they cannot deal with I do the same work have more tenure, more knowledge and get paid less (and they will find out)When you’ve decided they need to go, how would they have any other reaction other than it is you not me?? How can they reconcile that?? I would do the same thing, no different than you suck I have to go, but stronger because you did the “you have to go”Now I give the same respect and say we don’t talk bad about any former employee EVER. No different than we don’t talk behind people’s backs.But thrice blessed are you if you learn from other’s mistakes. I have good judgement which is the result of experience and I have experience which is the result of bad judgement.An employee that knows they are on the way out is toxic.

  7. Dave Hendricks

    We are working through these issues as we write. As a ‘crypto-centric’ company, we know that our future is tokenized. In a world where there are tokens, and there is equity, and potentially no relationship (not to mention presales and DAOs) it can be challenging to figure out whether to offer equity, tokens or some other form of participation and preference. When you then factor in the reality that many contributors may not be W2 employee, but rather advisors, it gets even more ‘interesting’.Glad you are thinking about this, there is no user manual for this new structure yet.

  8. Allen Miller

    For all their potential faults – could this area be one where ICOs end up being pretty useful? Issuing tokens to early stage employees doesn’t directly dilute the founders and could lead to very meaningful cash gains if the tokens appreciate in value. For employees who join post-ICO, you could reserve an “option-pool” of tokens and distribute as they are hired. You would likely need some form of vesting (or layered way of issuing tokens) similar to equity options but you could also build in ways for them to gain liquidity sooner (e.g. sell some of the tokens on exchanges) at certain points based on milestones achieved.

    1. Anne Libby

      There are non-token ways of doing this, too, like Stock Appreciation Rights and Phantom Stock. To my knowledge, not commonly used in early stage companies in NYC. (At least I don’t hear people talking about them.)Compensation, even without equity, is one of the most complicated things out there, so many opportunities for unintended consequences of decisions you make on the fly.

      1. Adam Sher

        I used Stock Appreciation Rights to grant distribution rights to certain employees pari-passu with the shareholders. The company was an S Corp, which limited type of non-equity compensation we could provide. We allocated the SARs to a limited number of employees with shorter vesting periods. SARs and options are usually taxed at income tax rates and the payout has 48% withholding. The reactions of the SARs payout recipients: nonplussed with the net payout.The next time around I’d let employees buy company stock from treasury, and likely avoid other forms of options / SARs.

    2. pointsnfigures

      You might run afoul of the SEC though. I’d be careful with tokens and how they are used for employee compensation. Interesting idea to chew on.

    3. cavepainting

      Companies that launch tokens and raise money through ICO might feel that they are doing so with zero dilution, but the reality is that unless they are building some core IP or assets that has value unrelated to usage, the value of the token is a proxy for the value of the company. Let us say the token crashes to zero, it sure does impact the value of the equity for it implies no usage of the product or service.Of course, there are many exceptions to this if the core product can be used irrespective of the token (like Kin vs. Kik). But if the token is a pre-requisite for using the product, the token and equity are more likely to mirror each other in being a proxy for value; especially when the token is crashing.

  9. Josh Rutstein

    I agree that the notion of “total compensation” needs rethinking. Equity might not be the best way to inspire a team. If we want employees to work hard and take risks, I think we should focus more on effort and less on success. Things are going to fail, but people should still try. I’ve written about “effort based compensation” and I think it’s a better way to structure the total package

  10. creative group

    CONTRIBUTORS:We admit that the VC and start-up environment as associated with the USV of the world isn’t in our wheel house. But running a business with employees who rely upon us being a partner with them to trust us with an well paid career is our daily reality. (Jobs are Walmart & McDonald’s)What we understand from Fred’s post and idea being revised and developed is that a person who received an incentive via options to forgo other opportunities that may be more financially secure will now be looking at a new model that benefits VC’s and founders even more. We acknowledge the herd wilfully will accept and agree.So the compensation upfront for these talented people who sacrifice themselves financially should expected to receive equitable salaries in the range of let’s say 400K? Remember many Angel Investors and VC’s had started off from the options received from working at startups. We have to be misunderstanding this. Only will make sense to those benefiting from the talents of others.You are paid what you are worth and what you accept. Don’t accept inequity.Captain Obvious!#UNEQUIVOCALLYUNAPOLOGETICALLYINDEPENDENT

  11. aminTorres

    An F-bomb right in the post… I love it!I thought that one of the primary points of equity compensation was to be leveraged as a retention mechanism. Surprised that you have left this out of the equation. This helps distribute the load of responsibility off the shoulders of the founders onto the shoulders of everyone joining the company. There is a difference between doing a good job to make sure my paycheck comes in every month AND I am going to kill it so that in addition to making sure my paycheck comes, my slice of the company grows also. Who wants to walk way from that? Seems like a win-win for everyone.

    1. Chris Lu

      The retention mechanism is a double edged sword. If the company continues to grow and do well, then the golden handcuffs are a powerful retention mechanism.However, the second the company starts to go sideways, the top talent of the company realizes that they can get a better package somewhere else and tend to jump ship. Its interesting to note that it is exactly at this point in time, the company may have to pay its top talent more (not equity compensation) to retain them, but when the tide begins to turn, the company is also usually most strapped for cash.

      1. PhilipSugar

        Truer words never spoken

      2. aminTorres

        or not.

    2. cavepainting

      Yep. Nothing drives home better the intensity of a point, especially if used sparingly and consciously.

  12. JMN

    solution: restricted stock to senior/executive employees only, combined with performance-based cash bonus to all employees

  13. jason wright

    ideology, philosophy, political point of view, they don’t put food on the table but they’re more valuable to a team than any amount of founding equity allocation.

  14. William Mougayar

    Solution: Give them Crypto Equity! – it’s liquid from Day 1- it appreciates very rapidly (often exponentially)- it doesn’t cost the company anything – the employees love it- note: take above with a pinch of salt 🙂

    1. jason wright

      you mean give them tokens? just go easy on handing them out to the marketing people.

      1. William Mougayar

        yes, tokens.

    2. Supratim Dasgupta

      But isnt there an overhead of company creating ones own altcoin?

  15. Brian Manning

    Great post, Fred. It still amazes me how much value employees place on equity that they often don’t understand and in reality have nearly zero chance of making a material amount of money on. It’s really amazing. It’s a total bubble. Too many companies take advantage of this perception of employee equity to motivate employees and inflate their compensation packages. In some ways you can’t blame founders for this but it’s so icky to have a practice of deceiving the people that have committed a large part of their life to you. I encourage companies I work with to downplay equity in comp discussions unless they’re in the very early stages.

  16. Dana Hoffer

    ESOPs should be replaced by ESPPs.https://www-store.shop.ibm….How about some Blockchain company seeking a raison d’être make a service for the industry that does this economically?For starters a company with promise and raising money could allocate a 10% oversubscribe position from the last stage of funding (F&F, Angel, Seed, Series A…). Same terms etc.For entrepreneurs that want to hold onto equity issue SARs (appreciation rights).Great post Fred. Glad the Jax Jags gave me a reason to check some email.This idea does away with compound dilution, strengthens the commitment to a company, could create favorable tax situations (K1s for S-Corps and LLCs prior to C Corp conversion), eliminates the “freebie” valuation issue (here’s a $10K signing bonus, want to use our ESPPs to buy in?) and much much more.If some bright Blockchain company spins this well it will be easy enough to do (and ComputerShare will buy the little company).Danahttps://uploads.disquscdn.c…

  17. Mark Gavagan

    Netflix’s approach – letting employees choose their own mix of cash and equity, annually – makes great sense, because everyone ends up getting what they value most, at the time.More on this: https://www.researchgate.ne

    1. PhilipSugar

      The only problem with this is that you are going to have one set of employees regretting/upset about their decision.I know that’s not rational, but it is human. I’ve tried this as well. Whoever is on the side that didn’t work out as well is going to want a “true up” or is going to be moping.

      1. Mark Gavagan

        Yes, this approach isn’t perfect and what you suggest might well be the case.However, if everyone is given the best information in advance, including a clear explanation of risks and opportunities, allowing them to freely choose the mix of cash and equity that works for them seems like a path worth considering.Otherwise, a person whose nature or circumstances demand their personal finances be very conservative or even risk-free, is forced to either work elsewhere or swim in the same pool as someone whose risk tolerance is the exact opposite.

    2. Gregory Magarshak

      I wonder what you guys think of this compensation model, which we have used to some extent in our own company:https://qbix.com/blog/index…Developers can opt-in to actually “partner with us” on a project basis.

      1. Mark Gavagan

        It’s interesting, because people are paid for the measurable value they create.My concern is that contributors are incentivized to “swing for the fences” (including pitches for plenty of ultimately bad ideas, that don’t truly serve your users’ interests) instead of doing what’s needed, but unlikely to garner great financial rewards.

      2. CJ

        I like this model applied internally to a company to set bonus payments. Bonuses are all to often a black box of managerial discretion, with this you could incentivize your workforce to push harder because the reward for their work is now very transparent.Honestly, one of the biggest issues with working for a company is not knowing if you’re being fairly compensated. And you often aren’t. When your great developer finds out that his crappy counterpart out earns him he’s not going to complain, he’s going to leave. Yet, for some reason, companies still practice this policy.With this level of transparency you can inject liquidity and transparency into the employee compensation process as well as further align your employees objectives with those of the company. Win-win.

        1. PhilipSugar

          I think this is more of a salesperson model. I.e. you are willing to give a salesperson that sells twice and much a bonus/commission of four times more than the one who didn’t because your fixed cost is half.I.e. you would need two average salespeople to equal the one great one and therefore you are willing to share the bounty variably because your fixed cost is half.As to your other point. I do not believe in “transparency” BUT I operate under the assumption that everybody knows what everybody makes.This means if you want to hire a new developer and you realize that you need to pay a new developer 10% more than an existing developer, you have two choices:Not hire the developerHire the developer and give the existing developer more than a 10% raiseYou are 100% correct hiring the new developer and not increasing the existing one means either:You want the existing one to go. That frankly should be your choice and not by making a person miserable because toxic waste is toxic.Or you acknowledge the market has changed and you need to increase the pay of the existing developer because if that is the market they can go elsewhere.I am on record. I do not believe in outsourcing (we can argue but that is my way)Great developers are 10 times more productive than not great ones.Solutions get solved by people talking to others for 5 minutes at a time, stack ranking is an ultimate evil because if I help you it hurts me.The cost of a new developer is at least a person year.Recruiting time and costs = 3 months3 months to learn how we do what we do with somebody that knows = 6 months3 months to do what we do and have it reviewed = 3 months

          1. CJ

            I have to say that this is an awesome way of doing business; wrt how you outlined hiring and compensating the developer in this scenario, I wish everyone did it that way. This IS transparency BTW.The typical company would just hire the new guy at +10% and let the existing guy get pissed when he eventually finds out. And he will find out as you said.I’m copying this for future reference and to pass along to my friends in corporate.

          2. PhilipSugar

            I have good judgement because I have experience, I have experience as the result of bad judgement (quote: mostly attributed to Mark Twain) I was convinced to that once, twenty five years ago. I ended up letting the new hire go and losing a developer. (actually he gave me a fire/ice plant which I still have in my office, he said I needed to at least have one plant……every time I look at it I remember)And I don’t think it is transparency because nobody needs to know what I make. Or what a salesperson’s W2 is, but if they find out too bad.BUTIf you set the precedent that the only way you get to market value is if you leave (or worse threaten to leave) you are a moron. If you think an unproven person is better than somebody that has done battle with you then you need to go.I have never done, nor will I ever do a counteroffer. If it ever comes to the point where that is a good decision, I would have to fire myself for incompetence.

      3. PhilipSugar

        The biggest problem I have with this is the hard problems that are not “sexy” will never get done. Yes it’s no fun writing a report, an interface, or reworking the backend so you get performance and scalability.These are the difference between a product and a project.These are what you have to make people do, but rotate them out.In this model you will only get “sexy” stuff worked on and while it might look good the hard work is never going to get done or rewarded.Edit: The biggest thing is security. Jane could be working on meticulously making sure that your product doesn’t get hacked and you lose your user data and go out of business. Yes, it’s proving a negative, but really important.

        1. Gregory Magarshak

          Right. This is not for every project. But you put out the call for people to increase your metrics, if that’s what you want, and people can take the risk and do it, for the compensation.

  18. bill

    You say “Compound that over ten years and you can see what happens.” But, given that this is dilution it actually doesn’t seem so extreme. Sketching out a simple model where the only dilution is employee equity, if you assume 10 years of 5% dilution then I show that the original stockholders still own 61% at the end of that period. That seems eminently reasonable to me at doesn’t at all feel like compounding against original stockholders.

  19. Rick Mason

    Unlike the coasts here in Michigan equity grants to employees by startups are common, but by no means universal. I know plenty of startups here where the executives are granted equity, but not the employees. There isn’t a culture here where employees expect equity or even fully understand it.

  20. pointsnfigures

    Agree sort of. A person who successfully built a start up that they took IPO once told me that the thing that ticks them off the most is how founders undervalue equity. It’s the way you build wealth. I especially agree with figuring out what the true cost is. The true economic cost, not accounting cost because they can be different

    1. joesmoe

      Yeah cry me a river, the early founder with 30% equity who got diluted while his employees enjoyed a measly 0.2% is so oppressed.Could only buy a BMW rather than a Lambo. Tough life eh.

  21. rick gregory

    If part of the pitch of working for a startup is that you’re going to change the world, become huge, etc… why wouldn’t an employee want to share in that? If founders are telling me that they want to grow the startup to be a a $1b+ company that leads its category, but that I’ll not benefit financially any of that growth outside of a salary, what’s my incentive to work as hard as a startup environment demands? Yay, I’m helping the founder potentially get rich!!!A great salary, you say? OK, but that hikes the company’s burn rate and unless it’s FAR over market then I, as an employee, will still ask why I should deal with all of the risks of a startup for a good salary when I could very possibly get a similar compensation package from a more established company that also reduces the risk of my job going entirely away.

    1. cavepainting

      It is all true… but the equation changes once the company’s risk is somewhat mitigated and it is well capitalized. At that time, the company can afford to pay more cash, but equity is more valuable than ever before and it has a real impact on P&L as options vest.Hence what was true at the start (equity is proxy for cash, reduces burn, etc.) is less so. It is more complicated and thus companies need to evolve their equity policy in accordance.

      1. rick gregory

        True enough. I just don’t like the founder’s attitude that they should the ones to see the outsized returns and the employees see very little or nothing. Without those employees, that founder’s idea remains an idea. They should share in the rewards of making it a reality though weighted by their role and the risk that they’re taking.

        1. joesmoe

          It is so skewed that it actually makes what Fred is suggesting here offensive.The standard distribution these days is like….Founder1 (30%) Founder 2 (30%) Founder 3 (30%)10 key employees, 0.2% each if they’re lucky. All the intellectual fruits of their sleepness night extracted and given no pension into the future.And people wonder why Karl Marx proved so influential.

    2. joesmoe

      Not only that. It is a certainty that if you sign up to work for a startup you will be signing up for more brutal work hours and higher levels of demands over a more established companies.Founders keep trying to demand the impossible: an ownership mentality out of their employees who both sides know they’re robbing blind in equity.

  22. LIAD

    Felix Dennis, a recently departed flamboyant UK entrepreneur, billion pound fortune built from publishing magazines, has a book ‘how to get rich’, where he preaches his rules of the road, telling it like it is.He was flabagasted by option culture. Ideology was pay people very well. But no equity ever. He was also very much against expense accounts.This from his book.”Getting rich all comes down to ownership. Every single percentage point counts. You don’t need to start handing out shares like sweeties, because it will come back to haunt you. In the end, you’re going to get your money from the sale of an asset. The less of that asset you own, the less money you will get. It is as brutal and as simple as that”

    1. Michael Mullany

      I might suggest that this is the part of the reason why so much technical talent leaves Europe and comes to work in Silicon Valley (myself included).

    2. joesmoe

      And as a developer / former startup entrepreneur who understands equity, I’m not stupid either.If I’m joining a startup and you’re looking to me as the guy to build you’re entire backend for three nontechnical founders. Then your choices are: pay me a good salary and good equity of at least 5% or more, and I will go balls to the walls helping to make it work if I believe in the vision.Or don’t. Give me “20,000 shares” equalling a pittance of a rounding error on a percent — I’m not stupid, I know it what it means. So I will insist on boundaries. My work for you is no longer my life, it is now merely a thing I do among others taking my time and attention.You as a founder won’t like that. But then again, you don’t have a choice. You need me more than I need you.More developers just need to clue into this.

  23. lostdiaspora

    Finally this is being discussed, I have always wondered what the subtle nudges towards this mentality were. Valuing a startups equity is next to impossible because none of the tools work because there is no history except the general sectors and there we know the odds imply it’s worth nothing, to the employee on a rational economic basis. On a behavioural basis it’s worth a lottery ticket as thats what it is, the triumph of hope over experience as most VCs will probably testify. The real issue is fivefold: a) how to hire b) motivate c) retain good staffd) align their interests with the long run interests of the firme) defer expense cashflow into the futureI think options have been used historically for all these but in particular a) and e). wrt to the rest I do wonder the extent to which a lottery ticket might motivate employees, not a lot while it looks like a real lottery ticket and paradoxically perhaps motivates the wrong way when its a winning lottery ticket because of Prospect theory. c) last only as long as it takes to cash out in a lot of cases which also potentially creates all sorts of talent cliffs at inopportune times. d) I think is a myth because of c). Now I think there are solutions out there that address all these issues and perhaps the easiest is to commit to pay all employees a fixed percentage of revenue once profitability is achieved, I know there are a lot of potential issues and details around that but I’m confident they can be worked out. The biggest is of course the Amazon/ creative accounting issue but I think even that can be addressed. It does address a lot of the issues from b) to e) better than options, is much more easily understood and from an moral perspective rewards labour for building a successful business because thats what good teams do, not founders, not ideas. a) may be a problem but until someone tries we won’t know, wish me luck!

  24. ThatOtherOtherGuy

    If you aren’t giving equity, I expect to get paid appropriately. And that is for 40 hours a week.If you want me 50-60+ hours a week, I’m getting overtime or substantial equity.If you treat me like a wage worker, I’m fine acting like one.

  25. J Byrne

    Good introduction to a good topic that will be discussed forever because of the complexity, and the many company & people variables involved. It’s worth a checkup periodically, whether you’re a VC or company. Also I’m not surprised anymore at the recipients who don’t fully understand what they get/have, and companies who don’t effectively communicate.

  26. Bill Healy

    Fred, enjoyed the post. You referenced some extensive writing on this topic in the past. Can you point me to the date(s) of the previous posts? Many thanks.

    1. K_Berger

      At the top of the page, click on Archive and then MBA Mondays. Scroll down to the posts about Equity between Sept and Nov 2010.Or, also at the top of the page, just search for “equity”.

      1. Bill Healy

        Many thanks!

  27. kidmercury

    from an employee perspective in the companies i’ve worked at i think cash bonuses partially tied to company performance tend to do the best job at creating the right incentive structure. two companies i previously worked at that did this seemed to have employees motivated in the right direction, and one of the companies in particular has a long tenured staff with little turnover. my current employer does not do this, but does offer RSUs; in my opinion they are mostly just wasting equity.

  28. Rod Grubb

    Are you not pofessionally mature enough to write without being vulgar? Grow up.

  29. Bryan J Wilson

    Agreed – granting options to every last employee, in retrospect, feels like a lazy demonstration of democracy (when private companies are rarely that). As someone who’s been in senior finance roles at a few tech companies, I can’t tell you how much time I’ve spent explaining how equity works to other employees (to the point where I hosted fairly popular lunch and learns – ping me if you need a deck in a pinch!).Part of me feels granting options/equity to senior leaders only is the way to go, and pay everyone else in cash (plus variable comp where applicable). Seems like a healthy balance and could attract stronger entry-level/mid-career talent, if you can afford slightly higher salaries.

  30. joesmoe

    Typical f*cked up VC thinking. Yeah, what our economy sure needs more are more share buybacks rather than meaningful reinvestment of profits into new R&D.Yeah it isn’t like the founders and VC’s don’t already get away with highway robbery when they extract all the gains of a company’s intellectual product out of the tech workers who did *all* the work building that company into the amazing gem that it was to be sold.Surely what we need more of, is less compensation for the people who actually do the work, and more for the board members and shareholders who like leeches extract all that value out for themselves while contributing almost nothing.The facts are: employee options are far too low, not the other way around.

  31. Capitalistic

    It’s similar to PhD programs: Cheap labor with the promise of an outsized return, adjusted for whatever “risk”.

  32. PhilipSugar

    yes

  33. Patrick

    Buying back shares granted as equity to employees is equivalent to a short term loan from the investor to business to pay the employee. At some point in the future the business will have to pay back the investor (with the buyback) where the business will pay back the investor back at a premium (if the business is doing well).

  34. lunarmobiscuit

    Fred, do you know the history of the employee stock option pool? Was there one VC way back in the 70’s or 80’s who insisted on that structure, then others followed? Or did it come from some earlier VC on the East Coast and already fully adopted when Sand Hill Road came to be?The ~20% pool is one of those ideas which most funders and fundees take for granted as gospel, despite likely being an idea less than two generations old. Most of the standard preferences are in that same category. Everyone uses them. Most everyone never questioning whether they are still the right answer.Thanks for questioning this one.

  35. BillMcNeely

    I’m confused with what you are driving at. Link to your post?

  36. creative group

    REPOST:CONTRIBUTORS:We admit that the VC and start-up environment as associated with the USV of the world isn’t in our wheel house. But running a business with employees who rely upon us being a partner with them to trust us with an well paid career is our daily reality. (Jobs are Walmart & McDonald’s)What we understand from Fred’s post and idea being revised and developed is that a person who received an incentive via options to forgo other opportunities that may be more financially secure will now be looking at a new model that benefits VC’s and founders even more. We acknowledge the herd wilfully will accept and agree.So the compensation upfront for these talented people who sacrifice themselves financially should expected to receive equitable salaries in the range of let’s say 400K? Remember many Angel Investors and VC’s had started off from the options received from working at startups. We have to be misunderstanding this. Only will make sense to those benefiting from the talents of others.You are paid what you are worth and what you accept. Don’t accept inequity.Captain Obvious!#UNEQUIVOCALLYUNAPOLOGETICALLYINDEPENDENT

  37. Yuriy Blokhin

    Are you alright?

  38. Michael Elling

    The winners rewrite history.