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But Why?

Being an investor and board member means that you are close to the companies you invest in but not “in them.”. This near and dear relationship creates some interesting challenges for both the management and the investors. One of them is understanding the difference between information/reporting and a real understanding of what is going on in the business.

I often find myself saying “but why?” at board meetings:

  • “Revenues are soft this quarter” – but why?
  • “MAUs are up 150% over last quarter” – but why?
  • “We are going to miss our ship dates” – but why?
  • “We expect to decrease our hosting costs by 50% next quarter” – but why?
  • “We can’t seem to get any interest in the next round” – but why?
  • “We are getting a lot of inbound interest from investors” – but why?
  • “We have a lot of turnover in our engineering organization” – but why?

The beauty of working with investors who see a lot and have seen a lot is that they can often help you diagnose the disease by looking closely at the symptoms. But you have to be willing to engage in that exercise and be open to hearing “but why” and be prepared to answer it.

Central European Summer Time (CEST)

The Gotham Gal and I have been married for thirty years this June and we are spending the next month in Europe celebrating that and all that has come from it.

Blog posts will be arriving central european summer time (CEST) until the end of June. 

And they will be about all sorts of things that may or may not have anything to do with technology and startups.

Now off to breakfast

From The Archive: Employee Equity – How Much

I’m skiing this week. It’s snowed two feet in the last two days. So we will continue to dip into the archives until I come up for air, later this week.

I saw this tweet exchange yesterday about my employee equity post.

 So I’ve reposted it here below.

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The most common comment in this 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:

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.

Planning For Next Year

For the past few weeks I have been going from Board Meeting to Board Meeting reviewing, discussing, debating, and, ideally, approving the 2017 plans for the companies that I work with.

Here are some thoughts and observations about the year end planning process:

1) Companies should start the annual planning process early. I think September is a good time. It should start with a wide open data gathering process which involves as much of the organization as is possible. 

2) The planning process must be grounded in the strategy which should be set in advance of the planning process. If a strategy adjustment is required, that needs to happen before the plan can come together.

3) The senior team needs to do the plan as a group. That can involve offsites, a set of regular (weekly?) meetings, or something else. But planning is a team effort and a plan can’t be handed down from on high like the ten commandments.

4) My number one feedback on annual plans is that they should have less focus areas. I think three big bets is good for most venture backed companies. Five is an absolute max. The more you try to do the less you get done.

5) The numbers should fall out of the strategy and plan, not the other way around. If you don’t have enough money to do everything, change your strategy. Don’t plan by numbers. Plan by developing a set of priorities that come from the long term strategy, and informed by the inputs of the organization.

6) Don’t drop your plan for next year on your Board the day before a year end Board meeting. The good news is that none of the companies I work with did this. I am very happy about that. It is best to give the Board a preview (ideally multiple previews) of the plan as it is coming tother so that you can get feedback and buy-in well in advance of the final approval process.

I am a big fan of the annual planning process. I realize that all plans end up evolving during the year and things change and companies adapt. But a good plan gets everyone (including the Board) on the same page, working on the same things, and driving to get to the same place. And that alignment is incredibly valuable.

Numerai and Polychain

USV recently made two investments in hedge fund managers. You might gather from that fact that we are moving away from venture capital. But that would be an incorrect assumption. What we are doing is finding new ways to invest in technologies that we think are interesting. These would be technologies like artificial intelligence, encryption, and blockchain.

Last week it was leaked, and then announced, that USV had led a round of financing for Polychain Capital, a new kind of fund that invests in digital tokens. We have discussed these digital tokens here at AVC and elsewhere. We do plan to directly invest in blockchain based protocols via tokens, but we won’t be able to invest in all of them in a venture capital model, so we are also betting that a fund vehicle focusing on these assets will make a good investment.

Yesterday, my partner Andy wrote a blog post on the USV blog about Numerai, a new kind of hedge fund that allows machine learning experts all over the world to crowdsource public market investments by building models and sharing the selections that come out of their models. The data they use to power these models is encrypted and so are their models. It is the “blind leading the blind” according to this piece in Wired. I like that description as the focus moves away from things like fundamental and technical stock analysis to true pattern recognition done by machines. Numerai uses cutting edge encryption technology (a variation on homomorphic encryption), machine learning, and pays out using the bitcoin blockchain. It’s a trifecta of things that are interesting to us, as recognized in this tweet by MIT’s Technology Review.

In both cases, USV invested in the “GP” of these funds. In Polychain, we also made a small investment in the fund itself. We did not do that in Numerai, although it is possible that we could choose to do that in the future. Our investments are largely in the companies that manage these funds and they are a bet that these new technologies will offer new ways to build fund management businesses that over time will be highly valuable. These are both startups and we think of these investments as classic early stage investments with all of the risk and return that comes along with them.

Video Of The Week: Albert’s Talk At Web Summit

My partner Albert Wenger gave a talk at Web Summit about the coming Knowledge Age. Many of you have seen previous versions of this talk which I have posted here. But Albert is evolving the talk as he learns more about some of these ideas.

It’s a short talk, about 15 mins long. I have included the video and the slides below that.

If You Need A Drink After Voting

If you are like me, you might want to celebrate the end of a shrill and divisive election season with a stiff drink or a strong coffee.

And our portfolio company Foursquare has the exact tool you’ll need to do that.

Go here and enter your home address and Foursquare will map your voting place and bars, restaurants, and coffee shops nearby.

Here is my map:

foursquare-votiing-map

I plan to vote bright and early on Tuesday morning and then head to one of these many excellent choices for my morning coffee.

And, whatever your political orientation, I hope you go out and vote on Tuesday.

Feature Friday: The NFL on Twitter

Last night was a revelation for me. I’m not joking. I wasn’t really expecting to be blown away by the experience of watching football on Twitter. I was.

I installed the new Twitter app on our AppleTV and watched the entire Jets Bills game on Twitter last night. It looks like this on the TV in our family room:

I was talking to folks on Twitter throughout the game and many said that they don’t understand the difference between having the tweets flowing up on the screen vs on your phone.
For me, it’s a huge difference. You can watch the game and follow the conversation about it without having your head in your phone.

But there is so much more Twitter can do to make this experience even better.

For starters, I would like to be able to log into the Twitter AppleTV app and then have options to only see tweets from people in my timeline or to have those highlighted or prioritized.

And, I would like to be able to use the Twitter app on my phone to control the AppleTV Twitter app like the Apple Remote app controls the AppleTV. Then I could tweet from the AppleTV app and be able to reply and engage right up on the screen.

I expect Twitter to showcase all sorts of live sports in the coming months in their apps. You can watch these events on your phone in your Twitter app. Or you can watch them on AppleTV and XBox and, I think one other device. I expect Twitter to add apps for other devices as well.

Everyone here at AVC knows I am a huge fan of Twitter and very long on the stock. So take all of this in that context. I think the addition of live content to Twitter is a game changer for them. It amplifies what is unique and different about Twitter and the experience is fantastic. Well done Twitter.

Video Of The Week: Allen Iverson’s Hall Of Fame Speech

My two favorite basketball players, Patrick Ewing and Allen Iverson, are both products of John Thompson Jr’s Georgetown program of the 80s and 90s. Both went on to have hall of fame careers in the NBA and both were franchise players on teams that got close but never won an NBA championship. The thing Patrick and Allen have, more than anything else, is heart.

And Allen’s heart is on display in this rambling 30min acceptance speech he gave at the Basketball Hall Of Fame yesterday.

It’s about 25mins of him thanking people (his family, the people who shaped him as a child, his friends, his coaches, his teammates, his competitors, etc) and about 5mins of speech making. But in all of that are a few gems.

  • the feeling of stepping on the court against Michael Jordan for the first time
  • his relationship with the Philly fans
  • his relationship with the media
  • John Thompson Jr’s decision to recruit him to Georgetown and “save his life”
  • how he learned the crossover

Allen is far from perfect, as a player and as a person (who is?), but what you see in this speech is how he managed to hold it all together throughout a chaotic career and life. His reputation is now “solidified” as he says at the end of the speech. I am very happy for AI.