Posts from Uncategorized

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That framework is now out of date as the market has moved (up in case you were wondering) and I need to update it.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.

Funding Friday: The Merry Merkle Tree

Our friends at TrueBit are trying to raise $250k to support Covenant House Toronto.

They have built a virtual Christmas tree and are accepting donations in Ethereum here.

The Gotham Gal and I have donated 5.5 ETH. Our donation may take a few days to show up on the leaderboard.

I am hoping those of you out there who are holding a lot of ETH might part with a little bit of it to help a great cause.

You can do that here.

CS Education Week In NYC

All over the city this week, students in NYC’s public schools have been celebrating CS Education Week by doing events and hackathons to showcase their coding skills.

Through NYC’s CS4All program, over 1000 teachers have been trained to teach CS classes in their schools. That is over 500 schools to date. Over the course of the ten-year CS4All program, over 5,000 teachers will get this training so that all 1700 school buildings in NYC will have at least one CS teacher and many will have two, or three, or even four.

Most of these 500 schools, and many others around NYC, participated in CS Education this week. I was out in the schools along with my colleagues at the Department of Education, CSNYC, and the companies that support us, including Google, Accenture, and Alexandria Real Estate.

I met this eighth grader up in the Bronx at In-Tech Academy, a 6-12th grade school that specializes in STEM education and mostly pulls from the Kingsbridge section of the Bronx. He told me that he wants to be a game designer when he grows up. I told him he was well on his way and that he just needed to keep up his schoolwork and his excitement for coding and making things.

But it wasn’t just me out in the NYC public schools this week.

A bunch of Google engineers went out to the schools and helped with the hour of code. Google has developed a K12 CS Ed curriculum called CS First and Stephen Bloch was helping a student do a lesson from that curriculum.

The thing that most excited me this week was to meet all of the NYC public school teachers who have been trained under the NYC CS4All program to teach CS to their students.

This is a photo of a teacher named Ms Calise from Horace Mann, PS90Q in Queens, where a bunch of teachers have taken advantage of the CS4All program to learn how to teach CS skills to their students.

So, needless to say, this week has been very gratifying for me. CS Education is seeping into hundreds of school buildings in NYC and will continue to do so for the next few years until it is in every school building in NYC.

I am so thankful for the generous support of corporations and non-profits like Google, Accenture, Alexandria Real Estate, Hearst, AOL, Two Sigma, Wachtell Lipton, Math For America, Robin Hood, Hutchins Family Foundation, Paulson Family Foundation, and many many others, without whom this work could not happen.

If your company or non-profit wants to join this group and help bring CS to all students in NYC, please email me or leave a comment in this blog post and I will contact you.

The Great Firewall

We arrived in Shanghai late Monday night after a long four-airport three-flight day and all I wanted to do was crash. The Gotham Gal wanted to check her email so she logged onto the hotel WiFi and attempted to do that. As I was falling asleep I heard her call down to the front desk and complain that the Internet wasn’t working. I told her we could deal with it in the morning.

So when we got up, we grabbed our laptops and went downstairs to have breakfast and fix things.

I set up VPN software on both laptops and the Gotham Gal’s iPhone. For some reason that I don’t entirely understand, my Pixel with a TMobile SIM card seemed to be able to bypass the great firewall and access Google and Twitter without need for a VPN.

But even with firewall software on our devices, accessing western Internet services in Shanghai was flaky. Sometimes things worked, sometimes they didn’t and it wasn’t entirely clear why.

But more than the inconvenience, and it wasn’t a big one, the entire notion that China has chosen to block some of the world’s most essential services inside of China’s borders seems crazy to me.

I understand the value of protecting home grown services from competition from Google, Facebook, and Amazon. But the local versions of those services have grown so powerful over the past decade and cultural norms (like WeChatting) have taken hold so strongly that the protection seems unnecessary at this point.

Of course there are the censorship issues, which the New York Times recently shamefully heralded, but how hard is it to get a VPN if you want to check Twitter and search Google for uncensored news?

Xi Jinping heralded the dawn of a New Era for China in his talk at the 19th Party Congress this week. He asserted that China is strong and ascendent and those are both certainly true.

I would argue that China is strong enough now to fully join the Internet without any controls or constraints on it, like the dominant modern society that it wants to be and, frankly, already is.

Mexico City

Mexico City is an amazing place. The Gotham Gal and I were there around this time last year.

The people, the culture, the energy are all great in Mexico City. It feels like a place on the move where good things are happening.

So I was upset to hear about the devastating earthquake last night.

We have had so many natural disasters in the last month and I understand that we may all be fatigued from giving to all of these needy causes.

But I took some time this morning to give and thought I’d share with all of you where I sent some funds in case you want to do the same.

  1. Salma Hayek’s Crowdrise Campaign to UNICEF’s on the ground relief efforts: I donated $1000.
  2. Bitso’s (Mexico’s largest crypto exchange) Campaign to benefit Red Cross and Brigada de Rescate Topos Tlaltelolco A.C.: I donated 2 ETH.

It feels good to send some funds to organizations on the ground that are actually helping people in a difficult time.

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.

___________________________

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.