Equity Grant Math

I saw a tweet yesterday that said:

is @cdixon the new @fredwilson?

I wasn't sure how to take it, so I took it as a compliment, particularly given the roll that Chris is on right now on his blog.

His most recent topic is equity grant math. In that post Chris states:

The one number you should know about your equity grant is the percent of the company you are being granted (in options, shares, whatever – it doesn’t matter – just the % matters).

Chris is right that the most important number in a grant of equity is the percent of the company that is being granted to you. Earlier this week I got an email from one of our portfolio companies with option grants to approve. It listed each person's name, their job description, and the number of shares they were being granted. It was a nice presentation but I couldn't approve the grants because it did not show what percent of the company each grant represented. I had to go look up the latest cap table, get the fully diluted number of shares outstanding, and add another column detailing what each grant was in terms of percent of the company. Then I was able to approve the grants.

But I need to differ with Chris on one thing. The total number of options or shares being granted isn't totally meaningless. If you multiply them by the share price paid by investors in the most recent financing, you'll get a sense of the "investment value" of the grant. That's the "money at work" you have in the deal by virtue of your employment.

Some will say you should multiply the number of options or shares being granted by the exercise price, but the exercise price is often much less than the last round financing price. That difference between financing price and exercise price is valuable to the option grantee and represents the difference between the value that the company was able to get a valuation firm to place on its common stock and the value that the company was able to get an investor to invest in preferred stock. It is certainly true that common stock isn't worth as much as preferred stock, but it is also true that the third party valuations that companies obtain are often conservative.

The other thing that you need to know is this percentage is likely to decline over time as the company dilutes to raise additional capital and recruit additional people. It is very hard to say what an appropriate amount of dilution you should expect. It depends a lot on what stage of the company is at when you join. If it's getting close to an IPO or exit, you may be spared any dilution. If you are one of the first ten employees, count on being diluted at least in half and possibly more. Everything else is in between the two.

Like all great blog posts, the comments to Chris' post are fantastic. Make sure to read them when you read his post (and you should read his post).

If after reading Chris' post, his comments, and this post, you are still confused about how this works, please let me know in the comments and I'll do my best to explain it.

#VC & Technology

Comments (Archived):

  1. aarondelcohen

    Fred:I think the challenge with your point is that the number you refer to as investment value is a tricky number.1. It’s too low and given that our job is to create 10x the value (minimally) that number might not seem very high (especially over 4 years)2. That number (say @ Yelp or Heavy or Slide or something) could be very difficult to achieve when valuation has gone up in inflationary times. That can become misleading and entrepreneurs rarely say, “Well the value of this grant is $80,000 but hey that could become meaningless given our huge valuation and the preferences etc.” To me this is Chris’ broader point.To me, Chris’ post is more relevant by how entrepreneurs set expectations for their team and maintain their integrity by being candid and transparent. Everybody talks in small companies. So CEOs need to be honest and they will find that the truth will keep things far simpler.I made an offer to a young man this week who has a chance to participate in a Ycombinator style program and maintain a majority of the equity in his anayltics startup. I strongly encouraged him to go for it, but he might join Nate and I because he wants to get better faster and come back to people like you with more experience. He’s getting a very small percentage of this company, but over the length of his career it might very well make sense for him to join us.Chris and Caterina are likely to do far better on Hunch than anybody else and that’s fine. They started it. But if Hunch does well then it creates opportunities for everybody see PayPal Mafia or Google riffs Chris Sacca and FriendFeed etc.Not everybody can be an entrepreneur, but if I’ve learned one thing over the past 12 years it’s that you really don’t know know who will be the best or why they will be.Startup employees may choose small for the lifestyle, the autonomy or a whole host of other advantages. Equity compensation is nice, but I encourage my colleagues not to underestimate their ability to one day do it themselves. That can really, really pay off well.

    1. fredwilson

      I’m not sure I totally get your point. But my point is percentage offered is the key number but investment value also is important too

      1. aarondelcohen

        Yeah, I reread it and it’s jumbled. My key point is CEOs should not seduce employees with false promises of wealth. Rather, they should explain that a company’s success lays the groundwork for them to do lots of other things with their life, including if they so desire, starting their own companies.If you enter Slide (post of $500mm or Yelp (post of $200+mm) maybe you will make money on the stock, maybe not. But either way if those companies do well and you were a key factor you will have positioned yourself well for the future. Long ago, that was me at Concrete Media and it paid off.

  2. ssaint

    Great post Fred! I’m really enjoying learning about the VC industry through your posts. Do you have a blog post (or know where there’s a simple article elsewhere) explaining vesting? I’ve been reading both Chris and your posts lately and they’ve been excellent, but I still don’t understand vesting properly…

      1. fredwilson

        Thanks. I knew he’d have one

    1. fredwilson

      I suspect brad feld has oneGoogle feld.com vesting and see what comes up

  3. reece

    The comments on Chris’ post are great, but they’d be so much easier to read and interact with if he had Disgus! If he wants to be the next Fred Wilson, he needs to step it up!

    1. aarondelcohen

      I agree he needs disqus.

    2. fredwilson

      Guess what? Your comment is going to be the catalyst to make it happen

      1. reece


  4. Nate

    What’s refreshing is that people like you, Chris, and Paul Graham talk openly about an opaque and scary (for inexperienced founders anyway) business.Happy side effect: you attract founders who want to do business the same way you do.

    1. fredwilson

      That’s the point!

  5. William Carleton

    Fred, I’ve read Chris’ post and the comments so far and think between your and his posts, lots of good territory is being covered, in terms of what folks should look at when assessing the value or potential value of their option grants. Very much like that in the above you are giving some rules of thumb by which to account for future dilution; it is so important to not assume that a percentage somehow is forever or that the company will not continue to issue shares in financings, etc. One thing that is largely missing in the threads so far, though, is the impact that liquidation preferences can have. Maybe everyone is assuming scenarios in which there is true upside for preferred and common alike, but as you know of course there can be scenarios (much more common in the current environment) where companies can be sold for a price where the preferred may be made whole, but the common has little or no value. Good tip for someone looking at a prospective offer might be: ask your employer if it has a management incentive plan in place designed to set aside a portion of sale proceeds to key management. If so, this could be a sign that management lacks faith in the equity value of the common and/or that the liquidation preferences are substantial, and could indicate that there is a risk that only the preferred (and management, to the tune of the pool) will get proceeds of a sale. Of course, if all are bullish on where the company is going, the financial fundamentals of the company are good, etc., there may be reason to suppose that sale or other liquidity will be at a price where the common and preferred pull out the same or nearly the same value per share (as converted).

    1. fredwilson

      That’s a good point. In the downside, there isn’t much value to equity grants

  6. Joe Lazarus

    Thanks for the link to Chris’ blog… I just added him to my Google Reader. This information on grants is also helpful.If you’re comfortable sharing, I’d love to know what percentage of the company is typically granted for various positions based on your experience. If I were offered a VP role at an early stage startup, for example, what’s a reasonable grant? I assume it varies by level (VP, Director, Manager, etc) and by company stage (at incorporation, pre-Series A, post-Series A, etc). Any benchmarks you can provide would be interesting to know.

    1. fredwilson

      Hard to do justice to this in a comment but at maturity, the mgmt (not the founders) should own 20pcnt with the CEO at 5-7pcnt, the COO at 1.5-2.5 pcnt, VPs as AS A GROUP at 3-6pcnt, and everyone else making up the rest. You can work back from there to get to what the grants need to be at an earlier stage to deal with dilution

      1. Joe Lazarus

        Thanks Fred, that’s helpful info.

  7. kirklove

    As someone who is neither a VC nor an entrepreneur I find reading and participating in your blog and Chris’ (along with Brad’s, Bijan’s and Mokoyfman’s) incredibly engaging. And Chis has just been crushing it as Gary Vaynerchuk would say.Granted 90% of the time I can’t truly comprehend all the vernacular and terms. Heck I just “tumbled” in to Fred Wilson for the great tunes, but am quite glad I decided to stay for the full conversation. I say keep it coming. I’m having an absolute blast learning and it’s a heck of a lot cheaper than Wharton. 😉

    1. fredwilson

      Its free except for the time you put in and the content you contribute!

  8. Nate Westheimer

    It’s a tired saying, but I’ll throw it out there:”50% of something is a lot more than 100% of nothing.”My dad was the first person to tell me this, when I got started with BricaBox. With that venture, I owned well over 50% of the company still when I decided to close it. That well over 50% turnout to be of nothing.With my new venture, I’m sitting well south of that 50% number, but with little sacrifice to ownership. Why is this?It’s because my “less” comes with “more” team of invested people. The more people who feel like meaningful owners of the Company (meaningful in terms of both % and their attitude towards it), the more valuable my Company is.So, % matters, for sure — it’s the basis on which investors and employees can do real back-of-envelope dreaming — but so does the culture around that number.

    1. fredwilson

      That’s why ‘investment value’ is an important number. 1.5pcnt of facebook, apparently what sheryl got for joining as COO, is worth 150mm right now

      1. Reid Curley

        My only problem with your “investment value” or “money at work” terminology is that it can cause people to confuse option value with granted stock value. Chris’ feeling that strike price doesn’t matter notwithstanding, Sheryl presumably has a pretty high strike price on her options that reflects the value of the company when she joined not when it was founded. It would be more accurate to say that she has $150mm of leverage in the deal or 100% carry on a notional $150mm amount than to imply that she got handed $150mm for walking in the door. Her options are only worth anything to the extent value goes up. I know that you and most of the comment makers on this blog understand this.Chris’ post originally was about how engineers could be more sophisticated about evaluating an options proposal. If you say to someone who doesn’t know the drill, “the investment value of your options is $100k,” they are going to think that is much the same as giving them $100k in cash.

  9. chris dixon

    Fred – I agree that it’s totally reasonable to present the option grant in $ terms (multiply % ownership by last round post-money price). I just think you should also reveal % ownership or total shares outstanding as an ethical matter. You and I know that % is the primary way management and VCs think about equity – that’s at least one way management should present it to employees.BTW, I actually think the strike basically doesn’t matter when it’s an early stage company with super high volatility and strike is standard 20% or so of last round valuation. See http://www.cdixon.org/?p=259

    1. fredwilson

      Yup. Your point about tranparency is spot on. Its really not right to refuse to share that info

  10. scott edward walker

    Fred – Solid posts by you and Chris. As a corporate lawyer for 15+ years, I just wanted to make one quick point from the legal side: Under Section 409A of the Internal Revenue Code, a company must ensure that any stock option granted as compensation has an exercise price equal to (or greater than) the fair market value (the “FMV”) of the underlying stock as of the grant date; otherwise, the grant will be deemed deferred compensation, the recipient will face significant adverse tax consequences and the company will have tax-withholding responsibilities. The company can establish a defensible FMV by (i) obtaining an independent appraisal; or (ii) if the company is an “illiquid start-up corporation,” relying on the valuation of a person with “significant knowledge and experience or training in performing similar valuations” (including a company employee), provided certain other conditions are met. Thank you (and keep up the great work).Scott Edward WalkerWalker Corporate Law Group, PLLC

    1. fredwilson

      We use third parties for almost every company to obtain the 409a valuations. Its best practice. But the whole thing is idiotic. Grant prices have come way down now that boards can pay someone to give them low prices and have their asses covered

      1. scott edward walker

        Agreed – thanks

  11. CollegeHippo

    Thanks for the nice post Fred. A very important point has been made by Chris

  12. Matthew Thorne

    I’m a venture capital attorney so my perspective may be somewhat different than that of Chris or many of the people sharing comments thus far. His article makes a lot of sense from a view-of the-world-at-exit standpoint, but what is possibly missed by saying that the percentage of the Company represented by the Grant is the only number that matters in valuing an option grant is that keeping track of this percentage is often very difficult and labor intensive over the lifetime of the grant. For example, a 10%-of-the-company grant immediately following a Series A investment could end up representing .05% of the Company at exit. Dilution from later investments, other option or equity grants, the issuance of warrants and the affect of preferred preferences all have to be considered in determining the mathematical and real percentage of the Company that the grant will represent from grant to exit, and Engineers and other startup employees are not generally interested in keeping track of all of these variables over the life of the option grant. I agree that knowing the percentage of the Company that the grant represents at the time of exit is paramount to determining the value of the option, but knowing the percentage of the Company you are being granted when the grant is issued will do very little in helping you to know what that exit percentage will be in the future, there are just too many variables.That being said, having worked with portfolio companies and the venture investors that fund them all of my career, I have not seen any evidence that Companies have ever tried to “trick” engineers or other employees by playing with the share numbers of a grant and keeping the percentage of the Company represented by the grant a secret. That is not to say it doesn’t happen, but these Companies generally grant options with the goal to incentivize their employees (partly to incentivize loyalty, partly as a salary substitute accepted by the recipient because of the upside potential) and any “trick” played by the Company will likely defeat this goal. Consequently, my experience has been that Companies generally grant options in an amount that they think will provide the respective employee with a sufficiently incentivize employees to give their best efforts in a job where the risks are much higher, but the rewards can also be much bigger than non-startup jobs.Employees that cannot deal with some risk and uncertainty, both of which are great words to characterize options generally, are better off not working for a startup.