Employee Equity: Too Little?

Sam Altman, who is now running YC, has a good post on employee equity that has been making the rounds this weekend.

He makes four observations about employee equity:

– employees don’t get enough

– the requirement to exercise quickly upon leaving is painful

– the tax treatment of options is closer to salary than stock

– companies don’t tell employees enough about their stock and related information

I generally agree with the latter three points. But I am not sold on the first point. We have seen some of our portfolio companies make very large grants to early employees and that ends up hurting the founder’s stake because investors factor all of the shares that have been issued into the valuation they offer.

This issue is getting particularly visible in silicon valley where the value of a top software engineer has risen considerably in recent years. Let’s say that you want to hire a top software engineer and are competing with equity grant offers from Facebook and Google where the value of the grant is $1mm. If you have a current valuation on your company of $10mm, then you have to offer 10% of the company to compete for that engineer. I am not saying the engineer isn’t worth it. She is. I am just pointing out how dilutive employee equity is becoming in silicon valley. We are seeing similar things happening in NYC and I imagine they are happening elsewhere.

Since I started in VC, the percentage of a company that non-founder employees owned was always in the 15-20% range after the team is fully built out. In recent years, I have seen that number creep up to the 20-25% range and if you extrapolate current trends out a few years, it could easily be 30%.

So I guess what I am saying is that this is a market we are participating in. And this market is becoming very competitive and a lot more transparent. The benefits of both of those things are accruing to the employees and they are getting more and more equity as a result. Sam may be looking in the rear view mirror with this first assertion. I think like many things, the market will take care of this problem. It already is.


Comments (Archived):

  1. Matt A. Myers

    I mean the same can really be attributed to most VC -> investments made too, no?”He makes four observations about equity investments:- companies don’t get a fair valuation, just what market rate the investor will likely have to pay based on what others are willing to pay…”Of course with convertible notes that would be mitigated a fair amount. I wonder if a similar idea for employees could work too — stock issuances and rules based on performance of the company, as opposed to fixed amounts. Has this idea ever circulated and been discussed?

  2. Matt A. Myers

    “She is.” change to “They are.” ? I’m willing to open up this discussion again. πŸ™‚

    1. Shaswat

      Noticed that too πŸ™‚

    2. Matt A. Myers

      I feel like replying to this, will likely make it a blog post anyway.I understand what Fred said previously on the topic, that there is an imbalance of exposure or perhaps you could call it “promotion” in language of men via the use of referring to he / him / his. However reenforcing a dichotomy either way isn’t helpful.Perhaps an easier example to consume: If you say “I am happy” or “I am sad” – you separate those in your mind, so when you then think to yourself “I am happy” but then you’ll realize sometimes you’re sad or maybe you are a bit sad – something in your life is making you sad but isn’t the only piece of you – then that “I am happy” statement will cause cognitive dissonance, or you’ll perhaps learn as a coping mechanism to ignore certain feelings and not process them – which can have a myriad of negative trickle effects (unhealthy).The best way to manage this psychologically so it’s not harmful or causing internal confusion and discomfort is to say “I am happy AND I am sad” – which then turns thinking into a spectrum as opposed to all-or-nothing, black and white thinking. This is actually more kind too and inclusive when it comes to gender, as not everyone identifies fully as male or female, and there certainly is a spectrum of different attributes that mix physically, mentally, emotionally – behaviour wise – that any individual can have a mix of.I am not sure and can’t say I always bring my language use back to as gender neutral as possible, it’s a practice that you’d have to start and then you’d catch yourself as you go.Here’s one of my favourite Einstein quotes re-imagined:”A human being is part of a whole, called by us the Universe, a part limited in time and space. We experience ourselves, our thoughts and feelings, as something separated from the rest a kind of optical delusion of our consciousness. This delusion is a kind of prison for us, restricting us to our personal desires and to affection for a few persons nearest us. Our task must be to free ourselves from this prison by widening our circles of compassion to embrace all living creatures and the whole of nature in its beauty.”- Albert Einstein a la MattI imagine yes, someone using their own more direct reference such as “his” would feel more directly, deeply connected to our self, our ego self – which in fact is us talking about ourself and what we most what most of us can most strongly identify with, intimately – though I think it’s a healthy practice to always bring others into your thought – to help you feel more intimately connected to others – even if it’s through editing your words afterwards, a practice to keep your mind and ego in check and become a contrast for oneself to make sure we’re not becoming too self-involved.

    3. fredwilson

      I will make a deal. When the average tech person uses a gender neutral pronoun in their writing I will do that too. Until then its she

      1. Matt A. Myers

        IMHO that’s the wrong leading metric to follow for the best, most needed change. But okay. You do have a broad reach too.”Be the change you want to see in the world”If equality is what is needed, I fail to see how applying more pressure/exposure – bringing the lever closer toward the “female” side and further away from the “male” side – is affective in the end, instead of just eliminating that spectrum as best possible by not reenforcing its existence.

      2. Melissa Perri

        These comments just go to show you how very rare it is to see “she” or a female pronoun in association with the word “engineer”. If the word was changed to “he” I bet there would have been no comments on the gender pronoun used and more comments on the actual topic of this post. I appreciate the effort Frank makes to consciously write female pronouns. It furthers the dialogue and hopefully one day there won’t be any comments on the gender.

        1. Matt A. Myers

          There would have been comments, likely from women from what I have seen (or anyone who is taking an active role in changing the status quo of language use) – which is fine – but I would guess if it was “they” instead of he or she, then there in fact would be no comments.Do you think that would have eliminated that issue – if “they” was used instead? That’s more inclusive than using specifically “he” or “she” – yes?

      3. jason wright

        can’t you just slash it? s/he

        1. Matt A. Myers

          “They” is still more inclusive and a little less hassle to read/digest.

          1. jason wright

            Fred’s on a mission – ‘they’ will do me.

          2. ShanaC

            grammatically harder to handle, can create reading confusion.I actually prefer s/he since it allows for the singular form more easily in English.I wish we had a set of pronounces that are the singular third person that are un-gendered and that are not objects (no it, in other words). There is no consensus for one, however.

          3. Matt A. Myers

            “They” also has the definition of “used to refer to a person of unspecified sex.”

          4. Kirsten Lambertsen

            Fred should be able to use ‘he’ or ‘she’ interchangeably (which the standard approach in writing – I was a Comm. major) without people feeling hassled or distracted πŸ™ I think that’s the point.

      4. Dale Allyn

        I prefer “s/he” in situations like this post, as I find it less distracting, and probably more accurate. But this is your blog and I appreciate the content and community however it comes. πŸ˜‰

      5. ShanaC

        that’s some deal, you could spent your entire rest of your career not seeing that happen.

      6. Anne Libby


      7. Kirsten Lambertsen

        For everyone asking why he didn’t write s/he or they, would you be asking that if he’d written ‘he’ ? Be honest, now.If he was writing about manicurists or fashion designers, would it have bothered you? Would it have bothered you if he’d used ‘he’ in that context?It’s amazing to me that using ‘she’ instead of ‘he’ is seen as some kind of incendiary act, or even worth noticing.Keep on keepin’ on, Fred.

      8. Your friend

        I suppose we would do well to recall “The Power of a Pronoun”: http://www.joyent.com/blog/…Not doing it, in other words, is a firing offense.

    4. Royce

      He said “engineer” singular. Using a plural pronoun in that situation is incorrect grammar. And it makes you look stupid.

      1. Matt A. Myers

        Haha. Such kindness.. (Sarcasm if you couldn’t tell)It’s too bad for your argument’s sake that language evolves – and that you’re wrong.Let me google “define they” for you — or you can just click this link here: http://lmgtfy.com/?q=define

        1. Matt A. Myers

          Oh, and notice the kindness in my response? I didn’t call you stupid, I pointed out your argument was wrong – and luckily you can learn (if you’re open to that kind of thing, growth and learning) and then you won’t make that mistake again.Yay for learning and kindness!

        2. Royce

          When things change due to stupidity it is more appropriate to label it devolution rather than evolution. My objection has nothing to do with a male/female distinction, it has to do with a singular/plural distinction. I’m fine with culture coming up with a gender neutral singular pronoun. But using a plural pronoun for a singular antecedent and then saying it makes sense because of Google is sort of like saying the it makes sense that the U.S. went to war with Iraq because a bunch of people thought Iraq had WMD and was responsible for 9/11.

          1. Matt A. Myers

            I don’t follow your reason, and your examples are apple and orange comparisons.Enough people started using “they” as a singular version of an unspecified gender for it to become a definition in curated books that are listing commonly used language – and you think that’s devolution?Devolution doesn’t mean what you think it means, and in fact what you were describing is still called evolution, whether it is selecting for positively or negatively. Innovation on the other hand can go either way.I feel your firmness, rigidity or perhaps perfectionism – which could come from stubbornness or other – is likely not allowing you to see “they” as a viable option, that many other people – enough for it to become dictionary definition – believe and find realistic, reasonable.

  3. William Mougayar

    What do you think about these other 2 points he makes:1. Increase of the size of the option pool post-A round.2. Increase the vesting period to 5-6 years.

    1. awaldstein

      For an initial grant 5-6 years is just a bad idea from the employee perspective.I would never take a gig that had more than 4 years vesting for the initial grant.Would you? Why would anyone? That is why there are follow on grants.

      1. William Mougayar

        He makes some good points about why it might be desirable in some cases, and it’s addressing the younger employee who you don’t want to see them leave after 4 years.It’s a moot subject in case of an exit, as you can negotiate full vesting when that happens.

        1. awaldstein

          Completely on the other side of the fence on this William.There is no younger/non senior/not yet a rockstar employee who gets full vesting on change of control. This is not reality as I’ve experienced.And honestly, you don’t get employees to do what you want by creating structures that work for you and not for them.Can you give me a dialogue where a ‘normal’ employee can be convinced that against industry standards they should take their piece of vesting and extend it out 6 years? Will require a lot of alcohol to make this sound rationale πŸ˜‰

          1. William Mougayar

            I knew you would say something about the younger thing. It’s reality. You and I are not the norm nor the target in this.On the 2nd point, it’s not about getting employees to do what you want via structures; it’s about rewarding everybody fairly if the company does well.

          2. awaldstein

            How is a four year vest unfair though? Or a non incentive?The reality is that in 100% of my circumstances when things went well, there was a secondary grant before the 4 years were over.What am I missing?

        2. JimHirshfield

          Additional grants with new 4 year vesting periods are typically granted to employees you want to retain after their initial 4 year grant has vested. So that addresses retention.

      2. JimHirshfield

        I’d take 6 years over 4 if the amount of options was 50% more, which I think is Altman’s point.

        1. awaldstein

          Not I.50+ % of startups tank. A larger percent dribble on. I would take an incentive to create success and engage faster.I’ve taken longer deals around equity but only where the company was public and I was driving a turnaround with a different type of currency.

          1. JimHirshfield

            Timing of tanking or succeeding… hard to predict if either happen quick or long. Generally success takes time. Few exceptions. So as founder, I’d want you motivated beyond short term. Gimme your long view game.

          2. awaldstein

            I don’t think of it that way Jim.Long-term or short, I look at it as market cycles and in almost every case, if you can’t catch or see the updraft in a market after a four year cycle, leadership in both sales and marketing (maybe more) gets changed. And usually it should.It’s just life in the market and in a few cases, its happened to me, leaving behind both my best friends and references, and in two cases, significant returns 4-8 years later from that vest.

    2. Dave

      Isn’t increasing the size of the option pool ultimately an investor issue. Investors want to put in $X and own Y% of the company. Increasing the option pool post-financing dilutes the investors as well so presumably they would offer a smaller pre-money. The ungranted option pool for the life of the round is almost always factored into the pre-money, which has always struck me as stupid but is the way the market has worked for as long as I can remember.Longer vesting period seems to move into periods employees can barely contemplate. Some larger companies, notably Amazon, do back-end weighted vesting but that seems difficult for smaller companies to sell.

      1. William Mougayar

        It’s all factored in, of course. Small, gradual increases should be digestable by everybody, as they make sense. If your new valuation is 5X the previous one, then you can afford to increase the options pool by a bit.

        1. Dave

          Where a new financing comes in with a huge increase in valuation, I’ve often seen employees/founders get re-loaded with new option grants. Re-load amount varies by perceived go forward value of the employee/founder.

  4. awaldstein

    90 days to exercise is very tough.I once had a full year to exercise. A gift and one that helped me and hurt no one.

    1. William Mougayar

      Increasing that period is very easy to do. You can make exceptions by taking a board resolution.

      1. awaldstein

        Mechanically easy sure. In reality I have never changed a vesting period nor had one changed. Nor can I think of a situation where I would change one honestly.

        1. JimHirshfield

          That’s an exercise period, not a vesting period. And like you said no one gets hurt.

          1. awaldstein

            I’m with Charlie below, the thing to do is shorten the vesting period and extend the exercise time frame.This idea of extending the vesting period as a way to retain employees just seems backward and top down spreadsheet thinking to me.

          2. JimHirshfield

            Vesting as a way of retention… Yeah, that’s the whole point of vesting. Not sure what the diff is between 6 years versus 4 plus a new grant after that for addl 2 to 4.

  5. Matt A. Myers

    Has the idea of “convertible notes” for employee equity ever circulated or been discussed?I think it could solve a lot of issues and really help with incentivizing everyone in a company if it’s structured smartly.

    1. vadimoss

      Convertible notes for employees do sound like a problem solver in many cases. It just needs to be explained very well. Otherwise an out of college graduate would have no idea how this thing is structured. On a side note, I had this persistent thought in my head while reading the original posts and all comments. It sounds like employees are supposed to know all ins and outs of equity delusion. Not every founder would know much about it. Pre-money, post-money, liquidation preferences, valuation caps – you kidding me:)?Also if employee would be so knowledgable on the topic , “they” πŸ™‚ may NOT be so excited about taking all risks alongside with founders while there is a solid offer from FB and such. I found that the vast majority of people prefer stability over questionable high returns from some risky ventures. Those who don’t, start their own business. At the end founders are selling their dreams, to employees, investors, customers. When you strip it down to the real life numbers and put against all the risks involved, the dream becomes a reality and not so dreamy anymore. Increasing the vesting schedule with simultaneous grant increase is very clever and sounds like another problem solver btw.

    2. Dave

      Tax treatment of a note would be as bad or worse than options. You’d have gain when you received the note and interest taxed as ordinary income as interest accrued, even if interest was never paid. Options are unique in that the taxability is deferred until exercise.

  6. jason wright

    Three Women in a Boat by Jerome K Jerome.the founder, the investor, and the employee.the division should be based on how much paddling each has to do.

    1. Matt A. Myers

      I hear Three People in a Boat by Jerome K Jerome is the best edition.

      1. jason wright

        that’s what i hear. haven’t read it – sold out.

        1. ShanaC

          no copies anywhere

          1. jason wright

            out of print.

  7. WA

    Employees tend to value “their” contributions according to internal and external equity perceptions. Reward structure for ultimate contribution versus others inside and out of the company. That does not exclude founders in their minds in many cases. Behaviorally it comes down to distribution of wealth rationale by each. Perhaps addressed at that level there might be less “redistribution” of wealth debate for some.

    1. Matt A. Myers

      I feel a situation that is similar to how convertible notes work could do well in an employee equity structure. I’m not sure if this has been done before, nor what it would look like in the end, but I can see it being a good incentive that could be more fair for everyone.

      1. WA

        The rights and position of a debt holder as well as the right to greater participation via equity conversion. I find favor in that Matt. Ultimately convertibles bring cetain dilutive effect but not neccesarily immediately. Incentive via convertibles to stay on beyond pure equity risk early on might be of great meaning/reward to the organization as well. Especially at those times things appear on the brink, if employees understand exactly how a conversion works, rights of a debt holder and benefits of a successful and / or premium conversion. I like it. It also could lead an employee into a deeper sense of a job responsibility in all senses of equity participation. And in the case of a walk away prior to conversion the benefits to the company and shareholders avoiding further dilution are there if structured in. Thoughtful idea Matt. Very.

      2. sparkzilla

        I posted this to HackerNews in response to Altman’s original post:As a founder I looked into paying vendors/employees with options, but have found they are too brittle. Because option deals are created at the start of employment they require a lot of faith on the part of the founder, who does not know the employee’s abilities or temperament. Options do not track well with performance and cannot be adjusted easily. I also do not want to be in the position of considering terminating an employee because they have more options than what I think they are worth, and employees should not have that fear either.Instead I am working on giving vendors and employees a convertible note that is based on their performance month-by-month. Let’s say an employee or vendor is taking $5000/month less than they should be because it’s a startup. The company credits them $5000 to their note each month (this can be more if there’s a risk premium), and adds any performance bonuses as well as they come up. This lets management clearly track performance against the shares they are giving, and lets the employee know that if they work more they can get more. As time goes on the value of the note increases and the employee can convert their note to shares at the current valuation (or a discounted valuation).This seems a lot more flexible to me than options, and is less stressful for the founder and the employee. Am I missing something?

        1. ShanaC

          I love this idea. I wish it were more common.

        2. rick gregory

          Interesting idea, but you look at this from one side – the founder. The employee is also taking a risk – usually a lower salary, perhaps fewer benefits and the risk that those options will be worthless for reasons good or bad.Too, your idea that “the employee can convert their note to shares at the current valuation (or a discounted valuation).” is something that will probably favor the company, not the employee. If you give me, say, 2% equity at $1/share that’s one thing… but if you dribble out equity as you outline at current valuation over time the per share strike price is likely rising over time (we hope!) so I either need more shares to have the same upside or I need to have the strike price set at the valuation those shares had when I was hired.

          1. sparkzilla

            Hi Rick, the strike price should be set at the time of hiring. I also believe the employee should have a risk premium. The way I am looking at this is to give the employees the same discount as a cash investor. So if a cash investor gets a 25% discount on a convertible note, then an employee hired at the same time would get the same rate. Because investors and early employees have the same terms it means there is a clearer understanding of incentives all round.

  8. Scott Barnett

    This could certainly be naive, but why do I want to “compete” for the Engineer who has an offer from FB/G+ and they are getting a $1m stock option grant? First, isn’t my grant worth “more” because my upside (as a $10M valued startup) is much higher? And second, don’t I want to hire someone who truly believes in our vision and wants to have a big part in making it a reality? Somebody who felt this way would be more open to taking a working wage and reasonable options so there is enough to go around (The person who needs us to “match” FB/G+ suffers from the Alex Rodriguez problem and not somebody we want or can afford….)This is an extremely tough problem for sure – but all the more reason for startups to always be recruiting – build as big a pipeline as you possibly can (much bigger than you really need) and earlier than you need it – so that you can find the “true believers” who are coming to you for the right culture and mission reasons – not just financial.

    1. Matt A. Myers

      Good points. You also have to take into account if that stock is actually worth what they’re offering.

      1. Scott Barnett

        Well, my stock certainly isn’t! If we’re a $10M startup, you’re buying into the vision/dream. FB/G+ at this point are very large established companies. Engineers aren’t going there to have a huge personal impact. I’d like to think that still matters to the right people.

        1. Matt A. Myers

          Except IMHO Facebook is bloated value wise, Google not as much. I think a better way to see the right fit with someone is if they’d make enough but enjoy what they’re working on. If they purely like to code and don’t care about a broader scope of things, I wonder how well they interact with others and how valuable overall they’d be to an organization in the long-term.

          1. Scott Barnett

            exactly – to my point about culture and mission fit. That has to be there….

          2. CJ

            As an engineer, I shouldn’t have to take a salary hit just because I enjoy my job or believe in the company as those qualities make me a better asset. Is the owner taking a salary hit because he enjoys coming to work? Is he giving up equity because he wants to build the best team? Prove that to me and I can be more flexible with my salary demands.

          3. rick gregory

            If you’re motivated mostly by the compensation a startup isn’t the place for you. Most early stage startups simply cannot compete with an FB or Google if the latter really want you so your choice is easy. You want the max compensation, you aren’t willing to take the risks inherent in a small startup so go to the large, established company that can offer you higher compensation. Just don’t complain if that startup that offered you 2% of a $10mm company exits for $150mm 4 years later and you find out you’ve passed up $3mm+.

          4. CJ

            >”If you’re motivated mostly by the compensation a startup isn’t the place for you.” – No just entrepreneurs apparently. I mean, they’re mostly motivated by the compensation yet no one tells them that. It’s only the guy with hard, marketable skills that’s supposed to work for dimes on the dollar for the love of it, right? As JLM says, if one goes to the pay window, we all go the pay window.

          5. Matt A. Myers

            Didn’t say there’d be a salary hit or below market pay.Re: Owner taking a salary hit – You can’t really compare because the incentive for the majority share holders is usually to work as hard as possible, so paying themselves whatever they need to take care of themselves properly is really all I’d think they’d want — which pay wise, someone who works as hard is invaluable — people who work this hard likely start their own companies too. Sounds good though, that main equity holders aren’t just padding their pockets with profits.

          6. CJ

            No, you didn’t say hit or below market, I took your ‘if they make enough’ to mean a compromise on salary rather than an implication that salary would be at or above market.I’ve read a lot of sentiment that engineers should be willing to work long hours and for below market pay to make a startup succeed and that it’s just startup culture. That’s great, as long as compensation is commiserate. After reading how a ton of companies were conspiring to keep salaries down and then adding that to the push for more H1B it makes me doubt a lot of founders about compensation. As an engineer, I wouldn’t make the sacrifice of compensation for love anymore because it seems the deck is stacked against me compensation-wise to start.

          7. Jacque Offal

            commensurate not commiserate. although if it’s not commensurate, there probably will be commiserating.

    2. Dave

      You have a great point. Google, FB, Amazon and others can always outbid a startup if they really want to for a single person if the person is interested. Both Google and FB have been known to mix in restricted stock with options to “guarantee” that there is real value provided. Restricted stock can go up or down with changes in stock value but there is always something there unless the company goes to zero. Less binary than options where above the strike price has value, below has zero value.Historically a large company provided many less restricted shares than options–originally ratios ranged from 1:3 to 1:7–but in the current market the big companies seem to be providing everything, stock, cash, options to get the right people in.

  9. JimHirshfield

    The amount of equity Altman proposes may be high, but the points he makes are reasonable. Great to see them widely distributed and discussed. Thanks for sharing your perspective.

  10. pointsnfigures

    I read this three times since there was so much in it. There are a lot of moving parts, and it’s impossible not to think about certain companies. I think the tenor of his writing is good-and I like the idea of extending to ten years since that is getting to be what a lot of companies go for before exiting. The idea of another level of stock outside the option pool, preferred and common was interesting too.

    1. LE

      the idea of extending to ten years since that is getting to be what a lot of companies go for before exiting.Forgetting the subject that is being discussed for a second, there is a tremendous psychological difference (and perception) between something typically taking a certain amount of time and knowing hard and fast that something will take a certain amount of time.One of the great things about being in business is that you don’t have certainty. You don’t know how much you will make or even when. If you knew for sure what the next 10 years would be that kind of takes the fun out of it. Personally, I’m glad I don’t know exactly what the next 10 years will bring. If I did I think that would kill the day to day.The unknown (and upside potential) is a great motivator, once again, imo, but I think that’s basically psychology and human nature and many people would probably agree.

  11. John Pasmore

    Why not put founders in the Preferred? They wouldn’t need same % in this case if Preferred has a preference.I posted to the original YC here https://news.ycombinator.co… — advocating that stock should be given to employees instead of options, though this would need IRS to NOT treat these grants as income….”Take the market value of a job minus the amount the employee is actually paid (the startup discount) and pay the discount in stock…”

    1. Dave

      I never quite understood that argument. Preference protects downside in sales less than purchase price not upside on growth. Putting the founders in preferred doesn’t seem to solve that problem. And the IRS treatment on stock grants is quite clear and has been for decades. It is either taxable when it vests (normal rule) or up front if you file an 83(b). Predicating an argument on changes in the IRS treatment of stock grants makes it a wish not an argument.

  12. Joshua Baer

    Fred, what do you think about giving employees 10 years to exercise? I always thought it was crappy that they get stuck with the option of paying money they probably don’t have or losing their options.

  13. dblockdotorg

    Sometimes I hear founders say that comparing startup comp with established profitable companies like FB or GOOG is either apples to oranges or comparing companies in different markets. Thoughts?

    1. Eran Galperin

      Yep. The motivation for working on either is different. Startup equity will not be worth much in 99.9% of the time, so it shouldn’t be your main motivation for working there. If you want to earn – go work at a big corp., if you want to learn and make a difference, work at a startup.I just wrote about this topic yesterday – http://www.techfounder.net/

    2. CJ

      Wrong. Money is money and engineers want to be rich just as much as entrepreneurs. The perception that you should spend your life building someone else’s dream for little pay simply because you love the job is nuts to me.

    3. ShanaC

      Sort of. I keep thinking this is about a not equlized/fair/overly complicated employment market

  14. Dave

    Sam’s post is an interesting one. But on point 2, regarding exercise extension, I haven’t seen anyone talk about the retention aspect. Two thoughts:1. My company was always transparent that part of the value of vested, in-the-money options was retention because the cost of exercise was fairly significant to the employee. Allowing someone one year or the balance of a 10 year option term to exercise undercuts that retention impact, certainly if included as a systematic term. Extending the exercise period case by case for truly unique circumstances is easiest.2. We were transparent that an employee could participate in value creation up to the point where they left, but not long after. Employees could exercise options then the company could buy them back after the 6 month accounting holding period was finished. Employees would typically lose the home run impact from big value increases where you got a forced conversion of the preferred if we exercised, but it was all transparently discussed. Company could always pass on the repurchase if it didn’t have cash or if the investors didn’t want to put up their money to fund a repurchase via an assignment of repurchase rights.

  15. danielharan

    If I gave 4 employees 5% each instead of raising a seed round, would you be more or less likely to invest in a series A?

    1. Matt A. Myers

      Are your employees are working for free for that 5%?

  16. Frank W. Miller

    This might sound a little angry but here goes.<rant>Hmm, VCs complaining about compensating the people actually working their arses off to make the VC rich. Never heard that before. And you wonder why people don’t have a very high opinion of VCs? Not that any of you care about that since you’re rich.And BTW, nice PC use of the she preposition. Helps to deflect the condescending rich guy tone of the rest of the post.</rant>

    1. fredwilson

      I just went back and re-read my post to see if I was complaining. I didn’t see a hint of it. I was simply stating what I see happening.

      1. Frank W. Miller

        Well, since I lobbed in this grenade, I should be man enuff to defend it I suppose. πŸ˜‰ I believe that you’re not TRYING to sound like you’re complaining or being condescending but here’s why it came off that way to me. I’m sitting here having my morning caffeine and scanning by blog collection and I read this post. I have several VC blogs that I follow and yours is quite interesting btw.This post, while containing these three other bullets, is mainly about the issue of employee equity percentage. Having been through all this I have some experience from the employee side and the structure there was very similar to what you’ve stated you have observed over time.. While I felt I was treated very well when our company was acquired and really had no complaints, I got to see the detailed inner workings. I absolutely could not believe how much money there was sloshing around in the deal compared to the percentages that myself and other employees had. I thought back to the year and half of 60+ hour weeks (normal, periods of 80+). I started thinking to myself. Jeez, me and a dozen others just busted our asses to make these guys like HYPER rich (like orders of magnitude more than we got) and this is all we get? The VCs showed up for a meeting a month and had a few phone calls with the CEO.Now I get that VC is extremely high risk and that VCs have to have high percentages when 9 of 10 of their investments get flushed down the toilet. But that doesn’t change the fact when you hit the 10 bagger, you’re doing pretty damn well compared to those who made it for you. I guess my only suggestion would have been, some topics (like commenting on a few percentage points of difference for the employee pool) might be better to just skip over wrt your blog.

        1. LE

          You know what? To me it sounds like you have a blue collar attitude. In other words to compare it to sports, you don’t understand the game, business that is, and how it is played. If you did you’d understand the fact that many VC’s work pretty damn hard [1] and are under a large amount of stress to get those big wins (for their partners). Also nothing prevents anyone from being a VC other than that they are not in a position to be a VC. Anymore than they are not talented enough to host late night talk. There was no coin flip that made Fred Fred.The thing about what Fred does is that you don’t see what goes on under the hood. That’s a problem with many business situations. [2] People from the outside don’t know what goes on that they don’t see to get someone to a particular point in time. They just see the results.In any case I apologize for the “blue collar attitude” but I wanted to get your attention (admitting even that throwing a comment like that isn’t a good idea and bad form).[1] Check out the bags under Fred’s eyes. Fred doesn’t have it easy. He works way to hard and certainly doesn’t need to at this point.[2] I had someone the other day say to me, after I told them what my consulting charge was, something like “oh so you charge $x for making a phone call”. For real. Like I’ve spent my entire fucking life thinking about such and such (while client hasn’t) so it’s “only a phone call”. Not to mention the fact that it’s not even my full time gig. It’s something I literally do for fun and research purposes. Bottom line: Fred gets paid for what he knows and can do for his investors.

          1. Frank W. Miller

            NOTICE, I’m being a little sarcastic here!While I respect your opinion, I couldn’t help but immediately thing of these lines from Broadcast News:Blair Litton: Oh, you think anyone who’s proud of the work we do is an ass-kisser. Aaron Altman: No, I think anyone who puckers up their lips and presses it against their bosses buttocks and then *smooches* is an ass-kisser.;)

          2. LE

            Except that defending someone is not the same as ass kissing.If you are a regular reader of this blog you will notice that I will typically defend someone even if they have said negative things in the past to a comment that I have made, or, have directly slammed me.

      2. LE

        I just re-read it as well.So now you know why it’s so hard to have peace in the middle east.A good read is “the Jack Story” which kind of explains this phenomenon.http://classicshowbiz.blogs…A guy buys an automobile and the car breaks down. Gets a flat tire. He opens the trunk and he had just bought it recently and there’s no jack. So he starts to talk to himself. “I bought this car! It cost me twelve hundred dollars! No jack!” He is pacing as he does this in front of the microphone. Danny had such a wonderful voice and presentation, “I need a jack! I got no jack! Now I gotta walk?! Ah… Ah… it’s not so bad. It’s not so bad. I’ll get there and he’ll see that I walked and I’ll get my jack and he’ll drive me back. But what if he says I can’t drive you back? I’ll have to walk! I’ll have to… in this weather!? This guy won’t even drive me? What kind of a human being is this?!”And Danny Thomas is building the story. The guy isn’t going to drive him back, the guy is going to charge him a lot of money – and it gets one laugh after another and finally the punchline is – he walks in and says, “Listen, mister. You can take your jack and you can [shove it]!”</blogquote>

    2. Dave

      I don’t see his comment as a complaint. Ultimately employees equity stakes are market dependent. Startup employees, particularly developers/technologists, are highly valued in a pretty liquid market ranging from very large to very small companies. I agree with Fred that the market tends to take care of what the “right” equity stake target is.

  17. sigmaalgebra

    That a software engineer employee, not a founder, is commonly worth 10% of a startup is a bit too much to swallow. We need to slow down, back up, and ask just what the heck such a ‘software engineer’ has that is so rare and valuable?Especially for a startup, software engineering remains essentially just a simple subject. For more explanation, the subject is still not much more than (1) algorithms and data structures, e.g., from a good one hour lecture from Sedgewick, Knuth’s TACP, etc., (2) allocate-free, if-then-else, do-while, call-return, try-catch, evaluate an expression and assign the resulting value, (3) SQL, (4) use APIs. Learning (1)-(4) is surprisingly easy. E.g., for (1), yes, we know that finding a leaf in an AVL tree, a red black tree, or via binary search is O(ln(n)) — now that we know that we can move on. What about building a really big k-D tree? Likely won’t need that. If get tricky, then can modify heap sort so that it has good locality of reference in some cases important in a virtual memory machine — likely will never need to know that.The usual bottleneck is poor documentation or very specialized knowledge, e.g., on some APIs. The solution here is to hire some consultants for a day at a time, have them give a lecture (get a good video recording of it) and leave some appropriate, well documented, running example source code. What is needed is a consulting budget, not 10% of equity or a ‘rock star’, ‘ninja’, ‘full stack’ programmer.Calling a programmer a ‘software engineer’ is a bit much because there is rarely more engineering involved than in, say, being a line cook in a restaurant or a furniture maker.E.g., for each of SQL Server high end stored procedures, installation, administration, monitoring, backup and recovery, tuning, and very high performance and/or reliability, hire an expert for a day. If working with SQL Server becomes a huge thing, then maybe are already a big company and need a database administrator (DBA) and staff, not 10% of equity. Big companies and the woods are awash in highly experienced DBAs that never saw a single share of stock in anything.Want a software development ‘process’? Sure, if have 100+ programmers. For a startup, write (1) some design documents and (2) the code with a lot of internal checks, logging, and documentation. Make the code run well; if need some weekend work by the people who wrote the code, then so be it; then on Monday it does run well.I’ve seen good and important software projects done with essentially no ‘process’ at all. Software is still essentially bench-made work by craftsmen; for centuries, craftsmen did well without any ‘process’. If such a craftsman needed to get good with a new glue, varnish, shaper, milling machine, or welding technique, then he called in an expert in the specialty for a day or two and then continued on; the situation remains much the same for software engineering today.

    1. PrometheeFeu

      A good software engineer manages to put all those things together well and fast. They will make the system easy to change and easy to scale. That can easily be worth 10% of the company or more. After all, if your servers start collapsing when you hit the curve in the hokey stick, you might as well pretend you didn’t get your big break because it’s going away fast.

  18. brandoncarl

    I think it’s worth pointing out that the 10% of 10mm equals 1mm isn’t correct, and sometimes not even close to correct.Namely the implied volatility of the employee’s option is substantially greater for a small company than a large company. As a result, the time value of the option is much larger, especially when expires are years away.I see software engineers make this error all the time, and it causes them to undervalue what their stake is worth.

    1. Bill

      Excellent point. I used to try to take 50% (for one financing remaining to liquidity) or 25% (for two financings to liquidity) of the initial stake multiplied by a range of exit values. That gave me a better sense of valuation. It was somewhere between zero and those numbers.

      1. klochner

        someone with more experience than you has already modeled out those scenarios in reaching the $10M valuation.

    2. klochner

      An option is always worth less than the equity it’s written against. In this case the equity is worth $1M (10% of company at $10M valuation) , so please explain how the option is worth so much more. Professional investors value 10% of the equity at $1M, why should an engineer do otherwise?

      1. brandoncarl

        So to get to the heart of this, you have to break down the the type of award. I was referring to ESOs (employee stock options), but the time value concept applies to RSUs (restricted stock units) when considering taxation.You are correct that an option is worth less than the equity it’s written against. I didn’t say that it was worth more, I said that the time value of the option of one company is substantially greater than the other, and that most conversations value equity options incorrectly.For the ESO, given an option on a notional value of $1 million, struck at-the-money, with a 5 years expiration, the value of the option will most likely be worth substantially more for a startup than for Google (this is assuming the same terms). Both options have zero intrinsic value, but the value of the startup option has substantially more time value. And as you say, both options are worth less than the corresponding equity (which is a call on the assets struck at the liabilities). To give you an idea of the difference, if Google’s implied volatility was 15%, and the startup’s implied volatility was 300%, the Google option would be worth $155,000, while the startup option would be worth nearly $1,000,000.Alternatively, for an RSU, the non-taxed value is identical: $1mm vs $1mm. However, you have the option to elect 83b, which is your option to buy a call option on your taxation. By electing to pay your tax up front, you are basically paying your premium on a call. As a result, the same analysis applies as above, except that you would multiply the results by the effective tax rate.Hope that helps!

        1. klochner

          Thanks, that’s interesting, but I didn’t see in there how options on 10% of a $10M company would be worth more than $1M from google/fb.Google and Facebook are granting RSUs, so $1M RSU should be valued substantially higher than options on 10% of a $10M company.

          1. brandoncarl

            Yes, RSUs would most definitely be worth more than options on the same number of shares of the same company.

          2. klochner

            That’s not really what I was getting at. $1M RSU grant from *any* public company should be worth more than an option grant on 10% of a $10M company.

      2. PrometheeFeu

        Because value is relative and engineers and VCs have different liquidity preferences for one thing. VCs don’t care much about liquidity. They are the illiquid portion of the LPs’ assets. Engineers may need to cash out to buy a house, pay for medical emergencies etc… That means engineers will value startup equity at a lower price than VCs.

        1. klochner

          Seems something was lost in translation. I was asserting that (options on 10% equity of $10mm company) < ($1mm cash or RSU).

  19. John Revay

    Fred – I recall some posts in MBA Mondays…and I think you covered it at the MBA Monday live event you did @ USV a little while ago…..I think you summed up the ending cap table;20% Founders40% Investors/VCs20% EmployeesI forget the last 20% – was it general option pool on top of the 20% for employees?

    1. Oliver Rothschild

      John – when you say “ending cap table” what stage of funding does that represent? E.g. if you have the distribution you cite here after Series A, and then raise a Series B, do those new investors dilute everyone else so you get 50% investors/VCs and less for founders and employees?

  20. CJ

    This issue is getting particularly visible in silicon valley where the value of a top software engineer has risen considerably in recent years. – Not for a lack of trying by the powers that be.

  21. ShanaC

    I think a lot of this is that engineers are overvaluing startup experience – there is huge competition for getting into a startup right now, as well as huge competition for engineering talent. engineers are demanding crazy amounts compared to the unknown of fitSince engineering talent is not equally replaceable – you see problems.

  22. Ron Williams

    Other costs are going down to start though. So maybe employee equity going up is the correct adjustment. Not sure if anyone loses. Investors and founders get more motivated co-owners.

  23. David Fontenot

    The biggest problem is that young engineers have no idea how to evaluate equity at all to begin with, and many founders are actually obfuscating the percentage of equity they are getting by just throwing around large numbers of shares that don’t really mean anything.Most young hackers aren’t negotiating at all, so this gives startups the opportunity to lowball them and take advantage of the informational asymmetry. In fact, the current market almost encourages startup founders to do so.With HackMatch, I help hackers negotiate the offers they get every day, and I’m consistently finding that startups are lowballing them in the initial offer by at least half of the equity that they would be willing to give without a hesitation.

  24. seedRoundGuy

    One question worth posing: does “founder risk” warrant having a large equity stake anymore?Large founder ownership is predicated on founders taking the most risk to start a company. More risk == more potential reward, thus more equity.However, over time (certainly over the next few decades) the riskiness of becoming a founder will continue to decrease drastically: it takes less time to start a company; seed capital is plentiful; entrepreneurship is the new norm; cost of growth approaches zero; etc etcGiven this, shouldn’t founder equity stakes naturally go down, as being a “founder” becomes more just a circumstance of timing (in the limit), and risk premiums decrease?Ultimately, it’s up to employees, but they will just boycott excessively “founder-friendly” equity structures by starting their own companies, or moving to companies with more distributed equity structures. And in fact, this is exactly what is happening; it will probably continue to happen even faster over the next 5-10 years.Fred touched on this in his last 2 sentences, just my add’l .02

    1. Peter

      Cant the same be said for investors? Especially in a world where money is cheap?

  25. Henry Porter

    What are the best books and articles on negotiating equity as an employee?

    1. Mary Russell

      I just published this deck this week and people are finding it helpful:http://stockoptioncounsel.c…Here’s a list of great posts on the topic: http://stockoptioncounsel.c…- Mary Russell, Stock Option Counsel Legal Services for Individuals

  26. Oliver Rothschild

    Quick question I don’t understand about this and Altman’s post: when you say ’employees own 15-20% of a company’ how does that apply to pre-series A companies? Is that 20% pre-dilution at a given stage of growth or post-dilution? E.g., if my company is pre-series A and the founders own 100% of the company, do we set aside 20% for employees and protect that from investor dilution? Or do we aim at 20% now and realize that everyone (including employees) will be significantly diluted through investor rounds?Thank you!

  27. Swami Kumaresan

    Fred: what do you think about extending the vesting period to compensate (by even 20%)?Have you guys looked at what % of granted equity ends up being forfeited over long time horizons in your portfolio companies?

  28. ErikSchwartz

    Who cares about the $10MM valuation now? There’s no market anyway (in most cases). The bet you are making working at a start up is that the company will be worth more later (with the employee’s help).The type of hire who does not see that is probably best served working at a big company anyways.

  29. Guest

    Why would you ever worry about trying to equate the base $ of the option? All that tells you is where your $0 line is. It is all about projected growth, and the fact that you have 0 downside risk means you are going to be risk biased.I understand you are approaching this problem as a talented VC, but the mental rubric for a potential employee isn’t the same as an investor, as there is a highly restricted opportunity cost for this quasi-money that you are getting.Now if companies did issue stock and not options, then things would change in a huge way, but that’s not the world we live in yet

  30. ErikSchwartz

    From the founder’s perspective what you really need to figure out is how much this particular hire will add to your valuation over the entire term of their employment. Then figure out what percentage of that to give them. In the early stage every hire you make needs to be accretive in the valuation of the company.If you have the compensation discussion on those terms it totally turns around the conversation.

  31. Marcos Menendez

    Maybe the question is not if employees should get more or less equity, but if users should get any equity.High valuations of Whatsapp or Instagram are not solely based on the technology built by their developers, but mostly on the fact that they hold a preferred relationship with millions of users. Since the value lays on the users, shouldn’t they be rewarded somehow? Maybe with a share of company stock?That’s what we will do by the way at http://www.thegooddata.org In our case users will be the only owners of the company

  32. Mary Russell

    I’m pleased to hear that you agree that employees need more info on equity. Until companies are on board with this, it’s up to employees to seek the info they need to make a good decision. I suggest employees ask these three questions to get the conversation started:1. Ownership – β€œCan the company take back my vested shares?”2. Risk/Reward – β€œWhat information can you provide to help me evaluate the offer?”3. Tax Benefits – β€œIs this equity designed for capital gains tax rates and tax deferral?”Here’s a deck on how to get the right info: http://stockoptioncounsel.c

  33. Erik Caso

    In reading a lot of these comments, it seems there’s a real adversarial tone when it comes to founders vs. employees. I wonder why that is. My company is based in southern California and in Boulder, two places where I don’t encounter that attitude much at all. Regardless, I wonder if this portends an unfortunate trend.

  34. Bruce Cranendonk

    I am a little surprised that more companies do not use “phantom equity” awards with employees. This prevents the unwanted dilution and yet allows employees to participate in earnings thus providing incentive.

  35. awaldstein

    Thanks Charlie– a voice of experience and reason.

  36. Elia Freedman

    I always heard that the exercise immediately clause is there so you have equity to hire the next guy if the current one leaves. What is your thoughts in this?

  37. Aaron Klein

    That’s exactly right. If you are competing with Google on the amount of equity at time of issue, you’re competing on the wrong factor.For what it’s worth, we never had a requirement to exercise after leaving until this year. Now that a lot of the risk is gone and the equity amounts necessarily drop, you need more incentive to stay. I haven’t had any arguments on that front.

  38. William Mougayar

    Making exceptions to exercise time is just that – exceptions. Reality is that you may need that.

  39. Mark Essel

    Dug this comment Charlie.My views of this have matured on this topic as an early employee who’s startup was recently acquired. You have to trust your founders and investors deeply without a seat at the cap table

  40. JLM

    [email protected]:disqusYou actually know too much for your own good and your discussion is way too informed and intelligent. Stop that shit right now.What nobody factors into this equation is “failure”. Most of the option schemes will amount to naught. The companies will never get to the pay window.Employees should carefully consider whether they should ask for a second turkey at Christmas rather than more equity. One of these is more likely to provide a feast than the other.JLM.

  41. William Mougayar

    And you can issue retention grants on an annual basis.

  42. John Pasmore

    Definitely situational. But because a founder usually can’t deploy Capital through subsequent rounds he/she should not be overly penalized with dilution. Theoretically, if you’re successful at raising additional rounds it’s because the business prospects warrant additional Capital; so as the business prospects get brighter the founder is being diluted; granted the valuation is increasing, but again he/she is, in effect, being penalized for not having Capital while driving the value creation. If he/she is sitting in same class as VC I would think their interests would be highly aligned. Sitting in Preferred would create tax issues, I believe, but in a successful business, with say a 2x preference, it should have a Net positive impact. This would be crucially important in the case of exits between 1x – 2x (preference amount) of deployed capital, where VC get’s cash (or whatever consideration is paid) and Common doesn’t get a distribution with founder in Common.

  43. John Pasmore

    Great POV, appreciate your insight…

  44. Dave

    Founders and employees are often re-loaded with new grants following a new financing round. Investors’ practices vary and the founder/employee grant sizes can vary significantly–because it is the time when investors/Board allocate based on go-forward value so someone may see a big increase in their stake or only a small grant or nothing at all (i.e., the founder who left)– but it has been relatively common in my experience.Also, the preferred preference is a key thing that allows common option pricing to stay lower than preferred pricing. If you start giving the preferred preference to employees, the preference ends up valueless because everyone has a preference and the option pricing would have to increase.At the other end of the spectrum, in some larger private companies I’ve seen–particularly private equity backed companies not VC companies–everyone ends up in common and there is no preferred but the option price becomes becomes essentially a liquidation preference and the employees cost to exercise goes up not down with everyone in a single class of stock.

  45. John Pasmore

    Everyone in Common is great. If there is $20 million invested and the Company sells for $35 million where the $20 million has a 2x pref — that’s not good….

  46. John Pasmore

    Fred’s post, I believe, is related to the similar post on YC/Hacker News — my particular POV comes from my hypothetical proposal that IF equity were not taxed as income generally then perhaps it would be more fair to skip options and give employees actual shares with some repurchase rights (etc, etc, etc).So the thread here on the merits of Preferred vs Common as it relates to the impact on options is kind of off message for me. Kind of my fault as within the somewhat flawed universe of option grants and founder (not all employees) dilution I suggested that perhaps putting founders into preferred could solve for some issues.The discussion is super helpful and your perspective is definitely well informed. My original post had a big hypothetical regarding tax treatments at the top of POV.

  47. Dave

    2X preference is something you never want to agree to and typically says your company didn’t have many options. All structures have pros and cons.-Everyone in common sounds great until you realize your option stake costs much more to exercise, particularly if you leave, because it is priced at fair market value. I’ve seen a number of $1,000,000 plus costs to exercise in a common only structure. Typically it would be a faction of that in a preferred structure.-A $0.20 option price even under a $1 liquidation preference that goes away in big return scenarios is preferable to many employees over a $1 option price for the same options with no “preference”.-In the all common, $1 scenario the price to exercise goes up massively and the option price becomes essentially the liquidation preference (because investors get all the proceeds until they receive their money back) and it never goes away.-In an all common stock structure there is no forced conversion point, unlike a preferred stock structure where the investors must force convert at some point and do away with their preference or have their economics capped at their preference.

  48. Aaron Klein

    Yes. Talking about equity in detail is critically important. We talk through every term, how many shares, what our value targets are, shares outstanding, etc. We’ve always found that to be to our advantage β€” no one else does it!New round of employees now have to exercise within a quarter after leaving. It’s structured so that in exceptional circumstances, we can help them fulfill that clause if it’s the right thing to do. If I ever so dramatically failed that we had to do a layoff, there’s just no question…we’d take care of people to the best of our ability.

  49. jason wright

    by definition employees tend often not to clearly understand terms.

  50. Elia Freedman

    Thanks. Well put.

  51. awaldstein

    I will as I’m doing a raise for one of mine and two of clients now.

  52. jason wright

    a person who works for another – it has a long and difficult history.