Posts from September 2014

When you come to AVC for the first time today, you will be met with a “modal” that shows the site loading slowly. This is my way of participating in a day of protest to send a message to the FCC and others in government that I don’t want to see an Internet where some sites can pay to load more quickly than others.

We’ve discussed this issue so many times at AVC that it’s old hat to most of us. Many of you don’t see things the way I do. I understand and respect that. But today, I am showing solidarity with everyone who sees it my way.

The modal will be gone tomorrow in case it annoys you.

This may be the most popular AVC post of all time based on the amount of traffic it gets month after month after month. I think I may rewrite it at some point because while I still believe the basic ideas here are correct, some of the math has changed due to market pressures and it deserves a rewrite. With that caveat, here it is.

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The most common comment in the 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:

NOTE: The numbers below are as of 2010. They have moved a lot since then.  The Senior Team numbers have moved the most. I would not recommend using these numbers or you will be below market with your employee equity grants.

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.

The President said this the other day:

The world’s always been messy… we’re just noticing now in part because of social media

I don’t think terrorists posting gruesome videos on YouTube and spreading them virally via Twitter, Facebook, and many other internet media channels is “social media”. It’s just Internet media, in which anyone can post anything on the Internet. There is nothing social about it. It’s anti-social in fact. Maybe we should call it user generated media. That’s an accurate term.

The same is true of some hacker getting access to celebrities’ nude selfies and posting them on Reddit and elsewhere. That’s not social media either. It is just Internet media.

We are going to test our notions of free speech and civil rights as we go forward. Should Twitter and YouTube be actively taking down this stuff? And if so, where is the line drawn? What do they take down and what do they leave up? They have been dealing with this issue for as long as they’ve been around but it sure seems like the stakes are getting higher and higher for them and every company that allows the posting of user generated content on their service.

The President is right about one thing. Humanity is at times horrible. Seeing that horror in your timeline next to something familiar and pleasing is deeply troubling. But we may need to get used to it. I don’t see any easy ways out of this mess.

I’ve always liked the idea of documenting a trip, leaving breadcrumbs for others to follow, or at least consider as they are planning a similar trip. The Gotham Gal and I do it very differently but we both do it.

She writes a blog post, chock full of photos, and a few links, every day recounting the prior day’s activities. Here’s her post on the day we recently spent on Lake Como. She has written hundreds of blog posts like that (according to her archive page, she has written 357 travel posts). If you are planning a trip to South Africa, you can go to her blog, search on South Africa, Cape Town, or some other keyword and get a bunch of posts like that which you might want to read while planning your trip. You can do that sort of thing for many places in the world that she has visited, with our without me and our kids.

I like to checkin to places on Swarm, save them on Foursquare, leave tips and photos, and then add them to lists on Foursquare. I’m building one now for the trip we are taking. I’ve built lists like this for Tokyo, Paris, and many other places.

Joanne’s approach is more like a travel magazine or the travel section of a newspaper. It’s great but you have to consume it in bulk quantities. What I like about my approach is it is microchunked down to the smallest atomic unit, the place, with value added metadata (tips and photos), and then built up into lists of various sorts. It feels more like a database that I am building than a magazine.

But both of these approaches work and deliver a lot of value to travelers who might want to follow in our footsteps. And we follow others in their footsteps so what goes around comes around. We use travel magazines, travel sections of newspapers, blogs, and Foursquare to plan our trips. Last week I read online a Food and Wine article on the Piedmont wine region, and it in, I read about a restaurant called Piazza Duomo, checked it out on Foursquare, and we booked a lunch there the next day. It was a fantastic lunch, now documented in a Gotham Gal blog post and a Foursquare tip.

I saw this video yesterday and immediately thought “I’m going to get one of those.”

We’ve talked a lot here at AVC about Net Neutrality. I hate that term because it’s got so much baggage now that it is essentially meaningless to me. What I want to see is a framework that everyone agrees to (application developers, bandwidth providers, last mile access providers, and the regulators) that says you can’t prioritize one bit over another in the last mile access network and you can’t charge application developers to deliver their bits to the end user.

This issue is coming to a head at the FCC as the comment period is ending and some sort of decision will be made this fall. So next Wednesday, September 10th, is the Internet’s opportunity to stand up and be heard.

If you are with me on this issue, please consider joining the Internet Slowdown campaign next Wednesday. There are all sorts of ways you can do this. You can change your avatars on your social media profiles, you can send push notifications if you operate a mobile app, you can put a slow loading graphic on your blog or website (there are WordPress widgets if you are on WordPress like I am).

And if you still aren’t convinced, please read Chad Dickerson’s piece in Wired this week on why this issue is important to businesses and everyone who uses the Internet to reach their customers and/or audience.

Every once in a while I learn about a product that is truly a game changer for me. The most recent example of this is Band Aid Friction Block.

The Gotham Gal turned me onto this product last week when I was getting blisters on my feet from some new shoes she bought me.

You rub it onto the parts of your feet where you are likely to get blisters and then you put your shoes on and are good to go for the day.

For all I know this product has been on the market for years and I’m the last one to learn about it. But in case that’s not true and some of you are, like me, unaware of it, I feel compelled to tell the world about it.

There are very few times that a $6 product is life changing. This is one of them, at least for me it is.

It turns out this is one of my most viewed posts of all time. I guess that’s a good thing. So I’m reblogging it today.
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The Gotham Gal and I make a fair number of non-tech angel investments. Things like media, food products, restaurants, music, local real estate, local businesses. In these investments we are usually backing an entrepreneur we’ve gotten to know who delivers products to the market that we use and love. The Gotham Gal runs this part of our investment portfolio with some involvement by me.

As I look over the business plans and projections that these entrepreneurs share with us, one thing I constantly see is a lack of sophistication in calculating the investor’s return.

Here’s the typical presentation I see:

The entrepreneur needs $400k to start the business, believes he/she can return to the investors $100k per year, and therefore will generate a 25% return on investment. That is correct if the business lasts forever and produces $100k for the investors year after year after year.

But many businesses, probably most businesses, have a finite life. A restaurant may have a few good years but then lose its clientele and go out of business. A media product might do well for a decade but then lose its way and fold.

And most businesses are unlikely to produce exactly $100k every year to the investors. Some businesses will grow the profits year after year. Others might see the profits decline as the business matures and heads out of business.

So the proper way to calculate a return is using the “cash flow method”. Here’s how you do it.

1) Get a spreadsheet, excel will do, although increasingly I recommend google docs spreadsheet because it’s simpler to share with others.

2) Lay out along a single row a number of years. I would suggest ten years to start.

3) In the first year show the total investment required as a negative number (because the investors are sending their money to you).

4) In the first through tenth years, show the returns to the investors (after your share). This should be a positive number.

5) Then add those two rows together to get a “net cash flow” number.

6) Sum up the totals of all ten years to get total money in, total money back, and net profit.

7) Then calculate two numbers. The “multiple” is the total money back divided by the total money in. And then using the “IRR” function, calculate an annual return number.

Here’s what it should look like:

Here’s a link to google docs where  I’ve posted this example. It is public so everyone can play around with it and see how the formulas work.

It’s worth looking for a minute at the theoretical example. The investors put in $400k, get $100k back for four years in a row (which gets them their money back), but then the business declines and eventually goes out of business in its seventh year. The annual rate of return on the $400k turns out to be 14% and the total multiple is 1.3x.

That’s not a bad outcome for a personal investment in a local business you want to support. It sure beats the returns you’ll get on a money market fund. But it is not a 25% return and should not be marketed as such.

I hope this helps. You don’t need to get a finance MBA to be able to do this kind of thing. It’s actually not that hard once you do it a few times.

My partner Albert penned a post yesterday (on and because of labor day) talking about the changing nature of work (more freelancers working on marketplace platforms) and suggested some interesting ideas. You can read his post here.

The two really interesting and related ideas are:

– A legal right for workers on these platforms to have real time (API based) access to the information about their work, pricing, supply and demand in the marketplace, etc, etc

– The development of algorithms (and coops and communities using these algorithms) that will allow these freelance workers to extract the best rates for their work

I believe that in the long run these platforms may/will be replaced by blockchain based networks of labor where there is no platform middleman and there would be no need for a legal right to an API because all the data would be public by default.

But who knows how long it will take for that transformation to happen? In the meantime, Albert’s ideas are really good and I would encourage people who are thinking about old school based regulation of these platforms to think instead of a new school regulatory approach along the lines of what Albert has suggested.