cdixon - Latest Comments in The one number you should know about your equity grant

Re: The one number you should know about your equity grant

David Hawley — Tue, 03 May 2011 20:30:10 -0000

Thank you for saying it!

Re: The one number you should know about your equity grant

Munish — Mon, 14 Jun 2010 15:29:55 -0000

Addign a clarification...
75% pay cut = taking only 25% or little less salary just for sustainment.

Re: The one number you should know about your equity grant

Munish — Mon, 14 Jun 2010 15:27:49 -0000

I found your blogs having the best straight out of the heart and "real" content. And also lot of questions answered. I found it getting related totally with whatever thoughts i have made till now of startup land. Thanks for guiding people like me.

I am going to join an internet start-up next month pre-funding.
Currently the brief status is:

2 founders spent 1+ yr bootstrapping
4 fresh out of college engineers made offers to join mid-this month.

They are giving final touches to their product's working demo for 1st round VC funding hoping for a $2M+.

I am 6 yrs experienced and going in for an Architect role.
I am going on a 75% pay-cut, since till now the company is funded by founders' own pocket. But i have planned things and i am out of "safe company" mode and prepared to WORK in startup mode.

They haven't yet formulated their final offer to me but What kind of equity should i be looking at in % terms ?

Your input on this will be highly beneficial for me.

Thanks !
MG

Re: The one number you should know about your equity grant

Aaron Cohen — Sat, 29 Aug 2009 13:35:54 -0000

Chris' rule shoud be standardized. Reality is people who hear they got a.005% of a company need to realize that without a staggering exit (this is 500k @ a $1bn valuation) that this slug of options indicates they are valued as a solid employee no more and no less. They are probably good but young in a replaceable position. This is reality.

And we should encourage our employees to think about careers and ot getting rich quick off their 1st or 2nd startup (particuarly when they are non-founders)

Re: The one number you should know about your equity grant

chris dixon — Sat, 29 Aug 2009 13:26:16 -0000

avi - so you think it's ethical when an employee asks what % their options represent (or, equivalently, the total fully diluted outstanding shares) to tell them that's a secret?

If you have CEO/VC experience you know full well everyone on the management/VC side of the table talks about option grants in % terms - why do you think we should then switch into another metric that no insiders use and seems only to exist to make the grant sound more favorable?

I'd agree that all that other information is valuable for the employee as well. But in my mind if management won't reveal outstanding shares or % they are slimy and shouldn't be trusted.

Re: The one number you should know about your equity grant

Avi — Sat, 29 Aug 2009 13:16:49 -0000

Chris

In theory what you are saying makes sense but you are encouraging something which will lead non-senior employees into a very confusing situation. Most options get offered to non-senior employees and I would suggest that your advice will cause more problems than it will solve.

Examples:

What is the right % for these employees to have? How do I compare a % in one company to what my friend got at another company? How do I adjust for the stage of the company? What employee knows how to negotiate that?

There is no way for them to anchor this around something tangible.

Having been on both sides of this negotiation I feel that as a member of Senior management it is better to negotiate a % because on a dollar basis it always sounds like too high an amount. However, as a junior employee who will receive a fraction of a %, how do you know what to ask for?

Partial Solution: There is a way to anchor this for a company which has recently raised money (as long as there are not large preferences) which is to use the most recent fund-raising price per share as an implied market valuation. Assuming that investors are smart and weren't duped by management into over-paying, then there is a good chance that a future exit will be at a premium to this.

So actually what I would encourage employees to find out is:
- How many options
- Exercise price
- Price per share paid by the investors
- Did they get any liquidation preferences
- When the investors paid this e.g. pre / post a bubble
- Research the investors i.e. are they likely to have set the price correctly
- Check to see if the management are trustworthy.

This has the added advantage of being translatable into actual dollars paid in options when combined with the vesting schedule. It also automatically adjusts as the value of the company goes up i.e. I get fewer shares which are worth more. In % terms it is impossible to know how to adjust the % as a company gets more valuable.

Overall I think your advice is very misleading and knowing your % provides you no extra information unless you are somehow negotiating the deal based on %.

Re: The one number you should know about your equity grant

chris dixon — Sat, 29 Aug 2009 10:05:29 -0000

AA - yes, if you know your number of shares and "fully diluted" (including unissued options) total outstanding shares you can compute your %. But note that management can do a things like raise money, increase option pool size, etc that might lower your % without notifying you. The company I heard about yesterday is telling employees the % and total outstanding are "trade secrets." Total BS.

Re: The one number you should know about your equity grant

chris dixon — Sat, 29 Aug 2009 07:44:02 -0000

Nivi - I love venture hacks and think what you guys are doing is great. I just totally disagree with you about the % ownership issue. Every VC and management meeting I've been in, everyone talks exclusively about equity grants in % ownership terms, but then suddenly when they talk to employees they switch to $ value to try to make it sound bigger. I think it's lame.

Re: The one number you should know about your equity grant

Diego Sana — Fri, 28 Aug 2009 20:17:44 -0000

This is a great advice, one that indeed every entrepreneur or engineer should get early on their lives. I wish myself that i had received it three years before, when i sold my first startup and got stocks as part of the payment without knowing the percent they represented. This may make me look dumb now, but these things really do happen even with smart and math oriented people, and nowadays it's clear for me that the acquiring company was not honest.

Re: The one number you should know about your equity grant

Aaron Cohen — Fri, 28 Aug 2009 18:22:48 -0000

Reid:

So there needs to be a greater emphasis placed on the career growth as opposed to the job. Working at Hunch or AnyClip or any of the startups represented in this discussion brings good and bad things. We need to really be transparent about all of that and when we are we retain the people we want most.

Re: The one number you should know about your equity grant

Reid Curley — Fri, 28 Aug 2009 17:14:31 -0000

@Aaron Cohen, AA, Patrice Borne: Bingo.

The sad fact is that you are not going to get rich off options unless you strap onto a one-in-a-million Google-type rocket ship. Even if you are a C-level guy who comes in relatively early and the company is pretty darn successful, the math isn't all that compelling. Your options represent 1.0% after all the dilution; sell company for $500 million; ignoring exercise price and any funky venture terms, you get $5 million pre-tax; depending on how/when you exercised, holding period, your state of residence and tax rates in effect at the time, you may end up with $3 million in the bank. A nice chunk of change to be sure, but not enough to buy that house in the Hamptons and live a life of leisure among the hedge fund guys.

I am sure things are different in the heart of Silicon Valley, but in my experience, once you are past the raw start-up phase, options are almost never that critical in a non-management hiring process. This may be the real reason that prospective employees don't ask what percentage of the company their options would represent. The prospective employee just does not attribute that much value to them. Further, once you are beyond 10-15 employees, many people don't even ask what the number of options they will get will be, let alone what they represent as a fully-diluted percentage of the company. It is a fair question to ask whether companies that are at this stage should be issuing options at all given the administrative costs of doing so.

The other thing that I would point out is that if you are going to educate your employees on how to value their options, you need to give them an overview of the relevant tax provisions. Depending on the individual's situation, the AMT can pretty much kill the incremental value of an ISO versus a non-qual unless the employee can afford to exercise them before the "bargain purchase" amount gets large (which is rare, particularly given the low wages that the options supposedly offset). So, it is often the case that you are either paying ordinary income tax or AMT on the most of the gain. Just about nobody pays attention to that, even those who know that their x,000 options represent 0.yy% of the company.

Anyone who wants to join a startup and has the options as their most important reason for doing so probably should be screened out in the interview process. I want people who want to work in a dynamic environment where they can do things they couldn't do at a more established company and everything they do matters to the business.

Re: The one number you should know about your equity grant

Patrice Borne — Fri, 28 Aug 2009 16:24:44 -0000

It is a very interesting post and the comments above are all making valid points.

I believe that knowing what percentage of the company your shares represent is the most important number because, when the company matures and, hopefully, either goes public or gets sold to a much larger company with deep pockets, the number that is going to matter will be the total money the company gets sold for. Then, and only then, will the value of each share be computed by using the number of outstanding shares. Obviously, if there is a special provision that says that preferred stocks get special treatment, the commoners will get even less.

The point I would like to make is that you often get an offer along the lines "you get paid less in salary, but you get shares/stock options to compensate. These shares/stock options have the potential to be extremely valuable in the future." In other words, you are being asked to accept a lower salary in exchange for the potential of selling your equity in the future.

Knowing your likely percentage after dilution in 3, 5 years, or more, down the road is obviously tricky, but one can estimate this number by evaluating the best case scenario (the worst case is that the startup won't be successful and your shares will be worth 0.) Take the percentage as of the moment you join and assume no dilution at all. Then, estimate what this startup could sell for in the future (use numbers of recent success stories) and figure out your best case payout. Now, take this number divide by the number of years you expect to have to wait before cashing out. Compare this number to the loss of income working for this startup compared to what you could get working for an established company and see if you are willing to take the risk. And remember, this is your best case scenario. You should probably correct this number by dividing it by 2 or 3 to take into account probable dilution. I won't get into the details of "opportunity cost" and taxes as this would complicate the whole calculation beyond what this discussion is about.

My personal experience is that it is usually not worth the risk, unless you are out of college and have minimal cost of living and can afford a low salary in exchange for a future pay out -or- you are in the founder/executive team and have preferred stocks that guarantee a minimum payout. The commoner will probably simply catch up on their loss of income due to lower wages but they won't be able to retire...

Also, if someone tries to sell you an offer with something like "we are going to offer you X shares/stock options currently worth $Y based on our latest financing round" be extremely careful. These shares/options are actually worth $0 because they are not liquid and you probably cannot sell them to anybody else.

Now, if you are an entrepreneur, working as a commoner in someone else's startup in order to build your chops so that in 5 or 10 years from now, you start your own company, that is probably worth it. Know what you are getting into and what your motivation is.

Re: The one number you should know about your equity grant

AA — Fri, 28 Aug 2009 15:00:06 -0000

Chris et all, thanks for the explanations. I get the point, and I def realize that a company gets bought on EV, but what I'm now beginning to realize, is this is all the same thing. When you say "you should only care about %-age ownership", that's basically the same thing as "you should care about share price, number of shares you own, and number of shares outstanding". ultimately, what's the difference here, seem like the same thing? I don't know if there is one (in most cases). I think maybe I was wrong in saying share price is the easier number to track, because in this case you actually have to keep track of how diluted you get/how shares outstanding changes as well. So this is I think where the flaw is in my thinking, versus %-age ownership, which is only 1 number to track, which changes over time. But ultimately, all this just seems like a lot of explanation around the exact same thing (which is fine, but I think that's exactly what was confusing me).

I think the more important/less convoluted point to be made in all this is Aaron's. I think the REAL dis-service that management does is to give young startup employees the impression that they will get *rich* from working with them. I had this happen time after time, when I was interviewing with prominent VC-backed startups, and it befuddled me. Most FOUNDERS don't get as rich as they think they might, after taking vc money, let alone startup employees (even in what appear to be successful exits); it's astounding to me that this "carrot" is paraded around to potential employees. I've had CEOs with big-name venture capital experience tell me how "I may never have to work again" after joining xyz corp.; simply worthless.

I think the two biggest motivating factors that went into choosing my current place of employment were:

1) Learning enough to feel comfortable being a founder myself: this was/is my REAL motivation for working at a startup. I have no delusions of getting rich as a startup employee; I am where I am to advance my career, and to learn more than I could anywhere else, so that I can ultimately be comfortable leading the helm, at another company. This was the primary driver in choosing my current employer; however, very few people emphasized this.

2) Being made whole: my all in-comp, if I weren't @ a startup and in my prior profession, would probably be no less than 3x what my salary is now (roughly). I think that with a moderately reasonable exit, I could make this back. This is somewhat important to me; maybe it shouldn't be. But it's nice to think that I might be able to make up my *immediate* financial opportunity cost, if things go at least reasonably decently.

I think #1 is much more important than #2, but ultimately, I think these are the 2 points founders should focus on, when hiring employees; aggrandizing the opportunity to be some kind of "lottery ticket" is the real trickery IMHO.

Re: The one number you should know about your equity grant

Aaron Cohen — Fri, 28 Aug 2009 12:27:07 -0000

Chris:

I think there is a broader issue here about the importance of equity compensation in startups and how its valued.

It raise many, many issues.

1. Few employees of a Venture-Financed company receive anywhere close to 1% of a company's stock. Typically 1% goes to senior level execs who are non-founders.

Given that there are very few large exits these days numbers significantly smaller than 1% are unlikely to make non-founding employees spectacularly wealthy. Even at mature Zappos with its 700MM exit, how many people there made $1mm on the transaction? I have to be believe that number is fewer than 10 outside of founders. How many employees had .1% of YouTube post Sequoia financing and got liquid with their Google stock at that time? It couldn't have been too many.

Equity compensation became a huge, huge part of the system in the late 90s when billion dollar market caps were plentiful and companies hired dozens of employees early in their trajectory because the IPO market was so open.

Things have changed and expectations need to be managed. In my opinion, few employees are going to see massively life changing events from their startup efforts. To be sure, founders and top executives could and will make millions if companies sell for exit north of $250mm. M

Most startup employees need to realize they are on a journey and that in addition to making a few hundred thousand dollars on a good outcome they are learning how to become more senior at the next company. Real wealth creation will take founding, seniority, or staggeringly large exits.

Good entrepreneurs and CEO should be preparing their people for careers beyond the current startup.

Re: The one number you should know about your equity grant

GW — Fri, 28 Aug 2009 11:16:02 -0000

Chris, it's refreshing to see someone come out and state the facts. From a best practice perspective, a related issue (which I haven't seen anyone post about) is how best to communicate these issues to your team beyond the initial founding group. Things becomes quite complicated when you reach 100+ people, financing rounds past the initial Series A, and you have a mix of founders, early non-founding early employees and later employees on the team. If not handled correctly, it is very easy to create an environment that cancels out entirely the motivational aspects of employee equity ownership. I remember one start up entrepreneur fifteen years ago (an MIT grad) who posted everyone's salary and ownership percentages on a white board above the reception desk. Needless to say, things turned ugly later on.

Re: The one number you should know about your equity grant

Louis Marascio — Fri, 28 Aug 2009 11:13:22 -0000

I completely agree and as an early stage entrepreneur I always discuss this with prospective employees. I would caution, however, that percentages must always be described to the employee as a point in time. I always tell them something along these lines: Your grant will be for X shares, and at this moment that represents Y% of the company, however that percentage will change over time due to additional financings, etc. I never document the percentage being granted, either, in terms of offer letter or any other form. Number of shares never changes, but percentages are relative, however you must be honest with employees about what they are really getting, so I completely agree with your thoughtful post. Thanks!

Re: The one number you should know about your equity grant

David Semeria — Fri, 28 Aug 2009 11:09:03 -0000

This is basically a discussion about dilution. Not every increase in the number of outstanding shares is necessarily bad, especially if new money is needed to grow the company. 2% of $100m pie is better than 10% of $10m one.

Re: The one number you should know about your equity grant

jrh — Fri, 28 Aug 2009 09:15:37 -0000

@AA
I've been on both sides of the table many times and can tell you that Chris et al are absolutely right.

Focusing too much on the stock price is a classic amateur mistake. There's no way to have any idea what the common stock price will be without knowing all the info that Chris (and others) talk about.

Re: The one number you should know about your equity grant

jrh — Fri, 28 Aug 2009 09:01:48 -0000

It always amazes me how many engineers don't pay attention to the number of shares outstanding. The flip side of this is that as an entrepreneur, it makes sense to have a large absolute number of shares. Engineers will feel better about their options package -- and their spouses will feel better too. It's easier to give out a big number of shares than to explain to every prospective hire how options really work. But you should always be honest and open with people who understand what's going on and want to know the numbers!

I think it's also important for option holders to know if the investors have participating preferred. As an employee, you need to have some picture of the following things to know what your options are worth:
1) What the company will likely be worth in the end
2) Current company valuation, as reflected in strike price -- at early stage often too low to matter but does matter if the valuation is high
3) How much the preferred shareholders will take out if they have participation
4) Of the total remaining for the common, minus the current valuation, what percentage will you get?

Another factor is that purchasing companies will often up the options grant and/or accelerate some vesting for employees they intend to keep. Yes, that's future compensation, but it's often keyed to what people have already.

Re: The one number you should know about your equity grant

chris dixon — Fri, 28 Aug 2009 08:35:09 -0000

AA - Forget about share prices. No one in finance cares about share prices (except as a proxy for the numbers that really matter). This is one of the most common mistakes people make in public and private investing. For public companies, professionals look at market cap (or enterprise value).

I can ask my lawyers to double the number of shares tomorrow (it's called a stock split). Does that make my company twice as valuable?

If someone comes along to buy your company, they will offer and certain amount of money for the company. They won't ever think about share price. (assuming no preferences and other complications), you will receive the amount they pay for the company * your percent ownership. Your percent ownership can change while your number of shares stay constant without you being notified. For example this happens when there is a financing, when the option pool is expanded, and for other reasons. Focusing on the number of shares is a trick management uses to deceive the less financially savvy.

Regarding options, the strike price matters if you are facebook and it's $5B, but at an early stage startup with (say) 300% volatility and the common struck at 20% of preferred, it's just not a factor. Ask an options trader or try those numbers in black scholes.

Re: The one number you should know about your equity grant

chris dixon — Fri, 28 Aug 2009 08:29:07 -0000

Bijan - I agree about preferences. I remember this was especially bad back in 2002-4 when so many companies had loaded up huge preferences so you had to sell for $100M or something just to beat the preferences. I know I am oversimplifying a lot but I'd rather have people at least asking for the % than nothing at all.

Re: The one number you should know about your equity grant

Jeff Potter — Fri, 28 Aug 2009 07:39:07 -0000

One other consideration is whether the stock is a grant or an option. If it's an option, you have to pay the option price to convert it. If you leave the company (and the options cancel upon termination of employement) but the company is still private, you end up having to gamble your own cash - potentially a lot of it - for something that may never be worth anything.

-Jeff

Re: The one number you should know about your equity grant

bijan sabet — Fri, 28 Aug 2009 06:27:11 -0000

Great post Chris.

as an aside i feel like engineers are often smarter about this issue than non-engineers in startups.

the other thing worth talking about are financing terms and their impact on employee options

for example, even if the VC terms are clean 1x, non participating pref, it's important to tell employees what liquidation preferences mean to them.

Re: The one number you should know about your equity grant

John Stauffer — Fri, 28 Aug 2009 05:52:35 -0000

AA -

The percentage ownership (or total number of shares outstanding) is important for you to evaluate the likely future value of the options.

Imagine you get offers from two startups, each including 10,000 options. The strike price for options from Startup A are $1.00, and for Startup B are $.10.

Which offer should you take?

Now imagine 4 years later (after you're fully vested), both startups get acquired for $100 million. Startup A has 10 million outstanding shares, and startup B has 100 million outstanding shares. Your options in startup A are now worth $10 each, while your options in startup B are worth $1.00.

Total outcome for startup A is ($10.00 - $1.00)*10,000 = $90,000. For startup B it is ($1.00 - $.10) * 10,000 = $9,000.

Now which offer do you wish you took?

It is true that your percentage ownership is not important to determine your value *once* the company has been acquired, but it's critical to estimating the value of the options when you are granted them.

In this case, you would only take the offer from startup B if you expected them to be worth at least 10 times as much as startup A.

If you are taking the offer before at least a B round of financing, I would expect to be diluted by 50%. This is definitely a conservative estimate, but it allows for the risk of additional rounds of financing as well.

Re: The one number you should know about your equity grant

David Semeria — Fri, 28 Aug 2009 05:20:21 -0000

As Bill said, how can the strike price be meaningless?