The problem with this model is that the company at liquidity event often rarely resembles the company during the early phases. As such, the employees which benefit the company the most during the early phases, and whose skills are most aligned to those phases will not be fairly rewarded if they make the (IMO, correct) decision to leave the company to make room for the right people at those later stages.
The assumption here seems to be that the primary value of an employee is their future effort, not their past. While there are certainly problems with poor employees leaving with some options vested, I fail to see this as an endemic issue where tons of bad employees are leaving companies one day after the initial vesting cliff (which should only result in the first tranche of options, not their full amount). If you have a big problem with this - I'd say the problem is not the vesting of stock options, but your failure to accurately create the right ISO plan and the failure to accurately identify which employees are likely to leave before you've attained the value you need from them.
>> The problem with this model is that the company at liquidity event often rarely resembles the company during the early phases. As such, the employees which benefit the company the most during the early phases, and whose skills are most aligned to those phases will not be fairly rewarded if they make the (IMO, correct) decision to leave the company to make room for the right people at those later stages.
Your concerns make sense, but can't you mitigate this with larger or better equity grants to those employees? Valuing their past effort is easily achieved with bonuses (I realize this requires the company to actually do it, but the concept works).
> but can't you mitigate this with larger or better equity grants to those employees
In a perfect world, yes, however, most companies are reticent to offer additional equity to existing employees. Not that it doesn't happen, but it usually requires the employee to ask for it.
One of the big issues, which I presume they expect this plan to help resolve, is how do you pre-judge a prospective employee's value? The employee wants a maximal initial grant, and the employer typically wants a minimal grant. The more they favor the grant desire of the employee, the longer the vesting period becomes - such that the employer is able to cut their losses if the employee doesn't pan out.
Simply knowing that if you leave, some other guy that comes after you is going to get your 1% entices you to stay around long after your usefulness has ended. Either way, the company is already out of their 1%, but now they have an additional payroll drag. Much better to accept the 1% if you're going to give it, and be done with it.
I'm also unaware of what the sourcing is by the article's author, wherein lies this huge problem that non-employees hold a bunch of stock in a company is making it difficult for companies to grow into their full potential. To be fair, if a company takes outside investment, it typically gives more stock to non-employees than employees, additionally giving them preferred upside and rights the employees as common stock option holders do not have. Again, if they feel the outside investors have much better aligned interests with the company than the current employees, they have a different problem than option grants.
> The DSP pool is egalitarian, shared equally amongst the first fifteen employees we hire. So it’s a rich incentive at 1 percent of the company (before any future dilution).
The fact that the author considers 1% of a startup's illiquid equity pre-dilution to be a "rich incentive" highlights just how much rethinking is required.
For argument's sake, lets assume an early-stage startup has no future dilution and five of the first 15 employees leave before a liquidity event. In 2012, over half of startups exits were $50 million or less. With a $50 million exit, the 10 early employees would each receive $750,000 pre-tax from the DSP pool. Even with a $100 million exit, each employee's DSP pool share is not likely to net $1 million after taxes.
Of course, at a typical venture-backed startup, dilution is likely to be meaningful, liquidity preferences can prevent employees from receiving anything at all and the odds are against a $50 to $100 million exit ever occurring. Experienced and/or savvy employees know this, and they can do basic math. So it shouldn't come as a surprise that early-stage startup equity is generally a poor retention tool. It's like using a screwdriver with a nail instead of a hammer.
Retention requires a sustained effort to keep employees happy on a daily basis. This is usually best accomplished with financial tools that provide for near-term, recurring rewards such as bonus and profit sharing packages, as well as non-financial tools (pre-tax benefits, flexible schedules, etc.).
Of course that incentive is not unique to this equity structure — see "Zynga Leans On Some Workers to Surrender Pre-IPO Shares", Wall Street Journal, 10 November 2011.
If the employee isn't adding value that is >= to their compensation, there is always an incentive to fire them. The point of this is to encourage those providing a value greater than the value of the DSP to stick around.
There's unique factors at play here, like the fact that an early-hire CTO can increase his personal equity stake by 50% a couple of months before IPO by persuading the board that five of the first few developers who've worked at sub-market salaries for the past six years are superfluous to requirements. The whole point of options and a vesting schedule is the assumption that employee number 5 contributes a lot more to the value of the company in those early years than they get paid for it. This system incentivises the firing of people who add proportionally less value to a 1000 person company than they did to a 10 person; i.e most developers, including those who have more than justified their compensation in the past and totally deserve their current salary.
There could easily be a trigger for this where if the company cancels their end of the at-will agreement, the equity is deemed to vest at a certain rate.
Reading this lead me to a tangentially related question:
Is there a recommended forum, website, subreddit, whatever, that discusses issues revolving around startup equity?
I'm new to the Bay Area, and working at my first funded startup. There are a lot of, for lack of a better word, things that strike me as strange about our current equity situation... and I'd like to know where I can discuss things like what is fair and equitable, and how worried I should be that certain fancy titles are being handed out like candy to non-developers.
I do, by the way, like the ideas suggested in the post - but I wonder about the company that achieves moderate success, but never achieves a clear-cut liquidity event. Instead it continues on for years, perhaps a decade, who knows, without being sold or IPOing. It would put an initial employee in an awkward position; they'd leave most of their equity on the table if they left, giving them no value for many years of contributions.
Wouldn't this lead to ever increasing office politics among the first 15 hires?
When an acquisition is in the air the by far most profitable move would be to start bullying others out. If the finances aren't transparent to at least those 15, I'd expect false rumors about the company's profitability going around to make other people quit.
You can't give 15 people 15% each, that comes out to 225% of the equity. Or is he saying that the 15 people will split the 15%? Because 1% that doesn't vest until a liquidity event isn't that special, it seems to me.
there's no indication that your normal grant would not be made in light of the additional 1% grant on the table if you stay thru IPO. The article even says that "the majority of Opsmatic’s employee stock — 15 percent of the company — is allocated to the DSP" so there's not particularly much employee stock outside of the DSP available for your "normal grant"
This really only makes sense for companies that are looking to exit or IPO, though stock options for any other kind of company aren't that compelling.
For other companies that are interested in playing the long game, I think it makes more sense to explore alternative compensation structures like profit sharing, etc.
As an employee looking to work with the typical exit-seeking startup, I would probably not be interested in the deal.
> For other companies that are interested in playing the long game, I think it makes more sense to explore alternative compensation structures like profit sharing, etc.
IMO, for non-growth oriented companies, I believe this is the best way to align employee and company interests. I can imagine that there are more effective means of doing so, but I can't imagine what they would look like. The devil's in the details, of course, but a properly-implemented profit-sharing plan seems to be well-received by the employees whom I've witnessed partake.
Growth and long term vision or lack of interest in an exit are not mutually exclusive. At any rate, I'd be curious to hear how companies like Mailchimp are doing these types of compensation.
By "growth-oriented," I'm referring to those companies who eschew any profit in deference to further growth (even if they could show reasonable profit at a slighter lower rate of growth). For these companies, they lack the immediate value to works of a profit-sharing plan, which, IMO, is one of the most valuable aspects of it.
This devalues that grant considerably by making the vesting cliff equal to the date of the liquidity event. I would not take this deal as an employee. I want less cliff, not more.
> in addition to a traditional stock option grant, we’re offering our first fifteen employees, or however fewer it takes to get to the next financing, an equal share of 15 percent of the company
This is additional to a standard stock option grant. Though I'm not sure what is meant by "traditional" here I assume there is some other amount of options with a standard cliff.
That's only true if you are doing it purely for the equity (which is a terribly idea).
Many startups will pay salaries that match (or almost-match) those of larger companies, but the work at a startup is likely to be much more interesting - you'll usually move faster and learn more than at a larger organisation.
We analyzed $500 million in job offers, and seed stage companies are the only ones still trying to hire senior software engineers for $120K or less... see the chart here:
The link is inaccessible, but from your comment - The fact that some exist in one group and none in the other still says nothing about the median or mean. In itself it might be a weak indicator of higher variance at best.
Larger software companies generally pays more, a lot more in some cases than startups.
Startups generally try to match salaries now, however, that is not enough considering the 1 year lifespan of most startups today, they need to raise in 1 year after the last round. The risk is the economic cycle where we seem to be near the top.
This is anecdotal - but the salaries quoted to me by big companies ("AAA", well-known companies even) have always been lower than what startups have offered. I've always perceived this as an extra upside for the risk of being on the sidewalk in a year's time.
I have. The problem has always been the onerous approval chain in big companies, or crappy recruiters who fill the offer with discretionary bonuses that add up to my asking price.
With startups I can actually negotiate and get results. With big companies every major hike in the offer needs to go through a long approval chain. In a few instances I've been off the market by the time they came back to me.
I've also had less jerking around with the aforementioned bonus structures from startups. With big companies I've consistently gotten "$Y base plus up to $Z discretionary", where Y + Z adds up to my asking. I've taken one such offer before and gotten completely shafted (i.e., highly positive performance review, bonus nowhere to be found). Startups are much, much more willing to simply pay my asking salary as base.
My impression with big companies is that their recruiters are their greatest liability. I've had recruiters ask for my salary be lowered because they're paying for my move. No thanks, I know exactly how much a move costs and it's nowhere near the (permanent! not one time!) reduction in salary. Things like that make a negotiation go south quickly. When it comes to smaller companies I've never been treated by HR/recruitment like I was born yesterday, whereas that experience is the norm with big companies.
I also have no complaints about my pay ;) But my experiences with big companies have left with me little desire to talk to them. It's always been a frustrating experience full of low-ball offers and treating me like an idiot.
Every time I've dealt with big-company salary negotiations it's felt like buying a used car. "Oh, we absolutely cannot go higher than that ceiling" "Welp, sorry then" "No wait, we talked to our VP..." - startups (or really, just smaller companies) have always been much more transparent and much more direct in their dealings.
I suspect this won't last forever as more founders notice that salary matching reduces their runway while not increasing the commitment or quality of employees.
Never underestimate the power of underpaying but deeply investing personally in your employees at a startup. Many people will produce better work at 70-80k with serious facetime with the CEO and complete control over product or business strategies. People appreciate agency over their work a lot more than many assume.
I generally like the sound of this, although really what it amounts to is a single trigger on a liquidity event. The dynamic pool part is the interesting bit.
Things I like
- Aligns employee incentives strongly with founders/investors in terms of seeking an exit. Some people now just jump from company to company collecting equity.
- When a company can expect an employee to be around for awhile and vice-versa, both invest more in each other.
Some questions and concerns
- Not all companies are going to reach a liquidity event and thus it may disadvantage employees if they feel more locked
in to staying onboard in a situation with limited upside.
- This may prompt more job candidates to only join companies which are sure-bets, and hurt companies with that crazy idea.
- Such a deal would probably even out with current offers of equity because time is equal to money, but the increased amount of equity will be used as leverage to reduce salary.
- Acquiring companies are going to hate this with a passion as they rely on there being some vesting time left in order to keep acquired employees.
- Although perverse, the dynamic pool aspect might make the first 15 employees try to get the others to leave since the upside of doing so is high. Likewise, if the pool is a certain size, there might be some resentment if the company hires more people and reduces equity for everybody else.
- What is preventing the company from simply adding more people to this coveted pool once one leaves, reducing the advantages the first few had?
I just want vested stock options to not expire soon after leaving the company, with no company call options on said stock. Those simple properties alone would help a lot.
It removes a lot of tax brain damage and risk for the employee when they are dealing with non-liquid company stock that they can't sell to anybody. Companies don't like it, since it doesn't let them take back a lot of stock left on the floor by many leaving employees, but so be it, they already have vested by one year at that point.
On the other side of the equation, founders and investors are increasingly tight-fisted with company ownership, allocating smaller stock pools to employees
Founders and investors are in a position of power, which means there is an easier solution to the quoted problem: create more shares (dilute) when necessary. In the mean time, just give out more stock.
The cliff is a failsafe against granting any equity to employees that should not have been hired at all. It is employee unfriendly in the sense that it is a concession employees make to the firm, but it's a "market" concession; it's part of the deal at most startups.
What about option grants at public companies? It seems like a way for top-level executives to loot the company while the rank and file get enough kicked down to them keep them quiet.
I'm surprised that most of the comments here ("I want less cliff, not more"... "why don't we just get rid of the cliff"...) are really employee-centric -- and not the kind of employee I want to hire as a founder/CEO.
Hey guys, we are on Hacker News, we're supposed to be entrepreneur-minded.
Most entrepreneurs start as employees somewhere and they don't want to feel locked in to staying for who knows how many more years than they would have otherwise, waiting (hoping) for a liquidity event so they can realize their equity and finally start their own company.
Thus for would be entrepreneurs, this structure would be a pretty big negative.
The assumption here seems to be that the primary value of an employee is their future effort, not their past. While there are certainly problems with poor employees leaving with some options vested, I fail to see this as an endemic issue where tons of bad employees are leaving companies one day after the initial vesting cliff (which should only result in the first tranche of options, not their full amount). If you have a big problem with this - I'd say the problem is not the vesting of stock options, but your failure to accurately create the right ISO plan and the failure to accurately identify which employees are likely to leave before you've attained the value you need from them.