Standardize your equity compensation plans for executives and employees as early as possible. It will:
- Make the negotiation process easier for you and employees;
- Give employees a simpler way to benchmark their equity compensation, understand future increases, and understand fairness of the company’s proposals;
- Reduce the brain damage and emotional toll every time compensation negotiations come up, since you’ve already done the work in advance;
- Allow you to plan ahead, ensuring you don’t overpromise stock options out of your overall employee equity pool that you intended to use over a longer period (e.g., prevent you from falling in love with a candidate and giving them way too much equity); and
- Permit you to retain the right to make reasonable deviations from time-to-time.
1. Pre-seed (or before first institutional round)
It can be hard to adhere to a strict framework in the very early days. At this point, your company is really not yet a “company” — it’s just your vision. Recruiting employees to join you may require being creative with their compensation packages (e.g., large equity grants), so it’s entirely normal to fly a little bit by the seat of your pants and make decisions on a case-by-case basis. At the end of the day, if someone is critical to getting your idea off the ground, then equity is generally your only form of currency in the early days.
2. Post-seed (or after first institutional round)
As soon as you’ve raised your first institutional round of capital with investors participating in company decision-making, started to get some meaningful traction, or have built what you’d call your early team that can get you through the first few milestones, it’s time to standardize your employee equity framework.
There is no one perfect plan and there are an increasingly large number of compensation planning tools available in the market, but what’s important is to pick one and build your version of it for your company. We recommend a modified version of a plan published by Fred Wilson, Co-founder of Union Square Ventures, back in 2010. Since then, as the market for startup employees has changed, Fred has actually endorsed an updated framework, which was published by the CEO of Skillshare, one of Wilson's portfolio companies.
Salary Multipliers
Exec team/C-level: 2.45
- VP: 1.86
- Director: 0.54
- Specialist/key contributor IC: 0.43
- Sr. Engineer: 0.40
- Engineer: 0.26
- Individual contributor/most staff: 0.23
Note: the exact multipliers used below are calibrated to the NYC startup market so depending on where you are you may choose to modify the multipliers.
For example, an individual contributor making $100,000 per year would receive an option grant worth $23,000. An executive making $300,000 per year would receive an option grant worth $735,000.
The next exercise is to establish a process for determining the value of your options. The simplest method is to take your most recent price per share at your last fundraise and then subtract out the strike price of the options (i.e. the 409a valuation of the common shares). In the early stages the strike price can be a somewhat irrelevant factor, however, as the company’s valuation grows, the strike price becomes increasingly important to compute. If it’s been a long time since the last fundraise, then you can establish an estimated market value of the company by doing a simple multiple of revenue that is appropriate for your industry and then working from there. Check out this premade template for reference.
3. Communicating option value to new hires
Best practice is to provide guidance to your candidates, new hires, and employees on the value of their stock options and the company. But be careful as making too strong of a claim about the future value of your stock or employee options can lead to legal trouble. Stay away from definitive statements about future valuation of your company or anything that can be construed as misleading when valuations inevitably change down the road.
The CEO in the blog post referenced earlier sends a slide deck to each new hire/candidate explaining the stock option valuation methodology and the company valuation. Or you could also just communicate details verbally. Whichever route you take, just make sure its abundantly clear that you’re not making any definitive claims about the future value of your stock or the company’s options.
Option Value Calculator
Sharing an option value calculator with candidates, new hires and employees can also help build their understanding of the value of their options. It allows them to calculate the value of their options using their own assumptions and it entirely avoids any legal issues since they are inputting the assumptions—not you or the company.
Note: This is not legal advice.
References
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