A VC - Latest Comments in Equity Grant Math

Re: Equity Grant Math

Matthew Thorne — Mon, 31 Aug 2009 17:35:05 -0000

I'm a venture capital attorney so my perspective may be somewhat different than that of Chris or many of the people sharing comments thus far. His article makes a lot of sense from a view-of the-world-at-exit standpoint, but what is possibly missed by saying that the percentage of the Company represented by the Grant is the only number that matters in valuing an option grant is that keeping track of this percentage is often very difficult and labor intensive over the lifetime of the grant. For example, a 10%-of-the-company grant immediately following a Series A investment could end up representing .05% of the Company at exit. Dilution from later investments, other option or equity grants, the issuance of warrants and the affect of preferred preferences all have to be considered in determining the mathematical and real percentage of the Company that the grant will represent from grant to exit, and Engineers and other startup employees are not generally interested in keeping track of all of these variables over the life of the option grant. I agree that knowing the percentage of the Company that the grant represents at the time of exit is paramount to determining the value of the option, but knowing the percentage of the Company you are being granted when the grant is issued will do very little in helping you to know what that exit percentage will be in the future, there are just too many variables.

That being said, having worked with portfolio companies and the venture investors that fund them all of my career, I have not seen any evidence that Companies have ever tried to “trick” engineers or other employees by playing with the share numbers of a grant and keeping the percentage of the Company represented by the grant a secret. That is not to say it doesn’t happen, but these Companies generally grant options with the goal to incentivize their employees (partly to incentivize loyalty, partly as a salary substitute accepted by the recipient because of the upside potential) and any “trick” played by the Company will likely defeat this goal. Consequently, my experience has been that Companies generally grant options in an amount that they think will provide the respective employee with a sufficiently incentivize employees to give their best efforts in a job where the risks are much higher, but the rewards can also be much bigger than non-startup jobs.
Employees that cannot deal with some risk and uncertainty, both of which are great words to characterize options generally, are better off not working for a startup.

Re: Equity Grant Math

Joe Lazarus — Sun, 30 Aug 2009 13:35:04 -0000

Thanks Fred, that's helpful info.

Re: Equity Grant Math

scott edward walker — Sun, 30 Aug 2009 13:09:46 -0000

Agreed - thanks

Re: Equity Grant Math

fredwilson — Sun, 30 Aug 2009 12:30:06 -0000

We use third parties for almost every company to obtain the 409a valuations. Its best practice. But the whole thing is idiotic. Grant prices have come way down now that boards can pay someone to give them low prices and have their asses covered

Re: Equity Grant Math

CollegeHippo — Sat, 29 Aug 2009 15:57:47 -0000

Thanks for the nice post Fred. A very important point has been made by Chris

Re: Equity Grant Math

Reid Curley — Sat, 29 Aug 2009 14:47:47 -0000

My only problem with your "investment value" or "money at work" terminology is that it can cause people to confuse option value with granted stock value. Chris' feeling that strike price doesn't matter notwithstanding, Sheryl presumably has a pretty high strike price on her options that reflects the value of the company when she joined not when it was founded. It would be more accurate to say that she has $150mm of leverage in the deal or 100% carry on a notional $150mm amount than to imply that she got handed $150mm for walking in the door. Her options are only worth anything to the extent value goes up. I know that you and most of the comment makers on this blog understand this.

Chris' post originally was about how engineers could be more sophisticated about evaluating an options proposal. If you say to someone who doesn't know the drill, "the investment value of your options is $100k," they are going to think that is much the same as giving them $100k in cash.

Re: Equity Grant Math

scott edward walker — Sat, 29 Aug 2009 14:07:38 -0000

Fred - Solid posts by you and Chris. As a corporate lawyer for 15+ years, I just wanted to make one quick point from the legal side: Under Section 409A of the Internal Revenue Code, a company must ensure that any stock option granted as compensation has an exercise price equal to (or greater than) the fair market value (the “FMV”) of the underlying stock as of the grant date; otherwise, the grant will be deemed deferred compensation, the recipient will face significant adverse tax consequences and the company will have tax-withholding responsibilities. The company can establish a defensible FMV by (i) obtaining an independent appraisal; or (ii) if the company is an “illiquid start-up corporation,” relying on the valuation of a person with “significant knowledge and experience or training in performing similar valuations” (including a company employee), provided certain other conditions are met. Thank you (and keep up the great work).

Scott Edward Walker
Walker Corporate Law Group, PLLC

Re: Equity Grant Math

aarondelcohen — Sat, 29 Aug 2009 13:26:22 -0000

Yeah, I reread it and it's jumbled. My key point is CEOs should not seduce employees with false promises of wealth. Rather, they should explain that a company's success lays the groundwork for them to do lots of other things with their life, including if they so desire, starting their own companies.

If you enter Slide (post of $500mm or Yelp (post of $200+mm) maybe you will make money on the stock, maybe not. But either way if those companies do well and you were a key factor you will have positioned yourself well for the future. Long ago, that was me at Concrete Media and it paid off.

Re: Equity Grant Math

reece — Sat, 29 Aug 2009 11:56:45 -0000

Excellent!

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:36:02 -0000

Yup. Your point about tranparency is spot on. Its really not right to refuse to share that info

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:35:04 -0000

That's why 'investment value' is an important number. 1.5pcnt of facebook, apparently what sheryl got for joining as COO, is worth 150mm right now

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:30:11 -0000

That's a good point. In the downside, there isn't much value to equity grants

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:29:07 -0000

Thanks. I knew he'd have one

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:29:02 -0000

That's the point!

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:28:17 -0000

Guess what? Your comment is going to be the catalyst to make it happen

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:28:04 -0000

I suspect brad feld has one

Google feld.com vesting and see what comes up

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:27:04 -0000

I'm not sure I totally get your point. But my point is percentage offered is the key number but investment value also is important too

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:22:05 -0000

Its free except for the time you put in and the content you contribute!

Re: Equity Grant Math

fredwilson — Sat, 29 Aug 2009 10:22:02 -0000

Hard to do justice to this in a comment but at maturity, the mgmt (not the founders) should own 20pcnt with the CEO at 5-7pcnt, the COO at 1.5-2.5 pcnt, VPs as AS A GROUP at 3-6pcnt, and everyone else making up the rest. You can work back from there to get to what the grants need to be at an earlier stage to deal with dilution

Re: Equity Grant Math

chris dixon — Sat, 29 Aug 2009 07:41:01 -0000

Fred - I agree that it's totally reasonable to present the option grant in $ terms (multiply % ownership by last round post-money price). I just think you should also reveal % ownership or total shares outstanding as an ethical matter. You and I know that % is the primary way management and VCs think about equity - that's at least one way management should present it to employees.

BTW, I actually think the strike basically doesn't matter when it's an early stage company with super high volatility and strike is standard 20% or so of last round valuation. See http://www.cdixon.org/?p=259

Re: Equity Grant Math

aarondelcohen — Fri, 28 Aug 2009 18:19:21 -0000

I agree he needs disqus.

Re: Equity Grant Math

Nate Westheimer — Fri, 28 Aug 2009 18:11:38 -0000

It's a tired saying, but I'll throw it out there:

"50% of something is a lot more than 100% of nothing."

My dad was the first person to tell me this, when I got started with BricaBox. With that venture, I owned well over 50% of the company still when I decided to close it. That well over 50% turnout to be of nothing.

With my new venture, I'm sitting well south of that 50% number, but with little sacrifice to ownership. Why is this?

It's because my "less" comes with "more" team of invested people. The more people who feel like meaningful owners of the Company (meaningful in terms of both % and their attitude towards it), the more valuable my Company is.

So, % matters, for sure -- it's the basis on which investors and employees can do real back-of-envelope dreaming -- but so does the culture around that number.

Re: Equity Grant Math

kirklove — Fri, 28 Aug 2009 16:33:12 -0000

As someone who is neither a VC nor an entrepreneur I find reading and participating in your blog and Chris' (along with Brad's, Bijan's and Mokoyfman's) incredibly engaging. And Chis has just been crushing it as Gary Vaynerchuk would say.

Granted 90% of the time I can't truly comprehend all the vernacular and terms. Heck I just "tumbled" in to Fred Wilson for the great tunes, but am quite glad I decided to stay for the full conversation. I say keep it coming. I'm having an absolute blast learning and it's a heck of a lot cheaper than Wharton. ;)

Re: Equity Grant Math

Joe Lazarus — Fri, 28 Aug 2009 16:07:09 -0000

Thanks for the link to Chris' blog... I just added him to my Google Reader. This information on grants is also helpful.

If you're comfortable sharing, I'd love to know what percentage of the company is typically granted for various positions based on your experience. If I were offered a VP role at an early stage startup, for example, what's a reasonable grant? I assume it varies by level (VP, Director, Manager, etc) and by company stage (at incorporation, pre-Series A, post-Series A, etc). Any benchmarks you can provide would be interesting to know.

Re: Equity Grant Math

reece — Fri, 28 Aug 2009 15:45:17 -0000

Brad Feld has a pretty in-depth post about vesting equity here:
http://www.feld.com/wp/arch...