A VC - Latest Comments in Valuation and Option Pool

Re: Valuation and Option Pool

David Semeria — Sun, 29 Nov 2009 16:58:34 -0000

Terry, I may wrong, but surely a post-money option pool makes all these problems go away?

Re: Valuation and Option Pool

markslater — Mon, 16 Nov 2009 18:10:25 -0000

ditto

Re: Valuation and Option Pool

markslater — Mon, 16 Nov 2009 18:05:32 -0000

its a shame - i would like to have seen freds response to this as this is the exact issue i struggle with.

basically - entrepreneur provides a pool of options - if they are not used they share them with the VC.

Re: Valuation and Option Pool

markslater — Mon, 16 Nov 2009 17:50:12 -0000

but VETO yes.

Re: Valuation and Option Pool

fredwilson — Thu, 12 Nov 2009 22:25:32 -0000

get multiple offers

Re: Valuation and Option Pool

JonusC — Thu, 12 Nov 2009 22:21:46 -0000

Fred:
Great post and follow-ups. Very educational.
I am co-founder of early stage software company in HongKong and plan to seek VC funding in the New Year so your post very important for us to understand pre/post-money for options pool (we're thinking 10% pool), both social and economic benefits.
When you say ".. enterpreneurs need to find out what the market price for their company ...", how does one "find out the market price" for an early stage company? Isn't "market price" what is finally negotiated between owners and investors?

Re: Valuation and Option Pool

fredwilson — Wed, 11 Nov 2009 21:39:43 -0000

Thanks for sharing it ginsu. That's great

Re: Valuation and Option Pool

fredwilson — Tue, 10 Nov 2009 07:56:31 -0000

I agree. A lot of startup employees read this blog and other vc blogs. I think that's a good first step

Re: Valuation and Option Pool

fredwilson — Tue, 10 Nov 2009 07:56:31 -0000

Yup. That's the whole point of the post

Re: Valuation and Option Pool

brooksjordan — Tue, 10 Nov 2009 01:02:06 -0000

Hmm, seems shockingly simple when you put it that way, although there must be at least an art, if not a science, to follow-on rounds. But, now I understand what you mean.

For others who may be interested, I'll leave links to two useful posts, one written by you in 2004 about valuation and one by Brad Feld, inspired by that post, on valuation algebra:

http://www.avc.com/a_vc/200...

http://www.feld.com/wp/arch...

Re: Valuation and Option Pool

GeekMBA360 — Mon, 09 Nov 2009 19:09:10 -0000

Very interesting post. I think you should also include a third stakeholder in this discussion -- the hard-working, but often uninformed rank-and-file start-up employees.

I have never worked at a start-up that the entrepreneur/senior management explains the details with regard to "liquidation preference", "preferred participation", etc. Those details could have huge impact on how employees would be compensated when an exit event takes place.

I wrote a post on my own blog called "Don’t get screwed! Stock option questions you should ask before you join a start-up" (http://www.geekmba360.com/?.... And I got quite an opposite reactions from employees vs. entrepreneurs.

I think it's time to call for more transparency in term of VC investment for all parties involved.

Re: Valuation and Option Pool

JeffreyJDavis — Mon, 09 Nov 2009 14:36:17 -0000

Fred -

YOU have already hacked education with many of your posts. The content, and frequently the educated discourse which follows in the comments, is a clear hack to traditional B-School deal valuation / compensation system design curricula. I would love to see AVC comments hosted on a Google Wave blip to enable the search-ability and real time collaboration which we are (barely) missing.

Re: Valuation and Option Pool

Steven Wagner — Mon, 09 Nov 2009 10:58:43 -0000

We took this value versus recruitment/rentention into account in both Fred and mdorov's point of view. We are creating an profits interest system (http://meetkendall.com/2008... our employees.

The founder and investors are in traunches, in seniority and then the employee pool will also be a traunche based on the additional value that is created by the company.

Each employee will have shares from the traunche once the founding team and investors are paid (for a liquidity event) at a pre-defind level. The remaining traunches will pay determine the level of profits back to the team.

Frank - in the VC world, would this be blown-up by a A or B round terms? It acts as the same and I assume we could classify the VC firm's equity with a super senior position in one the first traunches?

Re: Valuation and Option Pool

Simeon Simeonov — Sun, 08 Nov 2009 16:26:06 -0000

Very true. In one financing I did as a VC, I negotiated super-hard for a sizeable option pool up-front because I knew one of the board members thought employees hardly needed any equity. It was a European company...

Fred's post prompted me to create a true pre-money calculator in the startup tool section of FastIgnite.

Re: Valuation and Option Pool

avc reader — Sun, 08 Nov 2009 16:17:45 -0000

Is there ever a case where the company does okay, but not amazingly well, and the next fundraising round is at a barely higher price, but with a larger option pool, so the true pre-money valuation for the 2nd round is actually below the true pre-money valuation for the first round? Is that a down round? Technically the face price is higher, but the true price is lower.

Re: Valuation and Option Pool

fredwilson — Sun, 08 Nov 2009 11:55:34 -0000

Yes. But the times they've not been are rare and you can always fix that in those cases

Re: Valuation and Option Pool

Mo Koyfman — Sun, 08 Nov 2009 11:50:13 -0000

agreed. wish everyone saw it that way...

Re: Valuation and Option Pool

fredwilson — Sun, 08 Nov 2009 11:43:06 -0000

I've said a bunch. In this comment thread and at the techcrunch comment thread

Re: Valuation and Option Pool

fredwilson — Sun, 08 Nov 2009 11:42:12 -0000

Good advice steve. But by all means, please hire a lawyer who does a lot of venture deals

Re: Valuation and Option Pool

fredwilson — Sun, 08 Nov 2009 11:40:53 -0000

Yes

Re: Valuation and Option Pool

terrycojones — Sun, 08 Nov 2009 10:16:40 -0000

A quick way of summarizing what I just wrote, along with you saying "we all get diluted together" is that yes, it can be that way. But (using the numbers in my example) to do that with a pre-existing option pool, the VC is diluting down from 22.2% to 20%. Doing it like that means you didn't originally buy 20%. You bought 22.2%, but you only paid for 20%.

All these details (like keeping track of unissued stock, inequities before the pool is fully issued, interests not being aligned) go away completely if the original team and the VC simply agree that they'll issue stock to new employees as the board sees fit and that new stock will be issued as needed at those times. One way or another, a pre-existing pool of phantom approved but non-yet-existent unissued stock is a mess - it means (until the pool is fully issued) that either the VC got more than they paid for, or that interests will not be fully aligned in hiring/firing.

Apologies if this sounds in any way pedantic or like I'm lecturing. I'm actually trying to learn. Maybe there is a way to avoid these problems with a pre-existing pool, but I don't see how. If I could ask a favor, please use an example with numbers if you reply :-) Thx!

Re: Valuation and Option Pool

terrycojones — Sun, 08 Nov 2009 09:38:37 -0000

Hi Fred

> Your point about being true in the fullness of time is absolutely correct
> and that is why your point about misalignment is wrong
>
> We all get diluted together

It could and should be set up this way, but I think it typically is not. If it were, the entrepreneur's dislike of the pre-money carve out would vanish.

Here's an example.

Suppose that pre-VC funding the company has 70 shares. The company agrees with a VC to sell 20%, with the proviso that a 10% pool of employee options is carved out ahead of the deal. Once the deal is signed, the original team still holds 70 shares, the VC is issued with 20 shares, and the shareholder's agreement allows the board to issue another 10 shares for the pool. If the company is sold one hour later, the VC should logically still own 20% of the company. If the approved but unissued option pool is not regarded as owned by the orginal team, the VCs would own 20 shares out of 90, or 22.2%. That's obviously (to me!) wrong. The math works correctly if those 10 shares are treated as owned by the original team, pending their issuance to future employees.

That way, if the company is sold after an hour, the VCs hold exactly 20%. If the company later hires 1 person who is awarded 1 share (which vests and is exercised), the original team then holds (70 + 9) / (70 + 9 + 1 + 20) = 79%. They have been slightly diluted, down from 80%. The VC holds their 20% all along - they are not diluted by the issuance of the shares in the pool: that's the original reason for carving out the pool ahead of time. When the pool is finally entirely issued (& vested & exercised) there's no need to continue counting the unissued shares as though they were held by the origianl team. The 100 shares are all issued: the VCs hold their 20%, the original team now holds 70%, and the new hires 10%. The math all works very cleanly that way.

To have the VC argue that not only should the company a priori set aside stock for the pool ahead of the financing, but ALSO that the VCs own a proportion of that pool too (which they don't even purchase) is a bit rich! If you're buying 20%, you should be happy with 20% :-)

That's how it *could* be set up. Of course the deal docs can be papered in any way the parties like. But those approved but unissued shares should be on the books somewhere, otherwise the deal is not as it might seem.

Fred - if you don't mind, or even expect, to be diluted along the way with new hires (which IMO is *great*, and the way it should be) then what's the point of carving out an option pool ahead of time? The traditional point of contention with the original team is then removed.

Sorry for such a long comment!

Re: Valuation and Option Pool

fredwilson — Sun, 08 Nov 2009 09:05:05 -0000

Yup. Even better are RSUs. Facebook uses them

Re: Valuation and Option Pool

fredwilson — Sun, 08 Nov 2009 09:02:17 -0000

Not true. But I'll save my thoughts on these points for a future post(s)

Re: Valuation and Option Pool

fredwilson — Sun, 08 Nov 2009 09:01:22 -0000

Right. Its just about price. We offer a higher valuation than we would because we want the options in the pre-money valuation