A Formula for Sizing Employee Option Grants — How Much Equity to Give
As soon as your company is up and running, you’ll need to start hiring. Consultants, employees, contractors — as CEO you’ll always be on the lookout for good people. Hiring is one of the most important jobs as CEO. Getting people to say “Yes” is hard. And they’ll start asking questions like “What’s the salary?”, “How many options?”, and “What are my options worth?”. As CEO, you need to have these answers. These questions are important — you need to properly incentivize your team. At the same time — cash will be tight — hence the prevalence of stock options, making everyone “owners” in the company. I’m a big fan of formulas and data-driven numbers, making for fair and transparent tools to get the right equity in place.
That’s why I created this tool — It’s an equity calculation spreadsheet that you can play around with to come up with the most stratight-forward and consistent numbers. Based on proven methods, years of research, and my own implementation at a successful startup, this spreadsheet has remained a tried-and-true method for managing equity grants. More details on the specific functions of the spreadsheet below.
Some context and history
Fred Wilson wrote a very popular blog post on this back in 2010. My methods are based on his — but I included an easy to use spreadsheet to go along with it. Bam! I also added in some additional mechanics around promotions, “evergreen” grants as employees move into year 3 and beyond, and included math on how to handle valuation changes and stock price changes over time. The biggest change between my numbers and his is that I increased the “multiples”, as he now notes in later posts, the multiples used in his formulas have changed quite a bit (gone up) — and do vary by market. It’s not hard to change the multiples in my provided spreadsheet further — so you can decide for yourself how generous (or not) or what you see as more market comps. For added context, you can see the section in the end with more details on what multiples I’ve seen.
The meat of it — crunching the numbers
The idea is simple and tools like this are used at most companies. First, create a set of levels for your employees. Most companies have between 5–10 levels. Think junior level, individual contributor, senior, manager, director, executive. That’s six levels. You may add in a couple more, but in the early days don’t get too granular. Place each job title or role within those levels. Example: Sr Engineer? Map to either the level I called Senior or Manager.
Ultimately, we want to get a dollar value of the options to grant. To do that, for each level, create a multiple that we’ll match with salary for the role. So if the salary is $120k, and the multiple for level Sr. is .5, you multiply those two to get $60k. If your most recent valuation was $2.00/share, we’d grant 30,000 options for that role.
Someone a level down, with a multiple of .4 and a salary of $80k -> we’d grant 16,000 options ($80k*.4/2). Your new VP of Marketing might have a 1.2 multiplier and a salary of $200k, and so the formula would yield 120,000 shares.
Startups generally shy away from talking about the dollar value here — as the cash value is ill-liquid and it’s more a game of hope than hard numbers in the early days. Bigger or public companies often do give the dollar value directly — as with a publicly traded stock option, it can be converted to actual cash much easier.
The attached spreadsheet includes a base set of levels (8 levels), a completed matrix of about 20 job titles (edit to your liking), and a sample set of 5 valuations for the different equity rounds you might raise (Pre-seed, Seed, Series A, Series B, etc).
There’s also a way to add an additional bump up or down — although I decided to rarely use that in practice. I use the valuation numbers used in fundraising — not the option strike price — as this then shows the options “in the money” right away — although that’s not strictly true. I’ve heard of some doing the opposite way — which is fine but it really just changes the scale on the multipliers.
Beyond the initial grant
It’s my belief that beyond the initial hiring grant, employees should continue to get equity over time. If you don’t believe me, do more interviewing with candidates where you’ll hear things like “I’m almost fully vested, so I thought a good time to look around at other options.” Not what you want. At most big companies there is a yearly grant. Here’s the four ways startups should grant equity:
- Hiring grant — based on the formulas laid out in the tool. This is the first and largest grant, generally vesting over 4 years.
- Promotion grant — any time an employee moves into a new role, they should get an updated grant that reflects the new position. The spreadsheet has a calculator for this. The idea is to re-calc the old position and the new position at CURRENT levels, and then grant the difference.
- Evergreen grant — you never want your employees to feel like they’ve “fully vested”. That takes away the drive to work for ownership. And people tend to start feeling fully vested well before they actually are. So I think you should start granting evergreen grants at year 2.5 on a 4 year vest, and each year thereafter. All equity grants should use the same formulas, where evergreen is a 25% grant of their position, with the same vesting schedule — typically a one-year cliff and 4 year vest. These stacking grants means there’s always more equity vesting and the staggering of cliffs helps to maintain alignment. See here for some additional details.
- Awards / Strong Performers — I expected I would do more adjustments to the formulas when hiring, promotions, etc. But in practice I found the formulas to work great and preferred the simplicity of not deviating. The formulas worked, the amounts were justifiable at each level, and the world was clean. I never really liked the promise of some rock-star employee, especially if I didn’t know them well, getting extra when they came on. However, I love awarding strong performers. Having run sales teams, I believe in performance pay. I also believe in more public contests / awards. So any bigger award would also include equity. “Star of the quarter” awards got 1,000 shares. During annual reviews I would essentially round up evergreen numbers on star candidates, and then a few out of band things here and there.
Some questions you may have
- “Nominal” salaries — In roles where you have many people in the same role but you have a wider range of salaries, I suggest using one “nominal” value of salary for the calculation. There are some valid reasons why someone in the same role but a different level of experience may get a higher salary. Maybe they live in a different locale, for instance. I think the equity grant should be the same across the role though. So set a nominal salary, run the calc, and use that number for everyone. No negotiations.
- How often to update — If you raise capital, the numbers change. That’s an epoch moment where a new valuation is set — so all the calculations change. You need to get a new 409a to set the stock option strike price. Well, even if you don’t raise capital, you need to refresh your 409a every year. I think the same for your numbers if you believe the values have changed. It can stay flat, but also be realistic. Don’t be overzealous, conservative is better here.
- Adjustments — As mentioned above, I ended up not using this much. There’s a push overall towards more transparency across the board with employees. Employees talk. The numbers get around. Keeping it formulaic and using nominal values makes things consistent. But, I also see the counter argument. There are reasons to offer more equity, like when an employee takes a lower than market salary, helping closing an important candidate, etc. There’s a column in the spreadsheet to add in an additional multiplier, like a 10% lift or even a deduction. Use with caution.
- More on multipliers — When I first implemented the Fred Wilson methed, I quickly saw how out of date his original multipliers were. I played with some numbers and ended at about double his values. Over time, I compared my numbers with other companies and CEO friends, and found my numbers were pretty middle of the road. I was more generous with full programs on promotions and evergreen, which don’t seem to be as common, but my initial grants were not small while not overly generous either. Matt Cooper, CEO of Skillshare, wrote up a post with his numbers: see here. His numbers are higher than mine, especially at executive levels. The Bay Area and NYC have the highest numbers. I also have the knowledge of seeing numbers inside of bigger companies. I’ve seen middle executive packages with a multiple of 0.5–1.5x — so roughly in the middle of my suggested numbers of those of Matt. We are close, pick yours, and then stick with it.
- But what about salary numbers? — I’m stuck on that! Yep, another set of hard problems. For this one though I’ve found there to be more data available than on the stock side. It won’t take long for you to get a handle on that.
Using the Attached Spreadsheet
Okay, now for the real stuff. Grab the spreadsheet file here. Everything you need is on the first tab. Tab 2 has more detailed descriptions and definitions but no formulas. The spreadsheet is pre-filled with reasonable numbers for an average venture funded startup, with roles, titles, salaries, grants. It also has already filled amounts for average valuations and shares outstanding. This section needs to be set for your company. The roles and titles could be close enough to work as is.
This is not easy. But the formulas outlined here are the best way to make this something you don’t need to worry about. I used this set of formulas and multiples for 4 straight years, across something like 200 hires successfully at Broadly.com. The numbers compared well to survey’s I did with other companies from the Foundry and NEA portfolios. It compares well to the AVC community. Do a little bit of work to confirm or edit for your unique business and then spend your time on other problems. This one is solved.
Written by Josh Melick. Josh has raised millions in venture capital, was CEO of Broadly.com, where he implemented these methods for hundreds of new hires. Josh was also an executive at Intuit, AT&T, and Salesforce.com.