More On Option Grants — Questions on Who, What, and When — Everything You Need to Know about Granting Equity.
This post will serve as an FAQ to go along with my previous posts on option grant sizing and co-founder stock equity splits. These are some of the questions I’ve heard — many directly from my past posts.
To best understand this post you should read my earlier series, including this one on advisors and consultants, as the terms and roles are relevant here.
Frequently Asked Questions
Co-founder amounts — The most common question I’ve heard is, “It was my idea. I’ve already done so much. Why would I give him 30%?”
Or sometimes people phrase it this way: “I don’t want to give you 30%, that feels too high, but I’ll give you 15% upfront and then 1% a quarter over the next 3 years” Wait, what? My math says that’s 27%. “Yes, but not right now, it’s over time.” Did you read about vesting? Positioning matters, just don’t be fooled by the math and terminology.
One of the differences between a co-founder and an employee is “ownership”. A belief, a trust that they will be your partner. Therefore, you come up with an equity split. The split shows them as an owner.
A co-founder is different than an employee. For an employee, you come up with a role and and grant the right size for that role. We’ll talk more about roles and promotions in a second, but the short version is that you grant an employee a very specific amount that is fitting for that specific role, without considering role growth over time. For founders, you make the assumption that they will end up taking on 10 roles over the years. They’ll do more and more. You grant “up front”, but look at the end game. They’ll own 30%, and you’ll own 70%, as the CEO. But the real world is messy — that’s where vesting helps. You aren’t giving away 30% on day one. In fact I recommend a 12 month vesting cliff. So in reality, they own 0% until they prove themselves over 12 months. You can fire them along the way and 0% it is. Get them to do their part. Live up to their title. At the end of year two they’ll have 15% (4 year total vest). At year 4 it will be 30%. Many founder relationships may end before that. Be prepared for it. Vesting protects you in those cases. So don’t be afraid to take some risks and don’t worry about the numbers just yet.
Okay, maybe you can sell it backwards like my example above if it helps you. Start with 7.5% and grow. I never liked those games, I’m too good at math — but you do you.
Promotions and evergreen grants — Unlike your co-founder, with employees you grant for a specific role in mind. Don’t buy into the hope of someone who can do it all, especially in the early days. Consider your specific need, hire for it, and grant equity for it. This advice applies equally to contractors or consultants. The best way to do things is to grant for a particular role and then make additional grants if there is a new role(s). These are the numbers. Do this well, and we’ll talk again then. I talk to some employees and founders that think you grant stock options to an employee just once, when they are hired. And then they fully vest. They respond to employee question with this line of reasoning, “If you wanted more you should have gotten a better deal upfront. You should have asked for more then etc.” That’s not the right way to do this. It’s better to iterate and grow together over time.
In my post I outline that with each promotion the employee should get a new grant for the new role. One could argue that the new grant from a promotion should be discounted to reflect what is left from their old grant. For example, someone was hired as Marketing Manager 2 years ago. Now they are becoming Director of Marketing. The original grant was for 4 years — so half vested. The new grant will be for four years (standard terms). Should you somehow subtract the remaining balance of the earlier grant to figure out a new one? Makes sense theoretically. In practice, no. Why not? Too complicated. Generally these are promotions. The new stock grant will be bigger than first. Be loyal. Don’t encourage perverse behavior of waiting longer. If they are a great employee (I hope so, you are promoting them), let them keep the extra. The numbers are generally not material. Keep it simple and move on.
Those advisors and board members — My opinion on advisors is a grant equivalent to that of a standard lower level employee. This is less than many people would recommend. But I’ve found most advisors only mildly useful. Grant extra only if warranted — but if you fix a small amount (say 10,000 shares for an average startup using Silicon Valley numbers) — and grant that to each advisor that helps you out a couple of times. It’s easy. It puts more people in your corner. Maybe stack a grant or two for those that do something more specific. Last thing on this: follow through. I’ve had several founders promise me grants who then fall off the earth for a year or two. Guess where I put those founders on my priority list when they show back up? Asking for something no less? Hmm…
Board members get more. Around the equivalent of a senior manager employee. Or more. Be willing to do more for the right board members. Contrary to what many might think, there’s not a lot of upside to being on an early stage private board. It’s work. It’s often not paid. The stock is often of little value — or even worthless. And guess what — when or if the companies fail, the board member shares some blame. There may be hard decisions like firing founders, legal cases, etc. All this is work. It’s hard to get top board talent in the early days. Be cognizant of this and grant accordingly. The number one risk of an independent board member is that they are more interested in being friendly with the VC on your board than you. Don’t put someone on your board who wants to impress VCs. That ends badly for founders.
Getting ready for a capital raise — So things are looking good at your company and you are getting ready for a raise. What happens now? When you go to raise capital, this is a time you need to get your stuff figured out. Grant all the known lists you have (you want a lower valuation number — a term sheet or fresh capital raises strike price). If you have other corporate issues, now is time to make sure things get cleaned up. Organize your HR folders. Make sure your legal docs are in order. This is a broad topic and can be a whole post — and probably will be one day.
Option pool size — Figure out how much equity to put away in an option pool. If you have a pool already, it will need a re-up. If not, you’ll need to create one. Investors usually want to see at least 15% for this, maybe 20% or even 25%. Use my formulas and build a realistic list of hires for the next two years, their stock option grant sizes, and add it up. This will broadly give you an idea of your needs. Add a few percentage points for a buffer. Use this spreadsheet to argue for 15% instead of 25%.
The time factor — One thing that really pains me — that I unfortunately see a lot — is the startup taking too long. Real life is slow and messy, but startups are supposed to be rocket ships! At least in order to qualify for venture capital. This is more applicable to startups looking to raise capital, so it may belong elsewhere, but it’s one of the most important positioning elements of any company. Why now? Why was it slow at first but is now ready to take off? This is important for new hires. Investors. Everyone. Show me why this option grant will be worth more shortly. Show me why my investment makes sense. Founders have to answer these questions — you are selling afterall. We are all making bets. It is a competition! Show me why I should bet on you.
What will my stock be worth? Is the option grant big enough? — This one is more for the new hire, consultant, advisor etc. trying to decide whether or not to take the job / take the offer.
Couple of things: Do the math yourself. Ask for the numbers. See what sounds right. Don’t believe all the bluster. Ask about promotions and evergreen. If you don’t find your new boss / the CEO believable, will others? Newer founders may not know all the answers. That’s okay too, but be sure they are willing to help you find out. Also, keep in mind that there are some things that they really shouldn’t share. So it’s important to simultaneously ask for more details but also be respectful. There is always a lot going on and a lot to consider. Be mindful of your role. Engineers and technical hires command more. Less true in sales, unless you are a proven top seller. So prove it. Bet on yourself — sales is one area I’m more open to creative deal structures. But, if it’s too good to be true, it probably is. Or maybe worse, the CEO is too naive to know the facts. You don’t want that either.
Good luck, and keep the questions coming!
Written by Josh Melick . Founder of Broadly.com. Ex-Salesforce, Ex-AT&T, Ex-Intuit. Part of exits at About.me, Demandforce, Ingenio, MxPlay.