I don't invest in companies, but if I did, having nonstandard vesting schemes would be a no-deal red flag, at least for any team that didn't have a mile-long pedigree starting and successfully building companies. Vesting is one of the most important protections the operating team has against hiring (and foundational) mistakes, and anybody who has ever started a company knows those mistakes happen routinely.
Some things to keep in mind when you feel the urge to twiddle the nods on how vesting works:
* It can take 2-4 months, maybe even more for senior hires, to discover whether a new hire is going to fit with the team.
* Your rational incentive for allocating ownership of the company to someone who doesn't belong on your team is zero or worse. You are helped not-at-all by the warm fuzzies a fired employee gets when they contemplate their options, but you are harmed immensely by the share of the long-term upside that those employees take from everyone who comes after them and executes well.
* Equity grants are not just a proxy for future money. They're legal contracts that can drastically complicate later bizdev events. You don't want a large pool of former employees wandering around with executed options. Think of every such person as a P>0.10 risk of a lawsuit threat.
* It is very hard (often virtually impossible) to claw ownership stakes back from former employees. You will, P>0.90, discover candidates later in the life of the company that you'd love to entice with an ownership stake. You will, P>0.90, have a cofounder or employee<4 that doesn't work out. At the same time, a cofounder or employee #1 that's still with the company 3-4 years later almost certainly earned their stake. Vesting balances these needs out.
Don't fuck around with vesting. Do what your lawyer says, or get one to sign off on the standard four-year+1-year-cliff scheme for your state. If you want to incentivize people to stay with your company for a year, pull other levers to make that happen. Don't pull the vesting lever for something as simple as "students just out of school have shorter time horizons".
Just from an efficiency standpoint, you don't need other levers for new grads. A reasonable engineering salary will already be highly motivational for someone who is coming off a student's budget, probably with loans just kicking in.
Some percentage of them are going to flake. That happens when you take people who have spent their lives in an environment with one eval loop and place them in a new environment with differing expectations.
Of those who would flake, some of them can be made into great employees. But a bigger carrot is almostnever effective at accomplishing this. The real need is generally along the lines of "effective mentorship" - which is far harder to implement than a revision to your employee benefits plan.
I think there's plenty wrong with the way most startups handle equity assignments (particularly as it relates to dilution without subsequent regrants, etc), but the viewpoint here just seems bonkers to me.
A year is a LONG time to a 6 year old, but to a 22-24 year old (avg. age of college grad)? Really? When I was that age I could easily imagine committing to things for a year. And even if that makes me an anomaly (which I seriously doubt it does), why would you bend over backwards to reward people that are going to jump ship right away due to their own ADD? Particularly considering they're the least likely to be making really useful contributions to the code and are basically (hopefully) mostly learning the ins and outs of professional development (IME, very different than school work, or even open source projects) on the company's dime at that point.
On top of all that, a lot of companies still use traditional options and other than in some very extraordinary circumstances, anyone quitting prior to a year of service and also prior to a major liquidity event would be foolish to actually exercise their options, which they'd almost certainly have to do to avoid losing them within 30-90 days (or so depending upon terms) of leaving.
Sorry, but this is just a half-baked idea all around.
What a terrible idea. If people don't want to stay for even a year, they don't need equity in a startup. That's what salary is for. And getting 1/4000th of the first year's equity grant after the first month won't motivate anybody who understands math, which is probably a trait that startups are looking for.
The idea is that the longer you stay with the company, the larger percent of your remaining equity you get per period. Hockey-stick equity, if you will ;)
I think it's actually a pretty reasonable approach. I've had people straight-up tell me during interviews that they're leaving their current position because they've reached either their one-year cliff or their four-year package and want a new opportunity with potentially higher gains. While leaving after four years if your options package isn't extended isn't unreasonable, the one-year cliff does seem a rather broken approach for keeping all but the most-dedicated people more than a year.
Of course, if your employees don't want to stay more than year and are only doing so because of the vesting cliff, you probably have bigger problems that need sorting out. But let's assume that your employees are only going to stay 12 months no matter what - would you prefer to give them 25% of their options, or ~3.6%[1]?
That assumes that the exponential grant continues for the entire period, not just for the first year as the article suggests. I'd also be a bit concerned about possible tax implications of that approach; three years in you only have 31% of your stock, and you get about 10% of the total in the last month.
Seems to me that this would be a pretty good way to get people to stay for longer than a year, the issue is when employees still leave early. With the cliff, there's one less shareholder around, helping the company stay under that magical 500-shareholder limit. You lose that benefit with the exponential grant.
[1] I've probably done the math wrong, but roughly solving m^48=100 (percent), getting about 1.1007^(month#) = total percent of equity granted at the end of that month
I've had people straight-up tell me during interviews that they're leaving their current position because they've reached either their one-year cliff or their four-year package and want a new opportunity with potentially higher gains.
The person who told you "I'm looking because I just hit my first-year cliff" actually told you "DO NOT HIRE ME". Listen harder.
People do leave when they hit four years. Four years is a long time! Some teams are O.K. with this, but if you're not, there's no reason to mess with vesting to solve the problem; just grant them more of the employee pool to stay.
Everyone is always looking for better opportunities. That's fine. Be the best opportunity for everyone on your team, or get better at recruiting. Vesting can't help you with this problem, but it sure can hurt you.
Makes me wonder about how their investment in effort has carried out over that time. I'm sorry, but X shares over Y time with additional investments of A, B or C, usually means X means a lot less (percentage-wise) for a continuation of effort.
The 500-shareholder limit is not a problem for employee options. You just use RSUs, or similarly place restrictions on common stock from being traded until it is registered. (IANAL)
Terrible idea, and based on the title of your blog, it's no surprise to me that you'd like all your equity in year one.
There are reasons for 3,4 or N year vesting - namely keeping employees invested in the business. If employees at a startup turned over every year, it simply wouldn't survive.
Salary is used to keep employees for a year. Salary and/or equity is used to keep employees for a meaningful period of time. There will always be the ones there to simply collect a paycheck, and likewise there will be ones who stick around for their 50,000 shares of equity without doing the math to realize their potential upside near 0.
If there is only one thing I wished someone had told me when I started out it would be not to include grants as part of your compensation calculations. It is rare that they'll ever be worth a dime and even rarer that getting a little less/more will make any real difference. I'm assuming we're not talking about public companies here or ones obviously on an ipo track (very short list).
They are like getting a portion of your money in lottery tickets - sure there is a minimal real value to them, but the only rational way to use them in planning is to value them at zero.
Rank and file grants are only about retention. If you are bitching and moaning about a cliff and your finances you really misunderstand how business works here.
But that's very understandable - silicon valley thrives on misleading the young and energetic on this very topic.
This is ridiculous. For starters, in what world is vesting based on value to the employee?
It's also more than a bit ill informed to think that time at a company is less "costly" for an employee the older they are, particularly when it comes to equity. Based on success rates of startups, once you are older you likely only have a few more shots at "winning the lottery", the costs of losing benefits (particularly medical) is higher, and showing forward career progress is so much more crucial. The cost of a few early setbacks is trivial as compared to setbacks towards the end of your career (unless you've already won the lottery, in which case, the discussion is moot).
Why would I want to treat new-grads better than experienced folks? And why would I want to incentivize somebody who doesn't like it after 3 months to stay for 4 months?
The 1 year cliff prevents disinterested parties from holding equity in my company and helps me retain people who have become important over time during that first year.
You're proposing improving my retention of lesser experienced people with lower bus factors in my organization. That seems backwards...
Equity is an incentive for loyalty and commitment to the company. If you aren't even sticking around for year then chances are you are barely finished training. You split just about the time you are actually becoming useful and productive. So the company has invested in you - but you ditched the company. That's the opposite of commitment.
This kinda reminds me of when I was a grade-school student and I used to wonder why the teachers got paid because it was us students who were doing all the homework!
I really don't think young people think/care much about equity until you're one of the hotter startups, at which point 1 year doesn't seem so long. If you're hiring on at Dropbox now, you're working that year. If you're hiring on at some company that's 6 months old that nobody has heard of, the equity is just a batch of lottery tickets.
Put another way, I doubt anyone has ever said "I would have worked there if the cliff was only 6 months".
"After a couple of months at a company, a new grad may think “hey, this isn’t THAT great’, and not stick out the next 9, 10, 11 months, because that seems to them, an insanely long time."
Then he made a mistake during the interview process. Remember, it's not only them interviewing you, it's also you interviewing them. Bring up issues you care about (work ethic, work load, flexibility), and you'll have fewer surpises later on.
"On the other hand, for someone who has been working for a few years, 8,9, or 11 months might seem to be a much shorter period of time, and proportionally it is. They might stick it out, get equity, and become much more committed to the enterprise."
Yes, the company can issue additional grants, there's no law in place to say that what you get on day 1 is the only equity you're going to get, ever. The company can structure performance (equity for shipping major products) or retention (equity for 2nd, 3rd, 5th, 10th, 50th anniversary with the company) however it pleases.
Suppose someone (highly qualified, not from the startup world however) can tweak your marketing message for a couple of weeks (i.e. work on your startup for 80-150 hours intensively) and as a direct consquence get you an audience of millions, because your message is now awesome. This person doensn't care about startups.
Say you are pre-money. How should you pay for this person's time?
You would think, if this person can really work for two weeks and give you a company that is worth seeding at a high valuation (due to traction), which also becomes a good signal and thereafter with the company's fantastic traction, money, and engaged audience, it has fantastic growth prospects - but without these two weeks will simply languish as another "project" - then a two percent stake with no cliff whatsoever is a no-brainer.
And, if you're a consultant, with few exceptions, taking an equity stake rather than cash is not a good idea. Happened a lot in the dot com bubble. Not pretty. Sure, if you're looking for work and a genuinely intriguing opportunity that only takes a couple weeks comes along, why not? But bad idea as a business model.
As an undergraduate at a top tier CS school, I have seen a lot of companies boast about these vesting schemes. Honestly, I don't think most new grads consider them due to the 1 year cliff. Most people I talk to will say "Well, if I want to leave, the new signing bonus/RSU package will just make up for the lost RSUs."
What really hurts companies is the drawn out exponential vesting periods. I believe Amazon does a package that is 15% after the first year, 40% after the second, 75% after the third, and 100% after four. Maybe my numbers are off, but you are rarely going to get new grads to commit to four years, even with that scheme. I'll take my 25% at another company after a year and move on.
Anyways, the work/experience/location/culture/salary is usually more of a factor than the vesting schedule.
For someone who sees 1 year as a long time, the one year vesting cliff may be a reason to discount the equity portion of the compensation package altogether, especially at a small startup where the chances of cashing out are low anyway. After a couple of months at a company, a new grad may think “hey, this isn’t THAT great’, and not stick out the next 9, 10, 11 months, because that seems to them, an insanely long time.
1) From the employer perspective in a startup: do you actually want an employee who's going to stay longer than a few months, based on any reason except the company and the work?
2) From the employee perspective: unless you're an extremely early employee, discounting the equity portion of a startup compensation package is probably the correct thing to do...
A company is unlikely to want the overhead of option/equity paperwork (and cap-table complications) for some restless joker who leaves after a few months. Nor are they likely to want an official policy of offering discriminatory vesting-schedules by candidate age.
Not an HR specialist and this may be beside the point, but i believe if you do this for the new grad you'd also have to give that option to the tenured folks as well otherwise you'd basically be discriminating based on age which is illegal.
They make sense in the same way that dollar cost averaging makes sense. Whinging that a year is too long to wait for the vest is pretty shallow. Now if it didn't start vesting for a year, sure that would be something, but since your 25% vested on the day of the 'cliff' your good.
But the bottom line is that shares are compensation and compensation is money. A startup needs to extract the most mileage out of the money they've got, this vesting schedule has been shown to be a reasonable choice over the last 50 years.
As someone with his not yet successful company, I am against 1-year cliffs. I believe in the 6-month cliff and am considering dropping it to 3 months.
When I make a poor hiring decision, I usually know within 2-3 months. A shorter cliff forces me to evaluate new-hires faster. No one needs 1 year to determine if a new hire was a good fit.
But it works both ways; there will be people who you like who decide not to stick with you. You want to minimize the number of outsiders who hold shares in your company. If you don't grok this, you need to talk to more experienced people; this has to be one of the top horror story themes in startupland.
Also, stop kidding yourself. Evaluating startup team members is very hard. You probably have a longer ramp-up than you think you do, during which you have very little ability to evaluate people; also, there is a huge class of bad hire that starts strong and decays rapidly.
There are all sorts of ways you can motivate yourself to evaluate new hires quickly. Use salary or sign-on bonuses instead of vesting. Messing around with your company ownership to accomplish such a simple tactical goal says something about how seriously you take ownership; it's probably not something you want to be saying out loud.
I am very experienced. Re: the number of "outsiders" - not as big a deal as you might believe. Good lawyering helps.
Its better to be considerate and balanced. The cliff only exists to protect against bad hiring decisions, 6 months is plenty enough time to figure out that someone is a bad fit.
You are correct about shares not being a very good tool for motivating people. Your suggestions about salary or sign-on bonuses are actually worse because that takes away from the working capital.
You don't sound very experienced. I mean that factually, not as an insult. For what it's worth, I've been in "key" roles (lead engineering, founder, and m-team) since 1996; I've spent my whole career in startups. I am not making the horror stories up, and they've happened in places with extremely good "lawyering".
>there is a huge class of bad hire that starts strong and decays rapidly.
Exactly. Also, startups = growth. As you grow, the game changes and usually gets harder. Someone you hired to take you from 0 to X^10 customers may do an ok job in the first 4 months when you have to go from 0 to X customers but may be terrible at getting you from X to X^2 in the next 4 months.
>Don't be a jerk and cut people off just before their cliff.
Saying that it sometimes takes more than 6 months to really evaluate new hires in specific roles is not the same as saying let's cut people off just before the cliff.
>Do the right thing and reduce the cliff
It is not clear at all that reducing the cliff to 6 months is "the right thing".
4-yr vesting with a cliff works, and the concept should probably be left alone. The are plenty of other mechanisms to provide incentives to good people, for the business owner/founder to experiment with.
I don't agree with this at all. Vesting schedules are an extremely important component of how equity in a company is awarded, and the one year cliff is an essential part of the formula.
Options are priced, when they are awarded, to have no present value. The exercise price of the option (the cost to buy a share) is equal to the current market value of the share. Furthermore, you can only hold the options for as long as you are an employee of the company. If you leave, you typically have 30 - 90 days to exercise (buy) whatever options you have vested, if you so choose.
Options are worthless when their exercise price is <= the market price. So, in the first place, it wouldn't make sense to vest options immediately (or "exponentially") in order to accommodate employee drop-outs. The ex-employee would have to exercise the option before the shares could have had time to appreciate significantly relative to their beta.
The value of incentive stock options is simply the value of being able to profit from increased market cap without having to actually risk or tie up any of your own money. On the CBOE (options market), you can buy options with a strike price equal to the market price, but with a set expiration date. The option has no inherent value, but the farther out that expiration date, the more "time value" the option has. I think LEAPs max out at expiring 3 years out. Incentive stock options however will typically have a 10 year expiration date. Just look at the time value of 3 year LEAPs and you will start to see how much time value a 10-year option actually has.
More importantly, the primary purpose of giving your employees options is to increase employee retention and align employees' and investors' goals. The secondary purpose is to reward employees when their contributions add long-term value to the company well beyond the scope of their salary. That type of exceptional contribution is never about 'cranking out code' for a few months to add some new feature. It happens when key employees bring with them a sort of magic which helps their team or even the entire company perform at a higher level. These are the people you want holding a meaningful equity share of your company.
If you ever run a company, it will fundamentally change how you look at these things. For example, you start to see all the taxes being confiscated from the money you are paying your employees (payroll, income, state, etc.) are taxes that the company is paying in order to reward their employees. There is no "company share" / "employee share". All that matters is how much money actually makes it to your employee's bank account. The more efficient the company can make the transfer of wealth, the less money comes out of company coffers.
Options, at least for now, are a more efficient way to pay your best employees so that they are equitably rewarded for the contributions they are making. After a certain point it's just too inefficient to try to compensate your key employees with a pay check ("the taxes are too damn high").
When options are part of an offer letter, those options should always have at least a 1 year cliff. It's pointless handing vested options to a new hire if they're going to be leaving and exercising them just a few months after they've been priced. In that case the options likely haven't appreciated, the employee has likely not made an unpredictable and lasting contribution, the employee is demonstrating they don't believe in the company, and furthermore the first year you work at a company is the likely the easiest year to establish a value for the services you'll be providing, and that should be paid out as salary.
This is a throw away account for a couple of reasons...but I wanted to make a point from the engineering grunt point of view...
>The value of incentive stock options is simply the value of
>being able to profit from increased market cap without having
>to actually risk or tie up any of your own money.
That may be true of the value of the option from a purely market point of view. That said, unless you are part of the rare group who is part of a facebook, twitter, or related that can actually trade on the private markets before an exit event.
The reality is, most engineers working for a startup are gambling their time and efforts for a single investment. More often than not, those investments of effort and time do not always result in much of a return.
From experience - a number of startups will push for rates that are "below market" for the promise of returns. That said, in the same time, day to day engineers (not the founders) who have experienced an exit has been on the order of basically $20-30k/year (over the term of one's employment). Often finding an arrangement with a more established company will result in a better return during the same time.
If you are in the market to join a startup for the exit, weigh your options closely. If you are in it to learn, work with a close bunch, and want to build something interesting, by all means pursue it.
Joining a startup is an investment of time and effort, you should not enter as a non-founder with the expectation of a monetary return. Most fail.
Options are priced, when they are awarded, to have no present value.
Let me introduce you to my friend Black-Scholes.
An option with a strike price equal to the current stock price very easily can have value, and the ones given to employees frequently have a lot of value. Even though the current strike price is the price of the stock.
The point about options pricing and appreciation is a good one, and it's worth considering: if you issue options to soon-to-be- former employees that only an irrational person will execute, only your most irrational former employees will hold shares in your company. Not good.
It makes sense when there's real equity being disbursed. One person has $500,000. The other has sweat equity. How do you calculate the relative value of the latter? Come up with a fair salary, and turn it into equity. Four years is a good starting estimate, but if the person leaves early, then the assumption on which the equity level was set is invalidated.
Being against the one-year cliff means you either (a) believe you will never make a hiring mistake or (b) believe that it doesn't matter who holds equity in your company. Both are dangerous assumptions.
Not having a cliff doesn't even help employees. It creates a culture where new hires need to be on the defensive from the moment they're hired, because management is strongly incentivized to release new hires as soon as they can to contain the damage of bad hires. In cliff vesting companies, management has a full year to figure out whether someone's going to work out, which is good, because most equity-compensated jobs have ramp-up periods.
Some things to keep in mind when you feel the urge to twiddle the nods on how vesting works:
* It can take 2-4 months, maybe even more for senior hires, to discover whether a new hire is going to fit with the team.
* Your rational incentive for allocating ownership of the company to someone who doesn't belong on your team is zero or worse. You are helped not-at-all by the warm fuzzies a fired employee gets when they contemplate their options, but you are harmed immensely by the share of the long-term upside that those employees take from everyone who comes after them and executes well.
* Equity grants are not just a proxy for future money. They're legal contracts that can drastically complicate later bizdev events. You don't want a large pool of former employees wandering around with executed options. Think of every such person as a P>0.10 risk of a lawsuit threat.
* It is very hard (often virtually impossible) to claw ownership stakes back from former employees. You will, P>0.90, discover candidates later in the life of the company that you'd love to entice with an ownership stake. You will, P>0.90, have a cofounder or employee<4 that doesn't work out. At the same time, a cofounder or employee #1 that's still with the company 3-4 years later almost certainly earned their stake. Vesting balances these needs out.
Don't fuck around with vesting. Do what your lawyer says, or get one to sign off on the standard four-year+1-year-cliff scheme for your state. If you want to incentivize people to stay with your company for a year, pull other levers to make that happen. Don't pull the vesting lever for something as simple as "students just out of school have shorter time horizons".