A few years ago, I was in the first board meeting for a startup that just closed its initial venture funding. The company’s founder, “Ray”, had been working with me since the company’s inception, and he asked me to be on the board.
At the end of the board meeting, there was a discussion about setting the exercise price for stock options. One of the new investors, “Larry”, said, “We should set the stock price as high as possible, so anyone who quits won’t exercise their options.”
I groaned my disapproval.
Being generous with your team costs you very little.
I spoke up and said, “That’s not what I would do, and that’s not what I did when I was running my company.
“I think we should set the exercise price as low as possible because we have an obligation to look out for the employees. How long is it going to take for this company to be liquid? Seven years? Ten years?”
Larry was burning a hole into my head at this point with his eyes. He was clearly pissed.
I continued with my thoughts.
“If we show generosity with the employees, anyone that leaves the company will feel good about their experience working with us, and they’ll say good things about us. That will help us recruit other employees…”
“Bullshit!” Larry screamed at me. “We will dilute ourselves. That’s what will happen!”
“I disagree,” I said. “And I have proof. When I fired two of my co-founders, I went out of my way to be generous to them on their way out the door.
“A couple years later, when we were raising our Series B, one of our new investors talked to them about the company. The investor told me, ‘I don’t know what you did, but they were very positive about the company. That’s not normal for a founder that’s been fired.’”
“That proves nothing!” Larry screamed.
“Both of the founders didn’t leave on good terms,” I said. “However, we took the high road, and I was surprised as anyone that it paid off. My point is this, being generous costs us so little, but you never know when it will pay off.”
The board supported Larry, not me. The initial exercise price was set high.
You are more likely to lose when you to try and keep all the equity for yourself.
Now, it would be clean and easy story if I was to tell you that the company fell apart by keeping the strike price high. However, it didn’t work that way. The company is now worth well over $1 billion.
So, Larry was right? There are other ways to can be generous to your employees, and that’s what Ray did.
More important than the exercise price is the amount of equity you give your team. If you try and keep all the equity for yourself, you’re not going to recruit a world class team.
Think about it. Why is a great engineer with multiple options going to join your startup if you’re not generous with the equity?
The answer is they will pass.
Fortunately, there was no pushback from Ray’s board on equity distribution. Everyone was in agreement that they needed to be generous. The result was Ray built a world class team.
In order to keep your world class team, you need to refresh their stock options.
Ray’s company has been around now for four years. That means that his early employees are now fully vested.
The question Ray wrestled with is what should he do to keep these employees from leaving? The answer was to grant them new options, but the question was how much?
I like the idea of looking at each employee as if you have to hire them again. What would you pay them? How much equity would you give them?
For example, let’s say you have an engineer you gave 0.5% equity as an early employee. Now, that engineer has two years of equity vested and two years left to vest. What should you do?
The answer is grant the employee two more years of equity at market rate vesting after the existing equity has vested. Let’s assume that’s 0.16% in this case. So the employee’s remaining equity would look like:
Year 3 Year 4 Year 5 Year 6
0.125% 0.125% 0.08% 0.08%
Now, the employee is incentivized to stick around. The reality is you’re going to have to pay someone to do this role, so why not give the equity to a known entity?
It’s going to result in less turnover and better results. And, even though your equity will be diluted, it will be worth more.
That’s the approach that Ray took, and he’s been able to retain most of his employees.