I recently wrote that it’s “fair for founders to own about 100% of a startup while employee #1 only owns a few percent.”
My argument was that the dollar value of stock that founders get when they start the company is actually less than the dollar value of stock that employees get when they join the company. The disparity between founders and employees is therefore just a matter of timing.
There’s a corollary to this theorem:
The first 1000x in valuation is the easiest.
The first 1000x in stock appreciation is easier than the next 1000x. Here’s why:
Let’s say the company is worth $1 when you start. To get a 1000x increase in valuation, you only need to grow the company to $1000 in value. So if you join a company when it’s worth $1, you only have to create $999 of value for your stock to appreciate 1000x!
If someone else joins the company after it’s already worth $1000, he has to create $999,000 of value for his stock to appreciate 1000x!
To get a 1000x return on your stock, you either have to create $999 or $999,000 of value. One of these is easier. By 1000x.
The first 1000x is the easiest, because it is easier in an absolute sense.
Is it fair for founders to own about 100% of a startup while employee #1 only owns a few percent? Are founders 10-1000x more valuable than employees?
The answers are
Yes, it is fair.
Value doesn’t matter, timing does.
In fact, many employees get better equity deals than the founders. There are two cases.
1. The founders are not intrinsically fundable
When the founders start the company, it is worth approximately $0. So their equity is worth $0.
Let’s say the founders work for 6 months, make progress, and then raise money at a $10M post. Then employee #1 joins and gets 1% of the company. So his shares are worth $100,000.
So each founder got $0 of stock when he joined the business. The employee got $100,000 of stock when he joined the business.
Every employee that joins the business gets more stock than the founders did. Not in shares, or as a percentage of the company. But in the only metric that really matters, the dollar value of stock at the time the employee joins.
That’s why some people say that anyone who joins a company before they raise money is a founder. In other words, anyone who joins the company before the stock has value to a third party, is considered to be a founder.
2. The founders are intrinsically fundable
Some founders can raise money with nothing to show other than their smiling faces.
Let’s say the founders raise money at a $10M post-money, simultaneous with founding the company. In this case, the market is valuing the founders’ contribution at $10M.
Then the company identifies employee #1 and tries to hire her. The company will have to compete with every company in the world for that employee, and therefore the market, not the company, is setting the employee’s compensation.
Measuring your stock in dollars is not at odds with measuring your stock in percentages. They’re just different views on the same data. If you’re an employee at Facebook and the stock price is monotonically increasing, look at the dollar value of your stock. If you’re joining a company today and you’re trying to figure out what you get if the company sells for $100M, use percentages.
(Note: This is the first time I’m testing this argument. Be gentle.)
“Training is, quite simply, one of the highest-leverage activities a manger can perform. Consider for a moment the possibility of your putting on a series of four lectures for members of your department. Let’s count on three hours preparation for each hour of course time—twelve hours of work in total. Say that you have ten students in your class. Next year they will work a total of about twenty thousand hours for your organization. If your training efforts result in a 1 percent improvement in you subordinates’ performance, you company will gain the equivalent of two hundred hours of work as the result of the expenditure of your twelve hours…
“When people interview managers, they often like to ask: have you fired anyone? Or how many people have you fired? Or how would you go about firing someone? These are all fine questions, but often the right question is the one that isn’t asked: When you fired the person, how did you know with certainty that the employee both understood the expectations of the job and were missing them? The best answer is that the manager clearly set expectations when she trained the employee for the job. If you don’t train your people, you establish no basis for performance management. As a result, performance management in your company will be sloppy and inconsistent…
“Andy Grove writes, there are only two ways for a manager to improve the output of an employee: motivation and training.”
There are many exceptions to this bit of advice but, unless you really know what you’re doing (you’ve been starting companies and investing in them for the last 10 years), keep it simple. CEO, founders, engineers, salesmen, marketers. If one of the founders wants to be the President, give him an internal title, but keep it simple for investors.
Note: This offer letter includes the follow disclaimer from Wilson Sonsini.
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[Click And Type Date]
[Click and Type Employee]
Dear [Click and Type Employee]:
I am pleased to offer you a position with COMPANY NAME (the “Company”), as its [Click And Type Position]. If you decide to join us, you will receive a monthly salary of $[Click And Type Amount], which will be paid semi monthly in accordance with the Company’s normal payroll procedures. As an employee, you will also be eligible to receive certain employee benefits including [list employee benefits here or “The details of these employee benefits are explained in Exhibit A.”] You should note that the Company may modify job titles, salaries and benefits from time to time as it deems necessary.
***Optional—Vesting Schedule May Differ Too***In addition, if you decide to join the Company, it will be recommended at the first meeting of the Company’s Board of Directors following your start date that the Company grant you an option to purchase [Click And Type Amount] shares of the Company’s Common Stock at a price per share equal to the fair market value per share of the Common Stock on the date of grant, as determined by the Company’s Board of Directors. [Confirm Vesting Schedule] 25% of the shares subject to the option shall vest 12 months after the date your vesting begins subject to your continuing employment with the Company, and no shares shall vest before such date. The remaining shares shall vest monthly over the next 36 months in equal monthly amounts subject to your continuing employment with the Company. This option grant shall be subject to the terms and conditions of the Company’s Stock Option Plan and Stock Option Agreement, including vesting requirements. No right to any stock is earned or accrued until such time that vesting occurs, nor does the grant confer any right to continue vesting or employment.
***Optional***Also, we are offering you reimbursement of relocation expenses for your move from ____________ to ________________, up to a maximum reimbursement of $[amount]. The items for which we offer reimbursement are __________, __________, and __________. (Example: one trip for you and your spouse to do a home search, shipment of household goods, etc.) We will only reimburse for reasonable expenditures which are supported by valid receipts provided promptly to the Company.
The Company is excited about your joining and looks forward to a beneficial and productive relationship. Nevertheless, you should be aware that your employment with the Company is for no specified period and constitutes at-will employment. As a result, you are free to resign at any time, for any reason or for no reason. Similarly, the Company is free to conclude its employment relationship with you at any time, with or without cause, and with or without notice. We request that, in the event of resignation, you give the Company at least two weeks notice.
The Company reserves the right to conduct background investigations and/or reference checks on all of its potential employees. Your job offer, therefore, is contingent upon a clearance of such a background investigation and/or reference check, if any.
For purposes of federal immigration law, you will be required to provide to the Company documentary evidence of your identity and eligibility for employment in the United States. Such documentation must be provided to us within three (3) business days of your date of hire, or our employment relationship with you may be terminated.
We also ask that, if you have not already done so, you disclose to the Company any and all agreements relating to your prior employment that may affect your eligibility to be employed by the Company or limit the manner in which you may be employed. It is the Company’s understanding that any such agreements will not prevent you from performing the duties of your position and you represent that such is the case. Moreover, you agree that, during the term of your employment with the Company, you will not engage in any other employment, occupation, consulting or other business activity directly related to the business in which the Company is now involved or becomes involved during the term of your employment, nor will you engage in any other activities that conflict with your obligations to the Company. Similarly, you agree not to bring any third party confidential information to the Company, including that of your former employer, and that in performing your duties for the Company you will not in any way utilize any such information.
As a Company employee, you will be expected to abide by the Company’s rules and standards. Specifically, you will be required to sign an acknowledgment that you have read and that you understand the Company’s rules of conduct which are included in the Company Handbook. [If Handbook has not yet been adopted add “which the Company will soon complete and distribute.”]
As a condition of your employment, you are also required to sign and comply with an At-Will Employment, Confidential Information, Invention Assignment and Arbitration Agreement which requires, among other provisions, the assignment of patent rights to any invention made during your employment at the Company, and non disclosure of Company proprietary information. In the event of any dispute or claim relating to or arising out of our employment relationship, you and the Company agree that (i) any and all disputes between you and the Company shall be fully and finally resolved by binding arbitration, (ii) you are waiving any and all rights to a jury trial but all court remedies will be available in arbitration, (iii) all disputes shall be resolved by a neutral arbitrator who shall issue a written opinion, (iv) the arbitration shall provide for adequate discovery, and (v) the Company shall pay all but the first $125 of the arbitration fees. Please note that we must receive your signed Agreement before your first day of employment.
To accept the Company’s offer, please sign and date this letter in the space provided below. A duplicate original is enclosed for your records. If you accept our offer, your first day of employment will be [Click And Type Date]. This letter, along with any agreements relating to proprietary rights between you and the Company, set forth the terms of your employment with the Company and supersede any prior representations or agreements including, but not limited to, any representations made during your recruitment, interviews or pre employment negotiations, whether written or oral. This letter, including, but not limited to, its at-will employment provision, may not be modified or amended except by a written agreement signed by the President of the Company and you. This offer of employment will terminate if it is not accepted, signed and returned by [Click And Type Date].
We look forward to your favorable reply and to working with you at COMPANY.
[Click And Type Name]
[Click And Type Title]
“If you decide to join the Company, it will be recommended at the first meeting of the Company’s Board of Directors following your start date that the Company grant you an option to purchase X shares of the Company’s Common Stock at a price per share equal to the fair market value per share of the Common Stock on the date of grant, as determined by the Company’s Board of Directors.”
You don’t get your options until the board grants them at the next board meeting. But they should start vesting on your start date.
The strike price is equal to the fair market value as of the grant date (sometime after the next board meeting). But that probably won’t be higher than the FMV as of your first day of work.
“This option grant shall be subject to the terms and conditions of the Company’s Stock Option Plan and Stock Option Agreement.”
These are big documents that you’re agreeing to without seeing. If you’re concerned, request copies before you sign your employment offer.
“Moreover, you agree that, during the term of your employment with the Company, you will not engage in any other employment, occupation, consulting or other business activity directly related to the business in which the Company is now involved or becomes involved during the term of your employment, nor will you engage in any other activities that conflict with your obligations to the Company.”
The company isn’t forbidding you to work on your own business on the side.
Get a lawyer to advise you on what you need to do to own your side business. At a minimum, work on the side business on your own time and don’t use anything owned by the company.
“As a condition of your employment, you are also required to sign and comply with an Invention Assignment Agreement (enclosed) which requires, among other provisions, the assignment of patent rights to any invention made during your employment at the Company.”
These Invention Assignment Agreements always seem too far-reaching but they’re rarely negotiated, especially if they’re coming from one of the major Silicon Valley law firms.
The Invention Assignment Agreement usually asks employees to carve out the IP they developed before joining the company by listing it in an exhibit. If you’ve developed a lot of IP that is relevant to the business, you might want to ask the company to list its IP instead of, or in addition to, yours.
At-Will Employment and Sundry Items
“You should be aware that your employment with the Company is for no specified period and constitutes at-will employment. As a result, you are free to resign at any time, for any reason or for no reason. Similarly, the Company is free to conclude its employment relationship with you at any time, with or without cause, and with or without notice.”
This is an offer letter, not a 5-year contract with the Chicago Bulls.
“You should note that the Company may modify job titles, salaries and benefits from time to time as it deems necessary.”
You have no job security.
“This offer of employment will terminate if it is not accepted, signed and returned by such-and-such date.”
This offer expires soon.
“This letter, along with any agreements relating to proprietary rights between you and the Company, set forth the terms of your employment with the Company and supersede any prior representations or agreements including, but not limited to, any representations made during your recruitment, interviews or pre-employment negotiations, whether written or oral.”
If it isn’t in this agreement, it isn’t happening, even if we told you it was.
Related: I have a job offer at a startup, am I getting a good deal? Part 1 and Part 2.
6. How much money do you have in the bank right now? How long will it last?
Investors call this runway.
If you’re making an essential contribution to the business, you should have a job as long as the company has runway.
Whether you’re essential depends on what the business needs today; e.g. assistants, recruiters, and salesman might not be essential if the company hasn’t finished building a product yet.
7. What was the company’s post-money valuation in the last round?
Let’s say the company’s post-money valuation in the last round was $10M. If the company is acquired for $100M, the acquisition value of your options should increase roughly 10x, assuming the company didn’t incur any dilution after the last round.
8. What are the investor’s preferences?
If the acquisition price isn’t greater than the investor’s preferences, the common stockholders won’t see a penny when the company is sold.
So don’t join a company with $100M in preferences unless you expect the business to sell for a lot more than $100M.
9. Who is on the board and whom do they represent?
Besides the CEO, the board has the greatest opportunity to increase or destroy the value of the company’s shares.
10. Would I hire the CEO and board to increase the value of my options?
The CEO and the board can easily destroy the value of your options through incompetence and/or greed. You need to ask yourself:
Would I hire the CEO and board to increase the value of my options? Identifying great people is an aesthetic skill, like seeing the beauty in a painting. Most of us don’t have this skill. And those of us who do still get it wrong a lot. Get help from someone who knows how to identify great people.
Do I trust the CEO and board to treat my options like their own? Don’t join the company if you don’t trust the CEO and board to avoid opportunities to treat their stock better than yours.
“Let’s work out the major points and we’ll give you a written offer. We don’t want to start things off on the wrong foot with an offer that is way off the mark.”
2. How does my compensation compare to my peers in the company?
Some companies pay more, some companies pay less, but an offer is fair if your compensation is in line with you peers’.
Your total compensation consists of salary, options, vesting, cliff, acceleration, bonuses, and severance. And a peer is someone who (1) joined the company at roughly the same time as you did (e.g. halfway between the Series A and Series B) and (2) has roughly the same title you do.
Most employees have a 4-year vesting schedule with a 1-year cliff, no acceleration, no bonuses, and no severance. The exceptions are for Vice-Presidents and higher (and founders).
By the way, your cliff may be longer than the company’s runway, but c’est la vie.
3. What are my options worth?
First you have to know how many options you have and how they vest. Let’s say you have 1000 options and they vest over 4 years. So you get 250 options a year for 4 years.
Now you have to guess what an acquirer would pay for your shares. Let’s call this the acquisition share price. Setting the acquisition share price to the preferred share price of the last round is a good start—let’s say it was $1/share.
Now multiply your options (1000) by the acquisition share price ($1) to calculate the acquisition value of your options: $1000. Since the options vest over 4 years, the annualized acquisition value is $250/year. And while the acquisition value of your options might be $1000 today, you’re naturally hoping that the company’s acquisition share price increases over time.
If the company has gained a lot of value since the last round, you might set the acquisition share price higher than the preferred share price. If the company has not has not done well since the last round, you might set it lower. Either way, you will have to ask the company for the preferred share price in the last round. Or if someone has offered to buy the company for $50M since the last round, I might use $50M to calculate an acquisition share price.
Finally, you will have to pay for your options—they’re not free. Options have a strike price—that’s what you pay for your options. Sometimes it’s much lower than the acquisition share price and can be ignored. Sometimes it’s high and can’t be ignored—high strike prices are becoming more common due to high-valuation rounds (Facebook), founder cash-outs, and high 409A valuations.
Most people think this number is important—it’s not. You care about the value of your options, not your percentage of the company. Your percentage will decline over time but the value of your options will hopefully increase.
This is for advanced Venture Hackers only. Don’t do this without an accountant and/or lawyer.
Exercise your options early if you want to start the clock on capital gains tax eligibility for your stock. Startup pros usually exercise their options early to lower the expected value of the taxes on their stock. In certain cases, you will pay less taxes in an acquisition or IPO if you exercise your options early.
Use an accountant or lawyer. Don’t sue us if this blows up in your face.