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> Early-stage companies should offer sufficient equity such that their employees should in expectation earn at least the same as they would at a public company.

> Early-stage companies should offer sufficient equity such that their employees should in expectation earn at least the same as they would at a public company. That's the joke! Nobody comes remotely close to offering enough equity that their total comp is equivalent! Imagine a company that just raised a $1M seed round on convertibles at a $6M valuation cap. Now say they offer an "extremely generous" 2% equity package to their first employee. What is that 2% worth? Well, the investors think that preferred shares in that quantity would be worth $120k. Of course, equity vests over four years. So your equity comp is... $30k/year. If it were preferred shares. But it's not, it's common shares. So it's worth even less. You'd need to offer more like 10% to claim you are matching the RSUs people are getting at Google or Facebook. But at that point, you might as well call the person a co-founder. And maybe that's in fact the answer: add co-founders, not employees. But this isn't what people are doing today. Instead they're convincing employees to take sub-market pay and sub-market equity to take a stressful job with almost no benefits.

rgossiaux 8y ago
Yes, I mostly agree. There's one nuance that I've been thinking about lately that I haven't seen anyone ever point out before, which is that high volatility will make options worth more than they are on paper. Here's a thought experiment: imagine that there are two employers on the market. One will always pay 200k/yr guaranteed and you can choose to work for them at any time for this wage. The other pays 100k/yr plus one Coconut per year, and Coconuts are currently worth 100k each. So far these are equivalent monetarily. But now let's add the stipulation that after one year, the price of coconuts has a 50% chance of going to 0 and a 50% chance of going to 200k each. Which would you choose? The expected value of each of these job offers is still equivalent (after 4 years of working at each, you'll have 800k in expectation). But you should definitely take the second one. Why? Because after one year, if coconuts drop to 0, you can just quit and join the first company. Then you have a 50% chance of 100 + 200 + 200 + 200 (coconuts to 0) and a 50% chance of 300 + 300 + 300 + 300 (coconuts to 200) which comes out to 950k, which is better than sticking with either company alone. This thought experiment fascinates me because it clearly shows the extra value that up-front stock grants have. The point is that you have some protection from downsides in the form of switching jobs, but no similar cap on the upsides, and the higher the volatility of the stock the more value this provides. I'm not sure what the numbers look like when you view them through this lens, but it does mean that an equity grant of 2% of a 6M company should trade off for more than 30k/yr.
- jiggunjer 8y ago
  this also requires one exercises the cocounut option at the end of every year. If you don't and they drop to zero in year 4...
  - rgossiaux 8y ago
    For the purposes of this thought experiment we're assuming that there's no price movement after year 1. In the real world this probability of failure in the future should be priced in to the year 2 price and doesn't affect the expected value anyway.
- munchbunny 8y ago
  I think that's a good point, but it's just unlikely to actually happen with startup options because of the typical 90-day exercise clause and limited information. The 90-day exercise clause and options instead of shares effectively forces you to buy the coconut, meaning that instead of a 50/50 chance of 0/200, if you plan on leaving before the event that resolves 0/200, then if your strike price on a coconut is $50, it's more like 50/50 chance of -50/250 because you expect to have to exercise when you leave. You can play with the exercise cost, but it does change your math quite a bit regardless. Now if startups gave actual stock instead of options or if they don't place a 90-day time limit on exercising vested options, this wouldn't be an issue. But almost all startups do it this way. The second point is that the company often doesn't look dead until much later. You're just not going to be able to tell one year in, or two years in, or three years in. So you won't be in a good position to capitalize on volatility like you would on the public markets. Then you have things like liquidation preferences that will skew your EV calculation, except they might happen after you join, but you may or may not ever find out that those gotchas are there. As it stands, all of this just creates an incredibly inefficient market that requires employees to take badly informed, high risk bets, where they often don't have deep enough pockets to absorb the risk.
  - rgossiaux 8y ago
    Both of these are good points. 90 day exercise windows are both unnecessary and terrible for employees and we should move to eliminate them as quickly as possible. I think the trend is slowly in that direction, but it really should just be a deal breaker for engineers. The limited information is also a good point. Some level of saviness and understanding of your company and market can help with some parts of this but certainly not all. If anything this may be a good argument for working at late stage private or smaller more volatile public companies. Then if you get lucky and get, say, Square from two years ago, whose stock has gone up 7x, you capture this upside (and if they do poorly, roll the dice again after a year, perhaps). This is quite mercenary and might not be the route that makes one happiest, though.
alfredallan1 8y ago
When you offer 10% per employee, how many employees can you actually take on??
- sidlls 8y ago
  That was part of the comment: at that point it's more like a co-founder not an employee. So: very few obviously. Perhaps more reasonable is 1-2% per for the first 5-10 hires, then 0.5-1% for the next batch, etc. Also I really think these should be RSUs, not options. Employees are already invested in the startup by paying a premium in the form of reduced salary and opportunity cost.
  - kentonv 8y ago
    If you give them Restricted Stock, though, they have to pay tax on whatever the 409(a) value is -- which is what the strike price would have been with options. You can give them a signing bonus to cover the tax, but at this point it's easier and actually better for the employee to give them the cash separately and say "you can use it to exercise if you like". Really the difference between options and Restricted Stock is measurable in dollars, so might as well just give people the dollars. (Note that Restricted Stock is not quite the same thing as Restricted Stock Units (RSUs)... RSUs are for later stage companies. But the principles are similar.)
    - sidlls 8y ago
      Sure; point being that employees ought not have to pay for their equity, because then it's not really compensation.
    - cimmanom 8y ago
      Yup, all the options for granting non-founder equity are absolutely awful from an employee POV. Maybe YC could lobby for a sane way to grant equity to early employees without penalizing the employee?
- maconic 8y ago
  I believe it was Sam Altman who had proposed a good solution to this, which is that you start off with a high number like that for employee #1 with decreasing numbers as the employee count goes up. If you are Instagram and become worth $1B with only 6 employees then everyone should benefit massively. On the other hand, if it takes 1000 employees to get to a great outcome, then obviously the founders and first employees will have been diluted by the addition of all the future employees required to achieve scale or an exit.

rgossiaux 8y ago

Yes, I mostly agree. There's one nuance that I've been thinking about lately that I haven't seen anyone ever point out before, which is that high volatility will make options worth more than they are on paper. Here's a thought experiment: imagine that there are two employers on the market. One will always pay 200k/yr guaranteed and you can choose to work for them at any time for this wage. The other pays 100k/yr plus one Coconut per year, and Coconuts are currently worth 100k each. So far these are equivalent monetarily. But now let's add the stipulation that after one year, the price of coconuts has a 50% chance of going to 0 and a 50% chance of going to 200k each. Which would you choose? The expected value of each of these job offers is still equivalent (after 4 years of working at each, you'll have 800k in expectation). But you should definitely take the second one. Why? Because after one year, if coconuts drop to 0, you can just quit and join the first company. Then you have a 50% chance of 100 + 200 + 200 + 200 (coconuts to 0) and a 50% chance of 300 + 300 + 300 + 300 (coconuts to 200) which comes out to 950k, which is better than sticking with either company alone. This thought experiment fascinates me because it clearly shows the extra value that up-front stock grants have. The point is that you have some protection from downsides in the form of switching jobs, but no similar cap on the upsides, and the higher the volatility of the stock the more value this provides. I'm not sure what the numbers look like when you view them through this lens, but it does mean that an equity grant of 2% of a 6M company should trade off for more than 30k/yr.

jiggunjer 8y ago
this also requires one exercises the cocounut option at the end of every year. If you don't and they drop to zero in year 4...
- rgossiaux 8y ago
  For the purposes of this thought experiment we're assuming that there's no price movement after year 1. In the real world this probability of failure in the future should be priced in to the year 2 price and doesn't affect the expected value anyway.
munchbunny 8y ago
I think that's a good point, but it's just unlikely to actually happen with startup options because of the typical 90-day exercise clause and limited information. The 90-day exercise clause and options instead of shares effectively forces you to buy the coconut, meaning that instead of a 50/50 chance of 0/200, if you plan on leaving before the event that resolves 0/200, then if your strike price on a coconut is $50, it's more like 50/50 chance of -50/250 because you expect to have to exercise when you leave. You can play with the exercise cost, but it does change your math quite a bit regardless. Now if startups gave actual stock instead of options or if they don't place a 90-day time limit on exercising vested options, this wouldn't be an issue. But almost all startups do it this way. The second point is that the company often doesn't look dead until much later. You're just not going to be able to tell one year in, or two years in, or three years in. So you won't be in a good position to capitalize on volatility like you would on the public markets. Then you have things like liquidation preferences that will skew your EV calculation, except they might happen after you join, but you may or may not ever find out that those gotchas are there. As it stands, all of this just creates an incredibly inefficient market that requires employees to take badly informed, high risk bets, where they often don't have deep enough pockets to absorb the risk.
- rgossiaux 8y ago
  Both of these are good points. 90 day exercise windows are both unnecessary and terrible for employees and we should move to eliminate them as quickly as possible. I think the trend is slowly in that direction, but it really should just be a deal breaker for engineers. The limited information is also a good point. Some level of saviness and understanding of your company and market can help with some parts of this but certainly not all. If anything this may be a good argument for working at late stage private or smaller more volatile public companies. Then if you get lucky and get, say, Square from two years ago, whose stock has gone up 7x, you capture this upside (and if they do poorly, roll the dice again after a year, perhaps). This is quite mercenary and might not be the route that makes one happiest, though.

alfredallan1 8y ago

When you offer 10% per employee, how many employees can you actually take on??

sidlls 8y ago
That was part of the comment: at that point it's more like a co-founder not an employee. So: very few obviously. Perhaps more reasonable is 1-2% per for the first 5-10 hires, then 0.5-1% for the next batch, etc. Also I really think these should be RSUs, not options. Employees are already invested in the startup by paying a premium in the form of reduced salary and opportunity cost.
- kentonv 8y ago
  If you give them Restricted Stock, though, they have to pay tax on whatever the 409(a) value is -- which is what the strike price would have been with options. You can give them a signing bonus to cover the tax, but at this point it's easier and actually better for the employee to give them the cash separately and say "you can use it to exercise if you like". Really the difference between options and Restricted Stock is measurable in dollars, so might as well just give people the dollars. (Note that Restricted Stock is not quite the same thing as Restricted Stock Units (RSUs)... RSUs are for later stage companies. But the principles are similar.)
  - sidlls 8y ago
    Sure; point being that employees ought not have to pay for their equity, because then it's not really compensation.
  - cimmanom 8y ago
    Yup, all the options for granting non-founder equity are absolutely awful from an employee POV. Maybe YC could lobby for a sane way to grant equity to early employees without penalizing the employee?
maconic 8y ago
I believe it was Sam Altman who had proposed a good solution to this, which is that you start off with a high number like that for employee #1 with decreasing numbers as the employee count goes up. If you are Instagram and become worth $1B with only 6 employees then everyone should benefit massively. On the other hand, if it takes 1000 employees to get to a great outcome, then obviously the founders and first employees will have been diluted by the addition of all the future employees required to achieve scale or an exit.