Startup Equity: Three Crucial Variables
(Part 9 of an n part series)
Startup equity has approximately a gazillion moving parts. But three of these variables are far more important than all of the others. These three components are what make your plan uniquely yours. They are the things that require real thought. They are also the elements that are most commonly viewed as “plug-and-play” in the world of startups.
Stock options are grants with four-year vesting schedules. Everyone knows this. RSUs have a three-year schedule. Everyone knows this as well. However, while these are the most common vesting schedules, they are not as “standard” or as scientific as you may think.
The truth about vesting is a bit more complex. Vesting should align with expected employment cycles and potential company objectives (time and performance.) If four years fit this bill, then great! If not, you should consider something(s) different. Two years may be right or maybe seven years makes sense. You may even need more than one vesting schedule depending on the level of participant and the goals for that job. Your vesting schedule is a key competitive differentiator. Doing the same thing as everyone else puts you at a disadvantage unless you are the absolute best in your industry.
If you die, you get one year to exercise. If you leave while still in good standing, you get 30 days or three months. Unvested options and RSUs expire immediately. Again, this is common knowledge but it is not based on facts.
A small number of companies have started granting equity that does not expire. While this is a generous offer, the likelihood that it will result in running out of grantable shares is far too high for most companies. But, you may want to look at longer periods for key positions, or termination rules that align with the tenure of an individual. If someone has been with you for eight years, they may deserve more leeway than a new hire. There is no easy answer that works, only easy answers that don’t.
Change-in-Control and Related Liquidity
Things are less standard in this area. Should vesting accelerate? What should expire? What the heck qualifies as a “change-in-control?” Accelerating vesting sounds great, but it may limit a company’s ability to show value. If critical positions have no “stickiness” then acquirers may offer less in return for the risk of losing key players. Acceleration of RSUs may result in income and taxes at times when participants cannot afford it. On the other hand, acceleration may be a great negotiation tool for participants in key positions.
All of this may lead you to “inspire” people to stick around after the transaction via continued vesting or earn-out periods. This can be effective, but may backfire if the time to transaction has already been extensive. One solution may be to build in performance criteria that trigger acceleration only if the value of the company exceeds a certain level. Properly designed and communicated, this can provide targeted motivation that drives those most responsible for achieving this value.
The emerging fourth member of the big three is performance conditions. Ten years ago these were seldom seen at startups. Now they are still uncommon, but commonly requested. We will cover this topic in an up coming post.
Take a look at your plan and agreements. How “vanilla” are your vesting, termination and change-in-control provisions? More importantly, why? Don’t sell your company short on such a big component of your pay and motivation package. Minor differences in these three areas can have a major impact on your ability to hire, motivate and keep your best talent.