Stock Option Counsel - Legal Services for Individuals. Attorney Mary Russell counsels individuals on equity offer evaluation and negotiation, stock option exercise and tax choices, and sales of startup stock. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.
Why do startups have an exponential drop-off in equity for employees? I've never heard a reasonable explanation of why there should be exponential drop-off in equity compensation based on joining time in a startup (vs. linear, for example). Obviously you need some time function to push prospective employees to make the jump when they are earning below-market salary, but is there a good reason why the drop-off is often exponential?
Stock Option Counsel Answer:
The Gray Area -- Revealed!
This is a great question because it reveals a truth: The difference between a founder and an early employee is gray, not black and white. There is not a true difference that would allow an exponential difference to be appropriate.
A Thinking Trick
It is very useful for an employee to reverse the exponential drop logic the company may use -- how much more than zero should this "employee" receive -- to acknowledge the gray area by thinking along the lines of "How much less than a founder should I receive?" While it is unlikely for an employee to come in at close to founder level, that should be ideal starting point to work from in your mental calculation of what is appropriate and will inspire you to perform at a founder level.
And remember that founders are notoriously delusional about how soon they will be funded, so don't drink the Kool-Aid. I see companies try to grant employee-level equity before a funding on the promise that they are "just about to be funded." They promise salaries that will be "deferred" until funding and try to bring on "first employees." If you're not getting paid today, you are not at an employee's level of risk. Be sure you are granted founder-level equity if you have founder-level risk.
Stick to Percentage in Negotiations
On a geekier note, the emphasis in this conversation should be on % ownership in the company, not the form of equity. Founders usually receive "restricted stock," and employees receive "stock options," but don't get caught up in those distinctions. The % is what's important.
Link to Quora Q&A: http://www.quora.com/Startups/Why-do-startups-have-an-exponential-drop-off-in-equity-for-employees . And don't forget to follow me on Quora HERE>