Am I an Employee or Founder???
"The difference between a founder and an early employee is gray, not black and white."
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Originally published April 23, 2013. Updated August 3, 2023 and November 1, 2023.
Quora Question:
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?
November 2023 Update: Great info on this point for technical co-founders / early employees from YC in this video called How Not to Get Screwed Over as a Software Engineer.
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.
Founder Delusions
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 a startup-phase-market-level salary 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.
Data Sets
Data sets on employee and executive offer percentages for early stage startups can be misleading and encourage companies to make unrealistically low offers to early hires. There’s two reasons for this. First, these data sets are for employees who are earning something like market level salaries along with equity. Second, these data sets exclude anyone classified as a “founder” from the data set for employees. They keep different data sets for founders! So the gray area between the two classifications makes the use of data tricky. Who is a founder for purposes of the data set? Depends on the data set. Carta, for instance, excludes anyone with 5% or more from the employee/executive data set and classifies them as founders! Even if they are earning market-level cash from their start date.
How to Think About This
Here’s the bottom line:
If you are joining before you are being paid startup-phase-market-level cash salary, you are a late stage founder. You should evaluate your equity percentage relative to the other founders within the company or within the market data set.
If you are joining for a combination of cash and equity at an early stage startup, the offer should make sense to you. Simply pointing to market data for the right % ownership is not enough. You’ll want to consider the market data for % ownership in conjunction with the dollar value of the equity based on how investors have most recently valued the company.
More here.
Link to Quora Q&A: https://www.quora.com/Startups/Why-do-startups-have-an-exponential-drop-off-in-equity-for-employees .
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Double Trigger Acceleration and Other Change of Control Terms for Startup Stock, Options and RSUs
What does double trigger acceleration mean? It protects unvested shares from cancellation in a change of control by immediately accelerating those shares if the individual is terminated as part of the change of control. Founders, executives and key hires, including employee-level hires at early stage startups, negotiate for Double Trigger Acceleration in their equity grant documents at the offer letter stage.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Originally published June 5, 2018. Updated July 27, 2023.
Change of Control Terms for Startup Stock, Options and RSUs
Startup stock, options and RSUs vest over time. Since they vest over time, some may not be vested when the company has a change of control (aka merger or acquisition). What happens to the unvested shares at change of control? It depends on the fine print in your equity documents.
Founders, executives and key hires, including employee-level hires at early stage startups, often negotiate for Double Trigger Acceleration to protect their unvested shares. Advisors and some founders and rare executives may negotiate for Single Trigger Acceleration so that their shares immediately vest at acquisition. However, these protections are not often negotiable for employee-level hires except at very early stage companies. Their equity will be governed by the general terms of the Plan, which will likely be either an unfavorable Cancellation Plan.
Single Trigger Acceleration
The ideal change of control acceleration term is Single Trigger Acceleration - so that 100% of unvested shares vest immediately upon change of control. Investors and companies often argue against this term because the company may be an unappealing acquisition target if its key talent will not be incentivized to stay after closing. This is especially true for technical talent at a technology company.
Advisors, some founders and rare executives may negotiate for Single Trigger Acceleration if they can make the case that their role will not be needed after change of control. For example, advisors naturally negotiate for Single Trigger Acceleration because their primary role is to advise a company at the startup stage. They would not be necessary after an acquisition as they’ve fulfilled their purpose by that time. Founders and executives sometimes argue for Single Trigger Acceleration based on aligning incentives. For example, I’ve worked with a CFO who negotiated for 50% Single Trigger Acceleration because he was hired with the express purpose of improving the company’s financial position to achieve an acquisition. Those with similar arguments may even negotiate for Single Trigger Acceleration to apply at IPO, which would be a very unusual term but a logical incentive for certain hires.
Double Trigger Acceleration
The next best term is Double Trigger Acceleration, in which unvested equity immediately vests if both of two triggers are met. First, the company closes a change of control. Second, the individual’s service is terminated for certain reasons (most often a terminated by the company without Cause or a voluntary resignation by the individual for Good Reason).
Founders, executives and key hires, including employee-level hires at early stage startups, negotiate for Double Trigger Acceleration in their equity grant documents at the offer letter stage.
The key argument for Double Trigger Acceleration is based on risk. If an individual at any level of the organization is taking a significant risk to join the company, such as sacrificing significant cash or other compensation elsewhere to join, they advocate for Double Trigger Acceleration to protect their upside in the event that the equity becomes valuable. A grant of 1% with Double Trigger Acceleration is more valuable because of that protection of the upside. A second key argument for this term is based on “aligning incentives.” If individuals on the team could lose valuable unvested equity by achieving a prompt acquisition, their incentives would not be aligned with the company’s goals of closing that deal. Double Trigger Acceleration rights bring the individuals' incentives in alignment with the company's goals.
This Double Trigger Acceleration protection is negotiated at the offer letter stage and included in the final equity grant documents. The key negotiable terms in this clause are:
Full acceleration so that a qualifying termination at any time after acquisition accelerates 100% of unvested shares;
Application to a qualifying termination in anticipation of, or for a certain protective period of time prior to, change of control;
Application to terminated by the company for Cause (narrowly defined, not to include arguable performance terms);
Application to a resignation by the individual for Good Reason (defined broadly to include a change in cash compensation, a reduction in duties or reporting structure, a geographic change, and anything else that would amount to constructive termination for the individual);
A broad definition of change of control including a sale of substantially all the company’s assets;
Immediate vesting at closing of the change of control if unvested shares would otherwise be cancelled without payment under a Cancellation Plan term. More on this here from Cooley:
Often overlooked, however, is that in order for double-trigger acceleration to be meaningful, the option grant or equity award must actually be assumed or continued by the acquiror in the transaction. This will not always be the case in a transaction – aquirors often have their own plans and ideas for incentivizing their employees. If an unvested option or equity award terminates in connection with a transaction, then technically, there will be no unvested options or awards to accelerate if the second trigger (i.e., the qualifying termination) occurs after the transaction.
Continuation Plan
If the startup’s Equity Incentive Plan includes a continuation term, the value of the unvested shares continue to vest after change of control so long as the individual stays in service after the closing. We’ll call this style of plan a Continuation Plan. The unvested shares are likely to be converted into another form, such as RSUs in the acquiring company or cash deal consideration. But the value is protected so that the deal value per share paid to vested shares at closing will be paid to these unvested shares on each subsequent vesting date. If the individual is terminated or resigns for any reason, they would not be paid out. If the deal does not provide for such continuation or substitution, unvested equity will be accelerated so that it becomes 100% vested and paid at closing.
If an employee's total number of shares was worth $200,000 at the acquisition price, and only 50% had vested at the acquisition, the employee would be paid $100,000 at closing. But the unvested shares would be replaced with a substitution or continuation award in exchange for the $100,000 in unvested value. That might be in the form of cash to vest over time, continuing awards in the original company, or new equity in the acquiring company's equity. Whatever the form, it would continue to vest over the remaining portion of the original vesting schedule.
Without the Double or Single Trigger Acceleration protections described below, the individual could be terminated for any reason, at any time, and would lose the unvested shares. However, those who stay at the acquiring company under a Continuation Plan will continue to earn the deal consideration for their unvested shares. (But beware. Those with unvested equity under a Continuation Plan may also be asked to sign new employment agreements forfeiting these rights as part of the acquisition, since the company’s leverage of termination is significant).
Cancellation Plan
Most startup Equity Incentive Plans allow the company to cancel unvested shares without payment in an acquisition. We’ll call this type of plan a Cancellation Plan. Under a Cancellation Plan, unvested equity can be cancelled and replaced with $0, even if the unvested shares had significant value at the time of the acquisition. For example, if an employee's total number of shares was worth $200,000 at the acquisition price, and only 50% had vested at the acquisition, the employee would be paid $100,000 at closing. The unvested value of $100,000 could be cancelled without payment even if the employee stayed on as an employee after the acquisition. In another example, if the employee was within the first year of service and had a one-year cliff vesting schedule, 100% of the grant could be cancelled without payment even if it was immensely valuable based on the deal price/share.
The distinction between a Cancellation Plan and the more protective Continuation Plan is not usually a negotiable term. The exception to this would be at a startup with employee-friendly founders and executives who are willing to advocate for changes to their Plan with the board and stockholders. When startup candidates encounter this term in their offer negotiation document review, their best course of action is likely to be to negotiate for Single Trigger Acceleration or Double Trigger Acceleration for their individual grants.
Negotiating Change of Control Terms
The availability of Single Trigger Protection or Double Trigger Protection and/or the distinction between a Cancellation Plan and a Continuation Plan is a factor in assessing the risk of joining a startup. If the fine print protects 100% of the unvested shares, the shares have a higher potential upside for the employee or executive. Without these protections, it may make sense to negotiate for a higher cash package or a higher number of shares to balance risk. Check out more on my blog about market data for startup equity offers and other key terms that affect the risk of startup equity including clawbacks and tax planning for stock options.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Bull’s Eye: Negotiating the Right Job Offer
Learn the four ways startup determine the right equity offers for new hires.
Boris Epstein is the founder of BINC Search, a next-generation recruiting startup that helps Silicon Valley companies hire technical talent at the scale they need.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
You’re negotiating your salary and equity. You know there is a right answer – a bull’s eye where the final offer should land. But where is it?
The company is deciding what to offer you. They know there is a right answer, and they’ll get there using these four factors:
1. Past Comp – your salary and equity in current and past jobs
2. Peer Comp – the salary and equity of others in your peer group within this company
3. Desired Comp – what you want to get paid, regardless of other indicators
4. Market Comp – your competitive offers in the market
The right offer for you is the bull’s eye at the center of these possible offers. You can maximize your final offer by thoughtfully using these factors in your negotiation.
Past Comp
The company may ask you to disclose your compensation in your previous positions – your Past Comp.
If you disclose these numbers, be sure to include detail or “color” on the numbers to show the true value of your Past Comp. Do you believe your salary was lower than it should have been because of difficult financial circumstance at the company? Are you overdue for a review and raise? Does your company have valuable equity or a bonus structure that should be included to accurately describe your Past Comp? Are you expecting to continue vesting or receive additional stock option grants that you would forfeit by leaving your company?
A thoughtful discussion of your Past Comp may be more effective than following the lore that you should never disclose this information. You can use your answer to the question to guide the company to the right offer.
Peer Comp
The company also considers your Peer Comp – the range this company is already paying employees in similar positions. You start shaping this number during your interview as you discuss roles, levels and opportunities and present information to help the company understand where you fit to add the most value to the team.
For a company with a thoughtful system of leveling, there will be names or labels for each position and a range of salaries and equity packages they offer within each level. Your negotiation work is to distinguish yourself and show that you are a peer of those being paid at the highest end of the range for your level based on your unique skill set or experience.
The more unique your position, the less experience a startup will have in defining your Peer Comp. If you are a first-hire designer, physician or other leadership or expert role, you may have to help the company understand who your peers will be. This is especially important in early-stage startups, where the hiring team might not understand that your new role should be considered a peer of, for example, vice presidents rather than junior engineers.
Desired Comp
The company also considers your Desired Comp – what you want to get paid. This is highly relevant to the right offer.
Desired Comp is especially important in equity packages, where your evaluation of the company’s equity may vary greatly from another candidate’s evaluation of that package. If you’ve been hoping for a home run exit during your career, you’ll be looking for an equity package that could get you there. If you’re strapped for cash and looking to maximize salary, you will have less desire for an equity-heavy final offer.
There may be some tradeoffs, of course, but the right offer will be centered on your Desired Comp. So do your self-reflection homework and know what you want.
Market Comp
Companies take into account Market Comp and need to know what they will have to offer to stay competitive. While companies have a general idea of what is “market” for each position, your personal Market Comp is unique and driven by your efforts to identify alternative offers. The only way to use the right Market Comp in your negotiation is to go out to the market, derive that information and communicate it to the company.
Once you have competitive offers, evaluate the equity packages and make thoughtful comparisons between them. For example, based on your appetite for risk and financial considerations, would you prefer options to purchase 1% of a Series A startup with a company valuation of $5 million or 5,000 RSUs of a public company with a current market price per share of $10? How many more stock options would the Series A startup have to offer you to equate to the public company offer? The company cannot make this estimation for you any more than they can decide which company is the best fit for your personality. When you own this process, you can confidently and effectively communicate to your company what is “market” for your equity offer.
Market Comp is also relevant after hire, as the startup job market can shift dramatically over time and new opportunities are always surfacing. As you continually find new information about opportunities, you can continually communicate with your company about what is “market” in defining the right salary and equity for your position.
Bull’s Eye: The Right Offer
With thoughtful attention to these four factors, you can use your negotiation to guide the company to the bull’s eye – the right offer for you. If you see the company using the wrong data, you can bring the conversation back to the truth as you see it and work toward the right outcome.
For more help on these preparations, you are welcome to read the full text of our interview here: The Right Offer – Long Form Q&A Between Stock Option Counsel and BINC Search
Boris Epstein is the founder of BINC Search, a next-generation recruiting startup that helps Silicon Valley companies hire technical talent at the scale they need.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Learn how startups determine the right equity stake offer for new hires.