Clawback Clause for Startup Stock - Can I Keep What I think I Own?
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Updated October 19, 2020 for a recent clawback event in the news.
Everyone loves a gold rush story about startup hires making millions on startup equity. But not all startup equity is created equal. If a startup adds a repurchase rights for vested shares (a.k.a. a clawback clause or clawback provision) to its agreements, individuals may lose the value of their vested equity because a company can force them to sell their shares back to the company in certain situations, such as if they leave their jobs or are fired prior to IPO or acquisition. Other examples of a clawback clause are forfeiture (rather than repurchase) of vested shares or options at termination of employment or for violation of IP agreements or non-competes.
Image from Babak Nivi of Venture Hacks, who warns startup founders and hires to “run screaming from” startup offers with a clawback clause for vested shares: “Founders and employees should not agree to this provision under any circumstances. Read your option plan carefully.”
How a Clawback Clause Limits Startup Equity Value
In a true startup equity plan, executives and employees earn shares, which they continue to own when they leave the company. There are special rules about vesting and requirements for exercising options, but once the shares are earned (and options exercised), these stockholders have true ownership rights.
But for startups with a clawback clause, individuals earn shares they don’t really own. In the case of repurchase rights for vested shares, the company can purchase the shares upon certain events, most commonly after the individual leaves or is terminated by the company. If the individual is still at the company at the time of an IPO or acquisition, they get the full value of the shares. If not, the company can buy back the shares at a discounted price, called the “fair market value” of the common stock (“FMV”) on the date of termination of employment or other triggering event.
Most hires do not know about the clawback clause when they negotiate an offer, join a company or exercise their stock options. This means they are earning equity and purchasing shares but do not have a true sense of its value or their ownership rights (or lack thereof).
Clawback Clause “Horrible” for Employees - Sam Altman of Y Combinator
In some cases a stockholder would be happy to sell their shares back to the company. But repurchase rights are not designed with the individual’s interests in mind. They allow the company to buy the shares back against the stockholder’s will and at a discounted price per share known as the “fair market value” or “FMV” of the common stock. As Sam Altman (now CEO of OpenAI) wrote when he was the head of Y Combinator, “It’s fine if the company wants to offer to repurchase the shares, but it’s horrible for the company to be able to demand this.”
The FMV paid by the company for the shares is not the true value for two reasons. First, the true value of common stock is close to the preferred stock price per share (the price that is paid by investors for stock and which is used to define the valuation of the startup), but the buyback FMV is far lower than this valuation. Second, the real value of owning startup stock comes at the exit event - IPO or acquisition. This early buyback prevents the stockholder realizing that growth or “pop” in value.
What is an Example of a Clawback Clause?
Famous Example - Skype Shares Worth $0 in $8.5 Billion Acquisition by Microsoft
In 2011, when Microsoft bought Skype for $8.5 billion (that’s a B), some former employees and executives were outraged when they found that their equity was worth $0 because of a clawback in their equity documents. Their shock followed a period of disbelief, during which they insisted that they owned the shares. They couldn’t lose something they owned, right?
One former employee who received $0 in the acquisition said that while the fine print of the legal documents did set forth this company right, he was not aware of it when he joined. “I would have never gone to work there had I known,” he told Bloomberg. According to Bloomberg, “The only mention that the company had the right to buy if he left in less than five years came in a single sentence toward the end of the document that referred him to yet another document, which he never bothered to read.”
Both Skype and the investors who implemented the clawbacks, Silver Lake Partners, were called out in the press as “evil,” the startup community’s indignation did not change the legal status of the employees and executives who were cut out of millions of dollars of value in the deal.
Recent Example - Tanium, funded by Salesforce Ventures and Andreessen Horowitz, claws back employee shares
More recently, Business Insider reported that Tanium, funded by Salesforce Ventures and Andreessen Horowitz, has forced employees to sell their shares back to the company at FMV after their employment is terminated.
The employees interviewed by Business Insider were not aware of that their contract included this clawback when they accepted their offers. “'Surprised' was my initial reaction," one such employee said. "I had not heard of that happening before. To me it felt like a gut punch. One of the reasons for working for the company is dangling the carrot of eventually going public or eventually getting acquired so employees would monetarily benefit from that.”
How Does a Clawback Provision Work?
Hypothetical Example #1 - Company Does NOT Have Clawback Clause for Vested Shares - Share Value: $1.7 Million
Here’s an example of how an individual would earn the value of startup stock without repurchase rights or clawbacks. In the case of an early hire of Ruckus Wireless, Inc., the value would have grown as shown below.
This is an example of a hypothetical early hire of Ruckus Wireless, which went public in 2012. It assumes that the company did not restrict executive or employee equity with repurchase rights or other clawbacks for vested shares. This person would have had the right to hold the shares until IPO and earn $1.7 million.
This is an example of a hypothetical early hire of Ruckus Wireless, which went public in 2012. It assumes that the company did not restrict executive or employee equity with repurchase rights or other clawbacks for vested shares. This person would have had the right to hold the shares until IPO and earn $1.7 million. If you want to see the working calculations, see this Google Sheet.
These calculations were estimated from company public filings with the State of California, the State of Delaware, and the Securities and Exchange Commission. For more on these calculations, see The One Percent: How 1% of Ruckus Wireless at Series A Became $1.7 million at IPO.
Hypothetical Example #2 - Company Has Clawback Clause for Vested Shares - Share Value: $68,916
If the company had the right to repurchase the shares at FMV at the individual’s departure, and they left after four years of service when the shares were fully vested, the forced buyout price would have been $68,916 (estimated). This would have caused the stockholder to forfeit $1,635,054 in value.
In this hypothetical, the individual would have lost $1,635,054 in value if the shares were repurchased at their termination. If you want to see the working calculations, see this Google Sheet.
No Surprises - Identifying a Clawback Clause During Negotiation
As you can see, clawbacks dramatically affect the value of startup stock. For some clients, this term is a deal breaker when they are negotiating a startup offer. For others, it makes cash compensation more important in their negotiation. Either way, it’s essential to know about this term when evaluating and negotiating an offer, or in considering the value of equity after joining a startup.
Unfortunately this term is not likely to be spelled out in an offer letter. It can appear in any number of documents such as stock option agreements, stockholders agreements, bylaws, IP agreements or non-compete agreements. These are not usually offered to a recruit before they sign the offer letter and joining the company. But they can be requested and reviewed during the negotiation stage to discover and renegotiate clawbacks and other red-flag terms.
What is a Typical Clawback Clause?
For examples of typical clawback clause language, see Part 2 - Examples of Clawbacks for Startup Stock.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Early Exercise of Startup 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.
Planning for your startup stock options? Consider an early exercise of stock options to protect your equity stake from taxes and forfeiture.
Most people learn the hard way about the complexity of exercising stock options at a startup. If you can spare a few minutes of attention, this post will teach you about early exercise - the easy street of startup stock option exercise strategies.
Early Exercise Stock Options
An “early exercise” is an exercise of unvested stock options. You pay the exercise price to the company and file an 83(b) election with the IRS before the options vest.
Early exercise makes you the owner of the shares in the eyes of the company. The shares are still subject to the options’ original vesting schedule, though, as the unvested shares can be repurchased from you if you leave the company prior to your vesting milestones. The repurchase price for unvested shares is usually the lower of your exercise price or the fair market value (“FMV”) on the date of termination.
Early exercise with an 83(b) election also makes you the owner of the shares in the eyes of the IRS. That means you start your capital gains and, perhaps, Qualified Small Business Stock (“QSBS”) holding periods, which sets you up for the lowest possible tax rates when you sell your shares.
Tax Benefits of Early Exercise of Stock Options
If you early exercise while your exercise price is equal to the FMV of the common shares, the exercise itself is not taxable and therefore defers all taxation until you sell the shares and have cash gains to use to pay the taxes.
This may seem like overkill on planning, but the tax bill for a later option exercise can snowball surprisingly quickly and make it impossible to exercise vested stock options. More on this here: Startup Stock Options - Early Expiration - The $1M Problem. Early exercise can, therefore, act as a forfeiture-avoidance strategy as it can defer taxes until sale of stock and, therefore, save people from prohibitive pre-liquidity tax bills for exercise.
When to Early Exercise Stock Options
Since options are granted with an exercise price equal to the FMV on the date of grant, it’s a safe bet to early exercise immediately after grant to be sure you can do so without a tax cost.
The most common approach is to negotiate for the right to early exercise in the grant at the offer letter stage, and then join the company and wait a while before early exercising. This allows employees to get some visibility on the company’s possibility of success and their own fit within the company. So long as the early exercise is completed while the FMV is still equal to the strike price, the early exercise is tax free.
If you early exercise (or exercise vested options) after the FMV has increased above the exercise price (such as after a round of funding following your grant date) you will have taxable income on the difference between the FMV and the exercise price in the year of exercise. (The tax rates depend on whether you are early exercising NQSO or making an qualifying early exercise of ISOs.) This might seem unappealing, as you would of course prefer to defer all taxes until sale of stock. However, some people choose to early exercise even if they have to recognize income on that early exercise in order to be taxed at exercise on the current FMV rather than paying higher taxes on a later exercise based on a higher FMV.
Investment Risk of Early Exercise Options
The downside of early exercising startup stock options is investment risk, as you have to pay the exercise price (and, perhaps, some taxes at exercise) out of pocket before you have any visibility into whether the value of the shares will go up in the future. That’s why early exercise is very common and an easy choice at early stage companies where the FMV and, therefore, the exercise price is low. For instance, a first employee might be able to exercise 1% of the company for, say, $5,000. It’s a less obvious choice when the company is at a later stage and the exercise price of stock options is significant. For instance, some startup stock options packages have a $1M+ exercise price.
Some key hires of later stage startups with higher option exercise prices negotiate for the right to early exercise (or exercise vested options) with a promissory note instead of cash. Instead of paying their significant exercise price with cash, they deliver a promissory note to the company. This is a promise to pay the exercise price at some date in the future. There is some complexity to this to address with your advisor if you are considering this path.
Negotiating the Right to Early Exercise Options
Early exercise is not available at every company. Therefore, if you want to early exercise you will need to negotiate for this right during your offer letter negotiation or after you join the company.
For example, some early Uber employees negotiated to add the right to early exercise to their existing stock option grants. This allowed them to early exercise their unvested options (and exercise their vested options) before the FMV of the shares skyrocketed, so that the tax bill for the exercise was only in the tens of thousands of dollars.
Despite the out-of-pocket cost for the exercise price and taxes, this was a wise exercise choice for a few reasons. First, if they had waited and exercised after the FMV skyrocketed they would have had to pay far more in taxes to exercise - in some cases more than $1M. More on that issue here. Second, if they had failed to early exercise and ended up leaving the company prior to the company’s IPO, they would have had to come up with those astronomical tax payments before they had a market to sell the stock. This is because the company had only a 30-day post-termination exercise deadline and an absolute prohibition on sales of stock prior to IPO. Third, many of these employees purchased their shares while the company was QSBS eligible and then held the shares for the 5-year QSBS holding period. This qualified them for 0% federal tax rates on up to $10M in gains on the sale of their shares.
ISOs v. NSOs and Early Exercise Stock Options
If you are early exercising stock options, it is more favorable to have the options granted as NQSO rather than ISOs. If you early exercise ISOs, you have to hold the shares for two years before sale for long-term capital gains tax rates on your gains. If you early exercise NSOs, you only have to hold the shares for one year for capital gains treatment. Therefore, if you are planning to early exercise immediately after the grant, you will want to ask the company to make the grant as a NQSO rather than an ISO.
If you are not planning to early exercise, you may not want to include the right to early exercise in your documents. That’s because of the $100K limitation on ISOs. ISOs are a tax-favored stock option that are subject to certain limits under the tax code. Only $100K in exercise price of stock options can become exercisable in any given year and qualify as ISOs. So if you have a $400K exercise price grant that is intended to be ISOs, all $400K of the options will be ISOs if you do not include the right to early exercise. If you do include the right to early exercise, all $400K will become exercisable in the first year and so only $100K of the options will be ISOs. The remainder will be NSOs which are less tax favored.
Don’t Forget the Section 83(b) Election
If you early exercise unvested stock options, you file a Section 83(b) election with the IRS within 30 days of the exercise. The consequences of a missed 83(b) election can be very, very unappealing. If you don’t have the attention necessary to follow through on that, don’t early exercise.
When to Exercise Stock Options
As you can see, early exercise of stock options is not the best choice in every situation. To learn about the best structures for a variety of cases, see Examples of Good Startup Equity Design by Company Stage. For a comprehensive analysis of when to exercise stock options, see this three-part series:
Part 2: The Menu of Startup Stock Option Exercise Strategies
Part 3: FAQ on the Menu of Startup Stock Option Exercise Strategies
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Silicon Valley Wins Big With Tax Break Aimed at Small Businesses: An eight-figure IPO windfall can mean a zero-digit tax bill
"If you planned well, you ended up with a phenomenal result," says Mary Russell, an attorney at Stock Option Counsel in Palo Alto, Calif., who advises tech employees on their compensation. "If you didn’t, you were in a really tight, messy spot." Photo by Mikhail Nilov.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Startup equity and Stock Option Counsel, P.C. in Bloomberg Business this week:
“While venture investors and founders, who can afford top-notch tax advice, are using [the Qualified Small Business Stock tax provision to take advantage of 0% tax rates on startup gains], tech workers might not be as lucky. The rules are complicated, and it can be easy to miss out. For example, early employees needed to have exercised options at a time when their startup was still under $50 million in assets. ‘If you planned well, you ended up with a phenomenal result,’ says Mary Russell, an attorney at Stock Option Counsel in Palo Alto, Calif., who advises tech employees on their compensation. ‘If you didn’t, you were in a really tight, messy spot.’”
For more information about planning for option exercises, see The Menu of Stock Option Exercise Strategies. Happy strategizing!
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Seed Stage Startup Job Offer - Equity Negotiation Checklist
Working for a Startup? Seed Stage Startup Job Offer Equity Compensation Negotiation Checklist. Image from rawpixel.com.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Have a job offer from a seed stage startup? Individuals work for equity at seed stage startups (otherwise known as early stage startups) with the expectation that they will have great financial success if the company itself is successful. That dream can come true, but it depends on taking care of a few key details of the option or restricted stock at the offer negotiation stage. Here’s the Stock Option Counsel negotiation checklist for seed stage startup offer negotiations.
Percentage Ownership. The lore of Silicon Valley is that anyone who joins an early stage startup that is later a huge success will become rich. But if they fail to negotiate a significant number of shares at hire, they cannot expect that the value of their interest at the time of an acquisition or IPO will be impressive. Since being one of the first startup employees is extremely risky, there needs to be enough equity in the offer to balance that risk. I have seen individuals who are disappointed (to say the least) in these situations when they have accepted a below-market equity percentage and assumed that the founders would “take care of them” in the future. With these points in mind, I recommend taking the following steps before agreeing to join a startup:
Negotiate for enough shares up-front to balance the risk in joining the company. This is based on market norms, so do plenty of research among colleagues and advisors to confidently set market-based expectations.
Insist on time-based, not performance or milestone, vesting.
Expect that the equity interest will be significantly diluted and negotiate for enough shares to cover that expectation.
Making it Official. At the earliest stage startups, employees and founders often work for promises of future equity without signing the necessary paperwork to ensure that they have the legal right to that equity. They often start working with vague promises of future grants and “trust” that their business partners will “take care of them” in the future. This is misguided, as the purpose of a stock option grant or any written agreement is to not have to rely solely on the trust you have in any individual person. Since changes in leadership, investors, direction, etc. are guaranteed to happen at some point in time, you need protection from the company not promises from the current leaders. Before signing an Offer Letter or beginning work, I suggest to first:
Ask for a copy of the Form of Stock Option Grant or Restricted Stock Purchase Agreement, along with any other documents referenced therein. Review the terms and negotiate any issues.
Ask the company to confirm that the board will officially make the equity grant promptly after hire.
Board Approval Timing. Early stage startup companies often delay officially making grants to the detriment of their employees. This is due to administrative disorganization, a desire to delay the legal and valuation expenses of making the grant, or even a disagreement among executives and investors about how much equity should be allocated for employee grants. After starting in the role, take the following steps:
Follow up to be sure the grant is made by the board promptly. This should not take more than a couple of months.
Compare the terms of the grant to be sure they are as-agreed during the offer negotiation stage.
Tax Planning. The potential tax benefits to receiving equity in an early stage startup are unparallelled. The structure may allow for tax deferral until sale of stock - which avoids the problem of paying taxes on option exercise before liquidity - and lower capital gains tax rates or even 0% QSBS tax rates on gains. Achieving these tax benefits requires precise design by the company - such as restricted stock or early exercised stock options - and effective execution by the individual - such as the timely delivery of the purchase price and filing of the Section 83(b) election with the IRS. Early tax planning action items are:
Negotiate the tax structure during the offer negotiation stage. The right structure will depend on the stage of the company, so work with advisors if necessary to determine the most desirable structure for your grant.
Take care of the required follow-through to take advantage of the most desirable tax structures.
Legal Terms. Startup employees are sometimes very surprised by the legal terms in their grant years after they have accepted its terms. They might have assumed that they have the right to hold the shares that they have purchased and vested and find out that the company can forcibly repurchase the shares at their termination. Or they might assume that they have the right to earn their unvested shares following an acquisition but find out that they can be cancelled as part of the deal without payment. To avoid these and other unpleasant surprises regarding the legal terms of a grant, take the following steps during negotiation:
Ask for a copy of the Form of Stock Option Grant or Restricted Stock Purchase Agreement, along with any other documents referenced therein.
Review the terms and negotiate any issues before committing to joining.
If the legal terms have unexpected risks, negotiate for more shares or more cash compensation to balance the risk.
Have an offer from a seed stage startup? Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Have an Offer Letter from a Startup? The Equity Issues are Between the Lines
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Working for a startup? Learn more about the fine print terms of an offer letter. Plan ahead to protect your equity stake.
If you have an Offer Letter from a startup, you may notice that it’s light on information about stock options. You may see a few sentences noting that (1) the company will recommend to the board that the grant be made at the first market value on the date of grant; (2) the option will vest monthly over four years with a one-year cliff; and (3) the option will be governed by the company’s equity incentive plan and your stock option agreement. It sounds simple. But the key issues are hidden between the lines.
Change of Control Protections for Unvested Shares
A standard vesting schedule does not provide protection for unvested shares in the event the company is acquired. If you are joining in a senior position or as an early stage employee, consider negotiating for a double trigger acceleration upon change of control to protect the right to earn unvested shares. The most robust double trigger language would provide that 100% of unvested shares will accelerate if you are terminated or constructively terminated as part of or at any time following a change of control. See this blog post for more information on change of control terms for startup equity offers.
Clawbacks for Vested Shares
The equity incentive plan and stock option agreement are usually not provided with the Offer Letter unless requested, as the official equity grant is not made until after the start date. However, these agreements contain important details about the grant, so it makes sense to review them before agreeing to the number of shares or signing the Offer Letter.
For example, the equity incentive plan and stock option agreement may give the company the right to forcibly repurchase shares from the employee after termination of employment, even if they are vested shares of restricted stock or vested shares issued upon exercise of options. See this post for some examples of how those clawbacks may be drafted. Clawbacks dramatically limit the value of the equity, as the most significant increase in the value of startups has historically been at the time of an exit event. If this term, or any other red flag term, appears in the form documents, it makes sense to negotiate these out of the deal or provide for alternative compensation to make up for the potential loss in value before signing the Offer Letter.
Tax Structure
The Offer Letter may not include the terms of the tax structure, but if you have any leverage on those terms the Offer Letter negotiation is the time to address them. The right tax structure will balance your interests in total value, low tax rates, tax deferral, limited tax risks and investment deferral. This balance is different at each company stage. For example, at the earliest stage startups you may be able to meet all those goals with the purchase of Restricted Stock for a de minimis purchase price. At mid-stage startups you might prefer to have Incentive Stock Options with an extended post-termination exercise period to defer the investment until a liquidity event. At late-stage startups you might prefer Restricted Stock Units for a full value grant. See this blog post on Examples of Good Startup Equity Design by Company Stage and this blog post on The Menu of Stock Option Exercise Strategies.
Grant Timing
The company will set the exercise price at the fair market value ("FMV") on the date the board grants the options to you. This price is not negotiable, but to protect your interests you want to follow up after your start date to be sure that the board makes the grant of the options soon after your start date. If they delay granting you the options until after a financing or other important event, the FMV and the exercise price will go up. This would reduce the value of your stock options by the increase in value of the company’s common stock during that time.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
VIDEO Startup Stock Options: Exercise Price Basics
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
The Good Stuff - Continuation Plans - How To Avoid the Juno Drivers' Fate of Cancelled RSUs in a $200 Million Acquisition
If you're negotiating a startup equity offer, ask for the good stuff - a Continuation Plan - or even more favorable single or double trigger acceleration terms. Photo by Erik Mclean.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Bloomberg reported on startup Juno's rescission of driver’s RSU awards in its $200 acquisition by Gett. They reported that Juno promised 50% of founders shares to drivers, but that it appears that the maximum portion of the acquisition price they could have received was 1.5%.
What was the disconnect? A type of startup equity plan - a Cancellation Plan - that can dramatically limit the value of employee equity grants.
Some startup stock plans allow companies to cancel unvested equity in an acquisition without payment for the shares, even if the employees holding that unvested equity stay in service after the closing of the deal. We'll call these Cancellation Plans. (You can read more on all the variations of change of control terms in startup equity offers here.)
The standard for startup stock plans has historically been that unvested employee equity must be continued or substituted in an acquisition rather than cancelled without payment. We'll call these Continuation Plans. This means they must be replaced with either cash or equity awards with the same value as the deal consideration for the shares being cancelled. If they are not replaced for the deal value, their vesting will be immediately accelerated at the acquisition and paid the entire deal price for the vested and unvested shares. The replacement still must be earned over the original vesting schedule, so there's no guarantee of earning the unvested shares without also having single or double acceleration upon change of control protections. However, this traditional requirement offered protection of value for employees. Those who stay at the acquiring company under a Continuation Plan will continue to earn the deal consideration for their shares in some other form.
The Cancellation Plans that allow cancellation of in-the-money unvested equity without payment are grabbing value from employee shares. Unvested equity - RSUs, options, etc. - can be cancelled and replaced with $0. For example, if an employee's total number of RSUs were worth $200,000 at the acquisition price, and only 50% had vested at the acquisition, the employee would be paid $100,000 and the remaining $100,000 in value of RSUs would be cancelled without payment, continuation or substitution even if the employee stays as an employee after the acquisition.
In a Continuation Plan, an employee would receive the $100,000 deal consideration for the vested shares and 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 acquired company if it survives the merger, or substitute value of the acquiring company's equity, such as RSUs worth $100,000 in value of the acquiring company. Any such replacements would continue to vest over the original remaining vesting schedule.
When Juno, a ride-sharing app which promised 50% of its founders shares to drivers in the form of RSUs, was acquired by Gett for $200 million, they cancelled without payment all RSUs it had awarded and promised to drivers. The merger terms were not made public, but it appears that Juno had a Cancellation Plan allowing the company the right - which they exercised - to cancel unvested RSUs. All RSUs would have been unvested as the drivers reportedly had to work for 30 months to time-vest any of their RSUs and less than a year had passed between the grants and the acquisition.
The drivers instead received a one-time payment, which appears to be dramatically lower than the RSUs would have been valued in the acquisition. It was reported that the maximum portion of the acquisition price they could have received was 1.5%. It's not entirely clear that this is the case, as drivers report that they were never notified of their percentage ownership in the company at the time of the acquisition. But if the paltry payouts - one example was $250 to a driver - were actually at the deal consideration for the deal, it would mean that the original awards were such a low percentage of the company that they would have crossed into absurdity. Therefore, it safe to assume that Juno had a Cancellation Plan and it used it to cut its drivers out of a $200 million acquisition, less than a year after promising its drivers 50% of the company's equity. Ouch.
So if you're negotiating a startup equity offer, ask for the good stuff - a Continuation Plan - or even more favorable single or double trigger acceleration terms. More on those variations here.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Will this Seed Stage Company Become a Unicorn?
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Wondering if your seed stage startup will become a unicorn? Here's a great illustration of your chances from Dustin Moskovitz's presentation, Why to Start a Startup from Y Combinator's Startup School.
Wondering if your seed stage startup will become a unicorn? Here's a great illustration of your chances from Dustin Moskovitz's presentation, Why to Start a Startup from Y Combinator's Startup School.
For more, see the full presentation on YouTube.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
The C-Level View - Fine Print Issues in Startup Executive Equity Grants
Executives joining startups study the equity grant documents carefully for these issues to avoid surprises in the fine print that might limit the value of their equity. Photo by Daniel Putzer.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
For executives trading significant cash compensation for startup equity, the fine print of the equity documents can significantly change the risk/reward profile of the deal. Be on the lookout for value-limiting terms in the Equity Grant Agreements, the Stock Plan and the Certificate of Incorporation.
Equity Grant Agreements
The Equity Grant Agreements and Stock Plan are usually not provided to the executive with the Offer Letter, as the official equity grant is not made until after hire. However, these agreements contain important details about the grant, so it makes sense to review them before agreeing to the number of shares or signing the Offer Letter.
For example, the Equity Grant Agreements may give the company the right to forcibly repurchase shares from the executive after termination of employment, even if they are vested shares of restricted stock or vested shares issued upon exercise of options. This dramatically limits the value of the equity, as the most significant increase in value of startups has historically been at the time of an exit event.
They may also require the executive to agree to future retroactive changes to the terms of the equity. For example, they may include the executive’s agreement to be bound to repurchase rights that might appear in future changes to the bylaws or the executive’s agreement to sign onto exercise agreements or stockholder agreements in the future which may have onerous terms.
If the Equity Grant Agreements have repurchase or other forfeiture rights for vested shares, it makes sense to negotiate these out of the deal or provide for alternative compensation to make up for the potential loss in value. If the Equity Grant Agreements have commitments to be bound by unknown future terms, it makes sense to remove these commitments and have all relevant terms provided up front.
The Equity Grant Agreements will outline the tax structure of the grant and the expiration period for stock options. These can dramatically improve or limit the value of the grant. A well-designed stock option tax structure can provide for Qualified Small Business Stock tax treatment, which allows for 0% federal tax rates on the first $10M in gains. A poorly-designed stock option tax structure can lead to forfeiture of vested shares or a $1M+ tax bill before liquidity to cover those taxes. The key is to understand the proposed structure and negotiate for any changes to make it consistent with the intended option exercise strategy. It might even make sense to re-design the grant as an RSU rather than a stock option.
The Stock Plan
The Stock Plan (otherwise known as an Equity Incentive Plan) can have some of the same red flags addressed above under Equity Grant Agreements. They may also have other onerous terms especially relating to treatment of executive shares in a change of control. The company may reserve the right to terminate, for no consideration, all unvested options at change of control. This could be a significant cancellation of value and could seriously decrease the executive’s leverage in negotiation of post-acquisition employment terms. Also, if an executive has negotiated for favorable double trigger vesting acceleration upon change of control rights, this term could invalidate that benefit, as cancelled unvested options would not be available for acceleration in the event of a post-acquisition termination.
If the Stock Plan has this or other onerous terms, it makes sense to negotiate for modifications in the Equity Grant Agreements or for a grant made outside the Stock Plan with terms crafted for the individual executive. If the Stock Plan has a company right to cancel unvested options at change of control, it makes sense to address this directly in the language of the executive’s vesting acceleration upon change of control term so that the cancellation cannot occur without a corresponding acceleration of vesting.
Certificate of Incorporation
The Certificate of Incorporation will outline some key economic rights of investors, including their liquidation preferences. Executives joining established startups can be misled by their percentage ownership if the investors have significant liquidation preferences, either because of significant fundraising or onerous investor terms. For example, in a company with $50 million investment and outsized investor rights of 3X participating liquidation preference, the investors would take the first $150 million in acquisition proceeds and participate with common stockholders in the distribution of the remaining proceeds.
If investor liquidation preferences are high, it makes sense for an executive to negotiate for significantly more shares to balance the risk or negotiate for a management retention bonus to be earned upon acquisition to make up for the loss in equity value due to these preferences.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Stock Option Counsel's Mary Russell in the New York Times on Liquidity for Private Stock
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
“For start-up employees, the more explicit language around stock prohibitions can create downsides, said Mary Russell, a lawyer based in Palo Alto, Calif., who works with start-up workers to evaluate their equity compensation. When employees leave start-ups, they often have the opportunity to buy stock that has been set aside for them at a low price. But if their start-ups have been successful, they also need money to pay taxes that will be levied on the increased value of the stock.
Ms. Russell said it is not unusual for a client to say their private company stock is worth $3 million, but that they need to come up with $1 million to pay for the shares and cover the tax bill. “In the past, the solution has been to find a third-party buyer and sell enough of the stock to cover all of those costs,” Ms. Russell said.
The use of more explicit language to cover what is and is not allowed could eliminate the option of raising cash from a third party, Ms. Russell said.
She added that employees rarely read their paperwork carefully. “In some cases a company is simply clarifying its terms, but some are making a black-and-white shift to more restrictive terms,” she said.”
See Katie Benner, Airbnb and Others Set Terms for Employees to Cash Out, New York Times
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Quora: Formula for Option Grant Size at a Startup?
Yes, there is a formula for calculating a fair pre-IPO option grant size. Photo by Nataliya Vaitkevich.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
QUORA QUESTION: Is there a generic formula I can apply to determine fair pre-IPO stock option grants based on the company's size and # of fully diluted shares?
I am a tech worker who has spent all of my career with post-IPO companies and am negotiating an offer with a well-established startup of approximately 250 employees. I am not taking on a senior role.
This is a simplified version of part of the process I follow with my Stock Option Counsel clients who are evaluating private company equity offers. It works best with a mid-stage startup which has had a recent funding round from a well-known VC (a.k.a. someone whose investment decision you would trust).
Recent VC Company Valuation / Fully Diluted Shares = Current "Value" per Share
Current Value per Share - Exercise Price per Option = Intrinsic Value per Option
Intrinsic Value per Option * Number of Options = Intrinsic Value of Equity Offer
Intrinsic Value of Equity Offer / Number of Years of Vesting = Annual Value of Equity Offer
Annual Value of Equity Offer + Value of Benefits + Salary + Bonus/Commission = Total Annual Compensation
Use Total Annual Compensation to evaluate the offer or compare to market opportunities.
Certain legal terms may change the risk and, therefore, the appropriate number of shares. For more on ownership limitations, see Ownership - Can the Company Take Back My Vested Shares? For more on how companies decide the right offer for startup employees, see Bull’s Eye: Negotiating the Right Job Offer.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Quora Post: Why Do Companies Use Equity Compensation?
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Mary Russell: Thanks for asking me to answer this. Public companies emphasize equity because it matches pay with overall company performance. If the stockholders are doing well, employee stockholders do well.
Silicon Valley-type private companies emphasize equity because -- historically, anyway -- they were strapped for cash. They can offer employees options to purchase common stock at a discount from the price investors are paying for preferred stock. So employees receive a discount on an unusual investment in exchange for lower salaries.
But in today's marketplace for talent at these private companies, employees are negotiating for higher cash salaries than in the past. I see two reasons for this. First, private companies are having a much easier time raising cash than in years past because of the wider world of investor economics. When equity is expensive, cash becomes cheap. So these companies can and do offer higher salaries. Second, private companies are having to compete with hugely successful local public companies who are aggressively recruiting and retaining talent with impressive cash and equity offers.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
The Gold Standard of Startup Equity - A Guide 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.
Click to view the SlideShare to learn the three standards that define startup equity and three questions to ask to know if you have the real thing.
See this SlideShare to Learn the three standards that define Startup Equity and three questions to ask to know if you have the real thing.
1. Ownership - “Can the company take back my vested shares?”
2. Risk/Reward - “What information can you provide to help me evaluate the offer?”
3. Tax Benefits - “Is this equity designed for capital gains tax rates and tax deferral?”
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.
Negotiating the Right Job Offer – Long Form Q&A Between Stock Option Counsel and BINC Search
Read the full Q&A between Mary Russell and Boris Epstein. It’s full of insights on how to negotiate the right compensation offer from a startup.
Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. She is an attorney and the founder of Stock Option Counsel.
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.
Thanks for reading our shorter blog post: Bull's Eye - Negotiating the Right Job Offer. This is the full Q&A between Mary Russell and Boris Epstein. It’s long, but it’s full of lots of insights on how to negotiate the right compensation offer from a company.
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.
Mary Russell, Attorney @ Stock Option Counsel: Welcome, Boris. I’ve always enjoyed our discussions on compensation negotiations because you seem to believe that a candidate and a company can discover a “right offer.” Employees who come to me for Stock Option Counsel want to get to that “right offer” for salary and equity, and I’m happy you’ve joined us to share your perspective on how to get there.
Boris Epstein, Founder @ BINC Search: Thank you. I think there is a right offer in a compensation negotiation, and companies and candidates arrive there by identifying four data points:
1. The candidate’s Past Comp
2. The Peer Comp of the candidate’s level within the company
3. The candidate’s Desired Comp and
4. The Market Comp or competitive scenarios in the market
The epicenter of all the different data points would be what they would arrive at to get a right offer. So if all four numbers align, it’s really easy. If the four numbers are divergent in some way, then someone’s going to have to make tradeoffs and concessions. If the person’s making $100,000 but then they want $200,000, and market’s $150,000, someone’s going to have to make a tradeoff somewhere to arrive at the right package.
Stock Option Counsel: Let’s talk about each of those numbers.
BINC Search: For Past Comp, the company will look at the person’s situation to figure out what the offer would realistically have to be in order for it to be correct or acceptable. For Peer Comp, usually a company will look at internal equity, the peer class that the person would fall within at the company. Desired Comp would be what the person wants. Regardless of all the other indicators – it’s the “this is what I want” number. Market Comp would be the company’s understanding of what’s “market” for this type of individual and this person’s competitive scenarios or other offers.
Stock Option Counsel: Thanks. I think that gives candidates some information to broaden their sell and build their negotiation beyond a single data point. I’ve seen candidates who fear that their weakest points – their Past Comp as current salary or their Market Comp as lack of other offers – will define their final offer. But this conversation is a great reminder that there are many relevant numbers and many ways candidates can sell themselves. Let’s go on into the details of how the company finds the right offer.
Past Comp
Stock Option Counsel: On Past Comp, candidates often want to stick to the rule of, “Don’t reveal your current salary.” How can a candidate communicate Past Comp without starting out at a disadvantage?
BINC Search: I think a candidate should be stating their Past Comp up front when asked. This would be at the beginning of a process, if and when asked by the company. And then if and when asked by the company they should be divulging their either desired range or at least expectations for comp up front as well. And then it doesn’t need to be discussed until both parties know they want to work together. So I don’t agree with that rule of thumb about not divulging comp up front.
Stock Option Counsel: So how does Past Comp go into the company’s calculation? Are they just going to say, “Oh, you’re making that. So we’ll pay you a little bit more than that”?
BINC Search: Sometimes, yes. It’s a data point, that’s an important kind of measurement of you – you who are asking to be priced – was previously priced. That’s exactly what your Past Comp is. It’s a data point that tells a company how you were previously priced. That then becomes an indicator for how to determine your next package.
My recommendation to candidates is to be open and transparent with regards to comp. I’ve had debates with candidates about this and the common reason to not share comp is because that might hurt their ability to derive an offer. Whereas a company would typically look at someone who did not want to divulge comp as a candidate hiding something. So that that then surfaces as a different red flag that then becomes another topic of discussion – “What’s the person hiding? And why doesn’t the person want to share. Everyone else shares. What should I now be concerned about that I wasn’t previously concerned about?”
Stock Option Counsel: Is it really seen that negatively?
BINC Search: I’ve seen companies not extend offers to candidates who didn’t want to disclose comp.
Stock Option Counsel: So assuming the person is going to disclose it and fears it will lower their final offer from the company, what’s the way to make the case for why that data point is no longer the key relevant data point?
BINC Search: I think the means by which it is shared is the exact way to do it. Let’s say you worked at a company for ten years and you got an initial offer for $100,000 and then you didn’t get a raise for ten years. So then the company says your potential future employer says, “Hey, what’s your Past Comp?” And you say, “Well, it was $100,000. But I should let you know that I was offered this salary ten years ago and I haven’t gotten a raise in ten years. My understanding would be that market has shifted a little bit in the last ten years and that part of this process is to kind of figure out to what degree that has actually happened. So I’d just like you to know that wherever you’re taking these notes, that this was an offer that was given to me ten years ago. And now we can use it for whatever purpose you guys want to use it for.”
Stock Option Counsel: Can you think of any other ways to build the case that the Past Comp should not determine the right offer for the new position?
BINC Search: Whatever color you could add to the picture I think would be a helpful addition. That’s what the company’s looking for when they ask for Past Comp. They’re looking for some sort of data point to help them get to a decision. They’re not trying to screw you. They’re not trying to make a case to like drill you down or whatever. They’re trying to figure out the right offer so it’s helping them for a candidate to add color to it. Sometimes people add color like, “My current salary was $100,000, but I was given that a year and a half ago. I’m up for review in six months. I’m anticipating a raise to $110,000 – my manager promised me I swear – so I’m at $100,000 now but I’ll probably be at $110,000 in six months. Take that for whatever you want to take it for. That’s my comp history.”
Stock Option Counsel: That sounds really useful in using spin to avoid being tied to an otherwise disadvantageous Past Comp number. From a Stock Option Counsel perspective, I would see a candidate’s spin of Past Comp should include their valuation of their equity stake in their current company, the value of upcoming vesting they would be sacrificing to take the position and even the value of upcoming increases in equity grants or liquidity opportunities.
Peer Comp
Stock Option Counsel: Do you have any thoughts on Peer Comp, as in what is the best way to position oneself in that regard during the interview process?
BINC Search: For Peer Comp, companies internally are going to say, “Ok, this person who I just interviewed is going to fit in at this level, and the other people within our org that are paid at this level are making about this much. So therefore, this is about the range within which this person should be paid here.”
A candidate should be making sure that they’re being connected to the right peer class. They do this by just asking for some perspective around where they’re being considered, like where they’re fitting within the organization and what the expectations are for that level of a person. If I’m a fresh college grad and I ask that question and the company is comparing me to people with ten years of experience, that’s good because if I do well I’m going to get paid like people with ten years of experience. But if not then I may be put into an inaccurate peer class. That’s an extreme example, but making sure you’re being compared to the right peer class is a data point.
Stock Option Counsel: I know people are very concerned when they come into a company that they’re being considered for a position that’s appropriate for them and where they want to be. What do you advise people when they’re concerned that they’re not being considered in the right peer class? Once that emerges, is it too late, or can they make the case later and say, “Hey, let’s reconsider where I would fit in here.”
BINC Search: You can, to whatever degree it’s reasonable to do that. Information is going to drive that, so whatever information the company has to help the candidate understand why and where they’re fitting in is going to be one side, and the other side is going to be whatever information the candidate has that can help the company understand kind of where and why they should be there. So that’ll just be kind of the natural progression of the conversation.
Stock Option Counsel: Where and why would it be reasonable to go back and do a better job of selling oneself?
BINC Search: Well, the company may say, “Well, we’ve interviewed you, and we think you’d be a great fit on this team and on this level.” And the person will say, “Oh, that’s really nice. One thing that I wanted to bring up is that I heard about this team and this opportunity and I thought that might be a good place for me to fit potentially. That seems interesting.” So that would be the way a natural dialogue might go. Depending on what side and to what openness the company might say, “That’s good that you think that, but this is where we think you should be and why.” And the candidate will say either, “I’m open to both,” or they’ll say, “It’s nice that you think that, but this is where I want to be.” And there will be a discussion around it.
Stock Option Counsel: Do you have any advice for people on how to talk themselves up in an appropriate way and in a true way? This would be necessary to align themselves with the right peer group in the company and get themselves put in the right place for who they are and what they offer. I think that the worst thing would be to take an offer where you’re not valued and then just be stuck there for a while and then leave.
BINC Search: Yah, but then think about the other worst case of being leveled too high. And then having an inappropriate amount of expectation put on you that you’re not ready for. And you got that because you negotiated really well and sold yourself high, but now you’re in this job that you can’t do essentially. Right? So that’s the other side of the coin for like negotiating too high or for or asking for too big of a job.
I’d argue that the right resolution is to fight for clarity and understanding of roles and levels and opportunities and just be pretty true about where you can fit and add the most value. And try to be as eloquent and clear about that as you can be. So I’ve seen both sides, people who are under-leveled and then have to be popped up quicker and then people over-leveled and then it being a negative experience for both sides.
Stock Option Counsel: If someone’s selling themselves into a higher spot and the company settles on a lower spot, is it fair for the company to say, “We’ll reevaluate in six months or a year”?
BINC Search: That’s a reasonable concession that could be made. Like, “Hey, I understand that you want to be at this level. Our evaluation has not helped us believe that you’re there right now. But I appreciate your confidence. Why don’t we start you here, and in six months we can reevaluate you and if what you say is correct, then we should all have no problem helping you get to that level.”
Stock Option Counsel: Excellent. We’ll talk more later about how to approach those raise or promotion conversations.
Desired Comp
Stock Option Counsel: Can you give some examples of professional ways to communicate Desired Comp?
BINC Search: Usually it’s in the form of a conversation. Like the company will say, “Hey, what are you making right now?” And the person will say, “I’m making this.” And then the company will say, “What do you want to be making in your next job?” And the person will say, “This is what I want to be making.” And then if there’s alignment from an expectations perspective, then everyone thanks each other and moves on to the next topic.
That’s the way it should go. I don’t know how it always goes. Some companies never ask, and then sometimes it works out at the end and sometimes they get surprised and then that’s not a good thing. Sometimes candidates offer the information if the company doesn’t ask. And the company will thank them for it and then move on. Sometimes candidates will share this information or it will be discussed and then the company will decide to not move forward based on a misalignment. I guess those are a few scenarios that could take place.
Stock Option Counsel: You’ve mentioned that it’s difficult when a candidate doesn’t know what their Desired Comp is – when they’re at the end of the road and still don’t know what it is that they want. And Desired Comp is a big part of my Stock Option Counsel practice as a thoughtful, high-level understanding of the company’s equity helps candidates identify what equity offer they want to see. What do you suggest to help people identify that Desired Comp number?
BINC Search: There’s two points where Desired Comp is important. Up front in the beginning of a process you want to at least have an idea. It’s difficult for a candidate to know exactly what they want up front. Because their market experience is going to influence what they should want. So be up front before a candidate goes through an interview process if they’re making $100,000, it’s difficult to say I want $115,000. Some say, “This is what I want.” But then that’s immaterial because when they go through an interview process market is going to influence that potentially.
Whereas at the end after they’ve done a reasonable amount of due diligence on the opportunities they are considering, they should be able to start putting price tags on different opportunities should they work out. That’s the natural exercise that candidates should be going through. “Okay, this is starting to get close to home, what would they need to offer for me to accept? What would this package need to look like? What would it realistically take for me to leave my job?” It’s when things start to get realistic that they should start to be narrowing down to a Desired Comp.
Stock Option Counsel: So would you say that Desired Comp question would be “What does it take for you to leave your current job?”
BINC Search: Everyone has a “what’s this worth to me” scenario. They just need to understand kind of what it is. So Desired Comp is like, “What it would take for someone to not do something and in exchange for doing something?” So if someone’s making $100,000 a year now at a crappy job, and then they interview with a really good job, then the theory should say that for an equal amount of money they would rather be doing a better job than a worse job. That’s like a simple stupid way to come up with a Desired Comp.
Stock Option Counsel: Stupid is good. Go on.
BINC Search: If they’re at a job that they absolutely love and they’re making $100,000, and they interview with a job that is slightly less desirable, that slightly less desirable job would probably have to pay them. Let’s say the slightly undesirable job said, “We’ll pay you $200,000 a year.” Then the candidate says “Wow, okay, I’ll be doing something I like less, but I’ll be getting paid more. Therefore, that equation makes sense for me and my lifestyle. It’s now worth it for me to move forward.” So both are extreme situations, so in this instance in the case of coming up with a Desired Comp, it’s “What’s it worth to me to do this job?” And that’s as kind of pure and simple as a candidate should think about it given whatever circumstances exist in the world.
Stock Option Counsel: Do you have any examples of people who make that decision and are happy with it in that analysis? Or people you’ve seen overvaluing the salary or comp and not thinking enough about the position? Or people who were eventually unhappy because they were thinking too much about the position and not enough about the comp?
BINC Search: I generally recommend that people separate the money from the job when they’re going through their consideration process. Offers and comp packages confuse interest in job. So I always recommend that a candidate evaluate the job first, figure out the job they actually want, stack rank their options, and then start including comp into the equation. If they get the best job at the best comp, it becomes a no brainer. If they get the best job at a reduced comp, they have to make a tradeoff. But at least it’s clear. It’s like a separate kind of line item that they could evaluate.
You also asked about times when candidates have made mistakes. This is where market and transparency and chatter becomes a thing because the candidate feels they did a great job in-- let’s say-- negotiating an offer and then they hear that someone who seems to be a peer or close to their regard is getting something more than they are getting. There is that kind of look over the fence sort of a thing that goes down. They ask, “Hey, how did you get that? Why didn’t I get that?” I try to recommend that candidates don’t go down that route once it’s past decision point. If it’s past decision point, it’s difficult for a candidate to do much about it. It really just causes angst. But it’s a hyper-transparent market. So you do the best you can given the information you have and you should be at peace with your decisions until the next time.
Stock Option Counsel: I agree on separating the desire for the compensation from the desire for the job so that the compensation issue gets the full attention it requires. That’s especially important with equity compensation. There’s quite a lot of risk in accepting private company equity, and my Stock Option Counsel clients who take the time to thoughtfully evaluate their equity comp offer can find out: “Is this number of options or shares enough to inspire me to feel really, really good about taking those risks? If not, what would they have to offer to get me to that good feeling?” It’s a lot easier to negotiate from a position of confidence about what you desire and why.
Market Comp
Stock Option Counsel: How do you suggest candidates avoid being in the position where they’re looking over the fence and seeing that their neighbors are earning more than they are?
BINC Search: Well, you can’t avoid it. At the pace that this market is moving, there are always going to be better options, there are always going to be new options that surface that didn’t exist two days ago when you had to make a decision. It’s just generally going to happen. That’s why time of employment has started to go down. It used to be five years, then it was three years, now we see companies being open to hiring someone on a full time basis knowing that in a year or a year and a half they’ll reevaluate their options. That’s just what’s happening with the market. So companies make decisions based on the information they have, and so do candidates. There’s nothing you can do to not go through that experience.
Stock Option Counsel: Do you have a feeling on how quickly that shift in time of employment has happened?
BINC Search: Seven to ten years ago, five years used to be good tenure at a company. Then five to seven years ago, three to five years was a reasonable length of time. Now I think two to three years would be considered – not reasonably long term – but the reasonable expectation by which a candidate makes their employment decisions. While companies would love for their employees to retire with them and be with them in ten years, I think a lot of companies have a hard time knowing where they will be in five years or ten years or whatever time frame it is they want their employees to be with them. So I think everyone is in constant reevaluation. Everyone – companies and candidates – are in a perpetual evaluation of their situation mode, which generally makes for a great dynamic market in my opinion. It puts everybody in a place of accountability. Employers for their ability to employ and retain, and employees for their ability to perform and deliver, which is I think correct.
Stock Option Counsel: Interesting. Time of employment is also very relevant to equity compensation. If candidates are accepting four-year vesting terms in their stock options or are receiving stock options with high exercise prices, they need to be aware that they may not be vesting the full grant before departure and that if they leave the company they may have to come up with the cash to cover the exercise price and tax bill.
Going back to the question of Market Comp, do you have any thoughts on the best way to approach a current employer to reevaluate comp or talk about a raise?
BINC Search: Reevaluation of package? I think that the truth is that anytime there’s new data to be presented is a reasonable time and opportunity to have a conversation around comp. So the way this tends to infuse itself in the world most commonly is a candidate gets employed by company with the belief that he’s going to be there for three years. And then six months into it someone happens to call him and offer him a job for double the price. And then the person all of a sudden is victim to this huge offer and now wants to “do right” by this situation they’re in. So this person goes to their boss and says, “Hey, I didn’t mean to do this, but I have an offer for twice my salary now because this happened. So I just wanted to tell you.” So then the current employer says, “Oh, let us see if there’s something we can do to help.” And then there goes the counteroffer situation. That’s natural and what happens pretty regularly in today’s market. So anytime a new data point surfaces that would be worth reopening a comp conversation would be when it should happen.
Stock Option Counsel: The classic relationship wisdom is that you’re bound to be stuck in a bad relationship if you don’t have the courage to say along the way, “Hey, you know this or that isn’t working for me.” Do you think that those people who fail to keep bringing the data points forward to their employer end up angry and frustrated with their low comp?
BINC Search: Yah, there are people who don’t feel comfortable sharing this information and then kind of perpetuate the misery that they’re in or perpetuate the unhappiness that they are in. Yah, there are definitely people who are in that boat.
Stock Option Counsel: Do you want to talk more about that?
BINC Search: No, I honestly don’t really. People should do whatever they feel is right to do. For some people it’s worth it for them to keep their mediocre job with mediocre comp because that’s what’s fitting for their lifestyle. And then other people feel the need to go maximize their opportunity. I think it all evens out in the end. I don’t think people must go and chase top comp. I don’t think people must always be benchmarked to top of market.
Stock Option Counsel: How do employees make the case for what is Market Comp for their contribution? Generally, how do you describe Market Comp to your candidates?
BINC Search: This is a tough one. Market is when you usually derive competitive situations. That would be like a “market rate.”
If you go interview with five companies and all five companies extend you an offer for $150,000, it could be argued that your market value is priced somewhere around $150,000. If you’re making $100,000 now and all five companies offer you $250,000, regardless of what you’re Past Comp is, your market value is about $250,000. So whatever you’re able to kind of able to get from the market is about what market rate is for you.
Stock Option Counsel: Do you want to flush out what a market is?
BINC Search: Literally a market is like, picture an old world market where you walk from stall to stall and every stall is selling something. So if you have a product, and the product is a Snickers bar. And you walk around to 20 different stalls and say, “How much would you pay for this, how much would you pay for this?” And everybody says, “I’ll pay you a dollar.” Then that Snickers bar is worth a dollar. That’s “market” for that Snickers bar.
If you walk around to 20 different companies and ask every company, “How much would you pay me to work here?” And every company says $150,000, your market is $150,000. You may not like it, but that’s what market is for that person.
Stock Option Counsel: Of course that wouldn’t be realistic, as $150,000 is not going to come from every company. So how does it work in the real world now where there’s a lot of variation.
BINC Search: I don’t think there’s as much variation as people perceive there to be. I think the variation comes from the mis-bucketing of market points. So seed funded startups tend to pay pretty consistently. A-round funded startups tend to pay pretty consistently. And down the line to B-round funded startups, etc. So depending on the size and maturity of a company, there tends to be a reasonable amount of consistency with those types of companies. So if you interview with ten big companies you’re going to find there to be some reasonable level of consistency with that bucket of companies. There could be companies that are out of market for what a big company pays this type of individual. But there is a market for a type of person within a type of company.
Stock Option Counsel: I’ve heard employers argue that there is no such thing as market or that this is too subjective of a number to discuss. Can you talk about how the employees can identify what those points are? How do they know they have it right?
BINC Search: How do they know what market is? The only way to know is to actually go to the market and try to derive that information. They either have to collect that by going out and getting offers themselves or they have to collect data from their friends who got offers. But they should take that with a grain of salt because they are not their friends. That is a way to do it. Some people will go look at comp calculators online. I advise against using that as fact, but it is a data point. I don’t use any of them or endorse any of them. It’s not something that I would use to help determine any of this. But a candidate can to get some kind of idea of what some type of job is paying.
If a candidate interviews in the dark, then they don’t know what the market is. They wouldn’t know what it is. They may ask the recruiter what market is. They may ask another professional, like yourself, what market is. Getting some sort of sense of market is the only way they can get that data.
Stock Option Counsel: That’s great. What are you thoughts on equity comp and market? When you have a candidate who is interviewing and comparing equity comp, what kind of thoughts do you share with them on what’s appropriate for which stage of company? What do you say when someone asks you, “Is this right, is this fair, is this market for equity comp at this stage of company?”
BINC Search: In the position that we’re in, we have the luxury of being pretty connected to market. So we can give a candidate a pretty good idea of how on target – low on target or high something is in comparison to their position in the type of company. Same would go true for equity. We can recognize that and then advise accordingly.
How would a candidate figure that out? They would have go to through the same exercise. They have to use their Past Comp, if they have historically received certain sized grants or option packages from different companies, then that should be an indicator. They should be educated by the company around how the company benchmarks their level internally for that piece of the comp package for the Peer Comp. And then they should do their market homework.
Stock Option Counsel: I think Market Comp and comparing offers is where Stock Option Counsel and thoughtful attention to equity are essential. One percent of a Series A company and ten percent of a Series A company could be of equal value – “Market Comp.” I advise clients to take the time to evaluate and compare the equity offers and really own this process, because the companies are not able to make these evaluations for them any more than they can choose the right job for a candidate.
Do you have any final thoughts that you’d like to share?
BINC Search: I don’t know if I offered enough magic bullets. I don’t know if the goal of this is to have a magic bullet or to just perpetuate the conversation.
Stock Option Counsel: I think the goal is just to talk about things that are true. There’s much fear in compensation negotiations and people seem to feel they’re working against a secret formula or system that’s being used against them. It’s good to hear some truths about that system from someone who deals with this every day and say, “This is how to approach it and stand on the ground to be true and honest and effective.”
For the concise version of this conversation, see Bull’s Eye: Negotiating the Right Job Offer.
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.