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Startups Should Be Responsible for Explaining Equity to New Employees
When someone goes to work for a larger corporation or public company, the compensation package generally includes an annual salary, a performance bonus or commission plan, 401(k), and health insurance. When someone goes to work for an early startup, the compensation package general includes an annual salary, health insurance, and, instead of fixed-cost performance upside, a percentage of unvested options to purchase equity in the company. Of late, I’ve encountered numerous potential startup candidates and newly hired employees who have no idea what their equity means. I’ve noticed this for years – and experienced it myself – but I’m disturbed at the frequency now and so am compelled to write about it.
It falls on the hiring company to thoroughly explain equity options to their new employees. The concept is a nuanced one that, unless they’ve spent a career in startups or studied econ, new hires won’t have a basis of relevant knowledge from which to draw. Often avoided because they take time and could make an offer package seem less attractive, these discussions ought to be mandated so employees aren’t joining a company with a blanket pulled over their faces.
For startup employees who’ve not encountered equity before, there are resources online that will take you through the specific terms and changes in equity value over the lifetime of an early stage company. Check out Fred Wilson’s Skillshare class on Employee Equity and Brad Feld’s post on Equity Compensation Terms. What’s frustrating to me is that the true value of equity seems to often be skipped over when a company is presenting a comp package. The common statement I’ve heard from candidates is, “They told me I’m getting X-thousands or tens of thousands of options.” Full Stop. To the uninformed, 25,000 shares or 150,000 shares or even 5,000 shares can seem like a lot when your only reference is the stock market. And so, questions that employees should ask (but that employers should proactively volunteer answers to in the first place):
- What’s the total number of issued stock and stock options to date?
- What’s the strike price ($ value per) of the options I’m being granted?
- What’s the company valued at today, and what’s the total invested capital to date?
With this information an employee or potential employee can understand how much their X-thousands of shares are actually worth in ownership and, at least on paper, in dollars against the total valuation.
When joining a startup, the common refrain from everyone on the team is we’re in this together to create something new, amazing, and big. The reasons behind this sentiment are many. A literal one is that everyone sacrifices the security of more money for the opportunity to build a profound idea from scratch and, maybe, share in a potentially tremendous financial outcome. It is either a shady sales tactic or unintended blunder for startups not to explain exactly where each new employee stands in that potential share.
This is not an argument for circulating the entire cap table or compensation calendar. Everyone deserves his or her privacy. But in an industry in which early employees (1-20, 20-100) can make a massive difference in a company’s success or failure, startups owe it to those individuals to be sincere, transparent, and thorough in discussing equity. Don’t go suckering someone into thinking they’ve already made it on the day they sign their offer letter.
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Editor’s note: This post originally appeared on Tim’s personal blog.