Equity Should Be Employee-Friendly
Employee equity is often designed from a founder- and investor-centric perspective, and so has many features that that are employee-unfriendly. Partly as a result, a significant number of employees value equity at zero — they’re not willing to trade off salary for equity. They say, “I want a salary of X. If you want to offer equity on top, X + equity, that’s fine, but it can’t be at the cost of X.”
Employees not valuing equity is not in the startup’s interest. But it’s what happens when things are structured in a one-sided way: the other side stops caring. How can we fix that, making equity more employee-friendly?
Equity should vest every month without a one-year cliff. In other words, if I have 1% equity, vesting over four years, a month after joining, I should have 1/48 % vested. Why? I should be paid for this month’s work at the end of the month. If I’m told that the equity I’m working hard for may never vest, I’ll value it at zero. If this sounds like a radical point of view, try telling your phone company that you’ll pay your bill after a year, and that too only if you continue with them after that, and see what they say. Remuneration for work done this month should arrive at the end of the month, not year.
Once my equity vests, I should be able to sell it to investors in the next round of funding, at the current valuation. And investors shouldn’t be able to say no. I should also be able to sell it to anyone on the cap table [1] who wants to buy it from me — other employees, advisors, founders, etc. Once the equity has vested [2], it’s mine, so I should be able to sell it to others, no different from using my salary any way I want. If the company prevents that from happening, then they’re diluting the concept of ownership. If I can’t do what I want with it, it’s no longer really mine emotionally. When things come with strings attached, I tend to dismiss them.
There should be a 10-year exercise window after vesting, so that I don’t have to spend my own money to exercise options before they can sell them.
If a company goes public or gets acquired the day after I join, the entire equity should vest immediately. Why? Because, when I take the risk that the equity is most likely worth zero, it would only be fair to share the happiness if the company does unexpectedly well. Employees of a high-profile startup that got acquired got cheated when they didn’t get a payday. Obviously this destroys trust in startup equity as a whole.
Employees should be given restricted stock and not options, since options have more risk. Startup equity is extremely risky, compared to the stock of a listed company, which itself is risky compared to a diversified mutual fund. But options increase the risk to the max — there’s an even greater chance that your options won’t be worth anything, even if the company gets a financial outcome like being listed or acquired. It’s better to give restricted stock.
Employees should be first among equals: they should be given preferred shares if investors and founders get them. Investors shouldn’t have a liquidation preference that allows them to get ahead of employees in the queue and grab a disproportionate share of the proceeds. Imagine a scenario where you own a certain percentage of the company, and so does someone else. The company gets acquired and the other party gets all the money. Would you consider it fair? Of course not! The best way for investors to turn people off from playing the game is to tilt the playing field in their favor. It’s fine if the percentage of equity I get is small, but the playing field should be level.
Vesting should not require board approval. I’ve earned it, and the board doesn’t get to take it away from me.
When I’m offered equity that doesn’t meet the above requirements, I’ll value it at zero. If they offer a salary X with equity that’s not employee-friendly, I’ll consider the offer to be just be X and ask myself, “Would I work here for X without equity?” If the answer is no, I’ll tell them, “No, X doesn’t work for me. I need Y.”
[1] Ideally anyone, including people not connected with the startup, but selling to people already on the cap table is a reasonable compromise.
[2] Ideally, I should be able to sell the equity before it has vested: I should be able to sign a deal with a colleague where I get some money up front, and he keeps whatever returns the equity generates.