Guest author Rob Leathern was the founder of Optimal.

Please Educate Your Startup Team About Equity

I believe that the uncertainty around stock options and equity at startups often works unfairly—to the company’s benefit. 

As founders and CEOs, we don’t create a safe environment for very smart, technical people to not get embarrassed asking what seem like elementary questions about equity. We startup founders worry—wrongly—about being overly transparent. That makes us get defensive. I’ve made mistakes and done it too. 

But transparency on company valuations and financing terms also needs to not be reactionary, and to be paired with proactive employee education.

Beyond Cut-And-Paste Legalese

Companies like eShares now providing a better solution for startup employees to see how much equity they have than getting a cut-and-paste email from founders culled from an unwieldy lawyer-provided spreadsheet of stock grants and shares outstanding. 

But many startups still play “hide the ball” on valuation and equity terms during the recruiting process, and most companies still do little or nothing to make equity a better-understood trade for employees.

I wrote “10 Startup HR Ideas for Founders” late last year with some thoughts from my first 5½ year stint as a startup CEO. One of the most important points I made there was that startups owe it to their teams to educate them about equity, both in general and for their company specifically.

One issue too is the short timeframe given to employees to exercise when they leave—often just 90 days. Pinterest announced it would give employees seven years to do so, and I’ve since encouraged companies I’ve been involved with to extend exercise windows to a minimum of 2 years, especially if they are not issuing incentive stock options. (Incentive stock options, or ISOs, have different tax treatment than nonqualified stock options, or NQSOs—but that’s a topic for another post.)

At Optimal, one of our earliest engineers decided to leave the company in February 2011 to join a bigger company with a better base salary, and didn’t exercise their vested shares, which would have cost about $2,760. Because they were ISOs, they wouldn’t have had any immediate tax consequence to exercising, and in 2013, when we sold the business, those shares would have been worth about $83,000. (I consider our outcome quite modest by comparison to what some startups have achieved.)

 My cofounder and I tried to encourage the engineer in question to figure out some way to come up with the money to exercise, and we offered to extend the window three more months, but the engineer still chose not to exercise the options.

Most equity grants have a 12-month cliff—meaning you don’t get any credit for staying less than a year. My position is that if a resource-and-cash-strapped startup lets someone they consider “undeserving” of equity stay that long, the issue is with their management, not the employee. Don’t try to claw these shares back, in other words.

Finally, remember that the company’s current valuation and the percentage of the company an options package represents if exercised don’t give a complete picture. Liquidity preferences, particularly for early investors, can dramatically alter how much employees end up making. To help employees understand this, I recommend Dan Lopuch’s Venture Dealr, a visualization of what can happen as a company raises money.

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