Well, remember that equity is typically either completely worthless, or worth an enormous amount. That is: You can either cash out for incredible sums of money (after an IPO for example), or just sit on your illiquid equity that can't be sold even if there was a willing buyer.
In the unlikely event that your equity is EVER worth anything, the difference between 0.1% and 1% and 10% is the difference between you being super-rich, or super-duper-rich, or super-duper-mega-rich. Not a meaningful difference for many, as far as the incentive structures go.
Keeping the slices small allows the company to scale out and make sure that dozens or hundreds of its early employees will become very wealthy when the IPO happens. In many people's eyes, this is better than having a smaller early team get even richer. If the first 100 people all get 0.1%, you've only given out a total of 10% of the company, but every single one of those people are gonna be ridiculously wealthy in an IPO, and so you can motivate an entire early team that way...and increase your overall likelihood of hitting that payoff some day.
In the unlikely event that your equity is EVER worth anything, the difference between 0.1% and 1% and 10% is...Not a meaningful difference for many, as far as the incentive structures go.
Only if you're a financial moron. Even "IPO" doesn't mean Facebook money 99.9% of the time. If you're fantastically lucky, and the company you work for pulls of a $100M IPO, the difference between 0.1% and 1% is the difference between $100,000 (a nice bonus) and $1M (a nice nest egg). And that's if it's not been diluted (and it will be).
More likely, your company will fail (you get nothing) or get acquihired for $10M cash, at which point the difference between 0.1% and 1% is the difference after vesting between $10,000 ("yikes, will I even have anything after taxes?") and $100,000 (a nice bonus).
Seriously, if you're a developer thinking about working for a start-up, do yourself a favor and take half an hour to read the following two articles:
As much as I appreciate being called a "financial moron", I think you may have missed the point of my comment. The whole point, in regards to OP's question, is that equity is SUPPOSED to motivate a team to get to Facebook levels.
If you took 10m of funding and exited for 100m your VCs will NOT be happy, they need you to hit it out of the park to balance out all the losers in their portfolio. Similarly, your engineers who are taking less-than-competitive wages should not be happy, your founders should not be happy. Everybody's interests should be aligned, and focused on getting spectacular returns, not simply good ones.
We're saying the same thing. It's either worth a TON of money, in very very rare cases, or it's really not worth considering as part of your compensation package. Getting even a 6-figure cashout after taking a 5-figure paycut for 10 years isn't necessarily even a break-even for you. You might have LOST money on that deal. As such, the equity is NOT there (and shouldn't be interpreted) as a cash-like form of compensation. It is not that. It is motivation for you to get the company to Facebook status. That's all it is. So, back to OP's question: why give so little? Because if the company gave you more, you would be tempted to build a 100m company, and that's just not gonna cut it. Instead, many companies would rather motivate a larger group of people to want it to be a Facebook-level enterprise someday.
No, we're not. You're saying that there's little difference between 0.1% and 1% equity, since a big exit is a low probability event.
I'm saying there is a big difference between 0.1% and 1% equity, precisely because a big exit is a low probability event. One (0.1%) is almost always meaningless, the other (1%) can be meaningful in several different scenarios.
However, if you want to emphasize the motivation part of the arrangement, founders need to realize that offering an early engineer 0.1% or (God forbid!) 0.05% will have exactly the opposite effect that what they intend. The engineer will see people doing much less than s/he is to grow the company given 5% or 10%, and s/he will feel resentful and underperform. If you're a founder and you're giggling because you've hired this pretty good engineer for a low salary and only gave up 0.05% equity, then you're giggling at yourself, because your engineer hire will work resentfully for a few months and then run and grab the first reasonable job offer that presents itself, right at your most critical hour.
So founders need to either award their first engineer or two a reasonable amount of equity, or just forget the whole thing. But realize that if you chose that route, you'll obviously need to offer a market salary to recruit even remotely-qualified candidates.
Equity allocation is not about the VC's interests to a first approximation in the same way that getting VC funding is not a marker of success for a company, just a milestone. A founder's double digit percent of a $80 million exit is a good exit. And if each of four founders gets 18% or each gets 14% because there was an additional 16% allocated to equity for hiring doesn't change that qualitatively.
When a company is structured and run primarily for the interests of VC, shared interests have already flown the coop and it's about picking through the bones hoping for some meat.
I would say that's exactly right. Unfortunately, it's almost always framed as compensation. Which I think is ridiculous...since you have such a low chance of getting value out of it at all.
Which if I wanted my values "aligned with the vc' I should be getting 2-5% as the first engineer. The VC puts in money, I put in life. I already went down this route and turned them down. If they are low balling you, roll on and start your own thing or consult.
At a $1 billion exit an undiluted 0.1% is $1 million pretax. Exiting at $1 billion is a VC sized homerun. $1 million pretax is not super rich. In the US, once taxes are paid it doesn't even make a person an accredited investor.
The opportunity cost of the 0.1% should be seen relative to things like a controlling 30% at a $5 million exit and similar exits unattractive to VC.
There seems to be a fallacious premise that the size of an equity grant is inversely proportional to the odds of a massive exit.
This doesn't really explain the value proposition to the employee, though. It seems like the only reason someone would take these deals is because they have some sort of fantasy about working at a startup, or really prefer the environment to the point of working 50% more for 50% less pay per hour. I mean, I definitely see the pros of working at a startup, but I value my time, income, and low anxiety levels tremendously more than I value having a bit of extra freedom in my job.
The startup industry and the game industry both share traits with the Hollywood casting couch in terms of filling positions. Which is not to deny that so long as everyone is an informed consenting adult, there's nothing wrong with it.
Comments
Well, remember that equity is typically either completely worthless, or worth an enormous amount. That is: You can either cash out for incredible sums of money (after an IPO for example), or just sit on your illiquid equity that can't be sold even if there was a willing buyer.
In the unlikely event that your equity is EVER worth anything, the difference between 0.1% and 1% and 10% is the difference between you being super-rich, or super-duper-rich, or super-duper-mega-rich. Not a meaningful difference for many, as far as the incentive structures go.
Keeping the slices small allows the company to scale out and make sure that dozens or hundreds of its early employees will become very wealthy when the IPO happens. In many people's eyes, this is better than having a smaller early team get even richer. If the first 100 people all get 0.1%, you've only given out a total of 10% of the company, but every single one of those people are gonna be ridiculously wealthy in an IPO, and so you can motivate an entire early team that way...and increase your overall likelihood of hitting that payoff some day.
Only if you're a financial moron. Even "IPO" doesn't mean Facebook money 99.9% of the time. If you're fantastically lucky, and the company you work for pulls of a $100M IPO, the difference between 0.1% and 1% is the difference between $100,000 (a nice bonus) and $1M (a nice nest egg). And that's if it's not been diluted (and it will be).
More likely, your company will fail (you get nothing) or get acquihired for $10M cash, at which point the difference between 0.1% and 1% is the difference after vesting between $10,000 ("yikes, will I even have anything after taxes?") and $100,000 (a nice bonus).
Seriously, if you're a developer thinking about working for a start-up, do yourself a favor and take half an hour to read the following two articles:
1. http://rob.by/2013/negotiating-your-startup-job-offer/
2. https://michaelochurch.wordpress.com/2013/06/23/heres-the-pr...
As much as I appreciate being called a "financial moron", I think you may have missed the point of my comment. The whole point, in regards to OP's question, is that equity is SUPPOSED to motivate a team to get to Facebook levels.
If you took 10m of funding and exited for 100m your VCs will NOT be happy, they need you to hit it out of the park to balance out all the losers in their portfolio. Similarly, your engineers who are taking less-than-competitive wages should not be happy, your founders should not be happy. Everybody's interests should be aligned, and focused on getting spectacular returns, not simply good ones.
We're saying the same thing. It's either worth a TON of money, in very very rare cases, or it's really not worth considering as part of your compensation package. Getting even a 6-figure cashout after taking a 5-figure paycut for 10 years isn't necessarily even a break-even for you. You might have LOST money on that deal. As such, the equity is NOT there (and shouldn't be interpreted) as a cash-like form of compensation. It is not that. It is motivation for you to get the company to Facebook status. That's all it is. So, back to OP's question: why give so little? Because if the company gave you more, you would be tempted to build a 100m company, and that's just not gonna cut it. Instead, many companies would rather motivate a larger group of people to want it to be a Facebook-level enterprise someday.
No, we're not. You're saying that there's little difference between 0.1% and 1% equity, since a big exit is a low probability event.
I'm saying there is a big difference between 0.1% and 1% equity, precisely because a big exit is a low probability event. One (0.1%) is almost always meaningless, the other (1%) can be meaningful in several different scenarios.
However, if you want to emphasize the motivation part of the arrangement, founders need to realize that offering an early engineer 0.1% or (God forbid!) 0.05% will have exactly the opposite effect that what they intend. The engineer will see people doing much less than s/he is to grow the company given 5% or 10%, and s/he will feel resentful and underperform. If you're a founder and you're giggling because you've hired this pretty good engineer for a low salary and only gave up 0.05% equity, then you're giggling at yourself, because your engineer hire will work resentfully for a few months and then run and grab the first reasonable job offer that presents itself, right at your most critical hour.
So founders need to either award their first engineer or two a reasonable amount of equity, or just forget the whole thing. But realize that if you chose that route, you'll obviously need to offer a market salary to recruit even remotely-qualified candidates.
Equity allocation is not about the VC's interests to a first approximation in the same way that getting VC funding is not a marker of success for a company, just a milestone. A founder's double digit percent of a $80 million exit is a good exit. And if each of four founders gets 18% or each gets 14% because there was an additional 16% allocated to equity for hiring doesn't change that qualitatively.
When a company is structured and run primarily for the interests of VC, shared interests have already flown the coop and it's about picking through the bones hoping for some meat.
It sounds like the point of the equity isn't compensation - the point is to align the employees to the same goals as the VC.
I would say that's exactly right. Unfortunately, it's almost always framed as compensation. Which I think is ridiculous...since you have such a low chance of getting value out of it at all.
Thanks for your response, it's very helpful and answers this question I've never understood.
Which if I wanted my values "aligned with the vc' I should be getting 2-5% as the first engineer. The VC puts in money, I put in life. I already went down this route and turned them down. If they are low balling you, roll on and start your own thing or consult.
At a $1 billion exit an undiluted 0.1% is $1 million pretax. Exiting at $1 billion is a VC sized homerun. $1 million pretax is not super rich. In the US, once taxes are paid it doesn't even make a person an accredited investor.
The opportunity cost of the 0.1% should be seen relative to things like a controlling 30% at a $5 million exit and similar exits unattractive to VC.
There seems to be a fallacious premise that the size of an equity grant is inversely proportional to the odds of a massive exit.
This doesn't really explain the value proposition to the employee, though. It seems like the only reason someone would take these deals is because they have some sort of fantasy about working at a startup, or really prefer the environment to the point of working 50% more for 50% less pay per hour. I mean, I definitely see the pros of working at a startup, but I value my time, income, and low anxiety levels tremendously more than I value having a bit of extra freedom in my job.
The startup industry and the game industry both share traits with the Hollywood casting couch in terms of filling positions. Which is not to deny that so long as everyone is an informed consenting adult, there's nothing wrong with it.
What about the scenario where you're bought for less than $100m after 5 years? I don't think most companies IPO.
That was very well explained, thanks!