compensation guidance for venture backed startups

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Part of a presentation that I made at Stanford Business School on startup or venture-backed compensation

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Venture-Backed StartupCompensation Overview

Who we are Tim Wenzel Marlowe Rondoni Saar Gur

Agenda Common questions and surprises Options overview: A short test Options overview: Getting rich Expectations: Market data Negotiating an offer

Not covering How to evaluate a start-up Private companies that are not venture-backed (e.g., partnerships) Compensation as a founder or pre-VC funding

Question 1 Should I expect a serious pay cut when I join a venturebacked start-up? Answer (not displayed): Generally no unless you are talking about being a founding participant in a new venture. For most start-ups you can expect the following: - Base pay will be competitive, probably 50th percentile - More often than not, there will be no cash bonus (excludes sales); VP and above often see 20% to 50% incentives, 20% more typical - Signing bonuses are not common and will be resisted or awarded on a case by case basis

Common questions and surprises

Question 2 What should I expect in an offer letter? Answer (not displayed): Offer letters will include your title, your direct report, base pay and incentive, if any, prorated for service; a new hire option grant amount (subject to Board approval); typical California at will language; benefits eligibility. Also will include: -language on assumed legal to work in US (or else offer is void) -expiration (you must sign by a given date) -detailed option language (option agreement and equity plan usually distributed when actual grant is awarded) including exercise rights watch for time to exercise after termination; some plans have only 30 days -mandatory arbitration language -a separate PIIA (proprietary information and inventions agreement) -key hires may also have special option language, change in control/double trigger language

Common questions and surprises

Question 3 Can I expect an annual bonus? An increase in salary every year? More options? Answer (not displayed): Again, bonuses are not common except for sales and VP level and up (base comp is competitive, but total cash comp is 25th percentile). Most start-ups have a salary focal/performance review period. Merit/increase budgets have been 3% to 4% for salaried staff in past years (lately its been pay cuts, no raises, short work weeks for some positions, deep cuts in certain functional areas). Most start-ups are undisciplined on performance reviews, especially promotions. HR staffs are very recruiting heavy, administration, benefits . . .not compensation and incentives, organization strategy, etc. Further, regular benchmarking/market studies are done for later-stage start-ups; compression is a problem as is the problem of you get stuck where you entered the start-up. Option practices vary a lot, but grants are usually done annually based on performance, or goals around ensuring employees always have unvested options outstanding. Re-ups before IPO and other adjustments are common to ensure equity allocations are appropriate across all levels. Promotion grants are common as are grants to key employees.

Common questions and surprises

Question 4 What is the compensation range for a recent MBA? Salary? Equity? Answer (not displayed): An MBA requirement or desirability is typical for Sr Manager, Director level and above in sales, marketing, bus dev, finance, IT, OPS (there are some specialty R&D, engineering, product mgt/dev functions). General package will be base comp in low to mid $100s; equity will vary wildly on stage, company, etc.; benefits typically rich/contributions low; 401k but no match; time off moving to PTO 3wks to start (moving away from rich sick leave/combod with vacation) Compensation range: Sr. Manager: 94,000 to 105,000 Director: 110,000 to 150,000 VP: 140,000 to 190,000 Equity (Shares/Data Varies Wildly) Sr. Manager: 40,000 to 50,000 Director: 75,000 to 150,000 VP: 300,000 to 500,000

Common questions and surprises

An option is "in the money" if:a) It is vested and, therefore, exercisable. b) Its price is less than the stock's market value. c) Its price is greater than the stock's market value.

An option is "in the money" when its price is less than the stock's market value. Conversely, if the market value is less than the option price, the option is said to be "underwater.

Options Overview - Test

With nonqualified stock options, taxes are triggered:a) b) c) d) When the options are granted When the options are exercised When the stock is sold Both b and c

Usually you are required to pay ordinary income tax on the difference, or "spread," between the grant price and the stock's market value when you purchase ("exercise") the shares. Any subsequent appreciation in the stock is taxed at capital gains rates when you sell.Options Overview - Test

Employee stock options:a) Allow you to buy a certain number of shares of your employer's stock at a pre-set price within a certain time frame. b) Require you to buy a certain number of shares of your employer's stock at a pre-set price within a certain time frame. c) Prohibit you from buying any stock in your employer except at certain times.The pre-set price is known as the "grant," "strike," or "exercise" price. The time frame is known as the "exercise" period.Options Overview - Test

With incentive stock options, taxes are triggered:a) b) c) d) When the options are granted When the options are exercised When the stock is sold It depends

The tax is deferred until you sell the stock, at which point the entire option gain (the initial spread at exercise plus any subsequent appreciation) is taxed at long-term capital gains rates, provided you meet certain holding period requirements (if you sell at least two years after the option is granted and at least one year after you exercise). Otherwise, the options are taxed as nonqualified stock options.Options Overview - Test

Which stock options may be granted at discounts to their then market prices?a) Nonqualified stock options b) Incentive stock options c) BothISOs must be granted at prices equal to or greater than the stock's then market value. NSOs can be granted at a discount. Another unique feature of nonqualified options is that they can be transferred to children and charity, plan permitting.

Options Overview - Test

It is prudent to exercise your options early when:a) You have a lot of faith in your employer's prospects and, therefore, its stock. b) You are overdosing on company stock.General rule is to keep no more than around 10% of your portfolio in company stock. A quick way to estimate the value of your options is to calculate how much you would pocket after exercising them and immediately selling the shares, ignoring taxes for simplicity. If you are bullish on your company's stock, conventional wisdom holds that you should sit on your options until they are about to expire to allow the stock to appreciate and, therefore, maximize your gain.Options Overview - Test

How did you do? In general, youll be granted new hire options (ISOs) when you join a start-up Boards normally set guidelines for new hire grants Typical is an immediately exercisable grant with 10 year expiration, vesting over 4 years (first year cliff, monthly thereafter) Follow-on grants are common including performance and/or promotion grants, re-ups before IPO, new grants to ensure employees have unvested shares outstanding Valuing your grant can be tricky youll usually be told (and it is OK to ask) how many fully diluted shares are outstanding and the strike price. Not much more.Options Overview - Test

Question 1 Can I expect more options beyond my initial grant? Answer (not displayed): Option practices vary a lot, but grants are usually done annually based on performance, or goals around ensuring employees always have unvested options outstanding. Re-ups before IPO and other adjustments are common to ensure equity allocations are appropriate across all levels. Promotion grants are common as are grants to key employees.

Options Overview

Question 2 Do I need to have cash on hand to buy my options when I join a company? Answer (not displayed): No. You only need cash when you exercise. You can early exercise or exercise on vested shares (all or a portion in most plans). You need the cash when you exercise.

Options Overview

Question 3 What happens if I get fired? If I leave? Can the company buy my shares? Answer (not displayed): Typically you can buy your vested shares if you are fired or leave. Some plans have for cause provisions, especially for executives. Buy backs are more the case when you have early exercised and you are not fully vested in all or a part of the shares you exercised. In that case, the company buys back the unvested portion. In other cases, the company may retain rights to buy back shares. . .you need to read the equity plan carefully.

Options Overview

Question 4 How to I evaluate an option package? Answer (not displayed): Know your grant as percentage of fully diluted outstanding shares (your % of the pie); strike price; dilution assumption; exit assumption. As said earlier, you may not have much more information than the grant size, options outstanding, and strike price.

Options Overview

Getting rich with options - Example Grant of 50,000 options at exercise price of $0.10 10mm shares outstanding, fully diluted 50,000/10mm = o.5% ownership 25% dilution before exit Exit valuation

Getting rich: Options Overview

Getting rich with options - ExampleExit $50m $100m $500m $1b $10b % 0.375 0.375 0.375 0.375 0.375 Proceeds $187.5k $375.0k $1.9m $3.8m $37.5m

1. 0.50% ownership with 25% dilution expected = 0.75*0.50% = 0.375% at time of exit 2. Proceeds exclude the money used to purchase shares at the time of exercise and taxes 3. Excludes any liquidat

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