“My company is too small for the preview of Compaas.”
A week ago, Lisa and I attended a fun CTO Unconference hosted by First Round Capital. Tech leaders from all company stages shared their successes and challenges. One topic that often came up is near and dear to us at Cathy Labs: Compensation.
Be warned: I love talking about compensation. I love talking about how compensation is company culture made manifest. What is the right way to approach employee compensation? How does this change as companies grow? We talked about how compensation matters, and how so many companies lack the tools to do it right.
And of course, we talked with these company leaders about Compaas. Throughout the day, Lisa and I heard the same question time and again: “My company is too small for the preview of Compaas. But what advice do you have for me now?”
In developing Compaas, we’ve learned from the experts. We’ve interviewed founders at all stages, HR professionals, investors, and CFOs. So it’s no surprise — Lisa and I have some thoughts on this hard question.
Become awesome at explaining company equity to candidates and employees
If you’re a founder at a small startup, thinking about compensation, this is the place to start. Understanding your company’s equity — all the details — is necessary but not sufficient. You need to go deeper.
Put it in writing:
- Number of options granted to the employee. (That’s the easy one.)
- Are those options ISOs or NQSOs? What’s the difference? Why would that matter to an employee? (I’m not going to go into RSUs in this post. Most private-company RSUs are in big “Pre-IPO” companies, with finance teams and all the big-company structures.)
- Explain where the strike price comes from. How is it calculated? Relate it to the company’s Fair Market Value (FMV).
- How much would the employee need to spend to execute their vested options? How might the difference between strike price and value generally affect their taxes? (Yes — send them to a tax professional! But you should still be fluent in the basics here.)
- As long as you’re talking about taxes… Does your company allow employees to exercise their options before they vest? “Early exercise” can make a big difference in their future taxes. You don’t need to be an expert on options and taxation — it’s really hard. We recommend that you introduce some of these concepts to your employee so they know they exist. Recommend that they talk to a tax specialist about the impact of early exercise and 83(b) elections. If they’ve never heard of this stuff, they can’t know to ask.
- If the employee vests and executes all options, what’s their percentage of ownership? Do this calculation for them. Yes, in writing. Explain how future events, fundraising for example, can change this percentage. Explain why that’s not a Bad Thing. (note: Not every company feels comfortable sharing this information — but for small companies it can make a big difference in the way equity is perceived by employees.)
- What vesting schedules apply to the employee’s grants? If there’s a cliff, what are the associated dates? Be clear about their vesting progression and how it ties to their tenure with the company.
- How long after an employee leaves the company will they be able to exercise their options? Of course, it can feel awkward to talk about what happens if someone leaves. We want people to stay in our companies, right? But being open and talking about this has a positive effect. It shows employees that you’re not only thinking about what they can do for you. It shows that you’re planning for the long term, both for your company and for your people.
Being great at explaining equity is a differentiator for small startups. Almost everyone is terrible at explaining equity and how it works from the employee perspective. You can be better. Do your research and clarify your company’s policies and norms in writing. Treat your employee like an adult. This transparency establishes both trust and reasonable expectations, right from the beginning.
Show them the numbers
It might seem like a small thing, but you should run sample scenario calculations for your employees. This does more than show them that you’re not trying to obfuscate anything in the numbers. The sample scenarios you anchor on here set the tone for future expectations. When an employee can reproduce those calculations, that increases their confidence and trust in you as an employer. For example:
“You — the employee — received a grant for 10,000 options at a strike price of $2.00. Let’s say that when they’ve all vested, you execute all your options. You’d pay $20,000. You might decide to do that only when the company’s share price is somewhat higher — say $6/share. The company would have a $6 million valuation at $6/share (assuming no dilution). We think that’s easily attainable as soon as we sign a few more big customers. Then buying the options at $20,000, you’d have a value of $60,000… and a taxable gain of $40,000. Before you did that, you’d want to consult with a tax specialist to see how you can reduce that tax burden.”
The difference between the strike price and the value of the shares is key to employees. Seems obvious enough, right? But many founders make the mistake of only emphasizing the total share value, and forget to account for the cost of exercise. If the employee has been through this process before, that error can be seen as naive — or even worse, deceptive. This is an example of how it’s not only the numbers themselves that matter. How you talk about them affects your long-term employee relationships, trust, and credibility.
Be aspirational, but don’t go overboard
We’re founders because we’re optimists. We see that the future can be a better place. There’s a problem, and we are solving to make that happen. We’re going to make it big! The problem with being optimists is that sometimes we can go overboard. Sometimes, we can go way overboard. Be cautious of these common traps:
Don’t let recruiters oversell the upside.
Being a recruiter is hard. You have to sell the best things about a company, and that’s just getting candidates to agree to an interview. in an attempt to meet their numbers. Be clear about the value of company equity with everyone who recruits for your teams. Whether they are professional recruiters or hiring managers, everyone needs the same story. Work with them to develop a script, and encourage consistency in their messaging.
Don’t let yourself oversell the upside, either.
While we’re at it, don’t oversell candidates yourself when you’re trying to close them. Believe me, I’ve been there and I know what it’s like to want to have someone agree to join your company. You’re in sell-mode. You want this to work. But it can go too far if you set expectations that the company is highly unlikely to meet. Once that’s happened, it’s often impossible to avoid future problems around an expectation mismatch. No matter how much you want to land a candidate, don’t fall into this trap. After all, the relationship doesn’t end when you succeed in hiring this person. You want them to be successful and engaged once they join. You want them to encourage their talented friends to join, too! Don’t let your sales-job get in the way of setting up a good relationship — and making it work over time.
Support your managers.
Along that line, retention of great employees is hard. Make sure your managers are also not overselling to their employees. Morale and retention are hard problems, too, and equity upside is one tool that managers have to work with. There are temptations to over-emphasize the upside as a manager as there are in recruiting. Sometimes even more so! The manager is also an employee, who must consider their own future and career. They may be doubly tempted to spin an overexcited story and buy into it themselves. Check in with your managers. Give them the tools they need to talk to their teams about company equity and performance.
Finally, if you’ve been in startup-land, you have heard the stories. We all know people inside companies — some really successful companies — where the hype didn’t match the reality. Many of those problems with disillusionment and eroding company trust were avoidable. The companies failed to be consistent and clear with their employees about equity. They left their recruiters and managers to “wing it” when the conversations came up. Leadership was carried away by their own hopes and aspirations. And the employees were the ones who found themselves taken for a ride.
You can do better.
One last thing
At least a dozen times at the conference, I said, “This stuff is hard.” I’m going to say it again — this stuff is hard. No matter how much love and energy you devote to having the perfect approach to equity, there will be errors. Everyone makes mistakes, and you will too. So that’s our last bit of advice for founders of small startups. Decide — right now — that Future You will forgive Past You for not being omniscient. And then go take your best shot at it. The purpose of thinking about compensation and culture now is not to have a perfect system. Rather, it’s to practice and iterate, and shape your company over time. As your company changes, the work and care you put in now will reap their own dividends.