Archive for the ‘vesting’ Category

Is Dead Equity Crippling Your Company?

By: Noam Wasserman for Inc.com Dead equity — equity held by employees and founders no longer working at the company — is a large and growing problem. Facebook’s IPO minted many millionaires and even billionaires.  One who attracted much attention is David Choe, the graffiti artist hired to paint the company’s first headquarters.  Choe opted to forgo a cash payment “in the thousands” for the equity equivalent at the time. Thanks to that one decision, he owns nearly four million shares of stock, worth in excess of $100 million. Choe’s equity is a headline-grabbing example of “dead equity”: equity owned by people who are no longer actively working for the startup. Every share of dead equity could have been redeployed as incentive for a current or future contributor to grow the value of the startup.  Instead, the dead equity languishes on the cap table, weighing down the startup and making it harder to attract and motivate the people who could impact its growth. Facebook’s situation is far from unique, even among recent tech IPOs. Mark Pincus of social gaming company Zynga recently confronted a similar problem when he tried to reclaim equity that he felt he had over-allocated to some early hires. Imagine how much tougher a dead-equity dilemma becomes when co-founders, who tend to hold large equity stakes, are involved. Facebook co-founder Eduardo Saverin was able to hold onto a significant chunk of equity after his forced exit from the company; that equity is now worth billions. Other prominent examples of drop-out co-founders who held significant amounts of dead equity include those at car-sharing company Zipcar and at tech startup govWorks.com (made famous in the movie “Startup.com”). A Significant – and Growing – Problem Dead equity has always been a significant issue for startups. Founders and hires have always […]

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Fear vs. Greed at Facebook

By: Noam Wasserman for Inc.com Mark Zuckerberg and his executive team have been extremely successful at retaining equity in their company. But how well do most other founders do? Even as Facebook prepares to go public, Mark Zuckerberg, the founder and CEO, still owns 28% of his company. As a whole, Zuckerberg, his co-founders, and his former and present employees, own about 55% of Facebook. How did they do this? Fear vs. Greed Each time founders seek capital they face what my colleague Bill Sahlman refers to as the fear versus greed tradeoff. On the one hand, founders fear that they will be forced to shut down their startup if they run out of money, which leads them to rush to raise new capital. On the other hand, they are also understandably greedy about maintaining a high equity stake, by minimizing their dilution. (Dilution is the progressive shrinking of each executive’s equity percentage as the startup raises each round of financing.) When founders delay raising each round, they are typically hoping to achieve certain milestones that will raise the startup’s valuation. That will reduce the percentage of stock they will have to cede to their financiers, and thus reduce their dilution. In every round of financing, Zuckerberg and his Facebook team have impressively minimized their dilution. Our CompStudy data, which allows us to compare Facebook’s equity dilution against that of some 2,500 technology startups, shows how successful the team has been. To estimate how much the founders and other insiders owned after each of the startup’s first three rounds of financing, we used the two major factors that affect dilution: the capital raised by the startup and the pre-money valuation it received. As shown in Figure 9.5 of my book, The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can […]

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Unlocking Your Golden Handcuffs: How Common is Accelerated Vesting on Change of Control?

“I’m negotiating my equity-compensation package. How frequently do people get accelerated vesting on change of control?” In private ventures, vesting of equity stakes is the major form of golden handcuffs (see posts here, here, and here) used to keep executives at their ventures. However, other terms, such as accelerated vesting on change of control (AVCoC), can shorten those vesting periods. (See Brad Feld’s description of AVCoC in the middle of this post, or the VentureHacks overview here.) I recently got an email from a serial entrepreneur who has been brought on as the head of finance and operations in a mobile-services start-up. One of his questions was: How often do new-venture executives get AVCoC? If it’s not common for them to get it, he wouldn’t push for it and would focus his negotiating leverage on another term, but if it’s common, he wanted to push hard for it. (He felt that the start-up might be the subject of M&A activity in the future, and had already experienced working for a large company after a prior venture of his had been acquired.) I decided to dive into our fresh CompStudy data on equity terms to examine how common AVCoC is within new-venture management teams. I took a look at three levels of data: What is the overall percentage of executives receiving AVCoC? Does the percentage differ by level in the organization (e.g., CEO vs. other C-level executives vs. VP-level executives)? And has the percentage been changing over the last few years? For these analyses, I combined our 2005, 2006, 2007, and 2008 IT datasets, which gave me a total of 6,053 executives from 1,202 private ventures. Overall, the percentage of executives receiving AVCoC was 65.5%. However, as shown in the chart below, the percentage varied from a high of 76.4% for […]

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Golden Handcuffs and Vesting: Initial Interpretations

The “Summary of Vesting Data” post presented the overall patterns in my vesting data and delved into the founder vs. non-founder differences. My “Early Analyses” post listed both the most significant drivers from my regression analyses of vesting periods and some of the not-significant factors. The core table from that post is reproduced here: This post presents my initial interpretations (and those of the 2 entrepreneurs and the 2 VCs who contributed their insights in response to those posts), along with follow-up questions in italics below. As always, love to get your input on all of this! Significant regression result: Founders vs. Non-founders Not significant: CEOs vs. Other C-level executives vs. VPs In his comment, Chris stated that it is “economically irrational” to stay at a company after your shares have fully vested, highlighting the critical retention issues involved in vesting. Scotty countered that founders in particular are motivated by strong non-economic factors and usually want to stay at their companies even after they have fully vested. (Presumably, then, Chris’ point applies much more to non-founders than to founders.) Tim also highlighted the higher level of “founder commitment” as a factor in vesting/retention decisions. These latter arguments are consistent with my observations elsewhere about founder vs. non-founder differences. In particular, as described in the Founder Discount paper (summary-postings here and here), founders have stronger psychological handcuffs tying them to the companies they founded, so when it comes to vesting, boards should view founders as posing lower “retention risk” than non-founders. In contrast, the weaker an executive’s psychological handcuffs (i.e., the higher the retention risk), the stronger should be the golden handcuffs used by boards, as suggested by the first result listed in the table. Furthermore, much as founders’ psychological handcuffs weaken over time (in “Founder Discount,” this leads to a […]

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Golden Handcuffs: Summary of Vesting Data

To complement the detailed early results, here are some high-level summary data on the years of vesting. Across the full dataset (1163 executives from 225 companies), the range of years is 1 year to 5 years. The widespread rule of thumb is that vesting occurs over 4 years, and as expected, the most common period is 4 years. However, more than a quarter of executives (28%) have vesting periods different from that rule of thumb, which is what originally triggered the question for me of what was driving vesting terms. More specifically, the average years of vesting is 3.46 years (standard deviation of 1.15 years). The distribution across the full range of years is as follows: 1 year: 16% of executives 2 years: 1% 3 years: 7% 4 years: 72% 5 years: 4% Technical note: Given the non-normal distribution of the vesting dependent variable (and of all of its standard transformations), I used ordered-probit analyses instead of standard OLS. Focusing specifically on the founder vs. non-founder differences, the distribution is as follows, with %-of-founders in black bars and %-of-non-founders in white bars. In short, the 4-year “widespread rule of thumb” mentioned above applies far less to founders (it doesn’t apply to 40% of them) than to non-founders (it doesn’t apply to 24% of them). Interestingly, this works in both directions: there are more founders in both the 1-year and 5-year buckets.

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Golden Handcuffs and Vesting: Early Analyses

For people holding equity that has not yet fully vested: Does the vesting status affect your thinking about when you might leave your company? For investors or CEOs: Are you worried that a key employee will leave your company when his or her equity vests? Some background: My Founder Discount paper examined how founders’ “psychological handcuffs” affect (negatively) the amount of compensation founders want and/or can demand from their boards. Because these psychological handcuffs tie them more tightly to their companies, founders are much less likely to leave if they are being under-compensated. Therefore, founders are paid significantly less than non-founders, especially during the early years of venture growth, when founders’ psychological handcuffs are strongest. In a new working paper that follows up on the Founder Discount paper, I examine whether boards use “golden handcuffs” to tie executives to their ventures. The specific form of golden handcuffs I examine are the vesting terms for each executive’s equity, most centrally the number of years over which an executive’s equity (received at the time of hire or when vesting terms are introduced into the company) vests. Investors often impose vesting terms as a condition of their investments. In a post that takes a “Term Sheet View” of vesting, Brad Feld, a VC at Mobius Venture Capital, highlights the importance of vesting terms: “[T]he impact of this term is crucial for all founders of an early stage company … it can have profound and unexpected implications … many entrepreneurs view vesting as a way for VCs to ‘control them, their involvement, and their ownership in a company.’” A couple of years ago, I decided to get a more systematic view of the drivers of vesting, in particular examining how it is used ex ante to affect executive retention. The table below summarizes the […]

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