How to Discuss Stock Options with Your Team

Posted on Sep 6, 2010 | 31 comments

How to Discuss Stock Options with Your Team

I was thumbing through Twitter messages on my Blackberry on Monday (I use Twitter as a “mobile first, web second” product) when I saw the following Tweet (see graphic).

I resisted the temptation to jump in with a response because I knew it was too complicated of a topic to discuss on Twitter.  But I thought I should do a quick post on the topic.

1. Options are gravy – I lived through the first dot com era where we used stock options as a recruiting tool.  I freely admit this (along with nearly everything between 1999-2000) was a mistake.  We set our sites on our IPO price and then worked back to our current valuation and  showed potential employees what we thought they could earn (with all legal caveats) if the company was successful.

The stupid thing is we sort of believed it ourselves.  If Ventro was worth $8 billion on $2 million of sales surely a paltry $1 billion would suffice.  Goldman Sachs was an investor and the assured us an IPO would happen and riches would be had by all.  I think they believed it, too.

We obviously attracted the wrong people for the wrong reasons and this led to a lot of disappointment.  We had a lot of re-setting of expectations to do.

Options are obviously a very important economic motivator for your first 3-5 employees and your most senior management team.  But unless you become Facebook or Zynga they likely aren’t going to pay off big for everybody else.

So I developed this standard line that I used for all employees.  I’ve said versions of it on this blog before so I hope it’s not too repetitive.  But it’s critical to get this right:

“Join our company if you think you’ll learn from being here.  I think you will.

Join if you think your career will progress because you’ll be given more responsibilities than elsewhere and if you’re good at what you do you can move up quickly. We’re a meritocracy.

Join because you know you’ll be earning less than you could elsewhere at some meaningless job cranking out non-core code, producing Powerpoint slides or shuffling paper.  You can always earn more.  But join here if you want to grow.

Join because you like the culture.  You think you’ll have fun.  You’ll consider your colleagues close friends.

Join because in three year’s time when you look at this job and this company on your CV you’ll feel proud and it will be part of how you got where you were going.

Join because as we grow our ability to reward you will grow and your income will grow with our success that you contributed to.

We give out stock options.  I hope they’re worth money to you some day.  But let them be “icing on the cake.”  If they pay off handsomely that’s great.  But don’t count on it.  Don’t let it be your motivator or your driving decision.

Not because we don’t want them to be valuable, but because we don’t want to create an “options culture” around here.  Option cultures are corrosive, create the wrong incentives and attract the wrong sort of people.”

I’ve said similar hundreds of times.  And I believe it.  If you find out one day that company you went to work for was Facebook then consider it the lottery.  And that would be nice.

But if you’re the CEO who is spinning up a story about how the options for non-founders, non-VPs is going to be worth a lot some day then you’re probably doing some young entrepreneur a disservice at your expense.**  And when they figure it out some day they’re not likely to be very loyal moving forward.  Do the harder work and convince them to join anyways – without the stock option bravado.

** Unless you really are Mark Pincus, Mark Zuckerberg, Ev Williams or similar.  Then go ahead 😉

2. The best policy is transparency – The stream on Twitter, as best as I can tell, started with Chris Dixon sending the following Tweet (see graphic)

My interpretation of this Tweet was harmless enough.  I thought Chris basically meant that investors know what most deals (not just their own) get done at so they have a pretty good sense how to price seed, A, B, etc. rounds and still be competitive.  This is mostly true.  I don’t know whether I fully agree that they keep them secret for “informational advantage” but maybe.

I tend to keep valuations secret because I’m usually told by a trusted source and feel it isn’t my place to reveal confidential information.  I wouldn’t be a VC for very long if I did.  I see people’s private information for a living.

Anyhow, on the above Tweet Andrew Weissman (a VC) disagreed with the premise – I’ll assume Andrew read it how I did followed by Nate Westheimer who wrote the Tweet that Henry Blodget retweeted (opening image) about companies wanting to keep their valuations from stock-holding employees.

Quickly dissecting

  • I think Nate’s response slightly veered off topic.  There’s a difference between companies wanting to hide valuations and investors doing so.
  • I think Chris’s initial comment was about investors
  • Investors generally are not the people to reveal valuations to anybody – it is the business of the company and the CEO should manage this information.

Whatever the intent of the dialog let me encourage all management teams to be transparent with their employees.  My personal preference is to tell people the amount of stock options they are receiving (total number), the value of those stock options (say $100,000), the value of the company (e.g. $10 million post money) and therefore if we sold for $100 million dollars one day your gain would be approximately $1 million).

“If you perform extremely well in this role there is always a possibility of further allocations although that is clearly not guaranteed or promised.”

3. That said, don’t complicate the topic – If you’re the founder of a company you likely know a lot about things like Liquidation Preferences and how they affect value allocations when the company is sold.  You also understand that there are future financing rounds and in tough times this can change the value equation of stocks.

Some founders err on the side of telling employees absolutely everything.  I prefer not to.  It’s not that I don’t want transparency – it’s just that some issues are technical complications that aren’t material to the employees understanding of the issue.  I know some people will take issue with this approach and that’s fine.  But here’s my rationale:

I see way too many employees trying to understand all of the complexities and spending way too much time trying to calculate how much their options are worth through each fund raising round.  This really conflicts with my view that options are to be put in the top drawer of your study at home and treated like upside gravy.

The most complexity the more angst the more options end up working against your intent if you think about them the way I do.

Obviously I’m not talking about your most senior 3-5 employees who hopefully own meaningful stakes, are making salary sacrifices and have the experience in understanding stock option nuances.  Much experience tells me that most people don’t.

It kind of reminds me of sales employee bonus plans.  If you make them easy people spend their time selling.  If you make them complex to maximize every possible way to incentivize behavior sales people end up spending 10% of their sales time calculating how much their bonus would be if they structured their deal this way or that way.  Ah, the law of unintended consequences.

4. Valuation or percentages – it’s up to you.  I think either strategy is OK.  I prefer percentages (e.g. you’re getting 1.5%) for the top employees (in addition to the method I described above) and staying away from percentages for everybody else.

If you’re transparent about the value of the number of their stock options, the value of their stock options and the market cap of the company then they can do the calculation themselves (98% won’t know how, but they have all the information they need).

Why do I feel this way?  It’s really meaningless to say to somebody that you own 0.18% of the company.  It doesn’t make somebody feel better.  And by telling them the value they have all they need to assess whether or not it was a good deal.  Sometimes a percentage can be equally meaningless.

But I can buy both arguments.  I choose my way.  Either way, make sure not to over sell.  And I would opt for transparency.  There is nothing worse than an employee who wakes up one day feeling duped or a sense of mismatched expectations.  Then everybody loses.

  • Ian Peters-Campbell

    I've gotten more than one job offer with “X options striking at $Y and vesting over Z” where the company was thrilled to tell me about the options but wouldn't present any additional info for me to be able to judge the position objectively.

    In fact I don't think I have ever known of a company that has been open about the numbers, at least up front. I've found one or two that have been willing to disclose enough numbers to make reasonable calculations, but that is usually only with some concerted prying. From your post it sounds like your experience is very nearly the opposite, with companies over-sharing. Any idea what could account for the difference? I certainly hope that when I start a company I will err on the side of transparency, but I've always been curious about the reluctance of many companies to discuss the real numbers. Most seem to prefer the mysterious promise of El Dorado just over the horizon, despite the potential for pissing everyone off once they arrive and find it's just yellow sandstone…

  • drorm

    100% agreeing with you here Mark. At the end of the day, there are too many details and it's too complicated for the average employee, even in the valley, to really understand what kind of deal the options really represent. Many, for instance, don't know that preferred stock exists and that there are scenarios where the company will get sold and their options won't be worth a dime.

    At the end of the day, you can have a vague idea that your options represent x% of the company, and that you trust your CEO to try to get a good exit where the employees will get a good deal. Beyond that, it's probably too much information, and you're much better off focusing, as you mentioned in the post, on your job and career.

  • Dan Shapiro

    My two bits: I never express options as a percentage. Doing so has caused too much heartache when the person later realizes that the number they negotiated over, sacrificed their cushy job for, and etched in to their brains as a magical totem to bring them through their darkest hour, vanished with the most recent financing round. 5% is transient; 100,000 options is forever.

  • dlifson

    Is there any “rule of thumb” about how many options to give to employees? I had heard 1% to the first few employees, less for subsequent employees, and more for certain key executive hires.

  • damiansen

    Any thoughts on smaller companies where valuation is not set from outside investment? How would that work?

    [ maybe a too dumb/basic question, but better looking dumb for a minute that being it forever 😉 ]

    Also, is it frequent to give dividends on small companies (up to 20-30 employees), splitting them trough the stock options?

  • Kevin Kruse

    Great post. I, too, find that most employees want options but have no idea of their true value, the percent, or the numerous ways they'll end up being worth zero.

    Also, great advice on emphasizing Growth while recruiting. I've found this is the #1 way to attract and retain the right kind of talent.

  • Mark Birch

    Mark, excellent post. It comes down to what motivates people.

    I worked at Siebel during the dot com boom and saw first hand how options destroyed employee morale. Tom openly talked about how his company was creating millionaires. Fast forward a couple of years, those options were under water and most employees were left with worthless dreams of paper profits. At least Siebel gave out decent salaries, but the damage was already done and most of the earlier employees left.

    To all start-up tech founders, you need to repeat this mantra on a regular basis “money is not the motivator”. Studies have proven that increasing salaries and bonuses do not lead to higher loyalty and reduced employee attrition. In fact, they lead to the exact opposite (see dot com boom job hopping).

    What motivates people? Doing work that values their skills and gives them the control within their role.

  • Philip Hotchkiss

    There are many practical insights in this post. The two that stood out for me are:

    1. Of course you want everyone in an organization focused on producing, learning and creating shareholder value. You want alignment, but want you don't want is an overly obsessed “options culture”.

    2. When it comes to communicating options to employees wether from a recruiting or internal perspective – keep it simple as Mark suggests. Simple examples of What-If scenarios but not overly deep views into the myriad of complexities that surround options, cap tables, what VC round implications on ownership percentages, i.e. if participation rights are involved, etc. For most, this will NOT be motivating, it will be very confusing, and as Mark right points out, who wants to be told they own .18% of a company, and oh BTW, is that on a fully diluted basis or not. Argh – too much detail and you get a pandoras box.

    I've managed through these issues as a startup entrepreneur and as a sitting member on a publicly traded NASDAQ company's compensation committee – IMO- Mark's advice is as it relates to communications around employee stock options.

    Note: this advise does not apply to founders and the top 3-5 senior entrepreneurs leading the company.

  • msuster

    Ian, no … my experience isn't the opposite. Many companies either don't share the information or play up the value of the stock options beyond what is warranted. I'm trying to encouraging people to be realistic with recruits & employees. I think duping people about stock options makes no sense in building a long-term company. I think transparency & honesty will build a better long-term company.

  • msuster

    Actually, Dan, Neither approach exactly as you've laid out works well. Saying you own 100,000 options is totally meaningless. Do you own 100k out of 100 million or 100k out of 5 million. Big difference. The “number of options” with no other information is what most companies do.

    I advocate number + value of those options (e.g. $100,000) + value of the company today (e.g. $6 million post money) + some discussion about how much starts tend to be worth when sold.

  • msuster

    % to give out depends entirely on stage of the company + seniority of the people + your desire to have them. Giving somebody 1% at a startup is very different than Twitter (with its $1-2 billion valuation) giving somebody 1%.

    So no rule is exact, but let me tell you the general guidelines for a company that has raise, say, $5 million:
    – Hired CEO: 6%
    – COO: 3%
    – CTO:1-3%
    – VPs: 1-1.5%
    – Directors: -.25-1%

  • msuster

    Small companies obviously still have stock numbers and you could talk about the typical valuation of a company at your stage. Most seed rounds get done between $1.5m-$4.5m pre-money depending on the quality / experience of the team and whether the deal was competitive. So you could use a “theoretical” market value to illustrate what their shares are likely to be worth IF you can raise money.

    Dividends …. no.

  • msuster

    100% Mark. And to this day I've never spoke to any ex-Siebel employees who talk about the wonderful culture. Mostly they tell stories about being yelled at by Tom. It was also a Siebel employee who first told me about the title in the company of CVO (chief vesting officer). Seems he/she must have been an early employee 😉

  • ian_peterscampbell

    Got it, and agreed. What do you think causes the reluctance to share the numbers? Is it a desire to protect information from “competitors” (who I would think could backchannel info if they needed to?), a desire to sell potential recruits on the company, or something else? The problem I see with it is really that if you sell everyone on the Get Rich Dream when their stakes are too low for that to realistically happen, you wind up dealing with a lot of disillusionment once anyone lets information slip and it spreads like wildfire. The potential downside of that has always seemed so onerous that obfuscation loses any benefit, but people still seem to do it. Is it just a slippery slope thing, where once you obfuscate with one employee you have to continue?

  • Gabriele Maidecchi

    Very nice view, even if my company is still relatively small this is the kind of discussion we were having just few weeks ago and even if things here in Italy work slightly different it's a very helpful and refreshing opinion you have.
    Thank you for sharing Mark.

  • Jess Bachman

    What about “Join because you are passionate about the product and it's effect on society” . This probably doesn't apply to so-called 'dip-shit companies' but might be a factor in a company if product or service is one of those 'make the world a better place' types, like kiva, and I would even include twitter or blockchalk. If you are in the problem solving business, I would want to be surrounded by people who believe in the solution offered.

  • aweissman

    Yes, I read it how you read it

  • Empiricus

    Please note: The following comment may not apply to all industries.

    After 12 years in the IT industry, I have found in every case that Stock Options (SOs) are worthless. My roles have been at Fortune 100 companies and Startups. In every case, the SOs ended up under-water and worthless. Any minor profit afforded by these options was eaten up by taxation.

    I found that companies used SOs to add “gravy” to the offer. Companies could, without any risk, offer tens-of-thousands of SOs to Recent College Grads (RCGs), which struck awe in the minds of ramen-noodle-fed-starving-students. Unfortunately, students did not understand that they have a better chance at making money by entering the Publisher's Clearing House sweepstakes. Both SOs and sweepstakes have something in common: zero-cost entry, “Black Swan” chances of success – yep, SOs live in Extremistan (ala Taleb).

  • Entreprenuer TechIB

    I like this approach – I want to work on product/solution that I'm passionate about and I want those working for me to have the same attitude. Be passionate, get a chance to learn and grow and be proud of the Company your working for.

  • Scott Barnett

    Mark – I agree with you regarding the # of options if you aren't going to tell them the amount in the total pool… just to make sure I understand what you are suggesting. If I'm offering an employee 10,000 options at $1/share and there are 2M shares total in the company at $2/share, then you're telling that employee they are getting $10K worth of options in a company worth $4M? At that point, they are still able to pretty much determine their % ownership, no?

  • Dan Shapiro

    I agree completely. In fact, I usually provide all the information they care to hear, more than enough to calculate the percentage; I just meant that I skip the actual percentage number.

    For me, that includes term sheet stuff like preference overhang. I do it for two reasons: first, because it's all well and good to say you have an open culture, but disclosing information against interests before they've even joined the company makes people believe it, which gets candidates excited about the company. Second, because it leaves them wondering – what's the real information on the other offers I'm receiving, and how come *they* didn't volunteer the information?

    That said, I like your positioning – I'm noodling over how I might adjust to get the best of both worlds.

  • Campfirewest

    This is off topic, but I would love to see a blog post sometime talking about typical salaries for a company that has raised $5m in an A round.

  • Yann Ngongang

    We trust Silicon valley engineers to write complex algorithms, we shouldn't assume that knowing the cap table, shares outstanding of the company they're sacrificing for is too much for them.

    While I agree that one shouldn't hire the mercenaries who only want to get rich, we can't sell smart people on only passion. Smart folks know that joining a startup after employee #10 will hardly get you a down payment on a house if the company does reasonably well.

    In most companies, half of the people look up and aspire to be CEO, CTO, or CxO. So the commitment CEOs, board members and investors should make to the employees should be: “here are some options, if we succeed, you'll do well, and if you want to start or co-found a company tomorrow and have performed, we'll be there to support you” “We”= top execs and maybe even investors.

    Most people want to make money for security before greed. The fragmented nature of startups (and high failure rate) means security is lost. Then there is a salary cut and not even a large option payout.

    IBM used to give a pension – we cannot replace that pension for hope and passion – The silicon valley top brass (entrepreneurs, investors) need to figure out an alternative for most of these employees that are the backbone of these tech companies. They need to make a commitment to the careers of those who perform.

  • ideoplex

    I'll also add that nothing burns me more than a founder poo-poohing a long term issue by saying: “By the time that becomes a problem we'll all be sitting on the beach in …”

    That might apply to him, but it's likely to fall right back to me.

  • Sid

    Dear Mark!! Another amazing post from you . Loved it! I have a question . I hope you can clarify. Was reading your earlier post “Is it time for you to earn or learn” where you have mentioned the stock options worth.

    I am currently working for a startup since its inception 1.5 yr back. Have currently 0.12% of stock options.(6K out of a possible 5MM) . The company would most likely exit around 2013 mid-end and are going for their first round of funding(thinking to raise $2-3MM) and don't think would go for further rounds.Currently the company is into services business , but building a social media product. How much do you think i stand to gain if i stick with the company till its exit i.e. in 2013?

    It would be really helpful if you could shed some light to it.Looking forward to your reply and thanx once again for insightful posts.


  • temojin

    mark can i restate “We obviously attracted the wrong people for the wrong reasons and this led to a lot of disappointment. We had a lot of re-setting of expectations to do.” As “We obviously attracted all the right people but gave them all the wrong reasons.. and tools”

  • innonate

    Mark / Andy — I read the original tweet the same too, but by the time I got to the conversation it had vered more broadly about why valuations are kept secret. I “tuned in” (also, via mobile, heading to the beach) around here:

  • Day Laborer

    Not sure it's accurate to say options are “worth” a certain amount at grant based on a post-money financing value. Option are priced at fair market value at the time of grant, so the value at best (without doing some complicated Black Scholes valuation) is the in-the-money value, which won't be known until some point in the future. So using value would seem to be misleading, no?

  • Harsh Batra

    Mark I have an idea which I started by outsourcing the work. After 2 versions of the website I realise that I don't want to outsource anymore because it is very inflexible and expensive. I need to build a core team.

    I need to get a co-founder/partner with smart techies who believes in the idea and are talented. Im still searching, but I had stock options in mind as an incentive for them to join the project. This is a startup with no funding other than my own. I have had these questions in my mind for a long time now, so I was hoping you could help me get some clarity:
    – is offering stock options the best way to get them involved?
    – what is a good % of the company to offer?
    – over how long should this % vest, to ensure that the employee is in it for the long run?

  • Antone Johnson

    Mark, thanks for another outstanding post. I've struggled with these issues as chief legal counsel of a fairly large, late-stage private company where a lot of anticipation and misinformation has built up over the years about the value of everyone's options.

    Lawyers' inclination is to over-explain and disclaim everything, because the devil is in the details, and there's some risk of liability if employees can ever claim to have been misled in making important personal finance and investment decisions. That said, I'm a firm believer in the KISS approach, and the details of stock options can be both dry and incredibly confusing to most intelligent people. (I've watched plenty of executives' eyes glaze over when I tried to explain the tax treatment of a disqualifying disposition of an ISO in a same-day sale vs. a NSO exercise, the breakdown in their options between ISO and NSO treatment as a result of the $100K limit, etc. Even lawyers and accountants get confused sometimes.)

    The core problem is on the recruiting front, in my view. The inconvenient truth that you pointed out — namely, that options are not likely to pay off big below the senior executive level — is not something most startups are eager to share in the recruiting process. Yet when you ask someone to go to work for an early stage startup and work long hours for a relatively low salary, minimal bonus, fewer perks and benefits, and less resume value than a big, prestigious company, it's a tough sell without overplaying the potential to win the valuation lottery and become the next Facebook millionaire. Good HR execs know how to balance the message, pointing out the potentially great upside of options while taking care not to make any promises. The “You May Lose The Entire Value Of Your Investment” risk factor disclosure that we write into SEC filings takes on a bigger meaning when it's stock in your own company. Restricted stock grants at larger companies are even less likely to result in much of a payoff, because the numbers are so much smaller; they lack the leverage of options.

    I like the following approach: Tell the employee who is getting a grant of 10,000 options at $5.00/share, “Look at it as if the Company is making you a $50,000 loan to buy its own stock at $5.00. Except it's not really a loan; you never have to pay it back or pay interest on it, or pledge anything as collateral, or worry about your credit rating. In a downside scenario, you just walk away with the option being worthless, but you still got your paychecks and employee benefits. In an upside scenario, for every dollar increase in the stock price above $5.00, you make $10,000. So it's all upside and no downside, and it sure beats borrowing $50,000 from a rich uncle to invest in risky, illiquid, private company stock.”

  • Rajeev

    “Join our company if you think you’ll learn from being here. I think you will” contradicts with your later statements about not sharing the nuances of valuation changes in later rounds.

    In several cases, the reason people join startups is also because they want to learn how startups work – and knowing about how the various stages of financing dilutes the share and how the liquidation perferences are structured in the term sheet etc. are things I would want to learn by being in a startup.