Equity & Compensation Models for Startups

[Music] [Applause] [Music] so first we have Robert bar Betty he's a global head of executive compensation and benefits at JPMorgan and then we have Graham brown a partner at Lehrer hippo so first Robert well it's interesting the group that I sit in and within JPMorgan is terrific because they don't have to sell anything it's called the advice lab it's been around for quite a while it's a heritage JPMorgan Group we're a group of tax lawyers believe it or not we do have a good time you know what's a very smart analysts and associates to do the real work and I spend time both in the private bank as well as in the investment bank so I'm working with the I be with I POS buyouts M&A transactions as a tax lawyer I even lecturer at NYU and the LLM program here in New York so with that maybe I'll turn it over to you thanks Robert so Graham brown I'm a partner at Larry hippo we're a new york-based venture firm focused entirely on the very early stage of a company's life so we define that as as scene funding and we're typically the first or one of the first institutional partners we're one of the most active seed investors in the country we do focus on New York about two-thirds of our investments are here and we invest across stages or across categories we're fairly category agnostic and core areas for us include direct consumer brands and e-commerce enterprise software marketplaces consumer social and then some emerging tech as well but we're sort of coming in built to help companies go from that early seed foundational stage of five or so employees to 10 to 15 and raising a series a and then supporting them beyond great thank you so we had some questions that were submitted over the week so we're gonna start start off with the earliest stage so Graham can you just into some of the common terms that startups need to understand when thinking about equity and compensation for example cap tables or options those are some things that I think are top of mind for this group so yeah just cover the basics so cap table very simply it's a ledger of who owns what in your company it starts out very simply and gets more and more complicated as you raise it in additional rounds of capital bring in different structures you're gonna have common and preferred will be the two most common and then the key that you mentioned earlier is that the options in the option pool and that's how you're attracting talent to hire and retaining talent as well so clearly core pieces the business and I think the third really important term around this is vesting and that's you're giving people equity grants for the assumption that they're going to stick with you for a long time and you stage those out over typically a four-year period I think we'll probably talk about that later but those are kind of the crucial parts around equity and equity grants great and are there different types of startup equity the different types of equity I'll tell you predominantly you see options obviously incentive stock options you have non-qualified options you have a restricted stock units and they it's really phantom so upon the conversion of the unit to stock that's when the taxable event occurs then of course there's restricted stock which not be may not be the best because when invest it's taxable nobody has the money to pay the taxes if you turn around and do what they call an 83-b election on the stock you're paying tax immediately but the downside is if you're not there at the moment of vesting you lose it and you pay the tax and if the stock goes down you can't declare a loss on your return but these are predominantly if you do transition into either you know purchase by a public company or you go IPO you know that's when compensation changes perhaps 180 degrees and then you get performance measurements in like performance share units is a typical one that you'll see upon the metrics being satisfied you can either get stock cash or a combination of both but it's a good golden handcuff I might just say since we're talking about equity and jump ahead a little bit from maybe some of the questions I may ask if you have a plan and there's ISOs granted what's most likely they're going to be have an early exercise provision in the plan I mean I'm gonna tell you things that are pitfalls that people have run into which I think are important for you so you don't do the same trip in San Francisco I have a medical device company that now has a value as private $60 a share the shares were grant and then I mean I'm sorry incentive stock options but the incentive stock options were granted less than $1 the value of the company $60 and the co-founder cannot afford to exercise the option because the spread on that is actually subject to the alternative minimum tax which is a tax that can be devastating as a result you know how do you get that out of that problem so what I recommended is to let the options expire because if you did something else you're gonna be involved in a tender offer and then the whole idea is then I would take the spread on the option convert it to restructured stock units grant and put a time vest on it because they want to certainly keep the person there so it helps somewhat of the remedy but it's a big pitfall unless you have the early exercise early exercise means upon the grant I exercise it now I have underlying shares that still have the same vesting requirement I'm making 83-b election on the shares that starts the capital gain clock running right there and I'm not out of pocket and it's a way for the employees to get a hold of something where they really don't have the money remember the non qualified options are gonna be subject to ordinary income tax then the last provision I'll mention with respect to those options because these are very typical a lot of times you can only grant ISOs up to $100,000 a fair market value in one year so usually you don't get the 409a valuation exact so that it's topped off with non qualified options when you do that make sure and a lot of people forget and a lot of law firms forget put an intra family transferability provision in this allows the options to be to be gifted to a trust for your children or family members and remember this is a real discount because the operative thing for estate planning are discounts the reason it's not marketable so now I have a discounted option I can move to a trust or I could get a double discount by moving it to a family limited partnership and putting the unit's but this is all sets against beef scale-back but these are wonderful opportunities and wonderful plantings it doesn't cost anything and those are the operative words don't cost anything that you should take advantage of great well thank you for that sounds like you'll need a lawyer to dive into some of those terms or you call be and advice what kind of pitfalls should they think about with respect to the cap tables like when you're you know hiring people you're getting investors you know I think let's keep that in mind as before that you know and as part of the cap table how should they also think about advisors or board members like what are the types of things you should think about when giving away equity and creating a cap table yeah and so I guess one thing I'd say to avoid pitfalls is to really be cautious and protective of your cap table I think a lot of founders particularly at the beginning when they own a lot of their company will give grants and undervalue what their equity is worth whether it's to advisers whether it's to part-time service providers whether it's to there's early employees and it's easy at the beginning because you and so much but over time that starts to really really dilute you particularly as you think about further rounds of capital and so I guess just to avoid pitfalls I would always be very cautious and making sure your time those options to the value that you expect to get from them whether it's with an employee or a board member and in terms of a board member at the early stage we typically see a range for an independent anywhere from 25 basis points to a percentage and I'd say for advisors you're looking sub 25 basis 25 basis points would be high and so I think the key with those you're probably have a slightly longer vesting period with with a board member who you'd expect to be with you over three or four years advisors the key is tying them to very specific goals that you're trying to achieve over a set period of time and having those options vest over that set period of time so that you're fully aligned with what it is that you want whether it's helping you secure your first two three four customers whether it's partnerships whether it's help um I don't know branding and positioning whatever it is I think it's been very specific and strategic about aligning the time period in the duration with the amount of options that you're giving them and with a you know as as specific of ROI as you can get remember it could only be non-qualified options unless you're a full-time employee that's the only time you can get a grant of incentive structures okay great and so we're talking about options and sort of equity amounts but but what are those percentages me and how do you even value a company that's pre revenue how do you know my company's worth 10 million dollars how do you get those numbers yeah go ahead okay and I let on tours a few is it the earliest stage there's two values right there's there's lets you raise your first round of capital and you've got a value put on the company now that's not where you're gonna be issuing options but that is a that is a line that you can point to as what your company is worth and it's actually a good way to think about how you this is sort of this is a little further along but thinking about that value of your last round in how you compensate people going forward as it allows you to take a percentage value and put into a dollar value so if you know you want to give someone a hundred thousand dollars and their option grant should be a certain percentage of that dollar value you can really think about that once you have a value on your company and figure out a way to repeatedly give out very specific option grants that align with with a strategic plan at the earlier stage it's very much more art than science and so those first ten hires they're all going to look a little bit different they're gonna be much higher than you expect when your post series a and you're gonna be granting them all at a 409 a which you'll do probably after your first round of financing it will be valuing the common stock that you hold you can use someone like a Carta you can use any independent third-party firm to do it if you're really really small and have no money no revenue never raised outside capital you can basically get it done for free if you want to if you want to give option grants away before that but typically we think about it come in right around that first fundraising round you pay whatever it is $5,000 or less for a for 9a and that gives you a value on your on your common stock and what you can use for your strike price most important thing I would say is remember that valuation is so important under 409 a I rarely see audits but you know what I see them when it's respect to 409 a because some people like to use the previous year's valuation and they've done around and they unfortunately want to use that last year's valuation to do a strike price that's the thing the service is going to pick up the most because it's the 409a valuation this could be you know misinterpreted or an old value use and so forth but I did oh everything because at the very beginning you're trying to endear people to join you there are important people to you in the organization and they're taking a chance so what do you need to do you need to give them a little bit more equity so that they're going to be enjoying the same kind of you know enthusiasm that you do for the startup so I think at the beginning give a little bit more and then perfect number 12 verse 15 after that then it goes it gets ratcheted down and so now it's like a little bit about compensation so Robert how should founders compensate themselves and what about the early the early employees all right you know founders believe it or not I really am an advocate of founders getting paid and I'll tell you I've seen too many situations and I'll tell you because their job as the founder is one thing but it's a different job when they serve as the CEO and they're working very hard and with respect to that the market if they don't see you getting paid eventually I'll tell you the common comments that I hear they said well what the hell is he or she doing you know they're not getting paid are they really working and is a real value to them you know they think maybe another officer when the company if they put themselves as an executive chairman or a chairman so I believe in providing equity and and you know this may be an appropriate time to say this as well within with a young startup company the thing that you should think about which is invaluable and believe it or not a lot of people don't realize that it's called qualified small business stock and it's an exemption if you have fifty million dollars in value or less it's a c-corp remember a c-corp not an LLC and so consequently if it's a c-corp and founders especially with stock and in getting and induce people at the very beginning to participate in the company give them stock because if you hold the stock for five years and there's a transition event you get ten million dollars exempt from taxation coincidentally New York is a great state for that because they give you the ten million exemption on a state level or California doesn't and the federal level you get ten million dollars and I'm going to tell you what I did a transaction just a couple of months ago mom-and-pop got ten million I put shares for each of the three children and as soon as before we sold I had this trust irrevocable which means that look like a separate human being it has a separate ID number each kid got ten million dollars so now you got a situation we have 40 million dollars exempt from tax Pirandello say you can do a tax free exchange for the units for share and you're there and the last thing I'll say I had a c-corp recently and they switched to an S corp then they switch back to a c-corp so the question of the day came up through those shares qualified for q SBS originally granted the answer is yes because the majority of the time and stated C Corp even though it transferred so these are kind of the nuances and the last thing I'll say about this people that our founders here's the beauty of it I could take those shares and even before I hold them for five days I can roll them over to another C Corp after their sole free of tax so it's a way of continuing to jumpstart new businesses I can use the same because I just met with them to glucose which is a company we did an IPO for they didn't even know they had Q SBS you know and that serial entrepreneur is just doing that sorry so the initial shares of what you provide for the initial people that work for you are it's really important if it qualifies for the Q SBS by the law by the way this law is back from 93 it's 50% q SBS 50% of ten million and I think 2010 is up to 75% now it's one of the provisions that are in the tax code permanently one that we think about a lot too as investors and so when you see a lot of seed rounds maybe on safe notes or maybe a convertible notes for us the Q SBS time doesn't start ticking until we own equity and so there's certain situations and reasons why you might want to do convertible note for us as seed investors were effectively pricing 100% of our rounds so that the day where we get involved with the companies the day that time starts starts ticking and and by the way if you have that early exercise provision for the incentive stop shins I told you you grant it you exercise it as soon as you make the 83-b election even though you're not vested in the shares it counts towards ownership of the five years for q SBS that's another subtlety which is kind of interesting so important to focus on it great and so uh you know when a star up is making some of their key hires and there's various you know what kinds of ranges of equity are appropriate you know based on the stage of company you know if you're joining a new startup what can you potentially expect as far as maybe percentages of ownership and a company yeah so if you're among those first 10 employees in your critical business hire you're usually looking in percentage points and so percentage points and the difference is going to be once you're really passed series and a larger you're looking in basis points for the most point for the most part and so first 10 employees again these are assuming that you are a critical role to the business success whether you're a developer or you're in the marketing side of your sales usually it's somewhere between one to two and a half percentage points if you are joining a team of two co-founders and neither are technical and you're technical and you're gonna be their CTO you might see a situation where it's five or six percent instead so the way we think about it as investors when we come in and lead a seed round we're typically reserving an option pool of around anywhere from ten to twenty percent I'd say typically right around fifteen and we think about that as the hiring needs between when we invest in the series a and the Series A typically comes somewhere between twelve to eighteen months afterwards and so all those hires that are coming in that period we were thinking we should be allocating roughly fifteen percent of the company to those new employees Abbadon see really very similar percentages one to two percent you know you know these are not things that are off the radar usually people talk about it and think about it and best practices so I really do see probably the same thing I always see a reserve though of options because as you start to speed up towards the IPO you don't want to be overly diluted but on the other hand what you do want to do is have the options available without having back to the board if I was public I'd have an evergreen provision in it to make sure you don't have to run back to the board all the time you know with three to five percent to take care of it but on the other hand you know when you're growing fast you may be giving grants out you know every round so you have to review the option program you know at that particular time you touched on dilution and that's actually a question that has come up a lot in slide Oh so is there a way as a new employee to somehow get stock or options that are not dilutive or to maintain your ownership you know I had worked at a couple of startups and certainly did not have that but curious it their ways ways that employees can I have to tell you I take a look at provisions that would be similar to what you would see in an employment agreement now you know at the startup you may not have it but I always looked at the plan document too because these things should be covered what happens in this goes to dilution what happens upon death disability what happens on separation without cause what happened to separation for good reason change the control provisions you know non-compete provisions all those things should be handled someplace either in your documents or an employment agreement very seldom have I ever ever seen a situation in which they're gonna be protected from dilution I worked on an employment agreement for somebody and it was with respect to a German company that he's working for and I did get that provision in you know I told him you should frame it light it and show it because I read it rarely ever happens so you know but things you should be thinking about would be repurchased things to repurchase agreements because you know no offense but when private equity shall make them the bad guy so when private equity comes at oftentimes we got to look at that contract I just worked on one in which the CEO was let go was not the appropriate person to take the company public looked at the contract repurchase of the shares back to the initial value which was peanuts so all the appreciation they lost so things need to be looked at carefully is my advice but I deal with dilution and it always comes down to this who do you really want to be with the company I don't give options because usually by that time the strike price is too high but I do give restricted stock units out and with those units I do pre to post pre to IPO to post IPO I put a time based on it and that makes up the dilution because now I don't have to deal with the high strike price yeah there's no way around dilution and if the company is doing well the dilution should be a positive thing in that you own slightly less of what is a much larger and more valuable company and I think the way that sort of we advise and a lot of our founders who have I think really strong retention and plans in place or your and as you get later in later on I think more of your option pool is shifted to retention versus hiring new talent there's sort of three ways one is within promotions when you promote someone to a new role you up their options to where that new role would be the other is for star performers so there's sort of 10 maybe top 15% of your employees you give them grant based on a certain percentage of the base that they get you gave them originally and then there's sort of more of an evergreen mentality where two and a half years in when somebody's halfway a little over halfway vested with their full share grant you start then issuing new grants that are roughly a quarter of that original amount and you do those on a yearly basis and that gives sort of a continuous stack effectively of vesting equities such that there's never that cliff moment where an employee says I'm fully vested I have to start all over again I might as well you know this is when I should pick my head up and look at other roles and so there's a few ways that in a company you will kind of counter dilution but it's never there's never I've never seen anything in any of our companies and it wouldn't make sense where where employees are protected against dilution such that any time a new investment comes their react yeah I think the most important thing he said was retention and remember stop and think some of the private companies right now that are huge and how long the employees have had to deal with restricted stock units because a lot of times you'll see a double best rsu's would be more for the ranking pile and now more and more for the larger companies as well don't forget this q SBS and I'm telling you the reason I say that is even Ober has q SBS shares if you dig down so that's an important thing to think about but with retention a lot of times upon the exercise of an option like for example there may be an additional holding period of a year or two so that not everybody sells at the same time when it does have enough Facebook for example granite ISOs and there are issues with the double best as I said the RS she is vested but the taxable have been didn't occur until after the lock-up period but what they didn't figure out is that everybody was not only going to sell stock attributable to the withholding but the rest of the stock as well so that's something why you think about an underlying hold for retention so they don't grab all the money after the lock-up period and run so that holding period is important one thing maybe it's not appropriate at this time but I don't want to forget and mention it a lot of times their stock our options that people have exercised and they want to sell the underlying stock to a third party you got to look at the documents I have one person come in I had to give her a stiff drink because she had exercised Oliver ISOs know overly exercised should a 19 million dollar tax liability the problem is if she sold any shares she had to leave the company that was one of the provisions of Facebook so the only way she could get out of it is to a disqualifying disposition sell some of the underlying shares create the ordinary income to get rid of the alternative minimum tax so who you gonna sell it to so you have a third party but at the time the valuation of Facebook was 20 bucks then we're going to give her 20 to only the 20 bucks is subject to capital gains that two extra bucks she gets is ordinary income so if you ever have a third party think about the tax ramifications we have a question with respect to vesting and someone was asked about a reverse vest can you talk about maybe first what are some common vesting schedules and I think we all know about a four-year are there others and and what is the reverse fast well I'll just throw it frankly a best thing that I see most of the time and probably you have 25 percent then it's on a monthly basis up to four years that's that's pretty much the standard I'll say there's always variations on that theme a reverse best is I will see that if the founder gives another person founder shares it brings them on but how do you know they're not going to quit and take the shares with them and now you've got a non-employee owning the shares so what you do is you put a reverse vest on it so over time the shares begin to drop and become yours you know and it'll decline you know so I'm going to start off with you know 100 and let's just Ratchet it down over time so that if they do leave they're not gonna take the chairs with them is that the typical thing is yeah and the most common one we see is it's four year vesting with a one-year cliff at the beginning and then you start investing monthly and that's what we have in our term sheets in the reverse as far as I understand it gets you to a similar place it's just a slightly different structure okay great and so if everyone's submitting on slide oh I think we probably will take some questions on this but also feel free to raise your hands if there's anything in particular like addressed so we'll start with you so this is a question around a change of control clause of the stock option grant you mean whether you should have it or don't well I'll tell you what he's what they're usually referring to when you say that question there's going to be 280 G 280 G for me is that excise tax provision and I'll tell you what it means but interestingly enough it really applies to private companies as well as public companies so what it does is they take a look at your compensation five years from the date of the transition event and look at your w2 compensation they multiply by three if as a result of accelerated options for example and the time value is measured as well your one dollar over three times so let's say I've made a hundred thousand dollars a year three hundred thousand dollars my limit and what I'm getting because of the acceleration of the awards is one dollar more everything is subject to a 20% excise tax of it's a public company except for one years of compensation now that's public and let's say a private company so you have my VC partner over here and you've not that crazy about the management you know and how they're doing it and so you know as a result you know the question is there is going to be an acceleration and they are going to get over this three times hurdle right do they automatically get it no the people who are not subject to receiving it have to vote there has to be 75 percent vote that they're actually going to approve the additional amount of money that sorts out something to the 20 percent excise tax now they may say this VC group I happen it's not this VC group but I do have a VC group that's really irritated and so they're really afraid that they're gonna lose this additional about but they could lose the whole amount and so so to protect at least the amount up to the three times level that I'm talking about they have said we won't be subject to a vote and so forget that don't forgive that and they will take the additional amount now if I have a public company and I'm running against these acceleration things and say there's a severance plan in it what I do is I redesign it and I may put a non-compete in so the money attributable to the severance plan is really characterized as a quid pro quo for the employment agreement and that pulls money out of the transaction because that money has nothing to do that aren't compete with the transaction or I might have a consulting agreement so that it always reduces the amount below that three times but I think that's what you're referring to and if you're not I'm I'm sorry but you have probably comments with respect to that yeah it said the other comment I would have as it as it pertains to changing control so the way we structure our investments is there's a there's what's called a double trigger and so if you're acquired and then that's this one trigger and then fired without cause that's two triggers all your options are accelerated now there's also situations oftentimes that will negotiate with management where X percent of unvested shares at the time of a change of control will accelerate and then you'll still have some left over but well we're we're thinking from our side and what we're concerned about is that negotiating with the buyer and the fact that they're buying the company in part because they want the core team involved and if they buy the company and everyone invested 100 percent they're gonna have massive turnover and people just gonna leave with their money and so that's sort of a in terms of change of control what we think about at our stage that's how we're thinking about it and that's what we're putting in to make sure that the company is best set up for that but also fair to the employees yeah and I'll tell you something we just worked on a situation when I was asked that and it's similar to what you're saying there was acceleration for the senior management team and some of them may be replaced because the CFO maybe or the the GC but the other people we were afraid we're going to leave so what I suggested is you know for those options that weren't vested will value them today will Bank them and then consequently you'll get paid over two years the first year in the second year is a golden handcuff so they know what the award is going to be it's a handcuffed out there they know what the value is going to be and it's a great retention tool so when your company's starting at there are a lot of accelerator and incubator programs out there and it's great to get accepted but you often have to give some equity as part of that how would you think about you know it's going into those programs kind of cost-benefit they're probably more familiar with that yeah and so there's actually it's worth reading Paul Graham who's one of the early founders of YC has an interesting equation which basically results it's a very simple equation but it basically results in what's the value that you think you'll get out of that what you'll get out of in this case that accelerator and is that is it worth that much equity in your company and so it's really time the value you know this is how I would think about anything you're doing including hiring employees tying the value that you think you'll get out of it to the amount of equity that you need to give up woohoo and so and oftentimes it'll come with a small investment as well but really it's all about you're gonna give them this much of your company how much is that worth to you and in your business and if it helps you then you know it could in many cases you could absolutely be it could absolutely be a great investment I think the way that the way that Paul calculated for YC in early days was something around the lines of it was you know if they make a six point something percent improvement in your company over three months then it's that it's worth doing his argument was that if you look at our track record which at the time had some pretty amazing companies including Dropbox it's worth your time and so it really but it really depends and each company's different and so it has to be somewhat personal but there is kind of a baseline formula for thinking about is this worth it for me and then you have to make some assumptions around how much value that program will create for your company there's a few questions we had around kind of documentation and paperwork and you certainly mentioned a lot of them but when founders are getting started and making employees what types of agreements they need to have make sure they have in place before they kind of divvy up any equity well I mean you have to have a an equity plan in place what are the things that would always suggest have everything in this equity plan even if you don't think you're going to grant it because frankly performance share units are issues everything and the reason why I say that is the last thing you want to think about is going public if you get that opportunity and then you want something else in it and you have to go back for a shareholder vote so I like to see everything in the plan and the grant documents specifically will spell out of the ISOs are early exercisable for example or transferable that they're non qualified options and so forth and so the transferability provisions years ago am I going to go through the whole story but we put transferability provisions in Microsoft Microsoft ended up with 16 billion dollars of underwater options you know no more shares think about so we thought of a way for Ballmer not have vegetables thrown at him to go ahead and get the clean is balance sheet up as much as we could so I went to the SEC got the options stripped before ability provisions and we bought them and there was a shelf registration of six hundred twenty eight million shares what we did is when it was sell and this is all because the plan document allowed it so I assessed the institutional shareholder services which will be the watchdog after a few years of being public couldn't say anything although they did of course but we ended up putting the self registration selling you know when the stock was going up and by when it was going down but here's the difference I paid the people from money being paid to Microsoft and dropping it down because now they got a tax deduction for something they never would have gotten a tax deduction for so everybody was happy but these are types of things you got to think about so I use that as an example because all the transferability provisions I put in put the kitchen sink in so they don't have to go to anybody all they had to do is go to the board and get approval so that would probably be the most important documentation that that I would think you would want is the equity plan and have that down and then another question around as a founder when you have issues how do you know one two go to your advisors versus ones you need to involve your board and that's via Graham I think the first thing is to go to the advice lab and a lot of people do because the things a lot of time and money because they're educated enough in order to think through what they should be going to the advisor for and the attorney you know you got to hire sophisticated people on your board I think especially on the comp committee and the audit committee yeah I mean so all approvals will be going through the board yeah and then anything that's like a CEO or a CEO level grant will be a board decision as woohoo so I mean that's where that's where you're starting I mean our stage boards are very small it starts to become a little bit different when you're approaching a public company and you might have double-digit people around the table but for us it's usually three to five people what are the grand sizes that you're seeing for board members in equity so usually in our stage we it's pretty rare we'll bring in an independent board member okay there are occasions where it's a very specific or unique industry where we have someone in our network that we think can be incredibly helpful for the team and navigating the different roadblocks that they may run into whether it's a regulatory issue or otherwise but most commonly its investors at our stage right so it's the preferred holders so if we've done a series a and a seed round maybe you have someone represented from the seed maybe you have someone represented from the series a then you have probably two common board seats there are two management board seats and then maybe you have the your fifth which is this independent which you may then bring on but that's usually not going to be until post the series a it's great to have a BC though because besides the financing yeah they really know all the traps so they know the road map to get someplace so it's really important to put the right BC in order to do it and the right lawyers early yes there's documentation stuff your if you have good lawyers they should be giving you advice right absolutely so you know that brings a question around when you think about angel investing versus VC investors and you know when should a company you know it sounds like there's some keep that's a potentially working with the VC why would you work at what point are you looking for angels versus having kind of a real institutional investor yeah I mean angels are there's still great reasons to have and I would say for a lot of our rounds will include two three four five strategic angels as part of the syndicate because there are oftentimes the individuals that can really help and really serve as advisors and then you have them aligned with you from an equity perspective because they put money in and that's that's that's an ideal situation versus granting them equity so that they help you allow them to really buy in and be fully aligned with the team and I'd say the other situation sometimes you want to just put together a really small friends and family around to get a proof of concept up and running a couple referenceable customers you know a few data points that then you can go and raise a larger seed round and it's we will I mean now there's seeds kind of broken apart into precede seed and then post seed or whose mansion stage seed so there's a lot that can happen within the seed world but for us I mean we'll we'll do anything as small as a five hundred thousand dollar check and we might do a three million dollar check and so it really depends on they dynamic of the round but from yeah from a company standpoint I think it's am I ready to talk to venture capitalists part of that's gonna be your network what you've done before what your idea is how it differentiated from the market it is and often times it's better to get a few hundred thousand dollars together among angels make a couple hires get a little more progress and then go talk to VCS and raise with something that's a bit larger that's that's that's still pretty typical for what we see and I would do that I think it's important you know to have these angel investors that are real working with strategy with you helping you and so forth because that is the way that you get B C's interested by having quality people and advisors around you they know you've given a lot of thought to it you know they put their money in it so that makes a big I think statement at least that I've seen too for the BCS okay great so you know we've been asking just a lot of pointed questions but Graham is there any kind of top considerations we haven't touched upon that startups need to think about with making equity distributions and then Robert Ross q next yeah I mean I think high level the big the key decision is with co-founders at the beginning and what that looks like we're not super dogmatic as investors as to what you have to do I think the key is that you need to have given it real thought versus just I think the easiest thing to do is say we're even co-founders and we're gonna split it without really putting thought into what that's gonna mean and what that means not necessarily today but in five years from now and in ten years from now because this is a long journey and what you sign up for today you may feel very different about in two or three years and so we've had situations where it has been even splits and things have worked out incredibly well but by and large we would prefer to see if it's a three-person team one person who's the clear CEO people have spent a lot of time thinking about the effort they're gonna put in who's going to be the real driver who's gonna be handling all the pitch meetings etc etc there's one person that is going to have a larger ownership than the others and there may be three different ownerships and it's all built around a thoughtful analysis of you know how involved and how much I'm gonna drive this business to success and so I think the most typical thing we see is a CEO who has the largest stake and then two if it's three co-founders two other co-founders who have some slightly smaller stake depending on what their roles are gonna be I really see very similar things because frankly the biggest arguments come around to the ownership and how they're gonna split it up you know and and somebody's got to be the driver and be respected as that and oftentimes you'll find a file a founder that's a CEO they're maybe not the right businessperson to carry the business on and so they've got to recognize that and know when to step aside and have somebody else come in there it's experience I've governor talk in San Francisco to a whole group of professional CEOs that's all they do they come in and they take the public at one point in time they move it along they know what to do and they know what to say but to get that organized at the very beginning I think it's really important you know and the size of the grants because then suddenly the issue of dilution comes in if I hear dilution when it's like plastic to mrs. Robinson you know I mean I hear that word constantly you know about dilution and so that's something that needs to be worked out ahead of time because you want this to be smooth sailing it's rough enough out there regardless and so you want to make sure that you're doing things in a timely fashion in an orderly fashion I have a handout for you all that I think from that it may be helpful because it's called navigating compensation from pre to post IPO and it's got both planning from a corporate standpoint from a planning from an individual standpoint what happens as a checklist after your IPO and then it has the timeline for security filings and so forth but it was done in a Q&A format but by when I was interviewed by the Nasdaq so it's memorialized so it's a good thing just to take a look at your timeline as to what places you want to be on that timeline another question came in which i think is pretty interesting around you know when you're starting a company there's LLC's or S corp there's B Corp it's gonna what do you think about starting and what are the the key distinctions well that means C Corp is the C Corp you know is the QSB S and one other thing beside the QSB S is a magic word that another one that I hear constantly now through the new tax law Opportunity Zones so an opportunity zone google it and you'll find where all the locations are when I looked at Houston I know where all the politicians live because they're not necessarily in poor areas but look startups can't be in the best areas so we've had people that are investors that are really interested in certain companies as a good investment but not only that they're going to get AK USBs and again the opportunity sells Opportunity Zones I could take a capital gain and forego the tax on it and then within 180 days I invest in your company so I hold it for five years and I get five basis points checked off from the capital gains and another 10% of it seven years no tax after ten years so I have a VC actually in Nashville that worked with the company and what they're doing is VC is gonna be able to pick up the tax-free money because they work together and they're gonna have it held that the you know the requisite period of time but but that's another thing that you should think about because it could attract investors aside from the QSB s that you're me to C Corp for the QSB s you do and it's interesting I always see LLC's in Texas I never see C corpse I saw to see corpse in my last trip a lot of them n even know about the QSB s so there you go yeah I mean when incorporating if you're planning to raise from venture investors in the US unless there's something unique it's almost it's just a no-brainer to do a c-corp in Delaware yep and so if you're an employee at a startup and equities a part of your compensation it seems like at some point maybe you need to be talking to a lawyer an accountant or what kind of resources you think that they should really engage probably a bank so they can finances you know they don't have any money you know to exercise the option you know that's where it's very difficult to get loans for non-public you know equity so as a result you know you don't where you need to go to an accountant is when you're exercising it and you should think about if you do have the funds as a privately held company to pay the strike price and the tax for down qualified option then your consideration is when should I be exercising the option you know and if I've got a lot of money I can say well I'll borrow it and pay for the strike and pay for the taxes and have that many more shares but the point is you got to believe in the company you've got to have this so I think accounting is important but you know what a trust an estate lawyer for wealth transfer opportunities is really important too because there you can take care of discounts and really provide for your family and at the last moment if you're gonna have a taxable event what do you need you need a contribution to a donor-advised fund for a tax deduction that's one of the most valuable tax deductions out there is charity and that usually goes but before a transition event occurs you got to do that nine months ahead otherwise the service comes in what they call an assignment of income doctrine and they disappear the the transfer is a sham and they won't allow it so you got to do it before the transaction but don't forget a terrible contribution to reduce your taxes another question around like the ownership percentages for co-founders when you start and as you raise rounds how do they think about that oh yeah I mean I think that's back to that again usually I we like to see somebody who owns was the CEO the largest share of all the co-founders we have plenty of situations that it's completely even but I think that's usually the most aligned and yeah well so before we invest oftentimes there's a hundred percent of the company is owned by the founders and so that could be you know 25 25 50 it could be 25 25 25 25 we have some companies that have four co-founders and so it's just it really depends and then I mean thinking about dilution and going forward if you're gonna be on the the VC journey and you think you're gonna need a lot of capital raised maybe it's through a series D you are fifty percent at that seed stage is probably gonna be ten to fifteen percent at the series D stage that's just like that's how costly it is to raise round after round of venture capital which is why you see certain companies like Qualtrics which is which are outliers which became wildly profitable before needing to take on venture and were able to set terms and not sell that much of their company but most most companies that you see they get to this stage where their public the founders are generally only less than 20% yeah so we there's a lot more questions coming in but you have an opportunity after you know when we wrap up well I'll stick around so before we go you know you think about we mentioned having a handout for everyone but what other tools or books would you recommend that the founders here should essentially kind of read it's kind of better understand equity and for the you know startup employees how to think about you know taking equity so there's a ton of great resources yeah it's that I think like the slides are our Rabb o provide there's a there's just dirt there the great information out there certain things that I think are really good I think YC has some great content around this that you can use for an early stage founder Fred Wilson's written some really really insightful posts over the years and while some of them the actual numbers that plug in or have changed quite a bit over the last few years I think the general framework is incredibly insightful and let's see Paul Graham's is very good as well Cora is a pretty useful source as well just for user-generated content and people are constantly asking about you know what do I hire VP of engineering when I've got 50 people like what does that look like what's the equity range I should give that's that's all gonna be on there there's all good content once you've raised money then you can lean on your VCS so we have a person in-house who's recruiting and talent expert and we have access to all the benchmark data both from our portfolio companies but also from other startups and we can help frame any sort of equity grant or equity plan that our founders are looking to employ so there's a ton of great free stuff out there but then once you start rate fundraising both your VCS and and your council will have really good access to content and information most of the time you know people ask me how much should I grant what's the composition of the grand so forth so I will think of a peer group I don't necessarily have to have the same industry but I like to see what the revenue is you know and I'd like to see the size of the company the market cap and so I can go to probably private companies very similar in those two arenas and come up with what would probably be a reasonable thing to think about but well another area you can look at will be the compensation consultants they publish a lot you know Towers Watson pay governance Frederick W cook you look at that and they come up with statistics and numbers educational material and so forth for the tech companies you may want to check company Impella is a compensation consulting firm for which all the principals are former lawyers with Wilson Sonsini which is one of the big you know IPO companies out there especially on the west coast and and so oftentimes I'm on a panel with them or I'll ask them to be on a panel they have predominantly lawyers that are SEC trained and so forth so that gives you a good flavor and background so you can be much more educated about the whole process as well but at any rate you know a lot of people can't afford a comp consultant for so as a result you know they take a look at the materials and it still gives them enough to go forward with great and just one more thing while we're on the topic of resources for founders are there any sort of tools that you've seen for managing I could ECAP tables and sort of software that you would recommend or is it just son of an Excel the Cardo Cardo card is the big one right now thank you we're gonna partner with my and and basically you know this 409 evaluation is not a funny thing it's important right so a stock and option administrator who's good will keep track of that the last thing you want to do is keep your CFO or bookkeeper busy you know with spreadsheets trying to keep track of everything - it will kill you and kill them as well all right well great thank you both so much Robert and Graham this is great I hope everyone enjoy [Applause] [Music] [Applause] [Music]

Channel: Amazon Web Services

Views: 12,557

Rating: 4.9276018 out of 5

Keywords: AWS, Amazon Web Services, Cloud, cloud computing, AWS Cloud, startup, startups, equity, aws, co-founder, stock, cto, fundraising, compensation, ipo

Id: rXUFKDVtAVE

Length: 55min 48sec (3348 seconds)

Published: Wed May 15 2019