The current state of startup incentives is not looking good and must be replaced with something significantly better. I am going to make some proposals or suggest some ideas about what that “Better Thing” might be in this article.
Problems With Stock Options
Competing With Giants
Startups, which often focus on attempting to disrupt major competitors through speed, talent and execution, need to attract and unleash top talent. However, with the growth of the FAANG set of tech giants, it has become challenging for startups to attract the upper 1% of the talent pool, who are often able to command excessive salary + stock bonus plans from the likes of Amazon / Google / Microsoft / NVIDIA.
The author, for example, has turned down the option to join numerous startups at an executive level. Why? I could not make the numbers work for my family (supporting my wife and two children), even WITH the prospect of potential future millions in stock options upon buy-out or IPO.
Furthermore, the primary tool that startups have to offer, Stock Options, have not felt remotely competitive for a long time. One glance at Blind threads on discussions between startup and FAANG compensation packages demonstrates what I am talking about. There may have been a point when options being offered by startups seemed motivating, these days – most offers that a funded startup can put on the table simply do not compete.
Stock Options Used To Be Good
In the 1990’s, engineers working at Microsoft became ultra-wealthy by collecting stock options leading up to the launch of Windows 95. Microsoft’s stock itself split many times, creating more than 10,000 millionaires as a result. Likewise, Facebook and Google have produced many more high paid “winners” along the way.
Tax Problems & Complexity
If you are the employee of a startup who is “Lucky Enough” to receive stock options as part of your incentive structure, you might be shocked to learn about the extremely complex financial and tax laws governing these instruments. There are many situations where employees must choose to buy their options at exorbitant cost only to find that their paper gains evaporate and are replaced with massive taxes.
It isn’t a stretch to imagine that most employees do not fully understand the complex options they are granted, allowing for many loopholes and potential liabilities.
Jealousy, Resentment, Coasting
Another phenomenon linked with Stock Options is the extreme differences between payouts between potentially equally talented employees based on when they join a particular company. I have seen a number of discussions around how “newer” Microsoft employees would work alongside 1990’s Microsoft employees who earned vast millions. The seeming unfairness in compensation packages was the source of tremendous resentment, Bill Gates has even cited it as one of his biggest personal mistakes.
Dilution & Fine Print
Another very serious issue with how equity is provided to employees, founders and startups is that there are abundant opportunities for aggressive investors to pick the pocket of prior and subsequent investors. There are numerous ways to screw over employees and founders as the result of telescoping A,B,C,D,E,F rounds of financing.
A famous example is Eduardo Saverin being cut out of Facebook by Mark Zuckerberg. Still another example is in how the founders of SnapChat accidentally allowed a “Right of First Refusal” clause into their first round of financing that allowed venture capitalists to effectively hold them hostage for the duration of the company.
Long story short, more often than not, founders and employees finish their “long march” to IPO or launch a company only to discover that they would have been better off simply getting a FANG job and collecting a check for five years.
Left With Peanuts
Often, employees joining later in the life of a startup may find they are only eligible for a fraction of stock. The more rounds of financing a startup accepts, the more hobbled their ability to attract and reward the very best people.
I have personally received millions in stock options during my career, only to find none of them were worth anything. As a result, I am deeply skeptical of anyone offering them to me.
Being Acquired By People You Don’t Want To Work For
Another real threat of startup equity is that you may very well be acquired and locked into working for a parent company you don’t want to work for. While your CEO might be happy to sell you to ENRON / EXXON MOBILE or other entity, you might be surprised to learn that you are stuck working for AWFUL_CO for 5 years before you are even able to fully vest. You see – There is no mechanism to monetize or cash out on your options until the completion of such an acquisition.
And if AWFUL_CO wants to fire you or you quit? Too bad for you.
Getting Fired Or Pushed Out
Another obvious threat is being compensated in options and then getting fired or pushed out before you can vest. A famous example of this is Skype, who sold to Microsoft for $7 billion and subsequently ruined their options in a number of ways. The reality is, the convoluted legal jargon in the options often holds a lot of leeway to remove them or cancel them, resulting in many unfair outcomes.
Expense, Legal Risk And Overhead
Implementing options is legally time consuming and expensive. Whats worth, if you do it wrong, you go to jail. Even if you have a skilled professional who follows all the regulatory guidance, you can still find that you might end up on the wrong side of the law (because the law can be unclear and change dramatically).
A good example of this is Ben Horowitz’ story about how he narrowly missed going to jail by deciding against the advice of his executive in charge of options planning.
Long Story Short: Options Have Problems
Don’t get me wrong. Plenty of people have gotten rich off of stock options. I wouldn’t turn them down if someone offered me millions of them. But the downsides and complexity, tax risks and many other downsides make options seem highly unattractive as an incentive mechanism.
If you read the list of risks above and still want to use options, good for you! I personally would just like a big pay check and a pile of stock myself.
Short Timers & Multi-Taskers & Fractional Roles
There are many situations where employees should only work for a startup for a short period of time, perhaps 1 1/2 years. Reid Hoffman introduced the concept of a “Tour of Duty” based on his observation that many employees tended to only work for a particular startup for as little as 1 1/2 years due to the frequent changes in the needs of fast moving organizations.
These short timer stints might be convenient for the hiring company, but they do not offer many long-term benefits to the very best employees.
Furthermore, in my personal experience, the very .0001% top talent are ultra generalist hyper taskers who sometimes are capable of working for multiple companies at the same time. It is not uncommon these days for startups to have “fractions of a job.”
What Should Replace Stock Options?
So I have outlined just a few of the problems with stock options listed above. But what can be done about it? Well…cryptocurrencies have come up with some exceptionally interesting new solutions.
In this section, I will outline how an ideal cryptocurrency or token based stock options compensation plan could be designed and implemented.
Lets begin with the objectives:
- Attract and retain the absolute best people we can get at all stages of the company
- Avoid complexity, lawyers, excessive legal complexity and dilution for founders and employees
- Provide long-lasting rewards to all employees and founders which cannot be legally changed, tampered with, shuffled, stolen, taken away, diluted or otherwise screwed with by anyone
- Offer a ladder of incentives which increases to reward the best behavior
- Offer a method of exchange so that the option can be traded at any time, after a lock up period
- Enable employees or are fired, laid off or decide to leave to still profit from their tokens, trade them or have a fair exit other than seeing their compensation go to zero
- Force any “less desirable acquirer” to have to properly compensate and renegotiate terms with employees and founders on favorable terms
- Allow the employee to exchange the token or currency for public shares should the startup go public
- Allow the startup to grant tokens to customers and high value partners and advisors along the way
- Enable secure collaborative voting and decision making mechanisms to make any change to the underlying function of the token
- Preserve employee rights by preventing tampering with the token by venture capitalists, executives or aquirers
- Allow employees to be paid a monthly stipend to collect a % of overall startup profit on a monthly basis long into the future as a form of pension
- Force complete visibility into how tokens are distributed and governed (optional)
- Ensure that high value employees who join later can receive compensation equal to high value employees who joined earlier
- Allow fractional employees to work for many startups and receive worthy compensation for doing so
- Allow short time yet high talent employees to get paid what they are worth without needing to stick around for a decade
These are some of the objectives that I have in designing this theoretical new token, I think I will explore further in a future article.