Techpreneurship: Safe Diving in the Option Pool

Jeff Amerine

Techpreneurship, with Jeff Amerine

So, how can the equity ownership motivator best be used? How can equity be offered to key team members in a way that will be fair to the founders, fair to investors and fair to the team?

Most startup junkies — or startup junkies in training (SJITs) — don’t go down the path of creating something new and world-changing because they expect market-level salaries and fantastic benefits. Founders do what they do for a myriad of reasons, many of which have nothing to do with personal wealth creation.

Even so, as a founder, sharing the prospect of equity upside in a venture with co-founders and key team members can be an appropriate motivator if done properly.

Jerry Kaplan, a notable Silicon Valley entrepreneur famously said (I’m paraphrasing to delete the operative explicative),

“Equity is like manure, pile it in one spot and it just stinks, spread it around and amazing things will grow.”

Here are few thoughts based on my years of experience doing options and equity grants wrong, seeing lots of smart people do it wrong, and finally advising others how they might do it right.

• Creating the pool.  At the outset of creating your venture, set aside 10-20 percent of the total authorized shares or membership units for an option pool.
• Options defined.  Options are the legal right (an option) to purchase shares or membership units at an agreed upon strike price (like 1 cent, for example).  Options can then “be exercised” once the options have met the vesting criteria (i.e. longevity, performance milestone, change of control, etc).  The money is made in an option exercise when the market price for the share of stock is more than the strike price, i.e. the reason why a low strike price is advisable. So, in effect, options give the benefit of equity and appreciation in the value of the company without having tax implications until exercised. Options also have no voting rights or control unless at exercise the shares are held.
• How are options earned? There are all kinds of opinions on this. Here’s my preferred approach. Tie the award of options to the achievement of meaningful business milestones.  The milestones can and should be tied to individual, team and company level performance but should also follow the SMART rule for creating the objectives (Specific, Meaningful, Attainable, Realistic and Timely).
• How many options should be awarded? It depends. Look for what comparable companies have done for comparable levels of team members. Benchmark. This is not new ground, and there really isn’t one answer. Do make strata or bands of numbers of available options based on the team member’s level and impact on the success of the venture.
• When do  options vest? Options may not always vest at the time of award and probably shouldn’t. Many times a four-year vesting schedule will be used, and one-fourth of the options awarded against a given milestone vest each year thereafter.  Having a time component to vesting should help keep talent on board with the venture at least through a liquidity event.
• What are acceleration triggers? So, how ticked off would you be if a good percentage of your compensation was tied to options and prior to the options vesting, the company sold?? This was commonplace in some circles in the 1990′s and 2000′s, and is a perfect example of an unethical practice. Acceleration triggers fix that issue. Acceleration triggers allow for all pending options that have been awarded but not yet vested, to vest at the time of company sale, merger, or IPO (Ha! What’s an IPO?? Read about these in history books from the Bubble).

So here’s the sort of startup junkie redneck bottom line on options. Options are a means of sharing in the equity upside (founders – you WANT to do this), motivating performance, making it attractive to stay with the venture, all without giving up control or substantially diluting founders and investors. I have been amazed with regard to how poorly this has been done by lots of successful people who should know better.

Also, don’t try to structure this stuff on your own. Get the best venture-savvy corporate legal counsel you can find and pay them to set up the structure and option agreement templates EARLY in the life of your venture. It will make a huge difference.

So how ’bout it?  Go spread some manure on your team and watch them grow… Wait a minute, scratch that, just be sure to think through how you set up your option pool so everyone can enjoy a nice swim in the Sea of Equity.  That’s a bit better…

Share your equity and option war stories if you got some.  Some of us could wall paper our houses with options gone wrong from the past…but that’s another story for another day.

(Jeff Amerine is an IA advisor, entrepreneurship educator, and officer with the University of Arkansas Technology Licensing Office. Each Thursday, or whenever the spirit moves him, his Techpreneurship blog will appear in INOV8. Drop him a line in comments.)

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