Chapter 1: The Equity Perspective

A few years back, I had the opportunity to meet the two co-founders of a nascent semiconductor startup. Given my interest in the industry, I was eager to engage with them.

They expressed to me their lack of funding and their search for a VP of Engineering. They had identified a strong candidate but were only prepared to offer him a mere 1% equity with a vesting period of four years. I advised them that such a small stake would likely deter the candidate from taking the risk of joining their venture.

Their response was, "Why should it matter? We're on track to reach a valuation of $1 billion soon." I cautioned them, saying, "If you're not willing to be realistic about what it takes to attract top talent, then I’m afraid I can’t assist you." I wished them luck and moved on.

It appears there are two categories of founders: A. "Generous Founders," who willingly distribute equity, and B. "Selfish Founders," who are hesitant to share ownership.

We've all seen episodes of Shark Tank where entrepreneurs fiercely defend their equity stakes. Consider this question: "Does it truly matter if you own 80% versus 90% of your company?"

You might initially think, "Absolutely, that 10% is significant." While you’re correct, it’s essential to consider whether holding onto that extra ownership could jeopardize your success.

Research indicates that being overly stingy with equity can be detrimental. As stated in Noam Wasserman's 2008 HBR article titled, "The Founder's Dilemma," founders who are willing to give up equity to secure investors often build more valuable companies. Wasserman notes:

"Choosing to part with more equity to attract investors results in a more valuable company, leading to a more significant portion for the founder in the end."

Wasserman's views resonate with other industry veterans. Andy Ratchleff, a former venture capitalist and the current founder of Wealthfront, believes that one of the hallmarks of successful startups is the practice of sharing equity. In his article, "The Right Way to Grant Equity to Your Employees," he observes:

"During my time as a venture capitalist, I noticed that companies with low employee turnover shared common traits. They provided challenging work environments sought by top talent and rewarded exceptional performance through additional stock options or RSUs."

Reflecting on my experience at Micrel, a publicly traded semiconductor firm, I recall how liberally the CEO distributed equity. Despite holding a substantial share of the company and controlling the board, Micrel experienced significant turnover after four years when initial stock grants expired. Subsequent grants were minimal, leading to employee departures.

Many executives, myself included, pushed for revisions to the outdated stock option plan, but the CEO was resistant, prioritizing control over employee satisfaction. Eventually, an activist investor intervened, leading to his ousting.

This scenario illustrates Wasserman’s point: while it may feel empowering to maintain complete control, it can foster arrogance, which can ultimately harm both the founder and the company.

Being a CEO often feels overwhelming. Everyone praises your decisions, reinforcing your confidence, yet you may also recall how many doubted your vision and the likelihood of success. This duality can intensify your desire to retain control. However, clinging to every percentage of equity may not yield the outcomes you desire.

What I’m not suggesting is to give away equity indiscriminately, nor am I advocating for overpaying employees. Instead, I emphasize the importance of fairness:

Fairness cultivates loyalty and fosters a strong team, ultimately providing the best return on your investment. Yes, you may have to part with more equity than you initially prefer, but the long-term benefits will outweigh the costs.

I vividly recall a conversation with one of our investors during the initial funding round. Gill stated, "Brett, the equity you hold now is insignificant. I can assure you that investors will secure X, and the company will retain Y. The rest is inconsequential."

What I took from this was that there exists a fair outcome for both parties, and that’s what truly matters. However, not all investors share this mindset. Some, like the notorious "Raul," aim to extract every last percentage of equity.

Determining the appropriate amount of equity to give up isn't a one-size-fits-all solution. However, I follow this thought process:

1. If achieving success requires relinquishing more equity, then I’m on board.
2. You know you’ve allocated the right equity when both you and your employee feel satisfied with the arrangement.

Numerous online resources discuss equity distribution for various roles; these can serve as valuable guides. Additionally, networking with fellow entrepreneurs can provide insights, and your investors likely have research on equity allocation that can further inform your decisions.

Before I forget, it’s crucial that equity grants vest over time. A standard equity grant should vest over four years, with the first 25% vesting after a one-year "cliff," followed by monthly vesting of the remaining 75% over the next 36 months. This approach safeguards you in case an employee isn’t a good fit, preventing you from giving away too much equity prematurely.

Another important practice is refreshing your team’s stock options. As you secure further funding, dilution is inevitable. However, keeping your team motivated is essential, and refreshing their stock options can help achieve that.

This means providing additional stock grants when a funding round is closed, especially if dilution has been substantial. You may be surprised to learn that your investors will likely support this initiative.

To determine how much new stock to grant, assess how much ownership a specific position should have based on the company's lifecycle. For example, if an employee initially had 0.6% ownership but now holds 0.35% after a Series B funding round, and should ideally have 0.5%, a grant of 0.15% in new options would be appropriate.

Always prioritize fairness: those who took the risk of joining early deserve to be rewarded. I often told prospective hires that if they joined today, they would hold a larger stake than a hypothetical counterpart hired a year later.

Refreshing equity grants is also a vital retention strategy. In a competitive job market, you risk losing employees to competitors if you don’t offer equitable compensation. Your investors are aware of this and will likely back you, provided your approach is fair rather than greedy.

The two founders I met years ago failed to grasp these concepts and never got their business off the ground. This pattern is common; founders who understand Wasserman’s "Founder's Dilemma" have a significantly higher chance of building a thriving startup than those who do not.

Chapter 2: Lessons in Equity Distribution

The first video, "Equity is the opposite of equality, and it has no place in our schools (Ft. Barbara Kay)," discusses how the concept of equity can lead to divisive outcomes, particularly in educational settings.

The second video, "Are we thinking about travel the wrong way?" explores misconceptions about travel and how rethinking our approach can lead to more enriching experiences.