Chapter 1: The Importance of Equity Distribution

A few years back, I participated in the inaugural board meeting for a startup that had just secured its first venture capital funding. The founder, "Ray," who had collaborated with me since the company's formation, invited me to join the board.

During the meeting, a discussion arose regarding the exercise price for stock options. One of the new investors, "Larry," proposed, "We should set the stock price as high as possible, ensuring that anyone who leaves won't exercise their options." I instinctively expressed my disapproval.

Being generous with equity carries minimal cost. I voiced my opinion: "That’s not how I would approach this, nor was it my strategy when I managed my own company. We should aim for a low exercise price since we have a responsibility to our employees. How many years before this company goes public? Seven? Ten?"

Larry's glare felt intense as he was visibly frustrated. I pressed on with my argument.

"If we show kindness to our employees, those who leave will reflect positively on their experience here, which will aid in attracting new talent..."

"Bullshit!" Larry interrupted, raising his voice. "We will dilute ourselves!"

"I disagree," I countered. "I have evidence to back it up. When I let go of two co-founders, I ensured I treated them well during their exit. A couple of years later, while we were securing our Series B funding, one of our new investors had a conversation with them about the company. He told me, 'I don’t know what you did, but they spoke very highly of the organization. That’s unusual for founders who have been dismissed.'"

"That proves nothing!" Larry shouted.

"Both founders didn’t leave amicably," I explained. "However, we took the high road, and I was as surprised as anyone that it yielded positive results. My main point is that being generous costs so little, yet the payoff can be significant."

Ultimately, the board sided with Larry, and the exercise price was set high. Trying to hoard equity for oneself often leads to losses.

It would be an easier narrative if I could say that the company failed due to the elevated strike price, but that wasn’t the case. The company is now valued at over $1 billion.

So, was Larry correct? There are various ways to be generous to employees, and that’s exactly what Ray executed.

More crucial than the exercise price is the equity allocated to your team. If you attempt to retain all the equity for yourself, you will struggle to attract top-tier talent.

Consider this: why would a talented engineer with multiple job offers choose your startup if you aren’t generous with equity? The reality is they won’t.

Fortunately, Ray's board had no objections to equity distribution. Everyone recognized the necessity for generosity, resulting in Ray building a remarkable team. To maintain that world-class team, it’s essential to refresh their stock options.

Ray’s company has now been operational for four years, meaning his initial employees are fully vested. The challenge Ray faced was how to prevent these employees from leaving. His solution was to offer new options, but the dilemma was how much to grant.

I advocate for evaluating each employee as if you were hiring them anew. How much would you compensate them? What equity would you offer?

For instance, imagine you granted an early engineer 0.5% equity. This engineer now has two years of vested equity and two years remaining. What’s the best course of action?

The answer is to award the employee two additional years of equity at market rates, vesting after the current equity has vested. Assume that equates to 0.16% for two years, or 0.32% for four years. The employee's equity distribution would be as follows:

Year 3: 0.125%

Year 4: 0.125%

Year 5: 0.08%

Year 6: 0.08%

This structure incentivizes the employee to stay. The reality is that you would need to pay someone else to fill this role, so why not grant the equity to a known, trusted individual?

This strategy reduces turnover and promotes better outcomes. Even though your equity may be diluted, its overall value will increase.

That’s the approach Ray adopted, and he’s successfully retained most of his employees.

Chapter 2: Equity and Employee Retention

In the video "Should You Give Employees Equity?" we delve into the critical considerations and benefits of offering equity to your team.

Chapter 3: Determining the Right Equity Amount

The video "How Much Equity Should I Give My First Employees?" explores the essential factors in deciding the appropriate amount of equity to offer early employees.