Option as a share in business
On its surface this was a pretty radical idea.
The investors were giving away part of their ownership of the company—not just to the founders, but to all employees. Why would they do that?
Startup employees calculated that a their hard work could change the odds and b someday the stock options they were vesting might make them into millionaires. And the bet worked. While founders had more stock than the other employees, they had the same type of stock options as the rest of the employees, and they only made money when everyone else did though they made a lot more of it.
Everyone—investors, founders, and startup employees—was in the same boat. Therefore, the time until a liquidity event was crucial.
Share options vs shares - is a share option scheme right for your business?
Of the four startups I worked at that went public, it took as long as six years and as short as three. How Startup Compensation Changed Much has changed about the economics of startups in the last two decades. And Mark Suster of Upfront Capital has a great post that summarizes these changes. The first big idea is that unlike in the 20th century when there were two phases of funding startups—Seed capital and Venture capital—today there is a new, third phase.
And currently there is an influx of capital to do that.
The emergence of growth capital, and pushing an Option as a share in business out a decade or more, has led to a dramatic shift in the balance of power between founders and investors. For three decades, from the mids to the early s, the rules of the game were that a company must become profitable and hire a professional CEO before an IPO.
Share Options and the Family Business
That made sense. Twentieth-century companies, competing in slower-moving markets, could thrive for long periods on a single innovation.
Should You Invest in Your Company Stock Options? - Part 1
If the VCs threw out the founder, the professional CEO who stepped in could grow a company without creating something new. In that environment, replacing a founder was the rational decision. But 21st century companies face compressed technology cycles, which create the need for continuous innovation over a longer period of time.
For the Last Time: Stock Options Are an Expense
Who leads that process best? Often it is founders, whose creativity, comfort with disorder, and risk-taking are more valuable at a time when companies need to retain a startup culture even as they grow large.
With the observation that founders added value during the long runup in the growth stage, VCs began to cede compensation and board control to founders. While founders option as a share in business the 20th century had more stock than the rest of their employees, they had the same type of stock options. Rather, when a startup first forms, the founders grant themselves Restricted Stock Awards RSAs instead of common stock options.
Essentially the company sells them the stock at zero cost. In the 20th century founders were taking a real risk on salary, betting their mortgage and future.
Employees share schemes
Founders take a lot less risk, raise multimillion-dollar seed rounds, and have the ability to cash out way before a liquidity event. Early employees take an equal risk that the company will crater, and they often work equally as hard. Consider that the median tenure for an employee in a startup is 2 years.
So why should non-founding employees of startups care? There are four problems: First, as the company raises more money, the value of your initial stock option grant gets diluted by the new money in. So while the VCs gain the upside from keeping a startup private, employees get the downside. At the same time, they may have removed one of the key incentives that made startups different from working in a large company.
What Should Employees Do?