A message to founders in the city
Over the last 10 years of running and building tech startups, I’ve built up my fair share of experiences. I’ve had businesses in Montreal and San Francisco, I’ve been through two acquisitions and I cofounded the FounderFuel accelerator program in Montreal, today one of the North America’s more recognizable programs. Moreover, most recently I was proud to start this blog with my good friends Gabriel Sundaram and Joseph Czikk.
Through all of that I consider myself a humble person, but I do like to think I’ve seen quite a bit and talked to a lot of founders. It’s been four years since I’ve written a blog post and today marks my first contribution to MTLinTECH.
To start: I love Montreal. I’ve lived on the west coast twice (four years in San Francisco and a year in Whistler), but Montreal has always and will always be home.
We hear it over and over and over again. The startup ecosystem in Montreal is blooming and has never been stronger. It’s an exciting time to be an entrepreneur in our city and I’ve had the good fortune of meeting a ton of founders on a regular basis. I like to spend time with them to help answer questions, provide guidance and make introductions when I can. I’m a strong believer in the “give before you get” mantra of the startup world.
But there’s one thing that I’ve been hearing a lot in this city, something that founders in Montreal continue to do. It makes me cringe.
Founders in this city are not offering stock options to all their team members. It’s an abomination to me, to know that people are pouring their hearts into your startups without any shot at the upside.
And it’s not only happening with early stage startups, it’s happening with mature startups too!
About 18 months ago I received a call from a head hunter working for a successful ecommerce startup in the city that was looking for a VP Marketing.
We talked about the usual stuff, role and responsibilities, vision, growth of the company, compensation, and he was shocked when I asked about the stock option plan. He told me the company is bootstrapped and the two founders own 100 percent of the business. I wasn’t interested in the role either way, but even if I was, no stock options was a deal breaker from the start, not only because I could never gain from any upside, but because it told me a lot about the culture of the company.
When news hit about PlentyofFish’s exit for $575 million, in which the sole founder owned 100 percent of the company, I was shocked. This is unheard of: It’s an anomaly. It just doesn’t work this way, I kept thinking. (Let’s just say I hope the founder distributes a large portion of the gain to his team.)
But back to Montreal…
Here are my top five reasons why everyone in your startup should have stock options:
1- You pay them less than they would make anywhere else doing the same job.
2- You expect them to work hard, as hard as if the company was their own.
3- You must keep them motivated through good times and bad.
4- You hired them because they’re great, you don’t want to lose great people.
5- You must treat everyone in your company equally.
As a founder and CEO, you have three goals:
1- Build a great team.
2- Set the vision.
3- Make sure there’s money in the bank.
You’re never going to build a valuable business without a team. Stock options go a really long way in finding and retaining great people, and as long as you have proper vesting in place there’s actually no risk in giving stock options.
But I get the sense a lot of people don’t actually know or understand stock vesting, and perhaps that’s really the reason founders in this city are so afraid to offer stock options.
In a nutshell, stock option vesting gives an employee rights to assets of the company over time. For example, you may offer a C-Level hire four percent of the company in stock options on a four year vesting schedule with a one-year cliff. In plain English that means your new hire will accrue his four percent of ownership over a period of four years. To own 100 percent of their stock options, they must stay with the company for a minimum of four years.
The one-year cliff means the employee will own nothing until they stay with you for at least 12 months. If they stay 12 months (meaning they complete their cliff), most vesting plans will give the employee the equivalent of the 12 months in one lump sum, after which the employee will accrue more and more stocks after each month of service.
Let’s say you setup your company in this fashion:
- You have combined total of 2,000,000 outstanding shares in your company.
- Of the 2,000,000, you’ve set aside 20 percent as a stock option pool to distribute to employees (400,000 shares)
- You hire a COO and offer him four percent in stock options (80,000 shares in stock options).
- Your company’s vesting schedules are set to four years with a one-year cliff.
Scenario A
- The COO doesn’t work out and you let them go after 10 months.
- In this case, they have accrued zero percent of their 80,000 shares because they didn’t stick around long enough to complete their cliff.
Scenario B
- The COO stays with you for two years and then leaves.
- In this case, they have accrued 40,000 shares (50 percent of their potential to get 80,000).
Scenario C
- The COO stays with you for four years and more.
- In this case, they have accrued 80,000 shares (100 percent of their potential to get 80,000).
With vesting in place, you’re always protected because the employee needs to stick around to own their options. No stress for you and great motivator for them.
Of course there are scenarios in which the vesting schedule may be more or less complicated than this example, but you get the point. So there you have it, here is my message to you founders in this city:
Every employee in your startup must have stock options as part of their job offer.
And remember: as the founding team, you and your cofounders must have a vesting schedule in place for youserlf as well. If you don’t have it from the start, you best be sure your investors will have you set one in place at the seed round so get it done sooner than later. It’s one less friction point for your due diligence process. Vesting schedules are inevitable, so talk to your lawyers for more information.
If cofounder vesting is something you want to know more about, let us know. Perhaps that could be the focus of my next post.
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“And it’s not only happening with early stage startups, it’s happening with mature startups too!” - I would have expected to read this the other way around : “It’s not only happening with mature startups, it’s happening with early stage startups too !” .
The type of people you attract in early stage startups is different from the ones you’ll get at a later stage (when you’ve already raised or are generating revenue and possibly able to offer higher salaries / more stable environment) ; at the early stages, you want to be hiring people who believe in the vision / team / product enough to take the risk to demand equity over salary, and if they’re not I would argue they’re not the right first employees to begin with.
You bring up a great point Greg, but perhaps I made this one company sound bigger than it was. That said I’d argue that product is MUCH less important at the early stage than vision and team.
Great post Ian. I think most employees are skeptical of the value of options because they have yet to make real money (or any money) from prior exits. This is partly because they may not be getting large grants. But also because the exits have likely been not all that large. It’s standard operating procedure for VC-backed companies to create and then use a 15% option pool. BUT, i.) most of that goes to building a management team; ii.) in modest exits, the protections in the form of liquidation preferences kick in, so employees don’t tend to see much. It’s only with the big exits when VCs convert to common shares that everyone wins. So, basically, we need more big exits. Plenty of Fish would have been a great one if he had doled out some options.
Thanks Mark. A lot of good points in your comment, but what I’m seeing in this city is Founders asking me if their first hires should or shouldn’t be getting stock options. To me it shouldn’t be a question.
Very insightful article, Ian. Do you think it could also have something to do with supply and demand? With Montreal’s outsized number of university students and recent graduates per capita, I wonder if it could be linked to having so many interested and qualified people and just not enough jobs for them to need that additional kind of incentive. Of course, this would be irrelevant from the company culture standpoint you are referring to, but I guess it’s always easier to be generous when you don’t really have a choice.
Thanks for the feedback Guillaume. You’re right, Montreal has great talent coming out of its uniniversities, but I don’t think it has anything to do with Founders not offering equity. That said, I think people joining startups should be more aware that they should ask for Options. Which I don’t think is happening right now.
Ian - Great post. To your point near the end about founder vesting, I wrote a post here that could be helpful: http://swell.lpmo.com/keeping-peace-founder-vesting/
Thanks for sharing LP!
Great article! It’s a point of view we don’t ear very often.
I understand the part of retaining good people, but in a early stage startup, stock option and equity sharing comes with risk, stress, long nights without closing a eye and cashflow problems. For the founders and early owners, it’s part of the game. If I give out shares of my business, I’m looking for money, to minimize risk and stress or for someone who will bring bread on the table on a regular basis.
In your vision of things and in your experiences, is it something that employees taking stock-options understand? How do they deal with it?
And with your scenario, are you not always using your profits to buy back people who acquire options? Do employees really stay longer? I have 10 employees of the Millennial Generation and it’s stable for the moment (knock on wood), but all around me, millennials are moving from a business to another every year or so. Is it really a good idea to give them stock option?
Salut Arnaud, merci pour le commentaire.
Everyone in the company, be it the founders and employees, all share the risk of the startup. The reality is, a startups default status is failure, and the team must fight against it every day. As such, everyone in the company need to embark on the risky journey together.
Stock options aren’t something that you sell, they are something that you grant. You can sell equity to investors, but that’s not the same thing.
I do think that employees don’t quite understand how options work or why they would want them. In my post I was speaking to founders, but one could just as well written the post from the employees perspective: “Why you should have stock options if you work at a startup”
Yes, employees do stay for the long run. If your business is flying and they own a share of it, why wouldn’t they continue to increase the value of the company? In the end, they’ll benefit more!
Finally, there are always closes that protect the entrepreneur that can get fairly complex. For example, most options expire very quickly after an employee departs.
Firstly I put my hand-up for any venture that offers stock-options (early or mature). As it is now, I and many others fulfill the top 5 they need without it.
Part of the challenge you mentioned in my experience here in Montreal is that there are many start-ups out there where no VC are involved. At most there might be an Angel investor. Hence the compelling event to share, so to speak in what they see as their baby (even 20%) is not there. For example, in one case the team member got creative with ‘how to’ present the value of the founders’ baby to the target market. The idea in my view clearly had the potential of growing sales exponentially. Long story short it never took off because no VC pressure to grow and it was NOT the founders’ idea. Start-up remains same size, same place, same # of employees, sames sales level, etc.
Meantime I don’t get the sense that the current entrepreneur pool with VC backing actually appreciates the value return of a team participating in their baby. For example, in one company they began on the right path with a profit-sharing plan for all. The sales group rightly so began to capitalize all-for-one, one-for-all enthusiasm of this plan. Yet when success began to come in the door, in the next year the company removed the sales group from the profit sharing plan - ostensibly because they were already getting paid commissions for the success. Needless to say, sales dropped like a bombshell the next year.
Therefore I submit a re-education of these entrepreneurs is needed regarding the power of people for helping them get to where they want to go.
Hi Mike, first off I’m sorry to hear you don’t have stock options.
Second, an entrepreneur shouldn’t require VC money to put pressure on themselves to succeed. There are many bootstrapped business lead by entrepreneurs that put tremendous pressure on themselves. Lifestyle or bootstrapped or Venture backed, they should have no impact on the entrepreneur’s desire to drive value.
As my friend David Crow mentioned on Facebook when he shared my post, Venture Deals by Brad Feld is a great book to learn all about this and I recommend it to every entrepreneur out there. I read after years of experience and found a ton of value in it!
Hi Ian
Thanks but no need, I’m a big boy.
Entrepreneurs pressure to succeed varies and is unique to each one of them. And not all seek to drive value as you suggest, at least in my experience. Don’t get me wrong, I agree with you.
I now go and read the suggested book, for my own value drive. Thanks
If an employee (or hired COO in this case) does actually stick all this time, it’s worth the 4% and probably more..because without the COO, the founders might own 100% of a company that is worth peanuts compared to owning 80% that is worth in the millions. Startups should give employees more stock. Value is created over many, many years. You can already tell if the employee will perform good or not within the first year, so if it doesn’t work out there are ways to reset and get rid of him before vesting schedule hits again
Thanks for the comment Hammed, remember this was just an example. Moreover, you can always increase the grant size that you give people, and that on a whole new vesting schedule. That’s another way to keep people around.
Great timing for the article. Something I have been researching about. Found it quite helpful. Thanks for sharing Ian.
Thanks for sharing Ian. This is very valuable information for the montreal community. Everyone here is bringing good point of vues. I admire you taking the time to actually sharing your personnal experience to benefit others. Cheers and nice to hear that Montreal is still your home after all your past journeys