[LRUG] Looking to meet...

[Paul Robinson]

Something bothered about me last night when I was thinking it over again, so just one more comment:

On 14 Sep 2011, at 19:15, Stevie Graham wrote:

> Equity options are basically deferred compensation, so you should think about "what is the minimum outcome that would make me happy sacrificing salary today?" Consider the following: 
> - You accept a salary £25k less than your expectation.
> - You are given a 1% grant (although I have seen as low as 0.1% offered in lieu of "market" salary) , vesting over 4 years with a 1 year cliff
> 
> You have to stay 4 years for your grant to vest, and your position is also extremely weak to negotiate a better salary when the startup is well funded or profitable. That's a cost of £100,000 to you, and the startup has to exit for £10,000,000 just for you to BREAK EVEN. Have a good think about the product, the team, etc and ask yourself the questions "How common are £10MM UK exits?" and "Do I think there is a realistic probability that this company will exit for £10MM+?" 


This calculation doesn't take into account the strike price, or is assuming a strike price of zero.

Typically in most equity option deals, you are not being told "you will get some shares according to this vesting schedule", you're being offered the chance to *buy* shares according to the vesting schedule at a price fixed now (aka the "strike price").

Equity is normally given. Options are, as the name suggests, a promise of an option to buy.

If the strike price assumes a valuation of £5m, and you get to buy 1% after a year, you're going to need to find £50k to exercise your options. Typically, most banks will be happy to do this for you if at the point you're exercising the options the company is worth £10m, but what if it's worth £3m?

Also critical in working out the value of equity or options is that most founders will negotiate a different category of shares for angels and VC investors known as "preferential shares".

Let's suppose I am an angel and I give you £1m for 40% of your startup. You retain 60%.

A year later, somebody else offers to buy the company for £2m. You exercise your 60% vote to accept the offer. You have made £1.2m, and I get £800k back having lost £200k. You rode my £1m to become rich, but I'm now out of pocket. Hardly seems fair, and investors don't like it, so they came up with a cunning solution.

This situation is rectified with preferential shares. Basically, in this scenario, I get 40% of the buying price OR my £1m back (whichever is the higher), before you get anything. I don't make a profit, but I don't lose out either (other than the interest that could have been gained if it had been left in the bank).

Some firms have multiple tiers of preference in their shares. Typically employees who aren't founders are on the lowest rung so there's a chance that there is no cash left despite them holding perhaps as much as 5%!

When looking at equity/option deals, strike price, preference and vesting schedules all have to be considered along with the exit route and viability of the business model to work out their true worth.

Like I said, equity is great stuff in lieu of top-rate salary if you have it as some calculated risk, but it must be *calculated*, and not just assumed to always be a good thing.