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Should You Accept Equity As Compensation?

Trying to close a deal so we get paid – even if it is not a great deal.

I recently helped one of our clients negotiate their W2 employment agreement. We normally deal in freelancers, but increasingly we are being asked to lend our negotiating skills for full-time employment contracts. In the words of our client, “the agent is emotionally detached from the negotiation, and so can provide much more rational advice and action than I could on my own.”

In this particular case, we had already worked with this gentleman for years, and it was my pleasure to help.

The basic terms of the deal he was offered were perfectly acceptable:

  • The company was a newly funded startup.
  • Salary was ~35% below his market rate as a chief technology officer (CTO).
  • The low salary was being offset with a reasonable chunk of equity.

At first glance, everybody was fine with those terms.

The interesting and disturbing part was uncovered as we dug deeper into the structure of the deal and the kind of equity being offered. What did the finer details reveal? The company was not offering equity but rather options to purchase equity. This poses several issues:

  1. By forcing the employee to buy options, the company is essentially saying the sweat equity that you’ve already earned in lieu of a bigger salary will only be granted after you pay up. In other words, “Write us a check, then get the equity.” While the strike price is low, it does not go very far towards generating goodwill on behalf of the founders. It seems counter to the compromise of taking a lower salary in exchange for equity!
  2. The options being offered were in a different class of equity than the founders. As we all know from countless other articles, that can end in a scenario where the founders and investors cash out well while the employees do not. Sometimes those employees not only did the work to earn the equity but then wrote a check to exercise their options, and they still get screwed. #AddingInsultToInjury
  • The terms on the option plan required that the employee exercise their options (write a check) within 60 days of leaving the company.
  • The equity you earned (in exchange for your lower salary) is not yours unless you write a check.
  • You may have to purchase equity without knowing if the company ultimately will be successful and if the equity will have any value.

In order to combat this, we went through many rounds of proposed solutions. At each turn, the employer rejected the idea and (worse) failed to offer any reasoning or an alternative.

Here are all of the resolutions we proposed designed to find a common ground where both our client would improve their position while not increasing the cost for the employer.:

  1. The company pays for the options to be purchased, saving the employee the cost of exercising and de-risking them.
  2. The company lends the money for the options to be purchased until they can be liquidated. This has no negative net impact to the company.
  3. The company extends the option period for 10 years (instead of 60 days) so the employee doesn’t have to exercise his option until there is a clear value for them at which time there is no risk.

How did the company respond? No. No. No. Even when presented with this article and being told the would-be employee had done prior deals which had 10 year option periods. When a company behaves like this, it’s clear to see that they are being advised too conservatively. In this scenario, it is crucial that you – the would-be employee – take charge, and either walk away or bring in an agent to help. It is too easy to think that these things won’t matter in the long run but, truly, why take a lower salary for a lottery ticket if you can’t win with the ticket?

We eventually reached an agreeable compromise with the company where we felt our client’s interests were protected: the company agreed to a 5 year exercise period. Said differently, once our client eventually leaves this employer, the client will have five years to decide whether to exercise the options.

Regardless, the company’s initial reluctance to compromise or provide solid rationale signals poorly to the other side. At best it signals a culture of rigidity; at worse, it implies employees are meant to be exploited.

Your employees are the key to your success and finding good ones is very hard. When you finally find someone with the right skills and the right culture fit, you should really work to bring them in feeling good and committed to your mission. If you make a mistake, you have recourse. If you don’t, you may never have the opportunity to find out how good they are, because they will seek employment elsewhere.

At 10x Management, we work with smart entrepreneurs who wish to prioritize both speed and quality via best-in-class freelancers. They don’t rush hiring decisions (4-8 months for many W2 searches) because they know hiring is too important to shortcut. So they engage freelancers to move quickly while running a good parallel hiring process to get the right full-time employees. None of that is possible without fair, clear mutually beneficial deals. The cash components of those deals typically are easy to follow – the equity, not so much.

Michael Solomon
Michael@10xmanagement.com