For today's Insights and Opinions piece, we have an article from Lee Weinberg, an attorney, entrepreneur, and angel investor here in Los Angeles, who takes a contrary view on how stock options are granted in the technology world. Lee originally posted this on his blog, at CapitalistCounsel.com.
I have some strong opinions regarding the ubiquitous Stock Plans/Option Pools of start-up, tech and VC-land. Flame on!
The official goal of a broadly-based stock plan is to motivate the recipients of the stock (or stock options or equivalent) to work harder, stick around, and otherwise put in extra effort with a better attitude that will aid the growth and well-being (value) of the company.
Do broadly-based equity and option plans actually do that?
The theory from 1986-2000 for dot.coms and other (especially technology) growth companies was that equity (mostly in the form of tax-favored Incentive Stock Options, or ISOs) was what employees and officers all wanted and what would motivate them to take a job with and/or outperform for the company. This theory was applied across the board, for all employees, low and high, with the expectation that all would want to row together. After all, the company will IPO and everyone will get rich, right?
We all know how that turned out. Yet, despite the failure of nearly all the companies from those amazing days, it is still the custom (or at this point a law?) in start-up, tech and VC-land that all companies must have large and relatively broadly-based stock option plans. Some of the plans are more highly skewed to top management and technologists than others, but nearly all reach down several levels to award equity equivalents to what I would call “typical” employees. But what if I told you that, without the need for 20/20 hindsight, I think the idea of reserving a pool of 20% of a company’s equity for a stock plan designed to dole out equity to all (or even most) of a company’s employees was just as poor an idea back in 1998 as it is today?
Why? Because the overwhelming majority of rank and file employees (and even some top executives, depending on the industry) are much more motivated by “cash now (or on a date certain)” than the potential for more cash later – even the possibility of a lot of cash later. Admittedly, back in 1998, due to the gold-rush nature of the times, the average dot.com worker was a bit more likely to be motivated by a piece of equity, but still not nearly as much as we all thought at the time once you moved outside of the officer and technologist groups. Did anyone offer more cash instead of more stock to find out?
This is an example of a very common mistake in business negotiations of all types: Offering the other side what you would want or what you think they want, and not what they actually do want. The offeror thinks he/she is being generous, and yet is losing the negotiation and wasting a valuable resource in the process.
In simple terms, while many of the readers of this blog have made and will continue to make significant sacrifices (including investment dollars) to gain growth company equity, those of us who are investors and CEOs often forget that most people work at a job to make money in real time, and that most people spend what they make, plus or minus 15%. Not everyone is (or can afford to be) a delayed gratification thinker, not everyone likes to play the odds, and, unlike most of the denizens of the CEO posts, Boards and VC firms ratifying and using these stock plans, not everyone is in the game in the hopes of an equity upside. If you will pardon the repetition, if you offer most people “possible future money” vs. real money today in exchange for hitting certain performance targets or just for staying in the job and being productive (retention), most will take the real money today and, in fact, will be more motivated by a goal that they can control and from which they can see reasonably quick and measurable results.
So, do any Boards of Directors or CEOs actually ask company employees (including new hires) if they would like $5.00 more per hour of work (i.e., a $10,000 higher salary per year) instead of getting stock options? In my experience, as noted above, most non-senior-officer personnel will want the cash. Sure, some officers may want the stock instead of the money — but you need to ask! I predict you will find a surprisingly large percentage would rather get the cash, and, once you consider the staggering waste of giving somebody something they do not value as highly as you do, you will want them to have the cash too!
Some voices in favor of broad/increased employee equity disagree with my analysis, and claim a broadly-based stock plan is a wonder drug. I can be persuaded that there are some good times to put stock plans in place for the benefit of certain recipients (or, if a strong preference for stock can be shown across a larger group, for all personnel in that group). But please note that the cheerleaders doing the studies are only comparing the value of having stock plans for employees vs. the absence of any stock plan at all. They are not comparing the giving of something of value (more cash) vs. the value of stock (or stock options) issued pursuant to a particular plan.
I am not claiming that there is zero value to a stock plan or to giving equity to those who will be motivated by that equity and create a net-positive effect on the company’s overall value. I am saying that boards and CEOs need to think and use judgment and create plans that provide the right incentives to the right people who will in fact be incentivized by those incentives. Sounds simple, right? “Give the people what they want.” By doing so, you get the most value for the company. If an employee wants stock, give him or her stock. But if the employee wants cash more than stock, keep your equity! Otherwise, you would be wasting something (equity) that you probably value dearly – certainly much more than the amount of cash you would have to give this employee in order to achieve the same motivating result.
Apologies to all my VC and angel investor friends (remember, I am frequently on your team!), but unless (a) you created the big plan pool at 20% just to get a bigger piece of the pie and do not intend for the stock or stock options to be handed out in reality (word is out on this one, guys), or (b) you only give out stock and stock options carefully and then only to those officers, directors, contractors and employees whom you know value that equity more highly than your estimate of their present cash value, then, by following the path you have always followed, you are, unfortunately, wasting money (in the form of equity), time and effort and lowering the chances that the company you have invested in will “win.”Lee Weinberg is an attorney, entrepreneur and investor who has founded, operated, and financed a number of businesses in entertainment, media and technology. He is a principal of the Dauntless Founders Fund and of entertainment, sports and media business-development firm Dauntless, LLC, as well as a partner with Weinberg Gonser LLP, the affiliated law firm of Dauntless. His blog is at CapitalistCounsel.com.