Fred has a post about option pools and their impact on valuation this morning. It’s a great post and will be very helpful to many folks without a doubt. I share the same point of view and it’s one of many reasons I like co-investing with USV.
Once you set up a pool there are some typical and different ways to structure the terms and rights associated with them. There are number of issues but for this post I want to talk about vesting & change of control.
Vesting
Vesting is important for retention but more importantly it allows the company to put the equity in the hands of the folks that have put in significant time & value into the company.
We have a vesting schedule with our team at Spark Capital and I’ve had a vesting schedule everywhere I’ve worked previously.
Since startups require a fairly long time to create & build the company most options have a 4 yr vesting schedule (or less especially if the team has been working for some time) with some sort of initial hurdle period – also known as a cliff.
The structure I’ve seen the most is one that requires the employee to work at the company for a year before vesting any options. At the one year anniversary they vest ¼ of their option grant on the spot. After that they vest the balance of their options on a monthly basis.
I’ve seen cliffs as low as 6months and in some cases I’ve seen zero cliff. But the latter is extremely rare and I don’t like it much.
Change of Control
This is a term that describes what happens to the employee vesting schedule if the company is acquired by another company.
Let’s say you work at a company for 2 years, vested half of your options, and the company is acquired.
If the company option plan doesn’t have a change of control provision then either:
a) everyone lives with their original deal. You own what you vested. If you remain with the new company you vest the balance as you continue to work
b) a new deal is cut between the company/employees and the acquirer. The terms become jump ball at that point. New compensation, new vesting, retention bonus’, etc.
Founders like to have some sort of change of control acceleration. I’ve seem partial or full acceleration upon a change of control. That means at the time of the company sale some/all the invested options vest.
The challlenge with the change of control acceleration clause is that the buyer (acquirer) most of the time is buying the company because of the people that created the value. So if the employees are fully vested at the time of sale it will impact the purchase pice of the company.
One compromise I’ve seen is a “double trigger change of control” clause. That means the acceleration only happens if the company is acquired and the employee is fired without cause.
It’s a reasonale compromise. Although the double trigger will impact price and will make the acquistopm a bit more complex. The other issue is that it sets precedent. If you give it to yourself as founders and your senior team this right, than most likely you will have to give it to everyone in the company. You don’t have to of course but it can become complicated when everyone has a different set of terms.
Keep it clean & simple
I believe startups should adopt a clean and simple stock option plan. The cleanest way to do this is to make sure everyone has the same terms and rights (not everyone will have the same strike price which is expected and fair). And its a plan that you can live with as the company grows and won’t cause complexities in the future.