Why Don’t Start-Ups Allocate Options The Way Law Partnerships Apportion Ownership?

Why don’t start-ups allocate options the way law partnerships apportion ownership?

Or how early stage companies often screw up the stock option allocations.

 

At Greenough Consulting Group (“GCG”) we see four common problems with poorly administered equity compensation plans that lead to meager employee retention.

1.   Early grants create disproportionate rewards to the initial employee group

2.   Correspondingly late arrivals may not benefit proportionately to their contribution

3.   The incentive behind the equity compensation plan is limited to the vesting period, typically 3-4 years

4.   If the exercise price falls below the grant price, the incentive disappears

We are long time subscribers to Andy Rechleffe’s (former venture capitalist with Merrill Pickard and BenchMark Capital) views on stock option allocation in his article, Wealthfront Equity Plan whereby he not only advises clients and portfolio companies to actively budget for new hires, but also for:

1.   Promotions

2.   Outstanding performance and most importantly

3.   Evergreen grants

At GCG we feel the combination of issuing grants for promotions, outstanding performance and tenure are imperative for retaining the most productive employees. We have found the cost of replacing an employee to be approximately 25%-50% of their first year salary in early stage companies.

Now what does that have to do with lawyers?

Law firms, as well as many other professions, accounting, architecture and the like, as institutions have been around for centuries. Modern professional service firms annually allocate ownership units based on the productivity of the most valuable members of the firm. If this is a successful model for incentivizing employees as owners why not use the same method in start ups? Jay Adelson (serial entrepreneur and current co-founder of Central Electric) recently recommended this system in his article “It’s time to rethink start up equity”). He titled the system as Dynamic Stock Pool (“DSP”). It sure looks like a professional services firm’s allocation system of ownership allocation. So far none of our clients have been willing to go the DSP/professional services route. But like the battle between Uber and the taxi business, we at GCG think it’s only a matter of time.