Or, how early-stage companies often screw up the stock option and resource allocations.
At Greenough Group (“GCG”) we see four common problems with poorly administered equity compensation plans that lead to meager employee retention:
- Early grants create disproportionate rewards to the initial employee group
- Correspondingly late arrivals may not benefit proportionately to their contribution
- The incentive behind the equity compensation plan is limited to the vesting period, typically 3-4 years
- 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 with Wealthfront Equity Plan whereby he not only advises clients and portfolio companies to actively budget for new hires but also for:
- Outstanding performance and most importantly
- 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?
Institutions such as law firms, accounting firms, architecture firms, and the like, 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 startup 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.
GCG Drives Success For Portfolio Companies
At the end of the day, it’s worth remembering that 90% of all startups fail. There is so much competition among VC-backed startups, that keeping your top talent incentivized is key to success.
At Greenough Group, our CFO leadership collectively has many years of experience working full-time with leading VC firms such as 500 Startups and Oceanshore Ventures and their portfolio companies. If you’re looking for support in managing startup stock allocation or due diligence processes at your venture capital fund, reach out to our VC consulting services specialists or startup specialists and we’ll get right back to you.