A QD deck (17 slides) from Skrach Capital on equity incentives.

1. EQUITY INCENTIVES
How stock grants and options work

2. Equity incentives are usually given in the form of stock grants or stock options
• Companies use them to attract and retain talent:
2
Stock Grants Stock Options
Shares of stock that are given
provided certain conditions are
met
The right to purchase stock in
the future at a pre-determined
price

3. Anyone from founders, co-founders and/or employees can be incentivized with equity
3
Founders
Founders
Key
employees
Early
employees
Advisors
Board
members

4. Equity incentives are usually given when someone new joins a company
• They can be given when a new key employee joins
• They can be used to further incentivize and retain key employees
• Or they can be used to retain key employees during a liquidity (e.g., M&A) event
4

5. These equity incentives come from what is known as the employee pool
• A company’s employee pool is an amount of equity that has been reserved for
future issuance to employees
• Companies reserve this equity in advance and use it to compensate and motivate
their workforce
• Think of it as a supply of common stock that is used for employee compensation
5
Founders
80%
Employee
pool
20%

6. THE TALENT COMPETITION IS HARD
Startup?

7. Startups usually don’t have big budgets to compete with big companies for talent
• Usually, people that join startups could technically be considered underpaid
• They accept a lower pay because they believe the company will be successful
• And they are also being compensated with equity (i.e., equity incentives)
• Otherwise, they would need to be compensated at their market value
• But as mentioned above, startups don’t usually have those kinds of budgets
7

8. Equity incentives usually vest over 4 years
• Vesting is the process by which employees are given the legal right to their stock
grants and/or options
• Typically, stocks and options vest over 48 months (4 years)
8
0%
25%
50%
75%
100%
0 12 24 36 48
The industry standard is a 1-year cliff and
monthly vesting thereafter for the total of 4 years
% Vested % Unvested
Cliff

9. That means that nothing vests during the first year
• If an employee leaves before the completion of the first year, they haven’t vested
any portion of their equity and don’t get anything
9
0%
25%
50%
75%
100%
0 1 2 3 4 5 6 7 8 9 10 11
% Vested % Unvested

10. 25% vests after completing the first year
• The 25% that vests upon completion of the first year is known as the “cliff”
10
0%
25%
50%
75%
100%
0 1 2 3 4 5 6 7 8 9 10 11 12
% Vested % Unvested

11. Partial vesting begins after Year 1
• After the cliff, vesting begins monthly (or quarterly, or annually) over the
remaining period
• If an employee leaves before the end of the 4-year period, a vesting formula
applies and they get a percentage of their incentive
11
0%
25%
50%
75%
100%
0 12 24 36 48
% Vested % Unvested

12. Vesting ensures equity is earned fairly
• Since equity is another form of compensation, vesting is the mechanism to ensure
it is earned over time
• It’s common that founders/employees leave companies
• They can leave by choice, or because other founders/employees wanted them to
leave
• Oftentimes, founders/employees join a company but don’t plan to stay for the
long-term, either because they have other plans, due to personal matters, or
they’re simply approaching the end of their careers
12

13. When someone leaves they have a right to their vested portion
• But their unvested stock disappears into thin air and does not get reallocated
13

14. Unvested stock simply gets reabsorbed
• When someone leaves, their unvested portion is reabsorbed into the company and
everyone benefits ratably
• This is known as “reverse dilution”
14

15. During a liquidity event (e.g., M&A) incentives vest fully
• In contemporary equity plans all outstanding incentives vest fully prior to a
liquidity event
• The result is that merger consideration is shifted away from only prior
shareholders to key employees as well
• This way the resulting company retains a happy employee base upon closing
• This is especially common if the employee bases of the companies are relatively
small
15

16. Equity incentives are priced at fair market value
• In the old days, boards would determine the fair market value
• It became common practice that the share price for common stock, which is the
exercise price for equity incentives, was typically 10% of the price of the last round
• However, the IRS now allows companies to either: (1) use a professional valuation
firm, or (2) prove that their valuation is correct
• Nowadays, early stage companies usually value their common stock at 20% to 30%
of their preferred stock (i.e., the price per share of the last round of financing)
16

17. Pre-Seed Ventures
www.skrachcapital.com