Dead equity

Someone sent me this a16z article by Scott Kupor titled The Lack of Options for (Startup Employees’) Options. Scott makes a lot of good points.

Simple solutions to complex problems don’t work. They have unintended consequences that sometimes harm the very principles people are trying to protect in the first place. And other solutions (like handcuffing employees for the long term) may result in other problems, such as adverse selection; there’s still a balance that needs to be struck with supporting mobility of employees while also building value for the long term. The bottom line is that if companies are going to continue to stay private longer, we need to fundamentally re-think the stock option compensation model. We need better, careful, and more thoughtful solutions.

The big argument that Scott makes and that I agree with is that there’s no simple solution to the complex problem of stock options.

Many employees thinks that the solution is to extend the exercise window for all employees past the typical 90 day window. While this may help the departing employee by preventing them from losing their options, it creates the “dead equity” problem. That is, the employees who are at the company building it and getting it to the exit are the ones technically paying for the “dead equity” of the departing employees.

My biggest issue with Scott’s argument is that it’s not always “dead equity”. Companies offer equity compensation to employees so they can share in the growth of the company and to make up for the lack of cash compensation that startups can offer.

An employee who works at a startup, helps build it, and decides to take a job elsewhere should not automatically be deemed to own “dead equity”. In fact, it’s part of their compensation package and their vested options are and should be theirs to keep.

The fundamental problem here is education around an employee’s equity. Employees need to understand that stock options are an investment and likely a very risky one. Options are a right to invest in a company at a certain price for the future upside. It is part of your compensation package, albeit one that is a long-term investment.

Employers need to be helping their employees become shareholders in the company and exercise their right to participate in the upside. Unfortunately, the opposite of that is happening right now as employers are using equity the wrong way such as a retention tool or as a bargaining chip. If companies helped employees exercise, we wouldn’t have this discussion with extensions to begin with.

Employers set-up 401Ks so employees can contribute cash to retirement accounts. It’s no secret that tech employees command large salaries even at the entry level. The average tech employee can find a way to exercise their options throughout the course of vesting if they wanted to take that risk. For most employees, it’s not a matter of liquidity when these options vest — they just run into a liquidity issue because they wait the 4+ years until their stock has fully vested and appreciated greatly to decide to exercise.

Employees earn the right to their options by contributing years of service to their company. They should be armed with all tools and help to exercise and become a shareholder prior to becoming “dead equity”.