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March 08, 2012

Stock Options: Avoiding Awkward Conversations

In a start-up, there are no secrets. Sooner or later, everybody knows everybody else’s business. For founders, that means your decisions about salary and stock options are inevitably going to be gossiped about.

And in a market where companies are fighting over the best talent, those conversations can get awkward, fast. Say you’re trying to hire a great new engineer, and you end up adding another fraction of a percent to her equity offer to close the deal. Now she’s got a little more of a stake in the company than other folks at her level. When the last engineer you hired finds out what her offer looked like, you’re going to be having a difficult conversation.

I recently worked with a company, OpenBook, that’s found a way to avoid this problem. The founders are two serial entrepreneurs, and in their first company they basically set up the equity structure for their own benefit. They’d grant just as much stock as they had to, and no more. That meant different employees ended up with very different kinds of deals.


As the company grew, the problem got worse. It wasn’t easy for the founders to go back and grant more equity to an employee who’d gotten short-changed when he was hired, because the Board of Directors wasn’t thrilled about the idea of shrinking the pool of options. And as we’ve seen with the recent legal actions at Zynga, taking away equity from people who were given too much doesn’t work out that well, either! In the case of these two entrepreneurs, some of the key employees started
to complain that their shares weren’t fair in relation to the founders’ shares.

So when these entrepreneurs founded OpenBook, they decided to never have this problem again. Here’s how they did it.

The first step was simple: Before granting any equity, they came up with a compensation plan organized by employees’ responsibility levels and join dates. And they followed it.

Now, after a new employee signs an offer but before they actually start work, one of the founders will sit down with that person and go through the entire company’s capitalization table, explaining who owns how much of a stake. They answer any and all questions. If necessary, they’re prepared to justify every single person’s compensation. (They’ll admit that this practice is brutal and time-consuming.)

They’re also granting larger equity packages than most start-ups, and reducing their own ownership. They believe that this will help them attract, retain, and motivate a better team, and that will grow the value of the entire company, actually making them more money in the end.

It’s working. They’ve got an all-star development team. A lot of their employees have been recruited by other team members. They’ve been able to build and launch a very strong product – and within a week of the launch, they’d already signed up more than 600 customers! And most importantly, you can just feel a difference when you walk into their office. Even I, as an outsider, could tell how happy the employees were to be working in a system they believed was truly fair, and how much that happiness fueled their creative energy.

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Alex Kinnier

Alex Kinnier is a Venture Captial Partner at NEA. He's an Xoogler, a passionate product developer (from ad servers to air conditioners to Febreze) and a fan of NYC pizza. He is a father of 2 angels.

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