5

Option grants at Series A

Once you reach the milestone of a Series A fundraise, you will need to start standardising your approach to stock options.

We suggest a framework which divides grants into five categories:

  1. New hires – executives

  2. New hires – staff

  3. High performers

  4. Promotions

  5. Retention grants

This chapter details an approach for grants falling into the first four of these categories. Retention grants are covered in chapter 9.

First, we will discuss the principle of granting options to every employee in your team.

Equity for all?

Aligning your team

Should you offer your whole team stock options, or only some individuals? It’s a fundamental question, and one that may come up several times as you grow your business.

The argument for all-employee ownership is simple. It means every hire is invested in your business. It signals that you believe in every employee, and encourages collaboration, and a sense of responsibility. It also means you can address everyone with a single voice – for example, at off-sites and all-hands meetings. Your employees are no longer just employees – they’re co-owners, and this can be a major element of your company culture.

The opposing view, still common in Europe and in late-stage companies, is that many employees prefer tangible benefits – like a bigger salary, pension contributions, health care or a gym membership – to stock options.

All-employee ownership levels by stage
All-employee ownership levels by stage Source: Option Impact from Advanced HR (US data), Index European ESOP survey

Unsurprisingly, our research shows that all-employee ownership in Series A/B companies is most common in the Bay Area, at 75%. As you move east, this figure drops, to 32% in continental Europe.

For Series C+ companies, all-employee ownership is less common in the US and UK. This isn’t surprising: the collegiate feel of a startup diminishes as it grows, and the diluting effect of issuing options to all employees can be significant in a large company. Plus, later hires are likely to include more commercial and support staff, who are typically less attracted by equity.

Interestingly, however, continental Europe shows an inverted trend. Later-stage companies are more likely to have an all-employee scheme here than anywhere else. It seems that, in Europe, large companies use equity to foster a sense of community that is otherwise lost as they grow. This certainly chimes with our experience. In fact, we find a majority of European companies introduces (or re-introduces) an all-employee stock option scheme as they look towards a potential IPO.

It’s up to each founder how they approach employee stock options. But we strongly believe making a small grant to every new hire regardless of role, at least up to Series C, can bring huge benefits. Something like 5% of base salary works well. This award would not apply to employees who receive a larger grant as part of their package, such as C-suite employees.

Farfetch for All: using employee ownership to recognise and reward a whole team

Founded in London: 2008

No. Employees: 1,500+

Index initial investment: Series B, 2011

IPO on NASDAQ: September 2018

Offices: UK, US, Japan, Portugal, Russia, China, Brazil

Farfetch is the global platform for luxury fashion, connecting customers in over 190 countries with an unparalleled offering from the world’s best boutiques and brands from over 40 countries.

All quotes:

Sian Keane

Chief People Officer

For years, Farfetch granted options only to very early stage employees and senior hires, and on an ad hoc basis to high performers, without a robust methodology.
We needed a programme that would foster a feel- good factor and unite the whole team under a common goal. If we succeed, the company succeeds – and vice versa.

Since January 2017, every full-time Farfetch employee is offered an option grant.

More than just a token gesture

When it came to deciding on option grant sizes, Sian recalls:

We conceived a successful exit for the business, and considered what a meaningful payout would look like for employees at each career level.

They decided not to take tenure and performance into account when it came to option grant sizes.

Otherwise, decisions would have had to be made on a case-by-case basis. Fortunately, the option grants ended up broadly correlating with salary differences.

Communication is key

When it comes to introducing a new company-wide programme, internal communication is crucial.

We were not prepared enough.

Farfetch Founder and CEO, Jose Neves, announced the programme at the company’s All-Hands meeting, and employees immediately began asking questions. Questions their managers couldn’t answer.

Not everyone understood. Even the managers didn’t have all the information.

Farfetch knew most employees would struggle to understand a formal legal document. So they produced a simple five-page booklet, explaining the key points. They gave the programme a catchy name – Farfetch for All – and branded the booklet in their house style to make it more engaging. This proved to be a big hit with the team.

A recruitment tool

Not only has the programme motivated the existing team, it has also helped recruit new talent.

People come to interviews knowing about Farfetch for All. And if they don’t, we talk about it when they join. It has become a key part of our culture and our employer brand.

The next step

The Farfetch team forecast growth over the next three years, and plan to add options through equity-retention programmes on an annual basis.

We’ve created a pot for top-ups, specifically for high contributors after the two-year vesting mark

Lessons from Farfetch

Even though they implemented their all-employee equity programme further down the line, the success of Farfetch’s approach proves it’s never too late to make an impact.

Upfront vs delayed grants

Delayed grants can help you optimise for performance

You also need to decide when employees receive stock options. In the US, they’re almost always part of the offer package. But in Europe, fewer candidates expect them – which gives you more flexibility.

Overall, we recommend being consistent for any particular function. Avoid upfront grants unless there’s a compelling reason to offer them.

In certain roles, new hires will probably expect an option grant upfront. Such grants usually form a major part of compensation for executive hires (C-suite and VP-level), and individuals will almost certainly negotiate this before they join. For these roles, you should always offer the option grant upfront.

Some software developers, if not all, will ask about stock options before they join. Especially if they’ve worked at startups before, or if they’re in a major startup hub. To keep things simple and consistent, we suggest granting all developers upfront options too. Other technical hires, such as product managers and data scientists, may expect the same, but the picture varies more by location.

Holding off on upfront awards for new hires in other functions has one big benefit: you can find out who the real stars are, and compensate them later accordingly. This helps you to hold on to your best people, and keep them motivated. US companies rarely have this luxury – but in Europe, with the likely exception of executives and technical hires as discussed above, you can design a system that truly rewards performance.

We recommend reviewing new hires at 6 or 12 months, and tailoring their equity package based on their performance. Depending on your rate of hiring, you may want to make this an annual or bi-annual exercise for all staff. Later in this chapter, we’ll walk you through a suggested model for both reviewing performance, and for calculating appropriate grant sizes.

Giving a big upfront grant makes it hard to optimise for someone’s actual contribution. You don’t really know how good someone is when you hire them – but you know a lot more about them a year or two in. In the US you are usually forced to make a maximal grant when the individual is hired based on their title, but it is far better to dole out the equity over time based on the person’s actual contribution not their title.

Clint Smith

SVP Corporate Development & General Counsel, DataStax

Allocation by seniority

Balancing executive and staff equity

Once you’ve secured Series A funding, one of your core challenges will be to scale up. You may bring in new types of talent – particularly ‘go-to-market’ functions (sales, marketing, customer success) and support teams (recruiting, finance, business operations). You’re also likely to make your first executive hires.

This raises a question: how do you allocate options based on seniority?

European companies tend to allocate a high proportion of their stock options to executives – approximately 2⁄3 of the total in late-stage startups. In the US, this ratio is reversed. This reflects the fact that many European employees receive no options at all.

How option grants are split between non-founding executives and staff by funding stage in the US
How option grants are split between non-founding executives and staff by funding stage in the US Source: Option Impact from Advanced HR

New Hires – Executive grants

Equity for your C-suite and VPs

Executives include ‘C-suite’ employees and VPs. We recommend calculating executive grants as a percentage of your fully diluted equity (FDE).

Most Series A and B startups have no more than three true non-founding C-level executives – some combination of:

  • CTO (Chief Technology Officer)

  • CFO (Chief Financial Officer)

  • COO (Chief Operating Officer)

  • CMO (Chief Marketing Officer) and

  • CRO (Chief Revenue Officer)

A grant set at 1% of FDE for each would be typical in both the US and Europe for each of these roles. But there are exceptions, particularly for COOs and CTOs.

Grant size – Executives
C-level VP-level
Ownership range 0.8 –1.5% 0.3 – 0.8%
Number of execs Maximum of three true C-level execs as you scale Could build a team of five to eight VP-level execs
Upside of %1bn exit $10m* $3–8m*
*Pre-dilution, tax and exercise cost
You should bring in one phenomenal individual every year at exec level – and it needs to be a person you could not have hired the year before. Don’t miss the opportunity.

Dominique Vidal

Partner, Index Ventures

COOs

Equity for COOs can reach 1.5% or even 2% — and it can happen as late as Series C. That’s partly because the nature of the role varies hugely from company to company. If you’re hiring a COO, carefully evaluate how complete their skill set is. Are they assuming overall responsibility for the day-to-day running of the business? Do they have proven experience in scaling startups?

CTOs

CTO equity is correlated with a company’s geography and technical DNA. For Series A or B, 1% is typical in the US, and 0.7% in Europe. This reflects the higher pro-portion of tech-enabled business, particularly in e-commerce, in Europe. In the US, there are more pure software businesses, where proprietary technology is the key differentiator.

VPs

VP grants vary widely based on experience, and the importance of their function. As a rule of thumb: 0.3 – 0.8% of FDE at Series A, or 0.2–0.7% at Series B, works well. Product and engineering roles will be at the high end of this scale, whereas HR and Finance will attract smaller grants. VP Sales will also be lower, because commissions are typically a large part of their package.

Following your Series A, you might expect to hire around four executives: three at VP-level, and one at C-suite. As you scale towards Series C+, a team of 6 –10 VP-level executives is typical.

Executives don’t typically receive top-up option grants for high performance. Instead, they negotiate option grants up front, the value of which grows in line with the company valuation.

With the allocations suggested above, you can make a very crude calculation that at a $1 billion valuation upon exit, a C-suite executive with 1% would stand to make $10 million, and a VP executive with 0.3–0.8% would make $3 – 8 million. These figures are before dilution, exercise cost and tax have been taken into account. Nonetheless, this example expresses clearly the scale of the financial opportunity on offer.

New Hires – Staff grants

Options for employees below executive level

We suggest a different method for calculating, and communicating, option grants outside of the executive team. This is because the numbers can be misleading: a 0.05% share of FDE sounds trivial – whereas a grant of $12,500 (the same 0.05% at a $25m valuation) sounds much more compelling.

Instead, your starting point should be base salary. This has two further benefits. Firstly, salary is a reasonable yardstick for the value of each employee. Secondly, it allows you to maintain a standard approach, even with later fundraising. Grant sizes stay the same in cash terms, but the number of options granted automatically declines as the valuation – and therefore share price – increases. This means you offer consistent rewards, but those who joined earliest see the biggest benefit.

After you hit your Series A, you can expect to hire roughly 40 to 50 new staff below the executive level.

Potential hiring plan following Series A, up to Series B
Functions Level Total
Executive roles C-Suite 1
Vice President 3
Engineering, Product and Business Development roles Director 2
Senior 10
Individual 15
Marketing, Finance and HR roles Director 2
Senior 4
Individual 5
Sales and Customer Success roles Director 1
Senior 2
Individual 5
50

We’ve defined three groupings of functions in this table for guidance, based on what we see in the US in terms of option allocation benchmarks. Those in the first group tend to receive the highest allocations, with declining average allocations for the second and third groups. These distinctions can vary considerably from company to company.

Arrange roles into categories to suit your company’s structure. As you scale, you may well create additional groups to become more fine-grained in your allocations. But avoid this when you’re still a small company (under 100 employees). It will make your option plan more complicated both to implement and explain.

Likewise, there are three tiers of seniority defined here, to keep things manageable for smaller companies. Again, as your team grows, you might want to make more detailed distinctions between levels of staff.

In the table above, we’ve used the term ‘Senior’ to define either a highly experienced and capable individual with no people management experience, or someone with slightly less experience, but who is managing a small team. We find that option allocations to these two classes of employees are closely aligned. ‘Individual’ means someone with less experience (perhaps less than five years in a role) and who is not managing other people.

A ‘Director’ heads a functional area, but is not senior enough to be part of the executive team.

Calculating initial grants

Our OptionPlan app will help you

We have developed a 9-box grid to help you calculate grants for employees below executive level – the two axes being seniority, and function.

These percentages are somewhat higher than current European norms. We think they represent good targets for a new startup – but it’s important to remember that there’s no magic number, and may be influenced by the factors identified in chapter 3, related to ESOP size. In any case, the relative award sizes between levels and functions should be a useful guide, even if you choose to adjust them proportionally up or down.

Our OptionPlan tool will also help you to figure out what percentage allocations are right for you.

Visit www.indexventures.com/optionplan

OptionPlan allows you to choose between six different benchmark allocation levels for grants across your team. By customising grant levels and hiring plans, you can quickly test and refine your allocation strategy, and check the impact on your overall ESOP.

Size of initial option grants by level and function, expressed as a % of base salary
Size of initial option grants by level and function, expressed as a % of base salary Source: Index Ventures recommendation for ‘default’ grant sizes in Europe

What happens if we combine the typical post-Series A hiring plan shown in the previous section, with these stock option allocations by role?

Grants – The full picture post-Series A
Typical hiring plan and grants between Series A and Series B
Functions Functions No. of hires Grant % of salary Grant $ indicative per hire
Executive C-level 1 $250,000
VP-level 3 $100,000
Engineering, Product and Business Development Director 2 75% $97,500
Senior 10 50% $40,000
Individual 15 33% $20,000
Marketing, Finance and HR Director 2 33% $36,000
Senior 4 20% $13,000
Individual 5 15% $6,000
Sales and Customer success Director 1 33% $26,000
Senior 2 10% $5,000
Individual 5 5% $1,500
TOTAL 50 $1,600,000

We can apply the $1.6m in aggregate grants across all new hires from the table above, to a notional $25 million post- money Series A valuation. Doing this, we see that they represent 6.4% of FDE. Adding in a typical 4% allocation for employees hired before the Series A, we get to 10.4% of FDE.

This ‘bottom-up’ calculation is 1.6% below our top-down default recommendation for a 12% ESOP for Series A. Which is the situation that you want – giving some room for manoeuvre, in case your hiring plan needs to be stepped up.

Grants for high performers

Index Ventures recommends using its Performance Evaluation Matrix to help you calculate stock options awards related to performance and potential. This applies to any hires who received only the small (5% of salary) option grant upon hire, rather than a full one.

As suggested earlier this might be all hires who are neither executives nor in technical roles.

There are two dimensions: an employee’s performance so far, and how you think they’ll perform in the future. By assessing both on a three-point scale, you can place every employee in a 9-box grid.

The Index Ventures Performance Evaluation Matrix
The Index Ventures Performance Evaluation Matrix

The percentage breakdowns are a rough example, based on a typical startup. In this case, around 15% of your staff will be ‘Superstars’ (also classified as gold performers) who contribute highly today and have great long-term potential. Another 15% will be ‘Tomorrow’s stars’ (classified as silver performers), who you believe will add significant value in the future, even if their current performance is merely good.

The percentages are approximate, but should help you avoid a common founder’s pitfall: rating every employee a Superstar. Even if your overall team quality is high, it pays to distinguish the truly great from the good.

You can use the multiplier in each box, together with the base option grant award for each function and level (see page 74), to determine the right grant for each employee.

In some boxes, the multiplier is a range. That’s because, once again, there’s no magic number: you should do what feels right for you and your business. You could set a low multiplier for all ‘bronze’ employees in order to focus on motivating and retaining just your top talent.

Alternatively, you may opt to use the high-ends of our ranges to keep the overall team happier – but you may risk demotivating top performers if they don’t feel like their extra effort is being rewarded.

Always try to identify and reward your shooting stars – junior people who end up being top performers.

Dominic Jacquesson

Director of Talent, Index Ventures

Promotions

When promoting existing employees, we recommend ‘topping up’ their stock options to match what a new hire would receive in the same role. You could also apply the Performance Evaluation Matrix if they are high-performers, to offer them a larger top-up grant. If their existing unvested stock option grant exceeds this (which is possible for early hires), find a different way to reward them.

Balancing cash and equity

Adjusting to individual risk appetite

Joining a startup isn’t for everyone. It takes a certain type of personality, often combined with a higher appetite for risk.

But a person’s appetite for risk can change. Say an employee needs to secure a mortgage or wants to start a family: cash will become more important to them, even if they remain committed to your company’s mission.

To help, we recommend that you consider a formal cash:equity trade-off policy for new joiners. Job offers will feature a mix of cash and options, but with the chance to increase either one, in a fixed ratio.

You can keep this ratio simple at 1:1. So an individual could ‘give up’ $10,000 of salary in return for $10,000 of additional options. It is important to consider how valuable your equity has proven so far – so if you are seed stage, you may offer a 1:2 ratio, reflecting your higher risk-profile.

Your cash:equity policy should specify limits for a maximum trade-off (for example, 15% of an employee’s salary). Plus, you should clearly state how you’ll calculate future salary increases. An employee sacrificing cash in return for options, which vest over four years, should be eligible for a corresponding salary increase the following year. Or, you may choose to offer the trade-off over consecutive years (see table below).

In Europe, we’ve found risk appetite is generally more variable than in the US. A policy like the one above can therefore be a useful part of compensation negotiations with candidates. Particularly in three scenarios, that we have seen repeatedly.

Illustration of cash:equity trade-off at 1:1 ratio
Now +1 year +2 year +3 year +4 year
Base salary $70k $75k $80k $85k $90k
$10k salary sacrifice for one year $60k $75k $80k $85k $90k
– Cumulative vested options $2.5k $5k $7.5k $10k
$10k salary sacrifice for two consecutive years $60k $65k $80k $85k $90k
– Cumulative vested options (1st award) $2.5k $5k $7.5k $10k
– Cumulative vested options (2nd award) $2.5k $5k $7.5k

Poaching from corporates and banks

As you grow, you might need to hire experienced people from corporates in the sector you’re looking to disrupt. In some sectors – particularly finance – existing salaries are likely to be much higher than you will have established in your team.

Realistically, you’ll be talking to a subset of candidates who are willing to take a significant drop in salary to work with you, because they want to be involved in a smaller and more dynamic environment. But stock options are likely to be an important part of the package here. These hires will tend to be much later in your scaling journey, when your valuation will be higher. So you should be able to offer significant grants, without them being hugely dilutive.

Competing with tech giants

Intense competition for technical talent means big hitters like Google and Facebook offer very attractive hiring packages, particularly in engineering, data science, AI and design. It will be almost impossible for you to match the remuneration packages that these companies can offer. Cash:equity trade- off can help you to close the gap, but accept that you will often struggle to win out if a candidate has a competing offer from a tech giant.

Demand for deep tech candidates is exploding. The tech giants, as well as the leading VC-backed companies such as Palantir, are willing to offer cash compensation of $100k+ for top graduates, with RSU grants of $50k on top. This makes generous stock option grants a must.

Dominic Jacquesson

Director of Talent, Index Ventures

Relocating US executives

In a global marketplace, talent moves around. More and more US executives are coming to Europe. And, given the relative immaturity of the European startup market, you may well end up looking for US talent.

But the price can be high. For a US executive, relocation is a risk and a hassle, and compensation is generally higher in the US than Europe.

American executives typically demand much bigger option packages than European executives. European companies have largely been happy to accommodate these demands, perhaps because they are not, as yet, coming under pressure to bring their European executives up to parity. We expect to see a gradual equalisation of packages as local executives get wise to these disparities; as the number of European exits increases, there will be more tangible evidence of the value of options.

Clare Johnston

Founder & CEO, The Up Group

In each of these three scenarios, a combination of cash:equity trade-off, treating such hires upfront as ‘Gold’ or ‘Silver’ under the Performance Evaluation Matrix, plus the intrinsic appeal of being part of your startup, should help you compete. But we would advise against offering additional benefits to close candidates. Creating a two-tier system can seriously damage morale, and once you’ve started, it’s hard to stop. Know when the incremental benefit of closing ‘that’ key hire is outweighed by the motivational damage you could cause to your team by not treating individuals consistently. It can be a tough, but critical, judgement call.

Worked examples of option allocations

How to apply the rules

Worked example A: Cecille, Senior Developer promoted to Director
Senior Developer, hired immediately post-A: Promoted to Director of Engineering two years later
Series A valuation: $40m
FDE: 1m
Therefore, current share price: $40
Current valuation: $100m
FDE: 1.25m
Therefore, current share price: $80
Four-year straight line vesting
Base salary: $100,000 New base salary: $160,000
Initial grant (part of offer):
40% x $100,000 = $40,000
If hired externally: 75% x $160,000 = $120,00 grant,
equivalent to $120,000 / $80 = 1,500 options
(representing 0.12% of FDE)
No. of options granted:
$40,000 / $40 = 1,000
Unvested options remaining from initial grant:
50% x 1,000 = 500

New options to grant: 1,500 - 500 = 1,000
Representing 0.1% of FDE Total options granted = 2,000
Representing 0.16% of FDE
Worked example B: Tom, Superstar Marketing Manager
Marketing Manager, hired six months post-A: Identified as a Superstar twelve months later
Series A valuation: $40m
FDE: 1m
Notional valuation 6m later: $50m
Therefore, current share price: $50
Current valuation: $60m
Therefore, current share price: $60
Four-year straight line vesting
Base salary: $100,000 Base salary increased: $120,000
Initial grant (all employees):
5% x $100,000 = $5,000
As per grid, Superstar Marketing Manager option grant:
2 x 20% of salary = $48,000
No. of options granted:
$5,000 / $50 = 100
Option grant: $48,000 / $60 = 800 options, less 100 options granted
after he joined (ignore 1⁄4 vested) = 700 additional options
Representing 0.01% of FDE Total options granted: 100 + 700 = 800
Representing 0.08% of FDE
Total unvested options remaining: 800 - 25 = 775
Country by country review
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