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Option grants at seed

How much, and who gets it?

It’s not easy to determine how much equity employees should get – particularly if you’re a first-time founder. In Europe, there’s not much benchmark data. Often, all you have is a gut feeling, and the views of a small handful of advisors. This chapter, and the next, aims to close this critical knowledge gap.

When it comes to employee stock options, there are a few big questions that almost all founders ask, regardless of sector, stage or market:

  • ‘How much equity should I give to new hires?’

  • ‘How do I deal with the differing expectations for different roles?’

  • ‘How do I design a system that will be consistent and fair in the long run?’

In this chapter, we will address this set of questions at seed stage. In the next, we will move on to consider grants for Series A employees.

At seed stage, you are unsure of who is going to continue the adventure with you. We also see a lot of role and title inflation going on at this stage, which is best avoided.

Reshma Sohoni

Co-founder and General Partner, Seedcamp

Striking a balance

At seed stage, you will be hiring your first few employees – probably no more than ten.

Your company will have few formal processes. You’ll still be iterating your product offer, target market, and business model. So your employees will need to be highly flexible. You won’t necessarily have formal hierarchies or job titles, as you’ll still be figuring out both the skills you need, and the skills you have in your current team.

Compensation packages for your early team need to strike a balance. On the one hand, money will be tight, which makes options an attractive way to compensate your team. On the other, you don’t want to give away large chunks of your business to people whose contribution is unproven.

This is a conundrum, and it comes at a time when you want to be focusing on your product. So, like many aspects of running a startup, it can feel more like an art than a science.

The dangers of IOUs

Think twice before making vague promises

In the US, it’s common for companies to establish a formal ESOP as part of their seed funding round, and to start making formal allocations and grants. In Europe, where the costs and complexities of ESOP setup can be greater, this is less likely. However, it is becoming more popular, and we recommend it whenever possible. Increasingly, experienced talent will not join a company without a formal stock option offer.

It’s easy to run into problems with option grants when you have no formal ESOP in place. Any agreement you make is essentially an IOU – a loose commitment to offer something in the future.

This means you should be extremely careful, ensuring that any offer is clearly understood by both parties. Some founders make the mistake of agreeing equity terms on a handshake, and while this is often done in good faith, it can come back to bite either party.

When entrepreneurs make loosely-defined promises to their employees, it can be an absolute nightmare.

Sarah Anderson

Director, RM2

Best practice: dos and don’ts for early stage equity discussions

Do

  • Let your employee know roughly when the grant will be made, and when they can expect to see formal terms

  • Be clear on whether the grant is based on a percentage of the company’s FDE before or after the next fundraise

  • Consider backdating the vesting period to when the employee started working with you

  • Aim to give yourself maximum room for manoeuvre, while still reassuring employees

  • Keep comprehensive records of any verbal agreements regarding future option grants

Don’t

  • Make promises you might not be able to deliver on

  • Be vague to the point that your employees are confused or demoralised

  • Make detailed or open-ended promises in writing

  • Link grants in any way to business metrics, growth or valuation

ESOP due diligence at seed or Series A

You’re required to disclose all option grants promised to your existing employees. Make sure you factor these into the allocated portion of your ESOP,tobeclearonhowmuch unallocated ESOP remains.

The Family: Bootstrapping pre-seed by using employee equity

Founded in Paris: 2013

No. of portfolio companies: 231 active startups

Index initial investment: Seed, 2013

Offices: France, UK, Germany

Moving at startup speed, The Family transforms portfolio startups, special projects and virtual infrastructures into a highly connected community of entrepreneurs, operators and fellow investors across Europe.

Few European startups offer equity to all of their early employees, and co-founder Oussama Ammar sees this as a big mistake.

Too many European entrepreneurs underestimate the psychological impact of having everyone onboard

The Family doesn’t just encourage stock options: it insists that every startup it invests in creates a plan.

It’s one thing we feel really strongly about.

The team recommends startups allocate 20% of their options pool during their seed round, convincing investors to increase their pre-money valuation to accommodate this carve-out.

We like a standardised approach. In Europe, there are too many custom decisions, which slows things down and makes employees wary. We’ve been running training sessions for lawyers in Paris and Berlin to help them understand that dilution caused by stock options isn’t a bad thing that they should stop their clients doing.

The Family takes equity incentives so seriously that it has created Ekwity, a dedicated subsidiary to advise European startups on how to structure employee equity plans so that everyone is happy, committed and actually understands what they own.

Grants for very early stage companies

Formalised ESOP plans are becoming more common in European seed companies, as the market matures, and competition for talent rises. Founders still wonder how much equity is enough and how to properly size their ESOP. They usually now adapt Series A standards. Mirroring the US, The Family sees seed rounds in Europe looking more like Series A rounds of past years. And pre-seed is what seed used to be. Equity is therefore becoming a hot topic for pre-seed companies struggling to attract early hires when cash is particularly tight.

Pre-seed stage

Pre-seed startups haven’t yet raised funds with institutional investors and business angels.

Pre-seed founders rely on small amounts (usually less than €100k) of cash, coming from personal savings, or from family and friends.

Building revenues early to master your ownership and ESOP

The Family encourages founders to avoid the 20–25% dilution that comes with a seed round, and to go directly to a Series A whenever possible. They give an example of a pre-seed portfolio company with sufficient revenue to support a team of twenty, leveraging a 20% ESOP. It is now raising a €5–10m Series A.

Option grants for key hires at pre-seed

Option grants are made case-by-case, but The Family cautions against being greedy, offering these early hires sufficient equity upside to compensate them for the risk they are taking. It also suggests two approaches for bringing some science to the art:

First is Paul Graham’s equity equation 1/(1–n) according to which:

Whenever you’re trading stock in your company for anything, whether it’s money or an employee or a deal with another company, the test for whether to do it is the same. You should give up n% of your company if what you trade it for improves your average outcome enough that the (100- n)% you have left is worth more than the whole company was before.

Second is to apply a ‘sweat equity’ formula to attract and compensate key contributors who are working for free (or nearly free).

Example:

  • Contributor market-value: €500 day-rate

  • Time offered for free: 90 days

  • Risk co-efficient: 1.0

  • Notional valuation: €3m

Sweat equity grant

  = 500 x 90 x 1.0 / 3,000,000

  = €45k (1.5% of FDE)

This would be a special grant, topped up if the contributor becomes a permanent employee after a later fundraise.

Three Takeaways

  1. Be transparent to avoid confusion

  2. Ensure employees have the financial knowledge to understand your offer

  3. Create rules that encourage fairness and retention e.g. cliff > 12 months

Transparency is fundamental to a healthy startup. If a remuneration policy needs to stay secret, there’s something wrong with it.
Rather than treating stock options as an ad hoc incentive, they should be a core part of your remuneration package.

Allocation considerations and benchmarks

How much to give to early employees?

On average, startups that approach us for seed funding have ten employees – but it can be anywhere between zero and twenty. This early talent may well determine the company’s ultimate success or failure. They are also the ones taking the biggest personal risk.

If they’re experienced software engineers, or have taken a large pay cut to join, they will likely expect some level of ownership, even in Europe. Four or five of the first ten employees in a typical European tech startup could be experienced technical hires. So you’ll probably be forced to think about equity, even if you can’t grant formal options yet.

There’s no definitive answer here. But US benchmarks for seed-stage option grants (see table below) can be a useful guide – bearing in mind that European employees are generally less willing to compromise on cash compensation in return for more stock options.

Salaries have a natural ceiling at seed stage, due to cash constraints. This even extends to Silicon Valley, with an the upper-limit of $120k, even for ex-Google engineers previously earning $200k+. For experienced hires such as these, the only way to compensate them is through generous stock option grants. In Europe, $80–90k (€75k, £65k) sets a more realistic ceiling for top salaries.

European candidates on average are more risk-averse than those in the US, and may be less willing to compromise on salary. For junior hires, salaries tend to be closer to market value, since people still need to pay their bills. Stock options awards are correspondingly lower.

The size of your seed round also has a big impact. Seven years ago, seed rounds were less than $1 million, creating a very strong downwards pressure on salaries, the largest cash expenditure for most startups. Nowadays, seed deals can sometimes look more like a small Series A, with $4 or $5 million raised. This gives more flexibility for hiring plans, and salaries.

The grids below provide potential salary levels and option grants expressed as a percentage of salary. We believe these values are realistic for a European seed startup with ambitions to succeed in attracting quality talent. But it’s important to remember that there is no magic number.

Calculating initial grants

Our OptionPlan app will help you

We have developed a 6-box grid to help you calculate grants for employees below executive level – the two axes being seniority and technicality. We have also benchmarked salary information to get you started.

We encourage you to use our OptionPlan app to compare a set of six benchmark percentages for seed startups, and how these translate into grant sizes, ownership, and potential upside value.

Visit www.optionplan.com

Benchmarks for compensation granted in US seed-stage startups
Average FDE (in %)
Level of employee
Senior Mid-level Junior
Company function
Engineering Cash $120k $100k $60k
Options 1.00% 0.45% 0.15%
Product & Design Cash $100k $90k $50k
Options 1.00% 0.45% 0.05%
Business Development Cash $100k $90k $50k
Options 0.35% 0.10% 0.05%
Community & Marketing Cash $70k $70k $50k
Options 0.9% 0.25% 0.05%
Source: VCECS Seed Data from Advanced HR (2018)
Potential salary and option grants as percentage of salary in European seed company (top graph), resulting in implied ownership as percentage of FDE at valuation of $6m (lower graph)
Potential salary and option grants as percentage of salary in European seed company (top graph), resulting in implied ownership as percentage of FDE at valuation of $6m (lower graph)

Significantly larger grants, at the 2% or even 3% level, might make sense in specific situations. For example, if you are a solo founder who needs to hire in a wider range of experienced skill-sets to complement your own. Or a deep-tech company that needs highly sought-after machine learning, AI or VR developers.

For a typical seed team of ten employees, which we include in the OptionPlan default settings, these grants add up to 5% of FDE at a $6m post-money seed valuation. This total of option grants at seed stage is in fact close to the US average, and compares to a current European average closer to 3–4%.

In the US, it would be unusual for employees hired at seed stage not to receive options as part of their job offer. In Europe, it’s probably more like four of the first ten. And it’s not unusual to see no equity promise at all.

We believe that all employees at seed stage should receive stock options in Europe. Grant sizes may be lower than those above, if you are paying closer to market salaries, and if you are in a less mature ecosystem. OptionPlan’s different benchmark settings can help you to gauge the balance correctly.

In the UK, you now have a roster of startups which have achieved exits at values of $100m or even $1 billion. Because of this, candidates are more interested in the idea of stock than in the rest of Europe.

Reshma Sohoni

Co-founder and General Partner, Seedcamp

Dev shops

You may be building your technical team in Eastern Europe, hiring talented engineers from ‘dev shops’ for much less than you could in Western or Northern Europe. These hires will be less likely to take a pay cut in return for stock options.

Option grants at Series A
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