156. Take Care of Your Team with Option Pools and Increasing Exercise Windows

VC Minute
Please listen to Peter's message about option exercise window. Personally, I agree with him that exercise windows should be longer for employees. The 90-day industry standard is just an arbitrary number.

VC Minute – quick advice to help startup founders fundraise better.

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Carta knows quite a lot about startup compensation. we’ve been issuing equity to nearly a million employees now on the platform. One of the things that as an early stage founder, you’re gonna need to think about is your option pool.

You’re beginning your fundraise, maybe you’ve got a couple of employees already on the cap table but you’re looking to raise your seed round and you’re gonna say to those investors, , with this capital, one of the things we’re gonna go out and do is we’re gonna hire, our bigger team. Maybe it’s up to 10 people or so.

And you’ll need to set aside some company equity to incentivize those new employees. They’re gonna expect some equity in your company when they join.

When you do that oftentimes at the, let’s call it, between a company worth about 10 million to 25 million. So that’s, Seed to, you know, seed extension range.

The median employee stock option pool that we see is just under 14%. So you’re gonna set aside about 12 to 14% of the company and say, we’re gonna pay employees out of this pool of company equity. And the reason that you set it aside is because your investors are definitely going to ask you to set it aside so that it doesn’t continually dilute them as they join the round.

And as you grow, typically that option pool will generally drift up. by the time you become a unicorn it’s somewhere around 20% of the company equity is dedicated to employees. But it’s good to just think about that as you start fundraising, that you’re not just gonna set aside equity for investors, you’re also gonna need to set aside an option pool for employees. And that typically you want to set aside between, you know, 12 and 14% when you’re getting started.

This is a personal hobby horse of mine. Let’s talk now about exercise windows for employee stock options.

Typically a startup will issue ISOs, incentive stock options, to their employees in return for their work. That will become, that will have two criteria. They will have to vest that equity and then they’ll have to exercise that equity in order to actually own those shares.

The vesting is very simple. It’s generally done on a time basis. You’re gonna set that to a four year grant with a one year cliff, meaning you may have to stay at least one year to vest, any equity at all.

But then it comes time to make that second decision for employees, and that is the exercise decision. There’ll be a strike price, a fair market value of those shares, the employee has to pay that strike price upfront to get the shares. But then of course, you’re a private company, so it’s not like they get to sell those shares on the stock market the next day. So they do have to outlay some cash for future upside, which is generally totally fine. That’s the deal that they’re signing up for.

However, when an employee leaves a company or is laid off, which is happening a lot recently, they typically only have 90 days to make a choice about whether or not they exercise that stock. And very likely they haven’t exercised it yet so they have to pay out a decent amount of money oftentimes to exercise it at all.

Someone gets laid off, it’s an emotionally charged time. They may or may not believe in the prospects of the company anymore, and they have to make a choice about paying out money upfront for future equity in the company that just laid them off. It’s a really difficult moment

That 90 days doesn’t have to be 90 days. There are a lot of companies across the startup ecosystem that are allowing people two, three, even 10 years to choose whether or not they exercise that equity.

And it’s not costless to founders. This has tax implications And those shares don’t return to the pool. So it is dilutive to a lot of founders and investors.

But as a personal note, I think it’s still the right thing to, do to give people more than 90 days to exercise their stock, especially if they left involuntarily or were laid off.

Only about 20% of grants on Carta right now have longer than 90 days to exercise. And I’d love to see that that number go higher in the future.

About Carta
Carta builds infrastructure for tomorrow’s innovators. Founders can manage their equity, issue options, and pay fairly using Carta Cap Table and Compensation tools. You can get a weekly peek into data from 38,000 startups across the world by subscribing to our Data Minute newsletter.

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