It’s getting harder to know exactly what to do about equity compensation at pre-IPO companies. Values have been soaring (there are currently over 800 “Unicorns”, or pre-IPO companies worth more than $1B). There is so much money available that companies can stay private longer and grow bigger than ever before. All of this is challenging long-used models for equity compensation.
Companies and their consultants are rightfully questioning the efficacy of 4-year vesting schedules. Employees are asking for more equity as they become fully vested. Competitors are poaching the best people as they near the end of vesting for their original hire-on grants.
The following is a recent exchange from LinkedIn. The individual asking the question is a very experienced, and very good, compensation consultant who works for a major firm in the space. My answers are simply my opinions, and I am sure others will have different perspectives.
Questioner:
“HI - I am getting more questions about those high-level execs or engineers that are creeping up on their 3rd or 4th year of vesting. If the stock has really taken off since then, what kind of retention strategies are working for companies? Annual refresher grants pale in comparison to some of those original grants or new hire grants. Anything you've seen help people stay interested?”
“Specific follow-up question - does a large amount of unvested stock mean you could be ineligible for an annual refresher. I don't think I've seen that happen before. You?”
My Response:
“There is so much to cover here...”
“Pre-IPO grants that follow the now ubiquitous 4-year vesting schedule are a real problem in the marketplace. We are often recommending two grants at the same time:
- One grant with a shorter (2-3 year) vesting)
- Another with a much longer 6-8 yr) vesting.”
“There is no great reason to grant smaller equity awards at hire and then grant refresh grants in the future (for most companies).“
“There is very low risk when using larger, longer-term grants since the company gets the shares back if the person leaves. The refresh concept does not work with current skyrocketing valuations. If a high valuation company must refresh equity, we often recommend RSUs since they get rid of the high exercise price that comes with stock options (but, they have their own issues with prescriptive taxation and other considerations).”
“And yes, the level of “unvestedness” often drives potential refresh grants. When unvested values are really high, it doesn't make a lot of sense to give more unvested equity. When they are low, something needs to be done ASAP. We often recommend designing a refresh program for grants that will become 75% vested or more in the next 12 months.”
This topic is far more complex than a blog post can cover. The models for granting pre-IPO equity are broken. The “market data” you’ve been using is based on people generally adhering to those broken models. Equity in those models never considered companies worth billions, or staff sizes of several thousand before an Initial Public Offering. Those models do not account for SPACs, Direct Listings, Reg A offers, or IPOs worth $20, or even $50, Billion dollars. Your VC investors have little motivation to change. Your PE investors want to see more performance criteria. Your employees want to see a return to more equitable equity (as long as they make a ton of money). As a compensation professional, you have both a unique challenge and a unique opportunity.
You can follow the path that isn’t working, or you can do the hard work to determine the right path for your company. The process requires some brainstorming and education, but the results can be impressive.
P.S. Please stop using the notional value from your most recent preferred stock to value your equity against market data. That’s not how it’s correctly done.
Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is a leading expert on incentive plans and equity compensation issues. He has written several industry resources including a resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.
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