Allocating Equity in Startups Shooting for Acquisition

Guest article, courtesy of Michael Wolfe

Are the new wave of light-funded, acquisition-oriented companies granting their rank-n-file employees equity commensurate with the expected liquidation or relying on older venture-backed equity norms?

And if there is a new allocation model, what are the typical ranges for employees in this circumstance?

It is important to remember that conventions like four year vesting, one year cliff, 20% employee option pool, etc., are conventions and don’t have to be blindly followed.

I feel that four year vesting is appropriate for most companies.

The overnight flip (example: about.me) is still relatively rare. They get a ton of PR when they happen, but they rarely happen.
And even “quick” flips typically involve a few years of work, a few months negotiating and closing the deal, and then a couple of years of the acquired employees working at the acquiree trying to make the deal work. In-and-out in two years seldom happens.

When it does happen, well, the employee only did two years worth of work.

The vast majority of companies don’t get acquired in the first place. They may not even figure out their business in the first two years. Most either fail (in which case it doesn’t matter) or enter a multi-year slog.

So, implying to your employees that you expect to be flipped in two years represents a promise that is very unlikely to be kept.
And it could cause some short term thinking and executing…if none of us will be here in two years, why put a solid foundation in place? And it could attract short term employees.

And unless you want everyone to leave in two years, you’ll need to keep giving new stock grants so that folks always are vesting something.

Which means (and I think this is the real point): you will simply double the amount of stock that the employees are getting since you are vesting everyone twice as fast.

So the result would be larger employee pools, smaller founder pools, smaller returns for investors (unless they get founders to take the entire hit) and smaller acquisitions (since the acquirer will need to dig into their pocket more to provide vested employees incentives to stay).

What Startup Employees Should Know about Their Equity from SecondMarket on Vimeo.

So, I think there is a different question in here, one that I’d recommend someone ask, which is whether more of the value of a startup should be going into employee pockets, not founders or investors.

There are arguments pro and con, however I do not think the possibility of quick flips is one of the more compelling ones.

About Saul Fleischman

Founder of emerging social media tool sites. Bootstrapping innovation with lean startup development teams. I do project management, user experience, PR, marketing and community development.

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