ESOP GUIDEHOW TO MODEL YOUR ESOP

ALEXANDER JARVIS FOUNDER 50FOLDS

• INVESTING • EX-VC / FOUNDER 50FOLDS

• STARTUP • LAZADA • DELIVERY HERO • GROUPON… AND MANY OTHERS

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HELLO!

TOWN HALL NOTICE

THESE ARE ALL COMMUNITY PROJECTS. GIVE FEEDBACK▸ Startup is a bitch

▸ Startups are rarely each others’ competitors. We are in the trough together

▸ 80% of startup is all the same so why reinvent the wheel?

▸ If these materials can be better and you know how, please give back so everyone can benefit

▸ We stand on the shoulders of giants. I have shamelessly ripped material off where I liked their thinking from others including Andy Rachleff at Wealthfront

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CONGRATS! YOU LANDED A GREAT CTO NOW… HOW DO YOU RETAIN HER?

WHY DO YOU THINK GOOGLE AND FACEBOOK ETC HAVE BEAN BAGS AND IN OFFICE SLIDES…

THE OFFICE, CULTURE AND THE STUFF HR PEOPLE DO ARE IMPORTANT, SURE

CHALLENGINGWORK

ENVIRONMENT

ENGAGINGCULTURE

COMPELLINGEQUITY

INCENTIVES

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2 3

ATTRACT

RETAIN

ANYONE WHO SAID MONEY CAN’T BUY HAPPINESS, NEVER HAD ANY (APPARENTLY)

BUT THE REALITY IS MOST PEOPLE WANT TO GET PAID FOR THEIR HARD WORK

CHALLENGINGWORK

ENVIRONMENT

ENGAGINGCULTURE

$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$

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ATTRACT

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TALENT WANT MORE THAN A SALARY. THEY WANT EQUITY - IT’S THE WAY TO GET RICH (THINK FIRST 1,000 STAFF AT FACEBOOK)

FOUNDERS GET COMMON SHARES EVERYONE ELSE GETS OPTIONS - THE RIGHT TO HAVE SHARES

TO OFFER SHARES TO LOTS OF STAFF, ALL THE OPTIONS ARE PUT IN A STRUCTURE CALLED AN ‘ESOP’

AN ESOP IS AN EMPLOYEE SHARE OWNERSHIP PLAN. THAT’S NERD FOR ‘HOW YOUR STAFF GET PAID TOO’

THIS PRESENTATION TEACHES YOU HOW TO STRUCTURE AND MODEL AN ESOP

YOU NEED A LAWYER THIS AIN’T GONNA BE FREE

GET A LAWYER TO SET ALL THIS UP, YOU NEED TO DO IT PROPERLY

WHAT IS IN AN ESOP DOCUMENT▸ ESOP is basically an allocation of shares which will be granted to staff in the

form of share options (There are many types of options and we aren’t getting into them. Lawyers exist to deal with that level of boring)

▸ How the ESOP works needs to be legally written down, right?

▸ Terms: all the devilish details are in here, such as vesting, conversion mechanics etc. They apply to all staff unless there are side letters (typically rarely and for senior staff)

▸ Size of the ‘pool’: What % of the company are you going to give to non-founding staff? The pool doesn’t have to be issued straight away

VCS DRIVE FOUNDERS TO SET UP ESOPS AND TRY GET THEM TO MAKE A BIGGER PLAN THAN THEY NEED

WHAT ARE THE BIRTHING RITUALS OF ESOPS?▸ Founders hustle in the garage to make the latest pointless SoLoMo app called

Slackchat which seems to get traction. They convince a friend ‘John’ to join and they swear he’ll get shares… soon. They don’t have the cash to donate to lawyers

▸ VCs circle and want to invest, only they insist before they invest you need a big ESOP pool to attract and retain staff. They ask for 25% and the founders propose and agree on 15% since they show their ‘hiring plan’ (and are aware of the option pool shuffle)

▸ A lawyer gets paid and an ESOP is born. Founders can make good on their word

▸ John gets his initial grant and the ESOP agreement governs it

▸ John is happy (unless he hears a junior dev got more than him- which is not ‘fair’)

IT’S NOT ENOUGH TO JUST GIVE SHARES. YOU NEED TO EDUCATE STAFF HOW THEY ACTUALLY GET PAID. THEN KEEP REMINDING STAFF THEY ARE OWNERS OF THE COMPANY AND WILL MAKE $ IF THEY WORK HARD

STAFF ARE GIVEN SHARES AT A PRICE. DELTA BETWEEN THAT AND SELL PRICE X SHARES = $

HOW DO STAFF START UP, CASH IN, SELL OUT AND BRO DOWN? ▸ Creation: Investors make founders set up an ESOP. A % of shares are allocated (which with

almost certainty 100% dilute the founders)

▸ Issued: Founders and the rest of the board of directors (which now includes the lead investor) agree formally to dole out shares to staff. Senior staff are agenda items, junior staff are rubber stamped since how they are assigned shares is formulaic

▸ Vesting: Staff get all their agreed upon ‘issued’ options upfront, but they ‘vest’ over typically 4 years. They need to serve time before they are 100% vested. The options have a value - the strike price. The strike price depends on the last valuation or fundraise valuation. Earlier you join the better

▸ Exercise: Once shares are fully-vested it’s not bottle popping time. The shares are only exercisable when Hooli comes to buy SlackChat or it IPOs. The price per share of the acquisition is the ‘exercise price.’ The difference between the two times by the vested shares equals a Lambo or a Hyundai (after tax is paid)

DON’T THINK YOUR STAFF ARE DUMB. EVERYONE TALKS. WHILST THEY ONLY SORT OF KNOW WHAT IS ‘MARKET’, THEY DEFINITELY UNDERSTAND FAIRNESS AND LOGIC. MAKE THAT THE PLAN

ACCELERATED VESTING IS TYPICALLY ONLY FOR TOP MANAGEMENT

WHAT TERMS DO STAFF CARE ABOUT (OR SHOULD?)Issued shares •How many shares in total do they potentially get once vested?

Strike price •What you buy shares for when the option is given. Difference between this and exercise price is the upside per share

Vesting schedule

•The timeline of years over which shares are owned and exercisable

Cliff •Trial period where no shares are vested until the cliff date is met. Typically 4y vesting and 1y cliff means you get 25% only if you stick around for a full year

Accelerated vesting

•What happens at acquisition if shares haven't vested? •Single trigger: You get full vesting on acquisition •Double trigger: You get full vesting on sale and you get fired without cause

VCS WILL DEMAND YOU CREATE AN ESOP BEFORE THEY INVEST. IT’S LIKE PRISON, DON’T FIGHT IT; IT’S GOING TO HAPPEN

I CAN'T THINK OF A TERM SHEET THAT WE HAVE ISSUED THAT DIDN'T HAVE A SPECIFIC PROVISION FOR EMPLOYEE EQUITY.

Fred Wilson, Union Square Ventures

VCS LIKE ESOPS LIKE FAT KIDS LIKE CAKE. YOU CAN TRY GIVE LESS BUT THEY'RE GETTING SOME

WHAT YOU NEED TO DO IS MAKE A ‘HIRING PLAN’ FOR THE NEXT 12-24 MONTHS, THEN MAKE A CASE WHY THE POOL SHOULD BE 12% NOT 25%

DON’T LET YOUR INVESTORS DETERMINE THE SIZE OF THE OPTION POOL FOR YOU. USE A HIRING PLAN TO JUSTIFY A SMALL OPTION POOL, INCREASE YOUR SHARE PRICE, AND INCREASE YOUR EFFECTIVE VALUATION.

The Option Pool Shuffle by VentureHacks

THIS IS WHAT FOUNDERS NEED TO KNOW

http://venturehacks.com/articles/option-pool-shuffle

TO STEAL DATA SCIENTISTS AND MAKE SURE THEY NEVER LEAVE YOU FOR BAIDU/WATSON ETC

WHAT ARE THE GOALS OF AN ESOP?

ATTRACT NEW EMPLOYEES

RETAIN OUTSTANDINGEMPLOYEES

AND

99% OF ESOPS ARE HIT IT AND QUIT IT. STAFF ARE ISSUED SHARES AND THAT’S IT FOR 4 YEARS. THAT DOESN'T MAKE SENSE; IT TAKES AT LEAST 7 TO GET TO IPO. YOUR ESOP NEEDS DEPTH AND LAYERS (NOT HIDDEN SHALLOWS)

THIS IS NOT A GREAT PLAN, BUT SURE, DONE IS BETTER THAN NOT DONE

MOST ESOP PLANS LOOK LIKE THIS

NEW HIRES

WHAT ABOUT RETAINING AND STAYING COMPETITIVE?

WHICH ONLY ATTRACTS

NEW HIRESATTRACT NEW EMPLOYEES

RETAIN OUTSTANDING

EMPLOYEES

AND

THIS IS A BETTER PLAN. BASED ON ONE MADE BY ANDY RACHLEFF AT WEALTHFRONT. I JACKED HIS SWAG

THEY SHOULD LOOK LIKE THIS

PROMOTIONS PERFORMANCE EVERGREENNEW HIRES

THESE ADDITIONAL ELEMENTS ENCOURAGE TOP PERFORMANCE AND MAKE IT HARD FOR STAFF TO LEAVE

THIS IS THE DIFFERENCE OF ‘GOOD TO GREAT’

PROMOTIONS PERFORMANCE EVERGREENNEW HIRES

I KNOW, I KNOW. YES, THIS MAKES THINGS COMPLICATED. AND YES THE EXCEL MODEL TO MAKE THIS IS GOING TO BE HARD! BUT THE MODEL HAS BEEN DONE FOR YOU ;)

LET’S GET INTO EACH ELEMENT AND HOW TO USE THE MODEL

MY DOG USED TO CHASE PEOPLE ON A BIKE A LOT. IT GOT SO BAD, FINALLY I HAD TO TAKE HIS BIKE AWAY

LET’S START WITH NEW STAFF ISSUANCE

PROMOTIONS PERFORMANCE EVERGREENNEW HIRES

THIS IS BASIC STUFF

START BY ADDING ALL THE INITIAL STAFF DETAILS

MAYBE BE A LITTLE CAREFUL ON SAYING THEIR MARKET RATE IS REALLY HIGH!

THEN ADD THEIR ACTUAL SALARY AND THEIR MARKET SALARY

▸ You can find market salaries by going to payscale.com

▸ e.g. http://www.payscale.com/research/US/Job=Software_Architect/Salary/e16aaf35/New-York-NY

TO CALCULATE EQUITY, THE SIMPLEST THING TO DO IS CREATE A FORMULA THAT APPLIES TO EVERYONE. COMMUNICATE THIS IS THE COMPANY POLICY AND DON’T NEGOTIATE. IT’S FAIR

IT’S BASED ON COMMUNICATING A $ VALUE ISSUANCE NOT A % OF THE COMPANY

THE FORMULA OF CALCULATING THE $ VALUE OF SHARES

Seniority

$ %Team manager?

xDollar value of shares

issued

$x x =Base salary

I RECOMMEND THE MARKET RATE

IS THE BASIS FOR EQUITY ON THE SALARY OR THEIR MARKET SALARY RATE?

IF YOU ARE EARLY STAGE, I PERSONALLY THINK THIS IS WAY TOO LOW. A FAMOUS VC THINKS THIS IS OK

SENIOR STAFF GET MORE SHARES. DECIDE WHAT THE SCALE IS

TECH STAFF IN PARTICULAR WILL THINK THIS MAKES SENSE

IF STAFF ARE MANAGERS OF TEAMS THEY SHOULD GET MORE. THIS IS A MULTIPLIER

STICK TO THE INDUSTRY STANDARDS UNLESS YOU ARE VERY SAVVY

HOW LONG IS THE VESTING SCHEDULE AND WHAT IS THE CLIFF?

DEPENDING ON YOUR COUNTRY, THERE WILL BE DIFFERENT ESOP EXPECTATIONS

YOU CAN SEE THE SHARES ISSUED HERE. BEING MORE SENIOR MEANS A LOT MORE SHARES

DON’T LOOK AT THESE NUMBERS FOR GUIDANCE OR THAT THEY ARE BENCHMARK. NO, SERIOUSLY

IN THIS EXAMPLE, THE INITIAL GRANT EQUATES TO 14.173% OF THE SHARES

GIVE THEM THE DOLLAR VALUE NOT THE % VALUE

COMMUNICATING THE ISSUANCE TO STAFF▸ Issuances can be communicated either as 1/ a % of ownership, or 2/ a $ value

based on the current valuation

▸ “We are issuing you $200k of stock” raises less questions than “we are issuing you 0.002% of the company”

▸ A $ value is understandable. 0.002% may ‘sound like too little.’ In negotiation the $ value is grounded in itself as a value. A % is a proxy for value and irrational which can elicit ‘my friend has 0.5%’ despite the fact that company is worth only $1m

▸ I personally think if savvy staff for details on shares outstanding etc, you should share. Secrecy breeds contempt here

IF STAFF ARE PROMOTED, SHOULDN’T THEY GET SOME MORE INCENTIVE?

NEXT, LET’S DEAL WITH PROMOTIONS

PROMOTIONS PERFORMANCE EVERGREENNEW HIRES

PROMOTION GRANT

PROMOTION OVERVIEW▸ As staff get promoted their market value increases too. Since they could

potentially get a better offer it makes sense to ensure they keep up with the Jones’

▸ If you’re not totally convinced, think about this. You’re promoting them because they rock. You want to keep those people and motivate them

▸ When making hires, you tell everyone there is lots of potential for advancement right? Well you can also sell that they get more equity if they get promoted

▸ So what is this grant? When staff are promoted you issue the amount of stock necessary to get them to the market rate for their new position over what they were issued before

PROMOTION GRANT

HOW THE CALCULATIONS WORK▸ In the model you just need to update their salary and their new market rate.

The calculations are done, but so you know:

▸ The issuance formula is the same we used before for the marginal increase ▸ If their salary/market rate is $50k originally and the new rate is $100k, they

get issued, according to the same formula we used before, the salary basis of $50k more

▸ If no change in salary no increase for promotion grant ▸ If salary less than before, no increase in performance grant ▸ Performance grant is allowed in the same year based on promotion base ▸ If staff is paid more than market already, then it doesn't matter, only the

difference between old market rate and current market rate is paid

PROMOTION GRANT

ASSUMPTIONS▸ Set the vesting years for the promotion grant

▸ I recommend 4 years

▸ By stacking vesting schedules sequentially there is never a good time to leave the company

PROMOTION GRANT

THE MODEL MECHANICS▸ If you promote someone just change the promotion switch to yes

▸ Input their new seniority and level (team management)

▸ Make sure the salary and market rates are input

▸ Out computes their $ grant and # of shares which you can communicate to the staff in their performance review

GIVING THE HIGH FLYERS SOME ROCKET FUEL

PERFORMANCE BOOSTS

PROMOTIONS PERFORMANCE EVERGREENNEW HIRES

PERFORMANCE GRANT

PERFORMANCE OVERVIEW▸ Something startups don’t have is too much cash. Giving bonuses in equity rather

than $ has the distinct benefit of not being cash you could otherwise spend on growing

▸ Sales staff etc for sure have bonuses, but why not pay them in equity too ;) As they create more value they create more value for themselves

▸ Give equity increases to a select number of staff to make it seem special; only the top 10-20% employees

▸ The increase needs to feel large to feed egos, but needs to maintain the equitable nature of the whole plan

▸ The recommended amount is 50% of what they would get hired at today. This may be too rich for your blood, so figure out where you are comfortable

PERFORMANCE GRANT

ASSUMPTIONS▸ Set the vesting years for the performance grant

▸ I recommend 4 years

▸ By stacking vesting schedules sequentially there is never a good time to leave the company

▸ Set the “% of salary” you will grant staff

▸ 50% is recommended, but up to you and what makes sense

PERFORMANCE GRANT

THE MODEL MECHANICS▸ For performance grants just change the performance switch to yes

▸ Out computes their $ grant and # of shares which you can communicate to the staff in their performance review

LOCKING IN STAFF FOR THE LONG HAUL

EVERGREEN RETENTION SCHEME

PROMOTIONS PERFORMANCE EVERGREENNEW HIRES

EVERGREEN GRANT

EVERGREEN OVERVIEW▸ Large companies having long term incentive plans and so should you. Be

continually issuing more shares there is never a good time to leave. Putting in more time means they keep getting more affluent (on paper)

▸ This is a tool for all staff to keep them long term by making it progressively harder to leave

▸ Sequential stacking of plans means that you avoid vesting cliffs. There is not a point staff will start looking around for new opportunities

EVERGREEN GRANT

SEQUENTIAL GRANT STACKING▸ Below is an illustration of this

▸ After 2 years, every year a small but significant issuance is added which has it’s own cliff and vesting schedule

0.00

0.04

0.07

0.11

0.14

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5

Initial Grant

EQUITY

TENURE years

EVERGREEN GRANT

HOW THE CALCULATIONS WORK▸ The model assumes that after 2 years staff should start to give evergreen

grants. This is of course up to you

▸ A comment box will present itself to prompt you to issue these

▸ Formulas are as usual

EVERGREEN GRANT

ASSUMPTIONS▸ Set the vesting years for the performance grant

▸ I recommend 4 years

▸ By stacking vesting schedules sequentially there is never a good time to leave the company

▸ Set the “% of salary” you will grant staff

▸ 25% is recommended, but up to you and what makes sense

EVERGREEN GRANT

THE MODEL MECHANICS▸ For evergreen grants just change the evergreen switch to yes

▸ Out computes their $ grant and # of shares which you can communicate to the staff in their performance review

OK. LET’S GO THROUGH THE MODEL SO YOU KNOW WHAT’S GOING DOWN IN FUNKY TOWN

ASSUMPTIONS TAB

ASSUMPTIONS TAB

GENERAL ASSUMPTIONS▸ Grant basis - set the calculations on either their

actual salary or their market rate

▸ Cliff - standard is one year

▸ ESOP start date - set as the date you set up the plan and when staff in the t=0 cohort start vesting

▸ Current date - formula. This dictates what has vested. If you want to see what happens in 3 years time, change the data and you can see scenarios. Otherwise, don’t touch!

ASSUMPTIONS TAB

FINANCING ASSUMPTIONS▸ This is cap table territory. Read my cap table presentation to understand this stuff in more

detail

▸ Insert how much you raise and your pre-money for each round. This will tell you how much dilution there is going to be and also the strike prices of the shares. The strike price is key as it dictates how many shares staff get based due to their $ based issuances

Need a cap table?

http://alexanderjarvis.com/2015/01/08/ultimate-startup-cap-table-and-return-analysis-template/

Get the ultimate one below!

ASSUMPTIONS TAB

SUMMARY DATA▸ This is just a summary output of all the schemes on a yearly basis. Neat ;)

▸ If things are ##### out don’t freak out. Just means your valuations are getting too big (boo hoo). Just adjust the column width

POOL SIZING TAB

POOL SIZING

HOW BIG SHOULD MY POOL BE?▸ We talked about having a hiring plan to be able to negotiate with investors on

the ESOP size, right?

▸ This tab is an attempt to help build this bottom calculation

▸ Here you can see what you should target for

POOL SIZING

FINANCING SUMMARY▸ These are all calculations fed from the ESOP tab

▸ It tells you how much equity you actually plan on giving to staff on a per year basis. ie your hiring plan

POOL SIZING

SENSITIVITY TABLE▸ This fancy looking table shows you what VCs may ask for and what you actually

need +/- on an annual basis

▸ Witchcraft highlights your actual need (15%).

ESOP TAB

ESOP

EMPLOYEE DETAILS▸ Blue means type in stuff

▸ Yellow boxes means they are assumptions and have implications

▸ Note there are drop down menus. They don’t like you to write what you want

▸ Even if staff are hired in 3 years, their initial grant data is input here. You need to input their hire year and their first grant date so things work

▸ If you terminate people (figuratively) add in the date for vesting calcs

ESOP

YEAR 0 GRANT▸ This is the initial grant calcs for your first issue to the earliest of staff

▸ Note the blank in the first row. Founders have ordinary shares, they don’t have ESOP. You can also just not put them in here

▸ Add in their salary and market rate. Simples

ESOP

YEAR 1 GRANT▸ Yup, things have gotten more complicated, but fear not. Calcs are done

▸ Promotions/performance: change to yes if they have good news

▸ Seniority/level: same as before (copy cells) or if promoted change to match

▸ Grant date: type in the date of grant for vesting calcs

▸ Hire note: tells you to add grant date etc ;)

▸ Salary: Input the previous year data, or change if promoted etc

ESOP

YEAR 2+ GRANT▸ Only change is now you can start issuing evergreen grants. Yay!

▸ Recommend you do this for everyone not the elite few

▸ Just switch evergreen to yes. Nothing else to see here, move along please

▸ For all future years, just repeat what was done before

▸ You don’t need to have any assumptions for future years, but they can be useful to input (even if not 100% accurate) to do planning and scenarios. You can also use to negotiate with staff to show them what they might get and how much $ they can make

VESTING CALCS TAB

VESTING CALCS

NOTE▸ Don’t freak out. This is basically a black box that you never need to look at if

you don’t want to

▸ The sheet does all the calcs to figure out the vesting situation on a per staff, year, structure basis

▸ The benefit of this sheet is it drives the tab “Staff value.” You can select any staff and this sheet spits out everything you need to know. Cool beans!

▸ I’m not going to give you an excel class here. If you want to understand how it works, put on your nerd glasses and get auditing

STAFF VALUE TAB

STAFF VALUE

OVERVIEW▸ This is a little tear sheet you can use to show staff what their shares are worth at

various points in time

▸ There are only three numbers you can or need to change

▸ Staff name

▸ The minimum value of your company you want to present

▸ The increments in the value of your company (show a nice but not too crazy number ;) )

STAFF VALUE

ASSUMPTIONS▸ There is a drop down menu with all the staff names. Neat huh. Just click the

right person and everything automagically populates

▸ You can see what shares they own, both the initial and supplementary grants

▸ Set the valuation at around your last fundraise or valuation (409a if you are American)

STAFF VALUE

STAFF SHARE CHART▸ Here’s something you print for staff

▸ Staff value line is low as ‘Camie’ hasn’t vested many shares. In 4 years the blue line will be closer to the top of additional grant, but never at it (sequential stacking). It will exceed or meet the initial grant line though

▸ Initial and additional show the potential value of issuances depending on the valuation of the company at acquisition

GRANT GUIDANCE TAB

GRANT GUIDANCE

HOW MUCH SHOULD STAFF BE GETTING?▸ This is a hard question with not much data. This sheet attempts to offer some

heuristics for how much % of your company you should expect to pony up to get your talent

▸ If you have input please share numbers so this can be updated and the community can benefit