You've been eyeing a new startup for a while now. It seems like they're doing well一they just received a new funding round and are growing like crazy. So you take a chance and apply to one of their positions. Before you know it, you're in the final round of the application process.
Now comes the inevitable discussion about compensation. The hiring manager explains that you can choose between more cash and less equity, or vice versa. What do you do?
If you've worked at a startup before, you are familiar with this tricky situation.
If the startup keeps knocking it out of the park, you're bound to feel some of that upside in your wallet at some point. That said, the fact that only 10% of startups become successful makes the odds seem pretty grim. Can your team make it to an exit point?
With the startup market in Los Angeles booming, we decided to delve into the topic of startup equity. Read on to understand what startup equity is, how to think about the tradeoff between cash and equity, and why startups give their equity away (or not).
What Does Startup Equity Actually Mean?
Having equity means you have a financial stake in a startup. Typically, equity is used to incentivize employees to work towards a common goal, whether that be becoming the next unicorn or being acquired by a major enterprise. CEOs have good reason to offer equity. Hourful CEO and founder Walter Aguilera puts it this way:
"It's important to approach the process of building a company with a team mindset. Knowing there's equity involved helps everyone push through practically working for free at the early stage of a business."
That sounds all well and good, but it means you're putting a good deal of faith in your company's leadership team and coworkers to make the business successful. It's important to remember that equity gets diluted based on the company's performance and valuations that might not have anything to do with how well you, as an individual, perform.
Plus, you don't exactly have that hypothetical money at your fingertips. There are stipulations tied to how much stock you get, how long you have to stick around to realize your full equity package, and how you can exercise your options in the future.
What Should You Consider Before Accepting?
If you're considering roles at startups, expect to get varying levels of equity as part of your offer. Think hard about your level of risk tolerance as you prepare to negotiate 一 and maybe accept 一 the offer,.
"Would you invest your own money in this company? Because that is essentially what you are doing," she says.
To answer that question, you may want to step back and do an objective assessment of the company. Here are a few questions to get you started:
- Is the startup bootstrapped, or have they successfully raised funding? If the startup received funding, who backed them, and how reputable are they?
- What stage is the startup at? What is their plan to make it to the next stage?
- What is the size of the market this startup operates in?
- Who are the startup's biggest customers?
- Who are the startup's biggest competitors and do you think the company can build and maintain a moat?
- What's the startup's estimated cash flow?
- How much do I resonate with the founder's vision and mission?
You may not be able to find all this information, but you can get scrappy about it. Find and reach out to people who currently work there or worked there in the past to validate what you've found and get more insight. Look up the company on AngelList, Crunchbase, and review sites like Glassdoor. Read the startup's most recent press releases and announcements to find out what product features are coming down the pike and any notable new hires they've made. These could be fantastic clues as to how profitable the company might become over time.
How Much Equity Should You Expect?
Equity packages come in all shapes and sizes, but how much you get depends heavily on what stage your startup is at. Usually, 10% - 20% of total shares go towards the employee equity pool. This means that at very small startups (pre-seed to seed), you may be compensated only in equity. While that's not nice for your wallet now, it can be a fantastic time to get in, since shares will only continue to get diluted with more and more fundraising rounds.
"We gave equity to our first employees because, in my view, early-stage employees are critical to what you're building," says Val Young, former co-founder and co-CEO of apparel company RecRoom. "They ought to have both skin in the game and the opportunity to reap the rewards if things go well."
If you're joining a later-stage startup, on the other hand, you will probably be offered a mixture of equity and cash. Initial shares will have already been absorbed by current employees and investors.
"Many companies will be open to trading off between salary and equity and this can be an excellent negotiation tactic," Nextstep's Taylor writes. "That said, doing so depends on their cash flow - they might be flush after a venture round or are pinching pennies until the next fundraise. So if you are leaving a role with greater cash compensation, it's a good idea to set a total amount of salary + bonus + equity to keep you whole."
Another thing to keep in mind is that the amount of equity you get can hinge on your role. Many companies tend to give employees focused on technology more equity than those with business-oriented roles. According to TechCrunch, a senior engineer might be granted 1% of the company, whereas an experienced business development employee is given a .35% share.
As you might expect, job title plays a role as well. VPs and above are likely to get a much larger stake in the company than more junior employees. Browse AngelList's salary and equity data to see what might be reasonable in your startup's category and your career level.
Understanding Your Equity Offer
Not all equity packages are created equal, so it's important to educate yourself on the ways equity can differ from company to company.
One thing to bear in mind is that startups often denote equity in terms of shares in an offer letter. 50,000 shares can sound like an awful lot, but that may only be 0.05% of the total company shares. A quick way to level-set on how much you're really getting is to ask how many shares are outstanding. The number of shares you're offered, divided by the total number of shares will give you the percent of the company you own.
Another thing to examine in your offer letter is your vesting schedule. It's fairly common to have a 4-year vesting schedule at startups, meaning you gain 25% of the total shares you're given with each year you stay on with the company.
Of course, you won't actually receive your equity in dollars until an exit event. If your startup exits with a huge valuation, your equity could be worth a lot. But, if your startup never goes public and never sells, you may only get paid out what's left of the company's revenue according to your contract.
Finally, pay attention to what happens to your equity when you leave. Sometimes employers have a clause stripping away your equity, even if you've put in a full year. This practice, called a "one-year cliff," acts as a form of insurance so the startup doesn't relinquish precious equity to people who aren't fully dedicated for the long haul.
Should You Take It?
Working at startups isn't a walk in the park. Oftentimes you're doing multiple jobs at once for lower pay. Equity offers can be overwhelming, but all of your sleuthing and pre-research should bolster your confidence in the company's potential—what really matters most.
"You should only work for a startup if you really believe in the mission and team. But if you do, then taking equity is a no-brainer," he says.
Are you in the midst of making a final decision? Let us know how it went!
Not long ago, corporate social responsibility (CSR), was thought to be the province of massive companies that had the luxury to invest in goodwill programs, or had the need to soften their image as heartless monoliths.
The tenets behind CSR have become more important over the past few years as social and environmental concerns have come front and center for consumers, employees and even investors.
At its core, CSR is a business model in which organizations pledge to hold themselves accountable to shareholders as well as the public for the impact they have on society.
These companies differ from others in that they adopt a "triple bottom line" approach. They make decisions according to how their actions will impact people, the planet and their own profit, and quantify their approach in public-facing company reports, measuring their impact over time.
But they're not always doing this for purely altruistic reasons. CSR can reap big returns in public good will. It can also be a form of "tax-exempt lobbying," swaying governments and consumers to favor the business.
You might think that startups don't have the time or budget for CSR activities, but being socially responsible doesn't have to be all-consuming, and ignoring social responsibility can backfire in big ways. Below, we'll explore ways for even the smallest startups to incorporate CSR into their DNA, benefit the community and even see bigger returns in the process.
How Being Socially Responsible Can Give Your Startup a Leg Up
It's tough to make a name for yourself as a startup. Having the goodwill of potential customers, investors and — perhaps most importantly — your employees, can not only differentiate you among competitors, it can make the difference in what talent you're able to bring on.
In some cases, being able to tout a socially responsible approach can set you apart from competitors and impress investors. CSR-focused companies tend to get more press coverage in local news and more engagement on social media. That extra media presence can pay dividends and allow startups to show off their approach on social media. Some VCs are laser-focused on environmental and social causes, and even those who aren't might view corporate responsibility as a sub-component of their thesis.
"For Entidad, CSR is both foundational and a strategic differentiator," says Entidad CEO Jesus Torres. His company is focused on developing digital solutions that improve farmworkers' quality of life, creating smartphone apps that are built atop blockchain technology. (Note: I'm currently consulting for the startup.)
"The organizations we work with have built trusted brands by holding themselves to the highest standards of social responsibility. We knew from the beginning that to effectively operate in their respective worlds, we needed to do the same."
Corporate social responsibility does wonders for talent, especially right now. The pandemic, racial injustices and political upheaval are on the minds of many, and employees are looking for jobs that contribute to the greater good. In fact, 75% of millennials would take a pay cut to work for a socially responsible company. Research shows that putting money toward improving society rather than padding employee paychecks actually lowers employee wage demands while increasing productivity and retention.
Socially and environmentally responsible companies are particularly hot on public markets. By July 2020, environmental, social and governance (ESG)-themed funds pulled in $38 billion, reaching $100 billion in total assets for the first time. The Forum for Sustainable and Responsible Investment reported U.S. sustainable investing assets at $17.1 trillion in 2020, 42% higher than in 2018.
These trends carry over into everyday consumer behavior. A survey by Aflac found that 49% of consumers believe it's more important for a company to "make the world a better place" than "make money for its shareholders." Other studies have found that 46% of consumers pay close attention to a brand's social responsibility efforts when buying a product. And perhaps most importantly, 66% of customers are willing to pay more for products from socially responsible businesses. Higher margins give socially responsible startups a financial leg up while they are doing good.
L.A.-based swimwear brand KINDKINIS was built around such an approach.
"Empathy isn't just good moral practice, it's also a good business practice," founder Merilyn Lopez says. With every sale, her startup donates to Generosity.org, a nonprofit that builds wells in developing countries.
KINDKINIS also uses a cruelty-free, vegan fabric called rPET and just became PETA approved. The company has recently partnered with Wearable Collections as well, allowing customers to donate old swimsuits that Wearable converts into new yarn or fiber products.
"Our business strategy on sustainability came from knowing that the future is dependent on our collective attempts to cut back on waste," Lopez adds. This is one of the pillars that drives our desire to succeed."
How To Start
Your startup doesn't need to be built around social responsibility to make a difference and elevate your work. The first step can be as simple as donating a minor portion of your proceeds to a nonprofit that matches your mission.
"CSR is front and center and driving everything we do at Gray Whale gin. It is our why," says Gray Whale Gin co-founder Marsh Mokhtari. His company donates 1% of its sales to ocean-restoration nonprofit Oceana and environmental organization 1% For the Planet.
The key to CSR adoption is to start small. One way to approach this is to list all the activities your startup already does, then ask yourself how to convert them into more environmentally or socially responsible ones.
For instance, Gray Whale needed to source ingredients to make their gin, so opted to support small, local California farms that grew organic limes, sea kelp, and juniper berries. This choice led to other small changes, like decorating Gray Whale bottles with sustainable paint and using a 100% biodegradable cork. Co-founder Jan Mokhtari explains: "Our target market is the millennial gin drinker, and they want to make an impact with their purchases. They'll make a decision based on whether or not a product is doing good in the world."
Here a few questions to can jumpstart your thinking:
- How can we alter our benefits structure to be more socially responsible?
- What is our environmental footprint, and how can we decrease it?
- Can our product or people educate, feed, or counsel the L.A. community?
- Are there nonprofits we can partner with in a simple, equitable way?
Think about the answers to these questions with the greater good in mind, rather than just the PR it will bring to your business. If your commitment isn't genuine, it can backfire 一 not only with your employees, but with your consumers as well. Consider setting internal KPIs to actually measure how much value you've brought to certain nonprofits or communities. This can help keep your ego in check and allow your team to set more audacious goals in the future.
Remember to involve your employees in the conversation as well. Startups are known for the creative minds behind them. Startup talent is bound to dream up new ways to tie sustainable practices into everyday activities.
One easy way to get this started is to leave 2 - 3 minutes at the end of an all-hands meeting to get input or send an anonymous survey to pick your first undertaking. Putting these habits into practice early sets you up to grow your program over time.
Partner With Orgs That Impact Your Community
Want to get started quickly? Consider partnering with a nonprofit that pertains to your industry. L.A. startup founders have some of the most diverse options at their fingertips.
For instance, youth and family services nonprofit The Bresee Foundation would be an incredible partner to startups in the education, childcare or even healthcare industries. It serves central L.A. youth, combating poverty through youth and family services and gang prevention.
The Bay Foundation is ideal for companies looking to work with a local nonprofit focused on improving the environment. The staff at TBF are science and policy experts who deeply care about L.A.'s ecosystem and work to restore natural land and water habitats. (Note: I provided pro bono services for The Bay Foundation in 2020).
The Point Foundation is an excellent option for startups that want to volunteer their time as mentors. Point works to counter the high prevalence of bullying in schools and provide bisexual, transgender and queer students scholarships, leadership development, and community service.
Have any more suggestions? Let us know!
Column: Diversity Riders Can Make the Investing Network Better in LA. Here's How Entrepreneurs Can Help.
Back in August of last year, L.A.-based Act One Ventures partner Alejandro (Alex) Guerrero launched the Diversity Rider, along with a number of other marquee venture capital firms, including First Round Capital, Maveron and Greycroft.
It's likely not a shock to anyone that barely 7% of VC investment partners nationally identify as African American or Latino, according to the National Venture Capital Association and less than 10% of VC-funded companies are led by women.
In L.A. County, where Black and Latino communities represent almost 60% of the population, the numbers aren't much better. Given the fact that distribution of investment dollars roughly reflects the composition of diversity among investment partners, money invested in Black and Brown founders in L.A. is vastly disproportionate. Put simply, VC partners and check writers in L.A. don't look anything like their customers or employees.
Introducing the rider in a recent dot.LA story, Act One's Alex Guerrero put it like this:
"You haven't gotten those chances, not because you don't work hard or you're not there, but because you don't come from those networks, you don't have that wealth, you don't have that privilege and that's what's hindering you and that's not your fault. Sometimes you just don't hit the birth lottery."
While COVID was raging across the country and America was exposed to the horrific killing of George Floyd, Guerrero was thinking about equitable access to opportunity in a new and creative way. Specifically, he was thinking about the opportunity to drive real wealth creation for communities that historically don't have access to the table. He was also thinking about how the venture capital-financed ecosystem needed another tool to drive diversity, equity and inclusion across the entire stack. In particular, the equity component needed real and material change.
How Diversity Riders Work
Guerrero is asking for VC firms leading a deal to add a provision to their term sheets requiring a certain amount of capital in a given financing round be allocated to diverse check writers.
To understand how that provision — called a Diversity Rider — works, you have to understand how venture capital deals work. (This is a simplification, so, finance experts, please bear with me.)
VCs tend to make investments in a given company as a group, but that group of investors is typically led by a single firm, which gets to set the "terms" of the deal in the form of a contract, called the "term sheet."
It is the term sheet that defines many of the critical requirements and conditions of a company's financing event. These documents include many of the most salient and substantive details of an investment deal, including liquidation preferences, voting rights, pro rata rights, board composition changes, right of first refusal and, most importantly (at least, for some), the valuation tied to the investment round.
Much like any contract, everything is subject to negotiation and a lot of creativity can be introduced. This is where riders come along.
Guerrero's initiative is somewhat revolutionary in its incremental nature in that it didn't call for an explicit percentage of a round to go to DCWs, but rather just that a rider should be included and the lead VC. It's sufficiently flexible to enable all sorts of implementation, meaning the Diversity Rider can over time be added to more and more term sheets until it becomes a norm. Ideally we quickly get to the point that the Diversity Rider is perfunctory to include, and noncontroversial — or even better, it's no longer needed at all as the industry has internalized its mission and it becomeis the norm. What a world!
What Is Founders' Role in Expanding the Diversity Rider?
Alex and his supporters have already partnered with at least 10 venture capital firms that are committed to using the rider in their term sheets.
I asked Alex what obligations or part to play he thought founders had in the Diversity Rider call to action.
"Not only are founders incredibly essential to the growth of the rider," he said, "in my opinion they will be the key driver determining how fast the entire industry moves towards normalizing the topic of having a diverse cap table. When you [the founder] see the rider language in a Term Sheet, you will instantly know by their actions that that [VC] cares about D&I where it matters most: at the equity level."
But there's more that can be done, specifically, by founders who want to see their profits, and the ecosystem, grow.
"No founder should be dependent on any VC firm to be the ones to proactively bring up the topic of having a diverse cap table," he said. "These are your companies, and it is your call as to who gets the ability to participate, whether the existing or new investors like it or not."
It is tantamount to success across many dimensions and across many stakeholders to drive a higher participation of diverse participants in cap tables, with allocation requirements baked into the term sheet.
"Hopefully your VC investors will be understanding and supportive," Guerrero added, "but if in today's world you bring this up and an investor balks at it, you might want to ask yourself if you want to be in business with that person or firm in general since you wouldn't be philosophically aligned on this crucial aspect of building your business. I know that this topic of conversation can be uncomfortable, but if we don't commit to having this conversation everywhere, for every round, all the time, nothing will truly change."
We, as founders and entrepreneurs, have the ability to influence terms and make possible the change we want to see. We have leverage as a class, so let's use it for doing good while doing well.
Fernish will be allocating a target of 10% of all future rounds to diverse check writers as our own implementation of the Rider. (Shout out to Finix for setting a great example here for the rest of us!)
We've also broadened our board of directors and kicked off an exploration of DEI training to raise our understanding of unconscious bias in the workplace. We also recently donated to the Fund for South LA Founders and my time as a mentor to the inaugural cohort of this fund.
Why the Rider Works for L.A. Investors, Founders and Communities
Whether you hold a traditional Milton Friedman view that a company's responsibility is solely to its shareholders or a more modern and thankfully broader interpretation of a company's role in society, it is indisputable that more diverse companies — across investors, board members, leadership teams, all the way down to line staff — will have better returns over time. An extensive McKinsey report proved this from multiple angles.
Additionally, VCs are looking for ways to de-risk any and all investments. The rider will drive predictably higher performance so it's inclusion is another edge on the path to venture success. All around, this means the Diversity Rider is a win-win for diverse investors and the rest of the cap table alike.
Even better, the common class stockholders—i.e. the founders and the rest of the employees—will also get to benefit from this better performance. That makes it a win-win-win!
Also important: diverse venture investors get the opportunity to create multi-fold returns, rather than incremental returns, on their investments. Assuming that the investor is comfortable with the risk of an earlier stage investment, and has the financial wherewithal to spread their capital across a decent mix of companies, a blended "Internal Rate of Return" (IRR) target would be 20-30%. Someone who invested in an S&P 500 index fund WHEN? has seen a "compound annual growth rate" of 7-10%. And assuming the investor "picks a winner", this can be multiple multiples on the initial investment.
Venture and private equity as an asset class — and the wide range of preferential tax treatments for investments in this category — is how generational wealth is created.
This is also how DCWs expand their financial footprint, creating a flywheel effect whereby they can invest further. That wealth can, in turn, be used to forward initiatives of various sorts in their "communities" — however that might be defined — that can lead to more opportunity, more founders, more investment.
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