Start-ups and Why Godzillas Require a Different Tactic than Unicorns
The term “unicorn” refers to a pre-IPO company valued at more than $1B. When the term was coined in 2013 there were only 39 such companies. As of October 2020, there was a herd of at least 450 of them! Terms like “decacorn” and “hectacorn” have been used to define $10B and $100B companies, but I prefer Godzillas. Godzillas are truly unexpected. They cause you to change your approach. And if you don’t handle them well, they may destroy things that everyone finds valuable.
The guidelines for granting pre-IPO equity compensation have not changed that much over the past 35 years. Basically, investors approve a pool of equity that represents about 20% dilution, or overhang. This pool is refilled as new investors buy more stock, but the first pool is the lion’s shares of everything a company can offer prior to IPO.
When this model was first conceived, a billion-dollar IPO was practically unheard of. In 1995 Netscape was the largest IPO at $900M (for reference, Apple was only worth $3.5B). With valuations being pure guesses, it became common for companies to grant about half of their pool to the first 20-50 employees. Non-founding C-level officers often received grants of .5% to 1%. Then as prices and staff grew, reward sizes shrunk. In 1995, a good grant for an engineer may have been worth 1 or 2 times their salary…at the time of IPO.
This model meant that people who joined early had a chance to become millionaires and people who joined later still received material benefits. But that was before unicorns and Godzillas.
Recent IPOs have seen companies valued at north of $20B. Most of them have thousands of employees. Oddly, the equity guidelines that were written on a napkin decades ago still apply.
The expected pool for most companies is still around 20%. The first 20-50 employees still get about half of that. The remaining 10% is spread among the later hires, with occasional partial refills as new investors come in.
Where early-stage employees once became millionaires, they are now may be worth hundreds of millions, or more, an IPO. That first 10% is a gold mine. But that means that later employees are getting increasingly less of the spoils of success. Often their IPO values are quite similar multiples to those seen 30-years ago, even while the underlying value of their companies can be 50-100 times those in the past.
Either investors need to start sharing a larger portion of the company (highly advised), or companies need to rescale their guidelines to better reflect the true potential of their companies (also highly advisable).
This will not be easy, but it is time. Using risk and reward models from three decades ago is like examining seatbelts on stagecoaches. The models of tomorrow must be more flexible, more scalable, and far more equitable. Leaning on the self-fulfilling prophecy of “market” data that simply reflect common practices, instead of best practices, will be a hard addiction to cure.
Over the next few months, I will write some posts about how this may be accomplished. Hopefully, these will resonate and provide some direction for correction. What do you think?
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Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is also a leading expert on incentive plans and equity compensation issues. He has written several industry resources including the only resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, , “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or, follow him on Twitter at @DanFutureSense.
Posted by DanFutureSense on 12/15/2020 at 11:08 AM in Compensation Philosophy, Executive Compensation, Small Company Compensation, Stock/Equity Compensation, Surveys, Total Rewards | Permalink
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