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It was well past midnight, and I was on the phone with my co-founder and a potential “company-making” hire who we wanted to join our team. Very badly. An acclaimed systems engineer, this individual would enable us to take our business to the next level.
“If you look at the pay today, yes, it’s low, but we know that you will make up more than your fair share of return with the sizable ownership and equity package we are giving you,” said my co-founder to the potential hire.
The potential hire immediately responded back, “Yes, I get that. But I also like cash in my pocket now, and I am getting offers from other firms that, while not as generous on ownership, give me more of a sense of security today.”
I immediately chimed in: “Totally get you on that, but you also have to look at the downside risk. You can always, given your talents, go work for a larger company. This is the time where you have the opportunity to take a big swing at it and not be a corporate drone.”
After some pronounced silence, the potential hire immediately responded, “That actually makes a lot of sense. Send me the paperwork.”
In the earliest stages of a new company, entrepreneurs are often faced with two diametrically opposing forces: the need to grow and the need to conserve capital. Growth often takes capital, and vice versa. One of the most significant capital drains on an early stage business is the hiring of key executives and employees.
Luckily, entrepreneurs have a tool at their disposal that other competitors, especially larger corporations, do not. And that’s equity. Structured in the form of Employee Stock Option Pools (ESOPs), early stage businesses often grant significant ownership stakes to early hires as a way to both incentivize them away from accepting higher-paying job offers and maintain motivation for a longer period of time. Structured as a program that “vests” or grants increments of ownership on a monthly basis, ESOP options are the key way that very early employees get compensated, especially in a successful exit.
And yet, how do you explain this to potential hires who may be new to the space and weary of joining a company with a little to no track record?
There are a few ways to do this. First, you must break down and equate the value of the compensation to something concrete and real on par with cash in the bank today. Second, you must employ key sales tactics and highlight upside versus downside risk for the candidate.
Not too long ago, before quarantines took hold, I was sitting inside a pub in Washington, D.C., with my co-founder. We were prepared to review an offer with a new executive candidate who had no experience in early stage technology businesses and was highly skeptical of anything other than cash value. In order to prepare for this, we broke down the candidate’s equity compensation at today’s price and the expected gain in value over 12- and 24-month periods in relation to the salary.
The candidate was shocked to see data this tangibly and was immediately attracted to the ownership-heavy package.
When presenting an equity offer to candidates, it helps to be as tangible and concrete as possible. Demonstrate the exact dollar value of the equity at the present price and break down the increase in value over defined periods of time; preferably years of service during the vesting term and the expected lifetime of the company before exit. You can go even further by providing prospective candidates with research, comparative data and even tools to evaluate the equity value themselves. Front, an email productivity application based in San Francisco, even created this compensation and equity calculator that offers all of their candidates (and employees) complete transparency into how ownership stakes and values are calculated.
If a candidate is new to startup equity, highlight some of the legal and tax steps they will have to go through to realize the value of their ownership, all the while directing them to seek their own legal or accounting advice. This level of tangible value and transparency will go a long way toward closing even the most weary candidates.
Let’s go back to my example at the top of this article. The candidate was extremely skeptical of joining a new company and preferred the security of having immediate cash in his pocket. And yet, he was only looking at the opportunity from one perspective. Given his skills and capacity, he could easily go to any employer a few years down the road, even if our company failed (which it didn’t) and get a similar offer. By not accounting for the significant upside potential and limited eventual downside, he may have been miscalculating his own opportunity cost.
In conversations with prospective candidates, especially those with transferable skill sets, seek to highlight the opportunity cost of joining versus not joining. Even if a new company fails, they will still gain skills, connections and opportunities that will place them in a better position to get a job on the other side. More importantly, they are giving themselves a chance to see significant financial and career gains just through joining.
Early stage companies are beset by two competing interests: the need to grow and the desire to conserve capital. In order to conserve capital, entrepreneurs often recruit early, key employees through equity-ownership packages. Smart entrepreneurs convince early employees to take these packages, often with less upfront cash compensation, by structuring tangible and real value in equity and highlighting upside versus downside risk — a more compelling case than merely offering cash on hand.