Stock options – everybody in the pool

My friend and serial CEO Dan McNulty encouraged me to write about stock options.  My experience is that stock options encourage employees to “think like an owner. ”  I have always found that my colleagues are motivated by the potential of their options, and are interested in the drivers of their stock’s valuation.  So it’s an important subject and I appreciate Dan’s suggesting it.

Stock options are a subject that has been extremely well covered on the web, particularly by VentureHacks and Mark Suster of GRP Partners.  So, in this post, I’ll mostly point you to other blog posts.  Read them.  I’ll also try to provide some helpful information specific to medical device companies, and share a couple of thoughts from my experience.

From an entrepreneur’s perspective, I totally agree with Mark Suster:  Nivi at VentureHacks nails the options topic in his post “The Option Pool Shuffle.”  Fundamentally, providing stock options to employees dilutes the ownership percentage of founders and investors.   Consequently, the option pool is a critical factor in venture financing negotiations.  Nivi instructs the savvy entrepreneur to size the option pool based on a hiring plan, and to “discuss your hiring plan with your prospective investors before you discuss valuation and the option pool.”  Nivi even provides current ranges for option grants for high tech companies in Silicon Valley by title.  You must read his post.

Mark Suster of GRP Partners adds a VC’s perspective on the topic in his post, “Want to know how VC’s Calculate Valuation Differently from Founders?”  In particular, Mark points out that some VC’s include an overly large option pool in their term sheet, which lowers the effective pre-money valuation.  Jeff Bussgang of Flybridge Capital Partners provides a similar perspective here.  So, follow Nivi’s advice.

Brad Feld of the VC firm Foundry Group points out on his blog that “Most Series A investors expect you to use up most of the option pool for early hires so that when it is time to raise a new round, you’ll likely need additional options to incent your future employees.  This often ends up being a three way negotiation – between the founders/management, old investors, and new investor(s).”

While Nivi provides current ranges for option grants for high tech companies, medical device companies have different titles and different compensation scales.  So, where do I go for fresh, high quality data?  CompStudy.com of course.

CompStudy is the longest running, most comprehensive survey of equity and cash compensation for top management positions and boards of directors at private companies in the technology and life sciences industries. The study, in its 10th year, is produced by professionals at J. Robert Scott and Ernst & Young in collaboration with academics from the Harvard Business School and covers China, India, Israel, the UK and the US.

As an executive I insist that my companies participate in the CompStudy survey, to receive access to the data a no cost.  An awesome deal.  Just do it.

If you want to know more about stock option plans, head to Dave Naffziger’s blog:  http://www.naffziger.net/blog/category/startup-stock-options/

If you need help setting an option strike price (in compliance with IRS regulations), head to Brad Feld’s blog archives: http://www.feld.com/wp/archives/category/409a

If you want to know about restricted stock, accelerated vesting (typically when a company is acquired) and other stock ownership issues, head to Dick Costolo’s blog:   http://www.burningdoor.com/askthewizard/equity/

For more of an employee’s perspective on options, read Tony Wright’s post at http://www.tonywright.com/2008/a-newbies-guide-to-startup-compensation-or-stock-options-will-make-me-rich/

A couple more thoughts.  My opinion is that every employee in the company should have stock options.  Otherwise, the company creates two social classes – with and without – which quickly turns into an “us vs. them” scenario.  Also, annual stock option grants to existing employees are important for two reasons – to adjust employee ownership in view of subsequent financing events, and because future vesting promotes employee retention.  So, include annual grants in your “hiring plan” calculations.

While I’ve tried to cover the waterfront in this post, I’m sure to have missed something.  Let me know what I’ve missed, and share your experiences and opinions in the comments.

2 thoughts on “Stock options – everybody in the pool

  1. I strongly support the position that every employee in a medical device startup company receive stock options and annual grant consideration. At Acoustic Imaging we used bonuses to reward past performance [not many given as we were a startup] and stock option grants for future performance and to lock in top performers.

    Every employee at Acoustic Imaging had options and won when the company was acquired. It was a good outcome for all. Importantly as we built the company, everyone thought of themselves as an owner and made and argued their decisions accordingly. Along the way we continued to communicate the value of ownership especially as we added new employees. When we went to market, the stock options helped us recruit more than a few “star” salespeople in our market segment away from “top tier” competitors.

    Three of my directors were from NEA, InterWest Partners, and MedVenture Associates. I still remember Larry Mohr of Mohr Davidow Ventures telling me, we make money when you make money.

    Dan McNulty

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