Startup, Westing, Cliff: Shares in Business and Rights of Participants
One of the most attractive moments in joining a startup is getting options (rights to acquire a certain share in a startup at a fixed price). This gives ownership of the company's shares and helps balance the interests of management and employees. However, one aspect in the ordinary option package causes heated discussions between employees and managers, and this aspect is the annual threshold (cliff). We in Alconost have translated an article for you in which it is clearly and practically written about cliff vesting, options and risks associated with all of this.
The usual pattern of vesting rights to shares (vesting) covers a four-year period with an annual threshold (cliff) . This means that until your participation in a startup is a year old, you will not receive a share in the business. On the first anniversary you will receive 25% of the agreed share, and then you will receive the rest monthly. That is, if I am a startup developer with an option package of 4,800 units allocated, then in a year I will receive a share of 1,200 units (but if I quit or are dismissed before this point, I won’t get anything). Then, after overcoming the cliff, for each month of work in the company I will receive 100 units (1/48 of the option package).
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Many start-up workers hate this annual threshold. But managers and venture investors like it, because, as they believe, an employee will work very hard to achieve it. On the other hand, employees are worried if they will be fired right in front of the cliff. The sadness is that I saw it happen in startups. Managers keep an employee for almost a year, and then, one month before the annual threshold, they fire him.
For many executives, this is a way to make sure that only those employees who deserve this share in the company. If you are an employee in this situation, you will definitely be unhappy. You took the risk of working in a startup, and they fire you when there are only a few weeks or even days left before the cliff! But in most cases nothing can be done about it: such conditions are stipulated in your employment agreement, and you subscribed to it.
On the other hand, I knew people who became members of a startup at an early stage, stayed in it for just over a year, and then joined another startup. Such tactics are called "safety net" : having received a share of 25% in one startup, they switch to another in the hope that one of the startups will "shoot" someday. I knew one person who worked on Facebook for a little over a year in 2005 and left shortly after overcoming the cliff. Although his share probably brought him tangible benefits, he could have earned even more if he had remained in the company. But such people think that storing all the eggs in one basket is not worth it. And the founders of startups are getting very nervous when an employee does this: after all, it can inspire other employees to do the same.
Approaching the cliff, you will notice a lot of interesting things. In some cases, before an annual threshold, an employee climbs out of the way, working like a damn to show his significance (or vice versa: he remains in the shadow so as not to attract too much attention to himself). When the cliff is overcome, the leaders hope that the employee is satisfied and is not going to leave the company. This period immediately before and immediately after the cliff for many startups is very interesting, if not more.
In my first startup it was like this: if according to the results of the work we fired any employees before the cliff, we gave them a share equivalent to the time spent in the company. Thus, we supposedly had no annual threshold. We did this for several reasons. First, if we dismissed an employee who tried his best (albeit in vain), we saw no reason not to keep the link between his interests and the interests of the company. In fact, some of the people we fired helped us after they left. I don’t think they would do this if we didn’t offer them these conditions. Secondly, this tactic shows other employees that you, as a manager, treat your staff decently.
In addition, if in some cases you think that the employee is not very happy about the offer to leave the company, you can agree with him on an individual procedure for granting a share in the business by signing additional agreements in some form. In our opinion, to do so correctly.
Another move we took (and I’m sure very few people did) was a six-month cliff offer to employees that we really liked and wanted to hire. This gave them an understanding that we are interested in long-term cooperation, and strengthened trust.
But employees are not everything. If the founders of a startup attract venture capital investments, they are forced to work according to a rights-based investment scheme set by investors. For example, if you founded a startup with one partner, before receiving a venture investment each of you owns a 50% stake in a startup. Receiving investments in the amount of, say, $ 1 million for a startup, whose value was originally estimated at $ 4 million, suggests that 20% of the startup’s shares are given to investors, and another 20% is directed towards creating a pool of options for new employees. Thus, you still have a 30% share in the business, but you need to earn it within four years. If an entrepreneur is well able to negotiate, he can agree that the time of his work on the product, even before raising funds, is taken into account when determining the cliff. By the way, this way you can avoid the cliff altogether. The example described earlier means that after attracting investments in the amount of $ 1 million, each founder already owns not only 50% of the shares, but less than 1%, and he still has to earn all the remaining interest!
I witnessed how investors expelled the founder of one very famous startup just after a year of partnership. He began with the ownership of 100% of the company's shares, and ended up being dismissed from about 1% of the shares: his share in the company was eroded due to other investment rounds, and the term of the auction was not worked out.
More and more people are thinking about starting a startup or entering an already established one. It is important for both founders and employees of startups to understand the risks inherent in the agreement on the receipt of options.
One thing that I highly recommend to start-up founders who do not plan to attract venture capital investment is to work on a self-defined entitlement scheme . There are many cases where one founder left a startup at the initial stage, but then benefited from the efforts invested in a startup by another founder — and all because they founded the startup as equal partners. A good recent example is Paul Allen. In his new book, he talks about how Bill Gates tried to take his stake in the company on the grounds that, as Gates thought, Allen was not worthy of the current share due to his rare presence in the office (the reason for this was illness and other interests). If each of its founders has to earn its rights in a startup, this can help avoid many possible problems along the way. In addition, each of the founders will understand: everyone is interested in earning their right.
And in conclusion - some tips.
For those who expect to enter a startup : remember that entering a startup is largely based on trust and relationships. To get your share in a startup, you need to be in a startup for a while. It is important that you do not just join a company that has great potential in terms of business, but begin to cooperate with management that you can trust and with whom you can get along for a long time.
For founders attracting venture capital investments : almost all venture capital investors will ask you to work on a vesting scheme. The biggest concern of investors is that, having received a large amount, one of the founders will leave the startup early with a large share of the shares. Make sure that the investor’s vision for your company matches yours. After all, if even in the “candy-bouquet” period of relations with an investor, when he provides you with financing, you have doubts about him - what can happen in the future if things go wrong? If you worked on a startup for a while before entering the investment round, make sure that the funds raised pay for the months that you have already invested in the business.
And for founders who do not attract venture capital investments . If two people join together to create a company, and they are fortunate enough not to need outside financing, it is still important to be sure that each founder earns his share honestly. To do this, you can work in accordance with the vesting scheme. For example: each founder receives a 1/48 share of rights over a four year period. This is important for many founders of startups and helps them align interests in the long term.
PS It seems to us at Alconost that such complex share distribution schemes for the domestic start-up industry are still irrelevant. On the other hand, when the project grows to the attention of foreign investors and venture capital funds, it’s impossible to do with the simple principle “money in the morning, chairs in the evening”.
What do you think, when the western practice of distributing shares in startups comes to us? We will be glad to know your opinion in the comments!
About the translator
The article is translated in Alconost.
Alconost is engaged in the localization of applications, games and websites in 60 languages. Language translators, linguistic testing, cloud platform with API, continuous localization, 24/7 project managers, any formats of string resources.
We also make advertising and training videos - for websites selling, image, advertising, training, teasers, expliners, trailers for Google Play and the App Store.
Read more: https://alconost.com
The usual pattern of vesting rights to shares (vesting) covers a four-year period with an annual threshold (cliff) . This means that until your participation in a startup is a year old, you will not receive a share in the business. On the first anniversary you will receive 25% of the agreed share, and then you will receive the rest monthly. That is, if I am a startup developer with an option package of 4,800 units allocated, then in a year I will receive a share of 1,200 units (but if I quit or are dismissed before this point, I won’t get anything). Then, after overcoming the cliff, for each month of work in the company I will receive 100 units (1/48 of the option package).
')
Many start-up workers hate this annual threshold. But managers and venture investors like it, because, as they believe, an employee will work very hard to achieve it. On the other hand, employees are worried if they will be fired right in front of the cliff. The sadness is that I saw it happen in startups. Managers keep an employee for almost a year, and then, one month before the annual threshold, they fire him.
For many executives, this is a way to make sure that only those employees who deserve this share in the company. If you are an employee in this situation, you will definitely be unhappy. You took the risk of working in a startup, and they fire you when there are only a few weeks or even days left before the cliff! But in most cases nothing can be done about it: such conditions are stipulated in your employment agreement, and you subscribed to it.
On the other hand, I knew people who became members of a startup at an early stage, stayed in it for just over a year, and then joined another startup. Such tactics are called "safety net" : having received a share of 25% in one startup, they switch to another in the hope that one of the startups will "shoot" someday. I knew one person who worked on Facebook for a little over a year in 2005 and left shortly after overcoming the cliff. Although his share probably brought him tangible benefits, he could have earned even more if he had remained in the company. But such people think that storing all the eggs in one basket is not worth it. And the founders of startups are getting very nervous when an employee does this: after all, it can inspire other employees to do the same.
Approaching the cliff, you will notice a lot of interesting things. In some cases, before an annual threshold, an employee climbs out of the way, working like a damn to show his significance (or vice versa: he remains in the shadow so as not to attract too much attention to himself). When the cliff is overcome, the leaders hope that the employee is satisfied and is not going to leave the company. This period immediately before and immediately after the cliff for many startups is very interesting, if not more.
In my first startup it was like this: if according to the results of the work we fired any employees before the cliff, we gave them a share equivalent to the time spent in the company. Thus, we supposedly had no annual threshold. We did this for several reasons. First, if we dismissed an employee who tried his best (albeit in vain), we saw no reason not to keep the link between his interests and the interests of the company. In fact, some of the people we fired helped us after they left. I don’t think they would do this if we didn’t offer them these conditions. Secondly, this tactic shows other employees that you, as a manager, treat your staff decently.
In addition, if in some cases you think that the employee is not very happy about the offer to leave the company, you can agree with him on an individual procedure for granting a share in the business by signing additional agreements in some form. In our opinion, to do so correctly.
Another move we took (and I’m sure very few people did) was a six-month cliff offer to employees that we really liked and wanted to hire. This gave them an understanding that we are interested in long-term cooperation, and strengthened trust.
But employees are not everything. If the founders of a startup attract venture capital investments, they are forced to work according to a rights-based investment scheme set by investors. For example, if you founded a startup with one partner, before receiving a venture investment each of you owns a 50% stake in a startup. Receiving investments in the amount of, say, $ 1 million for a startup, whose value was originally estimated at $ 4 million, suggests that 20% of the startup’s shares are given to investors, and another 20% is directed towards creating a pool of options for new employees. Thus, you still have a 30% share in the business, but you need to earn it within four years. If an entrepreneur is well able to negotiate, he can agree that the time of his work on the product, even before raising funds, is taken into account when determining the cliff. By the way, this way you can avoid the cliff altogether. The example described earlier means that after attracting investments in the amount of $ 1 million, each founder already owns not only 50% of the shares, but less than 1%, and he still has to earn all the remaining interest!
I witnessed how investors expelled the founder of one very famous startup just after a year of partnership. He began with the ownership of 100% of the company's shares, and ended up being dismissed from about 1% of the shares: his share in the company was eroded due to other investment rounds, and the term of the auction was not worked out.
More and more people are thinking about starting a startup or entering an already established one. It is important for both founders and employees of startups to understand the risks inherent in the agreement on the receipt of options.
One thing that I highly recommend to start-up founders who do not plan to attract venture capital investment is to work on a self-defined entitlement scheme . There are many cases where one founder left a startup at the initial stage, but then benefited from the efforts invested in a startup by another founder — and all because they founded the startup as equal partners. A good recent example is Paul Allen. In his new book, he talks about how Bill Gates tried to take his stake in the company on the grounds that, as Gates thought, Allen was not worthy of the current share due to his rare presence in the office (the reason for this was illness and other interests). If each of its founders has to earn its rights in a startup, this can help avoid many possible problems along the way. In addition, each of the founders will understand: everyone is interested in earning their right.
And in conclusion - some tips.
For those who expect to enter a startup : remember that entering a startup is largely based on trust and relationships. To get your share in a startup, you need to be in a startup for a while. It is important that you do not just join a company that has great potential in terms of business, but begin to cooperate with management that you can trust and with whom you can get along for a long time.
For founders attracting venture capital investments : almost all venture capital investors will ask you to work on a vesting scheme. The biggest concern of investors is that, having received a large amount, one of the founders will leave the startup early with a large share of the shares. Make sure that the investor’s vision for your company matches yours. After all, if even in the “candy-bouquet” period of relations with an investor, when he provides you with financing, you have doubts about him - what can happen in the future if things go wrong? If you worked on a startup for a while before entering the investment round, make sure that the funds raised pay for the months that you have already invested in the business.
And for founders who do not attract venture capital investments . If two people join together to create a company, and they are fortunate enough not to need outside financing, it is still important to be sure that each founder earns his share honestly. To do this, you can work in accordance with the vesting scheme. For example: each founder receives a 1/48 share of rights over a four year period. This is important for many founders of startups and helps them align interests in the long term.
PS It seems to us at Alconost that such complex share distribution schemes for the domestic start-up industry are still irrelevant. On the other hand, when the project grows to the attention of foreign investors and venture capital funds, it’s impossible to do with the simple principle “money in the morning, chairs in the evening”.
What do you think, when the western practice of distributing shares in startups comes to us? We will be glad to know your opinion in the comments!
About the translator
The article is translated in Alconost.
Alconost is engaged in the localization of applications, games and websites in 60 languages. Language translators, linguistic testing, cloud platform with API, continuous localization, 24/7 project managers, any formats of string resources.
We also make advertising and training videos - for websites selling, image, advertising, training, teasers, expliners, trailers for Google Play and the App Store.
Read more: https://alconost.com
Source: https://habr.com/ru/post/242257/
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