Creating an employee-friendly startup share option scheme
Nov 09, 2022
If you’ve ever worked for a startup, or read about a Unicorn tech company turning employees into multi-millionaires overnight, chances are you've heard of equity.
Equity is the amount of ownership of a corporation held by a person or entity. This ownership is usually described as either a percentage of the total equity of the business or, at later stages, a finite number of shares.
The majority of tech startups offer equity as part of their total compensation, normally in the form of share “options”. The upside potential of these options is meant to compensate for the more gruelling (and in my opinion, rewarding) work of growing a startup company from founding to IPO (more on that later).
When we set out to design a share options scheme for PostHog, we decided to prioritize employee-friendliness for a number of reasons:
Many of us had personally been burned by unfriendly share option schemes when working at previous companies.
It helps us to attract talent by making our share options massively more valuable in practical terms, not just the pure $ amount (which in many ways may be the least important thing).
It's part of our culture to expect high performance but reward people well and ensure they are genuinely able to share in PostHog's growth. Having a good share options scheme helps people feel more bought in.
We also feel that it's just the right thing to do!
Grace McKenzie is the Operations Manager at PostHog. She tackles any and all back office projects that help build the scaffolding we need as our company scales. In her spare time, you can find her on the rugby pitch playing flanker or at her local billiards hall practicing her 8-ball breaks.
How share options work
When a startup company is incorporated, the founders decide on how to divide ownership between them by (quite literally) choosing a random number of shares to create out of thin air and distributing them to each other in some proportion.
In the common two-founder model, most startups distribute the shares as a 50/50 split between them, accounting for 100% ownership of the business. The shares are "purchased" for a nominal cost like a ten-thousandth of a cent because the value of a newly minted startup company is effectively nothing.
As our hypothetical founders pull Red-Bull-fueled all-nighters building their MVP and applying to accelerator programs, the valuation of their company slowly increases until the point where they seek outside investors to inject capital into the business to expedite growth.
In exchange for that investment, the founders must give investors ownership in the business. But, rather than giving away their own shares, they authorize a new number of shares to be created and exchanged for real dollars. In doing so, they “dilute” their ownership by increasing the size of the total equity pie, without growing their own number of shares.
This process of dilution will continue with every new fundraising round, impacting the value of a given person’s equity as well as the founders’ authority over the business relative to their investors.
Usually, the first fundraising round (the ‘seed’ round) will involve carving out a chunk of the newly generated shares to create an ‘options pool’, which can be dipped into to provide options to newly hired employees as the company grows in size.
What exactly is an option?
It's an option to purchase a share of the company at a given price – the “strike price” – which is known as “exercising” the option, thus becoming a percent owner of the company.
Options are almost always granted by way of what is known as a vesting schedule, where options become available for exercise progressively over the course of employment with the company. This is to prevent a new hire from joining a company, exercising all of their options immediately, quitting, and watching their shares in the company grow in value without contributing any work towards building the company.
The most common vesting schedule for tech companies these days is the 4-year/1-year cliff, which means that a quarter of your options vest after your 1-year work anniversary, and 1/36th of your remaining options vest each month for the following three years.
As a company, we feel that this structure strikes a fair balance between incentivizing team members to stay and contribute to the growth of the company, while not locking them into “golden handcuffs” where they are required to put in 4 years of work to reap any of the benefits of being a part of a startup.
How do share options turn you into a millionaire?
When you are granted your options on the first day of employment, the price you will pay to exercise them will stay static at whatever the Fair Market Value (FMV) per share is on your first day, irrespective of what the value is when you sell your purchased shares.
The FMV is decided through an external, very complicated process known as a 409A, and the initial sale price of the share is usually set when the company "goes public" or "IPOs" by being listed on a public stock exchange like the NYSE. This is known as a “liquidation event” and in the simplest terms, the difference between your exercise price and the price of the share you sell in the public market is cash in your pocket.
The reality of this is much more complicated, as there can be a number of tax implications depending on the type of option you were granted, when you decide to exercise them relative to when you sell them, and your overall income. You really should talk to an accountant before making any serious decisions so you don’t end up with an unexpectedly massive tax bill.
Making matters more complicated, the majority of standard terms in stock option plans limit your freedom in when and how you can exercise your options.
In the UK, stock options are offered under the tax-advantged EMI scheme, which has a different (and usually much lower) strike price than the FMV.
How PostHog does things differently
|Vesting start||On your first day||After a "probationary period"|
|Exercise window||10 years after departure||90 days after departure|
|Merger or acquisition||Double-Trigger acceleration||No acceleration|
|Good leavers||Includes performance lay-off||Doesn't include performance|
At PostHog, we recognize that you start contributing to the company on day one, so we feel that you should start earning your options on that day as well. Many others make you wait until after a probationary period, often three months, before your options start to vest.
Regardless of whether you resign, or are let go for performance reasons, you will have 10 years from the day you were hired to exercise your options. In most companies, you have only three months to exercise your options before you lose them entirely, which can make tax optimization and planning a stressful and difficult process. We also believe that this window allows you the opportunity to watch the company's growth before deciding to exercise your options. One thing to note is that based on IRS law, tax advantaged Incentive Stock Options (ISOs) convert into less favourable Non-Qualified Stock Options (NSOs) after 3 months, so there may still be an incentive to exercise sooner.
In the unlikely event that you are let go “with cause” (i.e. for gross misconduct, like embezzlement or discrimination), you will forfeit your options, which we feel is only fair.
What if the company gets sold?
In the event that PostHog is sold to another company before we reach an IPO, we have preferable terms that ensure team members who contributed to growing the company to that point are rewarded for their efforts.
If the company is acquired (first trigger) and you are terminated as part of that acquisition (second trigger), all of your options vest immediately and your 10-year window to exercise them begins. This can offer some protection and certainty to employees who exercise their options following this trigger, as shares in the company during acquisition are much more tangible than options to buy shares, and are often converted into shares of the acquiring company or bought back by the acquirer for cash.
What if I am let go from PostHog?
A "good leaver" in share options scheme is someone who departs a company but retains their vested options and can exercise them according to the company's specified schedule.
At PostHog, we believe that a "good leaver" is anyone who voluntarily resigns or is let go for performance reasons. Usually performance-related issues stem from a mismatch between a teammate and the culture of the company, and we feel it is always best for both the company and the individual to allow people to find the best fit for them (which is why we offer very generous severance.
In many other companies, only people who voluntarily resign are considered "good leavers" (and in some extreme cases, the concept of a "good leaver" does not exist and you forfeit your options regardless of how you leave the company).
As an open-source company, we are transparent about compensation including equity, because we believe that everyone who contributes to our success should reap the benefits.