We’ve written recently about how to preserve your equity when fundraising. This week we spoke with serial entrepreneur Chris Michel, who explained why founders should not be afraid to give additional equity disbursements — out of their personal stakes! — to reward senior staffers.
That’s what Michel did just six months before selling his latest startup, Affinity Labs, to Monster.com for $61 million in January. Michel gave up a tidy bit of his own windfall, but he has no regrets, and thinks more founders should follow suit.
F|R: You gave half a percent of your personal stake in Affinity Labs to three senior managers shortly before selling the company. Why?
Chris Michel: One key to success is having a very small and overqualified team. We all know this, but forget that the best people could also go and be CEOs at their own companies. In a “war for talent” you have ask yourself: What wouldn’t you do to bring the right people onto your team and keep them in the game? Rarely is compensation enough to make anyone happy. First, people want to be at a place that they’re proud of, surrounded by people who are as talented or more talented than they are, working on problems that matter. Second, they want to be [remuneratively] valued. Compensation is a necessary, though not sufficient, tool. But you can’t screw up the comp stuff because it’s the easiest thing to do right.
F|R: What is the right amount of equity to give away? Why not give senior mangers larger stakes up front?
Michel: Boards tend to be very cautious with compensation, and its unusual to increase someone’s equity unless there is a promotion or a retention issue. Typically VPs of early-stage companies get between 1 percent and 1.7 percent of a company. That’s just the benchmark, but it’s what investors will expect to see. The equity structure of a VC-backed company looks like this: The investors own 40 percent; the founder(s) own 40 percent; 20 percent is set aside in an employee option pool. After a round of additional funding, your senior managers may each be diluted from 1.5 percent to 0.75 percent. If you sell the company for $100 million — a very good outcome for a startup — the managers each get $750,000. If you toiled away for five years to build the company, is that worth giving up five years of a great salary? Maybe not.
F|R: How did you do it and convince your board to go along?
Michel: A request to give an unscheduled grant to people can cause heartache, because there is a perception that it depletes the option pool for future recruiting. But I went to my board and said: “Here, I’ll take 0.5 percent of my equity and 0.5 percent from the option pool.” They saw that I was taking it very seriously, that it was impacting me, and went along. We gave 1 percent to three senior managers, who each got 0.33 percent in addition to what they previously held. The lawyers had never seen anyone do that before. It turned out to be a little complicated, because you don’t want to create tax consequences for people, but that’s what the lawyers are for. The board was surprised, but it precipitated a philosophy at Affinity to proactively take care of our team.
F|R: How did your managers respond?
Michel: No one said anything in particular, other than “Thanks,” though I’m not sure they would. It certainly made me sleep better at night. But the psychological benefit to giving people equity might even be more important that the actual value. When people are serious owners of the companies they work for, they work harder. This wasn’t just altruistic. It was a smart business move.
Affiinity CFO, Curtis Atkisson, a recipient of the grant, responds:
I felt like I was being thought of as a “cofounder” of the businesses. That recognition is as important as the ownership grant…it has extended my commitment to grow the business post-acquisition. [It] has engendered loyalty.
F|R: How much did this actually cost you personally?
Michel: Maybe $350,000. It isn’t that I was super generous, my point is that you can very easily give away some of your ownership and it won’t affect you very much. It is the statement that matters. Over and over I see founders who are parsimonious with their equity, and there is good reason for this. But most startups die. If you run the calculation on the net represent value of the equity, this is the cheapest thing you can do to lock in good people. If your company is a “big win,” you’re going to make a lot of money anyway. If not, no one vests. There is no downside. It just makes sense for even the most self-interested founder to be very generous with their team. Net-net, perhaps those 1 percent benchmarks need to be fundamentally reconsidered.