Equity in the News: Stock Plans: Give the People What They Want - Lee Weinberg, Insights, socalTECH.com

http://bit.ly/cmlPUa

For today's Insights
and Opinions piece, we have an article from Lee Weinberg, an
attorney, entrepreneur, and angel investor here in Los Angeles, who
takes a contrary view on how stock options are granted in the technology
world. Lee originally posted
this on his blog, at CapitalistCounsel.com.

I have some strong opinions regarding the ubiquitous Stock
Plans/Option Pools of start-up, tech and VC-land. Flame on!

The official goal of a broadly-based stock plan is to motivate the
recipients of the stock (or stock options or equivalent) to work harder,
stick around, and otherwise put in extra effort with a better attitude
that will aid the growth and well-being (value) of the company.

Do broadly-based equity and option plans actually do that?

The theory from 1986-2000 for dot.coms and other (especially
technology) growth companies was that equity (mostly in the form of
tax-favored Incentive Stock Options, or ISOs) was what employees and
officers all wanted and what would motivate them to take a job with
and/or outperform for the company. This theory was applied across the
board, for all employees, low and high, with the expectation that all
would want to row together. After all, the company will IPO and everyone
will get rich, right?

We all know how that turned out. Yet, despite the failure of nearly
all the companies from those amazing days, it is still the custom (or at
this point a law?) in start-up, tech and VC-land that all companies
must have large and relatively broadly-based stock option plans. Some of
the plans are more highly skewed to top management and technologists
than others, but nearly all reach down several levels to award equity
equivalents to what I would call “typical” employees. But what if I told
you that, without the need for 20/20 hindsight, I think the idea of
reserving a pool of 20% of a company’s equity for a stock plan designed
to dole out equity to all (or even most) of a company’s employees was
just as poor an idea back in 1998 as it is today?

Why? Because the overwhelming majority of rank and file employees
(and even some top executives, depending on the industry) are much more
motivated by “cash now (or on a date certain)” than the potential for
more cash later – even the possibility of a lot of cash later.
Admittedly, back in 1998, due to the gold-rush nature of the times, the
average dot.com worker was a bit more likely to be motivated by a piece
of equity, but still not nearly as much as we all thought at the time
once you moved outside of the officer and technologist groups. Did
anyone offer more cash instead of more stock to find out?

This is an example of a very common mistake in business
negotiations of all types: Offering the other side what you
would want or what you think they want, and not what they
actually do want. The offeror thinks he/she is being generous, and yet
is losing the negotiation and wasting a valuable resource in the process.

In simple terms, while many of the readers of this blog have made and
will continue to make significant sacrifices (including investment
dollars) to gain growth company equity, those of us who are investors
and CEOs often forget that most people work at a job to make
money in real time, and that most people spend what they make,
plus or minus 15%. Not everyone is (or can afford to be) a delayed
gratification thinker, not everyone likes to play the odds, and, unlike
most of the denizens of the CEO posts, Boards and VC firms ratifying and
using these stock plans, not everyone is in the game in the hopes of an
equity upside. If you will pardon the repetition, if you offer
most people “possible future money” vs. real money today in
exchange for hitting certain performance targets or just for staying in
the job and being productive (retention), most will take the
real money today and, in fact, will be more motivated by a goal that
they can control and from which they can see reasonably quick and
measurable results.

So, do any Boards of Directors or CEOs actually ask company
employees (including new hires) if they would like $5.00 more per hour
of work (i.e., a $10,000 higher salary per year) instead of getting
stock options? In my experience, as noted above, most non-senior-officer
personnel will want the cash. Sure, some officers may want the stock
instead of the money — but you need to ask! I predict you will
find a surprisingly large percentage would rather get the cash, and,
once you consider the staggering waste of giving somebody something they
do not value as highly as you do, you will want them to have the cash
too!

Some voices in favor of broad/increased employee equity
disagree with my analysis, and claim a broadly-based stock plan is a
wonder drug. I can be persuaded that there are some good times to put
stock plans in place for the benefit of certain recipients (or, if a
strong preference for stock can be shown across a larger group, for all
personnel in that group). But please note that the cheerleaders doing
the studies are only comparing the value of having stock plans for
employees vs. the absence of any stock plan at all. They are not
comparing the giving of something of value (more cash) vs. the value of
stock (or stock options) issued pursuant to a particular plan.

I am not claiming that there is zero value to a stock plan or to
giving equity to those who will be motivated by that equity and create a
net-positive effect on the company’s overall value. I am saying that
boards and CEOs need to think and use judgment and create plans that
provide the right incentives to the right people who will in fact be
incentivized by those incentives. Sounds simple, right? “Give the people
what they want.” By doing so, you get the most value for the company.
If an employee wants stock, give him or her stock. But if the employee
wants cash more than stock, keep your equity!
Otherwise, you would be wasting something (equity) that you probably
value dearly – certainly much more than the amount of cash you would
have to give this employee in order to achieve the same motivating
result.

Apologies to all my VC and angel investor friends (remember, I am
frequently on your team!), but unless (a) you created the big plan pool
at 20% just to get a bigger piece of the pie and do not intend for the
stock or stock options to be handed out in reality (word is out on this one, guys), or (b) you only
give out stock and stock options carefully and then only to those
officers, directors, contractors and employees whom you know
value that equity more highly than your estimate of their present cash
value, then, by following the path you have always followed, you are,
unfortunately, wasting money (in the form of equity), time and effort
and lowering the chances that the company you have invested in will
“win.”

Lee
Weinberg is an attorney, entrepreneur and investor who has
founded, operated, and financed a number of businesses in entertainment,
media and technology. He is a principal of the Dauntless Founders Fund
and of entertainment, sports and media business-development firm
Dauntless, LLC, as well as a partner with Weinberg Gonser LLP, the
affiliated law firm of Dauntless. His blog is at CapitalistCounsel.com.