Happy New Year! Quick post.
First Round Capital is literally a treasure trove of valuable information. Its First Round Review repository is outstanding, and should be a go to resource for any startup founder. Today First Round Review published “The 30 Best Pieces of Advice for Entrepreneurs that We Heard in 2019.” It is a wonderful compilation of advice and tidbits with easy to understand and apply stories. Definitely worth reading!
I was recently in a board meeting and the topic of change of control stock option vesting acceleration came up. I wrote a pretty long post on this topic already so won’t rehash the basics again here. But the recent discussion confirmed my view that double trigger stock option vesting acceleration is very clunky, difficult for management teams to understand when it actually matters (at the time leading up to the change of control) and, in my view, should be used infrequently. I am pretty sure that my view on this is not that widely shared.
Absent provisions in a stock option plan or stock option agreements issued under a plan, an employee’s unvested stock options will simply terminate on a change of control (this is the default plan rule). This makes complete sense – once a company is sold in a change of control, the actual stock underlying the option is worthless going forward (in other words there is no longer a company to hold equity in as it was sold).
When a company is sold it is often very attractive for option holders to have their vesting accelerate immediately prior to the time of the change of control. This allows the option holder to participate in the change of control exit to a greater equity extent assuming the options are in the money. As pointed out in my prior post, option agreements may provide for single (just the change of control) or double trigger (change of control followed by termination of the employee following the change of control) vesting acceleration.
Implementing double trigger acceleration is often really confusing for the option holder (who likely worked hard to get the company sold). Implementing single trigger is easy, understandable and better for the option holder (again, who likely contributed to getting the company sold!!). So, I remain a big fan of single trigger. Simple = more understandable = better for the management team.
Critically, change of control acceleration is NOT standard. Often it will just apply to senior members of the company’s team. If the board (who grants options) is concerned with inadvertent windfalls (like when a senior team member joins 6 months prior to an unpredicted change of control and has vesting acceleration), then there are very easy ways to avoid that. Just have the single trigger acceleration kick in after a set period of time (like 2 years after employment starts) or have it apply ratably over a time period (like 25% of unvested options accelerate if the team member has been employed less than one year, 50% if less than 2 years, etc., so that any windfall is limited).
My overarching theme is that team members work hard to get to exits. Without the hard work of a senior team a good exit won’t happen. Reward them with single trigger acceleration. All incentives will be aligned and, most importantly, the team members will fully understand what they have in terms of equity potential.
Sorry for the big gap in posts!
As a bunch of you probably know, James Holzhauer is on a streak to set the record for Jeopardy game show wins. I just read that the show picks back up on May 20th with “live versions” (which are actually taped). I do not watch Jeopardy at all. But, the news stories have caught my eye so I have read a few of them. The other day I came across a print interview that included this question: Would you describe the traditional way of playing “Jeopardy!” as overly risk-averse?
Holzhauer’s answer: “I would definitely say it’s too risk-averse. The funny thing is, my strategy actually minimizes the risk of me losing a game. There’s times in a football game where a team goes for a big TD pass. If you don’t take a risk like that, you’re not going to win. Really, the big risk is never trying anything that looks like a big gamble.”
In case you don’t know, a core part of Holzhauer’s strategy is to go after the $1000 “answers” first so that he builds up a pot to bet when he hits a daily double. This is why he is the fastest money winner in Jeopardy history.
Anyway, I loved his answer as it made me think of many entrepreneurs – they take risk all the time! And guess what, so do VCs when they bet on those entrepreneurs! Risk is a given and taking risks is required.
Happy New Year everyone! I hope you all have had a great holiday season. Quick post just following up to my most recent post on independent board members.
a16z has a podcast series, and one of my CVF partners just sent me this podcast from them on independent board members. Great quick 23 minutes. Have a listen.
Tidbits of value from the a16z podcast:
- Independent member are able to diffuse hidden agendas among investors.
- Independent members are able to provide feedback to CEO by a trusted non-investor.
- Makes the overall board dynamics way better as the relationship between the VCs and CEOs is just different than the relationship between the independent board members and the CEO.
- The reality is that the VCs have to give up board control too once the independents arrive!
- Entrepreneurs don’t like working for others and CEOs always have to work for the investors. The independents make the board function better.
- Being a board member is MUCH different than being a board observer or advisor. Independents can start as observers/advisors but entrepreneurs need independent board members with board power.
Most startups as they mature get better and better people on their boards of directors. In this context, “better and better” means people that can really help the company grow from a strategic and operational perspective. Impartial, independent, outside directors. They are independent from the founders, independent from the management team and independent from investors. You can search “independent director” on Wikipedia if you like. The definition is not a topic of controversy. The terms “independent” and “outside” are used interchangeably. And there is a ton of literature (from blog posts to books) about the value that good independent directors can and should bring to a startup. Here is my take (and trust me, probably nothing I write here is new):
- Balance: independent directors bring balance to a startup board. Often there is inherent tension between professional investors (VCs) and founders. This is unavoidable and happens all the time. I am NOT talking about constant tension. That would be a big problem. I am talking about tension over particular issues (like salary adjustments, stock option grants, strategic direction, etc.). Independent directors will bring balance to whatever the topic is that is causing the tension. Good for the founders and good for the investors. A good outside director will be happy to be in the middle and bring balance.
- Connections and Exits: often independent directors have networks that can be incredibly helpful connecting the startup to others in the industry/sector. Think of top level customer relationships. Think of top level exit discussions. These are just examples. Independent directors are usually compensated (often with equity) so they are motivated to directly help. I suggest looking for people that recently retired from key “company” relationships. Make a list, track them down and recruit.
- Mentorship: Independent directors ideally should be great mentors to the founders, and probably to a lesser extent, the startup’s investors. What better person to bounce an idea off of than an independent director who does NOT hold any purse strings.
- Credibility: Getting a decently well-known (in the sector) independent director can bring lots of credibility to the startup and its team. This is common sense. The benefits of the credibility boost are enormous. Doors open, conversations are easier, business happens.
So, with just these 4 points above (and there are lots more – again, just google “independent director”) you might think that every startup would have at least one independent director! Well:
- Not that easy to find: Good team members, be they management or directors, are not that easy to find. In my experience it can easily take 6 months or more to find the right person. BTW, investors often recommend people to be independent directors. That is fine, but can upset the “balance” function that I explained above. I recommend that the founders source the independent. Sure, the person will ultimately typically need to be mutually agreeable to the lead investor and founders but having the founders source the person strikes the right balance in my opinion.
- Founders are hesitant to find due to control issues: this is unfortunate, but it happens often. Yes, every time the board grows by one person there is inevitable decrease in “founder control” due to voting. Each director gets one vote so the math is simple :)). The key though is that “control” mentality signals insecurity. Insecurity signals a lower chance of having positive high level strategic team building (so team building with the top executives and top board members). Lack of top level strategic team building typically leads to sub-optimal exits. The funny thing is that investors think very highly of founders who build great teams both in management and at the director level. Control mentality gets in the way at both levels as “the best” hires might not be sought out. Anyway, this is a very sensitive topic obviously. But think about the best companies you know and then look at the management teams and boards. The evidence is pretty compelling.
Have a great holiday season!