Hey, everybody.
Dan Martell here, serial entrepreneur, investor
and creator of SaaS Academy.
And in this video, I'm going to tell you why I was backwards.
Because I really think that the way people think about startup
equity is backwards.
That's why I did that little flip-a-roo.
And I'm going to teach you how to think about what you need,
the team structure, the percent equity, the vesting schedule.
And make sure that you avoid some of the legal pitfalls,
although I'm going to claim I am not a lawyer.
I do not play one on the internet, so definitely
go to your own counsel.
But be sure to stay to the end, where
I'm going to share with you how to get access to my Fundraising
Like and Pro training.
In that training, I'm going to talk about the three
phases of fundraising.
If you're going to allocate equity,
I'm assuming you're going to raise some capital that'll
fund that growth.
And I'm going to share with you my seven-week process
for closing your round super fast.
But first let's get into it.
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So I've got a funny story for you.
When I started Flowtown, it was my first equity funding
startup.
We gave 1% equity to our BD guy, maybe you've done this.
And we thought, hey, he's going to add a lot of value.
Great, great idea.
Turns out we were totally wrong.
So all of a sudden now, we have a guy that's got 1% equity,
the business had pivoted at that point.
He wasn't even doing anything for us,
and were about to raise our first round of funding.
And we had to get that back.
Let me tell you, that process, jumping on a plane,
convincing somebody to part with their equity,
getting that done in time so that we can close
around funding was very tough.
Now wasn't a Winklevoss moment, but it was definitely
a little frustrating.
So I've been fortunate enough to not only get counsel
after we went through that scenario,
we talked to our startup lawyer, and he gave us
a scenario I'm going to share with you guys in this video.
But I've been privileged to have the opportunity
to walk probably 100 plus founders around,
thinking of their equity structure in the comp model
and how to do it in a way that's going to scale.
So what I want to share with you in this video,
is how to think about equity so you have a better understanding
for allocating to team members.
Number one, build your dream team.
Here's the way I think about it.
You start off today.
What's your revenue number?
Could be zero, could be 50k a month.
You have a team.
You draw a little circles with their faces on it.
OK, this is our team today.
Fast forward one year.
What's the revenue goal?
What's the target?
Perfect, you now have that.
Then you start drawing the dream team
that you're going to need to build
to get to that level of scale.
If you don't start thinking about maybe a key CTO that you
need to hire, because you're current engineering co-founder
is just not going to cut it.
Or a CMO, chief marketing officer
that's going to be able to drive the demand to really get
to that next level of growth.
Or a CPO, a chief product officer,
somebody that's really going to lead the product side,
to free up your time as the founder,
to be able to really go after more strategic projects.
You're going to need to think about the equity allocation
to that dream team.
So number one is just sit down, where are you at today?
Where do you want to go?
Map out all the key roles and start
thinking about what that looks like,
so that you can use that when you're figuring out
what percentage of equity you're going
to need to put aside to compensate
that caliber of team.
Number two, carve out your equity pool.
Here's the deal.
It's tough for me to say, without knowing
the size of your business, where you want to go, et cetera,
but on average I will say that most founding teams usually
put aside about 15% equity for key hires.
Now, and I have a video.
If you search on my YouTube channel,
there's a video I did on equity and advisors and all
this stuff.
So if you search equity Dan Martell,
you will find some other videos talking about percentages.
But at a high level, 15% is kind of what you need.
Maybe it's a little high, maybe it's a little low,
depending on how big the team's going to be.
But think about it.
You might want to give, again, I don't know what
the market norms are right now.
You're going to have to do that research.
We're going to talk about it.
But maybe 5% to your CTO, 3% for your CMO, et cetera, et cetera.
Maybe half a percent to some advisors
or 1% to an advisor, et cetera.
You need to think about what are the different people,
and then give them equity, and carve it out
of your total thing.
Now I need you to understand, that every time you
give somebody else equity, you dilute and minimize
your ownership.
But the argument is, each new hire
is going to make the overall business more valuable,
because you're going to have more horsepower, more
bandwidth, more throughput.
So the overall pie gets bigger and more valuable.
But I want you to start thinking about carving out
that equity for the next one to two years.
And every year following that, depending on your funding
rounds, you might have to add another several percentage
points to continue to round out that equity pool.
Number three, research compensation.
Now this is very dependent on your city, where you live,
what are the market norms.
But there's incredible information.
Blog posts, core threads, sites like PayScale and Glassdoor,
Angel List has incredible content
around equity structures, et cetera.
But you need to figure it out for yourself,
'cause I'll tell you, a CTO in San Francisco,
in the heart of technology innovation versus a CTO
in Nebraska, no knocking on Nebraska, I'm just saying,
those are two different things in regards
to base salary, equity.
I mean a lot of startup companies
in non kind of major hotbeds of innovation,
the teams don't even know that equity is a thing.
They might hear about it, but they don't honestly
know if 1,000 shares is a lot or not.
They don't even ask for the cap table.
They don't understand what percentage
of the total ownership does that equity
represent in my business.
So sometimes they're very unsophisticated,
so I want you to do your own research for where you're
located, where you're hiring these individuals from,
so that you can understand how to build the comp
structure for you.
Because essentially, the way I think about it
is, low risk, a little risk, a lot of risk.
So when I was building my company Clarity,
we were marketing platform, or a marketplace for entrepreneurs
needing advice over the phone.
And I hired my first few engineers and kind of my CTO
and my product leads, et cetera.
I pretty much said, here's your base salary,
here's the equity structure.
If you take less base, then you get more equity potential.
because, and I'll talk about vesting in a second.
If you do more salary, then you get less equity.
Because it was really just like risk.
Are you willing to take no salary?
Then your equity looks like this.
Or do you want to take enough to cover your expenses, et cetera,
et cetera?
And I love it.
One time one of my engineers came to me,
and I gave him that option, and he said, I don't need a salary,
I live with my parents.
I want the max equity.
And I was like, I just hired an incredibly committed and driven
individual.
So that to me, is the opportunity to thinking
about how to research compensation
based on base salary you're going
to pay them, risk levels, and then
also how much equity to entice them to stick around,
do great work, feel like they're part of the founding team
and get ownership in the business.
Number four, vesting schedule.
So here's the deal.
Vesting means what percentage of the allocation
do you get over what timeframe?
Meaning that if I get, let's say 1% equity in a business,
and there's a four-year vesting schedule,
that means that I don't get the potential
of the full 1% for four years.
Then there's the cliff.
The cliff is, how long before I get any part of that equity?
So if you think about it, if you did four years with 1%,
you get a quarter, a quarter, a quarter on each year.
But with a one-year cliff, so four years with one-year cliff
is the norm, although there's some incredible companies
testing out different models, doing five years, seven years.
I believe AngelList, for example,
is up to a 10-year vesting schedule.
Just because they want to align the reward with the commitment
to long-term focus.
So what's happened right now, especially
in the hotbeds of startups is, people are jumping around.
They're literally going to work at Facebook, getting a year,
getting that.
Going to work at Amazon, doing a year, getting their equity.
And it's causing a lot of turnover
amongst technical teams.
So anyways, all I will say is, you need some vesting schedule.
Allocating stock, like I made my mistake
and that giving that 1% without any vesting,
is not the way to do it.
I actually invested in a company and they had two co-founders.
And right off the bat, they didn't do founder vesting.
They essentially allocated 50-50 of the business.
They went to raise their first round of funding.
In that process, one of the co-founders, the CEO,
realized that his other co-founder was not
going to be the right person for the business.
Like literally, they got to go.
And he had to buy him out in that round
to clear out the cap table, because 50% equity
for some person that's running around that's not involved
in the business anymore, will essentially stop you
from growing your business.
Because you won't be able to allocate anything.
And most investors won't even touch you,
because there's not enough meat on the bone
to be able to incentivize future hires.
So they had to buy that co-founder out.
And it cost, I believe, $600,000.
You got to think about this.
So the business was maybe six months old.
So $600,000 to a co-founder for a six-month-old business,
because he knew he had the business by the short
and curlies, was not a cool scenario.
So I want you to think about vesting, even
for you and the founding team.
A lot of, if you're doing a series A,
the investors might ask you to reset
some of your founding stock so that has a vesting schedule,
so that it aligns with their interests of you continuing
to build a huge and meaningful company.
So that's the thing.
Four years, one-year cliff.
That means they don't get the first 25% until the first year.
And then it vests on a monthly schedule.
Number five, stock options versus other types of equity.
Look, again, not a lawyer, I'm just going to say this.
An option is an option to buy the stock.
So that's a stock option.
I give you the option, you don't have
to exercise it if you don't want to,
because there's a tax implication and all that.
I'm not going to get into that side of things.
But that's an option.
If you give somebody, essentially
allocate them the stock itself, then it's a different thing,
because now there's no vesting.
So they're, and trust me, if you talk to some lawyers,
there is restrictions RSUs, there are so
many different ways to slice and dice share structures.
I suggest, keep it plain Jane.
Keep it simple.
Delaware Corp., again, I'm giving you legal advice,
I really shouldn't.
Anyways, I'm going to stop, because I don't get myself
in trouble.
Talk to you startup lawyer.
Do the vanilla.
In regards to documents and structures,
there's existing templates that have
been created by Wilson Sonsini, WSGR,
who's a top law firm in the Valley to Y Combinator has
got fundraising docs and seed templates, et cetera.
So just keep it simple.
Don't do anything wacky.
If new investors want to do some weird thing,
just don't do that.
Keep it simple, so that you don't
have to spend time into the future, when you're successful,
fixing, because that's what'll happen.
The lawyers don't mind, because they get paid regardless.
Fixing some really weird scenarios in
regards to allocation.
So stock options versus others.
I'm a big fan of the options.
Keep it vanilla.
Don't do anything creative.
Number six, plan for grants and promotions.
Now here's the deal.
If you hire a CMO and they're amazing, you're just like, wow,
they're crushing it, they're doing great,
and all of a sudden now, they come to you and they say, hey,
when I started, you gave me 1% equity and I feel,
because I know that this other person just got 2%,
that I'm more of a 2%er because I'm adding as much value
as this new hire.
You got to plan for that.
You got to understand that if you hire somebody
as a junior developer and every six months,
this is what I love about startups, is literally, people
that are 23, 24, young people can just rise and all
of a sudden be leading the operations
or leading the marketing department at a young age,--
They're going to want to get compensated accordingly.
Because they know their market value
at that level of promotion.
So you need to plan for that in your allocation structure.
So just plan for issuing more grants and stock options
and for promotions within your existing team as people
kind of demonstrate their ability
to handle more and more.
Number seven, you need to set the expiration timeline.
Here's the deal.
If you give somebody an allocation as an option,
they still need to exercise that option.
If you have somebody that ends up getting let go
or they take another job and they
had options that essentially vested,
you have to set a timeline for expiration.
Now some people will keep it short.
Other people are arguing now to keep it longer.
The norm is about three months.
Whereas they have three months after they
leave the organization to exercise their stock options.
Now the challenge with that is, there's definitely a tax
implication that they need to be aware of, where they're
going to have to pay some taxes depending on how they structure
it.
Again, I'm not a lawyer, I'll let
them deal with their own financial tax situation.
But some of them just don't have the money.
I remember I had a good friend of mine that did some marketing
consulting for Dropbox and he got stock option
as part of his comp structure.
And obviously, you know the story.
I mean the company went to like a $2 billion valuation.
He had to borrow the money to exercise his options to pay
the taxes just to own the stock itself,
because the valuation was so incredible.
And that's true for a lot of companies.
I actually know people that finance stock options
for employees at some of these unicorn companies,
because they can't afford to exercise their option.
So they have to work with a financing person that
essentially uses the stock as collateral
to lend them the money.
Super fascinating industry and financial model,
but I will say, you do as, the founders,
have to set that expiration timeline.
If you set it too long, there's a lot
of administrative overhead to manage that.
Three months is the norm.
But do your research and set that.
So quick recap on how you should offer startup equity
to your team.
Number one, we want to build our dream team.
Design it.
Number two, we want to carve out our equity pool.
What percentage are we taking from our equity to compensate?
Three, research compensation.
Your city, your market norms, use the online resources
like a Pay Scale, Glassdoor, AngelList, et cetera,
to figure out what those hires would require
for vesting schedule, so that you understand
how the equity vests.
Five, stock options versus others.
You can entertain it, you can ask your lawyer
about the other options.
I'm a big fan of keeping it simple.
Number six, plan for grants and promotions
of your team members.
And seven, set an expiration timeline,
so people know what their commitment or needs are if they
move on from your company.
So as I mentioned at the beginning,
I want to share with you really one of the most powerful
frameworks that I teach my coaching clients,
called Fundraising Like a Pro.
Now if you don't know this, one of my early mentors
when I built my company Flowtown,
first time I ever raised venture capital,
was Travis Kalanick from Uber.
This is before Uber, right when it was Uber Taxi.
He had hired somebody else to be the GM, my good friend Ryan.
And essentially, it wasn't even a thing.
But that, that environment, we'd go
to Travis's, what he called the jam pad to work on it.
He was an early investor in Flowtown and a formal advisor.
And he helped us with our fundraising process.
So when I share these strategies,
know that they, 80% of them came from the things
that Travis, who went on to raise
billions of dollars for Uber.
If anything, I mean regardless of all the stuff in the media,
Travis is a world class fundraiser.
You can't deny that.
And he taught us, my co-founder Ethan
and I, how do you think about that process,
the psychology involved, the tactics, the strategy.
I wrap all that up in the Fundraising
Like a Pro training.
So you can click the link below to get access to that.
I know it will help you close your deal really fast.
I talk about the three phases of fundraising.
And really a seven-week process to get your round closed.
So click the link, get access.
If you have found this video useful,
be sure to smash the Like button.
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As per usual, I want to challenge
you to live a bigger life and a bigger business,
and I'll see you next Monday.
Ready when you are, buddy.
Hey, everybody.