Virtually every startup job offers a percentage ownership of the hiring company as part of an employee’s compensation package. According to AngelList, most startup software engineers in San Francisco can expect to receive 0.1%-4% of the company they work for.
This equity is provided in order to align incentives. Employees who own a stake in the company are compensated for the company’s success and theoretically will work harder to achieve that success. In this post, I intend to show that this commonly-held belief is a myth. To be exact - equity in a startup does not incentivise an employee to work longer or harder.
Equity’s largest motivation is at the financial level. There are many other reasons a startup employee might work extra hours (belief in the company’s mission, threats of firing, the enjoyment of challenging puzzles, etc) but none of these are significantly impacted by equity. In order to determine equity’s effect (or lack thereof) on motivation, we need to look at how the financial impact of an equity stake impacts an employee’s motivation.
I find examples are best to work with, so let’s examine a statistically-average Silicon Valley startup hacker named Bill. He’s employee #7 and has been granted shares worth 0.5% of Wuzz.ly. His boss wants the team to put in extra hours in the coming weeks. Should he?
The average hourly freelancing rate for developers in San Francisco is $100. For the sake of argument, let’s say Bill is fairly new to the freelancing world and (only being able to work nights & weekends) has to lower his rate to $75/hr in order to remain fully booked.
If Bill freelances full-time over a weekend (sourcing clients through something like gun.io), he’ll make a tidy 75 16 = $1,200. In order to add $1,200 to his pocket equity-wise, Bill would need to add $240,000* to Wuzz.ly’s value in that same weekend. This assumes:
- Wuzz.ly is successful enough that employees actually see cash for their equity (i.e. liquidation prefrences and debt financing don’t take it all)
- We don’t discount the future value of Wuzz.ly stock (Bill can earn interest on freelancing income while he waits for the Wuzz.ly sale)
- Wuzz.ly never takes on additional venture capital and dilutes Bill’s position
- Bill’s employers have not threatened to fire anyone for not working over the weekend
Engineers that can add a quarter of a million dollars to a company’s value in a weekend don’t charge $75/hr. World-class engineers like that usually end up charging $300+/hr, meaning Bill would need to create nearly a million dollars worth of value in one weekend (this has happened before, Facebook’s Like button was concieved at a company hackathon).
This does not mean that we should stop using equity as a form of compensation as this is now standard practice. Lack of equity might cause an employee to feel left out and/or poorly compensated, neither of which is good for motivation or retention. Equity also allows us to feel more involved when the company succeeds.
Interestingly enough, I did find evidence that equity provides a powerful motivation in public companies. Managers with stock options that went up showed greater motivation at work for a year or more! This was only the case after employees saw a profit made off of their options, which makes it hard to draw correlations with privately-held startups.
Equity is still an incredibly-useful tool in a compensation package. I doubt a company could woo an engineer without it, despite the common recommendation to value it at nothing. The next time your boss “suggests” you work a weekend, I hope you have a greater understanding of how the numbers work out.