In Silicon Valley, share options are a really big deal: employees expect to get dibs on sizeable shares in the startups they join. Why bother leaving a comfortable corporate job or another exciting startup otherwise?
In Europe, options don’t have quite the same allure.
Matthew Rowell, head of partnerships at London-based legal tech platform Seedlegals, thinks it’s high time that changed.
“One major reason we have smaller unicorns [in Europe] is because people aren’t willing to stick around and drive value in the business for the five years it takes to vest options. It’s also comparatively easy to raise investment, so senior hires leave and set up their own companies. Employees aren’t quite as aligned to driving value in the business [as in the US].”
For that mindset to shift, however, it would help if more of Europe’s startup employees understood what an option scheme is – and what a good one looks like.
Luckily Seedlegals was ready to answer our questions. Founded in 2017 to help startups manage the legal paperwork around fundraising – and access funding as and when they raise it rather than waiting for an investment round to close – it now also enables startups to set up and manage staff option schemes.
Why did you move from helping startups with the legal paperwork around fundraising to helping them set up option schemes?
Startups were asking for it. After companies have got funding and are starting to expand, they want to attract quality people to their team.
Law firms charge a huge amount of money [to set up option schemes] – anywhere between £3,000-£6,000 – and it’s a slow, long-winded process, so we decided to use technology to start a scheme, and manage options online.
What is an option scheme?
An option scheme is essentially how companies give employees, consultants and advisors equity in the company. It helps assign the option pool that is created (basically a placeholder of shares), and also outlines all of the rules related to that award e.g. what happens if they leave the company. In the UK, EMI [Enterprise Management Incentives] schemes are a tax-efficient way of giving employees equity in a business.
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How big a share of the company do startups tend to put into an option pool?
From all the data on our platform [which has been used by around 40 startups since launch], the average option pool size is around 8.5%. Anywhere between 10-15% is pretty typical.
It’s normally agreed when you do a funding round: you say to investors, ‘Hey, we want a 10% option pool.’ It’s usually created pre-funding round, so it dilutes the founders’ shares not the investors’.
In America, the option pools are bigger – more like 15-20% – because most people expect options. In the UK it’s a halfway house; people are willing to take a bit of a paycut to work in startups if compensated by options. But they don’t live and die by it like in Silicon Valley. In Europe it’s a bit worse again, in Germany it’s really difficult.
How many employees are usually offered options?
Around 80% of startups on our platform only give options to two or three senior hires. The remaining 20% of companies might be much more general, offering options to 10-15 members of their team.
What options are they being offered?
Generally, senior hires are offered between 1-2%. Junior hires’ options are linked to salary.
How can a potential employee work out whether they’ve got a good offer?
What are the terms? What’s the amount? Work out how much you would be paid otherwise – if you take a 50% pay cut to join this company, for 1% options, based on a reasonable exit price, you can work out… Well actually, even in this scenario over the course of five years I’m better sticking where I am.
People sometimes focus on the percentage too much. They should focus on the value of that share now.
Find out when the next fundraising is happening. If you join a company super early, but there will be five or six more funding rounds, your share will dilute significantly. Ask about the exit strategy: are we going to exit for £100m, what is the vesting schedule, what is the price [of these options] based on what investors pay now? Do the maths.
What’s the typical vesting period – the time it takes for an employee to earn their full set of options?
Between four to five years, sometimes a little bit shorter. It normally starts the day an employee joins, with a one to two year cliff: that means, if you left within the cliff period you would lose your options.
What’s the typical strike price – the price the employee pays to buy the option?
Some companies do set exercise price to basically free if they’re being particularly generous. Sometimes it's market value – so the option holder only benefits if the company increases in value.
It will normally come after an employee joins. 90% of the time, companies set strike price to the same as the EMI value: that way there are no other tax implications. It’s normally quite a good deal for employees.
At what stage are the companies which are using your platform?
They’ve typically done one to two funding rounds, and have their first three employees, with about five to six people in the team total. Some have had up to 20 employees.
What else would it take to change the mentality in Europe?
Right now in the UK it’s really difficult, even if you’re working for a massively developed startup and your options are on paper worth a fortune, you can’t get access to any of that value yet. How do you get people to unlock that value?
Let’s say you have a five year vest period, and you’ve been there for five years, then normally you would have to pay some money into the company [to exercise your options]. The strike price would be about 70% lower than the funding round valuation. It doesn’t make sense doing that unless you know someone who’s willing to buy the shares – a secondary market.
We’ve started offering share transfers – for founders and investors to sell some of their shares. We’re of a mind to potentially to do a bit more of a secondary market.