Schafer: It’s Smart To Get In On Stock Options With Promising Startups

By By LEE SCHAFER, Star Tribune

Venture capitalist Rob Weber of Great North Labs really wants more Minnesotans to overcome their hesitancy and join promising young technology companies to get in on the stock options.

He obviously thinks it’s a smart business practice for both founders and employees to share in the rewards of ownership through options, but he’s got a larger agenda here, too. Weber and his partner and brother Ryan founded a firm committed to financing growing companies in the Upper Midwest, so they want to see its whole innovation community thrive.

Spreading around a little more wealth from successful businesses is one of the ways to develop a vibrant innovation cluster. Maybe employees don’t get seven- or eight-figure paydays when their employer gets acquired, allowing them to coast or become full-time investors, but a far smaller chunk of option-generated wealth is still capital.

It could provide the financial breathing room as one-time employees turn into company founders and start businesses of their own. And another cycle begins.

After checking with others in the startup community last week, it’s clear Rob Weber is on to something important. At the early-stage investment firm of Matchstick Ventures, for example, managing partner Ryan Broshar will insist a young company set aside a slice of the ownership for employees before Matchstick will invest.

Weber really warmed to the topic of employee stock options in a recent panel discussion hosted by the nonprofit startup accelerator Beta Group on one of the coldest nights here in years, and he got gently teased that it sure sounded like a manifesto. He’s not gotten around to putting down his thoughts on paper yet, so maybe it’s a manifesto in progress. But he preaches the importance of sharing in the ownership when he can.

Weber isn’t sure he can attribute a reluctance to accept stock options to Midwestern caution. It’s more likely a poor understanding of options, and that includes among the founders of young technology companies. Maybe one reason for that is having so many corporate headquarters companies in the region.

After all, there is a pretty good model for living a good life in Minnesota paid by the healthy salaries of UnitedHealth Group or 3M Co. It might be fun to work for a fledgling company, but fun doesn’t pay the mortgage.

Weber and his brother only recently became venture capitalists at Great North Labs, which also runs what they call a startup school. But they have a lot of experience as investors and even more running a technology company, Sartell-based NativeX.

It was by hiring about 500 people up through when they sold NativeX in 2016 that Weber realized Minnesotans didn’t have the same understanding of the value of stock options that Californians did.

“I can only recall about two or three employees negotiating their [options] out of about 300 we hired in Minnesota,” Weber explained in a follow up e-mail. “The majority of the employees in our San Francisco office negotiated theirs. I equated this to the perceived value of the … stock-like compensation structure. When you see early employees of companies like Google and PayPal make untold riches in your city from equity appreciation, it changes what you value as an employee.”

Weber helpfully shared the link to a short news item about Google employee number 53, its first company chef. When he left Google not long after its 2004 initial public offering, this chef’s stock was worth $26 million.

Nobody in NativeX did that well, but Weber characterized their proceeds as “very sizable” from receiving equity appreciation rights, a form of equity-based pay NativeX used that works like a stock option.

In its simplest form, an option lets employees buy stock at a fixed price. Maybe it’s not fair to say there’s zero risk, as it’s at least possible income taxes and bad luck can lead to a bad outcome. But it’s pretty close to risk-free.

By way of example, if the company is worth $1 million the day the employee starts work and each share is worth $10, the option grant might be something like 1,500 shares that can be bought at a price of $10 per share.

It’s generally understood that doing similar work for a big company pays more in salary and benefits. But if the value of this small company doubles, when fully vested the employee has a gain of $15,000.

The founders probably didn’t get into business to create a $2 million company, of course, and if the company in this example reaches $15 million in value, now the gain is more than $200,000 before taxes.

So what was that option worth on the day it was granted? Not $200,000, but it wasn’t zero, either. Part of the misunderstanding about options, according to the Webers, is that good candidates for jobs don’t understand how to do the math or calculate the odds of success.

An employee needs to know how many shares have been issued and other details of the company’s ownership, along with thinking a little like an investor about how likely the company is to be a big success. And no one in California can be any smarter about this kind of analysis than people are here.

“What the Silicon Valley ecosystem has figured out is the top talent can bounce back and forth between high-paying corporate jobs with low upside, and riskier, earlier-stage jobs with more upside, assuming stock options are present,” Weber said. “The Twin Cities could potentially create the same kind of dynamic because of how blessed it is with large [corporations].”

It might not be fun for big company executives to lose up-and-comers to startups, but Weber suggests they should also be thinking about when those employees come back, fresh from (hopefully) a successful technology company that’s been acquired. Big companies need to innovate, too, and these folks will have learned a lot about how to develop something new the market really wants.

Now everybody wins.

This article provided by NewsEdge.