Stock Options · Hiring

What are the pros and cons of granting equity to a CTO based on revenue milestones?

David Hattenbach CEO Secret Ingredient Marketing, Hugg Technology

June 4th, 2015

I have a CTO candidate who in addition to a healthy chunk of equity to build a demo, plus the promise of a generous salary wants an additional 2% of equity for every $1M in revenue the company generates capped at 8%. I have never heard of a grant based on revenue for a CTO. What are the pros and cons for a founder? 

A-level teams with B-level ideas succeed. B-level teams with A-level ideas fail. This course provides a comprehensive roadmap for building a standout team, teaching everything from hiring to structure, compensation, and culture.

George Lambert Interim CTO - CTO's for Hire

June 4th, 2015

He has skin in the game to make sure that you are successful. If you and he are not - then the percentages will not matter.  If you are both wildly successful then the company will be worth so much you will not care. If you had the cash to do it without equity it would not matter.  But be aware that if he is smart - he will also hit you with a non-dilution clause.  If he does - HIRE HIM INSTANTLY.  He wants to make money as much as you do.  Most Dev / CTO Types are not going to be that Revenue Focused - That will in my opinion maximize your long term results. 

Karl Schulmeisters CTO ClearRoadmap

June 5th, 2015

Startup CTOs are also involved in identifying and adjusting the product to the market.  this CTO wants a reward proportional to the work he's doing.  He really wants that 8% -but knows that asking for that is likely a deal breaker.  So he's offering a basis to prove he will push the product.

David Schwartz Multi-Platform (Desktop+Mobile) Rapid Prototyping + Dev, Tool Dev

June 4th, 2015

Ohhhh ... I like that model! I'll have to remember it!

When someone comes to me and asks me to architect a solution for them, they're basically saying, "we've got this great idea and we need to turn it into a living breathing thing. Can you help us?"

In other words, they want me to breathe life into their idea. Without it, the idea isn't worth the paper it's scribbled on.

If I succeed at breathing life into your idea, I want to be compensated for that beyond my hourly wage. Why? Because I want to participate in the VALUE I'm CREATING FOR YOU.

Put another way, I need to be smart enough to question a bunch of stuff and not just blindly build whatever you think you want wherever you want it. Imagine building a huge glassy office park in the middle of a slum, and you cannot get anybody to rent space in it. Why is it in that location? Because I didn't question you when you said that's where you wanted it built. Maybe it's because I'm from another city and didn't know it's a slum. Maybe I just don't want to "rock the boat" and disagree with you. Whatever the reason, if I build it and you cannot monetize it, then we both lose out.

I have a vested interest in your success by having equity in addition to my regular fee. You don't want a "yes-man". You want to build a successful business. Sometimes we may be at odds. But if you know that I've got a stake in the outcome, you might just pay attention to what I've got to say instead of sticking to what your over-bloated ego is saying sometimes.

Equity for the architects/designers of tech stuff keeps things in balance.

Cashflow ... same thing. It's icing on the cake.

I can also say from experience, most of the time that equity will never be worth a penny. Which is why I also won't work for 100% equity -- if it's your business, and you have a controlling interest, then the rest of us are essentially along for the ride. People who don't realize that probably aren't reliable themselves, and will bail as soon as they hit a financial bump personally.

Michael Barnathan

June 4th, 2015

Unconventional, but I like the idea of a *capped* split based on milestones. Treat the grant as if he's getting all 8% and figure out whether to make the deal on that basis.

Michael Brill Technology startup exec focused on AI-driven products

June 4th, 2015

I'm having a hard time understanding the principle by which he deserves more equity if the company generates more revenue. I assume the corollary holds whereby he returns his equity and salary you paid him if you miss revenue?

It doesn't make sense to me that he would double dip (increased value of company with high revenue + increased equity %) when he doesn't really have control over revenue.

And the biggest problem for you is that you need equity to do its magic when things are tough. In the proposed model, he only gets significant equity if things go great. If things take longer and he doesn't have equity then he's more likely to bail because he doesn't have enough skin the game.

Yet another problem is that his interests are no longer aligned with company interests. He will become frustrated that you're not investing enough effort into sales when you perhaps should be focusing more on investment or shoring up product or non revenue generating user acquisition or whatever. 

Compensate your sales people based on revenue, not your CTO. Give him an equity grant that is consistent with your expectation of his contribution and the stage of your company. That may be 1% or 50%... that's up to you. 

But what is being proposed will end in tears.

 

Marc Rowen

June 5th, 2015

I like the idea of salary rising according to revenue or some other metric. It doesn't make as much sense to me for equity to be tied to revenue, but as long as you feel today that he's worth 8%, I guess there's nothing wrong with it. 

If I were the one coming in, I would want my equity to increase based on my contributions (building the MVP, going from part time to full time, etc.). From a hiring view, you should have a 1-year cliff (for everyone, including yourself), which is enough time to determine whether the relationship is a good one. And if the relationship is a good one, and I think he's worth 8%, I want him to be assured he's getting that early. 

Leon Greene Entrepreneur, Innovator, & Operator

June 8th, 2015

Having little insight into the particulars of your situation, I would strongly echo:

1) cliff (time or milestone e.g.  product  launch) 
2) Everything Vests (4 years is common)  

Also, give some careful thought to the type of business you are building and the role of this individual in that long term. 4 years is a very long time in start up world and the person who is right to build your prototype is probably not the right person to be your CTO long term (at least if you are building any sort of operating business). That is a big growth expectation in most cases (great engineer who wants to and is capable of become both a great manager and a great executive). Those folks do exist (we were lucky enough to find one), but they are really few and far between. There is a good chance that the person you hire today will get you across the starting line but may not be the person you need to go to the finish. You can hope for the best but hiring is always uncertain. If they don't work out to be all you hoped for and more, that doesn't mean they aren't a valuable contributor but the last thing you want to do is to give away a ton of equity for a CTO hire and then have to do it all over again for the same role in 18 months. Be careful with your equity grants, especially for key hires.  

Employment should be at will with no equity acceleration on termination. If it doesn't work out or if their long term value doesn't wind up matching the amount of equity you negotiated. You don't want to be left holding the bag. Vesting is there for a reason. 

Further I would ensure that each "performance grant" is made following the revenue period for which it's earned and begins it's own vesting schedule (e.g. if in year 2 you earned the rev, then Q2 of year 3 they get a grant w/ a fresh vesting schedule of whatever length you want). That should help balance the relationship, keep a long term incentive, and ensure you have options to work with if they don't continue to deliver the value you hope for.

Michael Barnathan

June 8th, 2015

If you're not convinced the person is right to grow the company as well as build the initial product, then a four year grant isn't fair (and you might want to pay cash). It would amount to promising something you have no intention of paying.

Surya Jakhotia

June 4th, 2015

Based on the description, I am assuming your company is at prototype stage. A few things to consider:

- Include a cliff clause (1 year) as well as a vesting clause (4 years). 
- When you say generous salary - is this market salary? At what point does the company start paying this? Does it make sense to give out more equity than cash? 

- Given the role you are looking to hire him for plus the compensation, have you considered making him a co-founder?