transcripts/19-Employee-wealth-creation.srt

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While discussing the ATOM 60 stock options framework, we mentioned that when you think

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about how many stock options to grant to an individual employee, you must bear in mind

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that the financial benefit to that employee must be attractive.

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We also discussed that attractiveness can be quite subjective and usually depends on

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the earning capacity or annual worth of an individual.

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So a benefit of $200,000 in four years might seem attractive to someone earning $50,000

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a year, but may not seem so attractive to someone earning $100 million a year.

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So how do you decide what the intended benefit must be?

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Well, you look at it with respect to their criticality rating and their annual worth.

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Let us say you have an employee in a senior role that bears the highest criticality rating

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a drawing a salary of $75,000 per annum because they have taken a pay cut, but their market

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worth is $200,000 per annum.

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What would be an attractive intended benefit for such a role?

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Also, being a startup, let us consider a horizon of say four years, after which you expect this

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individual to earn that benefit.

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You would also waste those options over four years and you might assume a liquidity event

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of some sort, which means someone willing to buy your shares after about four years.

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So we have a senior role rated criticality A with a market worth of $200,000 per annum.

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What would be an attractive intended benefit for such a person after four years?

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While we will provide you with a few guidelines, I want you to think about this along with

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me.

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Let us start small.

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Would earning an extra $25,000 from stock options after four years be very attractive?

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Probably not.

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While some money is better than no money, it may not exactly classify as very attractive

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at a senior criticality.

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How about $200,000 in four years?

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Well that certainly sounds like a significant improvement over $25,000, but let us examine

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it further.

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$200,000 in four years means roughly $50,000 extra per year.

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But this person also took a pay cut, so they lost $125,000 per year in salary.

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While they earned only an extra $50,000 a year out of stock options.

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Now it does not look so attractive.

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Build your own personal scale to make these calculations.

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A good thumb rule to use is as follows.

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For someone at the highest criticality rating A, start with an intended benefit of about

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six to eight times their current market worth in four years.

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We always assume the intended gross benefit for an employee, just like we mostly talk

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about the gross salary and not the salary after tax.

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So in our example, using six to eight times the current worth of $200,000, the intended

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benefit comes to about $1.2 to $1.6 million in four years.

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Considering that they gave up a cash salary of around half a million dollars or more in

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four years, they would still profit from their stock options.

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If you go up to 10 or 12 times, the amount would be $2 to $2.4 million in four years.

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This was for criticality A. You could use the same or a descending multiple for criticality

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ratings B, C, D, and E. So if criticality A is eight X of the annual worth in a four-year

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period, B could be six X, C, four X, D, three X, and E, two X.

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Using a descending multiple essentially means you're using a weighted system where you

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assign higher weights to higher criticality ratings.

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If you were to use the same multiple throughout all the criticality ratings, people would

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still get a different number of stock options because their salary might be different.

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The difference in the grand numbers between two people under this method would be less

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stock.

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Using a higher multiple for higher criticality ratings might be reasonable to do in many

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instances where you believe that the ability to create value goes up with an increase

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in criticality.

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Try both the options, the same multiple for all, and a different multiple for different

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ratings.

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Think about it for some time and then decide what works best for you.

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So to recap, we start with calculating the intended benefit for an employee.

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An amount attractive enough for that individual at that criticality rating.

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But this amount will be earned by them through stock options and not as a cash bonus.

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You need to determine how many stock options you must give them so they can earn this intended

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benefit of $1.6 or $2 million in four years.

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They will earn this amount by selling the shares that they receive after exercising

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the options.

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So you need to understand how much profit one equity share might provide in four years.

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To do that, you need to look at your financial projections.