The Turn Of The Screw – An Underkill Approach To Negotiating Your Startup Employment Package

Turn The Screw

Author Henry James understood the impact a ghost could have on a story. He also recognized that two ghosts haunting two children was even more effective than a single ghost and a single child, as his character Douglas notes in the 1898 novella, The Turn Of The Screw:

“I quite agree – in regard to Griffin’s ghost, or whatever it was–that its appearing first to the little boy, at so tender an age, adds a particular touch. But it’s not the first occurrence of its charming kind that I know to have involved a child. If the child gives the effect another turn of the screw, what do you say to two children – ?” “We say, of course,” somebody exclaimed, “that they give two turns!” (italics from original text)

James understood that the introduction of each ghost and child effectively “turned the screw” – to a point. However, just as a carpenter understands that over-tightening a screw can cause it to break; James realized that too many “turns” of his metaphorical screw would render his ghosts ineffective as literary devices. Turning the screw just enough is an art in carpentry, literature and negotiation.

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Question: What is the optimal negotiation strategy?

Answer: It depends. Just as the optimal sales, competitive and management strategies will depend on an evolving array of circumstances, so do negotiation strategies.

For instance, if you are buying a house, you probably do not care how “good” the Bro Foe seller feels at the end of the negotiation. Your objective is to minimize the purchase price of the house. As it is unlikely you will have any interest in establishing a long-term relationship with the seller, you can afford to utilize an aggressive, hard-nosed negotiation style. You can walk away in a huff, get red in the face, raise your voice and leverage your extensive high school thespian training, if you so desire.

However, if you are negotiating the lease of a house with your future landlord, your approach will likely be much more subdued, as your objective is not simply to achieve the lowest price. You must also consider the landlord’s integrity, communication style and desire to maintain the property in its current condition. Unlike buying a home, negotiating a lease is not simply a transaction. Rather, it is the basis upon which your rapport with your landlord will be based. A solid foundation, comprising trust and mutual respect, will facilitate a long-term, mutually beneficial relationship.

When you negotiate your compensation at a startup, you are leasing a home, not buying one. As such, employ a negotiating style that considers both the near-term gains of a lucrative employment agreement and the rewards derived from a long-term relationship based on mutual trust and respect.

As with any negotiation, firmly define the least attractive deal you are willing to accept before you being your discussions. If you are unable to attain such terms, your decision is easy. However, avoid turning the screw too tightly by asking for unreasonable concessions.

Power Tool

At one startup, I attempted to hire a very qualified attorney for a business development Power Toolposition. He seemed to have the right personality, enthusiasm and business experience. However, as we negotiated his employment agreement, he displayed a disappointing inability to put down his screwdriver. In fact, the poor judgment he displayed in finalizing his employment agreement caused me to withdraw our employment offer. I was concerned that his desire to use a power screwdriver with me did not bode well for his ability to establish Bro relationships with potential BDC (Big Dumb Company) partners.

Cash Out

One way to avoid breaking the screw is to avoid overreaching when negotiating your base salary. When pursuing a position at a startup, seek a team you can trust to reward you for your future accomplishments incrementally increase the overall value of the adVenture. In such an environment, your overall compensation, including your base salary, will increase in concert with the expanding scope of your responsibilities.

At one of my first adVentures, I expended no effort negotiating my initial cash compensation. That is correct, no effort. When the Founder asked me what I wanted to be paid, I told him, “Whatever you think is fair.” He was shocked and stammered before proposing a salary. I accepted his modest offer on the spot, despite the fact that it was a fraction of what I could have earned at a BDC. Instead of focusing on my salary, I used my negotiating capital to increase the size of my option grant.

I was cavalier about my salary for two reasons. As described in Joining An AdVenture, I was fortunate that my spouse had a secure, stable job. In addition, I knew the startup could not possibly pay me a comparable, “market” salary. The Founder had never even heard of Wharton, my alma mater, let alone did he realize that recent Ivy League MBA graduates were making well over $100,000 at the time of our discussion.

After two months of making a substantial impact on the company, the Founder unexpectedly notified me that the Board approved his request to double my initial equity grant and to substantially increase my cash compensation. Even though I was still paid far less than my Wharton classmates, it was rewarding to know that I was working with a team that was committed to appropriately compensating each member for his or her contributions. When the company achieved a successful exit, the return on my options significantly exceeded the cash compensation I would have been paid had I taken a position with a BDC.

I am not advocating that everyone follow this unorthodox path. In fact, a reasonable degree of salary negotiation is usually prudent. However, my experience serves to illustrate that if you join a team that you trust to appropriately reward you for your future contributions – you can avoid breaking the screw when negotiating your compensation and still be fairly rewarded for your efforts.

How Do I Negotiate My Option Grant?

As noted in What The Heck Are My Startup Stock Options Worth?!, the number of options you are granted is meaningless if you do not know the company’s Total Capitalization. To properly position your option negotiations, refer to your option grant in terms of a percentage of the company’s Total Capitalization, rather than as a whole number. For instance, you should ask for an equity grant, “equal to 1% of total capitalization,” rather than a specific number of shares.

If you are joining an organization as a Manager, Director or Vice President, consider negotiating your option grant based on your boss’s grant. For instance, you might ask your prospective boss for an option grant that is fifty percent of the grant they received when they were hired. The message you send with such a request is, “I am sure that you negotiated a fair option grant for yourself and thus I am comfortable receiving a fraction of what you were granted.”

I have used this approach to good effect on several occasions.

Balancing Act

When making job offers, I often allowed prospective employees to select between a range of options and base salaries, as shown in the chart below.

Comp Plans Base Salary Stock Options
A $65,000 10,000
B $75,000 7,500
C $85,000 5,000

Sample Compensation Plans to be selected by a prospective employee

Offering employees a choice of more or less cash and stock served as an effective Blondin Test. Those who selected the highest salary and fewest options often proved to be ATM Operators, while those that maximized their options generally were Bank Robbers.

This approach was well-received by most prospective employees, as it empowered them to select the compensation plan which best fit their financial needs and risk profile. It was also an effective means of reducing compensation negotiations. By presenting an employee with a variety of “choices,” between which I was indifferent, I was usually able to bind our negotiations within a narrow range of acceptable alternatives.

If you can financially afford to accept the additional risk, consider negotiating a base salary that is lower than what is offered to you, in exchange for additional options.

Ask Not

When negotiating almost anything, it usually does not hurt to “ask.” However, there are certain provisions that you should never request when joining a startup. Not only is it highly unlikely you will be granted such concessions, asking for them may break the screw, especially if you are applying for a relatively junior position (i.e., below Vice President). The lower the level of your prospective position, the less flexibility the company will have to negotiate “special terms.”

Anti-dilution – An anti-dilution provision is one in which the holder is protected from the dilutive impact of future equity grants. NO EMPLOYEE should ever be granted such a provision, as it is healthy for all equity holders to be equally impacted by future dilution. It is very uncommon for any party, including investors, to be given this protection. When one party has a preference in this regard, they are prone to favor decisions that are not in the best interest of the unprotected equity holders. Such misalignment of interests can often result in highly contentious and destructive conflicts.

Accelerated Vesting – This provision initiates automatic vesting of all or part of an employee’s option grant, usually upon the occurrence of a specific event, such as an acquisition. Only a handful of the most senior executives at a typical adVenture should benefit from this provision.

If your employer widely grants this provision, it risks making the company less attractive to a potential acquirer, as accelerated vesting could reduce the employees’ incentive to remain with the acquiring company after an acquisition is consummated.

When accelerated vesting is granted to a few senior employees, it should be predicated upon a “dual trigger,” two events that must both occur before automatic vesting takes place. In addition to an acquisition, the second trigger is termination without cause. It is fair to accelerate the vesting of options of senior executives that are fired without cause after an acquisition, as they likely created much of the adVenture’s value. A dual-trigger provision also takes away an unscrupulous acquirer’s incentive to fire such executives as a means of recapturing their unvested options.

Severance – You should not expect your startup to pay you anything in the event that your position is terminated, with or without cause. Startups are risky endeavors and you should not attempt to mitigate your risk by contractually binding the company in this manner. If you are doing a great job and you are terminated without cause, it will likely be due to the company’s financial failure, in which case the company will not have the financial wherewithal to pay any severance. In limited circumstances, top executives are granted severance clauses to entice them to join an adVenture. However, in all such cases, severance should only be paid when an employee is terminated without cause.

Extra Vacation – I was always surprised and unimpressed when potential employees attempted to negotiate additional vacation time. At most startups, it is a challenge to use the minimum vacation you are granted. Employees who asked for additional vacation communicated their lack of understanding of the time commitment associated with a startup.

When negotiating your employment agreement, keep in mind that consistent personnel policies are of paramount importance. When a company makes exceptions to company-wide policies, such as vacation accrual, it places itself at risk for a lawsuit. In some jurisdictions, employment law requires that every employee of a “like class” (often loosely defined by the courts) be treated equally in all regards. Thus, an exception made for one employee could become grounds for legal action. As such, avoid requests that would require the company to make an exception to its standard personnel policies.

Ask

Performance-Based Bonus – It may be difficult to negotiate the specific terms of your performance bonus at the time you join a startup. However, include in your Offer Letter a provision that binds your employer to “negotiate in good faith with respect to establishing a performance bonus within forty-five days” of your start date. If you do not document this term in writing, it is possible that the bonus may never be properly defined. Most courts consider Offer Letters to be legally binding agreements. As such, if your Offer Letter includes a performance bonus that is not subsequently defined, the company is effectively bound to pay you the entire bonus, irrespective of your actual performance. Even so, you should always strive to minimize any such ambiguities by clearly defining all the relevant parameters of your bonus.

Ideally, a portion of your bonus should be based on personal, quantifiable goals, such as sales, lines of bug-free code written, business development deals closed, or whatever tasks are applicable to your position. The other half of your bonus should be predicated upon the company’s overall accomplishments. In this way, you can still earn a portion of your bonus if you succeed, even if the company does not reach all of its goals. In addition, this compensation scheme aligns your interests to those of the organization. Persuading your employer to grant you a performance bonus may make it financially viable for you to accept a lower base salary and thus garner a larger stock option grant, as previously discussed.

You Are Not Entitled – Do not aggressively negotiate your title. Such actions might be interpreted as a sign that you are an ATM Operator, as opposed to a Bank Robber.

Rather than vying for a specific title, you should focus on clearly defining the scope of your responsibilities and determining whether or not you are joining an organization which will allow you to add value in a variety of creative ways. Titles are more germane at a BDC, as a means of defining the scope of each employee’s role. As discussed in What Do Bill Gates And Karch Kiraly Have In Common?, the roles and responsibilities within a startup are fluid, which significantly diminishes the relevancy of employment titles.

On a personal note, I never granted a new hire a title that was more senior than any position they previously held. This occasionally became an issue when I recruited former BDC employees. At times, prospective employees who were former Managers or Directors at large companies felt they should be a Vice President at our startup.

Wrong.

Senior employees at large companies have the benefit of a legion of support staff and financial resources to assist them. Thus, the skills required to be successful in such an environment are different than those required of a Vice President at a startup. As such, I insisted new employees accept the same title they held in the past and earn any advanced titles once they proved their ability to perform at our startup.

Accrued Vesting – As noted in Entrepreneurial Entreviewing, I often assigned potential hires a small consulting project while they were wrapping up their duties at their current place of employment. As a prospective employee, this can also be to your benefit, as it can give you an opportunity to “test drive” your future boss, peers, and potentially even your future subordinates. When accepting positions at a couple of startups, I have taken advantage of this chance to “try before you buy,” as a means of reducing my risk.

Although you should not ask to be financially compensated for such consulting work, it is appropriate to ask that your options begin vesting on the date you begin consulting. At one of my adVentures, I consulted for over three months, and thus entered the company on day one with options that were in their fourth month of vesting.

Equity Investment – It is entirely appropriate to request the option to invest in a current or future funding round. If the executive team is smart, they will encourage such investments, as it will serve to further align your commitment with the company’s long-term financial performance.

Turning The Screw

Negotiating your employment package is a delicate operation. You must be firm and strident in order to maximize your near- and long-term compensation. However, unlike a one-time negotiation in which you will not have a lasting relationship with the other party, you must balance a “tough” negotiating style with a reasonable degree of flexibility.

If you play too hard-to-get, the startup may move on. Most entrepreneurs do not have the time or patience to chase down and drag an employee into their adVenture. As such, being too coy and twice clever may be to your detriment.

Underkill

The word “overkill” was derived during the 1950s as a means of describing the potential impact of nuclear weapons. It is defined as “any effort that seems to go farther than would be necessary to achieve its goal.”

Henry James created a masterful classic of gothic suspense with the judicious use of two ghosts and two children. By avoiding an overkill approach that risks “breaking the screw,” James deftly keeps his readers frightened and engaged. A similar underkill strategy will help you craft a startup employment package that will reward you in both the near- and the long-term.

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Copyright © 2007-9 by J. Meredith Publishing. All rights reserved.

John Greathouse

John Greathouse is a Partner at Rincon Venture Partners, a venture capital firm investing in early stage, web-based businesses. Previously, John co-founded RevUpNet, a performance-based online marketing agency sold to Coull. During the prior twenty years, he held senior executive positions with several successful startups, spearheading transactions that generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.

John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara’s Faculty where he teaches several entrepreneurial courses.

Note: All of my advice in this blog is that of a layman. I am not a lawyer and I never played one on TV. You should always assess the veracity of any third-party advice that might have far-reaching implications (be it legal, accounting, personnel, tax or otherwise) with your trusted professional of choice.

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  • Hi Saul,

    I really enjoy your posts. This one in particular. You make some great points. I’ve negotiated all sorts of compensation agreements with various start-ups and have to say that the negotiation is more indicative of the managements competency and style than anything. Looking back on the past I can see a correlation between the success of the company and the early negotiations. Those hiring managers who were open and honest and had a process in place for new hires were much more successful than those who tried their best to play the upper hand and keep things “secret”.

    Nothing scientific about this assessment except that my tenor is filled with several successes and a few failures.

    In the instances where the management was not open about the value of equity I took more cash. And it paid off. In the cases where the management was transparent and fair I took more equity and it paid off handsomely. For me it was the difference between becoming a key part of the team and being hired as an employee. When a boss keeps many secrets they tend to be micro managers and controlling. And in a start-up its key to have the feeling of equality. Nothing drives success more than a team working towards a single goal with the feeling that they will all share in the success.

    Keep up the good work!

    Adam

  • UncleSaul

    Adam – well said. I agree that the “right” mix of stock / cash is heavily contingent on the degree to which you trust the company to reward you for your future efforts.

    I am glad this approach has worked for you in the past. I meet far too many people who did a poor job of reading the Mgmt team and ended up bitterly disapointed.

    Take care,

    Uncle Saul

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