transcripts/19-Employee-wealth-creation.tsv

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0	8080	While discussing the ATOM 60 stock options framework, we mentioned that when you think
8080	14000	about how many stock options to grant to an individual employee, you must bear in mind
14000	17720	that the financial benefit to that employee must be attractive.
17720	22800	We also discussed that attractiveness can be quite subjective and usually depends on
22800	27360	the earning capacity or annual worth of an individual.
27360	33440	So a benefit of $200,000 in four years might seem attractive to someone earning $50,000
33440	39120	a year, but may not seem so attractive to someone earning $100 million a year.
39120	43560	So how do you decide what the intended benefit must be?
43560	50920	Well, you look at it with respect to their criticality rating and their annual worth.
50920	56520	Let us say you have an employee in a senior role that bears the highest criticality rating
56520	63160	a drawing a salary of $75,000 per annum because they have taken a pay cut, but their market
63160	66800	worth is $200,000 per annum.
66800	70680	What would be an attractive intended benefit for such a role?
70680	76720	Also, being a startup, let us consider a horizon of say four years, after which you expect this
76720	79560	individual to earn that benefit.
79560	84120	You would also waste those options over four years and you might assume a liquidity event
84120	90680	of some sort, which means someone willing to buy your shares after about four years.
90680	97480	So we have a senior role rated criticality A with a market worth of $200,000 per annum.
97480	103760	What would be an attractive intended benefit for such a person after four years?
103760	108360	While we will provide you with a few guidelines, I want you to think about this along with
108360	109360	me.
109720	111480	Let us start small.
111480	117960	Would earning an extra $25,000 from stock options after four years be very attractive?
117960	119960	Probably not.
119960	126120	While some money is better than no money, it may not exactly classify as very attractive
126120	129040	at a senior criticality.
129040	132520	How about $200,000 in four years?
132520	138280	Well that certainly sounds like a significant improvement over $25,000, but let us examine
138280	139640	it further.
139640	145120	$200,000 in four years means roughly $50,000 extra per year.
145120	151360	But this person also took a pay cut, so they lost $125,000 per year in salary.
151360	156840	While they earned only an extra $50,000 a year out of stock options.
156840	160400	Now it does not look so attractive.
160400	165240	Build your own personal scale to make these calculations.
165240	169240	A good thumb rule to use is as follows.
169240	175440	For someone at the highest criticality rating A, start with an intended benefit of about
175440	180760	six to eight times their current market worth in four years.
180760	186240	We always assume the intended gross benefit for an employee, just like we mostly talk
186240	191360	about the gross salary and not the salary after tax.
191360	198200	So in our example, using six to eight times the current worth of $200,000, the intended
198200	204360	benefit comes to about $1.2 to $1.6 million in four years.
204360	209400	Considering that they gave up a cash salary of around half a million dollars or more in
209400	214400	four years, they would still profit from their stock options.
214400	221500	If you go up to 10 or 12 times, the amount would be $2 to $2.4 million in four years.
221500	228080	This was for criticality A. You could use the same or a descending multiple for criticality
228080	235600	ratings B, C, D, and E. So if criticality A is eight X of the annual worth in a four-year
235600	244240	period, B could be six X, C, four X, D, three X, and E, two X.
244240	249360	Using a descending multiple essentially means you're using a weighted system where you
249360	253960	assign higher weights to higher criticality ratings.
253960	259440	If you were to use the same multiple throughout all the criticality ratings, people would
259440	266760	still get a different number of stock options because their salary might be different.
266760	271320	The difference in the grand numbers between two people under this method would be less
271320	273720	stock.
273720	278720	Using a higher multiple for higher criticality ratings might be reasonable to do in many
278720	284480	instances where you believe that the ability to create value goes up with an increase
284480	286760	in criticality.
286760	291680	Try both the options, the same multiple for all, and a different multiple for different
291680	293120	ratings.
293120	298280	Think about it for some time and then decide what works best for you.
298280	304440	So to recap, we start with calculating the intended benefit for an employee.
304440	309600	An amount attractive enough for that individual at that criticality rating.
309600	315000	But this amount will be earned by them through stock options and not as a cash bonus.
315000	320400	You need to determine how many stock options you must give them so they can earn this intended
320400	325080	benefit of $1.6 or $2 million in four years.
325080	329720	They will earn this amount by selling the shares that they receive after exercising
329720	331000	the options.
331000	338080	So you need to understand how much profit one equity share might provide in four years.
338080	341840	To do that, you need to look at your financial projections.