Initial Equity Grants vs Refreshes

I’ve been wondering why startups take a different approach for the initial grants in year 1 vs refresh grants in years 3-4+? That is, when you join you get a big grant in year 1 with no more grants for 3-4 years. But once you start getting refreshers, you often get smaller annual grants (that still vest over 4 years) instead of another big grant.

From the employees’ perspective, it would be much more exercise- and tax- efficient if instead of “a new grant every year” (with an increasing strike price) we were given another large 4 year grant with the lower strike price at the beginning of the refresh period.

I asked someone who’s been around a while and he said

This is something that is decided purely from the CFO’s and CPO’s perspective.

I’ve asked my CFO but haven’t heard back (yet?).

If anyone knows why startups treat refreshes different from initial grants, leave a comment!

In the meantime, I ran through a scenario to understand its implications a bit more. While doing this I realized that this also greatly decreases the number of shares. Maybe the assumption is that after 4 years, the options should be more valuable, the employees are already invested, or they’re just more likely to leave sooner. So maybe that’s why companies like it.

Let’s run through a comparison.

Say you get 100k options. You can get them in a single grant in year 1 (“Plan A”), or you can get 1/4 in a smaller grant each year, but still vesting over 4 years (“Plan B”).

• Plan A: 100k options at $1 strike = $100k to exercise
• Plan B: year 1-25k options at $1 strike, year 2-25k options at $2, year 3-25k options at $4 strike, year 4-25k options at $6 strike = $325k to exercise 100k options.

However, Plan B also changes your vesting schedule. At the end of 4 years, you won’t have 100k options. You’ll have 62,500 options.

• in year 1 you’d vest 25k/12=2k per mo
• in year 2 you’d vest 50k/12=4k per mo
• in year 3 you’d vest 75k/12=6k per mo
• in year 4 you’d vest 100k/12=8k per mo
• from years 5 on (assuming annual 25k grants, instead of smaller ones) you’d continue vesting 8k per mo

So by the end of year 4, you’d only have 62,500 vested options. And those 62,500 vested options would cost you $150k to exercise. Showing our work:

• 62,500 options is 25000/4*4 (from year 1) + 25000/4*3 (year 2) + 25000/4*2 (year 3) +25000/4*1 (year 4).
• $150k exercise price is 25000*4/4*$1+25000/4*3*$2+25000/4*2*$4+25000/4*$6

RESULTS

If you decided to leave at the end of 4 years and exercise everything,

• Plan A: you’d pay $100k to get 100,000 shares
• Plan B: you’d pay $150k to get 62,500 shares

And this doesn’t account for other potential tax consequences of having a higher strike price in latter years…. But Plan A is clearly superior.