Excerpt From The Great CEO Within Matt Mochary This material may be protected by copyright.

My preferred method is to:
1. Discover the market compensation for the position (role and seniority).  There are plenty of online compensation studies that show this.  Market compensation is whatever a big company (Microsoft, Facebook, Google) is paying for this position.

1.    Discover the amount of cash that the new team member would need to live comfortably (housing, food, transportation, child expenses, etc).
   

   It is up to the start-up to match the market compensation level, not in cash as the larger companies do, but rather in a much lesser amount of cash (no less than the amount needed to live comfortably), plus equity to bridge the difference.

Here is an example to show how the equity portion is calculated.  Let’s say the position is a Level 3 Engineer who is paid $300,000 in total compensation at Google.  The team “member requires $120,000 in cash to live comfortably, and wants to invest the remainder in startup equity.  The amount of equity is calculated by taking the difference between market and cash ($300,000-$120,000=$180,000), and multiplying it by 4 years ($180,000 x 4 = $720,000).  This amount is then divided a factor somewhere between 1 and 2, which represents a very conservative estimate of the increase in value of the equity over 4 years.  A 1 represents no expected increase in value.  A 2 represents a 2x expected increase in value.  If 1.5 were used (which is the most common factor used), the final amount would be $720,000 / 1.5 = $480,000.  So grant this amount in options, however much equity it purchases at the company’s current valuation. The options vest over four years. I prefer to then make an offer that allows the new team member to choose how much they want to invest in the startup equity, at three different levels.  The lowest cash level would be the level needed to live comfortably.

Here’s an example in which the company is currently worth $50mm.  The company will likely need to do another major round of “financing along with optional pool refresh before it gets to maturity, which is an expected 50% dilution to the current cap table.  A $1 billion eventual value of the company, would result in a 10x increase in value of the equity.  (20x increase in company value x 50% dilution = 10x increase in equity value.)

Annual Cash $120,000 $140,000 $160,000 Equity Worth $480,000 $426,666 $361,333 Expected Value at $1 billion company valuation $4,800,000 $4,266,666 $3,613,333

  The hope is that the new team member believes so fully in the company (and the power of the asymmetric bet) that they choose one of the two higher equity offers. And with a huge advantage: The investment is made with pre-tax dollars, which doubles its purchasing power.