How to Help Your Employees Value Equity
How to position ESOP to new employees
Would you prefer $50 today, or $100 in six months?
For most people, the answer is $50 today. Our preference for immediate over longer-term rewards is called temporal discounting and it’s the reason we find it hard to save for the future.
One of the benefits of working for a startup is the opportunity to earn equity and share in the upside of the value you create every day. In a successful outcome, employees can earn a life-changing amount of money.
However, our natural tendency to discount future gains often means employees will prefer a slightly higher salary to a significantly larger ESOP grant. Temporal discounting is compounded by employees also having to make predictions about the:
Probability of success (will there be an exit?)
Dilution Factor (how much will their equity be diluted by future rounds before exit?)
Exit Valuation (what will the company sell or IPO for?)
All of which creates a sense of uncertainty about the future most people will naturally seek to avoid.
So we need to get better at helping future employees understand the leverage of equity vs salary. While salary gives you an incrementally better life today, with equity there’s the possibility of a lump sum that could help you change direction in life (see Alexey Mitko’s experience at Canva, Koala, and founding Eucalyptus in his excellent ESOP guide).
To help the founders we work with position their ESOP more effectively to employees, I unearthed a systematic review of studies involving training sessions and behavioural interventions used to reduce temporal discounting. This review analysed 98 studies between 2008 and 2017 on adults.
The meta-analysis concludes that training sessions (including money management training, motivational training, and Cognitive Behavioural Therapy) are mostly ineffective in reducing temporal discounting.
However, behavioural interventions are effective — 86% (n = 114) found the expected reductions in temporal discounting (TD) and only 13% (n = 17) found null results or unexpected increases in TD.
So what are these interventions and how can we adopt them?
Episodic Future Thinking (EFT)
EFT is projecting yourself into the future to pre-experience an event. Participants either imagined specific events of spending money or merely estimated what the money could purchase in the scenario.
When messaging the value of ESOP, make it clear what the equity could be worth in 7-10 years and what the employee could buy with it:
“By selecting Option 1 vs Option 3, you give up $40k annual salary today, but at a $100m exit you walk away with $600k more. That’s a large deposit on a home or a seed round for the company you want to start in the future.
If the company is as successful as we and our VCs believe it’s going to be, the difference is $6 million. With that amount you buy the home in cash, pay off your parents’ mortgage, and still have plenty for your seed round.”
20 out of the 24 experiments (83%) employing an EFT manipulation found the expected reductions in TD.
The presence of a social context influences decision-making, based on the rationale that when an individual makes a choice on behalf of their group, they prefer alternatives geared toward the group’s long-term benefit.
While an extra $40k in salary is helpful, it’s unlikely you will donate a significant proportion of that to charity while trying to meet your expenses and save for your future.
The probability of a multi-billion dollar exit for any company is low, but if it happens you can give back to the causes and communities you care about most by setting up a PAF and engaging in philanthropy. Several of the founders in our portfolio have done this with secondaries in the last few years.
Five experiments tested the effects of the presence of a social context on DD; 80% (n = 4) found positive effects on TD.
This one’s obvious — frame the future reward with positive emotions. Most experiments (85%) in the emotion priming category found positive results on TD.
All experiments found lower discounting when delays were presented as specific dates instead of amounts of time (January 2026 vs four years from now).
Reframing of Rewards
How the two amounts of money are described in a study matter. Draw attention to the magnitude, rather than the delay.
eg. “the chance to make $8 million by 35 years old vs making an extra $40k today”
Of the 26 experiments, 25 (96%) found positive results from the reframing of rewards.
Clearly, you should use these interventions wisely and accompany them with an unvarnished explanation of the risks.
While I believe equity is preferable to salary in most cases, particularly while you’re young, startups are high risk and there’s a good chance that even if your seed round was led by top tier investors, that employee’s equity will end up worthless. I myself have worthless ESOP from a Series A startup that had competing term sheets from Accel and Valar.
Nevertheless, if we counter the natural human tendency to discount future gains by positioning equity effectively when we present employees with offers, hopefully we can ensure thousands more Australians participate in the upside of the businesses they help build, and change their own lives in the process.
Books I’ve read
Short stories exploring the troubled lives of the scientific luminaries who changed our understanding of reality and the edge of chaos between genius and madness.
A collection of Carlo Rovelli’s musings on history, philosophy, physics, and politics. The writing is gorgeous and the length of each piece is perfect for a 10-minute read before bed.
An accessible introduction to moral philosophy for anyone who wishes they knew more but finds the primary texts too much of a challenge.
Podcasts I’ve listened to
Describing the differences between consequentialism and deontology, investigating the neuroscience of morality, and exploring techniques to enable the uptake of effective altruism.
The best explanation of Panpsychism I’ve heard because over a long conversation Joe Rogan continually challenges Philip Goff and forces him to clarify his arguments.
The box analogy is very entertaining.
Assumes a $10m valuation today. For simplicity this chart does not subtract the strike price of the options, account for dilution or capital gains tax.