It certainly worked out for me," claims Edward Esber, a former marketing vice-president for VisiCorp in San Jose, Calif. Like many hired field workers in the sowing of new businesses, Esber had gambled on the eventual success of the embryonic enterprise with which he had cast his lot rather than seeking the haven of a larger, proven company. And he won -- big. When Dan Fylstra and Peter Jennings founded VisiCorp (then called Personal Software Inc.) in 1978, Esber was the first outsider to be granted stock. To help keep his energies from flagging in the tough early going of the still-private software company, he was granted liberal stock options that eventually were to reward him with a large percentage of VisiCorp stock. The lure made him keep his nose to the grindstone for more than three years while increasingly more equity became vested to his account. Last May, after putting in about 45 months of labor, Esber retired. "I'm now able not to have to work the rest of my life, if I decide to do that," he beams. Esber is 31 years old.
Giving away founder's stock as a means of first attracting key employees and then retaining them for as long as possible has rapidly become a way of fast-growth life among proliferating young companies competing for a limited amount of engineering and managerial talent. "The challenge of the '80s is to keep your key people," proclaims Alan F. Shugart, whose four-year-old Seagate Technology, of Scotts Valley, Calif., is particularly imaginative in devising ways of sharing the wealth. "There are only so many experienced disk-drive engineers to go around. How do you keep them down on the farm after they've seen Paree?"
The "Paree" he is referring to is being built from the gathering of venture money that has been piling higher and higher throughout the last few years, from $39 million in 1977 to an estimated $1.7 billion last year. By the close of 1983 more than $2 billion will undoubtedly have been involved in venture financing. This swelling mound of greenbacks represents a powerful economic force that, since 1980, has been forging small businesses, like a machine from the Industrial Revolution stamping out nuts and bolts. One by-product of the surge in start-ups has been that the new entities have, in turn, raided the ranks of established businesses for their front offices and laboratories.
Many of the fertile new ideas come from ex-employees of successful start-ups who, like Esber (now in the process of writing a business plan for his own venture), have struck it rich from having even a modest amount of equity therein. Apple Computer Inc., of Cupertino, Calif., for example, was "pretty well spread around," as one insider put it, when the company went public in December 1980, at $22 a share. Apple is reputed to have created a couple of dozen millionaires among its employees on that occasion, and already some have left to organize their own companies. At 3Com Corp., a private, four-year-old, high-technology corporation in Mountain View, Calif., founder and chairman Bob Metcalfe predicts that "an engineer here can expect -- assuming we make our business plan and the world doesn't come to an end -- to own between a quarter and a half-million dollars in stock by 1986." Of 3Com's 50 staff members, at least 25 are soon-to-be-blessed engineers. When the opportunity to cash out arises, undoubtedly some of them, too, will be off to gay Paree -- which these days is doing business as downtown Palo Alto.
Clearly, the chance that the stock of a small private company or an early-stage public company will be worth considerably more in the not-too-distant future has been an offer not easily refused by employees who stand to be given some of it by the entrepreneurial team. Indeed, the top ranks of some firmly ensconced public companies with far fewer get-rich-quick opportunities to offer key employees -- their stock is comparatively fully priced in the public marketplace and is not apt to appreciate dramatically -- have been well picked over. But IBM, Hewlett-Packard, Xerox, even PepsiCo, and any number of other Big Board businesses have managed to survive the loss of valuable employees. A few, like Texas Instruments Inc. and National Semiconductor Corp., have been noticeably shaken; if the raiding continues, many more could be also.
Seagate is a typical example of just how fast money begets money when a start-up is successfully brought public. Alan Shugart founded Shugart Associates, a manufacturer of computer disk drives, in 1973. That company was eventually sold to Xerox Corp. In October 1979, Shugart cofounded Seagate with four other expatriates from various larger companies. The five founders purchased a total of 6.2 million shares at $0.005 each. That's right: five-thousandths of a dollar, making their total capital commitment a whopping $31,000. Two years later, Seagate went public at $10 a share. Working out the gain is a simple matter of a few decimal places.
A number of other large investors in Seagate made hay as well. The major stockholder was Dysan Corp., owner (as of June 30, 1981) of nearly 5 million shares. Other venture capital sources cumulatively held some 4.6 million shares. Under a 1979 stock option plan, 620,000 additional shares were owned by key employees, who had been allowed to purchase them under an accelerated program. Had they wanted to, this group alone could have capitalized yet another disk-drive business with the $6.2 million the key employees were suddenly worth. But had they held their stock, it would have been worth an extra $18.6 million in mid-June 1983 -- and they could have started two more, or each could have branched off on his or her own.
When a growing company goes public, the release of available investment capital is fiscally explosive. But, although labor was cheap and plentiful during the Industrial Revolution, in today's business world the number of available skilled workers is solidly fixed. Because the battleground is so keen for talent that can make a company -- or break it by its absence -- now most venture capitalists financing start-ups or first-rounds, particularly with technology companies and particularly on the West Coast, virtually demand that the founder part with his or her stock right from the beginning and provide for ongoing dispersal as the company grows. Increasingly, a prospective capitalist will sour on a promising deal solely on the ground that the entrepreneur appears too greedy on paper.
Says Hank Smith of Manhattan's Venrock Associates, a financier and board member of VisiCorp among other companies: "We think it's very important that the ownership be shared among all the key employees. We would be much more positively inclined toward a situation where the founder was going to give up a significant percentage." Venrock's deals are executed on the expectation of fully diluted ownership, including stock authorized for future stock option conversion. Crown Associates, a venture capital firm in New York, is concerned with creative people in general being well taken care of in any industry, says partner Chet Siuda. "And it's not necessarily management. Marketing people can be creative as well. Some marketing people in technology companies make more than CEOs," Siuda notes. "Most companies being founded today are not an individual so much as a group of people. They're getting together with an understanding that they're all valuable, and they all want to share in the success of the company."
West Coast venture capitalists tend to take even more stubborn stances, despite their frenetic and sometimes cutthroat search for high-tech investment opportunities. Don Valentine, president of Capital Management Services Inc. of Menlo Park, Calif., is one investor who rejects owner avarice out-of-hand. "Unless there is broad distribution of major equity portions to the primary key individuals, we're not an investor," Valentine, an active funder of such technology start-ups as Apple Computer and Altos Computer Systems, flatly asserts. "We don't believe you can build a major company with one man owning all the equity and the others being employees with no ownership in the enterprise." In a start-up situation, the functionally key positions are, as Valentine puts it, "a sales guy, a guy in finance, two or three engineers, and maybe a manufacturing person. All of those people have to participate."
Echoes William Hambrecht, president and chief executive officer of the San Francisco investment banking firm of Hambrecht & Quist Inc.: "Single ownership doesn't work anymore. Although equity sharing isn't new, it's more important now than it used to be. If you want to get a good design person in a semiconductor company, for example, it's going to cost you a few shares. The successes of these companies have not gone unnoticed. People want to share in it. I'm hard-pressed to think how you could go out and acquire good people without giving them a share of the ownership. Most entrepreneurs now understand that. I would have trouble imagining that someone with 80% of the stock could keep a key team together and happy."
Perhaps the one-entrepreneur day is not fading quite so rapidly as Hambrecht and Valentine think. The single founders of a few highly profitable companies have, even lately, been able to keep more than 80% of their businesses. Among them, Andrew Kay, founder of soon-to-be-public Non-Linear Systems Inc., manufacturers of the Kaypro computer in Solana Beach, Calif.; and K. Philip Hwang, chairman and founder of public TeleVideo Systems Inc. in Sunnyvale, Calif., are two who are mentioned, with wonder, by veteran venture capitalists. But eight-year-old TeleVideo has been undergoing management turnover in marketing, finance, and operations -- executives who, notes Valentine, "had no equity in the company and have been lured away elsewere." Despite TeleVideo's rapid rise in the over-the-counter stock market, a dubious Siuda adds, "the jury's still out on how successful TeleVideo will be in the long term -- and we invest for the long term."
Because there is a brisk seller's market in high-tech employment, smaller, state-of-the-art companies that do not offer equity sometimes have unexpected problems keeping key people. For example, in the Boston area recently, Software Arts Inc., creator of VisiCalc, which has just released the sophisticated TK!Solver, lost three high-echelon employees to Lotus Development Corp., whose equally sophisticated 1-2-3 is the best-selling business program for microcomputers. And the three weren't aggressively wooed; they sought. employment at Lotus on their own. The transfer is attributable, at least to some extent, to Lotus's generous and individually negotiable incentive stock option program (ISO). The company has formally reserved an exceptionally large fraction of its shares -- more than 20% -- for employees.
Not only are such small, swiftly growing companies generally eschewing the old keep-as-much-for-myself philosophy of entrepreneurship, but another direction is being struck toward companies' trying to outstrip each other with the extent of their generosity. In Santa Clara, Calif., floppy. disk manufacturer Dysan Corp. emblazons its golden handcuffs with the jewels of Dysan's investments in start-up companies, some of whose speculative shares are granted to a few high-placed executives.
Far more democratic, however, is Applied Technology Ventures of Santa Ana, Calif., which was founded in 1979 by three expatriates from Texas lnstruments (see INC., April, page 47). It was established as a partnership apportioned 40%, 40%, and 20% among the trio; no one else had even a tiny fraction. But early this summer, ATV filed for a public offering (as ATV Systems Inc.), and nearly onetenth of the new corporation has been given away, not through stock options with vesting requirements, but as a grant right out of the founders' pockets. The windfall isn't going merely to the typical handful of key executives and select engineers that most companies court, but more broadly to 90 workers of some 1,000 in all areas of the company. The gift is no small potatoes. Since the basis for the shares is zero (to meet state regulations, the company may have to value them nominally at something like a penny each), and the preliminary prospectus estimates that the stock will come out at $15 to $20 a share, the recipient of an average amount -- 10,573 shares -- stands to take in an immediate $158,595 to $211,460. Because the range goes as high as 100,000 shares to an individual, some particularly fortunate employees could one day take home as much as $2 million.
These plump sums might well have gone straight into the personal bank accounts of the founders, but they were willing to make the sacrifice for the greater good. Says co-founder and executive vice-president Douglas O'Connor: "It may come out of the partners, but that's the way we believe in motivating significunt people throughout the organization to do the extraordinary thing. It's liquid, and it's something of great value." (The shares are restricted, however, and are not instantly salable. Under the Securities and Exchange Commission's Rule 144, the granted stock cannot be sold for two years from the date of acquisition.)
ATV's open-wallet style of bestowing wealth is not yet the norm. Even in start-ups, the incentive stock option (see sidebar, page 69), rather than the outright stock grant, is the fundamental enticement. Start-up stock is cheap, so an employee may wind up equally well off, but he or she usually has to wait several years to become fully vested and then another year-and-a-day to reap the capital gains tax benefits of the ISO. To a corporation, the main attraction of granting options lies in the incentive-giving vestment period, which keeps the handcuffs locked, typically, for four or five years.
Another advantage to the sharing of equity at small companies is that it helps keep salaries in line. Says Lotus's Mitchell Kapor: "There's a separate kind of psychology of motivation which distinguishes between salary and equity. The folk wisdom of our industry has it that a stellar programmer will be 5 to 10 times as productive as an ordinary but competent programmer. Given that an ordinary but competent programmer makes $40,000, does one then pay the superstar $200,000? No. The difference would be in equity."
The phase during which the employee joins the company is also a factor in how much equity is granted. If he or she signs up when there isn't even a product, the new employee gets significantly more stock than the person who comes in six months or a year later and risks far less. At Lotus, the conveyance may be through a stock purchase -- repurchase plan or an ISO. No employee is granted unrestricted stock. "The employees understand," Kapor explains, "that to realize the full benefit of the equity, they are making a long-term commitment to the company."
At public Analogic Corp. down the road in Wakefield, Mass., the casual "I'll pay you $50,000 and throw in a few options" approach is on its way out as an employment lure. Instead, the high-tech company says it is now "cranking in" ISOs as a means of formally distinguishing salary from reward. But with typical New England languor, Analogic's vesting period is planned to stretch to seven years before the reward becomes completely collectible. And at that, Analogic faces a typical problem of a public company: How much can its stock go up, even in that amount of time? Because of the diminished drawing power of public stock as an ISO incentive, Seagate's Shugart counsels that "you may save yourself some problems if you do some overstaffing while you're private."
One simple way to lock up loyalty through equity participation is to start with it from the opening bell. When Microcomputer Systems Corp. in Sunnyvale was founded by James Toreson (see INC., July 1982, page 47), its engineers were made major stockholders -- a step calculated to keep them at design tables for years to come. Otherwise, Torreson felt, "if you take them from rags to riches in two years and they leave after the company goes public, the whole company crumbles. The ultimate effect is to screw some little old grandma in Wisconsin who's just bought some hot technology stock." He is genuinely pleased to have his key employees become millionaires as the enterprise flourishes, but, he cautions, "do it when the company has its flywheel going well enough so that it doesn't need those people as much as it did initially."
A corporation can grant qualified options in perpetuity, if it wishes, but because ISOs are expensive to the company -- it forfeits the opportunity to take compensation deductions for tax purposes in exchange for making the recipient's tax situation attractive -- many taper off their programs after the initial vesting period. A further complication to a public company is that each new program, because it dilutes holdings by using shares that are authorized but not outstanding, must be voted on by stockholders within 12 months of its institution.
Even if there is ongoing option-granting once an employee is 100% vested, there is a good chance that he or she will leave anyway for greener start-up pastures or to give birth to a company of his own.
"Well," Don Valentine comments, "Lincoln freed the slaves -- if someone's going to leave, there's no way you can prevent them. For the first four years, you have a vesting program. After that, they won't want to leave because they own consequential amounts of the company and are participating in its internal culture. What you try to do is provide not only an equity position, but also an environment." One adverse effect of handcuffs that have rusted shut is that advancement by natural selection can become clogged and prevent movement of other valuable employees from below. "When someone leaves," says Valentine, "that gives another person a chance. It's a little disconcerting and inconvenient, but you can't have all the good people in the world."
Adam Osborne, founder and chairman of Osborne Computer Corp. in Hayward, Calif., feels that an employee who stays too long can actually be detrimental to a company. "Companies change," Osborne reflects. "The type of personnel that is needed in a company during the start-up phase is not the same that will then drive it if it's successful. When it moves out of the entrepreneurial phase, suddenly all the things that the employees were so good at, they're no longer good at. And they start to get very disgruntled."
Osborne grants stock options to its employees across the board. One positive result is that "people become very concerned about what's going on around them," reports Osborne, who lacks a controlling interest in OCC (a condition resulting from a divorce settlement). "If we have a morale problem, he notes, "it's a strange one. Our people get upset because their yields are low in manufacturing, which is a good kind of morale problem to have. In many industries, they'd say, 'The yields may be low, but that's no skin off my nose; I'll still get my hourly wage.' "
If employees depart to found new companies, Osborne isn't overly concerned, even if they are in the same industry. Successful entrepreneurs are rarely ones who have made their money as part of a team, he believes. "For example," says Osborne, "when Xerox bought Scientific Data Systems, there were some 34 instant millionaires, of which 3 are still millionaires today." Most of the others lost their wad in trying to run their own businesses. "Egos are their worst enemies. They get absolutely unrealistic notions as to the part their contribution played in the overall success of the venture."
That is just the pivotal moment, however, that Richard Riordan, a private venture capitalist whose Los Angeles law firm, Riordan, Caps, Carbone & McKinzie, specializes in investment law, is not nearly so sanguine about. Well-heeled workers leaving companies to start their own is a "worrisome problem," Riordan frets. "First you want the guys who can work day and night to get a product off the ground. But then professional management has to provide incentive and keep them coming up with new ideas so the company remains floating." Because of changing casts of important characters, says Riordan, "looking down the road five years from now at any computer company in existence today is a little scary."
Such a relatively small start-up as 3Com soon discovers that it is next to impossible to find reliable people without liberally dispersing ISOs to everyone, down to the last secretary. And that is exactly what 3Com does, because the problem extends not only to attracting them, but to keeping them and getting them to put in the long, devoted hours that start-ups often demand. "The way to do that," says Metcalfe, "is to make it absolutely clear that there are rewards for coming, for staying, and for working hard. Without equity, there's suspicion. With it, there's more inherent, intuitive trust: This person has stock in the company, therefore his actions must be in the best interests of the company."
The lure of equity participation may not be so compelling in a corporation that has become established as a market force, since often its stock is selling at 60, 80, or even 100 times earnings and thus appears fully priced. Because ISO regulations prohibit issuing options for less than the curent value of the common stock, a prospective top employee will see little room for equity enhancement in the near future, even if the options are substantially proffered. Nor will the issuance of convertible debentures be appealing, inasmuch as the recipient will have to treat them as ordinary income.
One clever solution to this dilemma that is gaining some use is the creation of a different class of stock. Independently appraised at perhaps one-fifth the price of the common, the so-called junior stock is then granted through a qualified ISO. Provision is made for the junior common to match the senior common sometime down the road if the company continues to prosper, at which point (if all goes smoothly at the Internal Revenue Service -- probably a big if; the IRS has yet to comment) it will receive equally favorable ISO tax treatment. An alternative solution might be for a company to spin off corporations rather than establish separate divi. sions, giving key employees shares of the new stock. Another ingenious proposal heard around Silicon Valley is for a company to finance a key employee who is about to leave anyway, on the theory that the company can cash in on a piece of his action.
Indeed, nowadays, simple equity, because it is so widely obtainable for even modest properties in the labor pool, often isn't enough. At least it doesn't seem so to forward-looking management. 3Com and Tandem Computers Inc. are two companies that offer sabbaticals to employees, in addition to regular vacation time (in this instance, a sabbatical occurs every fourth year and consists of a six-week hiatus). At Tandon Corp. in Chatsworth, Calif., not only do top executives receive liberal stock options, but they rest easy under founder Sirjang Lal Tandon's no-fire policy. Tandon feels that if someone is hired who doesn't work out, the mistake is Tandon's own and, like a spouse wronged in an unhappy marriage, the employee ought dutifully to be paid off.
All told, it is probably Seagate that is setting the style in the design of golden handcuffs. Seagate's shackles reach well beyond standard perks. For starters, everyone is allotted $100 annually to spend on non-work-related "personal development." One employee took sky-diving lessons, another used it for instruction in child care. Seagate sponsors any group that constitutes an athletic team, even if it is not part of a league.
Further, everyone is on salary; even in manufacturing, sick days are paid days (however, Shugart's dictum is that if you get sick too often, you get fired). Seagate also pays more-than-competitive salaries. And employees promoted from within receive some 20% higher wages at Seagate than in a similar situation at another company.
All Seagate employees share in profits on a quarterly basis. In some quarters, profit-sharing has run as high as 9%; once, however, it was zero. (Seagate's profit-sharing criterion is a 20% return on equity.) In case the potential for an extra 36% of salary per year isn't enough, Seagate has a "stick-around" bonus. When profit sharing is distributed, a 50% "kicker" is entered in the books. If the employee is still at Seagate 12 months later, he gets the kicker. It has worked out pretty well, says Shugart, particularly when the company has failed to pay in a given quarter. "At least I could pass out the stick-around bonus checks [from the prior year's profit-sharing], and it made it a little easier. It's a way of saying thank you for staying."
From the beginning, Seagate implemented the best available medical, dental, and educational plans. Every employee is entitled to get his or her eyes examined once a year, plus a new pair of glasses each year. Seagate also has orthodontics coverage of $1,000 for employees' children. And an employee seeking psychiatric relief from the emotional strain of a California lifestyle will get half of his bill paid by the company, up to 52 visits per year.
In production, a worker who has perfect attendance for six weeks, including no tardiness, is granted an extra day's pay. In addition, the name of each person who gets the bonus is put into a hat. Every month, $2,000 is shared by 12 winners. Seagate reports perfect attendance from 60% of its production work force. Once Shugart was asked by a technician why there weren't perfect-attendance awards in engineering, too. "I don't know," conceded Shugart, "do you want to work in production?" "No," said the technician." "Then don't bug me about it," was Shugart's reply.
Some Seagate touches are paternalistic but effective nonetheless. The company is big at giving away T-shirts, caps, sweat-shirts, and other such paraphernalia on special occasions, such as when a production push has been accomplished. All the clothing says SEAGATE, and Saturday at the local shopping mall is like seeing a full-page ad in the newspaper. The company has instituted a "Take a Taxi on Us" program that helps keep drunk drivers off the roads. Not only can any tipsy Seagate employee call a cab for a recompensed ride home, but so can any Seagate employee who meets someone else in that condition. Names are kept in confidence.
Almost as much as anything else, though, Shugart is convinced that, in the end, what keeps an employee content is a job that is fun and exciting. One reason why start-ups are draining the pool of key employees from larger companies is that the smaller companies are not steeped in bureaucracy and haven't yet fallen into inertia. Keep the groups small, he feels, and give key employees key jobs with key authority. "Why do we have to standardize everything?" Shugart asks rhetorically. "People have to be given the opportunity to fail." On the East Coast, John Cullinane agrees. Founder, CEO, and chairman of the board of Cullinet Software Inc., a public company in Westwood, Mass., of which all 800 employees are eligible to participate in the stock option plan, Cullinane goes so far as to consider money "third or fourth in the scheme of things." Higher up the psychic remuneration scale, in software anyway, is pride of authorship, followed by "a lack of bureaucracy that gives employees a chance to impact the success of their project and the company."
There already are signs that what is happening at the fiery core of the technology industry is spreading to the workaday world as well. Entrepreneurs who only a couple of years back could care less, are discovering that a key employee is a key employee even in retailing or aluminum extrusions. Companies that have been resting on modest profit-sharing plans or other qualified retirement programs now are offering ISOs as well. What an ISO costs a company in tax deductions can be repaid in low turnover and minimizing job training.
The employees of People Express Airlines Inc., for instance, all have been provided equity. That fact, says Bill Hambrecht, was one of the main allures when Hambrecht & Quist financed the company -- an anomoly for the usually high-tech-minded firm -- and then brought it public. "You could get on their planes and feel the difference: Everybody in the cabin was an owner."
Another example is four-year-old, private Geo-Con Inc., a contractor in Pittsburgh, which has extended unusual open-ended stock options to its 25 full-time employees. After a one-year vesting period that allows the parties to check each other out, the employee can buy stock at last year's price. The employee also is granted a cash bonus carved from one-third of the company's pretax profits, which can be used to acquire stock. Because his company is so small, founder and president Chris Ryan is extremely careful at both ends of the deal. Even if an employee is fired, Geo-Con can't renege on the repurchase price of the stock it has offered, and if a major stockholder dies, the company has insurance to cover the repurchase of his stock. But if the stockholder should leave or retire, there is a limit on how much stock can be cashed in per year.
There are no formal restrictions on how much stock an employee can buy. So far, Geo-Con employees are timidly taking out only small chunks, even though the company's sales have grown by 3,800%. But enough has been siphoned off so that Ryan's earlier 90% ownership has been reduced to just over 50%. And he is content at that level.
"Ownership is the best incentive," Ryan reasons. "Our guys in the field are making little business decisions every day. These decisions affect production. Ownership is a motivating thing -- it motivates them to make the best decision."
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