I was having lunch with some folks yesterday and struck up a conversation with someone who’d been in the Bay Area for most of his career, but had recently moved back to Colorado.  We talked about hiring.  He mentioned that hiring in the Bay Area wasn’t hard, the real devil was retention.  As soon as one year had passed and 25% of an employee’s shares had vested, they were poached or off to the next startup.

Why?

Because from an employee’s point of view, 25% of the offered stock options for four companies is worth more to an individual than 100% of the offered stock options in one company.  It’s diversification 101. Most startups fail, and if you can quadruple your chances of owning options worth something, why wouldn’t you take it?  Even if you are leaving money on the table by losing the 75% of unvested shares.  (Of course, the cost of exercising the shares within the time limit matters too.)

This churn is horrible for the company.  The company spends two to three months bringing an employee up to speed and only get the remainder of the year of work from the employee.  When that employee departs, they take their experience and hard won domain knowledge.  A company can ameliorate this issue by making the job better (more responsibility, more opportunity, cool tech), adding to the diversity of the employee’s pay structure (paying more cash, which may reduce the need for option diversification) or increasing stock option compensation (more options).  The latter two increase labor costs, and the former is already emphasized in the initial recruitment pitch.

This is an interesting example of unintended consequences.  Two entirely reasonable premises: “we want our employees to be invested in the success of this fragile company–give them options instead of salary, but we want them to stick around before they get the entire payoff–make it vest over a period of years” lead to employees rationally making choices that hurt the company: “I’ll stick around for the year, but then I’m outta here”.

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