Tech Startups Urge Staff to Take Pay Cut Now and Get Stock Later

April 17, 2020, 11:00 AM

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Business is booming for Medal.tv as house-bound users flock to the gaming startup, making it one of the rare coronavirus success stories. Half its employees are still taking salary cuts in the wake of the outbreak.

In return, the 33-person company is offering those employees restricted stock units which will vest over one year. The company intends for employees to be able to sell those shares when Medal eventually closes its next round of financing. Timing on that: to be determined.

“If everything goes well, not only does the company save money and slow down its cash burn, but the employees that exchange their salary for stock will have a bigger payout during our Series B round,” said co-founder Pim de Witte.

Medal is among a growing number of startups offering stock-for-salary trades to preserve cash as the tech industry reels and economic uncertainty mounts. Medal, which lets players clip and share snippets of games on social media, has doubled its user growth rate since shelter in place orders started. The company said while high earners were “strongly encouraged” to take the deal, the pay cut and stock option swap was voluntary. It’s a move that only works for “employees who believe in the financial outlook of your company,” De Witte said.

Venture capitalists have warned startups that Silicon Valley’s funding spigot could soon tighten, prompting many startups to try to build up a cash pile to withstand for at least the next year to 18 months. In the first quarter of 2020, the number of VC deals shrank by 27%, even though total money invested stayed mostly flat. Already, more than 24,000 employees have been let go at hundreds of tech companies, according to tracker Layoffs.fyi.

For some startups facing economic uncertainty, salary reductions are a more humane and sustainable alternative to cutting staff, and the short-term blow can be lessened with promises of equity. But the trade-off could have drawbacks for employees, particularly if more startups go out of business or fail to conjure a sale or initial public offering in coming years. Another risk is that companies never get around to readjusting compensation once the economy recovers.

Seth Bannon, who runs the venture capital fund 50 Years, said he’s seen startup pay cuts range from 10% to 40% in recent weeks. “When capital becomes scarce, even if business is doing well and a startup is hitting its growth targets, they have to make painful changes,” Bannon said. “Who knows when you’ll be able to raise capital or what the market is going to look like in the coming months?” For startups aiming to cut costs, boosting equity for employees is “a way for companies to say, we’re cutting salaries but you didn’t do anything to deserve this, so we’re giving you an equity bonus that makes up for it,” he added.

Another venture firm, DCVC, said its startups are pursuing a variety of responses, but that some portfolio companies are taking a 20% to 30% pay cut, and in many cases are then offering employees ways to earn more cash in the future—including bonus multipliers or stock in the form of options. Options lock in an employee’s ability to buy stock at a set price. The employee still has to pay the money to get the shares, which can present a financial and tax burden on those earning less during the crisis.

Oh My Green, a startup that delivers healthy office snacks, coffee and catering to Apple Inc., Lyft Inc. and other office kitchens around the U.S., cut two-thirds of its 600 employees last month after most of its clients shut their offices and moved their workforces home. For the remaining staffers, Oh My Green offered the choice to take a quarterly salary reduction in exchange for an equity boost that vests immediately.

About 50 people took the company up on its offer, giving up between 10% and 60% of their salaries. The swap was mandatory for members of the senior leadership team.

“We had to make hard choices,” said founder Michael Heinrich, who saw revenue at the company quickly sink. “It’s better to cut deep at the beginning of a crisis to conserve cash because it’s easier to rehire people than do multiple rounds of morale-destroying layoffs.”

Oh My Green does have some recourse. In January, it raised additional funding from investors. Heinrich expects that the money will help tide the company over for at least 18 to 24 months, he said, declining to disclose the amount raised. The startup, which is backed by Bannon’s 50 Years, has also retooled its operations to send snack boxes home to customers, and had recently acquired a smart refrigeration company whose customers include large hospital chains still in business.

Sensorydata Corp., a smart fabric tech startup that makes bed sheets and wheelchair covers to prevent bed sores and other pressure injuries, said it had to halt product trials at hospitals inundated with coronavirus patients. So the company shifted its attention to procuring surgical masks and other personal protective equipment during the virus outbreak. In the meantime, it’s asked employees to take a 50% pay cut but is providing them with additional stock options and sales commissions from the PPE products they sell.

“We have to keep the ship afloat, and I don’t know how long it will be until we raise the next round of funding,” said founder Reuben Katz. “This way, we’re all in it together.”

While some VCs laud the boost in equity as a way to provide an eventual payout to employees when the economy turns around, others caution against being too quick to dole out shares.

“That would be the last advice I give to companies trying to survive this pandemic,” said Edith Yeung, a managing partner at early-stage fund Proof of Capital and adviser to 500 Startups. Yeung advises young companies to first try to curb the cash burn by reducing rent or software costs, or delaying payments and other expenses. “Equity is best used to motivate employees to stay with you, but in a downturn most people already want to stay employed and keep their benefits,” she said.

To contact the author of this story:
Shelly Banjo in Hong Kong at sbanjo@bloomberg.net

To contact the editor responsible for this story:
Anne VanderMey at avandermey@bloomberg.net

Mark Milian

© 2020 Bloomberg L.P. All rights reserved. Used with permission.

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