Recently, I was asked by a client about ways to reduce their equity burn rate. The company is VC-backed and coming off a recent successful Series E raise. Business is thriving and an IPO is anticipated in a couple of years. So my spidey sense started tingling… What do you mean by reducing the burn rate? What’s the underlying issue and how do you know what problem you have?
This led me to thinking: What are some of the key metrics companies like this ought to consider when measuring the effectiveness of their employee equity programs? Equity compensation is a key, some would argue the key, to attracting and retaining top talent at venture-backed companies. How do you know if it’s working as intended?
Here are the top equity compensation metrics that help measure your program’s effectiveness—and perhaps more importantly, indicate whether you have a problem to address.
1. Equity Dilution
The most common—and often considered the most important—metric is equity dilution. Equity dilution can be measured in a number of different ways, but it essentially refers to how much future ownership of the company investors provide to employees.
To calculate equity dilution, you first need to measure your fully diluted shares. Fully diluted shares equals total common stock (including preferred) plus the amount approved to be issued as options or restricted stock units (RSUs) to both current and future employees.
From there, the most common ways of calculating equity dilution are the following:
- Current Overhang = (Outstanding Options + Unvested RSUs) / Fully Diluted Shares
- This measures the portion of fully diluted shares allocated to current employees
- Total Potential Dilution = (Current Overhang + Remaining Pool) / Fully Diluted Shares
- This measures the portion of fully diluted shares allocated to both current employees and future employees
While most companies target 12% for earlier-stage companies and up to 20% dilution for later-stage companies (excluding founders), numbers do vary. Equity dilution is, in most cases, the first question to be answered when it comes to how your employee equity program is being managed.
High equity dilution may indicate overspending and justify the need to slow spend. However, a low rate of dilution might indicate a highly valued company and does not automatically imply a need to increase spend.
2. Equity Burn Rate
Equity burn rate measures the percentage of fully diluted shares granted annually through all equity awards to employees, typically including stock options and/or RSUs through new hire grants, refresh grants, and promotions. This metric should be assessed alongside the forfeiture rate, or the rate at which shares from departing employees are forfeited and returned to the pool reserved for future awards.
- Equity Burn Rate = (Shares Granted Annually / Fully Diluted Shares)
- Net Equity Burn = Equity Burn Rate - Forfeiture Rate
- High forfeiture rates may offset burn but could also signal retention challenges.
A controlled burn rate ensures sustainable equity allocation while minimizing excessive dilution. If net equity burn remains high, the company may need to reconsider its hiring strategy, compensation approach, or retention programs. Many companies budget for burn rate but fail to analyze performance against that budget, particularly the proportion going to new hires versus refresh versus other types of awards.
For VC-backed companies, most published benchmarks are focused on the percentage of fully diluted shares being spent. However, this can be misleading where companies have valuation extremes, particularly at later-stage companies. In these cases, an additional metric to consider is their Shareholder Value Transfer (SVT) to ensure that equity awards remain reasonable relative to valuation.
- Shareholder Value Transfer (SVT) = (FMV of Total Potential Dilution) / Post-Money Valuation
This is a similar metric to one used by public companies, so for later-stage companies, comparing this to public company benchmarks can be illuminating. A seemingly reasonable equity burn rate percentage could still result in outsized awards if valuations are high.
Tracking SVT provides a clearer picture of equity efficiency. If SVT appears excessive or above the burn rate, it may raise concerns. In addition, monitoring incremental dilution from each funding round can help prevent excessive dilution of early investors.
3. Equity Holding Power
Equity holding power measures the retentive effect of unvested equity levels. Typically, this metric should be assessed both at present and projected a year into the future to determine whether employees have a strong reason to stay.
The measurement of this metric is fairly simple:
- Holding power = Number of unvested options and RSUs / Total number of options and RSUs granted
Generally, this metric is focused on high-performing employees, critical roles, and executives. For those groups, many companies look to ensure that holding power is at least 75% of a typical new hire grant to maintain strong retention.
This metric can also be used to identify potential flight risks and help focus on broader strategies, not just equity-based. Lastly, looking at holding power by the segment of the population can help focus your refresh strategy on where to spend your equity without unnecessarily increasing your burn rate.
4. Equity Efficiency
Equity efficiency measures the increase in revenue or valuation relative to the amount of equity issued to achieve that growth. This ratio can be an important metric for venture capital firms and company leadership as it highlights the return on equity dilution.
- Equity Efficiency Ratio = (Increase in Revenue or Valuation) / (Equity Issued)
A higher ratio indicates a stronger return on equity granted, meaning the company is growing significantly without excessive dilution. If the ratio is low, it may suggest that too much equity is being granted relative to the value being created, which can raise concerns among investors.
Late-stage companies should monitor how much employee equity they issue per funding round and compare it to the resulting increase in valuation. Tracking equity efficiency ensures that each issued share is contributing meaningfully to company growth, making the company more attractive to both investors and employees.
5. Equity Engagement: Measuring Employee Sentiment Toward Equity
Employee engagement with equity grants provides insights into how well the equity program is resonating. Several behavioral indicators can help measure this engagement.
- New Hire Equity Choices: While offering a formal equity-for-choice program can be problematic and is not common, you can often gather from the new hire negotiation process whether candidates are willing to value more equity compensation over cash.
- Early Exercise Participation: If early exercise is allowed, do employees take advantage of it?
- Critical Talent Participation: Are key employees actively engaging with equity opportunities?
- Post-Employment Equity Behavior: Do departing employees exercise their options, or do they let them lapse?
High engagement rates indicate strong confidence in the company’s future, while low engagement suggests the need for better communication or restructuring of grants. If employees don’t see value in their equity, the program may need adjustments.
Leveraging Equity Compensation Metrics
Equity is one of the most expensive forms of compensation. Companies that manage equity efficiently can sustain higher valuations with less dilution, preserving more ownership for early investors and employees.
These metrics are more than just numbers; they are valuable tools that can help shape a company’s future. Most importantly, the best results come from managing your equity compensation programs actively all year round, not just checking in once or twice. This ongoing effort will help keep the team motivated, make the most of your resources, and drive your company towards greater success.
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