Offering employee equity can give you the chance to be ahead of others in terms of battling for top talents. Likewise, it is a wonderful way of rewarding excellent performers and encouraging an owner’s mindset by providing your team something they can expect along the way as the business progresses.
Since you are just starting your business, here are suggestions for equity structuring:
• Plan your team
Offering equity to employees will allow you to recruit the best talent out there. Now, what are the crucial positions and who do you need to fill these positions.
• Create your equity pool
Plan your equity ahead of hiring new recruits. Reserve equity key positions and remember that hiring senior-employees may mean granting higher equity.
• Research competitive salaries and benefits
Look into averages of equity and salaries for different roles – particularly in your industry.
• Set cliff and vest schedule
The standard is 4 years for vesting and 1 year for cliff. This is typically enough to make people stick around for awhile while you determine if they are a good fit for the share that they will get out of your business.
• Stock option VS restricted option
The usual path to go is to grant employees stock options. This is for startups at their early stage of operations. For those who want to issue stock down the road, there are tax implications that need to be explained to employees.
• Granting equity can help in employee retention, promotion and recognition
When will you grant equity? Is it after the employee has proven his/her worth? Or is there a fixed period – for example, two years of service? Will there be more equity for an employee who got promoted?
• Expiration timeline
Employees want to have large savings they can get out of their employment. It may be unfair to force them to exercise their option at a time when they are not facing any financial trouble. Consider setting a longer timeline.
How much should an early employee get?
Two percent is normally the equity given to early employees. Keep in mind that in total, the equity pool for employees is 10%. If your startup is already enjoying substantial funding and you’re dealing with an employee who entered your company not as a first employee, 2% is quite a good offer.
What if the employee is a first employee? Check your fund. Is it small? Does he have special skills, and would he make huge contributions to your operations? If that person is more of a co-founder, you may need to consider giving him a bigger piece of the pie.
What about exits?
Remember, equities for employees are not that easy to determine, especially in cases of exits, because a business’s financial health is usually unstable. Thus, there are no exact answers. But we’ll give you examples.
For companies that do well, you can promise your employees about $40,000, which is enough for them to buy a new car. If you’re doing great, you can settle for about 400,000 (employee can buy a new house), and if you’re a decade-old company with really stable business, you can shell out something that can allow your employees to proceed with a new start in their life. For this, we’re looking at $4 million.
For most startups, however, this is not the case. Equities usually don’t count at all. We can cite many small businesses that stopped operations or didn’t sell for an amount that’s larger than the investment. It is therefore advisable to always keep your company’s financial health in shape.
For business liquidation:
Assuming there’s some funding and that the number of employees is 10 or less, you can very well work within the 0.1 to 1% range. To achieve the “car” equity mentioned above, your business will have to sell for at least $10 million, and for the “house” equity, the business should sell for at least $100 million. For the grandest achievement of providing employees “a new life”, we’re talking of a business valuation in the vicinity of $1B.
To be realistic, there were not many that sold for $100 M or more, so generally, employee expectations must be limited on the “new car” option only (that is about $60,000 equity).
Educating your team on equity parameters is a must. Remind them that salary and benefits are the most important financial compensation and that equity should be viewed only as icing on the cake. Yes, we have heard some success stories on equity, showing that it is not impossible for startups to hit it big. But still, equity shouldn’t be considered as the key driver for working hard and making significant contributions.