Your startup is growing and it’s growing fast. You just received an investment and you need to hire… fast. People are becoming more and more drawn to working at early startups for the exhilarating opportunities and dog years in learning experience. However, early-stage startups equal being strapped for cash, meaning early employee salaries are often lower paired with higher equity stakes.
Granting equity to these hires is an art, not a science. As a founder, the equity package you offer your employees reflects your beliefs about the growing company and can have serious financial impacts down the road.
That’s why we’ve created this guide to help you navigate the journey of granting employee equity.
Disclaimer: When designing an equity strategy, you should consult an attorney to structure your plan in order to ensure you reach the cultural and financial outcomes desired.
Granting Equity To Startup Employees
First, let’s define who your employees are. Who exactly qualifies as your early employees versus later employees? What is the difference between founder’s, first-hires and so on?
These are the people that created the vision for the company and were part of bringing it to life. When they joined, there were no other employees, customers, product, company name etc. These brave souls are analogous to explorers venturing out into the unknown in search of discovery… Think Lewis & Clark heading west to claim the territory for the US and map the landscape. It is wild, and dangerous but also exciting and you could be famous (as long as you don’t die).
The Founder’s Share: Founders typically are granted 100% of the original equity – split amongst them if there is more than one. As they add investors and employees, the company issues new shares, increasing the total amount outstanding and the Founders percentage is diluted down.
2) First Hires
These are the people usually sit side-by-side with the Founder, joining when the company might have built some items of value, but still early enough that joining was an extremely high risk. Early employees are analogous to pioneers. The trail has been identified but they are the very first people to move into the new land and try to live. They get to select any place they want – the landscape it totally open, there’s no floor plan, but there of many dangers and risk as well.
One of the Founder’s primary job in the first 12 months of the venture is to attract the best possible people with key skills and experience needed to succeed. However, there is no rational reason that talented, valuable people should want to join something so risky. The essential deal can be framed as, “Please join us as we change the world. We can pay you a salary 50% of what you are making now and then you will be expected to work 200% of the traditional hours. It will be super fun and you will love the passion of the team, but we have a low probability of ultimate success. Ready?”
So how do you attract the right talent and make it worth their while? Equity and emotions.
A First-Hire’s Share: A talented first-hire recognizes that there is a chance for high-risk but also high-reward when joining a startup. It’s crucial to identify the level of commitment and value this person brings to the table, and issue a share that is reflective of that.
But one of the key words here is commitment. Startups are notorious for high turnover. To avoid dishing out shares left and right to people that aren’t ultimately committed, it can be wise to set a standard time in which no shares will be issued so that shares are only granted to those that stick around, continue to add value and truly believe in the mission of the company.
3) Later Employees
These are the employees that join later in the company’s lifecycle and have the potential to receive salaries comparable to what they could make at other, more established companies. These employees are analogous to settlers. They are in the first significant wave of people moving into the area. There is still great opportunity remaining, but there is also some infrastructure in place. Others have set up stores, roads and learned how to grow crops. It is still exciting, but the risk is much less daunting due to the work of the explorers and pioneers who came before them.
A Later Employee’s Shares: While these employees are making higher starting salaries than the first-hires did when they first joined, they still need to be recruited and sold on the vision of the company. The work hours will be long and the risk of company failure is still a factor as well. Thus, during the recruiting process, offering equity is a great lever to pull in order to push someone across the finish line. While this number will most likely be significantly less than what the first-hires were granted, it is still a great value-add that people today consider a reason to join a growing startup.
Early Employee Equity is an Art
An early stage company is 100% reliant on their first employees to work side-by-side with the Founders to crush a ton of incredible work in order to win in the marketplace. The Founder’s job is to land 2, 4 or 6 phenomenal people who are not only on board with their vision but will also propel it to reality, creating value for everyone. The equity not only has to be worth it for early employees but the work and vision has to also be meaningful to attract the RIGHT people that will join as early employees.
“For your first key hires, three, five, maybe as much as ten, you will probably not be able to use any kind of formula. Getting someone to join your dream before it is too much of anything is an art not a science.” – Fred Wilson
The key aspects to attracting the right founding team is balance and transparency. Your earliest employees should be members of the core team and each person should bring something that is key to driving the success of your company. This is where the artistic work comes into play. Some people will have highly valuable (and more expensive) skills, others may have more specialized skills and some might be have more common ones. Regardless of where someone falls on the spectrum of skills, that founding team and their balance of skills, talents and connections are the crucial elements to your company’s success.
Transparency comes into play when you set clear expectations on the amount of equity someone will receive and the timeline in which they can expect to receive it. If you are offering equity for your company, you are giving away a piece of your child. You want to be sure someone is as dedicated to your child as you are. That is why, as mentioned before, it can be smart to set a benchmark in which someone will be eligible for equity – whether that is after 6 months, a year, etc, determine what you think is the right amount of time and commitment, and grant that equity to those that have proven their commitment to your company.
Later Employee Equity is a Science (kinda)
Once you have assembled a core team that is operating the business, you need to move from art to science in terms of granting employee equity. And most importantly you need to move away from points of equity to the dollar value of equity. Giving out equity in terms of points is very expensive and you need to move away from it as soon as it is reasonable to do so.
Fred Wilson, respected VC at Union Square Ventures, has a 5-step plan for how to grant equity to later employees:
Figure out the “best value” for your company based on a financing round, a buyout offer, or a discounted cash flow model.
Break your org chart into brackets. For example, the 1st bracket is the senior management team, the 2nd bracket is director level and key engineers.
Assign a multiplier to each bracket (a good example would be 0.5x for the 1st bracket, 0.25x for the 2nd bracket).
Multiply the employee’s base salary by the multiplier to get to a dollar value of equity (for example, a $100K salary for someone in the 1st bracket would equal a dollar value of equity of $50K)
Then divide the dollar value of equity by the “best value” of your business and multiply the result by the number of fully diluted shares outstanding to get the grant amount. This should result in an equity grant in dollar values, not in percentage of the company (important!)