No pilot flies alone and every plane needs a crew. Likewise, every founder needs a team to take their idea off the ground.
Yet, early stage startups often do not have the budget to hire a dream team. This is why startups often offer equity instead of salary to their first hires.
In fact, close to 20% of the jobs ever posted at The Hub offer equity as a form of compensation.
Moreover, giving out equity also works as an incentive. Having equity, in short, means employees are directly invested in the company’s future. That may be why employees that own equity work on average 8 hours more per week than those that do not own equity.
Yet, giving out equity requires careful consideration. You need to figure out how much equity you want to give out of your company and when.
In this blog post, we’ll first walk you through the different options that exist for giving out equity. Second, we’ll talk a little bit about the concept of vesting before helping you do the basic math on how much equity to give out.
Equity Options: Stock Grants, Stock Options & Stock Warrants
There are three main equity options: stocks or shares, stock options and warrants. Each of them has their own benefits and disadvantages, depending on the country you work in. So before you make up your mind on an equity structure, please do consult your lawyer. You can also consult legal companies like Bech-Bruun or Fondia through our tool section.
1. Stock Grants
Let’s start from the real basics: One share/stock represent a slice of the company. Different stockholders own different amounts of stocks, representing their ownership share of the company.
When we talk about stocks as a form of equity given to employees, we often talk about a Stock Grant. A stock grant is simply an amount of stocks an employer grants to the employee as a form of compensation.
Stock Grants are especially good offering, especially for a startup employee for three reasons: For one, early-stage startups often only share out a small amount of stocks. Thus a single stockholder owns a larger share of the company. Second, as a stockholder the employee will have formal rights in the company. And third, the employee can receive the stocks immediately, at a market price.
However, for the startup there are possible risks involved. Mainly since with Stock Grants you are directly giving out a share of not only your company but also decision power. Therefore, you do want to be sure of who you bring onboard into your team.
2. Stock Options
Stock options are, as the name implies, an option to buy or sell company shares at a discounted or stated fixed price. If you give your employee a Stock Option, you are basically giving them the promise of purchasing company stocks from you with a certain price. This price is normally better than one could ever find in the market.
To give out equity in the form of stock options, you need to start with a stock option plan. This plan specified the price of the stocks often referred to as the grant price, as well as the time period during which the employees are able to exercise their options. This time period is defined by a vesting date (more on this the next chapter) and an expiration date. An employee cannot exercise their options before the vesting date or after the expiration date.
The main benefit of Stock Options, is that you are only giving out a possibility to purchase stocks – not the actual stocks. Furthermore, employees can only exercise their options in a given time period, normally a few years after their employment. Therefore, stock options also serve as an incentive for the employee to truly commit to the startup for a set time period.
3. Stock Warrants
Warrants are like stock options, with one major difference: With Stock Warrants you will give your employees the right to purchase stocks from your company. Whereas with Stock Options, you will give your employee the possibility to purchase stocks from you personally.
This may seem like a trivial difference. But in practice the difference is vast, especially to the finances of the company. The employee has to pay for the right to purchase the stocks issues through warrants. Hence, if you use Stock Warrants right you may not only build a committed team but capital for your startup.
What Is Vesting?
As mentioned among Stock Options and Warrants, a vesting date is the first date an employee can obtain their stocks. The vesting period, in turn, refers to the time period before an employee can fully exercise their Stock Options or Warrants. During the vesting period, the employee will receive a portion of the stocks every month or quarter (i.e. 1/16 or ¼), becoming fully vested after the vesting date.
There is no one-schedule-fits-all when it comes to planning the vesting schedule for your startup. The typical vesting period seems to hit somewhere between 3 and 5 years. And, as a rule of thumb most new employees are subjected to the so-called “cliff” -period, when they will not receive any stocks. Typical “cliff”-period in startups is the first year of employment.
By following the “cliff”-vesting schedule you can ensure that the people you onboard are actually committed. With no stocks in the company the employee has a clear incentive to stay for the first years of the journey. And the longer the employee stays onboard, the more they will gain.
If you are currently planning your vesting schedule, we recommend you continue reading with i.e. Georg Colindres’ post at startupPerColator on the common templates you can apply.
How Much Equity Should You Give Out?
The idea with this step is to have a formula in mind for how important each role is to your company. Sure you’ll say: everybody on my team is equally important. But there are clear factors to take into account and quantify. Therefore, we created a clear formula you can use as inspired by Buffer’s public equity formula.
Decide which positions are important for your company and assign a percentage value from 0 to 1. In example, if your product is software, a Product Manager is quite critical therefore you might assign this position a 0.7%.
When you are one of the first three to start a startup, the risk of failure is high. At least higher than if you joined in as the 60th team member of a scale up. The risk factor is the value that takes this difference into account.
You can calculate risk factor based on the size of the company at the time of the employee joining the company using multiples; , 6 people has a value of 2, 15 people has a value of 3, 30 people has a value of 4 and so on. In example if a new Product Manager joins the company when there are 22 employees total, his or her risk factor will be equal to 4
Just give it a thought, what are the seniority levels in your startup? Do you have team leads or maybe C-level senior workers? Though we want to believe in flat hierarchies in the startup ecosystem, there still are differences in seniority level to take into account.
Consequently, you can then add a value number to each seniority level; 0.1 for senior, 0.2 for Lead, 0.3 for director and so on. In example if our Product Manager is a “Senior Product Manager” you would add a 0.1 to his calculations.
Startup Equity 101? – The Main Take Aways
It is not easy to figure out how much equity to give your employees. Or in what form to do that. There are a number of factors to include in your equity plan, such as the employee vesting period, the employee position and employee importance to your startup.
To dive deeper into the world of equity, we recommend you start with either this video from Y-combinator explaining your options or this amazing thread in Quora covering the FAQs answered by experienced founders.
And as for country specific information, here are a few helpful links: