Here are some important tips on sharing your business’ equity and drawing up agreements with your employees
Giving equity to employees is an excellent strategy for small start-ups, as it provides them with a way to reward their employees when they are still running short on liquid capital. And while it can be a daunting prospect to give away shares in your business, the reality is that it helps to ensure that everyone feels part of the same team and that you’re all working toward the same goals. It sends a powerful message that says: we’re in this together!
However, how much equity is too much, and at what point should your employees be able to cash in? Let’s take a look at your options and how to go about dividing equity among your workers properly.
Everyone is Different
Of course, the first thing to consider is that every business is different and every employee is different. Your exact mileage may vary depending on the structure of your organization and the role of the employee. You may even want to offer your staff various options – perhaps give them a choice to forego a conventional salary entirely in order to earn more equity.
Remember that the agreement needs to be appealing for both parties though and must never feel as though it’s just a way for you to avoid paying while you try and find funding.
Considering Dilution of Equity
You also need to consider the way you want to share out the equity while being careful not to dilute your share too much. Not every employee should be entitled to an equal share of the business, so you need to consider the contributions of each player and then give them an appropriate amount to reflect that.
Of course, this leaves you with a smaller slice of the pie but if the strategy works, then you’re going to have a smaller slice of a much bigger pie – so it should be a good investment. It is still very important that you maintain the controlling interest so by setting aside 15%-20% of the company’s equity for the key members of the team, you’ll be able to spread the wealth around in ways that suit you most.
What if People Leave?
Drawing out contracts to ensure that everyone is happy with the agreement and that you and your staff are protected is imperative to your overall success. In particular, you need to be careful about giving out equity to recipients that then quit and take it with them.
For this reason, your agreement will normally include clauses to ensure you have the right to purchase the equity back at the market value. When they leave, the equity automatically reverts to you but you need to pay for it.
Eventually, your team should be able to ‘cash in’ if they so wish. That’s why the options also need to have a ‘vesting schedule’. That means that the employee will earn increasing purchase rights over time. A common way to arrange this is so that employees earn 25% of the grant each year over the course of four years. This ensures that they stay committed in the long run.
Vesting rights can also accrue as the market value of your business improves. That means that employees are better motivated to earn their upside before they can sell off their options. In short, you don’t just give over a portion of your business and then allow your staff to sell it or leave with it as they wish.
More Options for Your Equity Options
If you want to be even safer though, you can choose to set up a ‘phantom equity plan’, which essentially means you owe the employee the equivalent amount but they don’t technically own the equity. You can also opt for another route and consider using equity to pay for outsourced services.
There are countless options for how you want to use your equity and this can be a very effective way to keep everyone motivated while also managing your cash-flow. Consider which of these options works best for your organization and then get advice on drawing up agreements that will be mutually beneficial for everyone involved.
Written by EquityX