Issuing Equity to Early Employees in a Startup
What is it, and when to consider for Startup Founders
The traditional practice is to issue stock options to early employees, with the stock vesting over time. This provides a win-win for both the company and the employee.
The employee wins because he/she gets stock in a growing company at a low price. The company wins because it gets talented employees at a low cost. Both sides are incentivized to perform well because of the financial upside that exists if the company succeeds.
How should Equity be issued?
Vesting: Employees who work for your startup should have their equity vest over time, rather than immediately upon hire. This ensures that employees will remain with your startup long enough to benefit from their equity grant, and that they will stay motivated as your startup grows and becomes more valuable.
Typically, this means an employee will have his/her equity vest over a 4-year period (1 year at 25%, 1 year at 50%, 1 year at 75%, 1 year at 100%). This provides the following benefits: Employees are incentivized to stay with your startup long enough to see its growth (1/4 of their shares will be vested after 1 year, 1/2 after 2 years, 3/4 after 3 years).
They are also incentivized to stick around long enough for their shares to become fully vested (i.e., 100% vested after 4 years). This means they have 4 years worth of incentive to stay with your startup until they can fully cash out their shares.
When you first hire an employee, you should offer them some ownership in your startup (i.e., equity). The amount of equity you offer should be proportional to their position within the organization (e.g., founders typically own more than early employees).
For example, if you offer 10% of your company’s ownership to each of your first two hires, then each hire would receive 5% ownership in your startup when hired and receive another 5% one year later when their shares become 25% vested; another 5% two years later when their shares become 50% vested; and another 5% three years later when their shares become 75% vested; leaving them with 100% ownership after four years as long as they remain employed by your startup through this time period (note: employees can leave before this time period ends but they won’t get any more shares unless they rejoin later on).
You may want to use an “anti-dilution clause” in your stock purchase agreement that specifies that if you issue more shares to any of your employees in the future, then they will get an equivalent number of shares as well.
When you should not issue equity to early employees: Equity should not be issued to early employees if you are unable to raise any outside capital. If you can’t raise any outside capital, then you can’t afford to pay your employees anything. In this case, equity should not be offered until you are able to raise outside capital and the shares can be vested as described above.
How much equity should I offer my early employees?
The amount of equity that an employee receives is proportional to their position within the organization (e.g., founders typically own more than early employees). The standard is for a founder to own between 15% and 30% of a startup (e.g., 25%).
This means that if a founder owns 25% of his/her startup, then he/she will issue 1/4 of his/her shares (i.e., 6.25%) to each of his/her first two hires (i.e., 5% ownership for each hire).
However, you may want to give your first employee more than this standard amount in order to attract him/her or because he/she is a close friend or family member and therefore deserves more than the standard amount.
About the Author
I am the Founder of Cudy Technologies (www.cudy.co), a full-stack EdTech startup helping teachers and students teach and learn better. I am also a mentor and angel investor in other Startups of my other interests (Proptech, Fintech, HRtech, Ride-hailing, C2C marketplaces and SaaS). You can also find me on Cudy for early-stage Startup Founder mentorship and advice.
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