Employee equity is the act of giving you employees a part of the company. This usually comes in the form of stock, and would be part of their benefits package. Offering employees equity at a startup company is common. Here we will detail how you can do it.
Offering Employees Equity at a Startup – Overview
In exchange time and labor, employees may be given the option to receive a piece of ownership in it. This type of agreement encourage employee retention as some equity agreements require the fulfillment of conditions. Most times, being with the company for a fixed number of years will make them eligible for certain benefits.
Starting and developing firms commonly give employees equity. It helps them expand their high-quality employee pool even if they lack funds to offer competitive salaries. Using it to reward the top performers of the company can also be effective in motivating employees to work harder.
If you’re an entrepreneur considering providing equity to your employees, here are more details on how to do it.
Choose the Right Equity
It is important to understand the differences on how each type of equity works. By knowing the differences, you will be able to identify what is best for your company.
There are three main ways of offering employees equity at a startup.
- Stock Options – The business owners give their employees the right to buy or sell a certain number of shares. The caveat is that they must be executed at a specific price and date. It’s not an obligation, so the employees have a choice to purchase or not. It’s the most common type of equity that startups distribute to their employees.
- Stock Warrants – This pertains to the employee’s rights to buy or sell a certain number of shares. These can be executed at a specific price. Unlike stock options which are issued by the stock exchange, this type of equity is issued by the company itself. So, the firm can accumulate funds if the employee exercises stock warrants.
- Stock Grants – Stock grants are mostly provided to employees who have stayed at the company for an agreed number of years. Stock grants are when a company simply gives (or grants) an employee shares of the company. This encourages employee retention and engagement.
Prepare Your Cap Table
A cloud cap table tool, also known as a capital table, is mostly in use by developing companies because it’s vital in creating financial decisions. It’s a complex breakdown of a company’s share equity. It shows every investor’s part in the ownership of the business. You can derive this by multiplying the number of shares they own by the shares’ price.
Cap tables helps in the approximation of employee owned market value. This is important in shareholder reporting and the issuance of new capital. This type of tool also tracks the ownership percentage of a company plus all equity transactions. The user of the tool can oversee the entity’s ownership and its management.
Cloud cap table tools can also help startups manage, record, and see all equity transactions. Gone are the days of physical documents tracking your company’s equity distribution. Once you have a firm understanding of the total employee position, you may easily determine the percentage of stocks you can divide further for your existing employees.
Determine How Much Equity to Allocate Per Employee
Are you still wondering if you should start offering employees equity at a startup? If so then you are going to need to determine how much equity to allocate to each employee. Many startups use the seniority of their key employees as the basis in granting equity. Others allocate it equally regardless of position.
Most businesses propose more equity to the first few employees working with them. For instance, you might offer 3% equity for the first 15 employees. You can then offer 1% for the sixteenth to thirtieth employee the company hires.
If you do decide to grant equity on way or another, you need to be transparent with the employee. Sometimes startups fail which mean that employee equity positions would most likely become worthless. If this is the case, all of that work to receive ownership in the business would be for nothing.
Identify the Vesting Period
The vesting period is the timespan an employee must work for the company before being eligible for their share of company stock. The usual startup equity structure is based on a four-year vesting term. This means that each year the employee acquires 25% ownership of their shares.
A term you should be aware of is a cliff period. This is the minimum time an employee must stay with the firm before the vesting schedule begins. If the employee decides to quit before the one-year period, they will no longer be able to obtain their equity rights.
To discourage employees from leaving the company, a limited number of companies prefer to extend vesting periods or increase the portion of equity that employees vest each year.
Offering Employees Equity at a Startup – Summary
Granting employee equity is commonly used by startups. That being said, startup owners may be inexperienced at creating an employee equity program. Use this article as a guide in planning your employee equity program. You should now be able to choose the best way to distribute equity, determine the amount of equity to allocate per employee, as well as the vesting period. All of this will be easier by utilizing a well-prepared cap table.
There are tons of benefits to offering equity to employees. You can offer employees more competitive benefits packages and increase the talent pool at your company. Offering employees equity can also encourage them to perform at their best.
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