TLDR

  • Talent - For many startups, equity forms a common part of the compensation package they offer employees, particularly early hires. It can be an effective way of attracting and hiring talent when a startup is at an early stage and is financially restrained from being able to offer high salaries.
  • Incentive - Offering equity to employees is also an efficacious way of motivating employees to work hard.
  • How much? - How much equity you offer an employee will depend on factors such as the stage in the company's journey at which they join, their role in the company and what else is being offered as part of their compensation package.
  • How to set it up - Equity should be subject to a vesting schedule and founders should consider setting up an employee option pool to award this equity in a more disciplined and formalised way.

Most startups now offer employees equity as part of their compensation package typically forgoing their salary or settling for a lower one. This is to one, attract talent and compensate employees for the salary cut they will almost inevitably take joining a startup and two, motivate the employee to work hard due to the fact they may receive a significant financial payout if the company is sold or goes public.  

How much equity you offer employees will, like with a lot of things, depend on a number of factors. These include the stage at which they join your startup, additional forms of compensation, what position they are in, skills, experience & expertise and competing opportunities.

There are several online guides that describe how founders should approach this topic.

The standard is roughly 1.5% to 2% for a key employee near or at the executive level joining at a company’s earliest stages. An engineer or business development coming on board at mid-level later on in the company’s lifecycle is typically given 0.3-0.5%, whilst a junior employee can expect approximately 0.05%.

More often than not, timing outshines seniority or experience with those joining at the very early stages of a company’s formation receiving a large slice of the pie. Simply put, this is because more risk is being taken on the earlier someone joins.

Regardless of the size of equity awarded, all equity should be subject to a vesting schedule. Traditionally, most startups award equity through a four-year schedule with a one-year cliff, meaning an employee has no equity until they have worked 12 months, after which they are awarded 25% of their equity followed by 1/48 of the original equity allocation for each month worked until the four year vesting period is over.

This means that the employee is only fully vested after four years of working for the company, ensuring new hires are incentivised to stay and to prevent them leaving with all of their equity soon after joining the company.

Founders should also consider creating an employee option pool. This is simply a more disciplined way to allocate and award equity. You can read more about employee option pools here.

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