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Establish a fair and defensible framework for granting equity to early employees and create an environment of trust and positivity to help your startup succeed.
We see a lot of founders make mistakes when trying to hire and retain top talent, particularly around the issue of granting equity. As an early-stage founder, your approach to equity can make or break the relationship between you and your candidate, and can have lasting implications for your team and company culture. Often, founders are either reluctant to be generous with equity, give too much away too soon, or (perhaps worst of all) let their equity strategy become an afterthought.
We’ll walk you through why equity is so important and the three critical steps for developing an approach that won’t just serve you well now, but into the future:
Two words: Retention and commitment.
Equity is not just a cool carrot to dangle during the recruiting process. Equity is the best reward tool you have to align company and employee incentives for the long term, and can be a building block for success. First, equity can provide an incentive for high-performing employees to join your early startup team and may make up for lower cash salaries.
Equity bolsters a critical cultural tenet for early-stage startups: If we succeed, you'll succeed. In other words, we're all in this together.
However, generous equity grants do more than offset the potential cash dip of a startup salary — stock options make employees feel like co-owners in your company. Equity bolsters a critical cultural tenet for early-stage startups: If we succeed, you'll succeed. In other words, we're all in this together. What’s more, because equity typically takes time to vest, it encourages employees to stay for the long term.
Equity is an important component of an employee’s lifecycle, which starts at the job-offer stage and continues throughout an employee’s tenure. Equity plans should increasingly reward high-performing employees over time.
But, first, you have to build the foundation of your equity plan.
Some founders fall into the trap of thinking of equity as giving up their “baby,” rather than as part of a holistic hiring strategy. A guarded founder may feel skeptical of employees taking their equity and may try to keep as much as possible. On the other hand, a more generous founder may see the opportunity — while they give away more equity upfront, the equity they do keep may be more valuable as a result. But, if you think of equity like a pie, you don’t want to dish out all the slices before everyone’s been served.
Put aside your feelings about your startup and get into a mindset of giving away equity sustainably and in a way that makes sense for business growth.
Discuss equity early in the process before you hire employees. This is a critical framework. You don’t just need to consider equity for your future employees, but for yourself. Which brings us to the next stage in the conversation.
The general thinking is that, before Series A, founders should retain a total of 50 to 70% ownership. You can decide how much equity you’d like to keep and move forward from there, allocating out the remainder as it makes sense.
With two or more co-founders, there are several approaches. The first, and easiest, approach is an equal split among founders. This is fairly straightforward and creates a clean dynamic.
The second approach is a slightly skewed split. In some cases, this may be the most fair arrangement if one co-founder brings a much greater amount of experience, if the idea for the startup belonged to only one co-founder, or if somebody invested their own money upfront. However, we only advise co-founders to do a skewed split if there is a clear and agreed-upon distinction that warrants different equity levels, as it can create early conflict. You might face poor team dynamics if resentment brews, which can be far more damaging to your startup than any little bit of equity you might gain in divvying things up.
Whatever method you choose, come up with a strategy that’s clear, reasoned, and does not need to be revisited. Establish an agreement around vesting and buybacks, too. Yes, founders are also expected to have a vesting schedule. That way, a co-founder can’t quit early and split with all of their equity, plus the startup will have an option to buy back a percentage of the equity that has vested for that person if they did leave the business.
Additionally, it is important for founders and employees alike to take a step back and remember to focus on the overall enterprise value of the company, rather than just your individual percentage. As the phrase goes, no matter how much of a company you own, the value is always zero if the company does not succeed. As one of our partners likes to say, “The circumference of a circle is a linear equation (pie*diameter); the AREA of circle is exponential, (pie*r^2)…” Bottom line, it’s the size of the pie that matters much more than the size of the slice.
The founding team (the first 10 employees) can make or break your business — you want those employees to be committed and to feel highly motivated about their stake in the company.
We’ve seen companies be overly generous on early equity offerings because they want to make sure early team members are there for the long term. This might make sense if cash salaries are particularly low and you want a certain level of commitment, but you need a well-formed approach that’s in line with market data.
Develop a defensible framework that outlines equity ranges for a variety of roles. Create a sheet with estimates of how many people you think you’ll hire, both in the short and long term. Work out how you might spend equity apportionment for your first 10 hires and how you might change it for the next hiring round. Also, consider that you’ll need to allot a portion of equity to investors — typically 20 to 30% before Series A.
Once you’ve established ranges, ask if they are sustainable. New hires may negotiate for more equity, but the percentage you settle on should stay within your set range. If you hire engineers No. 5 and No. 6, and grant one X equity and the other twice that amount just because they asked for it, you could run into snags down the line when it comes time for performance reviews and raises. To avoid this, defer to your equity philosophy, create clear boundaries around what you’re willing to grant, and be prepared to defend your decision.
Grant equity based on market conditions so that you can position yourself competitively without giving too much away. As much as you may appreciate them, a junior employee should not get 5% of the company. Making a mistake like that can be a red flag for investors and set a challenging precedent for future hires.
Your first 10 to 15 hires are often enticed by equity, and they can be given a larger portion, particularly if they’re more senior and bring a great deal of experience. Our goal is not to be prescriptive about the exact amount of equity you should grant to employees — that’s for you to decide. However, because we know that examples are helpful for founders, here are fictional samples of how some companies might approach salary and equity grants (using screenshots from Carta, an Unusual Ventures portfolio company):
Additional grants refer to additional equity given out over periods of time. Equity grants should not be treated as one and done. Talented people usually want to move up the ranks. The earlier you can incorporate refresh grants into your company’s equity framework, the more you’ll inspire a performance culture.
Multiple grants can aid in retention because they don’t expire at the same time, but rather, are stacked so they’re rolling and have a constant impact on retention. One good framework to use when making a refresh grant is to determine what the employee would receive today if they were joining the company, and then take 80-100% of that equity amount and divide by 4. The logic of the refresh grant after only 2.5 years is you don’t want to wait until an employee is fully vested to reload them because their minds may turn elsewhere once they anticipate being fully vested.
If you only have a handful of team members, you don’t necessarily need a defined equity refresh plan in place, but there does need to be communication around what additional grants will be tied to so expectations are clear. Traditionally, they’re connected to tenure and high performance. We highly recommend you link additional grants to performance — it can be a powerful motivator and rewards top talent.
Once you’ve answered all the questions we’ve laid out, it’s time to get a lawyer involved. Signing a Word Doc isn’t an enforceable legal document. Treat equity as you do any other serious legal matter. Often, whatever law firm helped you incorporate or handled investment documentation can also help you draw up legal, enforceable paperwork around equity. Choose representation that has experience with early-stage companies.
Your legal representation may also be able to advise you on how to file an 83(b) election, a request to the Internal Revenue Service that you get taxed on the date your equity was granted rather than when it vests. This can be a huge tax benefit for founders and shouldn’t be ignored.
Because you’ve created an equity framework, you can feel certain about your plan and avoid an ad hoc approach to offering equity to new hires. With a clearly defined philosophy, you’ll save time in answering questions, making offers, and scaling your communication process. You’ll be able to confidently say to candidates, “We want you to be an important part of our team. Based on our equity framework, here’s what we’d like to offer you.”
Provide enough equity detail in your offer conversations so employees understand their valuation as the company grows. Percent ownership should be tied to a number of shares and the number of shares outstanding. Be clear, too, about vesting and additional grants. An established company can slap down an equity offer and say, “Trust me, this is valuable.” For startups, that won’t get you anywhere.
To our previous point, one of your superpowers as an early-stage founder is the ability to use equity as an incentive. When you’re competing for critical talent with tech giants, your generous equity offer could be worth much more in the long run than X Mega Tech Biz. Don’t just hand over the proverbial equity lottery tickets. Spell it out for prospective employees: “In 12 to 18 months, we’re raising our next round of funding, which would value our company at X dollars. You would get X percentage of equity, which could be the equivalent of $X.”
You should assume your employees will talk about their compensation, including equity. That’s just a part of human nature. The good news is that having a repeatable framework means you'll be ready to defend your compensation decisions should anyone come to you with questions.
What’s more, if you don’t document your equity philosophy — or at least talk openly about it within your company — you run the risk of employees wondering if they’re being treated fairly. Don’t shy away from this. If you’ve created a fair and defensible framework, these conversations can be a great opportunity. Treating employees well and being generous with equity creates an environment of trust, alignment and positivity.
At a minimum, publish your company’s equity philosophy on your internal wiki and talk about it periodically during all hands. Some tech companies also publish their equity perspective on their job opportunity pages. Be as transparent as possible about your equity decisions.
