Start-Up Employee Equity
Start-Up Employee Equity: What Every Founder Should Know
If your early-stage start-up is looking to attract passionate and dedicated employees, equity compensation can help you build a team that is committed to making the business a success. Employee equity is the practice of granting stock to employees as part of their compensation packages. If the value of this equity multiplies year-on-year as the start-up’s valuation grows, having a stake in the business can become a huge financial asset for the employee in the future.
How to Grant Start-Up Employee Equity
This article outlines how your business can grant start-up employee equity.
Create an Employee Stock Pool
The general rule of thumb is to set aside 10-15% of your equity for your employee stock option pool, which is dedicated for future employees. However, you can increase the amount of equity assigned to the pool as you distribute the equity, and the pool diminishes.
Choose the Type of Equity to Grant
Start-ups grant three main types of equity to employees:
- Stock options are the right to buy or sell a defined number of shares from the founders at a predetermined price. The employee can exercise this right between the vesting date and the expiration date. This is the most common type of equity that start-ups choose to distribute to employees.
- Stock warrants are the right to buy or sell a defined number of shares from the company at a predetermined price. Warrants can also only be exercised between the vesting and expiration dates, but they usually have longer expiration dates than stock options.
- Stock grants are the ownership of a defined amount of stock. There is no vesting date or expiration date on stock grants, so the employee can immediately sell the shares, if they so choose.
Determine The Vesting Period
The vesting period is the time during which an employee must earn their allocated stock by working for the company. The typical start-up equity structure is graded on a four-year vesting period, which means the employee earns ownership of 25% of their stock each year. A small number of companies choose to have longer vesting periods or increase the percentage of equity that employees vest each year to disincentivize employees from leaving the business. If an employee decides to leave a start-up and a portion of their shares have vested, they typically have 90 days after leaving the company to buy or exercise their stock options. If they choose not to, then they lose the stock options, and their stock options are added back to the employee stock option pool.
Determine How Much Equity to Assign Each Employee
Many businesses determine the amount of equity they grant to each employee based on the seniority of their role. Others offer equal amounts of equity regardless of their hierarchy. Early start-up employees take on a significant risk when they join the company, thus, businesses offer more equity to early employees to reflect this fact.
Document Start-Up Employee Equity in a Capitalisation Table
A capitalisation table is a record of all the shareholders of your company, including any employees, advisers, or investors who have equity (this might include friends and family who’ve invested in your business along the way). Your capitalisation table should include the total number of stock options that have already been exercised and the total number of shares still available in the option pool. Make sure to regularly update this document to ensure it’s an accurate reflection of the company’s current ownership.
Why Work with Gallagher Keane Chartered Accountants?
Gallagher Keane provide professional accounting, tax, and financial advice to many start-up businesses. This helps them make informed business decisions to reach their goals. Gallagher Keane provides cloud accounting services to clients, giving start-ups a modern accounting solution.
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