A compensation package isn’t as simple as it used to be, especially for startups. Apart from a basic salary, employees are also seeking additional benefits like bonuses, commissions, and equity compensation before deciding to join a startup. In fact, a survey by Schwab Stock Plan Services revealed that 77% of respondents find equity compensation an attractive benefit, making it one of the main reasons to accept a job offer.
However, bear in mind that offering equity compensation means giving some of your ownership in the startup to your employees. This is why it’s important for founders to fully understand your equity compensation plan and manage it well. Failing to do so may result in losing quality employees who can help drive your business to success.
In this article, we’ll go through questions that employees (or prospective talent) may raise to fully understand your startup’s employee equity plan. Specifically, we’ll cover:
- The benefits of offering equity compensation for startups
- Common questions employees ask about equity along with a free checklist
Benefits of equity compensation for startups
Equity compensation is a non-cash payment that allows employees to partake in the ownership of the startup once they meet the vesting requirements. This perk can motivate talent to be more goal-oriented and stay with the startup longer. Similarly, startups can attract prospects with equity without affecting the business’s bottom line. In short, it’s a win-win situation for both founders and employees. Other benefits include:
1. Recruiting top talent
Hiring and retaining quality talent is expensive, especially for early-stage startups. Most of them will demand a high pay package, and this is something startups may struggle to fulfill. Instead, incentivizing them with equity can automatically entice such talent to join the business, which helps in building a strong and skilled team.
2. Increasing retention
Founders can use equity compensation to encourage employees to remain with the startup until their stock vests—which is when employees officially own the stock. By setting a vesting schedule, it promotes long-term employment as employees get full ownership over the funds once they fulfill the vesting period, which typically becomes their retirement funds.
3. Boosting employee motivation
A good equity compensation plan is a powerful tool to align employees’ motivation with the startup’s strategy and goals. When given a stake in the startup’s success, employees will be happy and content at work, resulting in a more motivated, engaged, and productive workforce.
7 common questions employees ask about equity
Investors are not the only ones interested to know about your equity compensation plan. Employees are just as eager. Here are some of the most common questions employees (or prospective talent) have about your startup’s equity management:
1. How much equity is on offer on a fully diluted basis?
For employees, knowing just the number of shares they’ll get when they join a startup is meaningless. Rather, they want to truly understand what percentage of the business their stock options or other types of shares represent. If they ask how much is offered on a “fully diluted basis”, this means you will have to consider all stock your startup is obligated to issue in the future, not just the ones that have already been given.
2. How much funds does your startup plan to raise?
Each time your startup issues new stock, current shareholders get diluted. As new financings happen over the years, an ownership percentage that started out huge can get diluted and become a small percentage stake (although its value may not necessarily drop). As such, it’s vital for prospective talent to assume that their stock can dilute considerably over time if they know the startup plans to have multiple funding rounds in the next several years.
3. When was the last 409A valuation done?
The 409A valuation is an appraisal of a startup done by an independent third-party appraiser to determine the fair market value (FMV) of common stock. This is important as it sets the strike price: a set price at which a startup’s stocks can be bought or sold. If it’s been a while since your startup did its last 409A valuation, then employees can anticipate that your startup might have to do one soon, which can result in a higher strike price.
4. When is the vesting schedule?
The vesting schedule determines the duration in which employees need to work for your startup before their stock options become exercisable. Clarifying this duration is vital for employees as they need to ensure it fits within the time span they see themselves working for you. The standard practice for employee stock options is four years with a one-year cliff. This means that your employees must work in your startup for a minimum of one year before vesting any shares. For example, if they resign at month 12, they get 25 percent vesting; and if they leave after three years, they get 75 percent.
5. How much debt has the startup raised?
Debts are extremely common in startups that are doing extremely well, or deeply troubled. When prospective talent is offered equity compensation, they want to know how much debt has your business raised. This information is important to them as you need to pay off the debt to the investors first before they can get any money from an exit.
6. What happens to stock options if the startup is acquired?
In the event of an acquisition, employees want to know what will happen to their shares, especially if it’s before their vesting period. In some cases, it’s possible for the startup to allow employees to accelerate their vesting schedule which permits them to receive the monetary benefits from the shares even earlier.
7. How long after resigning can employees exercise their shares?
When an employee resigns, the person is given a limited period to purchase their options. Typically, the duration permitted to exercise their options is 90 days. If the employee leaves before their vesting schedule is completed, then they can keep everything they’ve vested provided it’s exercised within the 90-day window. However, if the shares are not vested, then it is forfeited and returned to the startup’s equity pool to be offered to new employees or investors.
Answering employees equity compensation related questions can be stressful at times. This doesn’t have to be the case. That’s why it’s helpful if you can anticipate the questions that’ll be asked by them.
The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Information about the company is provided by the company, or comes from the companies’ public filings and is not independently verified by LTSE. Neither LTSE nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding LTSE-listed companies are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. Advice from a securities professional is strongly advised.