09 Dec How much Equity to give your Early Employees Part 2
On my previous article post about employee equity, I did an overview on some important definitions and possible scenarios of stock compensation. On this second part we will review how a startup equity can be split in a way it is fair for all shareholders.
There is no real formula in which all companies base their employee equity programs, the options are countless. The way it is split will depend on each individual situation. Some factors, among others, that must be considered when making your calculations are:
- Role (And how essential this person is to the company and its funding).
- Startup stage (how early are they joining the company).
- Amount of contribution and experience.
- External investors.
- Sacrifices made to come work for you.
On a side note, if there are external investors, either if it is single or multiple phases of investment, the option pool for employees goes for around ten to twenty percent in equity.
Depending on the stage of your startup there are some ideas of possible formulas that you could use to distribute equity shares. If the idea just came up and no one but yourself is working on it then you get the obvious one hundred percent.
For a co-founder, many experts recommend not having more than five, you must have a checklist and weigh in each of the factors mentioned above and distribute the shares appropriately. According to Professor Noam Wasserman from the Harvard Business School, 73% of teams split the equity within a month of founding which he considers a terrible move since you are getting to know each other as partners even if your co-founder is a previous acquaintance. He provides a checklist to be assured that the split will be fair throughout the life of the venture.
Prof. Wasserman’s checklist:
- Will not change business model or strategy
- No pivots along the way
- Everyone scaling and contributing at high levels
- No doubts (whatsoever)
- No personal issues between partners
Then for angel or external investors (not family or friends, in which case it is better to see it as a loan), these are people investing in a promising venture. Some spend their money for the enjoyment of seeing a young business grow into success. A formula you could use to calculate the share amount is to determine the post-money valuation (C) by adding the assumed company value (A) and the amount of money they are willing to lend (B), then divide the amount invested (B) by the post-money valuation total (C). It should look like this:
- B/C=% (equity percentage)
This will then bring you to the employee equity split. Early on, the option pool can range from fifteen to twenty percent plus the market salary you initially agreed on. As time passes and the company hires more employees, meaning more possible shareholders, you might want to sit with the early team members and renegotiate the stock dilution.
Experts agree it is prudent to consider vesting all shares over at least two or three years. This allows you to have control on how the shares will be metered out in case one of your partners or shareholders withdraws.
Remind yourself that offering employee equity motivates the team as they will feel engaged by their share of ownership in the company, and if it succeeds then they succeed. But above all, the employee must be engaged and believe in the product and its sole purpose.