Marc Lore, co-founder of the shopping site Jet.com, saw at his previous companies how stinting on benefits hurt morale. So when he co-founded the e-commerce platform Quidsi in 2005, everyone but hourly employees received equity in the company. "I witnessed the passion and loyalty that came with people feeling like an owner in the business," he says.
Today Lore offers equity to Jet's entire work force, regardless of an employee's position or time spent with the company. There's a four-year vesting period, and each position gets a standardized slug of stock--and Lore sees its impact on his workers. "They're going way beyond their day job," he says. "Working nights and weekends, and not feeling like it's a burden."
Equity arrangements are increasingly standard for startups. AngelList, a site for investors and job seekers in such companies, provided data to Inc. showing that 80 percent of job postings from U.S. startups involve some equity.
Reasons vary: Honor, which connects families with caregivers online, offers equity to all staffers and finds it leads to more collaborative workers. That equity "creates a team sport," says co-founder Seth Sternberg, "where everyone's contribution directly helps them." Dennis J. White, a Boston-based partner in the law firm Verrill Dana, says equity also can "provide some compensation to employees" when you're short on cash. "It's also a retention tool--no one wants to leave and give up the upside" of stock.
So set up your plan correctly. "I've walked into some startups that couldn't accurately reconstruct who got what, when," says Will Ferguson, a senior partner at Mercer, a large HR consulting firm. You never want to tell investors that you don't know how much equity is left.
Equity grants can result in numerous minority stockholders, whose demands and grievances can be a major distraction. The mobile security firm Good Technology is one example. Last winter, BlackBerry purchased it for $425 million, less than half of the company's $1.1 billion private valuation. Some of Good's common stockholders woke up to find their stock options were practically worthless--after they'd paid taxes on their shares based on higher valuations. Now, minority shareholders are suing board members for breach of fiduciary duty.
White counsels sidestepping such complications by giving "phantom" stock instead of actual stock; that will provide financial incentives without granting shareholder rights and responsibilities. You can also give stock layered with restrictions, such as drag-along rights, which would give your investors the option to "drag along"--force--minority shareholders to support a sale of your company.
There are also risks of diluted stakes and shrunken valuations. In 2014, Square raised money at a $6 billion valuation, and promised to give millions of additional shares to its new investors if that value decreased in an IPO. When Square went public at half that valuation, those investors were made whole--leaving employees with diluted stakes in a far less valuable business.
One key, says Ferguson, is communicating to employees the stake they could receive and all the ways it could be monetized. "This is the fun part," Ferguson jokes about terms and conditions, "when people's eyes tend to glaze over." But, he adds, you need to be able to say, "This is how we're doing it, and here's what that means."
1. Do educate your employees
Be prepared to tell your staff from the outset how their shares can be monetized with or without a sale or initial public offering, what will happen if they leave the company, and so on, stresses Will Ferguson of Mercer: "Investing the time for them to understand is absolutely crucial."
2. Don't do it yourself
There's no such thing as a one-size-fits-all equity plan, says Dennis J. White of Verrill Dana. Restricted stock is subject to forfeiture if an employee leaves the company early, while nonvoting stock keeps minority stockholders from holding sway over company governance. These plans are "highly complex and raise a bunch of tax, accounting, and securities law issues," White says, so you really need expert advice to set one up.
3. Do draft a multiyear plan
"You need a multiyear plan not only for the first 10 people you want to hire but also for the next 100 you hire as you grow," Ferguson says. You may be more conservative at the start to make the equity last longer. After all, as you progress, you may find you need to lure a seasoned manager with a really competitive offer--while not diluting everyone else's stake.
4. Don't attempt the impossible
If cash is tight or dilution fears keep you up at night, you may want to think twice before giving everyone a handout, Ferguson says, especially if your investors are keen on rewarding those closer to the top. Another reason to forgo giving equity to all? If your company is organized as a limited liability company, or LLC, as opposed to a corporation, it will make fashioning equity compensation much more challenging and complicated, White says. Entrepreneurs should also keep in mind that venture capital investors typically place an overall cap of 15 percent or so on the amount of equity that can be reserved for employee options.