Equity and stock options, shared vision and experience: How early employees get ownership in startups

When looking at a job description, it’s often the salary that stands out. But the total compensation is a trickier puzzle to put together, with elements that might not be visible week-to-week, or in a single check.

For one, there’s the total benefits package to consider, including health insurance, vacation days, retirement and more.

Another form of compensation is a stake in ownership of the company itself. Through equity and stock options, companies are offering employees the chance to become shareholders.

In tech, this became among the features of new tools for company-building put into action by post-2008 founders. It was a different model than what’s typically found in corporations, and gained kudos for the show of egalitarianism that’s inherent in offering a bit of ownership to normal employees. Where companies work hard early to realize big returns that come later, this can be especially relevant.

Offering a share of the company can also be a form of compensation during startup days, when higher salaries aren’t an option.

Adam Mustchler, a partner at The Kedar Group who is active in the D.C. tech community, summed up how the CFO of an under-four-year-old company in Chicago that gave equity to employees described it the practice: “If the company [is] to achieve what we hope it will, think of this as a way to bridge the gap of what you might get paid somewhere else. We want you to have a slice of the pie.”

Speaking on how stock options can be a tool to attract, motivate and retain talent at a recent Venture Cafe Philadelphia event, OptionTrax Head of Sales and Operations Elena Thomas said offering an option that promises the ability to purchase stock later at a set price can help to offer employees a longer-term engagement with the company. Since most stock options are granted with time-based vesting, the employee earns the right to purchase the stock over a period of years — typically three to four years in software, with a one-year “cliff” before vesting can begin.

If you're a startup with five people in life sciences, what Facebook is offering is not what you need to be offering.

Granting ownership can motivate folks as they build the company that they literally own a piece of: “It also increases the sense of loyalty within a company,” Thomas said.

While one of the advantages of stock options is that they are non-dilutive — meaning they do not change the individual percentages of ownership — it’s important to consider the size of a company when considering about the size of a stock options package to grant. Different scale can call for different options.

“If you’re a startup with five people in life sciences, what Facebook is offering is not what you need to be offering,” Thomas said.

With equity, different positions can call for different amounts of ownership stake awarded. It may be worth giving up more to attract a star CTO who will be a company’s first hire outside the founding team than the 25th employee. For early employees, these conversations typically involve a difference of fractions rather than whole numbers. Only founders are owning double-digit percentages. Mustchler said an early engineering team might get offered 1.25 to 1.5%, and as the number of employees and funding rounds grows, the amount of equity moves further into fractions of a percent.

Still, there’s promise to be talking in terms of adding zeroes if a successful liquidity event is reached.

“People talk about this: A certain percentage of a billion is nice, a certain percentage of zero is nothing. Even if it’s a fraction of a percent, that could translate to hundreds of thousands if not more in the millions,” Mustchler said.

It can also make sense to set up an employee pool for stock options. Thomas said such pools are typically 10 to 20% of the shares of the company, and allows a way to offer equal value to employees, even as it changes over time.

When considering how much to offer, founders might also consider checking out an online guide. Here are a few:

• “The equity equation,” a 2007 essay by Y Combinator founder Paul Graham that proposed a formula for equity
• “The Holloway Guide to equity compensation,” by a San Francisco firm that publishes guides for founders
• “Rewarding Talent,” a guide to stock options for European entrepreneurs by SF and London-based venture firm Index Ventures

And it’s worth remembering that, for founders, another decision is whether to give up equity at all. While it can mean preserving cash or adding the right member to the team, there’s a tradeoff in giving up a stake in something a founder started. Plus, it can mean a cap table with more people on it when folks seek investment.

“It can incentivize people, but it’s not without its challenges,” Deb Tillett, president of Baltimore incubator ETC (Emerging Technology Centers), said at a recent Incubate Baltimore event.

For employees, Thomas offered a reminder that it’s also something that can be negotiated, just like any other part of the compensation package. Just like with pay, there’s a gap between what women and people of color often receive when compared to male counterparts.

When thinking about the value of joining a company in the early days, Mustchler said, it's the experience to be part of building something that's even more valuable than any potential payout later.

“My personal plea is to think about it upfront, so you negotiate stronger on equity,” she said. “Women end up with much less ownership than men.”

The potential to get equity isn’t the only thing that makes startups different from a bigger company when deciding whether to join. Nearly everyone we spoke to for this article sounded plenty of notes that had no percentages attached about when asked about benefits for early employees.

When thinking about the value of joining a company in the early days, Mustchler said, it’s the experience to be part of building something that’s even more valuable than any potential payout later.

“The most powerful thing about working for a startup is you will probably find yourself doing things that no one would let you do at a bigger company and you will see things that you wouldn’t see at a bigger company,” Mustchler said. “The level of learning that you will get at a startup is unparalleled.”

At the Incubate Baltimore event, Ann Quinn of Quinn Strategy Group said she talked to an early employee about the promise of leveling up.

“Part of the appeal was that this was a great way to get in, and then she really could think about what’s the next goal we need, and I do I want that, because I’m here and I could then move up into that role and backfill myself,” Quinn said. “In a larger organization that’s much more established, you might not have that.”

For founders looking to offer benefits, Tillett said there’s also opportunity to create an environment that employees want with flexible work schedules, and options like providing free lunch to employees.

“You can make your own rules,” Tillett said.

Sitting next to Tillett, Response Labs founding partner Dan Dawes recalled bringing on the first employees of the ETC-based digital CRM marketing agency, and the importance of shared vision.

“You have to be on the same page with what it is you’re building and why you’re building it and who you’re building it for,” he said.

In that sense, “it was a vision grab, not a money grab,” he said.

_

Technical.ly Philly reporter Paige Gross contributed reporting to this story.