We get asked by clients all of the time – “How much equity should we give our employees?” Every situation is a bit different, but we thought a quick guide could be very helpful.
Why you need to offer Equity
Attracting and retaining top talent is almost always the difference maker between success and failure, sluggish or rapid growth and ultimately good and great companies. Like most start-ups, you will likely need to provide equity as part of the compensation package since cash can be scarce during the early days. But how much is enough? Although there is not a cookie-cutter answer, the practices described below can help you define your strategy.
Before getting into the nuts and bolts, take a look at this great infographic if you need a refresher on how valuation and equity work throughout a company’s life cycle.
Early Stage Equity
If your company is still more of a vision that has yet to garner marketable value, the standard is to offer straight points of equity to your core team (i.e., 1%, 2%, 5%, 10%). According Y Combinator’s Sam Altman, “As an extremely rough stab at actual numbers, I think a company ought to be giving at least 10% in total to the first 10 employees, 5% to the next 20, and 5% to the next 50. In practice, the optimal numbers may be much higher.”
This gets expensive, especially if you need more than a few core members to launch your vision into a working, breathing company, so move away from points of equity as soon as possible.
Talk Dollars and Cents
If the question of equity is overwhelming and confusing, convert it to a dollar figure. When you talk about equity as dollars instead of the number of shares or a percentage, you may easily compare it to market conditions, other employees and future value. For instance, if you said, “all engineers will get two percent,” that percentage will have different values as your company grows and moves through rounds of financing. Talking about equity as dollars also rallies employees around the goal to increase company worth.
Deriving the dollar value of equity for each employee
We recommend two fairly simple approaches commonly used by compensation consulting firms to determine the dollar value of equity:
Use the current share price
Multiply the employee’s base salary by a fixed, predetermined multiplier
Current Share Price Method
Although your company’s formula may be different, the key is to use a consistent methodology that factors in fully diluted shares and the current company value. (This approach does not apply to the equity given to founders and investors, which should be set by the board.)
Company value = Determine the fair value of your company. You may use a recent offer, formal valuation or market analysis. For our example, let’s say your company is worth $10 million.
Fully diluted shares = This is the entire option pool both issued and outstanding, including common stock issued to founders, issued options and remaining options. For our example, we will assume you have 5,000,000 total shares.
Share price = Company value/fully diluted shares. Your share price would be $2.
Now that you have a share price, it’s easy to back into a dollar value. Let’s say you hire a senior engineer at $100,000 and want to offer $30,000 in equity value. It is presumed that $30,000 will increase over time, which may be factored into the salary assumption.
Now that you have a fair dollar amount, you can back into the number of shares:
Number of equity shares to offer = equity value/share price, or $30,000/$2.00 = 15,000 shares. This translates to .3 percent of the issued and outstanding shares (15,000 /5,000,000).
Once you agree on a basic formula, you can assign percentages to different levels in your company hierarchy.
Remember: If you’ve got anything you’d like to share – we’d love to hear it. And once you are ready to start bringing on key employees – give us a call! We know a thing or two about that….