A crucial success factor for Startups is the skill to manage finances. Almost 80% of startup founders bootstrap their way in. They operate with limited resources, ensuring optimization at every step.
Recruiting a team of experienced, passionate, and skilled talent is thus inevitable. But with limited cash, how can a startup attract promising talent? By offering employee equity!
To learn how, let us first understand startup hiring.
Hiring a great team for startups
Popular wisdom suggests hiring grade “A” players. But you can attract top talent only if your startup has received sufficient investments, brand awareness, and media traction in the early stages. Then does this mean you are stuck with mediocrity? Not necessarily. You might have to rethink the hiring process, and offering employee equity can be key.
Things which impact the hiring of a talented workforce
Workplace culture – Do not skip defining your work culture. How will you attract and nurture promising talent unless you know who suits the company well? Having a talented team without defining basic values, principles, and the best practices of your organization will lead to chaos. Create a workspace your team thrives in. Employee equity here contributes to building accountability.
Off-beat sourcing - Minds willing to risk the startup experience want to 'create'. You can find such passion among professionals and entrepreneurs alike. But you might have to explore unconventional methods for finding talent (e.g. boot camps). Explore where your startup will stand out from the crowd and offering attractive employee equity will increase your chances.
Beyond conventional qualifications – Sometimes a candidate’s muted strengths might make a difference to the team’s operation as a whole . One might not have the relevant job experience, yet studying their engagements beyond their professional sphere might shed light on a crucial skill suited for your startup. Equity for employees will help you keep them invested in the company.
Relevant recruitment –Don’t judge a candidate based on skills irrelevant to the job profile. A communication specialist can be weak at financial analysis and a skilled financial analyst can fail to be a flamboyant speaker. Intelligent employee equity distribution is key to retain talent.
How does offering employee equity help?
Any startup’s priority is to preserve cash and recycle earnings back into the company. It is only logical then to minimize cash handouts. A startup cannot compete with established companies in cash compensation. What then can startup recruiters offer? Equity for employees!
An early-stage startup should reserve 15% employee equity stakes for important players. On a successful payday, the equity’s value could surpass any established company’s salary compensation. Topping this, if your startup succeeds to come out with an initial public offering, your employees holding shares could even become rich! This is how earlier employees at Google, Facebook, Inc., Amazon, Uber, became millionaires.
You can structure equity distribution in many ways. The two most common ones are Incentive stock options (ISOs), usually offered to top management, allowing employees to buy company shares at a discounted price with tax benefits) and Restricted Stock Unit (RSUs), which is employee equity offered as company shares through a vesting plan, without tax benefits).
Pros and Cons of offering employee equity
There are two sides to every coin. Let us discuss the advantages first:
Cash Conservation –For some startups, employee equity might be the only option to bring talent on board. The conserved cash can then be free to use for important expenditures.
Aligns employee’s interest with the business – With equity for employees, a startup’s financial interests align with that of the company. It builds onus and assures them of the nexus between their commitment and the company’s growth.
Limits employee turnover – Most employee equity programs have a vesting schedule of four years with a one year cliff period. An employee gets nothing if they choose to leave within one year. This ensures that your talented resources stay invested in the company for a longer period and appreciate their bilateral growth.
Some of the disadvantages of offering equity are:
Complex process – Different grades of employee equity, timely payouts, tax issues, and tracking/adapting to modifications in the organization structure is tedious. Efficient HR and finance teams have to work hand-in-hand on this.
Transparency – While offering employee equity, a startup may need to be transparent about the company’s finances. This could be an uncomfortable scenario for some.
How to give equity to your employees?
An employee’s entitlement to the company’s shares is a win-win situation for both parties. If both play their cards right, the cash-in could be massive. So how to go about it?
Equity can be given in three ways:
Offer Stock Grants – Offering one share of the company means offering one piece of the company itself. For most early-stage startups, employee equity translates as offering stock grants . It is so because the startup can afford to give away only a small number of stocks at one time. This way they can also give the employee formal rights in the company, ensuring committed accountability. The employee can, in turn, cash in the stocks immediately at market price.
Offer Stock Options – With stock options as equity in a startup, an employee can buy company shares at a fixed price, at rates better than market price. This exchange has to happen within a fixed period (a couple of months to 3 years). These are short term investments. Their limit is defined by a vesting period and expiration date. In contrast to stock grants, by offering stock options the employee is offered an option to buy stocks, and not the stock itself.
Offer Stock Warrants – This is similar to stock options except that the company issues them. All transactions happen with the company. The employee has to pay the company to exercise this option. Employee equity in the form of warrants is also time-bound, but the period is much longer than stock options (as long as 15 years). Thus, a company issues stock warrants to ensure future capital. It is a better long-term investment plan.
How much equity should you offer?
Employee equity can be a complicated process. It is important to understand the true value of the company and be disciplined about equity distribution. Failing to do so to attract talent can cause founders to give away their stake in the company more than they can afford. Employees joining in the early stages tend to own higher equity as compared to the ones joining later. These early joiners are usually senior management.
Broadly speaking, in the early stages, the technical and first-line sales team can be offered 0.15 - 1 percent equity. Senior management including the COO can be offered between 1 to 3 percent. In the case of a CEO, equity can be as high as 10 percent. This may vary based on industry standards. Startup employee equity will also depend on salary compensation. High equity is packaged with a below-market salary and vice-versa.
Several free source tools are available to calculate employee equity. Important factors to keep in mind are the employee vesting period, their position in the company, and their significance.
Conclusion
A startup is as good as its team. It is crucial to source the right talent, nurture them, and ensure their long-term investment in the company. Understanding your employee’s motivation is key, and intelligent employee equity distribution can be a game-changer. As complex and challenging it may be, when done right, it promises mutual gains for the company and employees.