Early-stage companies face a few unique challenges when it comes to offering equity.
While it’s a powerful tool for attracting the right investors and employees, offering equity compensation also comes with dilution concerns, complexity, and required resources.
We highlight some of the things early-stage companies should be aware of when implementing these types of programs. You’ll learn the difference between offering investors and employees equity, and why offering employees equity is so important for early-stage companies.
Offering Investors Equity
To reward investors for the risk they’re taking by funding your early-stage company, founders need to give up a significant portion of equity. As the startup grows and proves its success, investors will usually offer better terms: paying more or accepting less equity in exchange for funds.
Concerns when offering investors equity in an early-stage company range from how much capital to raise, all the way to the nuances of super pro-ratas and concerns around dilution. Each of these subjects could have its own blog post, so we want to keep things simple and offer a few helpful rules of thumb to keep in mind when it comes to sharing equity wisely.
Generally speaking, the money raised early on is the most expensive money that startups ever take. This is because initial investors are receiving equity when the company is its least valuable. So every dollar invested buys a proportionally larger stake in the company.
As a result, influxes of investor capital provide room to grow the business, but can also come with the expense of limited control and room to maneuver later on. Deciding how much capital to take from early investors requires a nuanced balancing act between these tradeoffs.
Offering Employees Equity
Like investors, employees are also taking on a certain degree of risk when joining your company. Equity is a powerful way of rewarding these employees, and positioning your company to attract future talent.
Equity inspires employees to reach new heights of performance and operate with an “owner’s mindset” by providing them skin in the game.
When it comes to retaining this talent, equity is once again a powerful tool, as a profitable exit, buyout, or IPO can mean a major payday for early-stage employees.
Again, the concern here often revolves around how much equity to offer. You can get some general benchmarks for how much equity compensation to offer talent from guides like Index Ventures and the Holloway Guide to Equity Compensation.
There are many variables when determining how much of an equity stake to offer an employee, including:
- Skillset and experience
- Seniority and position
- Original contributions to the company
While each situation is addressed individually, it’s typical for more equity to be given out during the earliest stages of the company, and for the percentages to diminish over time.
Mitigating Risk While Offering Equity
Equity is an attractive way to generate investor capital and a potent tool for igniting an ownership mindset among valuable employees. But it can come with risks if it’s not handled properly, or doled out indiscriminately.
For growing early-stage companies with a lot on their plate, it’s easy for the management of the equity compensation program itself to fall on the back burner. Some companies decide to internally manage their equity compensation plans on spreadsheets, while others outsource it to vendors who don’t oversee all aspects. This can leave companies vulnerable to a multitude of risks once the business gets bigger or expands globally.
That’s why if you’re going to embrace the benefits of equity compensation, it’s critical you find the right partner to design, implement, and manage the program effectively and without putting the company at risk.
At Infinite Equity, we offer end-to-end equity solutions which allow our clients to benefit from all aspects of plan design and implementation, from employee adoption, to education, financial reporting, liquidity programs, stock administration, and consulting on how to distribute your equity wisely.
We partner with clients to implement and manage equity compensation programs that encourage a culture of ownership and all of the benefits that come with it. To learn more about end-to-end, early-stage equity solutions that can ignite your culture of ownership, contact us today.
