|June 6, 2014|
Previously published on May 29, 2014
As your company grows, you may reach a point when you want to bring in big talent, whether it be a new CFO, Director of Marketing, or someone to take your brand into a new space. Many of these so-called “rock stars” may be coming from big Fortune 500 companies with big salaries to match. Your fledgling company may not be able to offer them comparable salaries, but you can offer an obvious alternative: equity.
Founders beware, however: adding the phrase “and equity compensation to be determined as mutually agreeable to the parties” after the dollar number on an offer letter doesn’t add much value unless it has context. It leaves the company in a weaker bargaining position, too. This is where it becomes important to plan from Day One, well in advance of the recruitment of your rock star C-suite. So, how do you give that equity grant some context and make it appealing?
- Start with a Plan. If you know that you will grant equity to your employees, create an equity incentive plan the same day you incorporate your company. While it can be set up later, sure, creating an option pool from the outset will help your attorneys better advise you on how to structure your company’s capitalization table. Think about how much the founders’ shares will be diluted and what the company’s reasonable expectations for equity grants might be in the near term. One rock star employee in the next year? Five? Will you also have board advisors who need small bits of equity for compensation, too? What about low-level employees? What about not-so-low level employees outside the C-Suite, the “lifers” who came on board in the company’s earliest days? While difficult to think about at the outset, putting a plan in place well before prospective grants arise also means that the heavy-hitting C-Suite recruit will have less leverage with respect to changing the terms of the plan when the time comes. If a plan is in place, it provides a basis for granting equity without reinventing the wheel.
- Optics Matter. When you initially determine the total number of shares that the corporation will have (the “authorized capital”), don’t start with a low number: your life will be easier (and your legal fees will be lower) if you start with more authorized capital and don’t need to manage a stock split or increase in authorized capital down the line before you’re forced to do so for a preferred financing. Setting aside issues related to authorized capital and Delaware franchise tax for the time being, from an optics standpoint, an equity grant of 15 shares (with 1,000 total shares authorized, for example) simply doesn’t look as good as an offer of 150,000 shares (with 10,000,000 total shares authorized). Same percentage of shares, but the difference in number can affect a recruit’s first impression about the value of your offer of employment.
- Make it Objective. Before you even begin making equity grants, think about what amount of equity each level of employee should ideally receive. Your attorneys can provide good context about what’s “market” in their experience on this matter. If you start with a basic framework for grants, not only will you be able to ensure that equity grants to current employees are fair, but you will also be able to give valuable context to new recipients when making an offer. For example, you can then offer: “Based on past experience with similar executives, you’re receiving equity compensation that is in line with what other executives like you in our company have received.” No one becomes an outlier inadvertently.
As always, consult with an attorney as you’re making these initial decisions for advice on “market” terms, ideal language for your equity plan and forms of restricted stock or option grants, and working around prospective tax issues.