Granting Equity in Early-Stage Companies
Part and parcel of the American Dream is to be your own boss by owning or operating your own business. These days, a start-up enterprise will usually involve more than one individual. That brings to the forefront the question of how you divide the responsibilities and, along with that, the equity level of each founder.
Deciding the equity levels of the co-founders is step one, but then you need to recruit and retain top-level talent to bring success to your new enterprise. These individuals too will need to be rewarded with equity in the business, as they will no doubt be leaving for positions that pay more, and they will be required to work hard and long to bring the company’s goals into fruition.
Deciding on equity issues can be challenging and tricky. Done right, and the personnel involved will function harmoniously and strive together for success. Done unevenly, or wrongly, and equity distribution can create divisions among employees and even among the co-founders that can retard the enterprise’s forward movement.
If you are involved in a start-up and you need assistance in resolving the many issues of launching a new business, including determining equity shares, contact us at Adelman Law, P.C. We stand ready to help you navigate the steps involved in determining equity levels for co-founders and employees.
Understanding Equity in Early-Stage Startups
The co-founders of a start-up are usually owners, as well. Ownership provides control over the entire operation. Equity, on the other hand, refers to the value of an individual's stake in a company, which is typically represented by shares of stock in the company. An individual with equity in a company may or may not be an owner, depending on the company's structure and the number of shares they hold.
This brings into focus the first awards of equity in a company, which would be to the people founding the enterprise. For two co-founders, a simple equity distribution might be 50/50, but that might also be out of proportion to what each co-founder brings to the table. One co-founder may be more experienced in the tasks involved in bringing the enterprise to success or maybe bringing more capital to infuse into the start-up. Other splits may be more forward-looking.
After that, to recruit top-level executives and employees, you will generally have to provide them with an equity stake. These stakes could range from 0.1 percent to 3 percent or more depending on what they bring to the table. Companies typically reserve approximately 20 percent of the business’s equity for top employees.
Types of Equity Grants
Types of equity in a private business hinge largely on how the entity is organized. If it is a corporation, then shares can be issued. If it is a limited liability company (LLC), membership units can be awarded.
If it is a corporation, then common stock and preferred stock are the two routes to equity. Common stock is generally reserved for co-founders, early executives, and employees. The company’s Articles of Incorporation will define how many shares the entity is creating. The company will then decide how many shares go to the co-founders and how many remain for others to be recruited as major players. Preferred stock, on the other hand, is reserved for investors.
Restricted stock units (RSUs) are also used frequently. However, these equity positions are subject to vesting. In other words, a normal vesting option might be over a four-year window, with 25 percent vesting each year starting with the completion of the first 12 months of employment. After four years, the holders of RSUs can cash out their full shares. Vesting is also referred to as having a cliff to climb: No one can be vested until reaching the cliff of 12 months of continuous employment.
A vesting period can also be established for the purchase of stock options at a pre-set price. After the person fulfills his or her employment vesting requirement, he or she can purchase the shares.
In launching a start-up, you must set realistic expectations and anticipate anything and everything that may arise in the course of operations. A big part of this is deciding on equity and how it is to be distributed and vested. You also must be transparent about your equity philosophy.
You don’t want tensions and animosity to build among your staff over equity positions. “Why did she get 1 percent when I got only 0.5 percent?” Those kinds of questions can lead to staff unrest, and unrest can result in performance issues.
Understand How Your Attorney Can Help You
We at Adelman Law, P.C. have been involved in helping individuals create successful start-ups for more than two decades. We can discuss every aspect of your start-up with you, especially the crucial considerations that accompany equity distribution. Reach out to us immediately when you begin formulating your plan for a start-up.