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Long work hours, limited work-life balance, low pay… what are the benefits of working for a start-up again? Although what we’ve described here isn’t necessarily typical, it does describe a certain workplace culture that’s a little more prominent in technical centres or start-up hubs like Silicon Valley. However, many employees are willing to deal with some of the downsides of start-up life in exchange for access to your company’s start-up employee equity pool. Find out everything you need to know about how giving equity to key employees works, and how it can help take your start-up to the next level.
What are equity options?
Firstly, it’s important to understand what equity options actually are. Most importantly, they’re not shares of stock. Instead, they provide employees with the right to buy a set number of shares at a specific price-point. This means that early employees of major companies that are subsequently sold or go public can make enormous profits through their equity options package. In some cases, early-stage employees can effectively become millionaires overnight.
What’s the benefit of giving equity to key employees?
So, it’s clear that a start-up employee equity pool carries significant benefits to early employees, but what are the benefits for the start-up itself? Mostly, it comes down to recruitment. In the early days, your start-up may not have an especially healthy cash flow, meaning that you probably won’t be able to offer the sort of high corporate salaries that are necessary to attract top talent.
If you offer equity options, however, the prospect of a massive payday can convince potential hires to take a salary cut and come to work for your firm. Plus, these employees will be motivated to work harder and come up with greater innovations, because they have a direct financial stake in doing so. Of course, this situation is usually only palatable to talented workers if your company has a genuine chance of achieving product-market fit, which, for many companies, isn’t a realistic prospect.
How big should your start-up employee equity pool be?
Decided that you want to start giving equity to key employees? Firstly, you’ll need to work out the size of your start-up employee option pool, i.e., the portion of your company’s equity that’s reserved for employees. Generally speaking, companies set aside around 10% of their total equity for employees, but it’s up to you as to how much you wish to set aside for workers. For example, companies that wish to go down the employee ownership route (like John Lewis & Partners or Richer Sounds) may wish to make a much larger start-up employee option pool.
How much equity should each employee receive?
There’s no definitive answer as to the average equity for start-up employees, but determining how much equity each employee should receive depends on several factors. Generally speaking, early employees and senior employees (i.e., C-level executives) will receive a greater amount of equity – anything from 0.8% and 2.5%. Non-executive employees (i.e., directors, managers, and all employees) will receive lower amounts, 0.5-1%, 0.2-0.7%, and 0-0.2%, respectively. Remember, these percentages are just guidelines, so before you start offering equity benefits for employees, make sure that the finances make sense for your business.
As your company grows, you may be able to offer higher salaries that are more commensurate with the going rate. As such, you may decide to reduce the amount of equity you provide to new hires.
Should all employees receive equity?
The question of whether you should be giving equity for key employees and early employees exclusively, or every employee who works for your business, is a difficult one to answer. If you give everyone an equity stake, every hire will have a significant investment in your business, and the ensuing feeling of “togetherness” may help you to produce a more collaborative company culture. However, if you decide to give equity to all employees, your start-up employee equity pool will need to be bigger. This may dilute the founder’s share, meaning that you have less control over your business.
Ultimately, whether you decide to provide equity benefits for employees to every hire, or just key employees, is a decision for each business to make on its own – there’s no right or wrong answer.
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