Equity as a Way of Compensating Early Employees

By James Burbank−

For the purposes of this guide to equity as a way of compensating early employees, we will imagine a hypothetical case in which you have decided to finally quit your job and start a new company all on your own. For the purposes of this article, we will also imagine that you do not have too much startup capital and that you are in need of finding alternative ways of compensating your earliest employees.

In short, you have to come up with a way to pay them without actually giving them any salary. The most common and arguably the best way to do this is to give equity to your early employees.

What Exactly is Equity?

If we were to explain equity in its entirety, we would probably need to write a book or two on the subject. In layperson terms, equity denotes giving your employees a stake in your company. The most common way to do this is to provide them with stock options which they can sell down the line. Believe us when we tell you that this is the simplest possible explanation – there are so many legal, tax and accounting considerations to be made that you will definitely need to research this some more.

Why Giving Equity is a Good Idea?

The first and foremost reason why equity compensation is a good idea is that this will do away with all or at least a sizeable part of salary expenses, which was our starting position, remember. However, it is not only about cutting on outgoing expenses with equity compensation. Namely, when people have a stake in a certain company, they will not see it as just a job. They will see this company as part theirs and they will work much harder to make it as successful as they can.

Combining it with Salary

In many cases, the company will not compensate early employees solely in equity. They might pay a portion of market rate cash compensation and make up for the rest of it in equity. Depending on individual cases, the ratio will vary and it will start to move more in favor of cash compensation as time goes by.

How Much Equity to Give to Employees

There is no specific amount of equity that will work in every case, for every company and for all employees. In general, most businesses will set aside between 10% and 20% for the “option pool”, i.e. the employees. Individual employees will get anywhere between 0.10% and 0.5% for manager positions, once again depending on how big their salary will be.

How to “Sell” Equity Compensation

Perhaps the trickiest part of the whole equity compensation for early employees practice is convincing your future employees to actually accept this kind of compensation. The best thing to do is to mention this early in the hiring process, ensuring that they are aware of the fact that you are offering equity compensation. A great start would be to provide them with a plan for the future, financial projections and other types of analysis and predictions that will clearly show your company has future. Remember, a company that has very little chance to succeed hasn’t got a lot to offer in terms of equity.

To be perfectly realistic, equity compensation will limit your hiring pool. Common types of candidates that will accept this kind of early compensation include younger people without experience and/or whose living expenses are still quite low; people who already have a job and are interested in working part-time, waiting out for the big payoff; people whose retirement fund is already sizeable and who can afford not to get paid.

Closing Word

Please, keep in mind that this is a really basic introduction to using equity as a way of compensating early employees. Hopefully, it will answer some basic questions to LivingBetter50 readers who might be thinking of starting a business but who worry that they do not have enough seed money. You can always look up more business articles on this to research this subject more meticulously.

It is definitely an idea worth considering.

James D. Burbank has spent too many years traveling the world as part of his career in the trade show industry. He has seen innumerable businesses succeed and fail all over the globe. He is currently on hiatus, spending time with his family and trying to get his blog, BizzMarkBlog off the ground.