After years of experience working with startup founders and venture capitalists, I’ve learned about many iterations of startup equity compensation. It’s obviously a great motivator for employees and an important way to show you value new hires at your startup. Here’s what I’ve learned about startup equity and how you can apply it to your own company.  

In this post:

1. Why is startup equity compensation important? 

2. 4 tips for managing startup equity compensation 

3. 4 types of equity compensation 

4. Managing your startup equity compensation   

Why is startup equity compensation important? 

Startup equity compensation is a form of non-cash payment in which a startup offers shares of its company — or the option to buy shares — to employees and advisors. Startups sometimes utilize startup equity compensation as part of the compensation package to offset potentially lower base salaries. This is a great way to attract and retain top talent and motivate employees to help make the business successful and incentives mutually aligned. 

The goal in offering this type of compensation is that employees are partial owners of the company. If your company goes public or gets acquired, employees could cash out on that success. Equity compensation is also common among later-stage companies that are no longer considered startups but want to reward employees with more than base salary. 

One of the reasons equity compensation is important for early-stage startups is that cash can be limited. Offering equity allows businesses to augment salaries and non-cash compensation. But it’s important to keep track of who is getting what equity.  

This involves properly updating and managing your cap table. Then you’ll have an accurate view of who owns what stock, or has the option to, and you can check that you’re compensating everyone fairly. Part of that also deals with the equity offered. Let’s look into that a little more below.  

4 tips for managing startup equity compensation 

Oftentimes, the best way to learn about startup scaling strategies is to discuss with the investors who are writing fundraising checks: venture capitalists. 

I recently hosted a PrimeTime VC event with a panel of venture capitalists during which we discussed how early startup founders should think about their startup equity compensation. Here are four things I learned: 

Carefully consider your co-founder split 

If you have an equal co-founder, consider your co-founder equity split. Your options are to split the equity evenly or to have an uneven split. Jesse Middleton, General Partner at Flybridge Capital, and previously on the WeWork founding team says it can be good to have an uneven split.  

“I do think there is value if there is a CEO who is clearly the leader,” Middleton said. “There is value to having one person who has more votes than the others…. it’s nice to sort of balance it that way,” Middleton said at the PrimeTime VC panel.  

Reserve some shares for the founding team 

In addition to their own equity compensation, a founder (or co-founders) needs to set aside shares for their earliest hires. 

 “You're typically reserving roughly 10% for all of the people beyond the co-founders in that first round,” said Middleton.  

This 10% should include shares for your chief technology officer (if you don’t have a founding CTO), a chief product officer, and a chief marketing officer (if you have one).  

“Ultimately most roles are going to be somewhere in the one to three percent range — and that is your founding team of five to six people. Then you'll make a new option pool when you raise your round,” Middleton said.  

Compensate fairly to retain talent 

Zehra Naqvi is a two-time founder and an Investor at Headline Ventures, she recommends using stock to attract and retain your top talent. 

“Startups don't always have that much money and I think people anticipate not getting the best salaries,” Naqvi said. “I think shares should be something that is made abundantly clear about what you’re getting, 

Using your stock to fairly compensate employees is a great way to build trust and get buy-in from your early employees.  

“Always remember that there are future employees to keep happy in order to retain them,” Naqvi added. “Your company is only going to do better when you let go of control a little bit and delegate. But if you aren’t fairly compensating the people you’re delegating to, you won’t be able to retain them long-term. You need other people to be bought in and to help you.” 

Be thoughtful when granting equity  

Always be thoughtful about who you’re granting equity to. Naqvi noted that there will be some advisors who are highly accomplished and who you want to compensate, but it doesn’t necessarily have to be through equity.  

“You should be really choosy with who you're giving shares to,” Naqvi advised. “Find another way to compensate that person and really remember that your employees are what matter most.” 

4 types of equity compensation 

There are several ways to offer employees equity in your business. Here are four common types of compensation for you to consider.

1. Incentive Stock Options

One kind of stock option is an incentive stock option or ISO. With this form of startup equity compensation, employees are granted the option to buy a certain number of shares at a specific grant price, often referred to as the “strike price”. Those options then vest over time or can be tied to company goals. Once vested, the employee has the option to exercise, or purchase, their shares. Incentive Stock Options have special tax benefits if exercised and held for a specified time.  

2. Non-Qualified Stock Options

A non-qualified stock option, or NSO, offers employees the option to buy shares at a designated strike price. They are called “non-qualified” because they don’t meet the qualifications of ISOs. Taxes can be due upon exercising these shares, and upon selling them, but tax treatment may be different depending upon the option type. They can be granted to non-employees too, such as consultants and board members. 

3. Restricted Stock Units

With restricted stock units, or RSUs, employees can simply be granted existing shares of the company. Employees don’t need to exercise an option or buy their stock, instead, they earn shares over time. For private companies, most RSUs vest with a double trigger, meaning in addition to the time component, they don’t fully vest until a qualifying liquidity event occurs, such as an IPO (initial public offering). RSUs are taxed as income, sometimes via a sell-to-cover, meaning some shares are sold at the time of vesting to cover the initial income tax. 

4. Restricted Stock Awards

Restricted Stock Awards (RSAs) are like getting a gift of company stock, but you can't really own it until you meet certain requirements such as vesting or achieving specific goals set by your company. If those requirements or goals aren’t met by the end of the vesting period, the stock is returned to the company. 

Another form of equity compensation you may have heard of is Employee Stock Purchase Plans: An employee stock purchase plan is a public company offering which allows employees to purchase company stock via an automatic deduction from their paycheck. This deduction lowers taxable income for employees. Plus, companies will also sometimes offer a discount for the stock as well. Employees must pay taxes when they sell the stock they purchased. 

Managing your startup equity compensation  

Having interviewed more than 300 tech founders and venture capitalists, I’ve heard of many strategies for handling startup equity. Different founders will experiment with granting different types of equity and different splits amongst their founders and co-founders.  

No matter how you offer your employees equity, prioritize managing it well. Setting yourself up to manage your equity effectively is a great place to start. A platform like Fidelity Privates Shares can help you manage your cap table, data room, due diligence process, and beyond. It’s one of the best ways to have a clear view of your business’s equity.  

When it comes time for another fundraising round, you can confidently evaluate your existing shares and offer a new option pool to your team. This is how you can consistently compensate your team well and bring in new team members to help you grow. 

Equity compensation can be a valuable tool for scaling your company. Remember to use your equity intentionally and thoughtfully as you expand. 

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