Equity Compensation: How to Make Employees Founders
Startups with limited finances should consider using equity compensation. It’s a method for paying salaries, recruiting, rewarding employees, and maintaining cash flow. Yet, few founders understand how it works.
Equity compensation involves giving employees stock from the company. This approach makes them part owners and salaried employees. It replaces or supplements employee payment options
such as variable earnings, incentives, and supplementary wages.
In recent times, employees with stock have benefited when the companies issued Initial Public Offerings (IPOs). Some of them became millionaires overnight.
The stocks offered are either preferred or common stocks. Preferred stock is for investors, whereas common stock is for shareholders.
Read on to learn the process for employees to become partial owners.
Using Equity Compensation to Make New Owners
Currently, there are more than 6,000 Employee Stock Ownership Plans
(ESOP). Having this culture of ownership makes employees value the company more.
Making employees into owners has other benefits:
- reduces employee turnover
- makes employees more productive
- creates a feeling of dedication and responsibility to the company
- generates wealth and grows the company
- rewards employees for their loyalty
- incentivizes skilled workers
There’s always a question mark over whether it’s a good or bad idea
for employees to become owners. To make the right decision, the original founders must consider the nature of their company, its success and its internal relationships.
If they decide to turn employees into founders, here is the process they should follow:
Determine the State of Your Company
Companies in their seed stage will give more equity. Other factors affecting equity distribution include:
Decide How to Distribute Equity
- the date the employee joined the company
- influence on the company
- stock dilution due to demand from new investors
- stage of funding the company is in
Think about the impact of everyone in your company. The more important you are to the company, the higher your stock should be. Founders, key employees, and angel investors will each receive different equity percentages.
Offer Different Stocks
Some companies give employees stock immediately after joining the company. This stock might be closer in price to the stock the founders have.
Companies can also offer Incentive Stock Options (ISOs) that give employees tax benefits. With ISOs, you don’t pay income tax. You will pay the capital gains rate.
Other employees receive performance-based equity. The stock grants they receive depend on their job value and impact on the business.
Choose Vesting Terms and Schedule
Vesting means the length of time it takes for the equity to confer benefits. You must set restrictions on the equity compensation. For instance, employees can only get benefits after the vesting and cliff period.
Such restrictions prevent employees from taking the money and leaving abruptly. The company has to set a schedule for when the vesting periods will be. As an example, it can be on a quarterly basis.
Get More Business Solutions
Giving equity compensation is a subjective issue for the founders to decide on. Though it is necessary for a cash-strapped business to use it, they should take care when determining the recipients. The guide above will help in that process.
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