equity options startup

How to find startup investors… one of the most common questions we get asked at SeedLegals. While startups can offer a lot to employees, one thing most can’t offer is a salary at a fair market rate. This brings us to one of the first critical misconceptions about startup equity—your equity is a percentage ownership of shares, not of the company’s decision making. He uses playing blackjack as a metaphor to illustrate how this works. When you receive your shares, you’ll want to think about filing a Section 83(b) Election with the IRS. Dan Martell, the Founder of Clarity, puts advisors into two categories: formal and personal. The EMI Option Scheme is by far the most popular, it has the advantage that the employer pays only capital gains tax on the rise in value of the shares above the agreed option strike price. A guide for how many options a startup should grant, and how potential and current employees can evaluate their option value. We’ll put this in bold, because it should come through loud and clear: if you are paying your employees less than their market rate, they should have a stake in your company. There are many different types of options schemes to choose from in the UK – you can use any of the 4 HMRC approved option schemes or design your own “unapproved” scheme. At an early stage (up to 10 employees) the reports suggest you might expect to give up to 1 % of the total company equity per employee. We chat with Jennifer Justice, President of Corporate Development at Superfly, to discuss why she's such a bad-ass and how she's clawed her way into the inner circles of superstardom. The answer to this question should be based on both how much equity is available in the employee option pool, what is the value of this person and what is a good competitive offer that will incentivise them to stay? In terms of what value of options to give away to non-executive staff members, the general recommendation is that senior-level members get granted 50 % – 90 % of their salary in options, medium level staff member 25 % – 50 %, and junior staff members get granted 10 – 25 %. And when people in the startup world talk about “fairness,” what they’re usually talking about is how their startup equity is split. Equity-Based Options for Raising Startup Capital 13 Mins Read. In exchange for the risk of contributing that money, investors are hoping for a large reward. We’re only human, after all. When you sign on with a startup, your compensation package may include some sort of equity in the company – either stock options or stock grants. But if you’re starting to freak out about who gets what slice of your startup pie, take a deep breath, calm down, and get ready for Startup Equity 101. Co-Founder and CEO of Nextdoor, a social network for neighborhoods, talks about being 'out of sync' with the Valley all around him, and how he and his team have handled recent scandals. Unfortunately, there’s no tried and true percentage or calculation you can do. We’ve put together this article to help you decide, summarising industry-leading reports from Index Ventures and Balderton Capital, and drawing from our own data on SeedLegals to give you a comprehensive view. So how do you determine how much equity your investors get? Startup equity can be one of the most problematic things to come across in your startup. But not every startup is going to offer equity to employees; not every startup is going to offer equity to advisors; and not every startup is going to take on investors. Figure 1 – A graph to show the percentage of shares assigned to share option pools in UK funding rounds of between £200k – £3m on SeedLegals.com. Taking your business to the next level, no matter what stage you’re at, usually requires capital. When compared to America, options schemes in Europe are less generous (later stage European companies tend to have smaller options pools) and less inclusive (European options are far less likely to be offered to all staff members). So before we dive into different ways to split up the startup equity distribution, let’s take a look at what all of these new words actually mean. While there are different categories of investors — family members, angels, and venture capitalists being just three that spring immediately to mind — it’s fair to say that generally investors are going to get a bigger piece of startup equity than advisors and employees, if not bigger than the founders. But this isn’t the method most startups go with, mainly because each founder contributes a different amount of money and/or time. In layman’s terms, equity refers to how much ownership stakeholders have of a business. At these small percentages it is often best to talk in terms of value instead of percentage – 0.1 % of total equity pool sounds a lot less appealing than £20,000 of options at a £20 M valuation. Our data shows that half of UK startups put aside 5 – 15 % of their equity at funding rounds towards their options pool, with 10% being the median. Ultimately, the goal is to work out an agreement about startup equity that works well (enough) for you both. “The first disadvantage of stock options is that they are complicated and most employees require a base level of education to understand them,” James says. and the employee (what incentive package would they prefer?). Here's an illustration from Dustin Moskovitz's presentation, Why to Start a Startup from Y Combinator's Startup School on the chances so "making it" for a startup that has already raised seed funding. To dive deeper into the world of equity, we recommend you start with either this video from Y-combinator explaining your options or t his amazing thread in Quora covering the FAQs answered by experienced founders. We know the younger a start-up is, the more sensitive an issue capital is. Source: Balderton Essentials Guide to Employee Equity. Or put another way, options are the way in which you purchase shares of stock in the startup. Concerns over the cos... You know how on Dragons’ Den the dragons bring a pile of money with them? “But you can be damn sure what they’re willing to give up to make that future possible right here, right now.”. Tools, tips and expert advice to help you close your next investment. But it is important to set guidelines, and both Balderton Capital and Index Ventures have released reports on this topic which we have summarised below. It depends on both what the company is willing to offer and what the employee wants! How much they invest,” Ryan Rutan, Chief Innovation Officer of Startups.com, says. “Many of the companies we work with at Carta invest in educating new hires and periodically host training sessions for existing employees.”, “The second disadvantage is that stock options are subject to the tax code, which can change at any time,” James continues. You’ll need to review your equity package (and understand its tax treatment) or you’ll find yourself facing a really hefty tax bill. “A recent proposal would make it so that stock options are taxed at vest instead of exercise. Eventually, founders need to think about creating an employee option pool — a more disciplined way to award equity over shaving off more shares with each new hire. Every startup will offer equity to some combination of those four categories. He’s in those courtrooms a lot of the time. Shares. Stock grant: “A stock grant occurs when an employer pays a part or all of the compensation of an employee in the form of corporate stock.”, Stock options: “a benefit in the form of an option given by a company to an employee to buy stock in the company at a discount or at a stated fixed price.”, Shares: “a part or portion of a larger amount that is divided among a number of people, or to which a number of people contribute.”, Shares outstanding: “Shares outstanding is the total amount of shares that are held by all its shareholders.”, Valuation: “an estimation of something’s worth, especially one carried out by a professional appraiser.”, Vesting: “Employees might be given equity in a firm but they must stay with the firm for a number of years before they are entitled to the full equity. So an equity investment in a seed-stage startup is an even riskier game than the very risky game of an equity investment in a VC-funded startup. Another idea is to do a bit of both – give everyone in the company a low base value of options on joining, then allocate extra to the key performers as a reward. However, for the VC contacts (and make sure they are not ‘brokers’ if they are not licensed as such), you can offer a percentage (usually between five and 10 percent) from the investment, or a percentage from the issued shares in such investment (again five to 10 percent) or both.”. Startup equity incentive plans typically allow for grants of both flavors, with the specific situation determining which one is used. This small share in company ownership serves to compensate employees for the smaller salaries and job … But here’s the thing: it doesn’t have to be this way. Figure 2 – A graph to show the distribution of equity given to non-founder member c-level executives. Because if anyone who’s getting paid market rate doesn’t get equity compensation, then it stands to reason that everyone who’s not getting their market rate should. To protect against employees who are just signing up to collect a few months' worth of equity, companies use a “cliff,” which is a buffer at the beginning of an employee's tenure when vesting is suspended. So there you have it: a starting point for figuring out how to award startup equity to yourself, your co-founders, your investors, advisors, and employees. The answer to this question, it really comes down to individual/company preference, there is no right or wrong way to allocate equity options. But if you bet $3 and I bet $1, then we shouldn’t split the winnings accordingly.”, In that second scenario, one person was willing to bet three times more up front than the other person. Offering startup equity to early-stage employees makes up for that gap; motivates them to work harder, because they’re now part-owners of your company; and retains them if you choose to vest their stock over a four year period, which is common. Also the larger the company valuation, the more employees you have, so the less of an option pool you have to give away. If you’re looking to create an option pool or issue options with the EMI option scheme, our team are on hand to answer any questions, start a chat with one of our options experts or book an option scheme design call. For that amount, he suggests you can expect about two to five hours per month of involvement from your advisor. Even if you don’t go with the EMI option scheme there are many advantages to creating or choosing a different option scheme, and of course, deciding on which scheme to choose depends on both the company (what size, what stage, how many employees, what are cash flows like, what kind of culture would you like to create?) For instance, if your Cleveland-based startup is trying to set a valuation, you could try to network with founders in Pittsburgh, Columbus, or Detroit instead of more mature startup markets like Silicon Valley or New York.”. For formal advisors, Dan recommends compensating them with startup equity that’s worth between 0.1 percent and 0.5 percent of the company. Stock options allow an employee to buy shares of stock at a fixed price—the “strike price” —in the future. One paragraph in to any explanatory blog post and your eyes are already crossing, your fingers itching for the Facebook tab on your browser because all you want is to clear your brain with a mindless scroll through News Feed. “The best way to really determine the right valuation for your startup is to talk to as many founders as you can – both in your area, and that operate similar businesses,” Mike write. (In fact, just did the math, and 0.1% of an average pie crust is roughly 0.0282 inches. The alternative is paying a combination of the much higher income tax and capital gains tax, with the employer also having to pay national insurance. If the formal advisor is “amazing” and “will also help with the fundraising process,” he suggests going as high as 1 percent. But how do you get and retain great employees if you can’t pay them? One method is simple: Split it evenly and be done with it. An option is simply the right for you to buy shares of stock in the company at a predetermined price in the future. They’ll most likely have a different valuation that they’ve worked out as well and that’s when the negotiation starts. “Personal Advisors: These are people who I turn to for specific advice around tactics and strategy on an infrequent basis (maybe once or twice a year).”. The decision on how many options to give each employee will vary depending on the overall size of your option pool (a bigger pool means you have more equity to give them). For startup founders, company equity (a.k.a. It can give you leverage as a startup that will allow you to compete with the later stage companies. It’s one of the main ways startups compete with high corporate salaries, and aligns employees with company goals, a win-win! Mike recommends checking out Angel List’s valuation calculator, which lets you apply filters like incubators, locations, and markets — to name just three — in your process of figuring out valuation. It’s about making sure the company is being frugal all around, including when it comes to employee compensation. Glassdoor, Payscale, and GetRaised are good places to start on the salary front, and you can sometimes see the equity percentages companies offer on AngelList. While valuation is more art than science, entrepreneur and author Mike Belsito writes that there are some general things you should keep in mind. Giving equity to your employees is a fantastic way to attract top talent in the early days when cash is scarce. One question I get asked all the time by a team founding a startup is how to On the contrary, the advantages of not offering everyone options is that it allows you to be selective with option distribution, only giving options to key hires or star performers as a reward and to really incentivise them to stay with the business. It needs to be given away sparingly. They’re the people who contribute their time and expertise to startups — time and expertise that’s absolutely invaluable as founders often to wear a million different hats and learn on the go. “You’ll get a sense for what your ‘normal’ is. This can be summarised by a quote from the Index Ventures Option Handbook – “On average, European employees end up with only half as much ownership in later stage companies compared to their US counterparts.” But is this an issue? “The experience and / or prominence of the advisors (i.e. While startups often grant restricted stock to very early employees, stock options are the most common type of compensation granted to subsequent startup employees. Bootstrapping isn’t, after all, just about founders saving and scrimping. Share options have become a popular buzz term in the start-up and small business world. Access 20,000+ Startup Experts, 650+ masterclass videos, 1,000+ in-depth guides, and all the software tools you need to launch and grow quickly. “This allows founders and startups to make tangible equity offers to key hires.”. Startup equity is one of those things that it’s fair to say every startup founder without an MBA struggles with. 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