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Guide to Early Stage Equity

How to issue startup equity to early employees.
Our guide to
covers a very important, yet specific topic around equity. We wanted to provide a more comprehensive equity guide for founders. We will cover vesting, promotional grants, RSUs vs. ISOs, refresh grants, and best practices for communications. As always, we appreciate feedback. Any comments or suggested updates can be sent to
beth@homebrew.co.

Vesting

What is the new best practice vs. standard 90 days?

The short answer is 5-7 years. Every founder should take a look at the company’s objectives as well as its compensation philosophy. It is most common for balancing the idea that an employee is entitled to a longer window because they earned the shares that were vesting. There would have to be a tenure requirement (2 years). What you must ask yourself as a founder… Is this part of your value proposition to employees?

What is the standard/typical market practice?

If an employee is terminated, she has 90 days post termination to exercise any vested options. About 5 years ago there was a debate regarding whether or not this was fair. A 90 day period may make it difficult for some people to pony up cash and there are tax implications. Some employees tend to “rest and vest” where they are past their prime in terms of productivity. They are working but just waiting around for a liquidity event.

The shift to a longer post term exercise window allows employees to exercise their options post term (anywhere from 2-10 years). One nuance with this shift is the tenure requirement (employed for 2 years) to qualify for this benefit.

What about weighted vesting/aka “backloading”? Tell me more.

Typically, 4 years is the time it takes for an employee to vest 100% of his options. There is a 1 year cliff (employee will not receive any shares vested until the first anniversary of your start date). For RSUs (restricted stock units), the vest is 4 years with a 1 year cliff. Then, the employee can vest quarterly or monthly.

Some companies have played around with “weighted vesting” instead of 25% each year over 4 years. For example: company focus is on longer term retention of employees where they give a refresh grant layering more equity on equity that is already vesting over time. If you backload this vesting it helps achieve the objective of making the vesting window longer vs. wider. Here’s the way it could be set up: vest 10% first year; 20% 2nd, year, etc. focuses employees on longer orientation of equity award. This is not the norm for early stage companies. This is more common for executives.

Will weighted vesting/backloading inhibit a company’s ability to hire in an intense hiring market?

It is very uncommon to have back loaded vesting for new hire awards. Even for senior execs, it is a longer vesting period. Often, a sign-on bonus is awarded to balance the 5% vest in the first year. Companies may implement this with very senior employees where you are looking to do refresh grants where there is already a lot of value that is vesting on the table. Or there are shares that will be vesting in the near term. The vesting would need to balance what is already on the table.

Single Year Vesting - What is the rationale?

You may have heard about “single year vesting” with companies such as Stripe, Coinbase and Lyft. This type of vest is contradictory to the traditional idea of an equity vehicle being long term. There are nuances that are not reflected in the press about this.

Why would a company do this? For example, Stripe introduced single year vesting in Spring of 2021. Equity is more about a guaranteed value. This is unique to a company profile where IF your priorities are about attracting/hiring then moving to a phase retaining the brightest, it allows the company to have flexibility to give more equity to give to people who are proven entities in the company. Additionally, it can give employees flexibility where the valuation is growing.

If you give a new hire a 4-year award and the valuation is tripling over the short term, you might be overpaying for the level of talent you are hiring. In Fall of 2021, Stripe will communicate a guaranteed value. Any of the awards thereafter depend on employee contributions and performance. Is there a downside? You aren’t sharing upside for the contribution for that one year.

So what’s the benefit? The candidate has a guaranteed value despite the volatility of the stock price. If she knows that the stock price is increasing over that time, the company is using fewer shares when they are converting a year from the time of hire vs. at the time of hire.

Something to consider…
These programs are interesting and innovative BUT if they are overly unique -- there are communications challenges. Could this be a competitive disadvantage? Yes, if you don’t have a good internal and external communications strategy.


RSUs vs. ISOs

Restricted stock units are fairly easy to understand. You are giving someone a value with an implicit guaranteed value. For early to mid-stage companies, it is unusual to move to RSUs. An option is providing longer term upside in wealth creation. If you use RSUs, you are usually granting about 50% of the shares.
An incentive stock option (ISO) is a corporate benefit that gives an employee the right to buy shares of company stock at a discounted price with the added benefit of possible tax breaks on the profit

When do companies make the shift to RSUs?

It’s a unique profile. Consider the long term trajectory. What is the value proposition?
Company valuation at least 1B as private company/ Inflection point tends to be more @ 3B (according to our sources at Compensia)
Median market cap at time of IPO approx: 9B

What do I need to know about taxes?

When RSUs vest, there is a tax event. As a private company, you don’t want to grant RSUs and immediately require employees to pay for taxes. There is a special way to structure things so options can vest as a private company but taxes are due at the time of settlement which is after a liquidity event.
https://www.schwab.com/public/eac/resources/articles/rsu_facts.htm

Process

When do I need to think about setting up a stock refresh program?

Most commonly, companies set up a refresh program when there is a cohort of employees hitting their 2 year anniversary. The refresh is usually 20-30% of the new hire grant. For high performers, we’ve seen “superstar grants” that may be higher than 30%.

Communications around Equity

Start educating every candidate early in the recruiting process so they have context. There are tools (below) that allow you to compare financial data in an organization.

Market Comps

How do I get current equity information for early stage companies? Here are a few sources we recommend:
: Option Impact is a startup compensation tool that has been used by thousands of companies. With data from over 2200 startups, it's the only source for private company compensation data that is 100% free.
: The Radford Data & Analytics platform, a product of Aon's rewards practice, delivers compensation insights to the world's most innovative companies.
: Designs and implements scalable compensation practices for early stage companies.
- Consulting firm providing executive compensation and other advisory services.
**Another important source of information is the information companies (usually the recruiting team) is what companies are hearing directly from candidates. Companies must pay attention to what candidates are telling you during the closing phase. Recruiters should be proactive when asking for this important data.

Should valuation and % ownership be shared/private?

This depends on where the company is in terms of fundraising stage. As the business model improves and risk drops, candidates need to know less information about the valuation than someone who is stepping in at an early (Seed, A, B) organization. With regards to later stage organizations, the percentage of ownership is so low and won’t have the impact that a candidate wants to have. Therefore, this is less of a marketing tool for later stage companies.
Our hope is that this Homebrew Guide helps founders, employers, and job seekers demystifies how equity works at an early stage company. We promote creating an environment that is employee centric and provides a flexible environment. Communication around equity is essential. Companies must have an internal and external communications strategy. Without a good strategy, it is almost impossible to communicate your company’s compensation/equity value proposition.

Resources

We are big fans of
should you wish to go deeper on equity compensation. You can also find helpful information at
.


Updated: 09.27.21


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