Startup Employee Equity

[AJS-]

We are currently looking at offering equity in a new start up to 2 or 3 employees. The outline agreement is a 5% stake in the company after 5 years employment. The idea of this is to retain the core members of staff who will be building teams.

The company is privately held and highly unlikely to become listed in that time frame. I've found a few sample agreements online, but mostly related to public companies. Any idea how to structure this in the employment contract?

Total novice at this so any/all advice is welcome.

[Don]

1) Get a lawyer. This will cost less in the long run.
2) What salary discount are you looking at for the 5%? Think about that. None? (Generous - but might be fair since it could come to nothing...). You don't want to feel cheated later.
3) Its a very different thing joining a startup with a business plan to joining a company a year in and on target...or a year in and way off target. Bargain accordingly.

You will want smart, entrepreneurial people who want to work in a team. Not knobbers who want a chance at Dragon's Den.

HTH

[jeremyc]

What is the plan for this equity to be liquid and have any value i.e. enabling the employees to whom it is granted to benefit from it? You say there it is unlikely that the company will be floated, but is there an exit plan for acquisition or longer term IPO?

I assume that the founders and initial investors have a desire for some kind of event to generate them a return. Without it the equity grant is not much of a retention incentive!

A typical startup model is to grant stock options that vest over a defined period (usually four years, but could be five as you suggest). For example 25% of the options every year of a four year vesting period. You also need to consider accelerated vesting in the case of acquisition or some other transaction that provides liquidity for the stock.

As said: get a lawyer who can guide you through all this, not least ensuring whatever scheme is put in place is tax efficient for the company and the employees.

[AJS-]

There won't be a formal salary sacrifice as such, which I know is generous but the two individuals I'm bringing in are motivated to join a start up and taking a basic salary that is equal to their current, and will sacrifice steady commissions and built up clients in their current roles so I feel this is fair.

Regarding the eventual return the main priority is revenue generation for the first few years, it's not an oil well or a gold mine and doesn't hold any patents (it's a recruitment consultancy) so the anticipated return on investment is revenue generated and possible future sale of the business, though sale is likely to be more than 5 years away.

What I'm hoping to achieve with it is retaining and motivating the founding members of the team with possible profit sharing, and if we do sell the business a nice pay off after say 10 years.

One of my fears is that someone will quit after 6 or 7 years and still have a fair sized chunk of the company when they are working for a competitor or building a company of their own. Is this completely unavoidable?

Probably sound advice about speaking to a lawyer, but I'm keen to get as much as I can in place before the lawyer's clock starts ticking!

ETA: IPO is not really on the cards in the time frame that I'm thinking, but that would seem like the most simple eventuality as everyone's stock is just transferred to ordinary tradeable shares. What did I miss?


Thanks

[jeremyc]

AJS- said:

One of my fears is that someone will quit after 6 or 7 years and still have a fair sized chunk of the company when they are working for a competitor or building a company of their own. Is this completely unavoidable?

Talk to a lawyer who can walk you through the options open to you for different schemes. There may be a way to claw back share options grants or equity when an employee leaves, but bear in mind this will represent less of an incentive. The equity (or options) you grant to employees can (and most likely will) be a share class of their own with defined voting and other associated rights. Remember also that in the case of share options they are worthless anyway until such time as there is a liquid market for them.

AJS- said:

ETA: IPO is not really on the cards in the time frame that I'm thinking, but that would seem like the most simple eventuality as everyone's stock is just transferred to ordinary tradeable shares. What did I miss?

Speak to a lawyer. An acquisition or other type of transaction can equally easily generate a tradeable currency for the employees: an acquirer might grant their own stock in return for the employees' equity (which may for example be publicly tradeable) or your transaction terms might agree a conversion of equity/stock options to cash provided by an acquirer.

[Don]

Remember if you go down the separate share classes route that your prospective employees know full well the difference between A class and B class shares! Still - if they're not fronting money or working for free...