Equity compensation is a way of giving employees a share of ownership in your company. This can be a powerful motivator, as it gives employees a vested interest in the company’s success.
There are a variety of equity compensation methods available, and the best approach for your company will depend on a number of factors, such as your stage of development, your industry and your budget.
Standard Equity Compensation Methods
The most common equity compensation methods are stock options and restricted stock units (RSUs).
- Stock options give employees the right to buy shares of company stock at a predetermined price (called the “strike price”) after a certain vesting period. This can be an attractive incentive for employees, as they can benefit from the company’s growth and potential future success.
- Restricted stock units (RSUs) are grants of company stock that become available to employees after a vesting period. Unlike stock options, RSUs have no strike price and are typically taxed at the time of vesting.
Standard Vesting Practices
Vesting is the process by which employees earn their equity grants over time. There are a number of different vesting schedules that can be used, but the most common is a four-year vesting schedule with a one-year cliff. This means that employees earn 25% of their equity grant each year, but they must stay with the company for at least one year before they can vest any of their equity.
There are a number of reasons why companies use vesting schedules. First, vesting helps to ensure that employees are committed to the company for the long term. Second, vesting helps to protect the company from employees who might leave the company shortly after being granted equity. Third, vesting helps to align the interests of employees with the interests of the company. By vesting equity over time, employees are incentivized to stay with the company and help it grow.
There are a number of different vesting schedules that can be used, and the best schedule for your company will depend on a number of factors, such as your stage of development, your industry, and your budget. If you’re not sure which vesting schedule is right for your company, it’s a good idea to consult with an attorney.
Innovative Equity Compensation Strategies
In addition to standard equity compensation and vesting methods, there are a number of innovative strategies that you can use to attract and retain top talent.
- Tailor equity compensation to employee roles and preferences. Not all employees are the same, and what motivates one employee may not motivate another. By understanding the unique needs and preferences of your employees, you can create equity compensation packages that are more appealing to them.
- Incorporate performance-based equity grants. Performance-based equity grants can motivate employees to contribute to the company’s growth more directly. By tying equity grants to specific targets, such as revenue growth, customer acquisition, or product development milestones, employees are incentivized to work harder to unlock their equity rewards.
- Use equity pooling for collaborative teams. Equity pooling is a new approach to equity compensation that involves pooling equity grants for teams working on specific projects or departments. This approach encourages collaboration and fosters a sense of shared ownership among team members. As the team achieves its goals, the equity pool is distributed among its members, incentivizing cooperation and joint problem-solving.
- Offer dynamic equity allocation through ‘dynamic slicing’. Dynamic slicing is an innovative method for allocating equity that adjusts each employee’s ownership percentage based on their ongoing contributions. This approach ensures that equity is fairly distributed among employees, accounting for changes in roles, responsibilities, and contributions over time. By adopting dynamic slicing, startups can maintain a more accurate reflection of each employee’s value to the company.
- Implement time-based equity grants with accelerated vesting triggers. To further incentivize long-term commitment and reward exceptional performance, startups can consider implementing time-based equity grants with accelerated vesting triggers. Under this approach, employees earn their equity grants over a standard vesting period, but the vesting schedule can be accelerated if specific performance or milestone triggers are met. These triggers can be tied to individual achievements, team successes, or company-wide milestones. By incorporating accelerated vesting triggers, startups can encourage employees to strive for excellence and remain committed to the company’s long-term success while rewarding those who make significant contributions.
- Be transparent with your employees about your equity compensation plan. Employees should understand how equity is granted, how it vests, and how it can be valued.
- Get input from your employees on your equity compensation plan. Employees are the ones who will be most affected by the plan, so it’s important to get their input and feedback.
- Review your equity compensation plan regularly. As your company grows and changes, so too should your equity compensation plan.
In today’s competitive startup market, equity compensation is an essential tool for attracting and retaining top talent. By understanding the standard and innovative equity compensation methods available, you can create an equity compensation plan that is tailored to your company’s needs and that will help you build a successful team.
If you’re a startup founder or investor searching for expert guidance on equity compensation or other legal matters, please contact me, Jason Acevedo. I’m happy to help you navigate the complexities of equity compensation and create a plan that meets your goals.
Author, Jason Acevedo, is a partner in the Corporate and Securities Department.