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Saturday, February 15, 2014

Employee Equity - The Basics

When people talk about being employed by a start-up company they often talk about “getting in on the ground floor.”  In other words, one allure of employment at a start-up is the ability to see it develop and grow.  As a start-up, how do you leverage this potential opportunity and minimize your cash outlaw?  You have just entered into the world of employee equity or, in other words, offering an employee an ownership stake in the company.  Stated simply, employee equity is the primary tool utilized by start-ups to attract and retain talent.  Equally as important, offering employee equity reinforces a core tenet of startup culture: commitment to the team and the team’s commitment to employees. 

There are many ways your startup can structure its employee equity.  There are also many issues you should think through before signing ownership agreements between your startup and its employee.  Early mistakes regarding company ownership can easily become expensive mistakes down the road when your startup has matured and is actually generating dependable revenue. 

For example, employee ownership levels are highest in places like New York and San Francisco.  Ownership levels tend to lower in other communities.  The particular industry you are seeking to enter (e.g., services, media, engineering, etc.) also plays heavily into ownership levels.  Finally, how early or late stage the Company is at the time the employee joins is yet another key factor to be considered.  Experienced startup lawyers will help you develop an ownership level that is specifically tailored to your startup’s needs.  By balancing these factors (among others) a startup lawyer can help you successfully attract talented people who will commit themselves to your company.

There are also many types of equity a startup can offer its employees and founders.  Understanding these different types of equity can help you make informed decisions on how best to reward employees, attract new talent, and retain employees who have proven themselves.  Basically, there are four types of equity commonly issued by startups to its employees:

Founder Stock: These are shares of common stock that are issued to the founders when they are setting up a new business, adopting bylaws, and appointing officers.  This is called organizing the corporation.  The individuals who are issued such stock are the “founders.”  Usually founders stock has special vesting provisions among the founders to prevent them from leaving the company early and retaining ownership of the stocks.

Restricted Stock: Restricted stocks are stocks that are not fully transferrable until certain conditions are met.  In startups the restrictive condition is usually a waiting period of 3 to 4 years.  These are usually issued to employees or executives that are hired early in a company’s life.  Unlike stock options restricted stocks are owned by the employee when issued.  Therefore they may immediately trigger income tax liability for the employee.

Options: The stock option is an agreement or right issued to an employee to purchase stocks at some point in the future at a set or discounted price.  The option can vest in the future or only after certain performance goals are met.

Restricted Stock Units: These securities have characteristics of both options and restricted stocks.  The employee doesn’t receive the stock immediately, but instead received it according to a vesting plan and distribution schedule after reaching some performance milestone or remaining with the startup for a certain length of time.

At Moisan Legal, P.C. our lawyers can help you make sense of how your startup can offer employee equity in a way that will attract and retain talented employees while also protecting you and your company.


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