When founding a start-up, there are hundreds of decisions to be made during the course of the early years that can significantly impact your business.
One of these decisions will be how and who you choose to grant equity to.
If you are taking outside funding and hiring employees you’ll need to make these decisions pretty early on and you’ll need to live with them for the life of the business.
When you have something hot, everyone wants a piece of it. People will try and convince you as to why they are worthy of being a founding employee; how they can add value during the early days when you need help getting established.
It is very easy to give in to requests by colleagues friends/associates who might not have what it takes to be a founding employee.
When you have five staff, chances are you need two or three engineer-type people and two business/marketing/sales people. However, if you have a technology product then they should all have a level of technical competence. Finding people that satisfy this mix of skills is not easy.
During the early days you need to be tough and true to yourself as to who is worthy of equity. You need to listen to your instincts.
Chances are your mate who can code or sell is not the right fit. Recruiting the right hires is a process in itself and needs to be done thoroughly, and equity must be granted deservingly.
With this in mind, I am of the opinion that there are only three ways to receive equity:
- Be a founder – This means being the one who incorporated the entity and started with 100% of it. This is the highest risk, but highest return way to own a piece of the action.
- Earn it – This means working for the business over a period of time so that you earn shares that ‘vest’ according to the option pool, usually a four-year vest with a one-year cliff.
- Pay for it – The other way is via an investment in the company at a valuation that is fair to the founders and fair to the investors and leaves enough skin in the game for the founders to be incentivized and raise additional funding if needed.
In my opinion, there is no other way to get equity. At the very early stages when it’s just the founders and no investors it’s very easy to part with equity. However, at this stage it’s unlikely you’ve worked with these people before.
Therefore, it’s risky to just give them something without being able to work together to see if they are the right fit. You need to date before you get married. The same applies in start-ups.
My advice here is not to part with equity (outside of the founders) to anyone until you’ve got a formal investment in place and, as part of the term sheet, insist that all employees, directors and advisors be a party to the option plan and its associated vesting terms. This means that the CFO or the whiz director you’ve just found has to earn their right to own a piece of the business.
As the founder, you can play man in the middle between the option plan terms and your stakeholders by advising them that all stakeholders, including director grants, are subject to vesting.
This removes the need to have those uncomfortable conversations around equity.
My key point is to try and get your vesting terms in place prior to granting equity to anyone (during you seed round), otherwise you’ll end up making promises you can’t keep.
Oh… and as a founder, don’t ever forget the risks and sacrifices you’ve made to get to where you are today. Chances are those people asking for equity are just seeing the tip of the iceberg, but with this is mind: A-grade employees are always worthy of generous equity grants. You can’t do it alone.