Equity Compensation for Startup Employees

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A question that is often asked by entrepreneurs and emerging businesses is how much equity to give key employees and new hires.

While there is no correct answer to this question, there are guidelines and key criteria to consider. The key criteria are 1) other compensation and 2) the risk profile of the venture.

Other Compensation:
Equity compensation is one component of an employee’s total compensation. Other components include base salary, bonuses, benefits, etc. For each position and geographic market there are standard compensation rates.

For example, according to Salary.com, an Advertising Manager located in Charlotte, NC should earn between $58,727 and $113,908 based on experience and expertise.
If based on an Advertising Manager’s experience/expertise, their salary should be $80,000, the employer can offer them $80,000 without any equity. Or, the employer can offer a salary of $60,000, with the additional $20,000 offered in the form of equity compensation.

Equity compensation not only helps employers conserve their cash, but it motivates employees to perform better, as they can directly participate in the company’s success. As such, employers should generally opt to utilize equity compensation. Significant equity packages are required when hiring CEOs who generally have to take major pay cuts in order to join a startup.

Risk Profile of the Venture:
The second criteria to consider when determining the amount of equity to give an employee or prospective employee is the risk profile of the venture. For instance, in a high-risk environment, such as a start-up without funding (in which case new employees will lose their jobs if funding doesn’t materialize), equity compensation should be higher than usual.

Conversely, a well funded company, or a company that has already reached key milestones/is less risky, should offer employees less equity.

While these criteria affect the precise amounts of equity that should be offered to employees, Guy Kawasaki, created general guidelines regarding the range of equity that is typically offered to employees based on their position.

Guy’s list is as follows:
– Senior engineer: 0.3% to 0.7%
– Mid-level engineer: 0.2% to 0.4%
– Product manager: 0.2% to 0.3%
– Head Architect: 1.0% to 1.5%
– Vice presidents: 1.5% to 3.0%
– CEO (brought in to replace the founder): 5.0% – 10%

(A study by consulting firm the William M. Mercer, Inc. conducted in 1999 found that the median equity stake among non-founding CEO’s following an IPO was 4.0%).

Finally, it is important to note that equity is typically vested over 36 to 48 months. Vesting is critical as it helps employers retain employees. Sometimes vesting is done in equal installments (e.g., 4% equity stake vesting at 1% per year for four years), while at other times it is done in escalating installments (e.g., 4% equity stake vesting at 0.5% after the first year, 0.8% after the second, 1.2% after the third and 1.5% after the fourth).