In the tech world, startups sometimes offer equity to employees instead of cash. Equity-based compensation is a great way to keep employees devoted to your company, but handing it off comes with plenty of cons as well.
What Does It Mean to Give Employees Equity?
When you give employees equity in your startup, you’re giving them partial ownership of the company. Depending on the terms of your deal, this may give them the right to sell their ownership rights, which you might not be happy about down the line. Giving employees equity, typically in the form of stock or options, has complex legal and tax implications. Plus, it complicates your accounting and personnel paperwork.
The Pros of Giving Entry-Level Employees Equity
If you’re running a tech startup, the top talent you seek may expect equity as a condition of working for you. Having partial ownership in the company can boost loyalty. As the head of your company, you know you have to wait for a big payout, and when your employees have equity they share that long-term attitude. Depending on how you schedule the vesting of equity, you can also keep employee turnover to a minimum.
Giving out equity also benefits your company. As a startup, your funds might be tight. Giving out equity lets you reduce the money you need for salaries. That means you’re also less likely to hire someone looking to cash out at your expense, and it reduces the need to raise funds. Finally, you may be in need of some serious talent as you get started, and handing out equity gives you a chance to snag the right people.
The Downside to Entry-Level Equity
Equity-based compensation is complex. Very complex. You need to talk to a securities attorney to make sure you’re complying with securities and anti-fraud laws and a tax attorney to handle the complicated tax implications. When an employee with equity leaves, the restructuring that’s involved gets complex all over again. Selling your company is also more complicated if you’ve given away equity, as many purchasers may want to buy 100% of the company. What are you going to do if one of your equity-holding employees balks at the sale? By the same token, since your employees’ shares are essentially worthless until you sell the company or take it public, they may pressure you to sell when you don’t want to.
You also give up a lot of privacy when you have shareholders. Are you prepared to open up your books to your equity-holding employees? You may also find that your employees aren’t up to the task of ownership and shy away from some tough decisions that come with the territory. Finally, when your company starts to turn a profit, you may discover you were too enthusiastic about what your employees could bring to your business and gave away too much of the company.
Weighing the pros and cons of offering equity to entry-level employees is crucial, especially if your company is a tech startup. Look past the current needs of your business to make a decision that’s right for its future.