The Importance of Startup Equity
By Pete Petrella, Managing Director
For entrepreneurs, making difficult decisions is almost second nature. From figuring out how to raise precious capital to cutting ties with bad employees or poor clients, preserving the security and longevity of their emerging companies is top-of-mind. Yet arguably the most important challenge that startup founders must overcome involves employee compensation and equity distribution.
In the startup’s early stages, poorly allocating shares of the company can lead to disaster down the road. While focusing on the careful construction of an initial team of employees is crucial in establishing a solid organizational framework, determining an appropriate equity structure for the startup’s first workers can establish the right culture for employee retention and pay major dividends in the future.
Here are some tips for formulating a compensation strategy that can effectively support your startup:
Avoid rewarding unproven employees
While a candidate may have experienced success at larger outside organizations, the individual may struggle to adapt to the fast-paced nature of a startup company. Rather than rewarding employees for what they’ve done in the past, compensate them according to the difference they can make in the present and future. The creation of a lucrative bonus structure, including an incentive-based pay system, is a great way to reward employee performance without having to sacrifice precious equity.
Be disciplined with your employee pool
Inconsistencies in your startup compensation system can spell disaster for your organization. Choosing a fair and disciplined approach with your employee pool throughout the company will affirm your commitment to all workers, no matter their position or level of power. Create a formulaic equity structure that is reasonable based on an employee’s prior experience and period in which he/she joined the company.
Take a conservative approach
It’s nearly impossible to predict an employee’s future performance or envision the long-term state of the startup. Arranging structured compensation reviews can prove to be a great way to evaluate compensation packages for employees. This analysis helps startup leaders to reflect on their employees’ contributions to the company while offering feedback that can improve future performance. A tip for all startup founders: don’t fall into the trap of thinking that compensation is the only version of employee retention – it’s not!
Remember: timing trumps seniority and experience
In most circumstances, the timing of an employee’s decision to join a startup has a disproportionate impact on how much equity is offered. It makes sense: the earlier someone commits to a startup, the more risk the hire is taking on. It’s almost like exponential decay. As the first additions eat up more of the equity pie, the remaining shares decrease over time. That’s why your first hires can prove to be the most essential pieces of the puzzle. If you choose wisely in the beginning, your startup could be well on its way to success.
Keep your eye out for the unicorn employee
It’s important to keep all of these rules in mind during the early talent acquisition stages of a startup’s life cycle. However, exceptions begin to be made for unicorn employees – those with superstar talent and high-growth potential. Rules “go out the window” for these hires, as startups will attempt to entice these employees with a blend of salary and equity to recruit and retain their unique skillset. During periods of economic uncertainty, as businesses are forced to make tough decisions by letting go of quality workers, these unicorn employees may hit the open market. Startups need to remain fluid enough to hire these workers as they become available.
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To connect with Pete on LinkedIn, you can view his profile here.