Startup employee equity: how to grant it to early hires

Why set up the option pool at incorporation?

If founders take all the authorized shares, the company has to amend its charter before it can grant anything to employees. A plan with a reserved pool avoids that. It also covers two legal requirements:

• Rule 701: this rule under the Securities Act lets a private company issue equity to employees, directors, officers and certain consultants without registering it with the SEC. The equity has to be issued under a written compensatory plan or a written compensation agreement.
• ISOs: these can only be granted under a plan that stockholders have approved.

Rule 701 has limits, though early-stage companies are almost always well inside them. In any 12-month period, the equity a company sells under the rule can’t exceed the greatest of $1 million, 15% of its total assets or 15% of the outstanding shares of the class being granted. For options, the amount is the exercise price times the number of shares granted. If sales in a 12-month period go over $10 million, the company must give recipients extra disclosure before the sale, including a summary of the plan, risk factors and financial statements. It’s time to check where you stand once your 409A climbs, the board starts approving large executive grants, you begin granting RSUs or you reprice options.

At seed, a pool of about 10% of fully diluted shares is common. See Employee Option Pool.

What type of equity should early hires get?

At Westaway, we issue restricted stock to the first hires until the company gets its first 409A valuation. After that, we grant ISOs to US employees and NSOs to everyone else. Advisors follow the same pattern: restricted stock early, NSOs later. See Startup Equity Compensation.

How much equity should early employees get?

Two rules of thumb help:

• The first ten employees together usually get about 10% of the company.
  • Hires one through five typically get between 0.25% and 3%.
  • Hires six through ten typically get between 0.10% and 1%.
• More equity means less cash. Someone taking a salary well below market will expect more equity. Someone asking for a market salary should get less.

These ranges shrink quickly after a seed round. Treat them as starting points, not rules. Whatever you settle on, put it in the offer letter as a share count. See Exact Share Numbers.

How should early employee equity vest?

The standard is four years with a one-year cliff, then monthly vesting. Say an employee is granted 48,000 options:

• Nothing vests in the first year.
• 12,000 options vest on the one-year anniversary.
• 1,000 options vest each month after that until all 48,000 have vested.

The cliff gives both sides a year to see whether the fit works. If it doesn’t, the employee leaves with nothing vested. See Vesting Schedule.

What happens when an early employee leaves?

• Unvested options go back into the pool.
• Unvested restricted stock can be bought back by the company at the original purchase price.
• Vested options have to be exercised within the window set in the grant, often three months after the employee leaves. If they aren’t, they expire.

See What Happens to Startup Stock When You Leave. See Founder Guide: Equity and Hiring. If you’d like help setting up your equity plan or sizing grants, contact us.