How Compnay's Shares Are Given in Startups
In startups, equity compensation, including shares
and stock options, is a common tool to attract, retain, and
motivate employees, especially when cash resources are limited. Here’s how
shares are typically given in startups:
How
Shares Are Given in Startups
1.
Stock
Options (ESOs)
- How
it Works: Employees are granted options to purchase shares at a
pre-determined price (strike price). The options typically vest over time
(e.g., 4 years with a 1-year cliff).
- Vesting
Schedule: A standard startup vesting schedule is:
- 1-Year
Cliff: No shares vest in the first year. After one year,
25% of the options vest.
- Monthly
Vesting: After the cliff, the remaining 75% vest monthly over
the next 3 years.
- Liquidity: Employees
cannot usually sell shares until a liquidity event (e.g., acquisition,
IPO).
2.
Restricted
Stock Units (RSUs):
- How
it Works: Shares are granted outright to employees, but
ownership is subject to certain restrictions, such as time-based or
performance-based vesting.
- Advantages: RSUs are
simpler than options since employees don’t need to purchase shares; they
are directly granted after vesting.
- Taxation: Employees
pay taxes when RSUs vest, based on the fair market value of the shares.
3.
Performance
Shares:
- How
it Works: Shares are awarded when specific milestones or
performance goals are met. Examples include:
- Revenue
targets.
- Product
launches.
- Growth
metrics like user acquisition.
- Why
Startups Use Them: Ties equity to achieving critical business milestones
during growth stages.
4.
Founders’
and Early Employee Shares:
- How
it Works: Founders and early employees often receive equity as
part of their compensation.
- Equity
Split: The allocation of shares depends on roles,
responsibilities, and negotiations.
- Vesting: Typically
follows a standard 4-year vesting schedule with a 1-year cliff to ensure
long-term commitment.
5.
Equity
Pools for Employees:
- Startups set
aside an Employee Stock Option Pool (ESOP),
typically 10-20% of total company equity, for future employees and key
hires.
- This pool
allows startups to distribute equity to attract talent without diluting
founders' shares too early.
6.
Phantom
Shares or Shadow Shares:
- In some
startups, especially in early stages, actual shares may not be given.
Instead, employees are granted “phantom shares” that mimic the value of
real shares.
- Employees
receive cash payouts equivalent to share value during a liquidity event.
Key
Considerations for Startups Giving Shares
1.
Valuation:
- Startups
must perform regular valuations (e.g., 409A valuation in the U.S.) to
determine the fair market value of shares.
2.
Dilution:
- As the
startup raises funding through investment rounds, existing shares get
diluted. Employees need to understand how their ownership changes over
time.
3.
Liquidity
Events:
- Shares in
startups are typically illiquid until:
- An IPO (Initial Public Offering).
- An acquisition or merger.
- Internal share buybacks offered by the company.
4.
Tax
Implications:
- Stock
options and RSUs have different tax treatments based on when they vest or
are exercised. Employees should consider tax advice when accepting
equity.
Why
Shares Are Attractive in Startups
- Startups
often cannot compete with established companies on salary.
- Offering
shares aligns employees' goals with company success.
- If the
startup grows significantly or exits successfully, employees can gain
substantial financial rewards.
By giving shares, startups create a sense of ownership and
long-term commitment, driving growth and innovation in the early stages.
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