Employee Equity Management in Startups: Best Practices

by Sarath | May 20, 2020 | Employee Compensation , Employee Equity Management

Let us assume that you have the initial cash you need to set everything up for your business, but the trouble comes later when you look into the cash flow in the future. You are hurting for cash flow, which is the money coming in every month. Because of this, it can be really hard for you to pay your employees, especially the skilled engineers, programmers and others who can make up to six figures a year. The way out of this is by using employee equity in your startup.

The basic idea behind this is to offer your employees a share of your company’s future profits in exchange for lower or at times, zero salaries upfront. But as you do this, you will have to ensure that you manage the equity properly. For this, you will need to follow the best employee equity management practices.

This article will help you with all this. Keep reading to learn about the common practices and more about employee equity in a startup.

What is Employee Equity Compensation?

Employee equity compensation is non-cash pay that represents ownership in the firm. This kind of compensation can take many forms including performance shares, restricted stock, and options. The main idea behind offering equity compensation is to allow the employees of the company to get a share in the profits through appreciation. This can encourage staff retention, especially if there are vesting requirements.

Equity compensation has been in use for many years now by both private and public companies. In fact, it is very common amongst startup companies around the world. Companies that have recently launched their business might lack the initial cash or want to invest cash flow back into growth initiatives. In such situations, equity compensation option works well as it helps to attract high-quality employees and make them stay with the company for a long time.

Common types of equity compensation for employees

Let us say that you decide to give out equity compensation to your employees. Then your next move should be to find out which kind of equity you would like to use. Overall, owners that offer employee equity in their startup can give employees stock options. Stock options offer the right to purchase shares of the companies’ stocks at a predetermined price. This predetermined price is called the exercise price of the stock options.

Stock options usually are offered with a vesting schedule where the employees are allowed to gain control over the option after working for the company for a specific period of time. Nonetheless, stock options have an expiration date. Also, employees are not considered as the stockholders in the company, which means that they do not have the same rights as that of a shareholder. In addition to this, there are different tax consequences for options that are instantly vested to those that are not. So, the employees would have to look into the rules and decide if they should take the plan or not based on different situations.

Under stock options, there are two types namely, incentive stock options (ISOs) and non-qualified stock options (NSO). Out of both of these, ISOs are the only ones available for employees, not for non-employee directors or consultants. These options offer special tax advantages.

The next kind are restricted stock options, which also require the completion of a vesting period. And this can be done all at once after a specific period of time. On the other hand, vesting may be done equally over a set period of years or any other combination management finds suitable.

RSUs are similar, but they represent the company’s promise to pay shares based on a vesting schedule. Due to this, the employees do not gain any rights of stock ownership, including voting until the shares are earned and issued.

The other kind of equity compensation in a startup are performance shares. These are given only when special conditions are met. These could include metrics, such as an earnings per share (EPS) target, return on equity (ROE) or the total return of the company’s stock in relation to an index. Typically, performance periods are over a multi-year time horizon.

Who gets what and how much?

With your decision to offer equity compensation in your startup, it is time to find out how much you would be giving them. If you give them very little, they would take another job that pays them better. And if you give them too much and in the future, if they earn more than you, it would not be so good. So, for deciding this, you need to figure out if you would be offering your employee with a 100% equity compensation or a combination of equity and salary.

On the positive side, providing your employees with equity alone means that you would end up with employees who believe in your business and are willing to work hard to see it succeed. But the negative part about this is that it might eliminate qualified employees who cannot survive without some cash flow during the time it takes to make the business profitable.

As soon as you have sorted out the percentage of the salary that you will be offering to your employees, it is time to negotiate the amount of equity compensation will be offered. While there are no particular guidelines as to how much equity each kind of employee should get as every business is different, there are some things that you will need to consider. These include:

The employee’s predicted impact on the success of the company.
The amount the employee will get in salary pay and how much lower it is than a typical salary for an equivalent position.

Normally, you will be able to get the approximate amount the employee is worth to the company and offer them an amount of equity that is equal to their worth, which would be based on your predicted profits in 12 months. And that is how you will be able to decide who gets how much.

Difference between Employee equity and Team equity

Before you think team equity and employee equity to be the same, this is to let you know that they are very different. Each has been explained in detail below.

Team Equity

Team equity is the split in ownership or equity that the founders of the startup get. It has been seen that most startups split the founder’s equity. But there are many factors that influence how the team equity is divided. For example, if Founder A comes up with the idea or raises the most amount of capital for the company as compared to the other founders, it is very likely that Founder A will get a larger share.

Employee Equity

Employees are issued different kinds of equity. The kind of stock they get is based on the time when they join the company and the role they play. One of the main kinds offered is restricted stock, which is issued commonly to employees who were present during the startup or who are senior executives.

The most common kind of equity offered is stock options. This equity kind is also issued during the startup period of the company. The term “option” is key, as this type of equity confers a right upon qualified employees to purchase future shares in the company at a set price.

Employee Equity Plan Management

Employee equity awards are stock awards and options which might come with additional tax benefits for employees. This means that employees can end up with more profits in their own pockets. And this can create highly motivated employees, which becomes great for the owners. But as you offer equity compensation in your startup, you will also need to work on the employee equity management.

There are a lot of rules that have to be followed strictly where the plans need to comply with legislation and regulations to make sure that the tax rules are implemented correctly. An effective employee equity management solution integrated with payroll and personnel systems makes the task much easier. It will help you keep track of all the shares in your company and the plans as well.

Best Practices to simplify your Employee Equity Plan Management

From the above, it has become clear that offering employee equity in your startup allows your employees to own a piece of your business. Equity plans need a dedicated focus on things like compliance, regulation, tax, and reporting, which all add up to making an equity plan complex to manage.

In short, executing, managing, and administering the employee equity plans can be a challenge – especially since compliance requirements evolve and plan designs shift to suit immediate and future goals. Fortunately, there are some guidelines that you can follow to make sure that your plans become successful in fulfilling their goals. They include:

Design and launch your equity plan in a collaborative approach

The very first thing that you need to do is prepare a proper equity plan. Regardless of if you are expanding into new countries, sizing up an IPO, or even going through a change in ownership, you will need to set a unique set of goals for your plan. And before you can set the goals, you need to understand them since that is where everything starts. If you do not understand your goal, how would you expect your employees to understand it? So, create the goals list first that would help you then create the right employee equity plan.

Educate your employees on how your plan works

Obviously, you want to get the most of your investment. So, it is highly important for you to make sure that the employees see the benefits of joining and know how to enroll in the plan. This means that you will have to talk about your plan in such a way that your employees are able to comprehend easily. And even though a lot of the employees would not need to be convinced, for some, the talk of shares and investment can be something challenging. That is why it is important to communicate with them so that they understand how the plan would help both them and the company. Show your employees all the benefits (and risks) of joining and tell them what they need to do to enroll.

Provide employees access to manage their shares

You will need a cap table application like Eqvista where you can offer your employees a portal through which they can manage their plan. The employees would be able to see their shares, their contributions, alter their personal details, and trade in real-time. And that is not all; you too would be able to work on the employee equity management through the application easily as you set up the plan here.

Use a centralized data system to manage and record

As mentioned above, it has become important to manage multiple plans at the same time. And with this, it has also become highly crucial to integrate data associated with these plans, as maintaining accurate data is vital when you are managing information for employees who are participating in multiple plans. One of the ways to do this is by having a single data source for all employee demographics and plan details.

This would make sure that you do not have to keep maintaining the data changes due to overlap between plans and employee turnover, plan activation, and contribution changes. It will also ensure that all stakeholders have accurate information on an ongoing basis. The way out for this is by using a great cap table application. You will be able to track everything including the process of the employee equity management right from one place.

Support real-time transactions

With the advancement in technology and online transactions, timelines for execution are shrinking and with this, the employee expectations are increasing for rapid return of proceeds. By offering your employees real-time transaction capabilities, you are empowering them with direct links to the market, the ability to monitor their portfolios from anywhere, at any time, and immediate trade processing.

Those companies that have these ideas in their plans can offer online executions, with direct deposits to employee personal bank accounts in as little as four days. And this does not just help the company, but also keeps the employees happy. It’s the best way for the process of employee equity management.

Use multiple plan types to motivate employees

There are a lot of reasons for creating an employee equity plan including but not limited to: retention, motivation, connecting the employee’s performance to the bottom line of the company, creating value for employees, rewarding performances, and more. Nonetheless, consider how employee motivation may differ from an entry-level position to the C-suite, and the diversity of your participants.

In fact, it takes more than just one plan to meet your intended goals. This is why it is important to evolve your current plan into multiple plan types such as stock-settled SARs, share purchase plans, savings plans, RRSPs, tandem SARs, share appreciation rights (SARS), share units, and stock options. And it’s also why you should consider all your options and goals when choosing which plan types are best suited to your company. It is always a good idea to talk to an expert to help you make the right choice.

Automate equity plan administration

It has become more frequent where companies choose administrative solutions that automated processes, lower the total cost ownership, and reduce the risk of transaction and data errors. By choosing automated solutions, you can make sure of consistency and accuracy in processes such as blackout administration, reporting, suspension and termination processes, automating employee communications, option exercises, processing share sales, and generating online plan statements.

Leverage comprehensive reporting tools for audit, control, reporting and compliance

Best-in-class governance needs compliance with evolving legislation such as option expensing requirements, exchange requirements, and privacy legislation. The most effective employee equity management solutions offer advanced reporting tools for expensing stock options, completing monthly securities filings, and board meetings and shareholder governance expectations. Online reporting tools providing search-driven reporting functionality, as well as standardized reports, offer users the best of both worlds by allowing them to leverage the standard report templates required for ongoing reporting requirements and monthly filings.

Additional functionalities, such as easy exporting to MS Excel and access to a complete data history grant users the flexibility to manipulate these standardized templates. Higher levels of reporting functionality allow users to create and produce their own reports by selecting required data fields and formats. This functionality allows administrators unlimited reporting functionality and equips them with tools for any inquiry needs that may develop in the future. One such tool in the market that has all these features is Eqvista.

Control the integrity of your data through system integration

Combining employee equity management with your company’s existing system minimizes the need for manual processes and creates a more efficient and streamlined management system. Along with this, it would also make it easier to control information access and analyze information around your company and to external vendors. With system integration, companies can have direct links to payroll and treasury systems to support distributed payrolls, expatriates, global participants, and multiple currencies.

Automating the withholding process also permits them to run in local currencies, make sure settlement of the company proceeds directly to their designated account, and direct the withholdings to a designated corporate bank account, for seamless execution through all systems. Leveraging the proper technology to create direct interfaces between all systems that track and manage this type of information creates a highly efficient back office – and is a must for efficient equity plan management.

Consider outsourcing

Finally, implementing and managing equity plans is a daunting task that needs the management of many elements including transitioning and implementing new or existing plans, initial planning, tracking and managing new option grants, managing and executing stock splits, granting dividends and more. As you review and plan these processes for your plan, the points outlined above need to be carefully considered.

Additionally, it is important to bring in partners who have technical adaptability, global capabilities, proven results, and experience. It is also vital that they are focused and specialized in the plan-management industry so that you can make your own internal decisions while leveraging specialized expertise to ensure best-in-class equity programs. That is where Eqvista comes in. Eqvista can handle all the requirements you need for employee equity management. It would help you stick to all the steps here and manage the plans easily and effectively.

Why use Eqvista for your Employee Equity Management?

Eqvista is a cap table management and employee equity management application designed to make the complete process of issuing, recording, tracking, and managing shares smooth and easy. It will help you expand your business as you spend less time managing your company’s equity.

Here are the employee equity management features of Eqvista:

Cloud-base Cap table management solution
Managing your cap table in the cloud and share with all relevant parties
Issuing electronic stock (supporting Certificated shares)
Maintaining your equity ledger
Managing all equity accounting
Offering personalized shareholder portals
Creating ESOP (Employees Stock Option Plan), supporting RSU & RSA
Creating, managing and instantly apply your Vesting Plans to shareholders
Supporting all types of Convertible instruments as Convertible Notes, KISS, SAFE etc.
Creating, managing and converting Stocks to Options and Warrants
Waterfall Analysis and Round Modeling
FREE to use (for smaller accounts)

The technical features of the application are:

Compliance with regulations
Defensible 409A Valuations
Automation of many processes
Share the Cap Table with your client or partner and give them access rights
Versioning – you can see the history of changes and logs instantly
Assign different roles to each shareholder

The platform is constantly updated to ensure that the latest technology is up to date to help you in your employee equity management and cap table use. In short, you would be able to follow all the tips shared above by using the Eqvista application. Find out more about the Eqvista app here!