At this point, however, every per cent of equity counts; therefore, it would be wise for founders to have knowledge of how equity works prior to making commitments or entering into contracts regarding equity.
Why Equity Matters From The Beginning
Equity represents a level of ownership within your company. While providing a competitive cash-based salary is essential to employee retention, many companies provide equity to incentivize employee loyalty and alignment toward achieving the company’s objectives.
As a founder, it is vital that you carefully consider how much ownership interest you are prepared to relinquish. Relinquishing too much too soon could limit your flexibility during future funding rounds. Planning equity issues strategically creates opportunities for your employees and advisers while allowing you to maintain sufficient room for growth.
In addition to planning strategically for equity issues, establishing a clear equity plan is critical for avoiding misunderstandings as your company grows.
Create A Fair And Practical Equity Plan
An effective equity plan will reflect the contributions and responsibilities of each individual participating. Each participant does not necessarily require equal ownership in the company. It is advantageous to develop clear policies and procedures for determining the appropriate ownership levels for each position prior to beginning the recruitment process.
Many companies use vesting schedules which allow employees to earn their shares over a period of time as opposed to being issued immediately. Vesting schedules promote long-term participation by employees and serve to protect the company in cases where employees leave the company prior to completion of the vesting schedule.
Maintaining accurate records of each employee’s vested shares and periodically updating your company’s cap table will enable you to understand at any given point in time how ownership in your company has been distributed.
Understand The Financial Side Of Equity
While equity provides a number of potential benefits to a Founder, there are many other factors to consider, including the tax implications of owning Shares in your company. It is best to have knowledge about all tax-related aspects of equity (such as tax reporting), legal requirements, legal ramifications, and compliance with regulatory agencies prior to making decisions about the issuance of stock or other forms of equity. Many founders also find it beneficial to take some time to learn about various tax elections, such as the 83b election for stock options, in order to determine if they qualify for an election that could potentially reduce their federal income tax liability on eligible stock options.
Build A Strong Foundation For Lasting Success
Startup equity is much more than dividing up ownership in your business. When used strategically, equity is a valuable resource that enables companies to hire top talent, drive innovation and growth, and ultimately position themselves to take advantage of future opportunities. As such, Founders who understand the mechanics of equity are better positioned to make informed decisions that benefit both the company and its stakeholders.
