I run a start-up business and want to offer 5-10 per cent equity to two members of staff, without requiring investment from them. How can I make this an exciting offer but what protection do I need?
The story of private business is one that is littered with examples of owners who thought that individuals were indispensable at one point in time but who lived to regret that decision five or ten years later. Equity, once given away, is gone, and you need to stop and consider the consequences of that. Furthermore, you need to think about the situation not just now, but in the future as the company expands and you bring in more people. Having set the precedent now, will you then have to give away more equity to those new people? If so, how much left will you end up with?
Equity can be a very useful 'lock in' and retention mechanism especially since, as is often the case with start-ups, you do not have the ability to pay the same sort of salary to key staff that they might earn elsewhere in a more mature business. It can also focus their interest and motivation on the growth of the entire business, rather than just on personal goals. Additionally, it is a way of securing the services of senior people whose profile and reputation can enhance the business but who you could not otherwise attract. However, even if all the other criteria seem to be met, please do check a) that it really is a motivational/attractive prospect for the given individual, and b) you do have an exit strategy where the equity might have an actual value.
In terms of a) you might find that a long term bonus scheme (as opposed to short term commission) is more of interest to the people involved. If that is the case, you can make the equity offer as 'exciting' as you like, but it will not achieve the desired result. Likewise with b) the individual can't see something that is going to put 'cash in their pocket' immediately, so they really need to understand your vision of where the company is heading and when those shares will have an actual, as opposed to theoretical, value. Your realistic but enthused appraisal of the exit plans should make the offer exciting enough on its own - if not, well that begs the question on where the company is heading anyway!
If after all that you are really convinced that an equity stake is the way to go, then another way of making the offer more exciting is for the staff to work for it and towards it, rather than just give it away now. You can do that by them meeting their goals and KPIs, say over a two year period, after which, and assuming they are still with you, they get their reward. Their feeling of having properly 'earned' their stake ought to be a stronger statement than just handing something out now.
Finally, in terms of protecting yourself, you do need to get a proper legal Shareholders Agreement (SA) set up from the outset, setting out what happens in respect of the shares if they leave the company in every detail - are they bought back, and at what price, or do they revert to the company automatically anyway at that stage? What specific options you choose to include are down to you, but above all, don't cut corners and make sure the SA covers every eventuality and set of circumstances. It is often said that SAs are the business equivalent of the pre-nuptial, but easier to organise! Lawyers cost money, but the legal fees will be far higher in the future to untangle a mess, as will be hidden cost the business and your state of mind.
In short, only give equity away, at the right time, for the right reason, as an appropriate reward for the right performance, and knowing that it sets the right precedent for the future. Ensure that everything is legally covered and agreed.