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First Employee Equity: What You Should Know in 2022

Last updated: September 26, 2022
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After you've secured your funding for your startup, it's time to start building your team. Your startup's first employees have the opportunity to make a significant impact on the success of your company. Joining a startup can be a risk for employees, with the company's future in such a volatile state. You need to consider attractive financial options that can attract top talent to help ensure your startup's success.


It's common for tech startups to use stock options and equity that promise a financial reward down the line. When you want to bring on smart and dedicated employees, equity can help build a team committed to finding success.


A motivated startup requires a motivated team. Learn more about first employee equity and how it can help you become competitive in the job market and attract a team that can make a difference for your startup.


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    Why Should First Employees Receive Equity?

    You can't build a startup from the ground up on your own. While you can certainly get your startup to a certain point, you'll eventually need the help of a team to tackle the many aspects of running a business. Equity can be a valuable way to attract smart, dedicated employees to join your team and help you build your business into a successful venture.


    First employees for a startup are a major milestone where it's reached a point past the viable idea, and it's ready to begin development and fruition. Most startups are growth-based in the beginning stages and can't generate enough revenue to help the company grow. Investors are key in these early stages of development to help get the startup up and running.


    Through investors, founders use the funds to create a business that will grow to eventually earn more than they receive from the investors. But until then, founders need to be strategic about where they sink their funding. Employee pay is often seen as either related or unrelated to revenue growth, and paying employees often falls as a lower priority than funding.


    Startups have to offer below-market salaries to their early employees. To be competitive, they can offer incentives and equity for first employees who work hard and stay loyal. By promising payouts of future profits, you can present them with a lucrative opportunity to earn financial compensation based on their work.


    Recruitment

    – Early-stage startups struggle to obtain top talent as they compete with more established companies in their industry. These companies offer robust salary and benefits packages where startups still receive funding rounds to make ends meet. Offering equity is a way to become competitive in the job market and can be appealing to individuals. It allows them to become part of the potential of a great new startup and reap the rewards of success.


    Retention

    – Hiring a team of dedicated employees requires more than just hiring. You want to be able to retain your team for the long haul. You can structure your equity package in a way that is more valuable for employees who stay long-term.


    Motivation

    – Startup employees are more likely to remain loyal, engaged, and motivated to see the company thrive if they are a part of an equity package. First, employees give them a sense of ownership and a sense of being a part of something big. It can be a powerful motivator to perform well and understand the significance of the company's success.


    Startup equity compensation is a key part of startup culture and creates employee ownership. It gives them the motivation and drive to work together to reach a common goal that benefits everyone.


    How Much Equity Should First Employees Receive

    Before deciding how much equity your first employees should get, you want to evaluate your options. You should first understand the types of stock to make the right choice for your company.


    Founder Stock

    – Founder stock is the stock that you, as a founder, give yourself when you first create your company. There are provisions in place to protect this equity. As investors and employees sign on, you give a percentage of your share as an incentive to join in on your venture. Most founders will keep at least 40% of their equity after all rounds of funding and hiring during the startup stages are complete.


    Restricted Stock Awards

    – RSAs are stock grants that employees own shares in from the moment they receive them. RSAs are typically given to high-level employees, or senior figures hired early in the stages of development. RSAs have restrictions in place and are distributed over a vesting period. Restrictions such as retaining the right to have the stocks offered back to the company prevent the stock from being sold to a third party, keeping shares within the company, and preventing any ownership issues.


    Restricted Stock Units

    — RSUs are a common type of equity given to employees. RSUs are granted once a vesting period has been satisfied. Once the vesting period is complete, the RSUs are the employees outright, but they do have to wait on the previously discussed amount of time.


    Stock Options

    – Stock options are an upfront form of equity for first employees. It gives employees the option to purchase stock at a set price at fair market value when issued. The benefit of stock options is it gives employees to continue to purchase the stock at the market value, even if the stock goes up. The stock can be sold at any time for profit, but employees must invest their own money to take ownership.


    Virtual Stock Options

    – Virtual Stock Options are a unique workaround for startups that can help avoid tax and admin complications that can come with equity. Essentially, this option would allow employees to receive a virtual equivalent to a stock option that they can cash in later in their employment. This way, founders remain in control of their startup while still rewarding employees with a financial incentive. It's more similar to a quarterly or annual bonus.


    Choosing the type of equity to give to your first employees depends on what is best for your startup. Deciding how much to give them is dependent on the value they bring to the company. If they are someone who is integral to the development of your startup, you should offer as much equity as possible to get them on board and keep them.


    How to Set First Employee Equity

    Distributing first employee equity begins with a strategy. You want to understand your funding before handing out equity to new employees joining your team. You need to have a healthy balance of an attractive equity offer while still keeping equity for yourself and potential investors. Here is an example of a typical startup equity structure to consider.


    Create an Employee Stock Option Pool

    – Before you decide what stocks to grant your first employees, you need to determine how much of your equity should be dedicated to future employees. You can start with 15%-20% to get the first round of hiring started. After you've begun allocating equity as you hire top talent, you can reevaluate the amount you need as you grow your business.


    Choose the Equity Type

    – Now that you've got a good idea of the types of equity you can grant, you can choose which one would work best for your company.


    Determine the Vesting Period

    – The vesting period you select should be strategic. It's the period in which an employee can earn their allocated stock by continuing to work for your startup. A typical vesting period for a startup is over a four-year period, where employees earn 25% of their stock options annually.


    Most vesting schedules include at least a one-year cliff period in which the employee must stay with the company before vesting actually begins. The longer the vesting period, the more employees are incentivized to stay.


    Decide How Much Equity Each Employee Gets

    – Deciding how much equity each employee receives should be dependent on either the seniority of the role or based on the hierarchy. Startups have a higher chance of failure and usually find it more beneficial to offer the earliest employees the most equity.


    Document Employee Equity

    – Keep track of all of the shareholders, including your first employees who have equity in your company, in a capitalization table or cap table. This document helps ensure you always have an accurate representation of the ownership of your company and a financial document to share with future investors.


    Equity is complex; before hiring a team, you need to understand your options. Getting a handle on setting up equity as a financial incentive can help you create a successful hiring strategy. You can be sure to attract some of the brightest and most talented people essential for every startup.


    Finding investors for your startup can be time-consuming and stressful. When you need the capital to get your startup off the ground, Angel Match can match you with over 90,000 angel investors and venture capitalists in one place. Learn more about how Angel Match works here.