Congratulations — you have a great idea and you’re making it happen. You’ve formed a company, found some desk space to do the work, and you’ve started hiring amazing people. These early hires are going to help you build a profitable enterprise. These hearty souls, your early key contributors, might be a Director of Sales and Marketing or your Chief Technology Officer. And they will deserve (and probably expect) some sort of stock option pool, to reward them for their early loyalty and hard work to help achieve your vision. Particularly when you don’t yet have the revenue to offer market-competitive salaries, you’d like to be able to reward and incentivize your key people with a stock option pool or some other equity sharing plan.
This is where an Equity Pool comes into play. While many people talk about this in every case as an stock option pool, we often refer to it as an Equity Pool because it can either be an actual stock option pool or a share grant program.
An Equity Pool consists of shares of stock set aside for employees and even for non-employees (though with different forms of documentation). You can offer key employee a percentage of your Equity Pool upon hiring, upon a certain landmark or achievement, or to keep them pushing at critical points in your company’s growth. And to answer a question we get a lot: you can, but certainly are not required to, give all employees the same number of options or shares.
How Deep Should Your Pool Be?
How many shares should you set aside for your Equity Pool? We’ve worked with many tech-driven startups and what we can say is this: there’s a big range. The fat part of the bell curve is probably somewhere between 2% and 7% per each key contributor who is not also a founder. When companies create overall pools of up to a certain percentage of profits or actual shares to be used for incentives like these, that pool will typically range from 5% to 20%. The pool might be a little larger when a company is brand new. The pool may be a little smaller when a company is already up and running.
Option Pool Shares for Sale, or Gifts of Shares Over Time?
How that pool of equity shares is documented and shared can also be done in different ways. The primary decision will be whether to establish a capital-O Options program or to grant / give shares to your people.
The capital-O Options plan is the one that a lot of venture-funded startups use, where a share price is established at the time when an employee is first included in the plan. They don’t get their shares right away, but have a share vesting period (four years is pretty common, but plans vary). Once options are vested over time, they can be exercised, meaning that the shares can be purchased for the price that was set at the beginning. The idea is that these employees are getting some real dollar value because the shares will be worth more when purchased than when the price was set. Talk to your lawyer and accountant (both, not just one of them) about the tax implications for your company and your employees, and make sure to have them explain the 83(b) election to you.
The other main alternative is to simply grant / give shares to key contributors over time, based on work anniversaries or key performance milestones for the company or for the employees. These shares are ordinarily taxed as part of that employee’s compensation for the year in which they are given. On these as well, talk to both your lawyer and accountant about how to set up the plan and keep them informed on grant dates, amounts – like you would for any changes in your cap table. An employee Equity Pool can leverage the risk/reward of new hires with your startup, reward an employee with essential skills, and encourage buy-in and shared ownership in the company’s success.