Recruiting talent for startups is often referred to as “selling dreams,” because there’s never enough dough to pay people what they deserve. Compensation packages are usually a mesh of modest salaries, opportunistic equity stakes and access to office ping-pong tables. Equity may sound great at first, but the allure of owning part of the next billion-dollar company loses its luster when that unicorn starts to look more like a starving pony.
A question VCs often get from founders is how to secure the best talent without breaking the (often very small) bank. While there is no standardized formula, the theme we emphasize is transparency. Using equity to recruit talent is more complicated than divvying out pieces of pie, and finding the right balance of cash and equity for employees relies on everyone knowing what they are getting into. Here are highlights of what you need to discuss.
Equity vs. Options
While founding partners often split up equity, employees are usually given options. Although both align compensation with value creation and exit outcomes, they are not the same. Equity is granted stock; options are the right to purchase stock at a certain price (even if it’s just $1 per share). Founders like the idea of giving options since they are exercised only in successful outcomes or exits, giving employees the same perks as equity but helping the business avoid a slew of legal, governance and reporting headaches.
Common vs. Preferred Stock
Employees usually receive grants of common stock, not the preferred stock typically sold to investors. Both represent similar ownership in the company, but preferred stock generally carries a dividend payment and a liquidation preference that can greatly affect common stock benefits. When a business starts rolling in profits, dividends are paid first to preferred shareholders at their negotiated rate before they are scattered to others. In a failure, preferred shareholders get first dibs on liquidated assets, often leaving common shareholders with little or no consideration at all.
Founders need to decide on a vesting schedule and make sure employees fully grasp its implications. Both sides need to reach a balanced agreement between a smaller equity offer with a more aggressive vesting schedule and a larger offer that requires a longer commitment. Unfortunately, every position and employee has a different value to the company, which makes vesting schedules almost impossible to standardize.
When recruiting top talent, we often advise companies to use a sliding matrix of salary and the variables above to negotiate with each potential employee instead of slamming everyone into the same static offer. Trying to do the latter may seem as transparent as you can get (“Everyone gets the same deal!”), but people resent this approach — especially the experienced and talented early hires who are going to make or break your business.
That said, if you’re transparent and fair and still can’t find a middle ground when compensating with equity, well, you could always try more ping-pong tables.