Employee Stock Options

When it comes to how to pay your employees, there are two options: salaries and bonuses or stock options and equity. I prefer the former, and I’ll tell you why. Salaries and bonuses are paid once. It’s a no-brainer, and it has no effect on the piece of the pie that is the company as a whole. There’s no real repercussions to your start up.

But some employees value equity or stock options over salary or bonuses, and these employees have to be dealt with carefully. For instance, I think there has to be a vesting period of at least a year for the best employees in the company. Ninety percent of the time, I’d prefer the vesting period to be at least three years. This assures me that after two months an employee doesn’t run off with part of the company.

When it comes to deciding whether you want to offer employees stock options, you want to be sure that you’re offering equity to the employees that are going to propel your company forward in a significant way. Even if your employee is the best engineer that you have, I’d only consider offering them two to three percent equity in the company. Granted, this can be an incentive for your employee. It may make them feel as if they’re more connected to the company’s success. But stock options dilute over time.

Most stock holders hang on to anywhere from 10 - 60 percent of the pie once founders and the first round of employees or investors have taken their cut. The more people who are included in the pie, the less pie there is to share. Each time an employee is given stock options, your slice of the pie gets a little smaller — so does your control over the company.

A friend overseas has a developer who owns about seven percent of the company. This means they have voting rights and some control over the company. All this would be fine, except this person is trying to block funding and is making life difficult for the people still running the company. And that’s the risk you take when offering employees stock options in a start up. You have to ask yourself: Is it truly worth it?

What are your thoughts about offering equity in a start up?