Whether it is because founders are strapped for cash and can’t offer top salaries — or they want employees to have a genuine stake in the company they are helping to build — equity packages are relatively common in the startup world.
Equity is often part of a compensation package and, when the conditions are right, returns can be significant. But, equally, the rules surrounding equity — particularly for private companies, which are the vast majority of startups — can be complex.
So how do you know if you are getting a good deal?
What is startup equity?
In a startup, employees are usually incentivised through a salary and equity, the latter often taking the form of options or shares in the company.
Shares give an employee immediate ownership of a stake in a startup.
Options are the promise of ownership of a stake in the company at a set point in the future and at a fixed price.
Option holders only become shareholders when their options are exercised, meaning purchased, and have been converted into shares.
Then there is the all-important vest. To avoid employees joining companies and leaving soon after with a stake, most startups have a vesting period, with employees receiving a portion of their stake each month over (typically) four years.
This often includes a one-year “cliff”, meaning that if you leave before a year you get nothing.
“Vesting terms are driven at incentivising the employee to stay around and contribute to the success of the startup,” Shing Lo, London partner at Latham & Watkins, tells Sifted.
In rare cases where an employee is a “bad leaver” — if they commit fraud or compete with the startup, for example — they may lose all their equity.
How much do employees get?
As a founder, giving a new employee equity gives them a fraction of the upside if you sell at a high valuation later.
According to Anthony Rose, CEO and founder at SeedLegals, the median exit for a company in the UK is about £20m — so if you got 1% equity, that's £200k, or 0.1% is £20k.
So, how much equity do employees actually get?
Well, it differs from business to business and often depends on the stage of the company, its employee pool size and whether the equity calculation is based on the total company equity or employee’s salary, seniority and perceived value to the brand.
Let's say you’re a CTO getting paid £80k a year. In this scenario, Rose says, there's no need for a company to give you any equity — you would work for this salary alone, so any equity they give you is a sweetener.
But if you’re a CTO joining a very early-stage company and it can't pay you anything for the first six months, you might be asked to receive equity equivalent to the market salary instead.
Hypothetically, if a company’s valuation is £1m and the market salary for the role is £80k, you may agree on equity worth 8%.
“The overall employee pool tends to be between 10-20% of the fully diluted cap table of the company,” says Kendall Burnett, London partner at Latham & Watkins.
“A C-suite executive may receive up to 2.5%. Some companies may engage advisors who are compensated with equity in the company — typically up to 1%.”
What does a good equity package look like?
Christian Maskrey is SEO content manager at utilities comparison site AquaSwitch and joined the company in 2022 — two years after its launch.
Initially, Maskrey joined on a part-time basis. Instead of receiving his hourly rate for overtime, he accumulated the option to buy company shares at a lower price than the company's estimated valuation at the time of agreement.
There were 500 working hours worth of stock for him to earn from working extra hours — which he has now completed. Maskrey now works full-time at AquaSwitch and, by choice, no longer gets paid in equity.
“No matter how promising a startup is, most are totally at the mercy of the broader market, like little rowing boats in a huge ocean,” Maskrey told Sifted.
“The reality is that the vast majority of startups don't even make it to their worst-case exit plan.”
A startup employee package typically includes salary, perks and options — and Rose says the more founders load up on salary and perks, the fewer options are needed.
“Companies may have two different types of option schemes,” says Rose.
“One is for the first joiners at the beginning of the company — those early joiners are getting more equity because they're getting less salary, they're taking more risk and they may be able to exercise their options at any time.
“If they leave before the sale of the company, they still keep their shares — and that is useful because the first joiners are getting options to compensate for risk and lower salary.”
Rose says after year five, startups are usually paying market salary, have secured a Series A or B round and may be only a few years away from an exit. Here, he says, it makes sense for exit-only options, meaning employees only get options if they’re still with the company at sale.
There are several types of option schemes — some carry tax advantages, while others don’t.
For a startup hiring employees, EMI options are an HMRC tax advantage scheme that gives employees a stake in the company. The employee pays only 10% capital gains tax when they sell their shares and the company pays no tax at all. This is available to employees only.
If they're not an employee — and are a consultant or adviser, for example — a startup can give them unapproved options that don't carry the tax advantages.
“One thing that's really important to note is if you have employees, you mustn't give them anything other than an EMI grant because it can have significant tax liabilities for the company,” adds Rose.
Employees usually make a return where there is an exit, which can be in the form of a merger and acquisition (M&A) — meaning the sale of a startup to a corporate, private equity or another startup — or an IPO.
If you have been able to exercise them, you may be able to sell your shares in a late-stage funding round — this is often known as a secondary market.
Planning an equity package
Lauren Wong is VP of marketing at Cambridge-based biotech Sano Genetics. She has received various equity packages including stock options, EMI and restricted stock units (RSUs), which are shares used to reward employees.
Wong shares her tips for founders creating their employee equity package:
- Educate employees about the potential upside value and risks of accepting partial equity-based compensation. Many people in the company may be receiving it for the first time and this can lead them to over or under value equity as part of their package. Be transparent about current valuation and potential scenarios for future valuation.
- Consider equity as part of "full package" compensation to attract employees at early stages who may be willing to take a step back in salary in exchange for more equity.
- Plan for tax-efficient structures that, if done correctly, can mean significantly more upside for employees in the long run.
- Retain high performers with additional issuance of equity before they are fully vested to avoid diminishing incremental earnout potential after a four-year vest, for example.