How to avoid the most common errors with employee equity plans

Spela Prijon

Benjamin Franklin once said, "If You Don't Plan, You Are Planning to Fail."

Employee equity errors are most frequently caused by not planning ahead and forgetting to include as many factors as you need for a holistically good outcome. Below are the 4 most common mistakes, reasons for them and how to fix them.

1. Oversubscribed pool

Many businesses distribute more equity than is accounted for in the cap table.

What causes this to occur?

Mostly because budgeting does not account for refresher grants. Sometimes it is also due to the fact that grants are up for negotiation.

According to my research, 90% of businesses give out refresher grants, but only 10% of them have a formal strategy in place. In other words, it's likely that the equity strategy is poorly planned in more than 80% of businesses.

Why is it a problem?

An oversubscribed pool means that you granted more than you actually have. You can now either stop granting until the pool is increased in the next financing round (but what happens with the strike price if the share price goes up in the meantime?), ask the shareholders to dilute themselves more and grant more equity now, or decrease the allocations for the new hires.

All of these are difficult to navigate, and sometimes expensive to fix.

How can you solve that?

Start with the employee and ensure that you consider the complete experience from their perspective and make grant plans at each stage:

1. Grant for new hires
2. Grant for promotion
3. Grant for performance
4. Grant for tenure

This will give you a plan that takes into account all possible grants, and you can compare that with the budgeted employee pool. If it's over the budget, you will need to either decrease grants or take some refresher grants off the table.

The compensation philosophy and company values can help you determine which refresher grants your organization should have - and we can help you implement them.

2. Underutilized pool

The other side of the story is when an employee pool is allocated but not used.

For example, a 15% employee pool is available, but only 2% worth of grants are awarded.

What causes this to happen?

Because equity can be complex and opaque, people are often afraid of making mistake #1. As a result, the entire company is under-equitized.

How can it be fixed?

There is no requirement to use the entire 15%, but the founders, investors, and other shareholders experienced dilution to make room for employee grants. As a result, it makes sense to use it as a tool to increase the likelihood of success: attract and retain the employees who contribute to success.

Feel empowered to use the pool; it has already been agreed upon and is available for your use.

3. Over/Under equitization

Equity grants, like salary disparities, can cause problems. Some people negotiate, while others do not, and a company without a granting system is more likely to grant less to those who do not negotiate. Unfortunately, this usually impacts women and underrepresented groups, just like with salary imbalances.

What causes this to happen?

There is no system in place to inform hiring managers about the grants available for the job they're hiring.

How can it be fixed?

Create a system that shows how much each level and department allocates for new hires. This will also assist hiring managers in creating an exceptional candidate experience.

4. Education

If you're having a hard time understanding equity, most likely your candidates and employees are too. I see this as one of the biggest missed opportunities for companies and employees to align on common goals.

Why does this happen?

Most often people don't have time to perform on the job and educate both themselves and then the entire company about a new topic. Which is understandable.

How can it be fixed?

  1. Identify the "busiest crossroads" - meaning, teach the managers and hiring managers and they will now be more equipped to teach the team.

  2. Gather equity documentation in one place, and describe the "Equity philosophy", as well as most common terms of your equity plan.

  3. Use a tool that visually explains grants, vesting, cliff, etc. It makes it more tangible.

Tip: People that understand equity typically do so because they have either gone through the startup process themselves or because they were involved in a big event like an IPO, exit, or acquihire. You can go on a journey with them and create an event where you describe the starting phases, fundraising, and other events to bring the subject closer to the employees that haven't gone through the above - it truly works!

If you find yourself needing help with any of the above, reach out - we're happy to collaborate!

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