Someone on Quora asked:
What is the best way to compensate a contractor with equity at an early stage-startup?
Let’s say I’ve got 1M shares assigned to founders, representing 100% of the stock set forth in the articles of incorporation. Bootstrapped, without any non-founder investment, and without any outside professional help toward a valuation (i.e. no venture money to validate the value we think it’s worth).
What options (pun intended), do you recommend to accommodate and motivate an eager outside talented person who’s driven by equity and not cash? We’d appreciate the value this person can contribute and they’re eager for equity over cash.
Here was my response:
If you have issued out 100% of your stock, you’re going to have to rewrite how many shares your company has. If you plan to raise money later, then you’re still going to have to rewrite your share issuance.
I mean, you can take the shortcut and give out equity from your existing pool of 1 million shares that is already allocated, however at the end of the day, you’re still going to need to rewrite the share structure.
Personally, I write up my companies with 10 million shares issued to the founders and charter employees, however my articles indicate I have a total of 50 million allocated to the company, to prevent issues like this from arising. With this kind of allocation, you can give away equity to any contractor or investor without any real paperwork issues.
You may be wondering, how does writing more equity than what is issued prevent issues like this?
It’s quite simple. If you allocate out 10 million shares to your initial team and you have to give away 50% of your equity to an investor, you have a total of 15 million shares distributed and in use. If you need to go through another round and issue out another 50%, there would be a total of 22.5 million shares distributed out. If you need a third round of financing, you’ll have 33.7 million shares distributed. You still have enough equity to raise a fourth round, if absolutely necessary, at almost 50% of your equity for a total of 50 million shares, however that would be the absolute worst case scenario.
It would be quite ridiculous to give away 50% of your equity each time you went to raise funds, however sometimes you have to do what you have to do…
So now, to your question…
If you’re profitable, then maybe 1-2% of your shares would be enough to motivate a contractor. If you’re not profitable and you need the help, 5-10% might be a better choice.
Personally, I start companies with three cofounders, each taking on 1.5 million shares each. I set up a holdings company to take 1 million shares. 5.5 million of my 50 million shares are issued out to the founders. I use the 4.5 million for the rest of my staff.
I set aside 1 million of those shares for my future employees and another 1 million shares for board members, and then utilize the rest of the shares to distribute to contractors that I may need, such as photographers, designers, programmers, etc.
Since I only have 2.5 million shares left over to build with, aside from what may be used to raise capital, if necessary, I usually pick a number between 100,000-300,000 when I issue out shares to those contractors and/or partners, depending on how useful I believe them to be. If I need someone to fulfill a VP or C level position, I would consider 500,000 shares.
Then I make sure everyone’s shares vest, including mine, to decrease my margins for error in case someone was to quit or be unreliable. I would then have enough shares available to issue to a replacement. In case the employees work out, I would insert a clause for future salaries, contingent on the company being profitable.
Most other founders would say that you shouldn’t offer as much equity as I do, however that would be a personal preference. If I’m taking your help and this is successful, I would rather have you reap some rewards.
So, since your founders have a million shares, I would recommend you issue somewhere in between 10-50k shares to your contractor.
Using low numbers really isn’t visually appealing though, since most start up employees usually get thousands of options a month from their compensation packages.
It may be time to restructure the shares at your company, especially if you plan to raise money down the road.
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Originally posted on Quora.
Leonard Kim is Managing Partner at InfluenceTree. At InfluenceTree, Leonard and his team teach you how to build your (personal or business) brand, get featured in publications and growth hack your social media following.