The first time a founder sets out to set up a stock plan, also known as ESOP or employee stock plan, he faces many challenges.
They’ve been told they need one, but what is it and how is it done properly?
Your team is your greatest asset in a startup. In the first years of a startup’s life, there are many challenges: the product is at best in MVP status, the brand awareness in your market will be very limited, and there are almost no systems and processes. A team of startups weighs heavily!
Done right, a great equity plan will help attract great people to your company, align and engage them with your startups goals, and help motivate and retain them. Securing a high quality startup team and their focus and passion for the mission is critical.
But stock plans are very hard to get right, especially for new founders.
Here are the top 5 most common and costly mistakes founders make, based on my experience helping thousands of startups with their equity:
1. Founders don’t value their stock plan enough
First of all, let’s emphasize the value of a pre-seed stock plan. A pre-Seed pound with a pre-money valuation of $3 million and a 10% Equity Plan has $300,000 in capital that can be used to pursue the mission. It’s a kind of financing.
It’s funding you create out of thin air and use to build your team and business when it’s hardest to get capital. Almost all founders know how difficult it is to raise the first $500,000 from investors. With your share plan, you can easily create this value.
Even before you pick up pre-Seed, a founder can use the Berkus method and value their company to $2.5 million and make a 10% equity plan and put their equity to work with advisors, consultants, their first hire to get them help get pre-seed – Seed Milestones. That’s $250,000 financing (don’t use it all at once though)!
You can use it for super important things! It is crucial in the first year. Momentum is key here, and these purchases can save you months or years!
- Pay your advisory board in options
- Suppliers/contractors such as engineers or marketers pay in options (sweat equity)
- Hiring that first key hire or two, and balancing their cash pay with options
2. Having no advisors in a stock option agreement
Quality advisors are crucial to the success of a startup. First-time founders have to learn very quickly, and it’s much easier with experienced advisors. But how do you pay them? One thing is certain, people with skin in the game are more valuable to you.
Startup advisors are usually successful, giving back to an industry that has given them so much, and happy to earn equity in the form of options (or perhaps part cash/part options in some cases where advisors are more practical).
If you don’t pay them at all and rely only on goodwill, you’re probably reducing their impact because they’re less focused because they have less skin in the game. If you pay them in options, and they can see that their help will catapult the company forward, it’s worth it to them!
Check out our article on advisory stocksspecifically using the Founder Institute SAFT, to reward advisors.
3. Having handshake deals for sweat equity
Okay, I know it’s extra hectic in the first 6 – 12 months. You have 1 million things to do and you never seem to get over it. And you ask for help everywhere. I understand. I have been there.
But anyone big and experienced in startups knows that stock deals need to be done correctly and will judge you on your efforts.
You need to get good agreements signed with people who help you. Apart from the IP issues (check this out), people should be paid for their work. It’s great that many people will work part cash or part equity and even be paid entirely in equity.
If you don’t have appointments, 2 major problems almost always arise.
The first problem is that you offer too much, or the person thinks you offered them much more than you think. You might think they get 1-2%, and they think they co-found – I’ve seen this happen more than once. It’s an extreme case, but these disagreements are common and cause huge cultural and team issues and delays for startups.
The second problem is that the people who work for justice don’t really trust that they will ever get their justice and are therefore not motivated. If they never see an agreement signed, chances are they will quickly fade away. But if you confidently give them an agreement (including IE assignment) and then a decent grant of options, they’ll be more inclined to dig deep for you.
See also point 4 below.
BC (before Cake) you might have gotten away with this because setting up an ESOP was so difficult and expensive. But now it’s literally a click of the button and you’re looking professional and doing it right!
4. Not building a culture of ownership
If you don’t believe in your team owning and winning together, and don’t believe in it, your team won’t either. Even with equity options signed, you need to convince your team that their equity will be worth something. They know the high risk, but they want to know that you handle stocks professionally and that you work hard to ensure they can participate in every exit or dividend.
You need to show your team that if you win, they win and you treat them like owners. How?
- Make sure your Equity Plan includes rules that are fair to your team
- Give your team of investors updates on valuation, plans for the next round, possible exit or dividend
- Actively work towards liquidity events as much as possible. This can be secondary shares, exit or dividend.
5. Omit international teams
One team one dream! That’s what makes remote teams work.
There must be a belief that everyone is fighting together wherever they are. So what if only some team members can be included in the Equity Plan and others cannot. That’s not good for your culture and team motivation, is it?
For various reasons, it is not common practice to include international teams in Equity Plan. Reasons I’ve seen include: cost and complexity to implement, oversight, intent to do it in the future, lack of awareness, and lack of cultural requirements.
This is all changing. Now equity is expected to be part of the reward in many countries around the world. But why not? Anyone who helps build your startup should benefit. And as leaders, it’s incredibly powerful to help build wealth around the world, especially in countries where wealth creation is life-changing. And this gives hiring teams an edge over other companies that don’t offer equity globally, and
BONUS ROUND: Do not forget to plan your dressing table correctly. Typically, a Series A company has 18% of their shares in stock plans. You need to make sure you budget and plan your stock plan allocation from day 1, leaving enough equity for later hires. I think this needs another article!
Checking out our website and resources for loads of useful information on how to use your stock options as a driver of your company’s value, including a ESOP for Employee Directory, and a ESOP for startup guide.