A founder faces numerous difficulties while setting up an equity plan, sometimes referred to as an ESOP or employee share plan, for the first time.
One has been suggested to them, but what is it and how is it carried out properly?
In a startup, your greatest asset is your staff. There are many obstacles in the early stages of a startup’s existence: the product is at best in MVP level, brand awareness in your market will be very low, and systems and processes are essentially nonexistent. The staff at a startup moves a lot of material!
When implemented correctly, a great equity plan may help your business attract incredible talent, involve that talent in achieving your startup’s goals, and keep it engaged and motivated. It is essential to assemble a top-notch startup team that is passionate and focused on the purpose.
However, equity arrangements are extremely challenging to get correctly, particularly for first-time founders.
Here are the top 5 mistakes founders make that are both frequent and expensive, based on my experience assisting thousands of firms with their equity:
1. Founders don’t place enough emphasis on their equity plan
First, let’s emphasise the importance of an equity plan during the pre-Seed stage. $300,000 of financing is available in a pre-Seed pound with a $3 million pre-money valuation and a 10% equity plan to further the mission. It is a form of financing.
When it’s hardest to raise money, you produce money out of what appears like thin air and utilise it to expand your team and business. Most founders are aware of how challenging it is to raise the initial $500k from investors. You easily create this value with your equity plan.
A founder can use the Berkus Method even before raising pre-Seed to value their company up to $2.5 million, construct an equity plan that includes 10% equity, and use their equity to work with advisors, consultants, and their first employee to help them reach pre-Seed milestones. You have access to $250,000; however, don’t spend it all at once.
You can use it for really crucial things! In the first year, it is crucial. The key is to move quickly because these purchases could save you months or perhaps years!
• Using choices to pay your advisory board
• Offering options (sweat equity) as payment to suppliers and contractors like engineers or marketers
• Making the first or second major hires and balancing their cash salary with stock options
2. Ignoring advisors in a stock option transaction
A startup’s success depends on having competent counsel. First-time entrepreneurs must pick up new skills rapidly, which is made much simpler by knowledgeable advisors. How do you pay them, though? There is no doubt that individuals having stakes in the outcome are more valuable to you.
Startup advisors are typically prosperous, giving back to the sector that has given them so much, and delighted to receive equity in the form of options (or possibly a combination of options and cash in some situations where advisers are more involved).
They will probably have less of an influence if you don’t pay them at all and solely rely on goodwill because they’ll be less motivated because they have less at stake. They will consider it worthwhile if you pay them in stock options and they can see how their efforts will propel the business forward.
Check out our essay on using the Founder Institute SAFT to pay advisers and Advisory Shares in general.
3. Having agreements on handshakes for sweat equity
Okay, I admit that the first six to twelve months are the busiest. You have a million things to accomplish, and it seems impossible for you to finish them all. Additionally, you are seeking assistance everywhere. I understand. I have visited there.
However, anyone skilled and knowledgeable in startups knows that equity deals must be handled correctly, and they will be evaluating you on your efforts.
You must sign legal contracts with those who assist you. Apart from the IP concerns (look into this), people ought to be compensated for their work. It’s fantastic that many people will labour for partial payment in cash or equity or even receive complete payment in equity.
The absence of agreements nearly usually results in two significant problems.
The first problem is that you either give too much or the other person feels you gave them much more than you did. I’ve seen this happen more than time. You might think they’re receiving 1% to 2%, and they might think they’re a cofounder. This is an extreme example, but arguments like this frequently occur, leading to serious team and cultural problems as well as delays for businesses.
The second problem is that those fighting for equity lack motivation since they don’t actually believe they will ever receive it. They probably won’t last long if they never see, much less sign, an agreement. However, they’ll be much more willing to go the extra mile for you if you firmly offer them an agreement (with IP assignment) and then a genuine options grant.
notice point 4 below as well.
You might have gotten away with this in BC (before Cake), when setting up an ESOP was so complicated and expensive. But now, all it takes is a click of a button to look good and do it correctly!
4. Failing to promote an ownership culture
If you don’t drive it and believe in your team as owners who win together, neither will they. You need to persuade your staff that their equity will be worth something even with signed agreements for equity via options. They are aware of the considerable risk involved, but they still want to know that you are treating the equity with care and are making every effort to guarantee that they may take part in any dividends or exits.
You must demonstrate to your team that they share in your success and that you value them as shareholders. How?
• Ensure that the guidelines in your equity plan are equitable to your team.
• Update your team’s investors on valuation, plans for the next round, prospective exits, and dividends.
• As much as possible, actively work for liquidity events. Secondaries, an exit, or a payout could be included.
5. Ignoring teams from other countries
One dream per team! That is how remote teams function.
Everyone needs to feel that they are fighting alongside one another, no matter where they are. What if some team members are only eligible for the Equity Plan while others are not? That won’t improve your culture or the morale of your staff, is it?
International teams have not typically been included in equity plans for a variety of reasons. I’ve observed a variety of explanations, such as high implementation costs and complexity, oversight, future plans, a lack of understanding, and a lack of cultural requirements.
Everything is altering. It is now commonplace for compensation in many nations around the world to include equity. Why not, though? Everyone who works on your startup should gain something. And for leaders, creating money around the world is extremely empowering, especially in nations where it has a profoundly positive impact on people’s lives. Additionally, this provides hiring teams an advantage over other businesses that don’t provide stock worldwide.