How to determine equity allocation for early employees
The topic of fair equity compensation for employees has come up with every startup I have worked with. And I find myself repeating the same advice to all of them. I figured it’d make more sense to document it once and for all through this post.
So, the question is how much equity is fair to key early employees. Here’s my algorithm:
i. If it’s a post-Series-A company, key employees (VP-level executives with 5-10 years functional experience) should get anywhere from 1.5-3%. The more critical roles are at the higher end of that range. That is, most VPs end up with 1.5-2%. If it’s a tech-heavy company, the CTO or VP of Engg might get 2.0-2.5%. And if the CEO is hired post Series A, the CEO might get around 3% (or more if it’s a known superstar). Where do these numbers come from? The option pool is around 15-20%, so that leaves around 10-12% for VP-level execs and the rest for junior employees, coders and the rest.
ii. Now if you are hiring someone just before (3-4 months) Series A and you have not set aside an option pool as yet, one should expect around 50% dilution during Series A (35% to investor and 15% option pool). So, that implies a key employee should get 3-6% before Series A to end up at 1.5-3% after it. But one has to account for the employee taking on the risk of joining before Series A funding. So add another point for that which leads us to 4-7%. That is, most VPs get around 4-5%. VP of Engg or similar critical function might get 5-6% and a CEO hired just before Series A gets 7%.
iii. Now if one is hiring the employee well before Series A, you have to bump up equity further. If a small angel round has been raised but Series A is still a year or so away, I would increase the range above to 6-10% based on the functional role.
iv. Lastly, if we are talking about pre-seed VP, we additionally need to factor in 15-20% dilution in a $500K angel round, which in turn raises the equity to 7.5-12.5% (i.e 7.5% for regular roles, 10% for critical roles and 12.5% for CEO). This assumes that a founding team and an initial product are in place.
v. All of the above assumes that the candidate has ample experience for the role. Sometimes (usually with very early hires), you might hire someone who does not yet have the right experience for that role. Meaning the position is a big opportunity for that person and he/she would not have got the position at (say) a similar post-Series-A startup. Reduce the equity by 20-25% in that case.
vi. All of the above also assumes that the individual is a key employee but not a co-founder. The math is different for a cofounder and one has to think about how many cofounders are in the startup and other idiosyncratic factors of cofounder dynamics.
The above sounds very algorithmic and there are several reasons to deviate from it. But the algorithm is based on a very simple logic. There’s only 15-20% option pool and all employees need to be paid from there. So most of the numbers follow from that. To date, I have found the logic works quite well and is fair to both the employee and the founders. Let me know if you have a different approach
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