Equity grants are often a source of contention for founders of emerging companies. Slicing up the “pie” in the early stages can give rise to tense conversations between the founding team and among investors. One related issue that sometimes gets less attention is the issue of “top-up” option grants to early employees outside of the founding team.
When a startup company begins to make its first hiring decisions, it will need to answer a host of questions regarding stock option grants to early employees, on topics ranging from vesting terms to what percentage of the company the option grants reflect. Sometimes founders get a request from an employee that their options should be “topped up” by the company such that the employee may retain their overall equity percentage when the company issues subsequent equity (i.e. after a venture capital financing). At first blush, founders might think this request is only fair. After all, early employees can be seen as taking a big risk on joining a young company. However, founders should seriously consider the following factors against this “fairness” argument:
Work for it
Founders should set the tone that employees will work to earn their initial option grants without the expectation that the initial grant will somehow retain a certain percentage of the company’s capitalization.
Assume an employee has a top-up dilution guarantee. Upon a Series A financing (which itself is a dilutive event) the top-up grant will add to this dilution causing a second layer of dilution to be borne by everyone else. Investors will likely raise eyebrows if in their diligence process they find that employees have been guaranteed these kinds of rights.
Like it or not, employees talk to each other about their comp packages. It’s hard to set a precedent early and then stray from it. If founders give on top-up grants, they can guarantee that future hires will ask for them as well. If one employee gets them but others do not, undue tension can be caused.
It’s not necessarily a bad thing – Founders should explain to their employees that while dilution is a reality as future equity is issued, it’s not necessarily a bad thing – in fact, it can be a great thing as long as the size of the “pie” is increased for everyone. You’d rather own 0.1% of a company that’s valued at $50,000,000 than 0.40% of a company valued at $5,000,000.