Yesterday’s post titled Common Equity Grants for Startup Employees gave broad, simple amounts of equity for employees of a funded startup, which serves as a good starting point. In reality, things are much more nuanced with amount of salary being one of the biggest drivers of equity (e.g. more salary results in less equity). Another recommended way of determining the amount of equity for a position is to do it as a multiple of the market-rate salary in the context of the four year business goals.
Here’s an example of employee equity in a salary multiplier context:
- Employee position: $100,000 market rate salary for a software engineer with some experience
- Startup raised $2 million on a $3 million pre-money valuation for a $5 million post-money valuation
- Entrepreneurs decide the target equity goal for the employees is to make 2x their market-rate salary in value after four years (equity has four year vesting with a one year cliff)
- Assume the startup doubles in value each year by executing well and growing revenue with these being example valuations (these are valuations, not revenue):
Year 1 – $5 million
Year 2 – $10 million
Year 3 – $20 million
Year 4 – $40 million - Assume 50% dilution from future funding rounds (so really need 4x their market-rate salary to get to 2x after dilution)
- $200,000 as a percentage of $40 million is 0.05%
- Double the 0.05% to account for dilution taking out half and you have 0.1% to start
So a software engineer with a $100k salary would get equity amounting to 0.1% of the business for a startup that just raised a funding round, but still at an early stage. If the entrepreneurs wanted to offer a greater multiplier on salary, or if the business was more mature with respect to valuation, the percent ownership with be adjusted appropriately.
What else? What are your thoughts on employee equity in a salary multiplier context?
David Cummings on Startups 
What are your thoughts on bonuses? Also, interesting enough, I have found Atlanta employees don’t place much value in stock as very few companies ever have a meaningful exit. In my mind this is a mistake, but something I have witnessed. I feel that being overly generous is the way to go so everyone bears the fruits of their labor and incentives are aligned especially if the goal is to exit. If the goal is not to exit, then options may have little perceived value. And, I don’t think the formula is that simple, depending on the risk of the venture and the employees potential to have a big impact on valuation/results. Acquirers are very interested in the team beyond the founder and keeping them invested and motivated beyond the exit.
I think $40 million in revenue in 4 years is simply unrealistic. go to the Inc 500 fastest growing companies in america and count how many of them made it to $40 million in 4 years. and then consider the odds of just one of those dozen or so companies being in Atlanta.