Why should start-ups give out equity?

Each day, people from around the world come up with a million different ideas. Some ideas are as simple as “for my next holiday I want to go to the Himalayas to see the elusive snow leopard” or “for dinner tonight I am going to finally cook Ottolenghi’s vegan ragu” Other ideas are bigger, challenging the status quo and have the potential to change the world, such as  “how can you use all the body heat in the tube to power the street lights?” or “how can I transfer buskers money without using cash or card”. Unfortunately, the majority of the latter remain in the brains of the idea generator never to see the day of light and never become a reality.

One of the key differences between being an ideas person and an entrepreneur is being able to convince people of your idea. For an entrepreneur to be able to realise their vision they need believers and by believers I mean, they need investors, customers and employees who all help to make that vision a reality.

When deciding to embark on the journey of entrepreneurship one of the most critical components of success is surrounding yourself with the right people. We all know that entrepreneurs are a different breed, they see opportunities where others see risks, they thrive in chaos and have a level of determination and grit which most people just do not have. Often when we think about companies like Apple, Spanx or Virgin the first thing that comes to mind is Steve Jobs, Sara Blakely or Richard Branson. These entrepreneurs are incredibly successful, however, they did not get there on their own. No one is a superhuman, even the most dedicated entrepreneurs need sleep and can’t be in five places at once. These entrepreneurs had a team of employees, customers and investors who believed in them.

In the early days of a start-up, it can be challenging to attract believers, especially employees. Investors are typically Venture Capital firms who have their eggs in many baskets, ultimately spreading their risk. Customers see the final product or service once it is all polished and professional. To get to that polished product or service, an entrepreneur needs to convince employees to work for them. One of the easiest, most effective and efficient ways for an entrepreneur to attract and convince employees to work for them is by offering them employee equity. Setting up an equity agreement for employees is the simplest way to motivate and retain employees in a start up.

Start-up's have never been able to pay the salaries that established companies can offer. Early stage start-up's typically do not have stacks of cash lying around. If they are fortunate enough to have raised investment, this is typically allocated towards things like product development, marketing and R&D. How can a start up attract talent if they can’t afford to pay market rate salaries you may ask? This is where employee equity agreements come into play. By receiving an equity agreement, employees can be remunerated and compensated for their efforts by receiving options which can be converted into equity after working for a certain period. This is great for the bank balance of start-up's as they do not have to use all their scarce cash on salaries, but it is also advantageous for employees, as many employees who have an equity agreement as part of their employment package end up becoming richer than if they had received a cushy corporate salary (especially for early joining employees and start ups that did it before their first funding round). Wise has made over 150 employees millionaires through their employee equity agreements. This is the ultimate thank you to employees for being an early believer.

Once an entrepreneur has convinced employees to work for them, the next step is figuring out how to motivate and retain these believers. In the early stages of a start up, the majority of the knowledge, drive and ultimately the success of the start up rests with the employees. Employee motivation is imperative in any workplace but arguably more so in early stage start ups. There are less people to carry the load and arguably more pressure to make something work. After countless late nights in the lab trying to figure out how to make alcohol free tequila, employee motivation can lapse. Providing employees with an equity agreement is the easiest solution to solving the motivation problem as it aligns incentives for employees and start-ups. Knowing that all those late nights are helping to change the world for all sober curious people who still love a chili margarita sometimes is not enough motivation but knowing that you are a part owner of your start-up provides the motivation needed to continue.

Now that employees are hired and motivated, start ups need to ensure they are also retained. In the early stages of a start up a limited number of people have the majority know how. If Morrie from marketing leaves after 12 months chances are there isn’t another marketing person with all the knowledge Morrie had leaving a big void to fill. Cool workspaces, being able to bring your dog to work and weekly bootcamps are now not enough to retain talent. Equity agreements ensure employee retention by structuring agreements which vest over time. Equity agreements are designed to reward employees who have grit and determination and do not walk away when the going gets tough (or another newer start up approaches them). Employee options vest over time (typically 2 - 5 years). In simple terms, this means that an employee is eligible to own more shares of their start up the longer they stay working there. Basically the longer you stay, the bigger the piece of the pie. Having time based vesting means that employee retention is higher and the risk of a brain drain is lower which is a win win for both employees and start ups.

If that idea you have is still niggling at the back of your brain or keeping you up at night, why don’t you give it a shot? Feel free to give us at Pomelo a call, we love to hear about game changing ideas. Chances are, we will be your biggest believers.