Primary Considerations for Equity Allocation Agreements

Part 2 of the Equity series. In Part 1 of the Equity series I laid the groundwork for equity allocation by discussing the impulsive entrepreneur who gives away the business to friend and family just to have them involved in the new venture.

 

Part 2 focuses on equity allocation to key roles in your organization. Unless your entrepreneurial idea is to start a new kind of venture capital firm or become an attorney who specializes in IPOs, discussing employee stock option plan (ESOP) allocations and agreements with potential staff members may seem intimidating.

 

That’s why I am sharing some key considerations for you to be aware of when you are ready to start that conversation. My perspective is that of a former principal and chief financial officer of a private equity firm.

 

Equity allocation to Principal Management. EquityPart2-shutterstock_229730320 The rule of thumb for the allocation of equity to senior management and advisors is 15 – 20%.

 

The allocation to individuals depends on several factors and even timing. For example, if the founder(s) know they need to hire a CEO/President after they get the entity to a certain level, they should reserve some equity for this position.

 

Sales executives typically will earn more through commission than most of the management team, therefore should have the lowest allocation of equity of the C-Suite.

 

Technology and Financial positions are critical in most companies, which means the majority of the allocation should go to these positions.

 

Equity to advisors is another factor when divvying up equity, and discussed in more detail in Part 3 of this series.

 

Finally, there is vesting equity ownership as an employee incentive to perform well and stick with it while the company evolves from start-up to success. My advice is to keep it simple – don’t have one-off vesting arrangements for each person – keep it straightforward, make all terms and conditions with all option arrangements pari passu (on equal footing) with everyone – this makes it easy.

 

Part 3 concludes the Equity series with other key considerations for entrepreneurs considering equity allocation for their startup.

 

Mindy Barker & Associates (cfo@mindybarkerassociates.com) works with entrepreneurial growth companies to help maneuver the many questions of funding, employee compensation and other decisions and is available to discuss your questions on equity.

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