Should Equity compensation be an acceptable norm? And why?
What is equity compensation?
Equity compensation is a strategy used to improve a business’s cash flow. In addition to traditional salaries, the employees are offered a partial stake in the company. This perk often comes with certain terms where the employee does not earn returns at first. Also, most startups are short on cash but can issue shares at will and have equity to hand out, so you often find a guaranteed equity stake as a luring signing bonus for startups employees.
How is equity paid out?
Every company pays out Equity compensation differently. The 2 popular ones that companies use are vested equity and granted stock upfront. With vested equity, payments are made over a set number of pre-determined increments when an employee signs a contract. And granted stocks are handed upfront at the beginning of the contract.
What is the most commonly used form of equity compensation?
Equity comps come in various forms. Employers either offer stock options, restricted stock, or employee stock purchase plans. Regardless of the options, there are sub-categories that give companies more or less control over how equity is paid out. The solutions are typically favorable to new hires since options come with extended vesting periods and at no cost to them.
Entrepreneurs realize that scouting good employees require fair, clear and mutually beneficial deals. Offering dubious deals and convoluted contracts to a potential employee is a turn off and likely to walk away from the offer.
Here’s a profound example of a successful equity comp — Steve Ballmer’s journey to be one of the richest person in the world.
Ballmer was a sophomore at Harvard in 1975 and lived down the hall from Bill Gates. While Gates dropped out to start Microsoft, Ballmer was a total Harvard head — playing on the Football team, writing for The Crimson and acing in classes. After graduating, Ballmer dabbled with few things, worked as a Product Manager, wrote scripts for Hollywood and ultimately ended up at Stanford Business School. While in B school, Gates convinced him to drop out and join his then start up “Microsoft”, as the company was seeing explosive revenue growth. Ballmer was offered the role of a Business Manager with a base salary of USD 50,000, zero equity and 10% share in profits. Fascinated with the offer, he willfully accepted it.
With Microsoft’s exponential growth, Ballmer’s 10% profit deal soon became unsustainable rather unfavorable and therefore Gates decided to renegotiate and restructure the entire organization. After negotiations and reorg, promoters (Bill Gates and Paul Allen) owned 84% stake in the company, 8% was allocated for the investors and the remaining 8% was given to Ballmer (in exchange for his 10% share in profits). This was willfully accepted by all the stake holders.
The shares alone that Ballmer was awarded for joining Microsoft propelled him as a multi-billionaire. As of 2021, Ballmer’s net worth is approx. USD 96 billion, much of which is attributed to the value of his shares in Microsoft. Had he refused to accept Equity compensation, his career and life could have had a very different trajectory. With a great business acumen, a little bit of luck, and a fanatical drive to be the best he made himself one of the richest person in the world.
Keep salaries low and equity high. Keep the organization as flat as you can
― Sam Altman