Whether you are a new startup trying to raise seed capital, determining how to allocate the company shareholding or looking to benefit your employees - equity incentives can be a game changer.
Equity sharing not only rewards employees but recognises the importance of them to their company. In turn, the company is able to attract, incentivise and retain performing and loyal employees.
The incentive industry, like the entrepreneurial industry around it, is constantly evolving. In addition to the traditional employee share incentive schemes which remain popular, we have seen the evolution of the SAFE (Simple Agreement for Future Equity) Agreement and Grunt Funds.
In order to implement any equity sharing models, it is of the utmost importance to understand the whys and hows behind each one.
Share incentive schemes are used by companies to grant their employees an option to obtain shares in the company, as an incentive to the employees.
The incentive is that the options may only be exercisable after a specific time period or are dependant on the future performance of the employee, thereby linking the growth of the company with that of the employees’.
The most common types of schemes are share option schemes and phantom share schemes:
Employees are granted company shares which will vest at a later predetermined date. Shares can be offered to the employee at a market-related or discounted value. Companies can grant shares on a discretionary basis and can be linked to employee performance/longevity.
Share option schemes are most suited for companies wishing to provide employees with the opportunity to acquire actual ownership in the company.
Employees are granted an opportunity to obtain a cash benefit derived out of a share, payable at a later predetermined date. However, the shares never vest and the employees do not become a shareholder. Companies can also grant such awards on a discretionary basis and can be linked to employee performance/longevity.
Phantom or cash-settled share schemes are most suitable for companies who don't want to share ownership and may have a larger number of employees they wish to acknowledge and benefit.
SAFE agreements are intended to provide a simpler, more cost-effective mechanism for start-ups to seek early-stage funding. The agreement was designed with simplicity in mind, taking into account both the investor and the company’s interests.
A type of ‘deferred equity contract’ - a SAFE agreement between an investor and a company provides the investor with rights to future equity in the company in exchange for funding. Thereby postponing the valuation of the company until a later date, allowing the investor to benefit in the upside of the growth of the company.
This is beneficial to the company in the sense that, SAFE shares are classified as equity rather than debt, having no fixed maturity date nor incurring interest. The investor will receive the future SAFE shares upon a triggering event, but until such event occurs they acquire no right to equity or to have their investment repaid.
Three such major triggering events include equity financing, acquisition or dissolution. Upon an equity financing event, the company will issue preference shares to the investor or should the company be acquired or dissolved before such financing event these happenings will constitute an event itself.
The objective of a grunt fund is to make sure that startup founders are rewarded for everything they offer their company, not just the money they actually invest. Grunt funds are dynamic meaning they recalculate equity stakes as contributions to the company changes.
The comparison of a company and a pie is used and a grunt fund determines how to slice the pie by allocating a monetary value to tangible and intangible contributions made to the company.
A grunt fund is based on fairness, basically, each shareholder is rewarded with a percentage of the pie based on the ratio of their contribution to the total contributions (of time, money, intellectual property, loans or unreimbursed expenses etc). The value of the contribution is determined with reference to the given formula/cash multiplier, specific to that type of contribution.
Upon real revenue generation or a cash investment, the company would then allocate the shareholders real equity in the company, allowing them to fairly share in the equity of the company.
Equity sharing can be a difficult conversation to have but by choosing the right equity sharing model for your company it will ensure that the company and investor/employees’ rewards are aligned. Equity incentives can also be very complex, with tax implications for both the company and employee. A well-designed scheme will ensure that the benefits are passed to the employees in the most tax efficient manner.
If you would like to find out more about one of the models above or require assistance with the implementation and managing the tax implications thereof please book a consultation session with a Creative CFO consultant.
Comments will be approved before showing up.