Sharing equity: Be careful about spreading the wealth

Sharing equity with your workers is a worthwhile investment—so long as you know what you’re doing

Marc Lore, co-founder of the shopping site Jet.com, saw at his previous companies how stinting on benefits hurt morale. So when he co-founded the e-commerce platform Quidsi in 2005, everyone but hourly employees received equity in the company. “I witnessed the passion and loyalty that came with people feeling like an owner in the business,” he says.

Today Lore offers equity to Jet’s entire work force, regardless of an employee’s position or time spent with the company. There’s a fouryear vesting period, and each position gets a standardized slug of stock—and Lore sees its impact on his workers. “They’re going way beyond their day job,” he says. “Working nights and weekends, and not feeling like it’s a burden.”

Equity arrangements are increasingly standard for startups. AngelList, a site for investors and job seekers in such companies, provided data to Inc. showing that 80 percent of job postings from U.S. startups involve some equity.

Reasons vary: Honor, which connects families with caregivers online, offers equity to all staffers and finds it leads to more collabora- tive workers. That equity “creates a team sport,” says co-founder Seth Sternberg, “where everyone’s contribution directly helps them.” Dennis J. White, a Boston-based partner in the law firm Verrill Dana, says equity also can “provide some compensation to employees” when you’re short on cash. “It’s also a retention tool—no one wants to leave and give up the upside” of stock.

So set up your plan correctly. “I’ve walked into some startups that couldn’t accurately reconstruct who got what, when,” says Will Ferguson, a senior partner at Mercer, a large HR consulting firm. You never want to tell investors that you don’t know how much equity is left.

Equity grants can result in numerous minority stockholders, whose demands and grievances can be a major distraction. The mobile security firm Good Technology is one example. Last winter, BlackBerry purchased it for $425 million, less than half of the company’s $1.1 billion private valuation. Some of Good’s common stockholders woke up to find their stock options were practically worthless—after they’d paid taxes on their shares based on higher valuations. Now, minority shareholders are suing board members for breach of fiduciary duty.

White counsels sidestepping such complications by giving “phantom” stock instead of actual stock; that will provide financial incentives without granting shareholder rights and responsibilities. You can also give stock layered with restrictions, such as drag-along rights, which would give your investors the option to “drag along”—force—minority shareholders to support a sale of your company.

There are also risks of diluted stakes and shrunken valuations. In 2014, Square raised money at a $6 billion valuation, and promised to give millions of additional shares to its new investors if that value decreased in an IPO. When Square went public at half that valuation, those investors were made whole— leaving employees with diluted stakes in a far less valuable business.

One key, says Ferguson, is communicating to employees the stake they could receive and all the ways it could be monetized. “This is the fun part,” Ferguson jokes about terms and conditions, “when people’s eyes tend to glaze over.” But, he adds, you need to be able to say, “This is how we’re doing it, and here’s what that means.”

80% of job postings from U.S. startups offer some equity, according to data from AngelList.