Understanding equity grants and how it works in startups

Equity grants are a way for companies to give a slice of the cake (a percentage of the company's total equity) to their employees, offering them ownership stakes in the business.

Offering equity has become commonplace across the startup and scaleup ecosystem. As companies navigate their way through economic uncertainty and high costs of capital, the use of equity is an effective tool to attract attract, incentivize, and retain top talent.

Amid layoffs, tech companies are reported to give equity incentives to employees who survived the cuts to encourage them to stick around and grow with the company. "Companies are as concerned as ever about holding onto top performers and keeping staff motivated and productive," The Insider states.

Whether you're a new startup founder looking to create or expand your equity incentive plans, or an employee who was just offered an equity grant, this article tackles employee equity grants and what it means for you:

• What is an equity grant
• How equity grants benefit both employees and employers
• What is an equity grant agreement
• How does an equity grant work for employees
• What are the common types of equity grants

Equity grants, explained

What is an equity grant

An equity grant is a non-cash compensation given to someone, giving them a percentage of ownership to a company. This may come in various forms, such as stock options, restricted stocks, or stock appreciation rights.

For well-established companies with healthy cash flow, paying at or above-market salaries is generally an non-issue. For startups, however, it’s a different story. On top of any marketing, advertising, software systems and other monthly expenses, cash-based salaries can very quickly eat away cash reserves.

The ability to save cash through equity grants is extremely beneficial and just one of the many reasons why you should consider giving your teams equity.

How equity grants benefit startup founders and employees

Although equity grants may sound complicated, Cake has simplified and streamlined the process for you. Equity offers several benefits to both employers and employees.

Equity incentive plan as a talent acquisition and retention tool

Talent acquisition for early-stage and bootstrapped startups can be quite hard, especially in comparison to companies that already have an established reputation and networks. When cash flows are tight, giving salaries that are on par with those of more established enterprises is almost impossible.

This is where using equity could be one of the most powerful tools in your talent acquisition shed. The opportunity of becoming a part owner in the company, and empowering prospective employees, companies offering these programs have a far better chance at attracting and hiring talented individuals.

Additionally, equity awards also act as a retention tool to reduce attrition. By rewarding an employee’s performance and setting milestone-type reward gates, or aligning the rewards with time-based vesting, an equity grant can incentivise your workforce to engage with the business for the long haul.

Ownership as a way to boost profits

Ownership is also an extremely effective way to motivate employees. By telling someone that they are a part-owner in a company, equity can align your mission and objectives with your employees. As a result, employees are encouraged to be more productive and do the necessary work to help make the company succeed.

In our recent webinar on building global startup teams, Sondre Rasch, Co-founder and CEO of SafetyWing, states,

If there is one thing we need to learn from Silicon Valley, it is all employees get equity. This is such a powerful thing. It creates this long-term motivation, where you share in the benefits when a company gets successful where everyone is part of building it. It brings alignment from the individual to the company — we're all co-owners of this.
^{—Sondre Rash, Co-founder & CEO at SafetyWing}

What is an equity grant agreement

When a company gives an employee an equity grant, one of the first documents he or she will receive is an equity grant agreement. For newly hired employees, equity grant agreement is usually attached to a job offer letter.

An equity grant agreement is a legal document that breaks down the details of the equity such as the type of equity on offer, how many the person will be offered, the total value of the equity, any vesting periods or performance milestones attached to the offer, the fair market value of each equity unit, and other important legal information.

How does an equity grant work for employees

Typically, employees must first fulfill some requirements to earn these benefits, such as adhering to a vesting period or reaching performance milestones.

A vesting period means that before you acquire these ownership rights, you must work for the company for a predetermined period.

Performance milestones are another set of hurdles that can appear in an equity grant. These metrics and indicators can be attached to a company or an individual’s performance, and are tied to a set number of equity units which an equity agreement recipient must reach before having the right to acquire it.

What are the types of equity grant

There are various types of equity grant. Some of the most common types include:

Employee Stock Options

Companies that have employee stock ownership plans offer employees an opportunity to buy shares of the company's stock at a predetermined price (also known as the exercise price). But first, they must serve the company for a specific period of time. They acquire the right to transfer or sell the option after it has vested.

We have many resources about employee stock option plans here at Cake. If you want to deep dive into the topic of employee stock options, start with our comprehensive ESOP guide.

There are two types of employee stock options: ISO and NSO.

Incentive Stock Options (ISO)

Also known as qualified or statutory stock options, ISO refers to a benefit given to corporate employees where they can buy shares at a discount with the potential gain of tax benefits. An incentive stock option (“ISO”) is an option to acquire stock in exchange for the payment of an exercise price. Unlike an NSO, this type of option can only be granted to employees.

Non-qualified Stock Options (NSO)

A non-qualified stock option (“NSO”) is an option to acquire stock in exchange for the payment of an exercise price. This type of option can be granted to employees and non-employees (such as consultants, members of the board of directors, etc.). NSOs are the most common type of options that we see companies use on Cake.

Restricted Stock Units (RSU)

Unlike stock options, restricted stock units allows employees to own stock outright as soon as conditions are met, instead of having to buy them. RSUs are typically granted to employees after they achieve required targets or performance milestones, or when they reached a specific tenure.

Phantom or Virtual Stock Options

Although phantom stock or virtual stock options aren’t a form of equity, this type of compensation essentially mirrors the underlying value of the company's stocks, but any gains are paid in the form of cash (as opposed to the right to acquire shares in the company).

Quick-fire Q&A

Other FAQs on equity grants

What is the most commonly used form of equity compensation?

Stock options are the most popular form of equity compensation. This involves a contract where the holder is given the right to buy or sell shares of a specific stock at a predetermined price after a particular period.

How do you get paid for equity?

Different companies have various equity payouts. The two primary forms of equity are granted stock, which is available right away, and vested equity, which has certain conditions that must be met. Granted stock is available at the beginning of a contract. However, payments for vested equity are spread out over a set number of installments as specified in a contract. The employee basically accepts the risk of a delayed payout for the possibility of a large sum of compensation if the company proves itself successful.