Here's my most important lesson:Treat equity carefully: it can be as much of a help as it can a hindrance to a firm's success.
Granting equity to staff is often needed when firms do not have the reserves to pay staff cash for remuneration. While enabling a startup as such, this can curb its success later as will be explained. Moreover, a well funded startup should not by default grant stock options to all its employees, and instead be highly discretionary by being both shrewd and frugal.
Equity is sometimes but not always a great motivator to perform, and even can lead to worse performance. From being in a couple of startups already with multiple equity holders, I have found that equity holders can become complacent of their positions within a company, taking for granted of their long-term status within it and relating to others as outsiders or tools, and also not fearing being fired or reprimanded. This opposes conventional wisdom that equity promotes the striving for excellence. In this case, the provision of equity changes nothing in terms of performance, maybe making it worse.
Additionally, any equity holder essentially becomes reasonably non-replaceable for their position, which is detrimental when a more fitting external candidate can take their place, or when it removes promotion opportunities internally for non-equity holders regarding that position.
In terms of motivation, for many startups the provision of equity should be unnecessary with staff already motivated enough by the vision, challenge, work practices, team and environment of their startup.
Equity is better seen as a source of retention by way of giving a sense of ownership. This is especially important in a firm's difficult times when the desire to leave a firm can increase, and also in bubbles when better offers may be easily acccessible elsewhere. It is also important for attracting the most valuable candidates who see themselves as highly contributory to a firm's success and demand a stake in it. Retention through equity also lowers the risk of the most valuable employees leaving to a competitor: however this can be mitigated through a restructuring of power or better information management, not through just equity provision. However, providing equity to the most strategically important employees could act as a hindrance if such a position can become commoditized or systemetized later.
When absolutely necessary, granting equity should be to staff who are a combination of the following:
- highly strategic, sought-after and niche
- clearly promotable or able to work in multiple areas that sometimes don't always offer the most satisfaction
- loyal: unwilling to be transitory, and instead show a long term capacity
- can value organizational needs above their own
It seems like granting equity is a norm in startup practices, but this is not always justified. Care should be used so that staff are treated fairly but not overly compensated: and not only for the company's success, but ultimately their own. People say they've seen bad hiring destroy a company: minimizing equity distribution makes firing easier.
