Introduction
Startup founders make use of incentives to reward their early hires, with the objective of retaining them and ensuring that such employees buy into the institution's vision, while boosting productivity. One of the ways startup founders reward their early hires is by offering them equity in the organization. In this article, we would examine why founders make use of equity as a bait as well as the advantages and disadvantages of rewarding early hires with shares in the company.
What is a Startup?
A startup can be defined as a company in the infant stage of operation. The company is established to offer products or services to the public. Startups at the initial stage of their formation usually have limited funds to work with. The limit on resources may impact the founder's ability to offer robust salaries to the initial hires. It is therefore not unusual for founders to make equity ownership offers to the early hires as a means of getting the best hands available to commit to the building process of the company.
What is Equity?
Equity is generally described as the number of shares an individual owns in a company. Ownership of shares in a company gives a shareholder the right to share in the profit and loss of the company. Equity offerings to employees are best structured through employee share trust schemes which have been defined below.
What is an Employee Shares Trust Scheme?
Employee shares trust scheme is a shares program that allows for the acquisition of a company's shares by its employees. It is usually a long term plan that comes as a job benefit working with a startup. In an employee's shares trust scheme, the company is called the grantor and the employees are the beneficiaries.
The trust scheme has its own eligibility rules, vesting period and terms of participation spelt out in the contract between the company and the employees. A trust is established by the employer to hold the shares in trust for the employees and transfer the shares when the employees are eligible to benefit from the trust scheme. The trustees are independent of the company and can be paid for the services rendered. Legally, trustees owe a fiduciary duty to the trust scheme. Employees' shares trust schemes are created by a written trust instrument known as a trust deed. Employer companies that use an employee share trust should carefully review the draft determination and the activities of the trust to ensure it has not undertaken any activities that are more than merely incidental to the acquisition and distribution of employer company shares.
Founders have the discretion to determine who would benefit from employees' shares trust schemes. Factors founders consider when deciding to set up an employee's shares trust scheme have been outlined below. They include:
- The percentage of the company's equity to be set aside for the scheme. Some companies opt for 15% . It is important to note that the figure is not cast in stone and varies from organization to organization.
- The vesting period of the shares.
- The type of shares to be awarded.
- The dilution of founders shares as new employees of the company and investors invest in the company.
The amount of equity to set aside is dependent on the founders or board of the company but it varies between 15% to 20%.
It must be mentioned that founders also set up an employee shares trust scheme to show investors that there is an incentive in place to make employees committed to the company. This commitment is believed to allow for continuity in operations. It is advisable that a company hoping to raise different rounds of investment should set aside a small percentage of equity for an employee's trust scheme. When an employee leaves the company, he or she automatically ceases to be a beneficiary.
How Employees Can Participate in the Trust Scheme.
As stated earlier, founders determine how employees are eligible to participate in the scheme and the vesting period. Employees can participate in the trust scheme through the Exercisable scheme or Exit-only scheme.
Exercisable Scheme: in this scheme, employees can buy the shares at the end of the vesting period or after surpassing a milestone.
Exit-Only Scheme: in this scheme, there must be a liquidity event of some kind before the shares can be bought. Here the employees are not actually shareholders; they sign out their shares in the event of a sale and cash out.
Advantages of Employees Shares Trust Schemes
Employee retention: employees trust scheme reduces staff turnover and increases a company's employee retention rate.
Increased productivity: The creation of an employee's shares trust scheme increases the productivity of the employees and boosts their morale to give their best to the company.
Team alignment: an employee's trust scheme helps to create a team that is aligned and driven by a common goal.
Better company culture: the employee's trust scheme also leads to better company culture.
Attracting talent: companies with employee trust schemes tend to attract the best talents available. It is believed that giving employees a stake in a company make them feel valued, and encourages them to stay and help build the company. Team members who enjoy the benefit of this scheme see themselves as part owners and vested stakeholders in the business.
Compensation: employee trust schemes often compensate for low salaries and relieves pressure on cash flow.
Disadvantages of Employees Shares Trust Scheme:
Dilution of Share Ownership: the more the company issues shares, there is the possibility of founders being forced to dilute their shares and lose control of the company.
Financial Expectations: The founder's risk promising unrealistic financial expectations for employees.
Depreciation of Company shares: Depreciation in company shares could lead to low morale and an exodus of staff.
Conclusion
In essence, employee shares trust schemes are beneficial to both employers and employees. The creation of an employee shares trust scheme creates a mutual relationship that is beneficial to all parties. It is a scheme that startup founders in Nigeria should consider. We implore founders to ensure that compliance obligations are carefully considered when setting up this scheme and that the existence of the scheme is incorporated into the employment contracts of employees.
CAVEAT: This article is only intended to provide general information on the subject matter and does not by itself create a client/attorney relationship between readers and our Law Firm or serve as legal advice.
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