Life is very expensive these days. A few decades ago earning a $100,000 salary provided for a very comfortable lifestyle with plenty left over for savings. Today, a $200,000 income in San Francisco, New York, Chicago or Miami provides at best a middle class lifestyle.
The average sale price for an apartment in Manhattan is now nearly $1.7 million. The average monthly rent for a two bedroom apartment in San Francisco is nearly $3,900. The average car insurance premium in Miami is $264 per month. Income taxes, insurance premiums, real estate costs and consumer goods and services inflation have made living well a very expensive proposition.
The most talented employees recognize this reality and acknowledge that they won’t achieve their financial dreams through salary alone; it’s about ownership. They want a piece of the action and are willing to do what it takes to secure your company’s financial success and in the process their own success as well.
As an owner, the question becomes how much ownership should you give employees each year as part of their compensation?
A model to follow: The Wealthfront Equity Plan
Andy Rachleff, former Venture Capitalist and founder of Wealthfront, an automated investment management service with over $1 billion in client assets has developed The Wealthfront Equity Plan (“WEP”). This plan has been adopted by hundreds of businesses in pursuit of top talent including Equinix, Juniper Networks and Opsware. The plan’s structure is designed to align the interests of employees and founders; reward long-term thinking and inspire employees to work towards the success of the company instead of just their area of responsibility.
Rachleff’s WEP organizes ownership grants into four categories:
- New hires – These grants are reserved for your incoming employees and should reflect market rates.
- Promotion – These grants are given as part of additional compensation for employees that are promoted. The purpose is to bring the employee up to a market-level compensation given their skills and role within the company.
- Outstanding performance – Rachleff recommends making these grants once per year to the top 10 to 20 percent of employees. The additional grant allocated to each selected employee should equal half of what they would receive if they were a new hire applying for their job.
- Evergreen – After 2.5 years with your company, Rachleff’s WEP calls for annual grants to all employees. Each grant should be equal to one quarter of what a new hire would be granted for the same role and experience. The Evergreen grants are meant to keep your most talented employees for the long-term.
How much will this cost you? The total result is anywhere from 3 to 5 percent annual dilution in ownership. The increase in company equity value over time given your ability to attract top talent will more than offset the cost to company founders because of this dilution.
Here is Rachleff’s presentation on his equity plan:
[slideshare id=28297043&doc=wfwepownersdeck5-131115160138-phpapp02]
Also consider letting employees trade salary for more equity
This is especially valuable for businesses that need more cash. Many employees are excited about the prospects of ownership and are willing to go beyond what you decide to allocate. It’s becoming more common for existing employees and job recruits to request a reduction in salary in exchange for more equity. Let’s say you extend an offer of $120,000 in salary to a prospective employee. If the employee wants more upside, an alternative would be to offer $100,000 in salary with $20,000 in additional equity. Even though the salary reduction is long-term, the equity only needs to match the first year reduction since it’s presumed to increase in value significantly over time. When calculating the number of shares or options, it should be based on the current company valuation and number of fully diluted shares. This technique could also work if you are offering below-market salaries to highly-qualified candidates.
Always consult a qualified attorney
Structuring this type of compensation scheme and properly executing it requires an experienced attorney. Make sure you consult one with specific experience in structuring non-cash compensation and equity incentive plans for companies of your scale and within your industry.
