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The 5 biggest mistakes founders make with stock options up to Seed stage

- May 9, 2023 5 MIN READ
The first time a founder goes to set up an Equity Plan, also known as an ESOP, or employee share scheme, they’re faced with many challenges.

They’ve been told that they need one, but what is it, and how is it done properly?

Your team are your greatest asset at a startup. In the earliest years of a startups life, there are many challenges: the product is in MVP state at best, brand awareness will be very limited in your market, and systems and processes are almost non-existent. A startups’ team lifts a lot of weight! 

When done properly, a great equity plan will help to attract amazing people to your company, align and engage them towards your startups goals, and help motivate are retain them. Securing a high quality startup team and their focus and passion for the mission is critical. 

But equity plans are very hard to get right, especially for first-time founders. 

Here are the top 5 common and most costly mistakes that founder make, from my experience in helping thousands of startups with their equity:

 

1. Founders don’t value their equity plan enough 

Let’s first of all highlight the value of an equity plan at pre-Seed stage. A pre-Seed pound with a pre-money valuation of $3m and a 10% Equity Plan has $300,000 of capital that can be used to chase the mission. It’s a kind of funding. 

It’s funding that you create from what seems like thin air, and use to build your team and company at the point when it’s the hardest to get capital. Almost all founders know how hard the first $500k is to raise from investors. With your equity plan you create this value with ease. 

Even before you raise pre-Seed a founder can utilise the Berkus Method and value their company up to $2.5m and create an Equity Plan of 10% and get their equity to work with advisors, consultants, their first hire to help get them to pre-Seed milestones. That’s $250,000 funding (don’t use it all at once though)! 

You can use it for super important stuff! It’s critical in the first year. Momentum is key here, and these purchases can save you months, or years! 

  • Paying your advisory board in options
  • Paying suppliers / contractors like engineers or marketers in options (sweat equity)
  • Hiring that first key hire or two, and balancing out their cash salary with options

2. Not having advisors on a stock option deal

Quality advisors are critical for a startups success. First time founders have to learn very quickly, and its much easier with experienced advisors. But how do you pay them? One thing is for sure, people with skin in the game are more valuable to you.

Startup advisors are usually successful, giving back to an industry that gave them so much, and are happy to earn equity, in the form of options (or perhaps part cash / part options in some cases where advisors are more hands on).

If you don’t pay them at all and rely only on goodwill, you will likely reduce their impact as they’re less focused as they have less skin in the game. If you pay them in options, and they can see their help will catapult the company forward, and then its worth it for them! 

Check out our article on Advisory Shares, specifically using the Founder Institute SAFT, to remunerate advisors. 

3. Having hand shake deals for sweat equity

Okay, I know in the first 6 – 12 months things are extra hectic. You’ve got 1 million things to do, and it seems like you’ll never get on top of it. And you’re asking for help from everywhere. I get it. I’ve been there. 

But anyone great and experienced in startups, knows that equity deals have to be done properly, and will be judging you on your efforts.

You have to get proper agreements signed with people that help you. Besides the IP issues (look into this), people should get paid for their work. It’s awesome that many people will work for part- cash/part-equity and even get paid fully in equity.

If you don’t have agreements in place, 2 major issues almost always arise. 

The first issue is that you offer too much, or the person thinks that you offered them a lot more than you think. You might think they’re getting 1-2%, and they think they’re a cofounder – I’ve seen this happen more than once. It’s an extreme case but these disagreements happen a lot and cause huge cultural and team issues and delays for startups. 

The second issue is that the people working for equity don’t really trust that they will ever get their equity, and are therefore not motivated. If they never see, let along sign, an agreement, chances are they will fade away quickly. But if you confidently give them an agreement (including IP assignment) and then a proper options grant, then they’ll be much more likely to dig deep for you.

Also see point 4 below. 

BC (before Cake) you might have gotten away with this as setting up an ESOP was so hard and expensive. But now its literally a click of a button and you’re looking professional and getting it right! 

4. Not building an ownership culture

If you don’t believe in your team being owners and winning together, and drive it, neither will your team. Even with signed agreements for equity via options, you need to convince your team that their equity will be worth something. They know its high risk, but they want to know you’re handling equity professionally, and you’re working hard to ensure that they can participate in any exit or dividend.

You need to show your team that if you win, they win, and that you treat them as owners. How?

  • Ensure your Equity Plan has rules that are fair to your team
  • Give your team investor updates regarding valuation, next round plans, potential exit or dividend
  • Actively work towards liquidity events as much as possible. This could be secondaries, exit or dividend.

5. Leaving out international teams

One team one dream! That’s what makes remote teams work.

There needs to be a belief that everyone is battling together from where ever they are. So what if only some team members can be in the Equity Plan and others not. That’s not going to help your culture and team motivation is it? 

For various reasons it has not been common to include international teams in Equity Plan. Reasons I have seen include: cost and complexity to implement, oversight, intending to do it in future, a lack of awareness, and a lack of cultural requirement. 

This is all changing. Now its expected that equity is part of remuneration in many countries all over the world. But why not? Everyone that helps build your startup should benefit. And as leaders its incredibly empowering to help build wealth around the world, especially in countries where the wealth creation is life changing. And this gives hiring teams an edge over other companies that aren’t offering equity globally, and 

BONUS ROUND: Don’t forget to plan your cap table correctly. Typically a Series A company will have 18% of their stock in Equity Plans. You need to ensure that you budget and plan your equity plan allocation from day 1 to leave enough equity for later hires. I think this will need another article! 

Check out our website and resources for heaps of helpful info on how to use your stock options as a driver for your companies value, including an ESOP for Employees Guide, and an ESOP for Startup Guide.

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