Private Companies: The Progression of an Equity Strategy

April 01, 2024

Equity compensation plans are pivotal tools for attracting, retaining, and energizing key talent in both public and private companies. Yet, while public companies often adhere to more standardized grant practices, private companies find themselves navigating unfamiliar territory with each stage of growth. One recurring question for these companies is, "How can we adapt our ownership strategy effectively to align with our evolving needs?"

Initial Considerations

Developing an effective equity strategy involves balancing your company’s equity philosophy, utilizing market benchmarks, and ensuring affordability. Here's a breakdown of each component:

Philosophy: The company’s equity philosophy serves as the guiding principle behind its equity compensation program. It influences decisions regarding eligibility criteria, types of equity vehicle types (e.g., stock options, restricted stock units), vesting schedules, and allocation frequency. This philosophy reflects the company's values, culture, and objectives, shaping how equity is used to attract, retain, and motivate employees.
Benchmarking: Assessing market competitiveness involves comparing the company’s equity compensation practices against benchmark data, which may include surveys and market research. This is a critical process that helps gauge appropriate grant amounts and guidelines, considering factors such as the company’s funding stage, industry norms and the size of the employee equity pool. By benchmarking against industry standards, companies can ensure their equity grants remain competitive and align with market expectations.
Affordability: It is essential to ensure that the company can sustain its equity compensation program over the long term, which hinges on affordability. This involves understanding the impact of equity grants on dilution (i.e., the reduction in existing shareholders' ownership percentage) and balancing this with factors such as compensation costs and administrative expenses. Without a clear understanding of the company's financial position and capacity to allocate equity, determining appropriate grant sizes for new hires and refresh grants for existing employees becomes challenging.

By carefully considering your equity strategy as a sum of the above parts, a company can develop an effective equity strategy that supports its talent management objectives while preserving shareholder value.

From Creative Designs to Streamlined Strategies

Private companies often review their equity strategy in alignment with rounds of funding or changes in capitalization. Each round of funding can introduce a dilution effect for existing shareholders and may involve the issuance of new classes of stock for both investors and employees.

As a company progresses through successive rounds of funding, adjustments to the equity strategy may become necessary. These adjustments can include changes to the mix of equity vehicles, vesting criteria, and employee share allocations to align with evolving business needs and investor expectations.

Even without additional funding, a change in ownership, changes to corporate structure, pay philosophy, or commercialization, can shift the company's strategic direction. This may necessitate adjustments in equity distribution to align with new business goals and ensure continued commitment from key stakeholders.

Overall, the progression of an equity strategy for private companies involves adapting to changing circumstances, aligning with funding rounds and ownership changes, and balancing creativity with practical constraints as the company evolves and matures.

Here's the general progression of an equity strategy for private companies:

1. Startup Phase:

Founders retain a significant equity stake.
Equity primarily allocated to co-founders and key initial hires critical to early success.
Stock options are prevalent, with vesting tied to milestones or time-based criteria, offering potential upside as the company grows.
Equity grants vary in size based on the candidate and need.
Vesting may be 4 to 5years.
Equity grants are typically awarded as a percentage of a company.

2. Series B/C:

Equity remains crucial for attracting and retaining top talent.
Guidelines are established, often benchmarked by job family/level and C-suite benchmarked individually.
Stock options are still most prevalent equity vehicle. Vesting predominantly 4 years.
Introduction of equity refresh programs to motivate existing employees and recognize ongoing contributions.
Equity grants are often awarded as a percentage of company ownership. At this stage, companies might shift to a share-based approach, targeting a number of options granted to employees rather than a value.

3. Pre-IPO:

Equity strategies adjusted in preparation for an IPO, potentially incorporating time-based RSUs and delay of refresh grants until IPO launch.
Vesting length is between 3 and 4 years, depending on vehicle type.
Shift from percentage-based to dollar-value or share-based awards.
Eligibility may be limited by level or role.
Equity guidelines are in place, benchmarked by job type and level. Stratification for technical/non-technical or scientific/non-scientific roles.
Creation of a discretionary pool for outstanding employees who do not fit into eligibility requirements.
Consideration of equity alignment with company valuation and market expectations.
Additional grants or bonuses tied to successful liquidity events.
Introduction of ESPP to foster an ownership culture.
Formation of compensation committee and hiring of independent compensation consultant.
Plan documents refreshed with an evergreen provision.

Strategic Design

When designing your equity program, it is important to consider several key factors to ensure its effectiveness and alignment with your company's goals:

Purpose: Define the purpose of your equity plan. Determine whether it's intended to grant equity broadly across the organization or selectively to high-performing employees. You can establish ranges based on the value or number of shares to be awarded or set target amounts for all employees at specific levels.

Benchmarking: Aim to achieve market competitiveness with your equity compensation. Adjust the mix of cash and equity pay accordingly, based on benchmarking data. Research the best survey sources for your company's needs, as private company data can be unpredictable and may require careful consideration.

Other Factors: Consider various other factors that can impact your equity program's design and effectiveness. These may include overall company burn rates, grant frequency, eligibility criteria, employee participation levels, award timing, promotion grants, and new-hire grant levels. Additionally, consider special case roles, such as sales positions, which may require a different equity structure.

Differential Adjustments: Apply differential adjustments as needed to account for factors like geographic location or remote work arrangements. Non-United States based employees may receive differentials based on their country of residence. The type and frequency of equity awards, as well as vesting schedules, should be tailored to suit the specific needs and circumstances of your organization.

By carefully considering these factors and leveraging various levers in your equity program design, you can create a strategic and effective equity compensation plan that supports your company's objectives and helps attract, retain, and motivate top talent.

Strategies for Success

Each company's equity strategy is unique, reflecting its business model and objectives. While some may benefit from frequent reassessments, others may find a less frequent review cadence more suitable.

As a general guideline, the frequency of equity plan reviews should intensify as significant exit events draw nearer. However, the pace of reviews should ultimately align with the company's broader objectives and near-term projections.

To learn about evolving equity compensation strategies for growing companies, check out our webinar presented by experts from Infinite Equity and Pave. Available here.

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By Robyn Shutak
Partner

Infinite Equity
By Taylor Slayton
Senior Consultant

Infinite Equity