What is a typical employee equity pool size for a startup?

Startups traditionally set aside between 10% and 20% of their total equity to incentivize employees. Venture capitalists often insist on establishing this pool before investing.

Why do early employees deserve more equity?

Early employees take on greater risk joining an uncertain startup and commit to working intensely in a hectic environment. They should be compensated for both this risk and the extra effort.

How does the role of an employee affect their equity grant?

Key leadership roles, like an outside CEO, would typically receive around 5% equity, while a CTO or COO might receive about 3%. This allocation needs to be planned before distributing to anyone.

Should I prioritize salary or equity for early employees?

Consider the employee's individual preference. If they are more conservative, offer a higher salary and lower equity. If they value equity potential, a lower salary with more equity might work.

What's the biggest mistake founders make with employee equity?

Founders often regret not being generous enough with their early employees. Successful entrepreneurs rarely, if ever, look back and feel they gave away too much equity to their initial team.

Key Moments

Tim Brady - How Much Equity Should I Give My First Employees?

Y Combinator

Science & Technology4 min read5 min video

Jan 25, 2021|86,249 views|2,034|41

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Key Moments

TL;DR

Early startup employees should get more equity than later hires because they take on more risk and work harder, but startups should reserve 10-20% of equity for this employee pool.

Key Insights

Early employees should receive more equity than later hires due to higher risk and effort.

Startups traditionally set aside 10% to 20% of equity for employee incentives.

An outside CEO might traditionally receive around 5% equity, while an outside CTO or COO might receive around 3%.

The first employee, often an engineer in Silicon Valley, traditionally receives between 1% and 2% equity.

The decision on equity allocation should consider the startup's cash on hand and the employee's personal valuation of salary versus equity.

Entrepreneurs should view equity not as a fixed pie to be divided, but as a tool to increase the likelihood of success.

Early employees deserve more equity for higher risk and effort

When compensating the first employees of a startup, it’s crucial to understand that they should receive a greater equity stake than those who join the company later. This is primarily due to two significant factors: risk and effort. Early employees are joining a venture with an uncertain future; the business may succeed spectacularly, or it may fail entirely. This inherent risk, far greater than that faced by employees joining a well-funded or profitable company, warrants higher compensation in equity. Additionally, these initial team members are expected to work incredibly hard in what is often a chaotic and demanding environment. Their compensation reflects both the risk they undertake and the intense effort they are expected to contribute to build the company from the ground up. Consequently, the equity percentage should decrease as the company matures and becomes more stable.

Establishing an employee equity pool

A common practice in startups, strongly encouraged by venture capitalists, is to set aside a specific percentage of the company's equity for employee incentives. This pool typically ranges from 10% on the lower end to 20% on the high end. This allocated equity is then distributed among employees over time. It's important to note that this pool can deplete quickly, especially as the company scales and needs to attract key talent. For instance, bringing in an experienced external CEO might require an equity grant of around 5% of the company, while a CTO or COO could command roughly 3%. This highlights the need for careful planning before any distribution even begins, ensuring that future hiring needs are factored into the overall equity strategy.

Determining equity for the first employee

For the very first employee, often an engineer in the traditional Silicon Valley startup model, the equity granted typically falls within the range of 1% to 2% of the company. While online resources might show a broader spectrum from 0.5% to 3%, the 1-2% range is a common benchmark. When deciding on the specific grant within this range, two primary considerations come into play. First, the startup's available cash on hand is a critical factor. In the early stages, cash is often scarce, making it sensible to offer a lower cash salary in exchange for a higher equity stake, provided the employee is amenable to this trade-off. Second, the individual employee's perspective on equity matters greatly. Some individuals are more risk-averse and prefer the certainty of a higher salary, while others are more comfortable with the potential upside of equity. Understanding the candidate's financial priorities allows the startup to tailor the compensation package effectively, balancing salary and equity to best suit their needs and motivations, while still ensuring the employee feels valued and has a stake in the company's success.

Balancing cash and equity

The scarcity of cash in early-stage startups presents an opportunity to use equity as a strategic compensation tool. It’s often feasible to negotiate a lower salary with a prospective employee in return for a larger equity grant. This approach allows the company to conserve its limited cash resources while still rewarding the employee for taking on greater risk and contributing to the company's growth. However, this strategy is not suitable for every candidate, and open communication is key to ensuring alignment.

Understanding employee risk tolerance

Not all employees will value equity in the same way. Some may prioritize the security of a regular salary, while others will be more attracted to the potential financial rewards of a successful equity outcome. As a founder, understanding this difference is vital. You should use the compensation levers that best motivate each individual. For more conservative candidates, a higher salary and a lower equity grant might be more appropriate, ensuring their continued engagement and motivation.

Equity as a tool for growth, not a fixed division

It's essential to reframe how equity is perceived within a startup context. Instead of viewing equity as a fixed pie that must be meticulously divided, it should be seen as a dynamic tool designed to increase the overall likelihood of the company achieving significant financial success. The vast majority of startups do not become big financial successes; only a small percentage reach that level. Therefore, in your best interest as a founder is to ensure that your early employees feel a profound sense of ownership and are highly motivated. They will be working alongside you through long hours and will significantly influence the company's trajectory. Over three decades of experience in Silicon Valley, the founder notes, have not yielded a single instance of an entrepreneur regretting being too generous with their initial team members.

Mentioned in This Episode

Equity Distribution Guide for Early Employees

Practical takeaways from this episode

Do This

Give early employees more equity than later joiners due to higher risk and effort.

Set aside 10-20% of equity for employee incentives, often required by VCs.

Consider an outside CEO getting ~5% and CTO/COO getting ~3% when planning equity pools.

Compensate employees based on their individual valuation of equity versus salary.

View equity as a tool to increase the likelihood of startup success.

Ensure early employees feel a strong sense of ownership.

Be generous with equity for early employees, as it's rarely regretted.

Avoid This

Don't rely on a fixed chart for exact equity figures; it's more art than science.

Don't distribute equity without first planning for future hires like CEOs or CTOs.

Don't assume all employees value equity equally; some prefer salary security.

Don't view equity solely as a fixed pie to be divided; but as a growth tool.

Typical Equity Allocation for Key Startup Roles

Data extracted from this episode

Role	Equity Percentage
Outside CEO	~5%
Outside CTO/COO	~3%

General Equity Ranges for First Employees

Data extracted from this episode

Employee Position	Equity Percentage Range
First Employee (often Engineer)	1-2%
Online Ranges (for first employee)	0.5% - 3%

Common Questions

Traditionally, the first employee, often an engineer, receives between 1% and 2% equity. Online ranges can vary from 0.5% to 3%, depending on various factors.