Is it ethical to compensate employees with equity in a startup over cash?
My team is launching our startup on a very limited budget. I want to compensate them for their hard work. Is it ethical to offer up equity in the company? If so, is this a smart business decision to make?
I think employees at least the initial lot of people should be give equity over cash. The startup environment doesn't offer many of the benefits of working for an established set up and expects people to put in beyond normal effort to make it a success. Leaving these people out getting the fruits of their labor is not motivating enough. Finally, that can be the only attraction over a normal job. Equity will create the stickiness in the employees who will build the foundation of the company.
The ethical part is easy: if the employees agree to accept equity instead of cash, their consent is ipso facto evidence of being ethical. Compelling them to accept equity is not ethical. The difference is that employees have a choice.
In the real world, you would set up the compensation agreement upfront. If you offer equity, prospective employees would not have to accept it and can work elsewhere.
As for the wisdom of this arrangement, I'll leave it to others.
This can cause legal issues if the company does not return a profit for the company itself and can become a liability if your employees decide to act against you in such a case for false business representation in the case of no ROI.
Part 1: Ethics
The only way this is an ethics issue is if you know you are taking advantage of your team somehow.
Equity arrangements are bets we make in business - just like playing the stock market (which is trading companies' equity, after all).
How do you keep this from being an ethics issue? Be 100% transparent about what the ROI and prospects are. This is best done by giving a best/worst/most-likely scenario for cashflow over the next two to five years. If you don't lie, don't withhold key information, and answer all questions to the best of your ability, there's no unethical issue here.
Part 2: Smart Decision?
This is a whole other can of worms. While I disagree with most of Van Horn's post, I'd say the one thing he's 100% correct about is that equity is the most expensive form of payment a company can make. You're mortgaging your future wealth for immediate gains, and any economics student can explain why that gets so costly.
That said: If your team is awesome, reliable, and loyal, then rewarding them handsomely is likely a fair (and smart) transaction.
Consider: you don't have to offer equity to everyone on the team (and not everyone may be interested). Also consider: any equity arrangement should be tied to a vesting schedule, so you're protected from people who work for 2 weeks and bail.
Equity is a great way to get buy-in and keep employees aligned with the bottom line. The more profitable the company is, the more they are rewarded.
Equity is also a bonding agent. If the business succeeds, it'll be a great way to keep your founding members around until they aren't needed any more (acquisition, or massive internal growth). This helps to protect you from loss of key mindshare in the company.
Bottom line: i'd advise against treating stocks in your company as strictly monetary instruments. There are a lot of intangibles at play with equity-based employment.
Ethical or not, equity in the company does not satisfy federal minimum wage obligations. So if you do compensate with equity, make sure you pay it on top of at least the minimum cash wage.
Potentially "Yes" and Potentially "No".
Yes. If it is done with "eyes wide open". Did your team enter into their commitment with you and the company with this explicitly in mind? If so OK. They have made a judgement when becoming part of the team as to the probability of success. It can be a great way to partly fund the "fund" start up. It gives the original team a stake in the eventual success of the enterprise.
No. If you didn't originally share this concept with your team at the time of hiring it may be unethical to force this concept on them. That does not mean it shouldn't or can't happen but you will need to work harder in your communication with the team and individually to be sure you are not coercing anyone into something they really wouldn't have chosen or aren't in a position to accept. (Not everyone can do without a regular cashflow for personal expenses).
In either case you will need to be very clear about how much "equity" is being acquired by each member of your team. Is every person to receive and equal amount for each weeks work, or will it be in proportion (at the value of) an agreed salary rate forgone? Is there a differential between someone who works 60 hours a week relative to someone else who works 40 hours a week.
A combination solution might be wise where a minimum amount of cash is paid for services (payroll) with the balance of an agreed rate of pay accruing in equity.
Also consider how this equity will rank with the founding equity partners (who may have invested cash up front), how will their rights be affected by the incoming investors, you will need their formal permission. Consider the ethical considerations (and legal rights) of those investors.
I am happy to discuss further in person.
intersting that I stumbled on this discussion this morning, as I'm going through a similar situation with my business. I'm seeking help on the sales side of the business, and find myself wondering if a partnership of sorts might be the way to go. You all have some great insight here, thanks for that! Also, just putting it out there, if anyone is interested or knows someone who might be interested in a startup partnership, please send them my way!
You may want to look into the 'Shared Entrepreneurship' model of worker-owned. This model, growing by leaps and bounds every day is the most ethical business model out there, in my honest opinion. Worker owned cooperative businesses create jobs with ownership and democratic workplaces, are rooted in their communities and serve to build greater community wealth in these times of rising social and economic inequality. Just Google 'worker owned cooperative' and you'll find all the information you need to manage this in an equitable way.
Yes...!!!!!!!!b Good Idea initially but when you start to sell and the numbers go up then put them on salary plus incentive including stock
Compensation in the form of equity instead of cash isn't an ethical question, but could be a state issue depending on where your business is situated and how you structure the equity offering. Check with your state employment laws first. Here's an article of interest in this matter: http://www.wagehourinsights.com/exemptions/white-collar-exemptions-paying-employees-wages-in-equity-rather-than-cash/
Keep in mind that once you give the equity away you can't get it back without buying it back. So, if any team members leave, they take the equity with them leaving you with what's typically called 'dead equity'. If equity is something you want to provide, make sure it vests over a certain period of time. You may also want to consider stock options rather than straight equity.
Good luck with your new venture.
Yes, but you need to give them what they deserve!
The Slicing Pie model for equity allocation and recovery will tell you EXACTLY how much equity each person in the company deserves (instead of cash). It will also tell you the fair buyout price (if any) when someone leaves the company.
I've written a guide about how it works. I'll send you a copy if you contact me through SlicingPie.com!
First how is our business structured?
My understanding and best explanation on this was "Profit share and equity share are the results of different types of business activity. Equity share is the result of investing money into a business that is establishing a new company or when buying stocks of a publicly traded corporation. Profit share is derived from the results of overall business operations, such as a business partner receiving a portion of profits earned from manufacturing products."
Just don't give away to much of your company. good luck
Why would it not be ethical? In fact it is an added incentive to the employee to make the business profitable.
Who define ethnic? Its all bottom down to your perception!
To me, the word is fairness.
1. is such compensation is beneficial to the business as a whole?
2. is such compensation is what the employees looking for? (some employees like, some not)
3. Any decision should come from good intention, you should be in good position.
Also, why ask is it ethical to compensate employees with equity in a startup over cash? As long as your intention is a good one and accepted by the respective stakeholders at fair basis, why not?
I think it should be the employees choice as to whether they want to invest their own money in the business. Compensation should be a salary otherwise they are not an employee but an investor. That said, it is always good to know your employees are as motivated to realise the end goal as you are.
Not only is it ethical, but it is a great business model. That is how you had Microsoft Millionaires! Payment in stock options pay off if the company has an IPO. The staff who were there in the beginning get their payoffs in "sweat equity". In my 30 year career, I have worked for 9 companies, 3 that no longer exist. Two of them have rewarded me with stock options that have paid off. Enabling me to be debt free and retired at age 52. For the story on a couple who were able to retire at age 36, look at http://www.mrmoneymoustache.com. Mr. and Mrs. Moustache curate a blogsphere of likeminded frugal people and the forum is awesome. If you want legal or financial advice, I do have a good lawyer and a good accountant who can help give you advice. PM me for more info.
Ethical AND more expensive if you are successful. Find ways to raise funds as it's cheaper in the long run. There are plenty of Angels around and if you have a good idea and a good business plan funding should be easy.
To me it depends. What is the purpose for the business and much equity will they get? If it is 10-20% then yea that makes sense. If its less then 10% no not really. And for how long will they not get paid. 4-6 weeks? that is okay buy not any longer.
There is nothing unethical about doing this- if it suits your business model go ahead.However a word of caution-are you capable of giving equity to employees as a start up- is the model sustainable in the medium to long term?