No matter how young or old your company is, creating an employee option pool is a major undertaking. Employee equity will look different at every company, and the structure of your equity plan may change over time.

Looking to grant equity options to your team? Most people mentally file equity under “Finance,” but it’s largely a legal process involving copious paperwork and precise documentation. You’ll need to partner with a corporate attorney when you’re ready to take the leap.

Until then, this primer offers a basic overview and reflects our experiences creating employee equity long after our founding. For further reading, there are plenty of in-depth references online, such as this guide from Gusto.

Skip to:

1. Designing an Equity Pool
2. Corporation Type
3. Equity Management
4. Valuation
5. Grant Details
6. Internal Launch
7. Equity Maintenance

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1. Designing an Equity Pool

Depending on the structure of your business, the owner(s)—who are often founder(s)—will need to decide how many shares they are willing to allocate to an employee equity pool. Market data can help guide this determination. Looking forward, the pool should be large enough to accommodate anticipated headcount growth.

2. Corporation Type

To offer options, companies must have a certain corporate structure (usually C corporations). Your legal counsel can advise whether changes need to be made to your corporate structure and how these changes may impact the rest of your business.

3. Equity Management

While it is technically possible to manage your equity documentation with something as basic as spreadsheets, licensing an equity management platform will simplify the end-to-end process for both you and your employees. Your legal advisors can help guide you through selecting a platform, setting it up, and making adjustments during major events (such as fundraising).

4. Valuation

Any business offering equity, whether to employees or investors, needs a 409A valuation to establish the value of the business. This valuation is valid for 12 months and sets the strike price, or exercise price, for options or shares granted during that period.

To obtain a 409A, you must provide financial statements, forecasts, company background (management structure, ownership structure, history), industry information, and more to a valuation partner. The goal of providing this info is to help the valuation partner find comparable companies to benchmark against. You may also have the opportunity to supply a list of publicly traded companies that you consider appropriate comps.

Your valuation should match your expectations for your business. When your valuation partner returns the 409A, you have the right to discuss adjustments before approving the final version.

5. Grant Details

It’s time to outline the specifics of the grants you will offer to employees: number of options, vesting schedules, cliffs, exercise periods, and so on. While some parameters are more common than others—such as a 4-year vesting schedule with a 1-year cliff—these decisions should be governed by your internal discussions and the specifics of your company and your culture. Because employee stock options are part of compensation, compensation benchmarking data can be useful in your decision-making process.

6. Internal Launch

At this stage, your employee equity plan should be ready to roll out. Equity is an exciting concept. It’s also complex and often misunderstood. Your internal launch should include educational resources, both live and asynchronous, to help your team understand what their grants mean, what they need to do, and why it matters.

Because exercising options can have significant tax implications, we always encourage our team members to consult with a financial advisor when making individual equity decisions.

7. Equity Maintenance

As time goes on, your equity plan may be affected as you scale or from events like fundraising or acquisition. From an accounting perspective, option grants must be recognized on an ongoing basis as internal expenses (stock-based compensation expenses) based on the grants’ value, plus associated tax implications.

Finally, you will need to obtain a new 409A annually or after a material event, such as a fundraise. Each valuation will establish a new fair market value for existing options and the strike price for newly issued options.

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This primer merely scratches the surface; it is simplistic by design. The road to establishing employee equity can seem daunting, but like any big project, it’s a matter of breaking it down into manageable pieces.

The goal of this primer is to provide a bird’s-eye view of where to start and where to go from there. With the support of your advisors and team members, you’ll dive deep into the details at each stage.

When you reach the end, you’ll have accomplished something that could potentially change the lives of your employees. And no matter what happens, that’s an achievement in and of itself.

Ed. note: Organizational equity plans and policies should be designed in consultation with legal counsel. Equity choices on an individual level should be made with input from a qualified financial advisor.

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Part I

From Sole Ownership to Shared Ownership

Part II

In Pursuit of Shared Ownership

Part III

The Promise & Potential of Employee Equity