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Compensation for Sweat-Equity Players

Cliff Ennico on

"We are starting up a technology company and want to know the right way to compensate our technicians, developers and others who will be helping us grow the business. We don't want to give them equity at this time because we don't know how committed they will be to the business going forward. But we do want them to share in the growth of the company if it's successful. We've done some research online and it's all pretty overwhelming. Can you put together a simple 'checklist' of the different ways we can incentivize our key players?"

My motto has always been "No challenge too great; no fee too low." So here goes ...

You basically have five options (other than cash, of course) when compensating sweat-equity players in a startup.

Restricted Stock. By giving your sweat-equity team restricted stock, you are giving them actual shares in the company but with a number of strings attached:

-- The shares should be nonvoting. You don't want these people having the right to second-guess your management decisions.

-- The shares should be doled out over a period of time (usually three to five years), called a vesting period.

 

-- After a person's shares have vested, you should have the right to buy them back at book value or some other highly discounted price if the sweat-equity player leaves the company for a competitor or commits an illegal or fraudulent act (this is commonly called a clawback provision).

Stock Options. By granting options to your sweat-equity players, you enable them to buy stock in your company down the road at their current (much lower) value.

First, you put a value on what your company is worth today. Since you are just starting out, this will be an extremely small number, for example one penny per share. You then grant each sweat-equity player the option to purchase X number of shares -- say, 10,000 shares -- at that price (so, $100 in total) when the shares vest one, two or three years after the date of grant.

As the company grows in value, holders of options will exercise them by purchasing shares for the original option price ($0.01 per share). So if your company is later worth $1 per share and the option holder exercises all 10,000 of his or her options, he or she is getting $10,000 worth of stock for a purchase price of $100.

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