Coming up fast: Building to last/When to hand out shares

Coming up fast: Building to last/When to hand out shares - DILEMMA: We've been searching for a new sales director for months. At last we've found someone who seems exceptional and should fit our business culture, but she wants equity. My co-founder is imp

by PATRICK DUNNE works with 3i
Last Updated: 31 Aug 2010

DILEMMA: We've been searching for a new sales director for months. At last we've found someone who seems exceptional and should fit our business culture, but she wants equity. My co-founder is impressed, but reluctant to give her a stake in case things don't work out. What should we do?

ISSUES: The equity carrot should be used sparingly and only for the long term. Founders normally release equity for three reasons: to attract highly qualified, quality employees, to keep them and to motivate them.

It sounds like all three here, but are you viewing your prospective sales director as a new partner or a supplier of skilled labour? Either way, be sure she will make a significant difference to the value of the company.

Think about what you mean by 'equity'. She could buy a stake, or receive share options, or a mix of the two. Consider whether you can build capital value in line with her performance, but remember the dangers of a direct link to sales alone.

How do you decide the right stake? It's easy if you have just raised venture capital or are quoted, but much harder otherwise. Also remember you're offering a minority stake, not a controlling interest. If you're offering share options, you may already have an approved scheme. Many early stage businesses use these 'heads you win, tails you don't lose' schemes because they don't consume cash. In private companies, however, they only have value if the company is sold or floats.

Finally, what will happen if it doesn't work out? Will you commit her to sell back to existing shareholders? If so, how will you value her stake?

And what about everyone else? Other staff may feel they deserve a piece of the action.

ACTION:

- Above all, be clear, be positive and don't give equity grudgingly.

- A gradual build-up is better than a big grant so if you do go for equity, choose a mix of options and shares, but keep it simple.

- Try to link to performance/objectives, but accept there is always an element of luck.

- Protect the downside with a probation period and 'leaver' clause making sure that there are pre-emption rights for other shareholders and an agreed basis of valuation.

- Make sure you have considered your existing employees or those you plan to recruit.

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