Issuing shares to advisors and other senior executives can be a difficult decision to make. While you want to reward them for their hard work, you also do not want to give up too much ownership of your company. While it may seem like a complicated matter, it can be broken down rather easily when you incorporate the game of chess into this concept.
It may seem a bit strange to refer to the game of chess when discussing the share allocation of advisors and other senior executives, but just as there are different pieces on the chess board that play a unique role, each member of an organization has their own set of responsibilities as well.
This can be a useful analogy for thinking through equity compensation for your key team members.
The King
The “King” chess piece would be the founder(s) of the company (substitute with Queen for a female-led company). This King or group of Kings are the ones who first established the company and will be essential to its success. These folks typically own all of the shares in the company once it is first established, whether that be a structure with one founder (100% of shares), two founders (50% + 50% of shares) or even three founders (33% + 33% + 33% of shares). Although there are many ways to distribute these shares depending on additional or uneven contributions of the founders, these shares are often distributed evenly among the founders.
The Queen
Continuing with the chessboard analogy, the “Queen” would be the first significant hire of the company, a C-level recruit who is brought on as an equity partner. C level recruits are brought in at an early stage to help the company make significant strides for its organizational goals. The equity that the C-level recruit receives is often dependent on how well established the company is at the time of hiring.
Assuming that this C-level recruit (ex. CTO) is hired after foundational stage but still near the beginning of the company (let’s say 1 year out), when there is still a lot of risk and only some of the elements have been established by the founders, such C-level recruit could be allocated one-third (33%) of the shares in the company (For clarity, this would mean that the founder(s) would retain 66%, while the C-level recruit is issued 33% of the shares).
If the company decides to delay the hiring of their first significant hire, and waits (say 2 or 3 years out) until the company has a product, a customer base and the risk is much lower, the equity allocation to this Queen would start to reduce, potentially by ½ to ⅓ each year as a function of initial contribution, current valuation and stage of the product, among other things (reducing to 16.5 plus/minus 5% two years out or thereabouts, or 8.25 plus/minus 5% three years out or thereabouts).
There’s no exact math on this, and the anticipated contribution and market value for the skillset and contribution could be taken into account (as described in these articles Founders Agreement: Splitting that Za and Tips and Tricks: How to Compensate a New Team Member in Equity 16.5% of the company shares (For clarity, this would mean that the founder(s)v would retain 84.5%, while the C-level recruit issued 16.5% of the shares).
If the company does not want to give up the amount of equity typically required for a C-level recruit, but still wants to retain the services of a C-level recruit on a part-time basis, many companies hire advisors. Advisors are C-level recruits who only join the company part-time. As they are hired on a part-time basis, the advisors will likely have another job or position they are also working on at the same time. However, since they are not full-time employees, this allows the company to reward them at the level of a bishop, knight and rook, as listed below.
The Bishops, Knights and the Rooks
Following the hierarchy of the chessboard, below the queen would be the “bishops, knights and the rooks”, and in a typical organization, these would be the executive level employees. These are employees who have leadership capabilities and are able to lead day-to-day operations of the company.
To reward these executive level employees, a company typically reserves about 10% of its shares (plus or minus 5%) to compensate its executive level employees. These executive level employees are then given a small percentage from the 10% share pool. The percentage that each executive level employee receives, would be dependent on the number of executive level employees in the company (For clarity, if there are 5 executive level employees in the company and it was a 10% share pool, they would each receive 2% equity compensation).
An example shareholder capitalization table would therefore be:
King (Sole founder): 81.75%
Queen (Year 3): 8.25%
Bishops, Knights and Rooks (Heads of Business Development, Product, Content, Delivery Team (so 5 roles in total, 2.5% allocated to each) 10%
The Soldiers
Lastly, we have the “soldiers” - the next 100 employees for the company who may not necessarily be in leadership level positions, but who are essential to the growth and success of the business. Their contribution is extremely valuable, but what distinguishes the Knights, Bishops and Rooks is that their continuity in leadership is essential to keep the company running during the critical growth period.
The company will typically reserve 10% (plus or minus 5%) in the form of an employee stock option plan to incentivize these employees to “stay the course” as employees.
Once we add on the soldiers, the resulting shareholder capitalization table could therefore be:
King (Sole founder): 71.75%
Queen (Year 3): 8.25%
Bishops, Knights and Rooks (Heads of Business Development, Product, Content, Delivery Team (so 5 roles in total, 2.5% allocated to each) 10%
Soldiers: 10%
Disclaimer: It should also be noted that the share percentage ownership numbers listed above are merely observations based on past precedents, and should not be considered legal advice. Please consult with your accountant, lawyer and other trusted advisors before finalizing share allocations.
Price Per Share and Share Vesting
Executive shares are often issued under either a share buyback/restricted share issuance or option agreement. There are two implications: (1) that - if under an option plan, the options that convert into shares are not fully vested until a certain amount of time elapses and (2) the executive will need to pay for the shares once vested.
What is vesting under an option agreement?
This means that these shares are not fully vested immediately, rather they will vest over time in small portions, typically over a 3-year period, the timing of which is intended to incentivize these executives to “stay the course” and continue to work with the company during the bumpy startup journey filled with challenges, rather than taking on a different less tumultuous job. Often the company will reserve the right to buy back any unlocked or fully vested and exercised shares if the executive leaves the company.
Paying for the shares
A stock option is a form of equity compensation given to the employee that allows such employee to purchase the shares in the company at a specified price (market value at the time of option issuance) once the shares vest over a period of time. While similar to the equity compensation package given to the executives under a buyback or restricted shares arrangement, it differs in that the employee stock option plan requires the employee to exercise its rights to convert those options into shares at the end of the vesting period, and purchase the shares, rather than being rewarded with shares right away.
When the shares do fully vest, the option-holding executive often will need to pay the market value of the shares in order to convert them from options into shares.
In some executive equity plans, the company may loan the executive money on a very relaxed repayment schedule, with the intention that the proceeds of an exit event are used to pay for those shares.
More information about share buyback and employee stock options can be found below:
- The Purpose of Stock Option Plan
- Issuing Dates of Employee Stock Option Plans
- Mandatory ESOPS
- Overview of Share Buyback Agreement
Takeaways
- The King is the Founder of the company who typically owns all of the shares in the company when it is first established. If there are a group of Kings, the shares are usually distributed evenly among the Kings.
- The Queen (C-level Recruit), is the first significant hire of the company who is brought in as an equity partner. While there is no exact math on the percentage of shares issued to the Queen, the general rule is that the earlier you bring in the Queen, the higher equity the Queen is typically rewarded.
- The Bishops, Knights and the Rooks are the executive level employees who help lead day to day operations of the company. There is no set number, but companies typically reserve about 10% of their share pool for the Bishops, Knights and the Rooks, and distribute shares from the 10% share pool accordingly.
- Soldiers are the employees for the company who may not necessarily be in leadership level positions, but are essential to the growth and success of the business. The company typically sets out about 10% of their share pool to distribute to the Soldiers as they see fit.
Co-authored by: Kevin Lee