Q: Should you offer equity (for free or for purchase) when enticing someone to join the company at the C-level?
A: Some owners like to give up equity to key employees both to engender loyalty and commitment to the company and to bridge the gap between salaries in their area and what the company can reasonably pay. Other companies do not offer this “equity as payment”. There is no right or wrong. Most tech companies offer equity. It’s really the only way for them to attract high quality personnel who will work 60-80 hours a week to build the company. Investment banks and other entities pay high salaries for this work ethic (and still often offer performance-based options) but start-up technology companies cannot afford to burn their cash paying those salaries.
I know of someone who has helped a large number of small companies and accepted equity as partial or full payment. She has all these shares that she can’t collect on. (No, she is not I.) So if you do decide to offer equity, you must structure your Shareholder’s Agreement and/or Buy Sell Agreement to provide minority shareholder rights. Otherwise, you’re offering up something that may ultimately be nearly worthless due to the lack of an automatic buyback provision (upon severance or contractual end) or the omittance of non-dilution provisions.
(Of course, as the business owner, this could work for you. You can offer company shares with no embedded minority shareholder protections, thus protecting you further if you have a personality conflict or divergence of vision with your key employee(s). The person coming in should make sure their rights are protected but that often does not happen, especially in small and medium-sized businesses. From my experience, most owners and management teams know very little about properly structuring minority shareholder protections and have to consult an outside entity. )
If you do not wish to offer equity as payment, but still need a strong incentive to subsidize an initially lower salary, you do have equity alternatives. You can offer a percentage of gross profits or a percentage of net income. You can offer to pay your new management a specified percentage of any distributions BEFORE you distribute to yourself. These are just some of the ways to structure an offering to someone so the C-level executive you are recruiting can share in the upside of the growth he or she will help attain. In your C-level recruitment you can state, “we offer equity alternatives”. That would pique my interest!
If you are a start-up and seeking angel investors or have been in business for a while but are now entering a heavy expansion phase, you may be able to obtain investment by an “exec with a check”. An “exec with a check” is a C-level manager who likes getting deeply involved with start-ups or rapidly growing small companies but does not want to start his or her own company. Or he or she may have had their own company in the past, but now they’d like to help someone else do it. Since your company is early or expansion stage and needs money, the executive will contribute his or her money and his or her time for a sizable stake in the company.
Note to companies in the pre-revenue stage: Be careful when seeking an “exec with a check”. You can alienate executives who may consider working for you later on when you do have sufficient revenues and can pay a modest salary. There is nothing more off-putting than having a position misrepresented. I’ve heard tales by C-level executives of how they were recruited (and flattered) only to find out that “there was nothing there”. These individuals spread the word to all who will listen, making it difficult for the company to find good people later. Be upfront. Advertise for a hands-on, deeply involved investor. Do NOT advertise for an executive until you have some cash flow. If you are pre-revenue and don’t yet have any financial backing, believe me, an investor is what you want. If part of the reason you need the funds is to bring in a C-level executive because strategy, finance, or operations is not your skill set, that investor can help you find the person you seek.