LC036: Your Early Stage Equity Questions Answered

launchpeer - July 16, 2018

Today’s question:

Today’s question comes from Gary. I’m working with a new company and I’m trying to create an equity cliff investing schedule. I want to define criteria for what determines a cut-off for equity. If they leave or get fired, it’s clear that they should lose equity, but if a company takes longer to get off the ground then they could pull back on effort, which should reduce their equity, too. How do you define these milestones?

Jake’s answer:

It’s hard to even determine how much you should be giving for equity to early stage employees (we are not including co-founders here). It’s hard to talk about this in a standardize way, but I do have a few recommendations.

Don’t Give Equity to Early Stage Employees

Give equity to your co-founders and save some for your investors, but try to provide other incentives for early stage employees. It can overcomplicate things early on and can limit your ability to raise additional funding and can cause undue stress for you.

Give equity to your co-founders and save some for your investors, but try to provide other incentives for early stage employees. Click To Tweet

If You Do, Only Give it to Your Top-Level Hires

If you end up giving equity to employees, then only do it for key hires. For example, if you need to negotiate with equity for your CMO, that’s a good hire to give equity to because if that role does not perform, your company is not going to do well. Same with a CTO and other key hires.

Giving Equity to all Early-Stage Employees

If you are going to give equity to all early stage employees, then I would put a cliff in. A cliff is basically a way to rescind they equity you are going to give someone. For example, you wouldn’t just want to give someone 5 percent equity just for being a first hire. You would put a cliff on it and say that they would only get the equity if they stay with the company for a year or two.

For a sales person, you could give them the 5 percent, but then you would need to base it on sales performance. It can be hard to implement a cliff based on sales when you are early stage because you aren’t going to know if the goals you’ve set are feasible or not.

Tie to Meaningful Metrics

If you are going to make cliffs for them, it should not just be based on performance. A couple of ideas for other things to tie it to:

  • Time with the company (based the percentage on each additional year they stay on)
  • The number of employees they are managing
  • Number of times they meet with the founders to check-in on progress
  • Number of hours they work
  • Based on company revenue (the same for all employees)

No matter what you choose, make sure you draw a hard line. There should be no gray area on what they need to do to keep their equity. Also, if you make the equity progressive, you should put a cap on it. This will help you as you start fundraising for the first time.

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