A Jedi Mind Trick or Genuine Incentive? …
An employee share scheme (ESS) can be an exciting incentive but is often riddled with complexity and confusion. You may never know the true worth of an ESS until you either get lucky and rich or leave the company, full of frustration and regret. For example, are company shares worth sticking around for when a startup is still fighting for survival? Is the potential reward nothing more than a distant horizon with no hint of an arrival date? And is the value of the reward simply too insignificant to advance your life in any meaningful way? All these questions and more need to be considered before you decide if a scheme is a valuable incentive or simply a Jedi mind trick. Not all employee share schemes are created equal, so employees must look at the details before making a judgment.
Employees Beware
The potential of a big pay-day may keep people in a startup long after they have fallen out of love with the job, the employer or both. Also, as these schemes have become so popular, when you drill down into the small print, many of them may not be as compelling as you’d hoped. For the most part, the reality is if you are not a founder or early employee with a significant shareholding and possibly voting rights, what’s on offer may not be worth very much. That is, unless you have been super lucky and are joining the next unicorn superstar. Most startups fail, and of those that manage to survive, only a small fraction go on to achieve significant company valuations. Owning a small part of a very big and successful company could be life-changing, but conversely, owning a tiny share of a business that continually struggles to scale may not be much of a real incentive.
Check All Relevant Documents
Good companies will have an employee share scheme handbook containing all pertinent information, but it’s also worth cross-checking with the Memorandum and Articles of Association document – if such a document doesn’t exist, be wary. Some early startups may not have either of these documents yet, which may not be a deal breaker if you are part of a founding team, just as long as they are put into place soon after launch. In any case, always ensure the details of your personal shareholding are stated clearly in the contract of employment and, if appropriate, on the register listed with Companies House, or equivalent. Make sure you know when your shares will vest and what happens to your allotment should you leave the company, either before or after that date. Most employees adopt a blind faith approach, hoping their employer will take care of their interests. Consequently, many never even think to check that everything is in place and is as it should be.
Reward Not Guaranteed
Joining a startup is a risky endeavour and the offer of employee equity schemes that vest over time is certainly no guarantee of future earnings. Do your homework and make sure you are joining a business for the right reasons, such as your alignment to the vision and strategy. Not only must you have something to offer in helping the company achieve its goals, but in return the company must be able to offer you career progression, at least in principle and possibly subject to hitting growth milestones. A lot will depend on the size and profitability of the company when your shares vest. Sometimes, a financial event may require you to sell your shareholding, such as private equity investment or a trade sale.
Employee Share Schemes Explained
Employee share schemes in tech startups are often structured to prioritise founders and early contributors who took the most risk and made the biggest sacrifices in the company’s formative years. These schemes are typically set up to ensure that founders retain majority ownership and control, with a large batch of shares reserved for future investor funding. This arrangement leaves little equity for the average employee, making most share schemes more symbolic than lucrative. They are a nod to a culture of inclusion and to satisfy new employees’ expectations, but not necessarily much more. As a result, significant returns are usually only realised by founders and top employees, leaving others with modest, if any, rewards for their efforts.
How Much is Enough?
Founders usually retain significant control and larger equity portions, ensuring flexibility for future investment rounds. For later-stage employees, the shares received often represent a small fraction of company ownership, leaving limited financial upside unless the company achieves an exceptional valuation upon exit. For most employees, these schemes serve as incentives rather than generational wealth. Those who take the biggest risk are set to make the most reward. Depending on the numbers, you would need at least a single-digit percentage point of company ownership to achieve anything approaching a meaningful share valuation. This is, of course, provided the startup survives its first five years.
These Are Not the Shares You’re Looking For
So, what do we learn from all this? Well, not all that glitters is gold, and employee shares are not guaranteed to transform into real or significant money for many people. A smiling founder offering a stake in the company and an abundant supply of company-branded clothing is not necessarily trying to catch you out, but neither should you be off your guard. As ever, the devil will be in the details. You must do your own due diligence and fully understand what exactly is on offer. Even if the business proves successful and grows for many years, the size of your shareholding may still never grace you with anything like the compensation you feel you deserve. When joining a startup, you are being asked to take a chance on a new venture, perhaps with less compensation in the short term, but with the potential of future reward. Go into any such arrangement with your eyes wide open, so at least you’re informed. You could get lucky, and many have, but then again!
You may want to read: “Why Tech Startups Offer Equity to Employees.”
