Using percentages instead of exact share numbers is a risky move for both the company and the employee. It can cause confusion about the true value of the equity being offered and set false expectations. In the worst-case scenario, it could potentially cost the employee hundreds of thousands of dollars.
Of course every situation is unique, so founders should work with legal counsel to craft their equity awards. If you’re looking for legal counsel, feel free to reach out to us here.
In this article, we’ll examine an equity issuance from our fictional startup Gregarious Games Inc.
Percentages Create Confusion
The founder James is looking to hire his first employee Kiera. James makes an offer to a potential hire, Kiera, in October 2024. The offer includes a promise that Kiera will receive “1% of the company.” Kiera accepts, and they get to work. James and Kiera both forget about this. In June of 2025, when the company is preparing for a fundraiser, their counsel points out that they’ve never actually issued Kiera her equity. (This is an all-too-common occurrence.) During the period between October and June, the company has issued equity to several key hires and issued a few simple agreements for future equities (SAFEs).
The exchange above may seem straightforward, but when issuing equity, several questions arise. The statement “1% of the company” is too vague and raises several issues:
- The promise. There is a distinction between promising and issuing equity. James promised “1% of the company” to Kiera, but that does not mean that Kiera has ownership. She is not issued that equity until her grant agreement (typically a restricted stock grant or a stock option grant) has been fully executed. For more information on the difference between promising and issuing equity, click here.
- The calculation. When James offered Kiera 1%, what does that actually mean? There are various ways to calculate percentage ownership:
- Percent of authorized shares. When a startup incorporates as a corporation, it authorizes a certain number of shares in the certificate of incorporation. These authorized shares are the total amount of shares the company may issue. Let’s say that Gregarious Games Inc. authorized 10 million shares in its certificate of incorporation. If we’re measuring Kiera’s equity as a percentage of authorized shares, then Kiera would get 100,000 shares in the company.
- Percent of outstanding shares. Outstanding shares, sometimes referred to as issued shares, are the total number of shares currently issued to shareholders. This number must be equal to or less than the total authorized shares. Let’s assume that the company has 8 million shares outstanding of the 10 million authorized. If we’re measuring Kiera’s equity as a percentage of outstanding shares, then Kiera would get 80,000 shares in the company.
- Percent of fully diluted shares. Fully diluted shares represent the total number of outstanding shares plus the total amount of shares if all possible securities were exercised or converted. This includes option pool, unexercised options, warrants, and convertible securities such as SAFEs and convertible notes. Let’s say that the fully diluted shares in the company are 10.2 million. If we’re measuring Kiera’s equity as a percentage of fully diluted shares, then Kiera would get 102,000 shares in the company.
For more information on the difference between authorized, outstanding and fully diluted shares, click here.
If Gregarious Games is successful and the price per share reaches $25/share, then the difference in payout for Kiera between calculating outstanding instead of fully diluted would be $550,000. This is a significant amount of money.
- The timing. The timing of the equity issuance is crucial, as the number of outstanding or fully diluted shares changes over time. If James assumes that the company owes Kiera 1% as of October and Kiera assumes that it’s 1% as of June, then it could lead to mistrust.
The timing could also impact the fair market value of the shares in the company. Assuming the company is growing, the price of shares will increase over time, which will impact the taxes paid on the equity. In general, the higher the price of the shares, the higher the taxes the employee has to pay. So, if the fair market value of the shares in Gregarious Games increased between October and June, then Kiera would likely have a higher tax burden.
- The type. Lastly, when James promised Kiera “1% of the company,” he did not specify the type of equity. The type of grant impacts the value as well as Kiera’s tax exposure, so it’s essential for the company to clarify the type of equity grant. For more information on the types of equity grant, click here.
All disappointment stems from misaligned expectations. Using percentages in equity offers can be problematic because it is too ambiguous. When there is a lack of information, both parties are likely to make assumptions.
For example, Kiera may assume that all four variables above are most favorable to her, while James may assume they are most favorable to the company. This can result in a significant difference in how the two parties understand the offer, ultimately leading to tension and potentially alienating a key team member.
Exact Share Counts Create Clarity
So, how can a startup founder avoid those issues?
Don’t use percentages in your offers. Rather than percentages, just use the exact share counts.
However, if you feel you absolutely must use percentages, then be precise. Here’s an example of what James should have said:
“We’re offering you a stock grant of 80,000 shares in the company at a fair market value of $0.00001 / share. This equity award is equal to 1% of the outstanding shares in our company as of October 1, 2024.”
Using exact share numbers instead of percentages can benefit both the company and the employee in several ways.
First, it provides clarity and transparency about the actual number of shares being offered to the employee. This can prevent misunderstandings or confusion later on about the value of the equity, especially when it comes to vesting or exercising options.
Second, using exact share numbers ensures that employees are not affected by changes in the company’s equity issuance over time.
Using exact share numbers provides greater clarity and fairness for both parties involved in an equity offer.
Best Practices for Communicating Equity Offers to Employees
When communicating equity offers to your employees, it is important to be clear and straightforward. Here are some best practices to follow:
- Use Simple Language. Not all employees may be familiar with financial or legal terms. Use simple language when discussing equity offers. Avoid technical terms or acronyms that employees may not understand.
- Provide Background. In addition to providing the exact number of shares being offered, provide some context about what this means in terms of ownership stake and potential payout. For example, explain how many outstanding shares there are in the company and what percentage of ownership the employee would have with their offer.
- Be Ready to Answer Questions. Employees may have questions or concerns about their equity offer, so be ready to answer these questions honestly and transparently. If you don’t know the answer to a question, be honest about that and commit to finding an answer as soon as possible.
By following these best practices, you can help ensure that your employees fully understand their equity offers and feel confident in their decision-making regarding accepting or declining them.
Dilution’s Role in Equity Offers and Its Impact on Share Numbers
When offering equity, it’s important to consider dilution because it can affect the value of an employee’s equity over time. Dilution occurs when a company issues new shares or options, which can reduce the percentage ownership held by existing shareholders, including employees.
Using exact share numbers for equity offers is important, but it’s also crucial to consider potential future dilution events. For example, if a company plans to issue additional shares or options soon, it could dilute the ownership stake of existing shareholders.
To address this issue, many companies use a fully diluted share count when making equity offers. This means that they consider all potential future dilution from stock options, warrants, convertible notes or other securities when calculating the number of shares to offer an employee.
By using a fully diluted share count, both parties can have a clear understanding of how many shares will be outstanding after all potential dilution events have occurred. This can help prevent surprises later on and ensure that the employee receives a fair offer based on a comprehensive view of the company’s capital structure.
However, even with fully diluted share counts, there is still some uncertainty around potential future dilution events. Therefore, it’s important for both companies and employees to be aware of this risk and understand how it may impact their equity over time.
Overall, using exact share numbers can provide greater clarity and transparency in equity offers, but it’s important to also consider potential future dilution events and adjust accordingly to ensure fairness for all parties involved.