Can I tell employees and contractors they will receive a percentage of the company?

Takeaway: In most cases, I don’t recommend promising a percentage of the company because the outstanding number of shares can change pretty dynamically. You may promise someone .1% of the company and have an employee quit, which brings down the shares outstanding, which means you’re issuing the new employee more shares than you would have. It’s typically better to promise folks specific numbers of shares.

It can be tempting for startups to promise employees and contractors that they will receive stock representing a percentage of the company as part of their compensation package. However, this practice can lead to a number of problems and should generally be avoided.

Here are some reasons why companies should not tell employees and contractors they will receive stock representing a percentage of the company.

Dilution

The value of a startup's stock can be highly volatile, and promising employees and contractors a fixed percentage of the company's stock can lead to significant dilution of the founder's equity. As the company grows and issues more shares of stock, the value of each share can decrease, resulting in a lower percentage of ownership for the founder.

Complexity

Telling employees and contractors they will receive stock representing a percentage of the company can also create significant complexity in the company's capital structure. It may be difficult to accurately calculate the value of each share of stock, and this can lead to disputes and misunderstandings down the line.

Communication breakdown

Finally, promising employees and contractors a fixed percentage of the company's stock can also lead to communication breakdowns and misunderstandings. If the company's stock value fluctuates, employees and contractors may become confused or disheartened by changes to the value of their compensation.

Conclusion

It's generally not a good idea for companies to promise employees and contractors a fixed percentage of the company's stock as part of their compensation package. Instead, companies should consider promising folks specific numbers of shares. If you are a startup considering offering equity compensation, it's important to work with a qualified attorney and tax professional to ensure that the terms of the equity compensation are structured in a way that is legally compliant.