Continuous Share Dilution in Startups: A Practical Perspective

The concept of continuous share dilution, where existing employees receive a new share every week, can be a topic of discussion in the context of startup equity management. This article explores the less common but effective strategy of regularly diluting the share pool to incentivize and retain key personnel.

Introduction to Continuous Share Dilution

Have you ever heard of a continuously diluting cap table? This unique strategy involves issuing new shares to employees on a regular basis, thus diluting the current shareholders over time. The key aspect of this approach is that existing employees retain the shares they already own, while those who stay in the company receive additional shares. Essentially, the value of the shares held by each employee increases as they receive more shares, unless they leave the company.

The American Perspective

Standard Practices

Tim Krauskopf, in his answer, described a situation involving stock options that vest continuously over time, typically quarterly or monthly. In contrast, the scenario presented here involves the issuance of shares rather than the granting of options. Although such a situation has not been encountered in my experience, it is important to consider the administrative overhead.

The administrative burden of issuing shares weekly would be overwhelming, especially for a startup or early-stage company. For these firms, restricted shares are more common than stock options due to the associated administrative overhead and expense. To gain more insights into restricted shares, refer to Rewarding Key Personnel: Restricted Stock or Options.

Practical Implementation

This approach has been successfully implemented in our organization. We use a 5–10 pool of stock reserved for incentive shares, which are awarded as stock options to valuable employees. At times, this means that every employee, from entry-level to senior positions, could hold options with a vesting schedule. Each year, the board would renew the pool, and this process would continue to grant shares to employees throughout the year.

Each employee would vest more shares on a monthly basis, and if they left, all unvested shares would remain with the company. The employee could keep their vested shares by paying the strike price of the options. This process is highly dilutive to all other shareholders of the company, as new shares are continuously issued and tracked monthly.

Why Not Weekly Issuance?

Issuing new equity on a weekly basis to accomplish the same dilution effect would not be accepted practice. Most people would question why a company didn’t use a stock option pool like everyone else. The regular yearly dilution process simplifies equity management and maintains a standard practice within the startup community.

Board Oversight and Renewal

The board plays a crucial role in overseeing this process, ensuring that the correct number of shares are issued and tracked annually. This reduces the administrative burden and ensures compliance with legal and regulatory requirements.

Conclusion

Continuous share dilution, while unusual, is a practical approach to incentivize and retain key personnel in startups. By regularly issuing shares and tracking their vesting, companies can maintain a motivated and committed workforce. While not a standard practice, this method is effective in creating a sustainable and dynamic equity structure.

References

Rewarding Key Personnel: Restricted Stock or Options - Additional resources on restricted shares and stock options.