“Giving equity to employees can unlock growth - or unleash chaos. You decide.”
- Matt Glynn

Employees can be your greatest asset - or your biggest risk. And nothing blurs that line faster than handing out equity without a clear plan.

Giving employees shares or options can supercharge performance, attract top-tier talent, and align everyone toward a big exit. But if you don’t set up the structure properly - and legally - you risk blowing out your cap table, losing control, and tanking your company’s valuation.

Legal issues like this are easy to overlook. It’s tempting to promise equity to lock people in - especially when cash is tight. But equity isn’t a handshake. It’s a legal instrument with long-term implications for ownership, control, dilution, and your exit strategy.

In this “start up stage review”, we’re going to flag up some considerations to help you better prepare to tackle this part of your start up journey - before it tackles you.

“You're not giving away equity - you're building a team of partial owners. That changes everything.”

Managing Employee Shareholders effectively is an important stage of the start-up journey because:

◼️Talent Attraction: it allows early-stage businesses to compete for top talent without cash.

◼️Retention Incentive: it encourages employees to stick around and contribute long-term.

◼️Performance Alignment: it links individual performance with company success.

◼️Founder Control: if poorly designed, ESOPs can erode founder control over time.

◼️Cap Table Integrity: unmanaged option pools create confusion and bloat.

◼️Investor Signals: a structured ESOP signals professional governance and long-term planning.

◼️Exit Readiness: it enables smoother exits by aligning employee interests with shareholders.

◼️Tax Efficiency: well-structured ESOPs can be more attractive for employees than salary increases.

◼️Legal Clarity: it avoids employment disputes over informal or undocumented equity promises.

◼️Valuation Impact: ESOPs can impact pre- and post-money valuations if not properly managed.

The consequences of not attending to this issue may include the following: 

1. Legal Implications

◼️Enforceability Issues: verbal promises of equity without formal documents can trigger claims.

◼️Securities Breaches: poorly structured or undocumented schemes may breach local laws.

◼️Employment Law Risks: disputes over entitlements or fairness can spill into employment litigation.

2. Founder Relationship Issues

◼️Dilution Shock: founders may not realise how much of their stake is eaten up by employee equity.

◼️Voting Misalignment: shares without voting restrictions can unintentionally dilute control.

◼️Exit Friction: founders may face backlash during M&A if employees aren’t treated fairly.

3. Commercial Implications

◼️Investor Resistance: investors may reject cap tables that look over-incentivised or poorly structured.

◼️Reputation Damage: mismanaging employee equity can create toxic internal culture.

◼️Overcommitment: too much equity distributed too early leaves no room for future hires or funding rounds.

4. Operational Implications

◼️Motivational Mismatch: giving equity without vesting or performance triggers reduces its impact.

◼️Onboarding Confusion: no standardised equity communications = chaos in hiring processes.

◼️Admin Overhead: unmanaged options require time-consuming explanations and paperwork.

5. Biz Valuation Issues

◼️Equity Overhang: excess unallocated options can suppress valuation.

◼️Exit Misalignment: poorly structured plans complicate exit payouts and negotiations.

◼️Dilution Complexity: investors may penalise you if ESOP dilution hasn’t been properly accounted for.

The above lists are indicative issues – the relevance of which will depend on your circumstances, including the nature of business undertaken by your start up.

“If equity is part of your compensation strategy - treat it like any other major asset class.”

We’ve identified quite a number of potential issues that the start-up needs to consider and below are some examples of the types of steps you might want to consider taking to address these issues considered above. 

1. Establish a Formal ESOP (Employee Stock Option Plan)

◼️Create a legal framework that outlines eligibility, allocation process, and terms.

◼️Ensure the plan complies with corporate, employment, and securities laws.

2. Define the Option Pool Early

◼️Establish a pool that reflects future hiring needs - typically 10–20% is common at early stages.

◼️Model dilution impact on founders and future investors.

3. Tie Vesting to Retention and Milestones

◼️Implement time-based vesting (e.g., 4 years with 1-year cliff) or milestone-based vesting.

◼️Prevent walkaway windfalls and maximise retention.

4. Clarify Voting and Exit Rights

◼️ESOPs so that employee shareholders don’t inadvertently receive full voting rights.

◼️Ensure drag-along provisions apply to option holders where appropriate.

5. Align With Shareholders and Founders Agreements

◼️Ensure ESOP terms sit comfortably within broader governance structures.

◼️Avoid contradictions that lead to enforcement gaps or disputes.

6. Explain the Plan to Employees Properly

◼️Don’t oversell - equity is potential value, not a guaranteed payout.

◼️Use standardised templates and training to reduce misunderstandings.

The above suggestions are just a few of the steps you can consider taking.
There are many more things that need to be done to ensure the associated risks are effectively and pragmatically dealt with.

We’re not trying to be alarmists and go so far as to say that some of the legal risks we have flagged may never materialise for your business - but others can hit like a freight train.

The key point is awareness – just have a think about the issue – know that it exists and decide for yourself what you want to do.

Yes, we know you're juggling limited time, money, and human bandwidth. Sometimes ignoring a legal risk might even make sense – providing doing so is not illegal.

However, “Knowledge” has always been your greatest asset and know you have the GLS Knowledge Centre to help fill in details about the start up journey.

Let’s look at how things can go sideways:

Case Study 1: “The Over-Promise Problem”
A founder offered 5% equity to a key engineer verbally, then forgot to document it properly. When the company closed a Series A, the engineer sued to claim their stake - delaying the round and costing $70k in legal fees.

Case Study 2: “The VC Knockback”
A startup structured a 30% ESOP with no clear allocation or vesting. When investors reviewed the cap table, they balked at the founder dilution and lack of clarity. The deal collapsed.

Case Study 3: “The Entitled Ex-Employee”
An early hire was granted options with no cliff and left after 8 months. No bad leaver provisions meant they kept a significant stake - despite contributing almost nothing. At exit, they demanded full payout alongside the founders.

Giving equity to employees can be one of the smartest things a founder ever does - or one of the most dangerous. Done well, it aligns performance, attracts A-players, and shows investors you understand long-term incentive strategy.

Done badly? It dilutes control, triggers disputes, and damages your credibility.

Investors like to see ESOPs - but only when they’re clean, clearly defined, and properly accounted for. They don’t want to deal with cap table landmines. Neither should you.

GLS can help you build an ESOP structure that motivates, protects, and scales - without giving away the crown jewels.

GLS may well be able to help you navigate the issues associated with the Employee Shareholders stage.
Few, if any, integrated legal solution providers have made themselves as accessible to the start-up community as we have.

Consider engaging with GLS via any of the following means:

◼️GLS Start Up Centre: visit our world-leading start-up legal support resource – we might have a solution “ready to go” available to you at a fraction of the cost – visit www.gls-startuplaw.com

◼️GLS Knowledge Hub: check out the knowledge hub for more information on this issue to learn more about what you need to do
https://www.gls-startuplaw.com/blog

◼️GLS Support Plan: consider engaging your own in-house legal team capability with a highly disruptively priced GLS Start Up Support https://www.gls-startuplaw.com/plans

◼️GLS Legal On Call™: trial GLS Legal On Call™ for free - access up to 3 free in-house legal consults and feel the power of your own “on call” legal team https://www.gls-startuplaw.com/product/gls-legal-on-call-free-trial

◼️Book A Consult: book a complimentary one-off 15 min consult via our e-calendar
https://calendly.com/globallegalsolutions/startup-free-legal-consultation?month=2025-03

◼️GLS Start Up Clinic: join our next pro bono start-up clinic for an in-person free consult – book here.