How much in stock options should we offer new employees?

We're a software startup with annual revenue in the ballpark of half a million. We're completely bootstrapped, and have no current plans to take funding. We currently have 4 employees. We're looking to hire two new developers as we shift our focus to a new complementary product - one senior back-end web developer and one junior front-end web developer. The back-end position is much harder for us to fill. Both will be paid about market rates. No benefits.

I'm new to equity incentives. How should we plan to tackle this? What percentages for each? Is issuing options better than stocks? How do we go about setting a strike price? How big of an option pool should we set aside? Any advice on vesting periods or clauses to include? We're based in Canada, if that makes a difference. Thanks!

Fred Wilson have written well about this here.

As with everything, it depends.

If you look at the valley companies, commonly a stock option pool of around 5-10% pre Series A is set aside, and is supposed to last during the lifetime of the company (up until M&A or IPO). Out of this, stock options reach couples of percentages, or even more with key executives, usually around percentages for extremely key specialists, and tenths of percents or less for "ordinary" staff.

Important things to know about this is;

a) VC's or investors will want you to set aside this stock option pool BEFORE they invest. This means that your dilution actually increases.

b) It's stock options, not stock. A stock option is the right to buy stock in the future (a defined window) for a pre-set price. The idea that this set price will be preferable to the valuation of the company.

c) If you're not a likely M&A or IPO-style company (what Jason Calacanis refers to as a Life-style business, watch this video ) stock is pretty much useless. Ok, that may be very harsh, but in reality, the idea for non-founders to own stock is that it will become liquid (tradeable for money) in the future. Before the company is sold or IPO'ed, the stock isn't useful. Small companies don't pay dividends on stock (they prefer to grow), and shareholders agreements prevent stock owners from selling the stock to anyone.

I would suggest reading theres articles on whether a job offer is a good deal, we dont pay you to work here, we pay you so you can work here and cult creation for startups You should speak to an accountant about what the tax implications are for your employees (it would be quite the demotivator if they have to pay a bunch of tax on stock they cant sell)! Whats your reasoning behind offering equity? Do your current employees all have equity? What is the vision for the business/is equity appropriate?

Its a good idea for you vesting schedule to have a 12 month cliff (ie you get nothing until you have been working there for 12 months) and can take about 3 years to get the full amount of equity, with some clauses around accelerated vesting on events like sale/change of ceo/termination under certain conditions.

Make sure you shareholders agreement has clauses for removing owners if they are detrimental to the business as unlike employees you cant fire owners if its not in the shareholders agreement.