What is the best practice for compensating early employees with equity at a seed stage start-up?

This is a complicated question that likely requires legal advice particular to the startup. However, compensating employees at a seed stage typically takes the form of stock options or restricted stock units (RSU)s.

Stock options essentially give you the right to buy shares at a certain price (“strike price”) after a vesting period - typically, after your one-year anniversary date, with 25% transferred to you each year over a four-year period. The key here is that you must purchase the options. Your hope is that by the time you’re eligible to buy the options, the stock has appreciated. However, stock value could have eroded making it worthless, which doesn’t happen with RSUs.

RSUs are a relatively new financial creature. Similar to options, there’s a vesting period where the employee must satisfy certain conditions before the stock or its value is transferred (typically, there’s a period of time and other conditions - e.g., work performance). Unlike stock options, there’s no purchase involved. Instead, a certain number of units are allocated - or granted - to the employee, but there’s no value/funding until after the employee has satisfied the vesting requirements.

As always, please understand this answer is not offered as advice, but only to provide general information. Since there are many considerations involved with the complexities of these transactions, you really need to have personalized advice specific to your circumstances. Please check out LawTrades (www.lawtrades.com) and connect with an experienced startup attorney for additional guidance about evaluating equity distribution.

Equity.

You may try getting them to defer salaries, but they will probably not be interested. This may not be good from the business point of view either, because it just adds debt to the business

Generally the only to viable forms of compensation are cash and equity.

A startup's early employees are typically compensated in equity before there is a revenue stream to support salaries. The same can be true of early advisors and service providers (like attorneys). Determining amount and type of equity provided is something of an art. There are a lot of theories on employee equity floating around out there on the internet. In my opinion, best practice is to set aside an employee equity pool (to provide for visibility in terms of dilution) and award equity in return for services rendered. For employees, it is important that this is done through an option plan that includes vesting over time and protections for the company. Often, there is a certain amount of risk involved in an employee accepting equity rather than cash, so be prepared to make a determination as to the value of the company (and its stock as compensation) and what might be an appropriate premium to compensate for that risk. The specifics really depend on the company, the details of your progress, and your immediate plans. Happy to answer follow up questions or discuss further by phone call.