Should you give equity to an early employee
When employee equity is worth granting, when a profit share is the honest alternative, and how an undocumented verbal promise turns expensive.
The conversation that starts with "some equity"
You cannot pay what a good candidate is worth and so you are thinking about shares. Or someone already here has asked for some equity without specifying what that means. The phrase sounds simple and covers several different arrangements with different costs.
Equity is the one form of compensation you cannot quietly reverse next year. A salary can be restructured. A grant sits on your share register and shows up in every future conversation with an investor or a buyer.
What equity does not do and what it costs
Equity does not substitute for cash for most employees. Someone paying rent in a metro cannot bank an illiquid instrument and a grant offered in place of salary reads as the business asking them to carry its funding risk. State the salary first and treat equity as an addition.
It is also not free. Setting up a scheme properly involves legal drafting and a valuation and board and shareholder approvals, each of which is a professional fee with GST on top. The larger cost is dilution and governance. Every grant reduces your own share and adds a person whose interests must be considered when the structure changes.
Who should not be granted equity
If your business has no realistic path to a sale or a funding event then do not grant equity. A profitable services company that the founder intends to run for twenty years and hand to nobody has nothing to offer a shareholder except dividends it probably will not declare. The grant costs you real dilution and administration in exchange for a promise the employee cannot convert. Pay a profit share or a defined bonus linked to the numbers instead. It is cash and it does not require a lawyer each time you change it.
Also decline where the employee is treating equity as a replacement for pay they need now. And decline for a role that is genuinely replaceable. Equity is a tool for retaining someone whose departure would change the trajectory of the business. Granting it to hold an administrator sets a precedent that becomes awkward within two hires.
How a grant actually works
The mechanics are more involved than a percentage in an email. A private limited company creates a pool of shares set aside for employees and that pool is approved by the shareholders under a written scheme. Each employee then receives a grant letter referring to that scheme. The grant is options rather than shares which means the employee has a right to buy at a stated exercise price later.
The grant vests over time. A common shape is vesting across four years with nothing vesting in the first year and the remainder accruing monthly or quarterly after that. The scheme sets what happens if the person leaves before vesting completes, how long after leaving they have to exercise, and what happens to unvested options in a sale. Those three clauses cause most of the disputes so read them rather than accepting a template.
A cash-settled alternative deserves a look where all of this feels heavier than the situation warrants. A phantom share arrangement pays a cash amount linked to a valuation event without issuing shares at all. It avoids the register and the dilution entirely.
How to tell whether it did anything
The metric that matters is behaviour. Does the person now raise uncomfortable things, question a discount, care about the cost of a tool. A grant that changes nothing about how someone works was a cost without a return. A second test is whether they can explain their own grant to a friend. If they cannot then it is not retaining them.
The metric that flatters is gratitude at the point of the offer. Everyone is pleased to be given shares. That pleasure fades within two quarters if nobody ever explains what the shares are worth or what would make them worth more.
The common mistake
The expensive error is the verbal promise. Two per cent agreed in a car after a client meeting with no scheme and no vesting and no document. It feels generous and costs nothing on the day.
It reappears at the worst possible moment. During a funding round or a sale when a diligence process asks who has claims on the company. The former employee who left in year three remembers the conversation differently from you and there is no document to settle it. By then the amount in dispute is real money and the dispute itself can delay or reprice a transaction. If you intend to give someone equity then do it properly or do not say the word.
The regulatory and tax mechanics
Employee share schemes in India are governed by company law provisions covering how a pool is created and approved and by valuation requirements that apply when options are granted and exercised. On the employee's side the difference between the exercise price and the value at exercise is treated as a perquisite at that point, and a further charge arises on eventual sale of the shares. The structure available also depends on your entity type since an LLP cannot issue shares as a private limited company can. A qualified professional should confirm the treatment for your situation before any grant letter is signed.
This guide explains how something works. It is not legal, tax or financial advice, and rules change. Confirm anything regulatory with a qualified professional before you act on it.