The biggest problem with employee equity is the taxes. Investors pay cash for their shares, and the transaction is completely tax neutral. When a company sells its own shares in exchange for cash, the IRS does not charge a penny.<p>But if an established company wants to get equity into the hands of its <i>employees</i> now you have a problem. The way the tax law is written, you have basically 3 choices. Either the employee is paying you &quot;fair market value&quot;, or you are giving them options with a strike price at &quot;fair market value&quot; and they can hope for future appreciation. Otherwise, if you try to just give them shares, the IRS needs to be paid, and in cash! So, for example, to simply give 10% of outstanding common shares (an illiquid and diluting asset) to your employees, you would have to pay 4% of your company&#x27;s &quot;fair market value&quot; in cash to the IRS!<p>The problem is all in how you define this &quot;fair market value&quot; thing. If you sell some VCs equity along with what&#x27;s basically a note payable (liquidation preference) and then say the &quot;value&quot; of the company is equal to the total raised divided by the percentage equity stake they received, all while totally ignoring the &#x27;note payable&#x27; -- that&#x27;s complete madness! And it&#x27;s the world we live it today.<p>If, alternatively, you first subtract off the top of any amount raised the full amount of any liquidation preferences, then only the <i>remainder</i> was divided by the percentage equity stake to arrive at a valuation... For example, raise $10m for a 10% stake with a $10m preference -- then for tax purposes your common stock valuation should still be  $0. Now you can grant however many common stock shares you want all day long, and you don&#x27;t bleed cash to the IRS in order to do it.<p>Employees would still have to pay the full load of taxes on any <i>gains</i> when they sell the shares. But this fixes a huge challenge of fairly compensating employees with equity without even dodging any fair share of taxes. Taxes should be due and payable when liquid value is actually received, not before.