Equity plans are most commonly referred to as ESPPs, ESOPs, and Option Pools (but you can issue more than just options from them). The basic purpose of an equity plan is to set aside a pool of shares that pre-dilutes the cap table. This allows you to take from that pool of shares and issue equity in the future, without changing anyone’s ownership (since it pre-dilutes everyone).
Note that this isn’t the same process as authorizing shares under a security class, such as common. The authorized amount of a security is the “ceiling” amount for how much you can issue, but it doesn’t pre-dilute ownership like an equity plan does.
Let’s take the cap table below as an example. This is a fairly simple cap table with two founders and one consultant. This company has not set up an equity plan:
If this company issues shares to future employees, the new shares will add to the overall total, diluting existing shareholders:
Issuing shares in this way can be problematic, as it creates unknowns for the company and existing shareholders. To avoid this uncertainty, shareholders (founders and investors) will calculate an amount to set aside, such as 10% of the outstanding shares. By doing so, shareholders can know in advance how much their ownership will be diluted. Here is what the cap table would look like with a 10% equity plan:
Notice that the percentages for Founders A and B, at 54.113% and 36.075%, respectively. If the company brings on a few new employees who receive shares from the pool, the percentages will remain the same: