When a company extends an offer, there will be several elements for you to evaluate based on their competitiveness and what you personally value most. The cash usually gets our attention first (base salaries and incentive compensation, such as performance bonuses or commissions). However, other elements such as health benefits, equity, paid leave, training, and more, are all considered part of the full compensation package. This is known as “total rewards.” Let’s take a look at equity, which can be a little trickier to evaluate.
Equity offers provide the opportunity to own a portion of the company. It is often offered as a long-term retention incentive, as a performance incentive (since you have an ownership stake in company results), and to offset lower cash compensation, especially at startups. It is typically offered as stock options or as Restricted Stock Units (RSUs; a.k.a. grants). Each has its pros and cons.
(Note: Equity is complicated and there are many details beyond what we can cover here, so just be aware that there can be nuances and exceptions to many of the points in this post.)
Options vs. Restricted Stock Units (RSUs)
Options give you the right (quite literally, the option) to buy a set number of company shares in the future at a pre-determined price. This price is known as the strike price, exercise price, or grant price. The strike price is based on the company’s fair evaluation at the time of the offer, and it will not change after the options are awarded. Private companies determine the strike price based on their 409A evaluation. You don’t own the stock until you actually purchase (a.k.a. exercise) the options. The value to you is the difference between the fair market value at the time of purchase and the strike price.
Restricted Stock Units are shares that are granted outright, and the employee owns them when they vest. (The plan documents will outline the restrictions on trades and sales.)
Both options and RSUs will vest over time, such as 4 years. A pretty typical vesting schedule is a one-year “cliff” where you must be employed for 1 full year to vest 25% of your equity, followed by monthly or quarterly vesting thereafter.
Common vs. Preferred
Common and preferred stock both provide ownership in the company. The majority of stock issued is common. The label “preferred” is based on 3 key differences:
- Preferred stockholders have priority over the company’s income, so they will be paid dividends before common shareholders.
- Preferred shares have a greater claim on being repaid if a company fails. If that happens, common shareholders will be paid after creditors, bondholders, and preferred shareholders.
- Preferred stocks pay higher dividends than common shares.
Risk vs. Reward
Options are high-risk and high-reward compared to RSUs. Their value depends on future success. With a few exceptions, options/shares are usually not worth any cash value until there is an exit event (an acquisition or becoming publicly traded).
The upside can be significant if the company does well, but startup life doesn’t always work out well. The shares in future could be worth less than the strike price, leaving you with no practical value.
On the other hand, RSUs at a more established company might not have the same sky-high value potential as a startup, but they are less risky than options. Even if the stock value falls below the price on the grant date, they still have some value to you.
The cash compensation at a startup might also be less than you would receive at a more mature company. This means you are deferring more of your own cash flow for future equity ownership that may or may not be valuable.
Making Sense of Equity Options
With equity options, you’ll want two key pieces of information:
- The number of shares outstanding – First, you’ll want to ask about the total number of shares outstanding, which is the total number of shares issued. This will tell you what percentage ownership your options represent. If there are 10,000 shares outstanding and your offer includes 100 shares, that’s 1% ownership.
- The current value – You’ll also want to ask what is the latest value. Calculating this by the number of shares gives an idea of what you would need to pay to exercise the options. If this isn’t shared, you might be able to find information in Pitchbook or a similar source.Keep in mind that if in future more shares are issued, for example if an investor enters the picture, your ownership percentage reduces (known as dilution). The strike price will remain the same.
In addition, you can ask for a third piece of information:
- How do you decide how many options an employee gets?
As companies mature, equity offers become more structured.
- First, they’ll have options pools – options allocated for future hires – that are defined and approved by the board, reducing negotiation wiggle room.
- Second, they will have a more organized compensation strategy. They may decide to, for example, pay above the average market offer in equity and the below the average in salary (at larger companies these would be reversed).
- Finally, they will ideally have mapped each role to a level and have an equity (and salary) range for each level. They probably won’t share exact percentages or details, but hopefully they’ll be transparent enough to give some insight into their philosophy that indicates a thoughtful, fair offer.
The full outline of how equity is allocated is in the capitalization table, but don’t expect this to be shared.
Evaluating Equity
The earlier stage the startup, the more shares you’re likely to receive. Startups may be more willing to negotiate equity as they often need to save cash, but that’s typically at the higher levels. In general, the more senior the role and the earlier company’s stage, the more negotiating power you’ll have. Usually it is just the number of shares that you may be able to negotiate, unless entering as a high level executive. An extra .1% in equity could be worth much greater than an extra $10,000 in salary. Consider talking with a tax advisor to understand any tax ramifications, especially those around exercising options.
There are a few main steps you can take to evaluate your equity.
- Benchmark – First, you can use tools like AngelList for market data. If negotiating, you can make a stronger case if you have data showing typical equity in a similar role/company/geography.
- Research, research, research – Evaluating your equity offer is a subjective process with lots of future unknowns, with the biggest factor being the company’s success. Even if your equity package is relatively lower, at the right company the upside will still be great, so focus on the startup’s potential. Do you believe in the leadership team? Is the business model scalable? Is there a sound competitive edge?Do as much research as you can and as early as you can, so that you are able to make a quick decision on the offer. Assess a startup’s exit potential and through your interviews get a sense of what scenarios the leadership is aiming for.Ultimately, be clear on your own level of risk tolerance and what you’re willing to give up for a potential future upside.
- Calculate, if possible – If you have the data available, you may be able to get a more accurate picture of the value through an online calculator such as Carta.
Bottom line
When evaluating equity as part of your offer:
- Make sure you understand the definitions and the basic vesting terms
- Talk to a tax advisor to understand the implications
- Assess the equity, but consider all the elements of your compensation and benefits package
- Consider your own personal risk tolerance
- Use online tools to benchmark the equity offer
- Evaluate the company future as best you can
Definitions on key terms to know
