Made it to the offer stage of the interview process, but feeling lost on what the equity package actually means? You are not alone! We work with so many brilliant candidates who are experts in their domain, but then get completely intimidated when it comes to understanding startup equity offers.
At Lady Bird Talent, we believe that working for a startup can be very rewarding, both in work experience and in compensation! Many startups offer equity packages to their employees, coupled with their starting salaries. They use this strategy to bring talented people into the organization and incentivize them to help the company grow. We’ve all fantasized about being a part of that unicorn startup that IPO’dand earned the early employees mountains of money. If you’ve picked the right horse, your payout could be amazing.
If you are offered an equity package in a job offer, please know that these packages are not guaranteed compensation and include some risk. It’s important to evaluate the offer thoroughly before accepting. Equity packages can be confusing to those not in the financial world, and it is always a good idea to get the opinion of an actual financial advisor specific to your offer. This post will help you start breaking down the details.
In general, equity implies ownership. However, in most cases, an equity package does not mean you will own a portion of the company on day one. Your equity offer will come in the form of stock options or stock grants. Stock options offer you the ability to buy company shares at a predetermined price. Regulations are in place to enforce that the price must be a fair market value of the company stock when the option is granted to you.
Your options will be distributed a little bit at a time, or vested, based on the amount of time you work for the company. This is called the vesting schedule. A very common vesting schedule is four-year vesting with a one-year cliff.
A one-year cliff indicates that you will not have the option to purchase any shares until your first anniversary of employment. It’s important to note, if you leave the company before you’ve been there a year, you will lose all stock options.
After a full year, one year’s worth of your total stock options will become yours. The percentage is determined by the number of years on your vesting schedule. We most commonly see a four-year vesting schedule, where 25% is earned at the one-year milestone. If your schedule is five years, the distribution would be 20%. After this point, the balance of your equity vests to you on either a monthly or quarterly basis, depending on how the company has structured its terms.. Again, vesting does not mean you receive shares. Instead, you have the option to purchase shares at the price you were quoted at hiring.
A stock grant (not an option) is also commonly referred to as a restricted stock unit (RSU). A grant means you receive shares (or units) outright, usually on a vesting schedule. These shares are valued at the standard price when you receive them. You do not need to purchase an RSU. There is an excellent explanation of the differences between a stock option and a RSU here. RSUs are more common for very early-stage startups when the shares are not expensive and therefore less costly to the business. RSUs can be a great source of future income, but there are tax implications to consider.
Questions to Ask
Regardless of the form the stock offer takes, there are specific questions to ask the hiring manager as you review it.
- How many total shares are outstanding?
If you are offered 10,000 shares, how much of the company is that? 10%, 25%, 50%? That’s a critical question and can only be answered by knowing the total number of shares. For example, if 1 million shares make up the company, your 10K would be 1%. This is important because the percent you own will determine how much you’ll earn if the company is acquired. This is also called an exit event.
- How is the company doing?
Reviewing the current valuation of the company and its expected growth is important. You may love the company mission, but if it hasn’t achieved proof of concept or realized a product market fit, your investment of time and money can be for naught. There will be no million-dollar IPO in your future.
- What is the plan for future funding?
If the company needs funding in the future, your shares may be diluted. When a company goes after funding, they are offering shares of the company in return. Your percentage of the company will decrease as a result.
- Is there an exit strategy?
As mentioned above, an exit event is when the company is either sold or taken public. Many startups have a specific exit plan. If the hiring manager will not tell you, research the company and try to assign a possible likelihood to each scenario. Your shares are not really worth anything unless or until there is an exit event. It’s important to gauge what possible exit scenarios might be in the works so that you can decide if the risk is worth the payout. The payout will only be on your vested shares so if you haven’t worked at the company long you will not receive anything.
- If the company is sold, will they offer accelerated vesting?
Accelerated vesting allows you to vest shares sooner so you can receive more of a payout in the event of an exit.
- What is the possible dilution during a funding round or liquidation?
If the company offers you equity as a certain number of shares, then you still own that number of shares no matter if investors are offered shares or if the company is sold. However, if your equity is a percentage of the company, then any more stock purchases will dilute your total equity in the company.
- Are you planning to stay at this job for at least 4 years?
Keep in mind the company offers you equity on a vesting schedule so that you’ll stick around for a while. If you have no intention of doing that, an equity package may not be beneficial.
- What is my tax liability on an equity package?
You will not owe taxes on unvested shares. However, once you start exercising your vested shares, you can be taxed in certain situations. For example, if you sell any shares, gain dividends from your shares, or earn any other form of income from your shares, you will be taxed.
- Can I take my shares with me if I leave the company?
When your shares vest, you earn all rights to them. You can buy and sell the shares whenever you want. However, if you leave the company there is usually a deadline you must meet if you want to purchase any other vested shares. The most common time frame is 90 days. After that, you lose all unvested and vested shares you might have had.
- Can I negotiate the details of my equity package?
In most cases, everything is negotiable. If, after you have reviewed the offer, you feel like the package is not as beneficial as it could be, ask for more equity or different vesting terms.
Equity packages can seem complicated and confusing. If you know a lawyer or financial planner who would be willing to help you, ask them to review the offer for you. They might notice important details you’ve missed. This site has a terrific case study that takes you through a decision model for two stock offers. It will help you create one for yourself. Check it out.
Above all, remember that you are bringing talent, knowledge, and passion to the company. Don’t be afraid to ask for what you need. You are worth it.
Equity — According to Investopedia, equity is the amount of money paid to a company’s shareholders if all assets were liquidated and all debt paid off. If a company is acquired, it is the value of the company minus any liabilities owed by the company. In addition, shareholder equity can represent the book value of a company
Stock Option — The right to buy or sell shares of a company at a certain price and after a designated date.
Nonqualified Stock Option — A type of stock option in which you pay ordinary income tax on the difference between the grant price and the price when you exercise the option.
Incentive Stock Option (ISO) — A certain type of stock option that qualifies for long-term capital gains tax rates, if you meet certain stipulations. These stipulations include exercising the options while employed and then holding the stock for one year after exercise or two years after the grant date.
Vesting — Vesting offers employees access to company benefits over time, which gives the employees an incentive to remain with a company. The vesting schedule determines when employees acquire full ownership of the benefit. The most common vesting schedule is four years, often with a one-year “cliff,” meaning you must be employed for a full year to earn the first 25 percent of your equity.
Cliff — A stipulation in a vesting schedule. A one-year cliff means an employee must stay with the company for a full year to earn the first batch of shares.
Exit or Liquidity Event — When a startup is either acquired by another company or goes public. When a company is sold, it is up to the new owner to determine whether or not to continue a stock option plan, and there is no guaranteed payout for options that are not vested.
Accelerated vesting — During an exit, companies may offer stock options at an accelerated pace so employees can exercise more of their options in the sale/payout.
Dilution — Stock dilution is the decrease in existing value or ownership of a company as a result of the company issuing new equity through funding or sale of the company. New equity increases the total shares outstanding, which will dilute the ownership percentage of existing shareholders.