Congrats, You Received Equity! Now What?
So you got a job offer from the startup of your dreams, congrats! Chances are this offer comes with a base salary and bonus range in cash. If you’re lucky, your offer might even include equity that looks something like this: 0.00001%. A bunch of zeros followed by a one after a decimal.
While it is easy to dismiss the small fraction of a percent of equity as trivial, balk at what looks like a low offer or focus on cash compensation because it’s more tangible, equity offers can carry real value (just ask employees of Slack, Uber, Lyft and Pinterest).
So how can you be sure you’re prepared to understand the equity component of your offer, ask the right questions and make an informed decision about your offer? Ahead, OpenView’s Sean Fanning answers all the crucial questions everyone should ask when it comes to equity.
How Does a Company Decide to Give Equity and How Do They Decide How Much to Offer?
To understand equity allocation (the process of offering stock to investors and employees) let’s start at the beginning: when a company is founded. On day one the founders are the sole owners of the business – they own all the shares (the “stock” or “equity”) of the company. When founders agree to bring on financing partners – be that angel, seed, venture or private equity – they’re carving out a piece of the company’s cap table (the summary of ownership of the share of a business) and selling new or existing shares. Partners reserve part of the cap table for employees. This is known as the option pool.
The option pool can range from non-existent to more than 10% of the business and it represents a fixed amount of shares. While they take many forms, equity offers to employees most commonly come as option grants. Option grants are effectively a promise that you can buy a fixed number of shares of stock at a set price (the “strike price”). You are given the option to purchase stock. Companies have to be very thoughtful about how they dole out options to employees because the pool is limited.
The purpose of option grants is to give employees “skin in the game” and incent long term performance. Option grants also provide a company with a means to offer competitive compensation while preserving cash for operations in the near term. Much like salary, option grants are given commensurate with experience and seniority. Furthermore, companies must receive approval for every grant from the board of directors at each board meeting. When you receive an option award, recognize that your prospective employer and board have put significant thought behind what they’ve put forward.
What Do Folks Need to Know to Make a Decision About Their Equity Offer?
It’s easy to ignore the equity piece of offers (and many people do). Perhaps they’re more focused on base and bonus or they don’t understand the equity piece (or simply don’t care). The equity piece should matter, and the goal should be to understand the cash value of the equity option grant today.
In a perfect world a company would provide all the exhaustive documentation they provide to potential investors so candidates can make informed decisions about the potential future value of the stock. Instead, I suggest asking a hiring manager two things:
- What does my option grant represent in terms of fully diluted post-money ownership of the company today (a percent)?
- What was the company’s last post-money valuation? A * B = the theoretical cash value of your equity offer today.
Why is the theoretical cash value today important? For one, it provides a baseline for what you should expect to receive should you fully vest (meet the company’s requirements and be permitted to purchase the options, typically time based). Instead of focusing on how much of a company you could own, put the numbers in terms you understand: cold hard cash. Is this an exciting amount of compensation? Second, chances are you are evaluating multiple job offers. By understanding cash value today you can review competing offers on an apples to apples basis by looking at “all in” compensation (base, bonus, equity).
Why Is Cash Value Theoretical and What Keeps It from Being Real?
For one, you can only own shares that you’ve fully vested. Most commonly, companies structure option grants with four-year vesting schedules. In the four year schedule, 25% of your options are typically available one year after your start date (a one-year “cliff”). Thereafter, your remaining shares vest evenly each month. If you quit or the company is acquired before options vest, you lose out on those shares.
Some senior roles will include “vesting triggers” in which all options automatically vest should the business be acquired. Similarly, some offers promise to provide “true ups” to option grants. If a business raises more financing (e.g. venture capital) the company may create new shares to sell. Without a true-up, you’d own the same number of shares over a larger denominator (smaller piece of the pie). A true-up ensures that your ownership is preserved. Both of these terms are less commonly included in option grants, but do provide grantees more confidence that theoretical value will become real cash value.
Vesting, triggers and true-ups aside, once you vest your options in a private company you can’t necessarily sell your stock for cash. Shares of a private company are not liquid, meaning they can’t easily be bought or sold. Unlike trading a public stock, you must wait for a “liquidity event” to cash out.
What are these liquidity events and how can you understand how real the potential for your option grant to turn into cash is?
There is no good answer for this, but there are some questions you can ask!
Time to Liquidity: When Will Employees Be Able to Sell Vested Options?
This typically happens when a company goes public or is acquired. The last question to flesh out with your potential future employer is what the plan for future financings of the company looks like, which can give you a sense for when a liquidity event might happen. Is the company on the IPO path, still raising venture rounds, planning for a strategic or private equity acquisition in the next few years, or have no plans? This will give you a better sense for how soon and how likely “liquidity” is (and how vested you’ll be)!
You should pair a sense for “time to liquidity” with your own judgement on the track record (or lack thereof) of company management and the investors (if any) in the company. While past performance is no certain indicator of future potential, having a management team and investors that have “been there done that” should provide you hope they can replicate prior performance. Similarly, having outside investors should give you confidence that a third party has assigned value to your shares.
- Equity offers can represent a significant cash outcome, eventually
- Companies are very thoughtful about how they dole out equity to employees
- Your fully-diluted post-money ownership times the last valuation equals cash value today
- Understanding cash value today will help you compare apples to apples with other offers
- Shares of a private company aren’t liquid
- Management and investor track record can give you comfort around potential
- Future financing events can dilute your ownership or wipe out your equity ownership
Hopefully, these insights have equipped you with the tools you need to evaluate and negotiate your next equity offer like a pro. No matter how big or small your equity stake, it’s imperative to understand what it means today, what it might mean in the future and how to get the most out of it.
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