employee equity compensation in tech startups
September 25, 2021
September 24, 2021
September 25, 2021
September 24, 2021
You just got a job offer (exciting!) and now you’re thinking about negotiating — also exciting, but your offer includes stock options ... what now? .
It’s easy to know what your salary target is based on factors like where you live and your seniority. But how do you evaluate the options being offered and negotiate a compensation package that’s right for you? An offer of 100,000 options may sound like a lot, but the number doesn’t tell you much, because there are many factors at play that can determine the value of your options.
As with any negotiation, knowledge is power. Here are 11 questions that can help you understand the stock options being offered to you and identify areas where you can negotiate to secure a compensation package that meets your goals.
Many of these details may be spelled out in your offer letter. If not, it’s advisable to ask the company for specifics, as these points are essential for understanding the value of your options and making plans to exercise
There are two common forms of stock options that you might receive as part of a compensation package: incentive stock options (ISOs) and non-qualified stock options (NSOs). Restricted stock units (RSUs) are another type of equity, more commonly awarded by mature companies. Different tax rules are applied to each type, so it’s important to know what you’re being offered so you can understand the tax implications.
Also known as the exercise price, the strike price is the predetermined price at which you can buy ISOs or NSOs from your employer. The strike price is a key component of the upfront costs you’ll incur to exercise your options.
The company’s value is divided among everyone with equity. The valuation represents the whole pie — and as a shareholder, you can get a slice. You can also ask for the current prefered share price, though not every company discloses this figure to current or potential employees.
The 409A valuation is an appraisal of the value of the company’s common shares, calculated for tax purposes. When paying taxes on your equity compensation, the amount you owe is based on the 409A valuation.
You can also ask if the company gives employees ample notice before any 409A valuation increase, including fundraising rounds. As the company becomes more valuable and its 409A valuation increases, it can become more expensive for employees to exercise their options — so it’s helpful to have plenty of time to plan.
Your slice of the pie is determined by the percentage of the company you own, known as your stake. Your stake is the number of shares you own, divided by the total number of company shares.
If you’re comparing offers from multiple firms, it’s helpful to think in terms of ownership stake. If Company A offers you 100 options out of 1 million shares, that’s .01% ownership. If Company B offers 1,000 options out of 100 million shares, that’s .001% ownership. So, the smaller quantity offered by Company A actually equals a larger ownership stake.
Your stake at the time of exit will probably not be the same as your stake when you join the firm. As your company creates new shares for new employees and investors, your stake slowly goes down. This is called dilution. Although dilution may shrink your stake, your potential payout can still increase if the company’s valuation grows sufficiently.
If the company calculates your stake based on a fully diluted share count, that’s typically a more informative number than one based on a count of existing shares as of today.
If you’re comparing offers from multiple firms, make sure you’re looking at ownership stakes on an apples-to-apples basis, in terms of how the denominator is presented.
The vesting schedule determines when you can exercise the options. You can also ask if all employees are on the same vesting schedule and if there are any schedule accelerations if the company exits.
Early exercising is when you exercise your stock options before they vest. This could increase your profit by minimizing your overall taxes and/or decrease the upfront costs when you exercise.
There will likely be a point at which you can no longer exercise vested options, known as the expiration date. If you leave the company, the expiration date may change (see below).
When leaving a startup that awarded you options, you’ll likely be subject to a post-termination exercise window, which means you either have to buy the shares before the deadline—often triggering a hefty tax bill—or let go of your hard-earned equity.
Some companies have a 90-day window, while others are willing to extend the deadline by five years or more. Note: Even if your company offers an extended post-termination exercise window, your ISOs automatically convert to NSOs if you fail to exercise your options within that 90-day window. ISOs enjoy more favorable tax implications than NSOs. It’s also worth asking if the company has any repurchase rights for your shares if you leave the firm.
A tender offer gives employees a chance to sell a certain number of shares at a fixed price during a specific time frame. Some companies, especially later-stage firms (Series C or later) may offer tender programs on a regular basis to reward employees with a way to liquidate their options and/or shares.
Stock options are important for attracting and retaining employees, but making sure candidates and employees understand their stock options is equally valuable. Ask how the company empowers its people to make informed decisions about their equity.
It’s also advisable to learn about the business and its plans. The company may not be willing to answer all your questions, but it’s worth asking because the company’s future outcomes will heavily impact how much your stock options are worth.
You can get a sense of the company’s trajectory by learning about its projections for revenue and hiring. It’s also helpful to find out about plans for additional fundraising as well as the company’s exit strategy.
Additionally, you can ask what exit value will need to be met before common stock — the type you’ll own — has positive value. This speaks to a “preference stack” or liquidation preferences, which are terms negotiated by professional investors that determine who is paid first when there is an exit.
As you think about any offer, it’s important to have a clear understanding of your financial needs and goals, both short- and long-term.
Many startups, especially early on, are short on cash and likely to offer you more equity and less salary than a well-established company would. Some people might be attracted to offers featuring a significant amount of equity in a young, moonshot startup. They’re presumably comfortable with the reality that the company may generate a big payday several years from now — or turn out to be a total bust. Other people might be more focused on securing a consistent salary they can use to meet immediate financial demands and fund other investments or long-term goals.
To assess if an offer fits your needs (and negotiate accordingly), you’ll want to begin with a clear understanding of your personal risk tolerance and cash needs. In many instances, it can be helpful to speak with a financial advisor or other wealth management professional.
Already have stock options or are you leaving a company? Secfi may be able to help finance your exercise. Sign up to access our tools and speak with an equity strategist.