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Startups can be a massive accelerant for your career. Experience, knowledge and *sometimes* wealth. The wealth often comes in the form of equity compensation. To get you started, here is employee equity 101: what you need to know when accepting startup equity.
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First, it’s important to know the ways to get money for your equity:
- IPO (going public),
- aAcquisition (company gets sold or merges)
- Secondary (sell your shares--this is much less common these days with non-transfer clauses).
- IPO (going public),
- aAcquisition (company gets sold or merges)
- Secondary (sell your shares--this is much less common these days with non-transfer clauses).
There are also lots of forms equity can be granted but these are the most common:
- Restricted Stock Agreements (RSA)
- Options (ISO & NQSO)
- Restricted Stock Units (RSU)
- Restricted Stock Agreements (RSA)
- Options (ISO & NQSO)
- Restricted Stock Units (RSU)
Restricted Stock agreements (RSAs) are actual ownership in the company. Usually reserved for founders, acquisitions, and maaaaybe early employees (first 5 to 10, but rare). They are restricted because they have terms like vesting and a cliff.
Options are the option (hence the name) to buy equity at a later date for a pre set price. That price is set by the last 409a valuation conducted by a 3rd party. This is referred to as your strike price.
There are 2 forms of options. Incentive Stock Options (ISO) and Non Qualifying Stock Options (NQSO).
Only employees can get ISOs and the company can only grant $100k in ISO value per year per person. Major benefit is you pay income tax when you sell the stock NOT when you exercise (buy) the options.
NQSOs are also an option but can be granted to anyone with no restriction on quantity. Downside is you pay income tax upon exercise. In other words, you pay tax when you buy your stock (I’m unclear if it’s that day or that tax year. Almost found out with wework but…)
Restricted Stock Units (RSUs) are a promise to give you company stock. They don’t have a “strike price” but you pay tax when granted (not vested). The restrictions are customized per agreement and usually at the company wide level.
Other key terms/phrases to know are vesting, clif and exercise period. Here is why we need them:
Since the stock or option price is set upon granting (hopefully the price goes up over time so you want to lock that in), oftentimes stock or options are granted in a large block and then distributed over time. That time is called the vesting period.
Most typical is 4 years, but I’ve seen 3 and 5 and up to 7 years. It’s also most common for it to vest evenly but have also seen this “back loaded” which means you get more of your equity towards the end of your agreement. This is a retention tactic (and sucks IMO).
Because who has equity in a company is important, companies “protect the cap table” and make sure people have to stick around for a certain amount of time before they get ANY equity. This is called the cliff. Most common is 12 months but have seen 6.
If you leave a company prior to an exit (“liquidity event” I.e. getting paid) you will have to decide if you want to buy the stock that you have the option purchase. This is called exercising your options.
Most companies have a 90 day window (carry over from 90 day limit on ISOs, for another thread). That means you have 90 days from your last day to choose to buy your options. This is non trivial and millions upon millions of unexercised stocks get reclaimed by companies every year
Quick example, if you vested 1,000 shares with a strike price of 80 cents per share, within 90 days of your last day you need to pay the company $800 to convert the options into stock. This assumed a 90 day exercise period.
Companies may go as far as 10 years on this which is great. This is negotiable but requires board approval so it won’t be easy to change, but it can be done. Won't get into that now but that example would have different tax implications depending on the form of stock agreement.
OK! That’s it for now. I’m not a lawyer or a finance person but I did get every one of these forms of equity at wework, ran many many models when I thought wework would IPO and learned a ton in that process.
Equity is very complex but at wework I made more money than I would have with just a pure salary & bonus. We sold @case_inc for mostly equity (RSAs) and my comp package had Options and RSUs.
The full potential of the value was never realized but I went into it eyes wide open and knew that the only guaranteed thing was my salary. I hope this helps you in your quest to work in startups and gives you some insights into what to negotiate for.
If you disagree with anything in this thread or would change/add please comment or DM. The last thing I want to do is misinform people. I figure the best way to learn is to teach, so here it is :)
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