Startups and scaleups are attracting more talent than ever, especially upcoming talent relatively early in their careers. The startup path has become a more formidable career option than it used to be, and we see many switch from corporate careers to early ventures. While startups are for many an opportunity to pursue meaningful work and work towards a vision that aligns with their values, there’s more. As the startup scene is getting more mature, employee compensation is also maturing. However, there are a few key differences when comparing startups and corporations when it comes to money. Here’s what you need to know about startup equity as a prospective employee.
“While startups are for many an opportunity to pursue meaningful work and work towards a vision that aligns with their values, there’s more.”
Employee equity in a successful startup can be worth a lot
The first key difference between working for startups and most other jobs, is that with the latter, you rarely see any equity. However, with startups, that’s different. The best startup ecosystems recognize that it’s important to have employees enjoy the company’s success as well. Therefore, you are likely to be negotiating the amount of equity or options when negotiating your salary.
However, the concept of getting equity as an employee might be so foreign to many, that they take this as a given, and not something to negotiate on. That might be a mistake that costs one dearly. Startup equity can become very valuable later on. Therefore, it’s important to understand the role of startup equity as a prospective employee.
Startup equity in salary negotiations
Especially early stage startups might prefer to negotiate the whole salary package, as long as the equity fits their limits (available option pool etc.). The company might give out more equity if the candidate accepts a slightly lower salary, and vice versa. Naturally, candidates tend to immediately see only the dollar figures, as that’s a much more tangible number. Equity might be expressed as percentages – in which case the number usually appears very small – or in some cases as number of shares, which alone gives no real idea of how much is being discussed.
However, often the outcome is that candidates are trading away proportionately quite a lot of equity for only marginal gains in salary. E.g. say you get 5-10k more annually as a base salary, but trade away 0.10% of equity. With simple math, 0.10% equity in a startup valued at US$20 million would be worth twenty thousand dollars at the current valuation. While here already forgoing equity might seem like a bad choice, we need to consider how the equity is actually being granted, as it affects the calculation.
How employee equity works in startups
Usually, startup compensation for employees does not include immediate direct equity. Generally speaking, startups award equity in two forms, either as direct equity (company stock) or as equity options (both referred to together as ‘equity instruments’). The latter grants the holder the right to purchase company stock at a given price within a period of time. Many companies favor options, as they’re a bit less of an administrative hurdle to issue and manage.
Whatever the form, one things remains the same. You rarely get awarded equity or options immediately as you start. Rather, you receive equity by the means of vesting. Vesting means that the company grants equity instruments to the employee based on an agreed schedule. The standard schedule is 4 years vesting, 1 year cliff.
What this means in practice, is that whatever the amount of equity instruments on your contract, you’ll receive that over a period of four years that you work for the company. The 1-year cliff refers to the fact that you’ll receive the first portion of the instruments only after one year. From thereon, you’re usually awarded equity instruments on a monthly basis. So, if the total equity instruments in your contract are 0.1% of the total stock, you would receive 0.1% ÷ 4 = 0.025% after your first year, and then ca. 0.0021% every month thereafter.
What happens if I leave the company before 4 years?
One of the goals of vesting is to provide an incentive for employees to stay with the company long-term. However, you may end up leaving before all your equity is vested for various reasons, and that’s fine. In those cases, it’s good to assess the situation beforehand.
As a general rule, when you leave a company, you forfeit the equity instruments that have not vested. So, say you worked with a company for 2 years and your total equity was 0.2% with 4 years vesting. You’d have earned and free’d up yourself a 0.1% equity stake.
If it’s direct equity, some companies might have contract clauses in place whereby the company can buy back your vested shares at a fair market price. The price is usually the one of the latest funding round, if you have not agreed otherwise. With options, the company might have similar buyback arrangements too. One key difference there is that in order to convert the options into actual shares, you’d have to pay the company according to the strike price of your options. If you joined early and have a lot of options or if you joined later with a high strike price, this can mean a significant cash outlay. Often, you also have a relatively short window for exercising the options after your departure.
Why bother with equity?
The whole concept of startup equity for prospective employees might seem confusing and a lot to deal with. And it may well be! However, from a compensation perspective, it’s important to stay alert on this front. Startups can rarely pay the same cash salaries as big corporations, but your wealth as an employee can see an outsized increase. Thanks to equity. The valuations of successful startups tend to multiply manifold over their lifespan. This provides a hockey stick growth trajectory that your base salary is unlikely to ever see.
Naturally, compensation is not everything. There are almost as many motivations to work for a startup as there are employees. However, it’s good to be aware of these things. You wouldn’t want to unknowingly negotiate against yourself and trade out marginal short-term gains for significant long-term gains.
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