Startups can be a massive accelerant for your career. Experience, knowledge, and sometimes wealth are just a few of the advantages of working at a startup. 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.
First, it’s important to know the possible ways to get money for your equity:
- IPO (going public)
- Acquisition (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 in, but the most common are Restricted Stock Agreements (RSA), Options (ISO & NQSO), and Restricted Stock Units (RSU):
- Restricted Stock Agreements are actual ownership in the company and are usually reserved for founders, acquisitions, and maybe early employees (first 5 to 10, but rare). They are “restricted” because they have terms like vesting and a cliff (see more details on vesting & cliffs below).
- Options are the option (hence the name) to buy equity at a later date for a preset 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. The 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. The downside is you pay income tax upon exercise. In other words, you pay tax when you buy your stock.
- Restricted Stock Agreements 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 for understanding equity are vesting, cliff, and exercise period.
- Vesting: Since the stock or option price is set upon granting (hopefully the price goes up over time so you want to lock that in), often stock or options are granted in a large block and then distributed over time. That time is called the vesting period. The most typical vesting period 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).
- Cliff: 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. The most common time period for a cliff is 12 months, but I have seen 6.
- Exercising Period: 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 to purchase. This is called exercising your options. Most companies have a 90-day window (carry over from 90-day limit on ISOs). That means you have 90 days from your last day to choose to buy your options. This is a nontrivial decision, and millions upon millions of unexercised stocks get reclaimed by companies every year.
A 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 would 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 the exercise window, which is great. This is negotiable and requires board approval so it won’t be easy to change, but it can be done. Note that in this example, there would be different tax implications depending on the form of stock agreement.
I’m not a lawyer nor a finance person, but I received every one of these types of equity at WeWork, ran many many models when I thought WeWork would IPO, and learned a ton in the 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 for mostly equity (RSAs) and my compensation package had both 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.
You should always consult your own financial and legal advisors and consider your own unique situations before making what could be an important decision on equity.