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It is becoming increasingly common for a start-up company to offer new employees stock options (equity) as part of their total compensation package. There's much misunderstanding around how options work and how you should rationalise their value. So we thought we'd offer some learnings to help with your journey.
The Basics Imagine that there is an early-stage start-up where you want to get in on the ground floor. You ace the interviews. Your references sing your praises. You negotiate for the salary you want. And now you're 99.9% sure that an offer letter is coming your way. But there's one last hurdle to jump over: How do you ask for equity in the company? Yes, you should be asking for equity; a type of company ownership based on the value of its shares. The compensation package at an early-stage start-up typically includes equity and salary. It sometimes has other benefits like health insurance or a gym membership subsidy. You can ask for equity from the hiring manager during the hiring process, who may even be the founder or CEO, depending on how young the start-up is. The founders and their investors hope the start-up eventually goes on to a liquidity event (when equity is converted into cash for the business owners, i.e. you and the investors). If this happens, you could make some money depending on the value of the shares you own. How does equity work? The first thing to understand is that equity is not cash. Instead, it usually comes in stock options named 'common stock'. On the General Assembly blog, Matt Cynamon and Macia Batista explained that no employee is ever 'given' equity. Instead, employees often receive stock options, which are the option to purchase equity in the company at a heavily discounted price. You are also not given all your stock options upfront; instead, you earn more options at increments over a pre-agreed timeframe. This timeframe is called a vesting period. When you're in discussions with an early-stage start-up about a job, equity could be part of your compensation package. Therefore, you'll want to know how to negotiate for yourself in the best possible way and ensure that if all your hard work pays off, you see a payday. Author Celia V. Harquail, PhD, said equity is about your sweat, risk, life, commitment, and loyalty. Another way to think about it? 'It's like being in a band,' she continued. 'We don't pay the bass player less because her instrument has four strings. The band depends on the bass player just the way they depend on the drummer. So maybe they should all get the same share in the band's profits.' Let this philosophy guide you when you negotiate. Be a bit bolder than you might typically be. Why are you offered equity options?
Founders want to attract you to work for their business. You're taking a risk by joining an early-stage company. They're exciting places to work but are more likely to fail than more established companies. Equity options make you feel part of the business you're building.
Founders want to motivate you to work hard while you're there. Your options in the business will only be worth something if the business is a big success. Having all the employees motivated to work hard is vital for making that happen at early-stage companies. If you benefit financially when the company does well, you're more likely to work hard while you're there.
Founders want to keep you there. As you'll read below, you aren't just given your options on day 1; you earn them over several years working for the company. If the company is growing fast, the options you're earning can start to have profound value, so you're more likely to stay.
Realise that the odds are not good that there will be a big payday. We hate to be the bearer of bad news, but it's essential to understand that working at a start-up is risky. A commonly cited statistic is that 90% of start-ups fail, although' failure' can depend on the context. Nevertheless, the reality is that most start-ups do not go on to become the next Shopify or Checkout.com. In other words, you may negotiate for equity. Still, the start-up might never reach a liquidity event, and you will end up with nothing. That is just the risk you take in the start-up world. Of course, you should still advocate for yourself at the negotiating table. But it would be best if you were realistic that you won't necessarily be retiring to Tahiti in the next couple of years. A start-up is not a get-rich-quick scheme; it takes serious hard work. Don't shortchange yourself on salary. With the previous tip in mind, you should negotiate for equity with the knowledge that it is not worth anything yet. It only might be worth something in the future. 'It's not compensation until you have it in your bank,' Harquail explained. 'While it's still the possibility of equity or the potential of equity, it's nothing.' Please don't shortchange yourself when negotiating a salary because that money is what you need to live in the present.
Negotiate for equity as if you are an essential part of the company's growth 'because you are.
Suppose the company that you joined early on becomes financially successful. In that case, it will be thanks to your hard work. That's an excellent reason to negotiate a beneficial equity package.
Don't let anyone convince you that some early-stage start-up roles are less critical than others (and thus less deserving of equity). You have to remind yourself that you're an essential part of making that business grow if you're there. Nobody at an early stage start-up isn't vital to making that business happen. Negotiate for what you deserve.
Understand the terms and conditions of the kind of share you get.
People often think that all shares are equal, but they're not. We mentioned earlier that equity typically offered to employees is vested over several years. There will also be different classes of shares in some companies that'll be provided to higher-level managers or founders and co-founders or the first five employees. These are essentially another class of shares that will be more advantageous to you if there is a liquidity event. No matter what kind of equity you are offered, ensure you fully understand the terms and conditions.
What is vesting?
When you join a start-up, the company won't immediately give you all your options on day 1. The main reason is that if you left the next week, you would walk away with many options without adding value to the company. Vesting is a mechanism whereby you earn options over time, ensuring your interests are aligned with the company.
A standard vesting schedule used in UK and US start-ups is four years with a one-year cliff. Here's what your vesting schedule could look like if you are given 10,000 options and work at the company for four years:
Day 1: 0 options vested
6 months: 0 options vested. The one-year cliff means you don't vest any options until you've been at the company for 12 months; this incentivises employees to stay for at least a year
12 months: 2,500 options vested. At the one-year mark, you're' of the way through your four years, and you've passed your one-year cliff, so you get the first 25% of the options
Fifteen months: 3,125 options vested. Once you pass the 1-year cliff, typically, you'll vest options every month. At 15 months, you'll have earned 31% of your options
36 months: 7,500 options
48 months: 10,000 options. At the four-year mark, you've earned all your options from the original grant, so there are no more options to accrue.
Understanding how your options vest is vital to grasp, as if you think you'll only be at the company for 18 months, you'll only earn 38% of your options by the time you leave. Be sure to ask your prospective employer questions. Asking for a worked example like the above can be helpful.
Rely on your network for additional information.
Whilst it's always great to trust what a company's founders tell you about money or their company's situation, always verify their words with your own research.
Discreetly acquire more information about similar companies to ensure everything checks out OK. This is a critical way to use your network to find out what they know. Valuations and equity tables are a lot to take in when you aren't familiar with them. People in your network may be able to see potential red flags before you do.
Knowledge is power, and you can advocate for your professional well-being more effectively with data. It's always good advice to be as educated as possible. And that means having examples of colleagues in similar situations, what kinds of equity they were offered, and how they negotiated.
Give yourself time to decide whether to accept.
When you've been waiting to hear about an equity offer, you might feel compelled to accept it immediately out of gratitude or relief. Don't do this! Give yourself some time to decide whether you want to take the offer, which might entail circling back to your network to get their opinion. An excellent response to your offer might be, 'please give me 48hrs to consider it as this is a big decision, and I would like to sleep on it. That way, you'll ensure you don't shortchange yourself.
Don't be afraid to make a counteroffer.
Whether you decide to accept the equity offer you receive or make a counteroffer for more money is up to you. If you choose to make a counteroffer, you could frame your negotiation as another skill you bring to the table, which might impress the person who is about to hire you.
When you ask for equity at your company, make sure you feel good about the final decision. As First Round Review put it, 'The best negotiation is when both sides feel like they won.'
Have a lawyer look over your equity package before you sign anything.
Hire a lawyer specialising in start-ups to look over your package after you ask for equity in your company. Why should you do this? Because people make mistakes. In crafting offers, people can overlook potentially damaging clauses or conflicts. And sometimes, people can take advantage of your naivety.
Don't have a lawyer? Try your network again. Fundera provides options for finding a start-up lawyer. Although these resources seem targeted towards start-up founders, they could be worth checking out to find someone who will help an early employee.
Don't be too hard on yourself if it doesn't work out in your favour.
We're all doing the best we can do at the negotiating table. Don't put too much pressure on yourself when you ask for equity in your joining company. It is high stakes, but it is not the end of the game. If it doesn't work out the way you expect, there will be other opportunities. If you don't get what you need, you can stay for six more months and then find a company that values you more.
Of course, you should not make this mindset apparent to your employers' no one wants to hire somebody halfway out the door! But it is an idea that you can keep in your back pocket. Start-ups, after all, are lottery tickets. You might win big, but you can always buy another one if you need to.
Final thoughts on how to ask for equity in your company.
When you ask for equity in your company, come prepared. Remember to do your research beforehand, be ready to make a counteroffer and have a lawyer or someone experienced in these kinds of negotiations look over your package before you sign anything. If your start-up does become a success, you deserve to get everything that you earned through your hard work.
Taking ownership of a company is very exciting, but it is also a big deal, so do take it seriously. Hopefully, this article has given you some useful insight into how to approach this negotiation, but if you're just skimming and are only going to take a few things away from this, just remember the following:
Make sure you can manage your salary from a start-up.
See future upside from options as a pleasant surprise but a low-probability event. There is much uncertainty around whether your options will ever be worth anything. There might not be an exit event you can benefit from.
Work out if your options will be worth much if the business is a big success. As a general rule, get an estimate for an exit at '200m and '1bn. Your employer should be able to help you with this. If they aren't worth much when the business is worth '1bn, then it's best to ignore them.
If you're deciding between two offers, think about your risk appetite. Do you want much potential upside (go for a start-up) or more certainty (go for a scale-up)?
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