Considerations for Your Startup Equity Compensation (Part 1)
Nat Disston | March 05, 2015
Here at EquityZen, we talk a lot about startup compensation
and the nuances of it all (ISOs Vs. NSOs Vs. RSUs? The AMT Tax?). However, I
wanted to step back and provide a more general look at how startups award equity
and what you should consider when looking at startup job opportunities. This
will be broken into two parts, with the first talking generally about how
equity compensation is divided among employees and the factors that weigh in.
The second will give some numerical examples and guidelines for examining or
anticipating your startup compensation based on those factors.
The Employee Stock Option Pool (ESOP)
The first thing to understand is the Employee Stock Option
Pool (ESOP). When a company is founded they issue shares. These shares are divided
among founders, early investors, and a portion set aside for the first
employees. Each time a company raises capital they issue new shares to the investors.
Additionally, they authorize more shares to the ESOP to allow them to continue
hiring competitively as they grow.
Without talking in #’s, $’s, or %’s, there are 4 major
factors that weigh in on the effective amount of equity you may be given and
its (potential) value: Size, Funding, Stage & Age, and, of course, you.
These factors combine to determine the amount of equity the company has
available, the value and potential future value of that equity, and the
probability that your equity will actually be worth something one day.
A fairly obvious one, the more people sharing the pie, the
less of the pie each new person can have. If you’re among the first hires at a
company, your ownership would be relatively significant. If you’re joining a
1,000-person startup (whether the word “startup” is still applicable is another
story itself), you will own a relatively smaller portion. When evaluating a
startup job opportunity, it’s important to consider how many employees there
are currently and how many they intend to have in the future. When possible,
consider the turnover and how many employees have joined and left the company.
As discussed above, each time a company raises capital they
issue new shares to the investors. Again, this is a gross generality, but a
company that has raised more money has generally taken on more dilution than a similar
company who has taken less financing. Additionally, the more money they have
raised means the more money their investors will take if they are acquired. You
should consider how much money the company has raised and over how many
consecutive rounds they raised that capital. A company raising $20 million when
they’re already worth $1 billion will have way less dilutive effects on your
ownership than a company that raises $20 million when they’re worth $80
Stage and Age
The stage and age of the company, while similar to the
funding history, can also be used to evaluate your startup’s prospects.
Companies traditionally raise capital in the following progression; Angel,
Seed, Series A, Series B, Series C and so on through the alphabet until they
either fail, get acquired, or go public. The later on they are in this stage is
an indicator of the success of their product/market fit and business model. The
more established the company, the less risky your offer and the less equity you
are given. Consider the stage and age of the company from a risk versus reward
perspective. Equity in a seed stage company has a lot of upside, but it is very
risky. Equity in an established startup (again, the word startup here may be
debated) likely has more tangible valuable today, but with less upside. Simply put:
the success rate of a mature, established, well-funded company is much higher
than that of an early-stage startup, and you should adjust the expected value
of your equity accordingly.
The above factors are the general things to consider. More
specifically to you would be your role within the company. Are you a highly
specialized person, one of the few that can do your job? Are you joining the
sales team where incentives may better be tied to short-term performance (cash
commissions for sales instead of equity grants)? Consider the team you’re
joining, the impact and trajectory of your role, and your unique skill set.
* * * * *
The way equity is granted is part art and part science.
While equity can have huge upside potential, as we’ve discussed before, all
that glitters is not gold.
When evaluating startup opportunities, you need to assess your risk/reward
appetite, as well as your appreciation of equity and its upside potential
versus cash compensation. Of course, while equity compensation can be a main
factor into your decision-making, be sure to consider the other tangible
benefits of the job: career growth, work environment, and, of course, cash
For further reading, below are a few of my favorite articles
pertaining to this topic:
Next week I’ll
publish Part 2, which will drill down on some numbers to think about when
considering a job at a startup and the equity.
Back to blog homepage