Considerations for Your Startup Equity Compensation (Part 2)
Nat Disston | March 12, 2015
So we're stepping back to talk about how startups award
equity and what you should consider when evaluating startup job opportunities. In Part 1, we looked at the major factors that affect your ownership stake,
upside potential, and the riskiness of your equity compensation. Now we’ll look
at some numbers to demonstrate both how your equity package is determined and
what it might be worth.
So you’ve received an offer from a startup (or are hoping
for one) with a salary and some number of “options” for your equity grant. So
from what hat did they pull that equity number?
As we previously discussed, equity compensation is part art
and part science. The younger the company, the more this skews to being an art.
For example, the first few hires will be granted equity as a numerical percentage of the company such as 0.5%, 1%, 5%. Age, experience,
and how badly they need you will determine the final number. This is so because
there is less and less of a tangible value to assign to the equity the younger
the company. After the company’s first few critical hires and once they’ve
begun raising institutional financing, this practice should quickly mold into a more
Unless you’re joining a company that’s only a few people in
a closet with an Internet connection, this is the bucket most startup employee
prospects will find themselves in. You’re joining a company that has 10 to
100’s of employees and has raised institutional financing (i.e. VC funding).
These are two key factors because it means that 1) the company is beginning to
form a corporate structure and 2) has the backing of an institution that has
put a valuation and price point on the business.
As EquityZen's CEO, Atish Davda, explained for Inc Magazine there are certain questions you should ask when evaluating a startup offer. They include the number of shares outstanding and the company's most recent valuation. It is this information that can help assign a current, real dollar value for your equity.
Fred Wilson of Union Square Ventures has shared his methodology to ensure fair allocation of equity for employees that is easy to communicate in dollars. It may not be the industry standard, but it can help provide
a framework for your equity award and where the number came from. The idea is that equity should be given as a factor of your salary and communicated in dollars:
Firstly, your level within the organization will determine
the portion of your salary that will be given as equity. The most senior and
critical roles receive the most equity while the least critical, most junior
roles receive the least. A break down might look like this:
Non critical hire – 0.05x
So if you’re a Manager with a salary offer of $100,000. Your equity grant offer might equal $25,000
that will vest over 4 years.
That dollar value will be based on the Fair Market Value
(FMV) of your company. There are a few methods to determine the FMV, and each
company may choose a different route. One common method is the most recent
institutional financing round. If your company raised $25M dollars at a $75M
valuation, it is worth $100M ($75M + $25M). If there are 50M shares of the
company outstanding, then the price per share would be $2 ($100M / 50M shares =
$2 per share).
In this example, you would be offered 12.5K options in the
[Compensation x some multiple (i.e.
0.25)] / Price per Share of last round = #shares
[($100,000 salary x 0.25 multiple)/$2 per share] = 12,500
The goal of equity grants is to align the interests of employees and the company. It should not be confused with cash or other compensation. However, assigning a dollar value to your equity can take it from being a mysterious lottery ticket to something tangible. What's more, you have the ability to increase the value of your equity through output and contribution at the company. The company should continue to grow over the 4 years that your equity vests. Additionally, you will receive
retention grants that will increase the number of options you own to compensate for dilution and award superior performance. Equity is treated differently at each organization, but it is important for you to ask the right questions and understand what you are really being offered. Knowing the concepts behind how equity is issued and what it's worth will be critical in your decision making.
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