Considerations for Your Startup Equity Compensation (Part 1)
Mar 5th, 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 million.
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.
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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 compensation.
For further reading, below are a few of my favorite articles pertaining to this topic:
- - Is it Time for You to Earn or to Learn? (Mark Suster, Upfront Ventures)
- - Grant Equity to Your Employees (First Round Capital)
- - Employee Equity: How Much? (Fred Wilson, USV)
- - 5 Questions You Should Ask Before Accepting a Startup Job Offer (Atish Davda, CEO EquityZen)
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.