Considerations for Your Startup Equity Compensation (Part 2)

Nat Disston
Mar 12th, 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 formulaic approach. 

Tangible Equity:

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:

The Multiple:

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:

CXO  - 0.5x
VP – 0.4x
Manager – 0.25x
Employee – 0.1x
Non critical hire – 0.05x

The Dollar Value:

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 company:

[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 option grant

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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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