OWNING A PIECE OF THE company that employs you is an exciting proposition. But it also comes with risk.
Exactly how much depends on the status of the company in question and the type of equity you're offered. That's because there's a big difference between stock-based compensation at a startup whose value is difficult to discern and at an established company whose worth is calculable, though still variable.
Understanding the motivation behind the offer can also help you decide whether it's a good deal. Some companies use stock options to compensate for low salaries, while others grant shares on a vesting schedule as a way to retain employees who may otherwise leave.
No matter what kind of equity offer is on the table, it's important to ask the right questions, understand the tax implications and negotiate for a compensation package that makes sense for you.
Important Stock Compensation Terms
Before assessing a job offer that includes equity, learn these terms.
Stock option: The opportunity to buy company stocks after a certain date. Note that different stock options, such as incentive stock options (ISOs) and nonqualified stock options (NSOs), have different tax implications.
Strike price: The price at which a worker can buy or sell company stocks. If the employee strike rate differs from the general rate, workers may be able to make money by buying and selling company stock.
Exercise: To take advantage of the option to buy or sell stock at a specified (strike) price before a deadline.
Vesting: A schedule that parcels out value over time. Compensation stocks may take several years to fully vest, meaning employees gain access to a percentage of their promised assets each year. Leaving the company before assets are fully vested means forfeiting some of their value.
Restricted stock unit: Workers are granted RSUs; they don't have to buy them. RSUs are assigned a market value after they're fully vested, at which time workers can keep or sell them.
Clawback provisions: In some circumstances, companies reserve the right to take back stock options if workers leave.
Capital stack: The legal organization of invested money that determines which investors have tax benefits and rights in the case of certain events.
Stock Options at Startups
Founders dream of disrupting industries and raking in millions of dollars. Yet most startups fail. That's why experts recommend approaching any stock-as-compensation offer from an early-stage private company with a healthy dose of skepticism.
"Equity and options in a startup are worth less than the digital paper they're not printed on," says Heather Wilde, chief technology officer of ROCeteer, an executive coaching firm. "Don't bank on yourself ever getting any money from it."
Startups vs. Big Companies
When considering a job at a startup, it's safer to negotiate for a solid cash salary that meets your financial goals and market value. As for stock options, "the easiest thing to do is look at it like a lottery ticket that may pay off one day," says Josh Doody, salary negotiation coach.
If you are interested in accepting equity as part of your salary package, first research the company's financial health and where its money comes from. Figure out whether its management team has experience successfully building and selling businesses.
"The big mistake is to not go in eyes wide-open. Do your due diligence, analyze the business and focus on the management team's track record," says Jay Batcha, founder and chief investment officer at Optimal Capital. "You're investing in the people more than the product or idea or anything else. You have to trust this management team implicitly and have no question about their integrity whatsoever."
Make sure to ask what the company's exit strategies are if business is bad or booming and find out how those plans will affect your stock options.
"If your company can't articulate a few different scenarios, it's a red flag," wrote Raphaela Sapire, founder of Nasty Gap, which provides negotiation advice to women, in an email. "You're asking to understand what type of risk and upside you're introducing into your financial trajectory: your retirement, your children's college fund, your parents' retirement fund. This is a completely respectful, rational thing to want to understand so that you can assess the likelihood of its occurrence."
If you're comparing different job and compensation offers, Sapire recommends assessing the likelihood of making a certain amount of money from each offer after four years.
Other important questions to ask about stock-based compensation at a startup include:
What percentage ownership in the company does my stock award represent?
What kind of stock options are available, and what are the tax implications of each?
What is the vesting schedule, and is it negotiable?
What happens if the company is acquired or I am laid off before I vest?
When would I have to exercise my right to buy my options?
What would be my position in the capital stack?
Are there clawback provisions?
Equity at Established Companies
The calculus changes when considering stock-based compensation at established companies that trade publicly, because their market values are easier to determine.
"If you can put a real value on the equity you're being offered, then it's worth including that in your negotiation and trying to maximize the value," Doody says. "I think that's a real opportunity to potentially really improve a compensation package."
Doody coaches software engineers angling for jobs at top technology companies like Amazon, Microsoft and Google. These firms don't always budge much on the base salaries they offer but may entertain requests to boost stock grants. That means it's wise to research typical equity compensation at the companies and in the industries that interest you before accepting an offer.
When devising a negotiation strategy for compensation at an established company, consider your personal financial goals. Check with an expert if you're not sure whether and how you'll be taxed on your equity. Remember that investing in any stock comes with risk, and thanks to vesting schedules, you may only receive a small portion of the equity you're earning each year.
For example, one of Doody's clients decided he would equate $10,000 in cash salary with $70,000 worth of equity during hiring negotiations.
"The base salary is more important to him because he has a family," Doody says. "He decided, 'I'm willing to substitute that for equity, but I need to get a premium.'"