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Types of startup equity
Any competitive startup's pay package includes equity. Equity is usually in the form of stock options (ISOs and NSOs) or Restricted Stock Units (RSUs). For early-stage startups, stock options are far more common than RSUs. Here are a few important pieces of information when preparing to negotiate startup equity.
Stock options give you the right to acquire a certain number of shares at a specific price, which is generally the market value of the shares when the options are given. A 409A valuation determines this price, which is also known as your "strike price," "grant price," or "exercise price".
When an employee signs their offer, the strike price for the set of options they were given will be set and remain constant until the grant has been fully vested. Any new equity that the company issues in the future will have a new strike price attached to it.
External investors pay $X per share to purchase a percentage of the company during a venture round - this is known as the preferred price. The preferred price is almost always higher than the strike price, which we will discuss more in the valuation section.
Employee stock options are divided into incentive stock options (ISOs) and non-qualified stock options (NSOs). The primary distinction between the two is how they are taxed. ISOs are the form of stock option that receives the most favorable tax treatment - you want these ones.
- ISOs: taxed when sold, not when exercised (i.e., purchased) & lower tax rate when sold
- NSOs: taxed when sold AND when exercised & higher tax rate when sold
Important Terms to Know When Receiving Stock Options
A few terms you need to be familiar with if you are receiving stock options:
- Number of options: The number of options you have the right to purchase
- Percentage ownership: If you exercise all of your options, this represents your percentage ownership of the company's total outstanding equity. This is calculated as the number of options you receive / total outstanding shares issued by the company.
- Strike Price: The per-share price that you pay to exercise the options
- Preferred Price: The per-share price investors pay to buy shares in the company
- Vesting Schedule: In most cases, your equity award will be subject to vesting, which means you won't get all of your options right at once, but rather over time. A four-year vesting plan with a one-year cliff is the most common schedule. A quarter of your total options will vest on your one-year anniversary.
- Post-Termination Exercise: If you terminate your employment contract, you usually only have 90 days to determine if you want to exercise your options. After that 90 days are over, you lose all of your options, putting many employees in "golden handcuffs." Fortunately, several startups are beginning to provide longer PTE periods. Be aware, though, that even if your PTE window is more than 90 days, your ISOs will convert into NSOs after 90 days.
If you just left your startup job and need to exercise your stock options within 90 days, you'll need to come up with the money to pay for that. We'd recommend checking out EquityBee which connects you with investors who cover your exercise cost.
Restricted stock units (RSUs)
An RSU is a commitment from your employer to provide you with the company's shares in the future on a specific date if certain criteria are satisfied. Unlike stock options, you do not have to pay anything to obtain the shares. Instead, you are only responsible for paying the appropriate taxes when you get the shares.
Typically, there is a set of specific requirements that must be completed in order for you to be eligible for RSUs. Here are a few examples:
- Milestone-based (e.g., the startup must IPO or be acquired)
- Time-based (e.g., you stay at the startup for a certain period)
RSUs are more valuable than stock options, which can become worthless if the stock price (i.e. preferred price) falls below the strike price or if they expire. RSUs are almost exclusively offered in late-stage startups (Stripe, Brex, Instacart, etc.). Early-stage startups are more likely to provide you stock options instead of RSUs.
Valuing your stock options (i.e., what is my startup equity worth)
Whenever we work with a client who is negotiating startup offers, we will ask how many stock options they'll be receiving in their offer, the strike price of those options, and the latest preferred price. Sometimes recruiters try to withhold this information.
How to Make an Accurate Valuation
Step 1 is to get a rough idea of the value of those options. This is the formula we would recommend:
(Preferred price - strike price) * number of options = value of your equity
However, your recruiter will sometimes suggest alternative methods:
Preferred price * number of options = value of your equity
You should not use this formula, since it completely ignores the cost you pay to acquire the options (i.e. the strike price).
If the company doesn't have a preferred price that's updated within the last six months (i.e. no recent funding round), finding the value of the options becomes more complicated. Now we must estimate the preferred price.
If the company is listed on any secondary exchanges this is the ideal source (e.g. Forge, EquityZen). If not, you can ask the recruiter/hiring manager/exec team what they think is the correct value for the options, but do keep in mind that they will artificially inflate this. There are also some general benchmarks you can apply depending on the company stage.
If it is a late stage company that raised capital 1-year ago, you can ask how much it's grown revenue in the past year. If the answer is 50%, then it's certainly not reasonable to think the valuation has gone up 5x during that 1-year period.
How much equity should you expect from a startup?
Data on compensation is extremely situational. What an employee receives in terms of stock, cash, and bonuses is determined by their role (i.e., technical vs. non-technical), the industry they work in, where the startup is located, and of course, seniority. On top of that, perhaps the largest factor is what stage the startup is at.
We will break down the answer to this question into three sections based on the stage of the startup.
An early stage startup will usually offer the highest equity, as they have the highest associated risk. AngelList postings can be a good way to get a sense for what number you should expect depending on how early you join.
These numbers, aggregated by Leo Polovets, are a good starting point. Note, this is the high-end of the range (not the typical numbers) for equity offered to engineers in Silicon Valley at early stage startups.
- Hire #1: up to 2%–3%
- Hires #2 through #5: up to 1%–2%
- Hires #6 and #7: up to 0.5%–1%
- Hires #8 through #14: up to 0.4%–0.8%
- Hires #15 through #19: up to 0.3%–0.7%
- Hires #21 through #27: up to 0.25%–0.6%
- Hires #28 through #34: up to 0.25%–0.5%
The chart below, based on Babak Nivi's analysis, provides suggested equity amounts that many consider appropriate for post-series A companies in Silicon Valley:
- Vice president (VP): 1–2%
- Independent Board Member: 1%
- Director: 0.4–1.25%
- Lead engineer 0.5–1%
- Senior engineer: 0.33–0.66%
- Non-technical manager or junior engineer: 0.2–0.33%
The upper ranges would be for strong candidates with excellent track records. Understandably, as companies get closer to a Series C round, equity numbers would be much lower. The company's valuation plays a major part in determining the amount of equity awarded to employees.
A good rule of thumb for determining how much stock should be granted from companies with funding beyond Series C is to look at the ratio of equity you would be offered for a similar position at a big tech company (Facebook, Google, Amazon, etc.). An equal ratio can be used as the absolute maximum equity value for a stock option offer that should be awarded for a position at the startup.
For example, an E5 software engineering role at Facebook has slightly higher base pay per year than RSUs - the ratio between base and equity is 3:5 (60% base, 40% RSUs).
A similar role and level at a startup should receive stock options that match that ratio. Make sure to calculate this using the equity value formula we discussed above: (preferred price - strike price) * # of options.
How to negotiate your startup offer and specifically more stock options
It should be no surprise that cross offers will enhance your chances of receiving a better offer. Leveraging the range associated with preferred prices when comparing between two offers is a tactic we see work quite consistently.
We can positively frame the value of your shares by using the top end of the preferred price that Company A has told you when discussing compensation with Company B. Because it's in your best interest to not voluntarily share certain information, this can get a bit complicated and requires specific verbiage.
Selective Sharing of Important Information
Negotiating compensation fundamentally comes down to creating leverage — using other interviews and offers is the easiest way to do that. However, there are several other strategies that we have used to get our clients more stock options and higher total compensation.
In cases where you do not have any competing opportunities or strong leverage, it is vital to be very selective of what information you share. We need to create the impression of strong leverage by framing certain aspects of your current compensation in a very positive way.
This can include but isn't limited to:
- Any upcoming promotions/comp increases
- Unique perks (e.g. Sabbatical)
- Retentions bonuses
Again, these are just some of the strategies we use with our clients. They can seem simple at face value, but there are many details around language, tone, and delivery that make these negotiation processes tricky.
At Rora, we create scenario-based scripts to guide you through these tough conversations with your recruiter/hiring manager and get you the best deal.
If you want help negotiating your offer, sign up for a call with our negotiation team to get answers for questions specific to your unique case. We've helped hundreds of people just like you to get the most compensation possible.