5 Concepts to Know Before Signing a Startup Offer

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5 Concepts to Know Before Signing a Startup Offer

Applying for jobs is difficult enough. But for private companies, like most high-growth startups, the list of considerations is longer than most. The last thing you, as a candidate, want to be thinking about is how to decode the language of your offer and understand what it all means. As you embark on the application and interview process for companies of this type as yourself these 5 questions:

What type of equity is involved?

When it comes to compensation, equity describes the different ways that individuals can “own” a piece of the company. Broadly speaking, there are 3 main types of equity, or different ways that companies delegate rights: stock options, restricted stock awards, and RSUs. Each type of equity has its own set of limitations, often referred to as “restrictions”. Things you should look out for are: when you can buy (vesting), when you can sell, who you can sell to, what happens if the company is sold/goes public.

How does my ownership relate to the overall company?

Percent ownership of a startup is a multifaceted consideration. Percent ownership describes the portion of the company you “own” through stock. Having greater percentage ownership of a company means you have a greater opportunity to derive value from its success. You can think of percent ownership like having pieces of a pie. The important thing to understand is that when it comes to startup equity, the size of the pie can increase. Accordingly, the percentage of the company you own will change.

Take the simplified example below: you are an early employee at a new startup and are granted two shares of a company. Because this is a stock award, you immediately become a stockholder. This describes fully outstanding shares, or the stock that is held by a company’s stockholders. The other important metric to understand is the amount of fully diluted shares, or shares that will be available when all avenues of equity are exercised, including bonds and stock options. This “dilutes” the stock value by adding more pieces of pie to the equation. Other initiatives - like raising money through fundraising - can also dilute the value of stock, but add more potential value for shareholders. We’ll go deeper into the dilution of stock in a later article.

It’s imperative to understand the percentage of the company your shares represent, whether those shares are outstanding or fully diluted, and how much dilution you can expect. In other words - what is the true quantity of your equity, and how will this change over time? This affects the value of the company you are getting.

How is the company valued?

A company’s valuation, and/or future potential are equally important. While a public company can be valued on the stock market, understanding the potential of a private company is a bit hazier. That’s where the 409A valuation process comes in. The 409A is an independent appraisal that companies are legally obligated to complete. Companies generally get their first valuation prior to issuing their first common stock options. After that, they are expected to get at least once a year or following an event that directly affects a company’s value (i.e. raising capital).

409As determine the fair market value of the company, usually, through calculations based on fundraising amount, assets owned, and intellectual property. This “enterprise value” is divided among the total shares to determine the value of common stock. The market value determined by the 409A is also known as the strike price or exercise price. It is the amount that an employee will pay when they buy their stock options. The idea is that a company’s value (and thus stock price) will increase over time, where the employee’s potential profit is the difference between the current value and strike price of the stock. To illustrate, if an employee is granted the option to purchase 10 shares at the fair market value of $1.30 after their first year (the cliff date), and decides to exercise those options (buy the 10 stocks). Then, if at year 7, the company gets acquired and the employee decides to sell the options that are now valued at $4.50 per share, the employee will earn $3.2 per share ($32 total).

Overall, the value of common stock determined by the 409A valuation, in combination with the equity ownership amount, should give you a good idea of the value of your investment.

When will the equity vest? What is the schedule?

Equity vesting describes the timeline at which an individual gains full rights to their equity. The longer it takes for your equity to vest, the longer it takes for it to have value to you. The ramifications of this timeline can be great. Consider two equity vesting models - the front loading vest, recently adopted by tech giants like Google, and the more common, evenly distributed vest. While both models vest over 4 years, the front loading vest provides greater value for employees sooner.

Suppose you are considering offers from two companies: Company A uses the front loading vest, and Company B uses the evenly distributed vest both modeled above. For both companies, the equity does not begin to vest until the cliff date at year 1. This means that no shares are vested until the first anniversary of your starting date. Say you are only planning on staying at this role for 2 years - at Company A, 66% of your shares will have vested, versus Company B’s 50%.

Most companies include an exercise window, a timeframe in which people can exercise their options. These options usually have a 7-10 year timeframe as long as the person remains at the company, but can vary widely between organizations. Recently, companies are coming out with more employee-friendly policies, such as longer exercise windows and early exercise. Longer exercise windows keep the timeframe for options open even after employees leave the company. This extends the traditional 90-day expiration of options after an employee leaves. Early exercise lets employees exercise their stock options before they vest.

Is this company the right fit for me?

We all know that time is a limited resource, but this is especially true when it comes to early-stage, high-growth companies. By choosing to work at a startup, you are investing your time, resources, and knowledge into the company. Startups are known to integrate a variety of compensation methods to employees - such as flexible vacation, benefits, and opportunities.

Be sure to ask about:

Time-off benefits: Increasingly, research shows the importance of taking time away from work to recharge. Many companies have time-off benefits or minimums. See how your organization structures such initiatives. Consider AirBnB, which offers $500 quarterly for employees to travel, or Google which uses the 20% rule to incentivize employees to spend time doing things outside of work.

Mission and Goals: The alignment between an employee’s passion and interests with a company’s goals can create amazing synergy. Look into not just what a company’s mission is, but the specific ways they make progress towards it.

Growth Opportunities: Just as is the case with any investment, the opportunity for growth is an important one. See how your company plans to help you on your path - including rotational roles, education grants, or even visibility into different aspects of the business.

For more examples of non-monetary compensation to look out for in your offer, check out this article!

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