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Equity as Compensation: Here’s Everything You Need To Know

Compensation Guides
Congrats on getting an offer! New to startups and equity? Let’s break down a common component of a startup compensation package: equity in the company. We spoke with seasoned recruiters, exceptional top talent, and Contrary's portfolio founders to put together a guide to help you interpret and negotiate the equity component of your package.


What is Equity

Equity is ownership in the company, typically in the form of stock options. When you’re joining a company that is already public (i.e., selling stocks on the market) this can sometimes mean an immediate increase to your assets. But for start-ups and private companies, equity compensation represents potential profit should the company go public in the future.

Interpreting Equity as Compensation

Stock Options

Early-stage companies generally issue stock options as part of their compensation package. While the stock options don’t translate to immediate cash, they have the potential to be worth exponentially more than your annual salary, should the company be successful. When you’re presented with a stock option package, you will be given the number of shares, an exercise price, and the stock’s 409a valuation.
Shares: The total unit of company shares that you will have the right to purchase if you vest these shares — to be clear, you do not own these stocks until you’re vested and purchase them. We talk about vesting more below.
Exercise or Strike Price: This is the cost per share if you choose to purchase. The exercise price is often lower than the 409A valuation. Essentially, the company is offering to sell you stock at a discount.
409A Valuation: This is an independently evaluated, fair market value, of the company’s stock and is used to determine the cost to purchase a share. Always cross-reference the exercise price the company is offering with the 409A valuation to make sure you are getting a deal that’s good for you.
Let’s breakdown an example
You receive 20,000 stock options at an exercise price of $1.50. The company’s current 409(a) valuation values each share at $3.00.
  • If you stayed for 4 years, you would earn the right to purchase all 20,000 shares at $1.50 each. This would cost you $30,000.
  • If the company’s valuation stayed flat, you would own 20,000 shares that are worth $40,000. It cost you $20,000 to buy them, which means you made $20,000.
  • If the company’s valuation were to 10x ($30/share), your 20,000 shares would still cost you $30,000 to purchase and the value of those shares is $600,000. You made $570,000.

Restricted Stock Units (RSUs)

If your compensation package instead has RSUs, this means that you will be granted those shares upon vesting (continue reading below for more on vesting). You do not need to purchase the shares and instead will receive the value of the stock at its face value. RSUs are more common at later stage companies and stock options are more common at earlier stage ones.


Vesting

Receiving equity is tied to a vesting schedule, where the stock options or RSUs become available to you incrementally over a fixed period of time. The most common vesting schedule is a 4-year vesting period with a 1-year cliff where more options become available monthly thereafter.
This means that in your first year, you receive none of your equity, and if you leave the company before a year, you’re leaving behind all of your equity. On your 1 year work anniversary, you will receive 25% of the equity package. Then moving forward, you will receive 1/48th of your equity each month. Note that if you stop being a full-time employee before your 4th year, you leave behind all unvested stock.
Let’s breakdown an example
  • Jane Harris signs an offer that includes 10,000 stock options
  • For her first year, the only compensation she receives from the company is cash compensation (base salary, bonuses)
  • On her one year work anniversary, she will be granted 2,500 stock options
  • For every month moving forward, she will receive another 208.3 stock options
  • At the end of 4 years, she will have received all 10,000 stock options
  • If Jane had left the company after 2 years, she would only receive 5,000 stock options

How does the equity turn into real value?

What happens to your equity when a company goes public?

You now own publicly traded stock (if RSU) or the right to purchase publicly traded stock (stock option). This is a widely celebrated day for employees because their equity now has real value, not just theoretical value. Your hard work at the company is literally paying off. And if you were offered a great exercise price, you’re going to be able to buy the stock for much less than the average buyer in the market.

What happens to your equity if a company gets acquired?

Equity value is dependent on the success of the acquisition. If the company’s exit was a successful one, then the employee’s equity should still be valuable. But if a merger or acquisition makes the stock price lose value, your equity lowers in value too or may not be worth anything.

What happens to your equity if the company shuts down?

Your equity isn’t worth anything after a company shuts down. That’s the gamble of equity compensation — while there is potential for huge payouts down the line, there’s no guarantee. Although an early-stage startup may offer more equity than a later-stage company, there is a higher probability that the startup won’t reach the point when the stock becomes valuable. But even equity in late-stage companies holds risk, and you could still find yourself fully vested in RSUs worth exponentially less than their valuation when you started at the company. Equity compensation should be interpreted in the context of the company offering it: do you believe this company has a high-growth trajectory? Is it likely to succeed a few years from now? Are they targeting a consumer need, developing innovative tech, or building something with high-profit potential? Do the current employees seem mentally and emotionally invested, not just financially?