Why Transparency in Equity Compensation Matters
Nearly every Chief of Staff candidate that we speak with is flexible on their compensation package with respect to salary and equity, and if you’re targeting early-stage startup jobs, you kind of have to be.
Lately, we've seen a ton of posts on Twitter and LinkedIn that stress the importance of startups giving equity (table stakes, really) and educating employees on the value of their equity, with the latter topic getting a lot of special attention given the less-than-ideal macro environment we find ourselves in.
As a candidate, the equity portion of your offer letter is where you should spend a lot of your time asking questions and getting clarity. After all, people don’t join early-stage startups for the salary! But I’m willing to bet that most people don’t do this. If a company offers you 10,000 options, you don’t want to be like Morty:
Though the equity negotiation is a 2-way discussion, you might not be able to rely on the company to be 100% transparent with all the gritty details unless you ask for them. If this is the route that the company takes, it’s woefully misguided at best and actually crazy at worst. Some food for thought for founders:
If your equity is valuable, you need to treat it as such so that your employees do, too.
If you don't value your equity, why use it to compensate people?
Why would a top candidate choose your company when they’re evaluating multiple offers and yours is the most difficult to understand?
The way you treat the offer process and your equity sends a strong negative signal about the culture of your company.
Unfortunately for the candidate, there is an asymmetry of information that is in the founder’s favor when they head into these discussions. If you ask for clarity on the value of your equity, and you get get a lot of hemming and hawing or sense anything dodgy about their response, that will be your first red flag of many in your future interactions with management.
You can be certain that every founder is discussing equity details at length with C-suite hires for various reasons:
The candidate’s leverage is higher given their seniority and how badly the company needs to fill the role
The asymmetry of information is more balanced — the candidate’s knowledge and experience around equity negotiation is likely greater than the average candidate because they’ve been around the block few times
Equity compensation is more generous at the top with respect to both the base offer and incentive stock option grants distributed as part of the executive bonus compensation plan, so it’s a major point of discussion
So what questions do you need to ask when you find yourself evaluating an equity offer? The good news is, they’re pretty straightforward, and so is the math (for the most part). Let’s dig in.
The questions you have to ask to understand the value of your equity
What’s my % ownership of the company?
10,000 options might not be all that and a bag of chips because raw numbers are meaningless. I repeat: raw numbers are meaningless! If the founder doesn’t have the % ownership figure readily available, the follow up question to ask is “what are the company’s fully diluted shares outstanding”? Their answer will give you the information to run the calculation yourself using this formula:
(Your total # of options / the fully diluted shares outstanding) * 100
The key word here is DILUTED — it’s critical to get the fully diluted shares outstanding, otherwise the denominator will be lower than expected and your % ownership will look higher when it isn’t.
The second way to calculate % ownership is with the following formula:
(Current value of your options / current company valuation) * 100
The current value of your options is just your total # of options * the preferred price, or what investors paid to purchase shares of the company at the last round of financing. To use this formula, you’ll need to ask two questions:
What was the last preferred price?
What’s the company’s current post-money valuation?
FWIW, we’ve seen Chief of Staff offers with equity ownership of 0.1% to 1.0% plus the option to participate in the executive bonus compensation plan, which usually offers both cash and incentive stock option distributions. The equity ownership offered by a company depends a lot on variables like their size, stage, size of the option pool, and more. While it becomes trickier to compare offers from companies at different stages (say, Series A vs. Series B), what you don’t want to do is compare offers based on total # of options (20,000 isn’t always better than 10,000). Always know your % ownership of the company so you can make a sufficient comparison between offers and, ultimately, an informed decision.
What’s the strike price of my options?
The strike price is the price per share to exercise your options. Carta has an awesome startup equity calculator that you can use to compare multiple offers, including what your option payout could be based on a hypothetical exit value.
They include a disclaimer that the calculator examples don’t consider taxes or if the company exits for less than what has been raised, and another point I would add here is that it doesn’t consider dilution. If the company plans to raise again in the future, then your ownership % will decrease, but that doesn’t mean the value of your equity necessarily will. If the company raises at a higher valuation, your piece of the pie has shrunk, but the value of the pie got bigger (and so has your piece!).
Here is something to keep in mind when it comes to dilution. The following table shows the typical dilution that happens at various stages of funding:
If you join at the Series B and the company raises a Series D before a liquidity event like an acquisition or IPO, your expected ownership dilution is ~28% (formula below). Consider future dilution when you discuss future financing expectations, exit timing, and the company’s growth trajectory.
(1 - the percentage of the company owned by employees and founders at Series C * the percentage of the company owned by employees and founders at Series D), or (1 - 0.85 * 0.85)
What’s the vesting schedule?
Stock options vest, or are earned, over a period of time. The standard here is a 4-year vesting period with a 1-year cliff.
The 1-year cliff means if you vacate the role voluntarily or involuntarily within 12 months of starting, none of your stock options will vest, but 25% of your options will vest immediately once you reach Year 1 + 1 day. Over the remaining 3 years, your options will vest in equal monthly increments (so 1/48th per month) until you are 100% vested.
What’s my exercise window?
Let’s say an employee leaves their company after 2 years. Half of their initial stock option grant has vested and they’d like to exercise their options (remember the strike price?). How long do they have before the window to exercise the options closes? Some companies let you exercise within a year, 5 years, or even 10 years! The stats here vary wildly company to company, but I would be wary of anyone that offers just a 30-day window. That’s unnecessarily onerous on the exiting employee, and just because a company can have this term doesn’t mean they should.
Is there an option refresh?
For context, options are usually granted to:
High-achieving employees as a discretionary performance bonus
The option refresh offers existing employees additional option grants after a couple of years in the role and is part of a company’s employee retention strategy. In our earlier example, the employee that left at the 2-year mark likely wouldn’t have been eligible, but those who stick around for 2-3 years would be.
According to Shasta Ventures, “these types of refresh grants equal 25-50% of a full new hire grant (i.e., the amount of equity that would be required to hire a full-time replacement for the role at the current stage of the company’s development)”.
As a Chief of Staff, you’d likely be included in the executive bonus compensation plan as a new hire at the VP level or higher as well as any option refresh program, whether formal or not.
By no means is this list of questions exhaustive, but it covers some major points that you should dig into in your offer discussions. Hopefully it’s also given you some insight into 1) why it’s important for companies to educate their future and current employees on the value of their equity, and 2) why it’s important for you to understand the value of your equity. And remember:
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