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Happy Sunday, pals!

I attended another great NoBa Capital networking event this week where there was a guest speaker from Carta. It reminded me how low investment and equity literacy is for the average worker, so I made another guide for y’all.

One of the most common questions I get from friends when I’m playing career therapist is "Is this a good offer?” Equity, shares, stock can all be really confusing and, to make matters worse, offers rarely come with all the information needed to determine if it’s really worth taking instead of a higher direct cash wage.

Welcome to the comprehensive guide on startup equity and share options! Whether you're a founder, an early employee, or an advisor, understanding the intricacies of equity compensation is crucial in the startup world. This guide will walk you through the various types of equity, their implications, and what to look out for when navigating equity offers.

Disclaimer: This is not meant to constitute financial or tax advice. You should always consult a trusted advisor who knows your personal situation and tax implications before making serious financial decisions.

📚 Equity 101: The Basics

Equity represents ownership in a company. When you have equity, you own a portion of the company's value. This can be incredibly lucrative if the company grows and succeeds, but it also comes with risks. Let's dive into the different types of equity and what they mean for both workers and companies.

Types of Equity

1. Common Stock: The most basic form of ownership in a company.

2. Preferred Stock: A class of stock with additional rights and privileges.

3. Restricted Stock: Common stock that is subject to certain restrictions.

4. Stock Options: The right to purchase stock at a predetermined price.

5. RSUs (Restricted Stock Units): A promise to receive stock once certain conditions are met.

6. Straight Equity Percentage: A direct percentage ownership of the company.

Let's break these down in more detail:

1. Common Stock

Common stock represents basic ownership in a company. It's typically what founders receive when starting a company and what employees might receive through stock options.

2. Preferred Stock

Preferred stock is typically issued to investors and comes with special rights, such as liquidation preference or dividend payments.

3. Restricted Stock

Restricted stock is common stock that's subject to certain conditions, often used for founders or very early employees.

4. Stock Options

Stock options give the holder the right to purchase shares at a set price (strike price) for a certain period. The difference between this and common stock is that they must be bought and are not simply awarded.

5. RSUs (Restricted Stock Units)

RSUs are a promise to give shares of stock once certain conditions (usually time-based) are met.

6. Straight Equity Percentage

This is a direct percentage ownership of the company, often used in early-stage startups or for key hires.

⏳ Vesting: The Waiting Game

Vesting is a crucial concept in equity compensation. It's the process by which employees or founders earn their equity over time. This protects the company from someone leaving shortly after joining and walking away with a significant ownership stake.

Standard Vesting Schedule

The most common vesting schedule is four years with a one-year cliff. Here's how it typically works:

1. You receive your total equity grant on day one, but it's subject to vesting.

2. For the first year, you don't vest any equity. This is the "cliff."

3. At your one-year anniversary, you vest 25% of your total equity grant.

4. After that, you vest the remaining 75% monthly over the next three years.

This schedule incentivizes employees to stay with the company for at least a year and continues to reward them for staying longer.

Acceleration

Sometimes, vesting schedules include acceleration clauses. These speed up vesting under certain conditions:

• Single Trigger Acceleration: All or a portion of unvested equity vests immediately upon a specific event, usually a company acquisition.

• Double Trigger Acceleration: Vesting accelerates if two events occur, typically a company acquisition followed by the employee being terminated without cause.

Acceleration can provide important protection for employees in case of major company changes.

🏆 Exit Scenarios: When Do You Win?

After understanding all the complexities of equity, the big question is: when and how do you actually see a return on your equity? Here are the main scenarios:

1. IPO (Initial Public Offering): The company goes public, listing its shares on a stock exchange. After a lockup period (usually 180 days), you can sell your shares on the public market.

2. Acquisition: Another company buys your company. Depending on the terms of the deal, your equity might be paid out in cash, converted to shares in the acquiring company, or a combination of both.

3. Secondary Sale: Some companies allow employees to sell a portion of their vested equity to outside investors before an IPO or acquisition. This can provide liquidity, but often comes with restrictions.

4. Company Buy-Back: In some cases, the company itself might offer to buy back shares from employees. This is more common in companies that plan to stay private for a long time.

Remember, these scenarios aren't guaranteed. Many startups fail or remain private indefinitely, which is why it's crucial to view equity as a potential bonus, not a guaranteed payday.

🧮 The Dilution Dilemma: A Real-World Example

Dilution occurs when a company issues new shares, which reduces the ownership percentage of existing shareholders. Let's walk through an example to illustrate how this works:

Imagine you join a startup called "TechRevolution" as the first employee. You're granted 10,000 shares, which represents 1% of the company's 1,000,000 total shares.

Scenario 1: Series A Funding A year later, TechRevolution raises a Series A round. The investors put in $5 million for 20% of the company. To make this happen, the company issues 250,000 new shares.

New total shares: 1,250,000 Your shares: 10,000 Your new ownership percentage: 0.8% (down from 1%)

Scenario 2: Series B Funding Two years after that, the company has grown significantly and raises a Series B round. This time, they raise $20 million for 25% of the company. This requires issuing 416,667 new shares.

New total shares: 1,666,667 Your shares: 10,000 Your new ownership percentage: 0.6% (down from 0.8%)

Scenario 3: Employee Option Pool Increase Before seeking Series C funding, TechRevolution decides to increase its employee option pool by adding 200,000 new shares to attract top talent.

New total shares: 1,866,667 Your shares: 10,000 Your new ownership percentage: 0.54% (down from 0.6%)

In this example, your ownership has been diluted from 1% to 0.54% over the course of several years and funding rounds. However, it's important to note that while your percentage ownership has decreased, the value of your shares may have increased significantly if the company's overall valuation has grown with each funding round.

Dilution is a normal part of a growing company, but it's important to understand how it works and its potential impact on your equity stake.

💼 What to Look for in an Offer (and 🚩 s)

When evaluating an equity offer, there are several key factors to consider. Understanding these can help you avoid potential pitfalls and ensure you're getting a fair deal.

1. Number of Shares/Options and Total Shares Outstanding: This tells you what percentage of the company you're being offered.
   For example, if you're offered 10,000 shares and there are 1,000,000 shares outstanding, you're being offered 1% of the company.
   Red Flag: If the company is unwilling to disclose the total shares outstanding, this lack of transparency could be concerning.
   

2. Vesting Schedule: Understand how long it will take to fully vest your equity. A four-year schedule with a one-year cliff is standard.
   Red Flag: Unusually long vesting periods (more than 4-5 years) or no acceleration clauses could limit your flexibility and potential gains.
   

3. Strike Price (for options): This is the price at which you can purchase shares. The lower the strike price relative to the fair market value, the more valuable your options.
   Red Flag: If the strike price seems unusually high or the company won't disclose how it was determined, this could be a problem.
   

4. Option Type (ISOs vs NSOs): Incentive Stock Options (ISOs) can offer tax advantages but are only available to employees. Non-Qualified Stock Options (NSOs) are more flexible but don't have the same tax benefits.
   Red Flag: Being offered NSOs instead of ISOs as a full-time employee might indicate the company isn't structuring things optimally for employees.
   

5. Exercise Window: This is how long you have to exercise your options after leaving the company. Longer windows (several years) are more employee-friendly than short windows (30-90 days).
   Red Flag: Very short exercise windows can force you to make a big financial decision under time pressure or lose your options.
   

6. Liquidity Opportunities: Understand if and when you might be able to sell your shares. Some companies offer secondary sales or commit to regular liquidity events.
   Red Flag: No clear path to liquidity or very restrictive transfer provisions could leave you with valuable paper that you can't turn into cash.
   

7. Repurchase Rights: Some companies reserve the right to buy back shares under certain conditions. Understand if this applies and under what terms.
   Red Flag: Broad repurchase rights that allow the company to buy back vested shares at the original purchase price could negate much of the benefit of your equity.
   

8. Tax Implications: Different types of equity have different tax consequences. For example, exercising ISOs could trigger Alternative Minimum Tax (AMT).
   Red Flag: If the company can't or won't explain the tax implications of your grant, you might be in for some unpleasant surprises.

Remember, it's not just about spotting red flags, but understanding why these factors matter. Always consult with a financial advisor or lawyer if you're unsure about the terms of your equity offer.

📊 Benchmarks for Early Hires and Advisors

Equity compensation can vary widely based on the company's stage, the role, and the individual's experience. However, here are some general benchmarks to consider:

Early Employees

• First Employee: Typically 1-2% equity

• Employees #2 through #5: Often 0.5-1% equity

• Employees #6 through #10: Usually 0.25-0.5% equity

Advisors

Advisor equity is typically much smaller and often vests over a shorter period (1-2 years). Common ranges are:

• Standard Advisor: 0.1-0.25% equity

• Key Advisor (e.g., industry expert or well-known name): 0.25-1% equity

Remember, these are just guidelines. The actual amount can depend on factors like the advisor's involvement, the company's stage, and the specific expertise being provided.

🧠 Final Thoughts

Equity compensation is a complex topic with many nuances. While it can be a powerful wealth-creation tool, it also comes with significant risks and complexities. 

Here are some key takeaways:

1. Understand what you're being offered. Don't be afraid to ask questions and seek clarification.

2. Consider the whole compensation package, not just equity. Salary, benefits, and career growth opportunities are also important.

3. Be prepared for the long haul. Equity typically takes years to vest and even longer to become liquid.

4. Stay informed about your company's progress and financial health. This can help you make informed decisions about your equity.

5. Consult with financial and legal professionals. They can help you understand the tax implications and legal nuances of your equity compensation.

Remember, in the world of startups, equity is both an opportunity and a risk. Approach it with open eyes, careful consideration, and a balanced perspective on its potential value in your overall compensation and career growth.

Additional resources:

• Cake. equity questions chatbot

• Carta Equity Academy

• Slicing Pie (book)

That’s all for now, pals. See ya next week.

Eryn