Equity grants are important in startup recruiting because they can be an attractive component of a job offer, particularly for candidates who are interested in the long-term success of the company. By owning shares in the company, employees have a vested interest in the success of the company and are more likely to work hard to help it succeed. Additionally, equity grants can be a way for startups to offer competitive compensation packages to talented candidates, even if they can't afford to pay high salaries.
For additional information on employee equity, see Stock Options.
Below is the recommended talk track for recruiters and hiring managers to discuss the equity component of a candidate’s offer package. Equity can be complex. Notes below are designed to simplify the conversation with candidates who may have never received stock options in prior roles. The goal of this conversation is to:
- Explain what equity is;
- Help the candidates to avoid analysis paralysis;
- Focus the candidates’ attention on things they can control; the long-term value of the stock is something they cannot control
Explain stock equity
Stock equity in the company is given to new employees as part of compensation. A stock option is not a share of stock, it’s the right to purchase a set number of company shares at a fixed price. As a startup, the value is low, but as your company grows, the stock equity can be significantly higher.
As an employer, providing employee stock options has several benefits:
- By owning shares in the company, employees have an interest in making it successful.
- Employees have opportunities to make money.
- Employees are invested in the company and care about its outcome.
Below is how to explain stock equity to new employees, what they can expect, what decisions they need to make, and when.
Stock equity and strike prices
Each new employee receives a certain number of company shares in their name. These shares are set at a specific value known as a strike price (set at the company’s fair market value), which is usually low at inception because the company is just getting started. These shares are available for employees to purchase once vested.
Four-year vesting and a one-year cliff
Our standard vesting period is “4 years, 1 year cliff”.
This means it takes four years (the vesting period) before an employee can purchase all of the shares allocated to them. To be eligible, the employee must work for at least a year (one-year cliff) before they can purchase 25% of their shares. Thereafter, the remainder 75% of the original grant vests in equal increments (1/48th) for each month of service. As long as the employee works for the company, the stock continues to vest. The value is determined by the success of the company.
For example, Annie is a new employee and your company sets aside 10,000 shares of stock equity in her name at a strike price of $0.10 per share. After Annie has worked a year, 2,500 shares (25%) are vested. For each succeeding month of service, another 208 shares are vested.
No employee action until an exit event or employee departure
Most of the times, there are no actions required on employee stock option grants and employees shouldn’t worry about their equity grants. Below are situations / trigger events where an employee may need to take action with their shares:
- The employee leaves the company The employee has three months from their last day of employment to decide whether they want to exercise (purchase) their stock.
- The company goes public The employee can sell their shares in the stock market:
- First, they purchase their shares from the company at the strike price they received when they joined.
- They sell their shares at the price the stock market determines is the current value. For example, if their strike price is $0.10 and the stock market price is $5.00, they earn $4.90 per share. NOTE: Employees should not sell their shares for a value below the initial strike price.
- The company is acquired by another company Anything can happen in this scenario. Employees have no input concerning when this occurs, the value of the resulting share price, or the effect on their existing shares. In some cases:
- Employee stock options convert to the acquiring company's stock.
- Employees are paid out based on their outstanding shares.
Forecasting the future
Employees may ask for help in determining what their stock will be worth in the future.
Significant equity in stock options can incentivize early stage employees - a 0.5% equity stake isn’t typically offered to employees at Google - but this doesn’t offset the risks of failure. Only a few companies achieve the most ambitious of their goals and IPO. Startup founders shouldn’t try to forecast the future in positioning equity to compete for talented people. The value of options at early stages is often $0.
Instead, founders should ask candidates to answer themselves: what do you think the odds are of hitting our long term goals?
If a candidate thinks there is a 10% chance of the company hitting a $1B IPO, the risk adjusted value of the options of an employee with a 0.5% equity stake over 4 years assuming a 2x dilution would be $62.5k per year.
Since guaranteeing the actual value is impossible without a crystal ball, suggest that employees concentrate on doing their job well and think of ways to make the company more successful. Stock equity is really cool (if it works out), but it’s the one thing that employees have absolutely no control over. Instead, here are some things you can suggest that they focus on what they can control:
- Ask themselves what they are learning?
- How are they contributing to the company?
- As an employee, how will this present job position me for my next job?