From Erin, Paysa’s Equity and Compensation Expert
Since startups often offer equity compensation in lieu of higher salaries it’s important to understand equity and how to negotiate it. There are many nuances to consider when negotiating equity. If you want to see a full discussion on this topic, check out the Negotiating Equity Compensation guide I wrote for Paysa. In a nutshell, though, I would suggest talking to your potential employer about vesting, exercisability and the type of grant.
Stock options will be “subject to vesting.” What this means is that you will earn your shares over a period of time or when you achieve certain milestones. Every employee’s equity (even the founders’) has a “vesting schedule.” The most common vesting schedule in the start-up community today is over 4 years with a one-year “cliff.” This means that the first 25% of your grant will vest after one year (the “cliff”) and 75% of the grant will vest monthly over the next three years. Some companies opt for a more milestone based approach, accelerating the vesting schedule over time so that you earn 10% of the shares the first year, 20% in the second, 30% in the third and 40% in the fourth for a full 100%.
If you’re a full time employee it’s most likely that the Company will put you on the same schedule everyone else is on. Feel free to ask if that’s the case! If so, it usually takes a pretty special employee to negotiate a different schedule. Under some circumstances, you might be able to negotiate acceleration of your vesting if the company is sold.
If you’re a contractor or have a non-traditional relationship with the employer, you have a bit more flexibility to negotiate a shorter vesting schedule and/or acceleration. Consider for asking for a schedule that matches the timing of the work you plan to do for the company.
Are you able to buy your whole grant right away? If you have enough cash to buy the stock right away, you should ask the company for an “early exercisable” option grant. “Early exercisable” means you can purchase any number of your option shares at any time, whether the stock is vested or not. If a grant is not early exercisable, you can only buy the vested portion of your option shares.
Buying the stock right away is better from a tax perspective so if you can do it, it’s usually a good idea!
Type of Grant
The type of grant you get will also impact your tax liability. The company will probably offer you an option grant from under its stock plan. Option grants are usually either incentive stock options (ISOs) or Non-statutory Stock Options (NSOs). The main difference is in the taxation of the grant. An NSO is taxed as ordinary income when the option is exercised and taxed again when the stock is sold. On the other hand, an ISO is only taxed when the stock is sold. If you can’t early exercise your grant, an ISO is usually what you want. However, there are a few other considerations when making this decision, check out this article for starters and always ask your own tax advisor.
The value of equity is a moving target in any company, dependent on factors such as the stage and growth of the company, dilution and possible exit events. At the most basic level, you’ve been given the opportunity to buy stock at the lowest possible price today with the hope for significant upside tomorrow. Without a crystal ball, it is impossible to know exactly what, if any, that upside will be. However, several indicators can provide you with a good estimate of a company’s value. Read more on these factors in Valuing Your Equity on Paysa.