When negotiating equity with a startup there are a handful of variables that should be important to you. Those include:
- Number of Option Shares
- Type of Grant
- Vesting Schedule
- Acceleration; and
Amount of Equity
The number of options shares you are able to negotiate will depend on several factors, including the seniority of your position and the stage of the company. The more senior or integral your role and the earlier the stage of the company, the more equity you may be able to demand. If you are one of the first 5-10 employees of a company and your position demands a high degree of skill, connections or prior education/experience, you have a lot more power to negotiate a higher percentage of the company. After the first 10 employees, many companies adopt a standard equity schedule. If this is the case, you may have a hard time negotiating the amount of your grant unless you can make a case for why your skills are more valuable than your colleagues’. If the company is public, these schedules are almost always fixed and non-negotiable.
If you’ve been given a stock option contract already, you’ll want to make sure you understand what % of the company the number of shares being offered represents. Your ownership is a function of how many shares you hold in relation to all of the company’s shares that are then outstanding. The equation for determining ownership in a company is:
Your Shares / Fully Diluted Capital
“Fully Diluted Capital,” also referred to as the number of shares outstanding, is the sum of all issued common and preferred stock, shares reserved for issuance under a stock plan and all promised but unissued shares(such as warrants and convertible notes). So, if you are offered equity in a whole number of shares, you should ask your employer how many shares are outstanding so that you can do this math yourself. Or, you can simply ask them to tell you what percentage of the company the grant represents.
Type of Grant
Most companies will grant you an Incentive Stock Option (ISO) without any discussion. However, you should know that you most likely have a choice between an ISO and a Non-statutory stock option (NSO). However, choosing between these types of grants has important tax implications that you should be aware of. Take a look at theto learn more about the main differences between these types of grants.
Even if your company won’t let you request an NSO, it’s important to know the implications of holding an ISO so that you can maximize your grant.
Chances are you will be offered a 4-year vesting with a one-year cliff. This has become industry standard for VC-backed startups and even founders may have their vesting schedules reset to this standard during their first financing. If you’re not familiar with the concept of vesting, readfor a quick overview.
If you are offered this vesting schedule you can confirm that all employees have the same terms. If so, it will be very hard to negotiate something different. However, if you are a contractor or an advisor, you should be able to negotiate a shorter vesting schedule. For example, advisors are often given a vesting schedule of 2-years with a 6-month cliff. Or, if you are a contractor, your vesting schedule will most likely match the terms and length of your contract.
It’s important to understand how your stock vests and the implications that vesting has on your taxes. Most likely, you’ll want to file an 83(b) election with the IRS, which allows you to be taxed for all vested and unvested shares on the date of purchase.
One area that you may be able to negotiate is acceleration. Acceleration is the speeding up of vesting for a portion or all of your unvested shares upon the happening of a specified event. There are two standard types of acceleration: “Single trigger” and “Double trigger.” Single Trigger acceleration is when all or part of your unvested shares vest upon the happening of a single event – usually a “change in control” or an “involuntary termination.” Double trigger acceleration requires that both events occur, first a “change of control” followed by an “involuntary termination” within 12 months. The definitions for “change of control” and “involuntary termination” will be laid out in your option paperwork or in the company’s stock plan.
Single trigger acceleration is fairly common for advisors but almost unheard of for employees, so don’t expect to get that. However, double trigger acceleration may be available to more senior rank employees. As with all equity terms, ask the company whether other similarly situated employees have double-trigger acceleration. From the perspective of an acquirer, double-trigger acceleration acts as an incentive to keep key employees with the company after an acquisition. If your role is integral to the development of the company, you have a good argument for why you should receive double-trigger acceleration. You’re chances of receiving acceleration are less, though, if you’re a mid or low ranking employee since it’s usually only offered to senior or executive level employees.
An important aspect of the ISO/NSO distinction discussed above is the early exercisability of the grant. If a grant is early exercisable, it means you can purchase the shares at any time, regardless of whether or not they are vested. If it is not early exercisable, you can only purchase shares that have already vested.
If you have the funds to purchase your stock and you are leaning towards requesting an NSO, make sure that the grant will be early exercisable. This is critical since without the ability to purchase your stock on the date of grant, your tax liability will increase exponentially.
The other consideration here is when you will be forced to exercise your vested options. One of the restrictions on ISO grants is that they must be exercised within 3 months of an employee’s termination. If the exercise price is fairly high, it may be difficult to come up with the necessary cash to purchase your shares within the 3-month window. One strategy in this situation is to “net exercise” – using a portion of your shares to pay for the balance of the grant. While no cash is exchanged, the drawback is that you take a hit in your overall ownership. Another option that some companies are starting to explore is extending the post-termination exercise period. Doing this results in the forfeiture of ISO status in most cases, resulting in an NSO that will be taxed upon exercise.
If you’re joining a later stage company where the exercise price is likely to be substantial, it’s worth asking your employer whether the grant can be net-exercised, what the post-termination exercise period is and whether there is any flexibility. However, you may want to hold off on changing the exercise period of your grant until the event of termination so you can determine the best course of action then.