Equity compensation can be quite complicated, but it’s important to know that you have some room to negotiate the most favorable terms. The first step is to make sure you are comfortable with the basic concepts of equity compensation (see Fundamentals of Equity Compensation). Next, it’s important to set your expectations appropriately based on the type of company granting the equity. In general, the earlier the stage of the company and the more integral your role, the more aggressively you can negotiate. On the other hand, if you’re working for a large, well-funded company or a public company your negotiating power will be more limited. We’ll explore this concept further as we look at the different areas of equity compensation that are important.
The main terms of your equity grant that you’ll want to pay attention to are:
Amount of Equity
Type of Grant
Potential for More Equity
Much of the negotiation process involves gathering data to make more informed requests of your employer. Read on for more information and tips on negotiating your equity package.
How much equity can you expect?
It will come as no surprise that the amount of equity you can expect to receive is a direct function of 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 can ask for. First, let’s review the different ways the Company might quantify the amount of equity they offer.
The most basic way is to state the exact number of shares you will receive. This method provides you with the least information since 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).
For example, if you are offered 100,000 shares, this may sound like a large grant. However, if the fully diluted capital of the company is 800,000,000 shares, this grant only represents 0.013% of the company (100,000/800,000,000 = 0.013%). This may still be a good offer depending on your position and the size of the company but without knowing the total number of outstanding shares, you are missing an integral piece of the equation. 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.1 Or, you can simply ask them to tell you what percentage of the company the grant represents.
Most companies will express your grant in terms of percentages or “basis points.” If you are offered 0.5% of the company then no additional information is needed to understand the size of the offer. Alternatively, you may be granted 50 basis points (or bps). One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), so 50 bps is the equivalent of 0.5%. Again, no additional information is needed to understand the amount being offered.
So how much equity can you expect? 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 co-founders have taken their pieces of the pie, the first few employees often receive grants between 0.2-1.5% of the company. This is not a hard or fast rule, but rather a trend amongst new start-ups.
After the first 10 employees, many companies adopt a standard equity schedule. As an example, they may decide that all new senior engineers will receive 0.2-1.5% and product designers will receive 0.1-0.4%. 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.
What type of grant will you receive?
As discussed in Fundamentals of Equity, a company will grant you either a restricted stock grant or options in the form of ISOs or NSOs. If the company is early stage and pre-funding you are most likely to receive a restricted stock grant. This is advantageous since the exercise price of the grant will likely be low such that you shouldn’t have a problem paying for it. Alternatively, you may be able to negotiate a cash bonus to cover the cost of the stock sale or the tax associated with the stock grant. You will then hold the stock right away so the 1-year clock for long-term capital gain tax treatment will start immediately. If you are offered a direct stock grant, and you have the cash flow or receive a cash bonus to pay for it, you shouldn’t negotiate for a different type of grant.
If the company is post-funding then you are most likely to receive an option grant. As a rule of thumb, companies issue ISOs to employees. ISOs are good because they give the employee time to raise the necessary funds to purchase the stock without any negative tax implications. However, if you have the cash flow at the time of grant and your grant is early exercisable, you will likely prefer to receive an NSO. This is because exercising an NSO right away and making an 83b election will result in no taxable income with the benefit of ownership of the stock and the start of the clock for long-term capital gain tax treatment.
One tricky part of making this determination is that the company may not be able to tell you the exercise price of your stock at the time you negotiate your grant. However, you should be able to gather certain data points to help determine whether or not you can afford to purchase the stock right away. You can ask your employer what the exercise price was for the last set of option grants. This is a good starting point for the minimum amount you’ll pay. If the company has recently completed a round of funding, you can also ask the employer what amount investors paid for their preferred stock. Your common stock will likely be 15-30% of that price.
If you are offered an option you have every right to request that the option be an NSO rather than an ISO. Just be sure you understand all of the tax implications of each type before the grant is made. For a more detailed explanation of the differences between ISOs and NSOs, see Fundamentals of Equity Compensation.
Is the grant early exercisable? When do you have to Purchase the Stock?
An important aspect of the ISO/NSO distinction 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. Some companies are opposed to making early exercisable grants since it’s an additional administrative burden for them. Generally, the earlier stage the company, the more likely they are to be flexible. However, don’t be surprised if a company has a hard and fast rule against issuing early exercisable options – in which case, you’ll definitely want to stick with an ISO.
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 option that may be available 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.
What is my vesting schedule?
Companies today tend to offer all employees the same standard vesting schedule – 4-year vesting with a 1-year cliff. Even the founders are likely to be on this schedule. If 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.
One area that you may be able to negotiate is acceleration. 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.
Aside from receiving acceleration in connection with your specific grant, it’s always a good idea to ask what the stock plan says about the treatment of unvested option shares in the case of a change of control. The best-case scenario is for all outstanding options to automatically vest. This is pretty rare though since it makes a company less attractive to a buyer. Rather, you should look to see if the company has flexibility as to how the options are treated. While the company can not guarantee that all unvested options will be accelerated, having a conversation early on with the company may help gauge how committed they are to negotiating a deal that treats all employees fairly.
Is there potential for additional equity in the future?
If you are unable to negotiate additional stock or more advantageous terms for your equity, an alternative request is to ask the company to commit to an additional grant in the future. Pose the request as a merit grant if you achieve some goal within a specific time frame. The more specific you can be on the goal, the better, and always make sure the agreement is written in your offer letter. If you’re unable to define a specific milestone, you could ask for a more general commitment to a bonus in the form of equity in the future. However, your employer is less likely to commit to that in writing, leaving you with less negotiating power in the future.
It’s also worth asking your employer whether they have a policy of issuing “top-up” grants after funding rounds. Each time the company raises money in the form of an equity financing your ownership percentage is diluted (see Valuing your Equity for more on dilution). A top-up grant helps keep your ownership interest more or less the same. You should know that this is not a typical practice for most companies but it never hurts to ask the question!
What about negotiating the exercise price?
The exercise price of your equity grant is non-negotiable. This is because of strict penalties for both you and the company if your option grant is below fair market value. Be wary if a company promises you an exercise price in your offer letter. The price must be determined on the day the company issues the grant and it’s entirely possible that the price you were promised will change between the date of offer and the date of grant. The one thing you can confirm with the company is that the exercise price is equal to, and not more than, the fair market value of the common stock on the day of grant. However, you can never name your own price.
See Valuing Your Equity for additional information on how to value your equity compensation offer.
 You may also want to ask the Company whether they include promised but unissued stock in the calculation of fully diluted, as many companies don’t when determining employee grants. Similarly, if a company is on the verge of a financing, the number of fully diluted shares is about to increase (a financing is the sale of preferred stock not yet outstanding). If this is the case, you’ll want to confirm whether your equity percentage will be based on the pre-financing or the post-financing fully diluted capitalization. You clearly want the latter since you’d like a percentage of the larger, rather than the smaller, pie.