Below are some of the key facts that every startup employee should know about their equity, curated from a
recent SecondMarket event.
This article summarizes the commentary from our panelists, as well as select additional sources.
Lawrence D. Lenihan Jr. - CEO, FirstMark Capital
David S. Kidder - CEO, Clickable
Michael Gordon - CFO, Yodle
Lorien Gabel - CEO, Pingg
Why is equity given to startup employees?
Equity gives employees a vested interest in the company they work for and provides them with a long-term means of tapping into the success of the company. Startups frequently use stock-based compensation to align the interests of the employees with the company's shareholders and investors, without burning the company's cash on hand.
What are the different types of employee equity?
There are five types of individual equity compensation: stock options, restricted stock, stock appreciation rights, phantom stock, and employee stock purchase plans.
- Stock options give employees the right to buy a number of shares at a fixed price for a defined number of years into the future.
- Restricted Stock give employees the right to acquire or receive shares, by gift or purchase, once certain restrictions (e.g. working a certain number of years or achieving a certain goal) are met.
- Stock appreciation rights provide employees the right to the increase in the value of a designated number of shares, paid in cash or shares.
- Phantom stock pays a future cash bonus equal to the value of a certain number of shares.
- Employee stock purchase plans provide employees the right to purchase company shares, usually at a discount.
How much equity will a company give me?
Share allocation varies from company to company, though it tends to be higher if the employee has longer tenure with the company. The number of shares an employee is allotted can also depend on position at the company, how many other employees have been offered equity, the amount of capital the company has and its capital obligations. At some earlier-stage startups, employees may be given more shares but a less competitive salary.
How much are my shares worth?
Most employees are curious to know what the future value of their shares will be if their company IPO's.
Though it is difficult to know for sure what shares will be worth in the future, consider these four factors to develop a more accurate estimate:
- The valuation of the company at the time shares are granted
- The future outlook of the company (goals, number of competitors, number of investors)
- The total number of shares outstanding
- The percentage of those outstanding shares owned
The last one is particularly important. A company can allot you a large number of shares, but that number is meaningless without considering the total number of shares outstanding. Fred Wilson, a noted venture capitalist, developed a formula for founders of companies to use when determining how much equity to distribute to employees. You can theoretically use this formula to estimate the value of your shares. However, not every company will be transparent about the current value of the company, the shares they have allocated and the total shares outstanding. It may not be possible to arrive at any definitive answer.
How should equity factor into my decision to join a company?
Every CEO/CFO on SecondMarket's panel unanimously agreed: equity should never be the deciding factor in the decision to join a company. Believing in the vision of the company and the management team should be much more central to the decision process. Equity should not be the focus when joining a company; in some ways it is a lottery ticket. Employee shareholders are betting on the success of the private company and the future value of those shares, but there is no guarantee as to the shares' ultimate value. Equity is most importantly a way of aligning the best interests of the employee shareholders with the interests of the company. When the company succeeds, shareholders share in that success.
Should I involve a lawyer before signing anything regarding equity?
The consensus from the panelists was no, it sends the wrong message. As David Kidder, CEO of Clickable explains, "if they come with a lawyer, I know it is the wrong cultural fit. I have the same deal structure for my shares as my employees because we are all on one team working towards one goal."
What are employee liquidity programs? How do they benefit employees?
Liquidity programs provide employees with the opportunity to cash out some of their equity in the company without having to wait for the company to IPO on the public markets. The company creates a private marketplace where shareholders can sell shares to company-approved investors during designated liquidity windows. There are several reasons why companies set up liquidity programs, but one of the main reasons is to retain tenured employees and attract new talent. If your startup employer has created a liquidity program, you have more incentive to stay with that company longer because your share value will increase as the company grows. Furthermore the liquidity windows provide you with a way to sell those shares. To learn more about liquidity programs and why they are becoming increasingly popular, please visit: Trends in the Secondary Market.