We've all heard stories of Silicon Valley superstars who had equity in a company and ended up making millions when the company sold. This article will walk you through what it means to have equity and help you understand how it impacts your overall compensation package.
Fair warning – the topic of equity can get complicated. We are only going to skim the surface here and hopefully equip you with enough functional knowledge. We'll give some additional resources if you want to go deeper at the end.
Broadly speaking, there are two types of equity that companies often offer:
Below, we'll get into the details of these two types and how you make money from them. But first, we'll talk about vesting.
Regardless of which type of equity you receive from a company, it's likely that there will be a vesting schedule. This means that you will not receive all of the stock (or options) upfront. Instead, you will receive them over a number of years and only if you continue to work for the company.
Most equity grants include a time period called a "cliff". The cliff is used as a way to retain employees for a minimum amount of time. You will not receive any equity if you leave the company before the cliff has passed.
After the cliff has passed, you will generally receive some portion of your equity or options each month. This process of receiving equity over time is called vesting.
While there are exceptions, many tech companies have the same vesting schedule:
48-month vesting period
With these terms, you will receive 25% of your equity on your 12-month anniversary with the company and then receive 1/48th of your equity every month thereafter. If you leave the company at any point before the 48 months has passed, you will stop receiving additional equity.
Alright, enough about vesting, let's get into the types of equity and how they impact your job offer!
Stock grants are simple – the company grants you a specific number of shares in the company. The total number of shares you are granted will usually follow a vesting schedule similar to the above.
A variant of a stock grant is a restricted stock unit (RSU) grant. With an RSU grant, you don't own the stock immediately. Instead, the company will give it to you at some point in the future called the settlement date (potentially tied to a liquidity event like an IPO or sale of the company).
When a company grants you stock or RSUs you do not have to pay anything to receive them. As you will soon see, this is one of the key differences between stock grants and stock options.
Stock grants are easy to think about in the context of your compensation package. You can figure out the "cash equivalent," or how much your stock grant would be worth today, by multiplying the number of shares * the current stock price. You make money from the stock grant by selling the stock! But remember – you usually get this money over time due to the vesting schedule.
Stock grants are most common at publicly traded companies. This is because the IRS counts the value of the stock grants as taxable income upon vesting. What this means is that the IRS will consider the dollar value of the stock you vested during a given year as income that you must pay taxes on. Very large private or public companies have programs in place to help their employees pay for the taxes that incur.
For this reason, companies that are small and private (such as startups) generally do not issue stock grants – they don't want their employees to get stuck with a large tax bill and no way to pay for it!
In order to keep their employees aligned with the company's success and avoid the above tax problem, startups generally issue Stock Options.
Stock options give you the legal right to purchase a specific number of shares in the company at a specific price (called the strike price) at some point in the future. When you own stock options, you don't actually own the shares – you own the right to purchase them! Just like with stock grants and RSUs, nearly all stock option grants are going to be on a vesting schedule so you earn them over time.
The two most important numbers to look at on your stock options are:
Number of options. This number is the number of shares you can buy in the future
Strike price. The strike price is the price at which you are allowed to buy the shares in the future.
The general idea with stock options is that the employee will hold onto them until the company is purchased or goes public. Stock options usually have restrictions that prevent the employee from transferring or selling their options, which means they are an illiquid asset.
At a high level, you can make money from stock options when the company's share price is higher than your option's strike price. In this situation, it would be rational to buy the shares (called "exercising your stock options") if you were able to sell them because you can buy the stock for less than it is currently worth!
If the company's share price is less than the strike price, the employee will do nothing and cannot make any money from the stock options.
Many people try to value their stock options by multiplying the strike price by the number of shares in the company. However, this is not quite right. You only make money if the price of the company's stock increases in value. With stock options, you are making a bet that the company is going to be worth more money in the future.
So in order to come up with the "cash equivalent" number, you are going to have to make some guesses about what you believe the future has in store for the company. You can use this spreadsheet as a guide or read this article from Carta for more nuanced detail on how to do this.
When you exercise your stock options, it is possible that it will be a taxable event. You will generally be taxed on the profit you make from your options. You can calculate your profit with:
(current price per share in the company - strike price) * number of options
Keep in mind that it is possible that you might owe taxes when you exercise your shares even if you are unable to sell them. For this reason, many employees of fast-growing companies only exercise their options once the company is sold or goes public.
There is a lot of nuance to stock options and taxes, read this article from Carta for a more thorough treatment.
Also – Placement is not a tax or financial advisor. Please consult a financial, tax, or legal professional about your specific situation.
"Golden Handcuffs" is a term that some people use when describing how, in certain situations, leaving a company could result in a large financial loss. We'll explain how this happens.
When you are granted stock options, they are not valid forever – especially if you leave the company. Options have what's called an "exercise window" which dictates how long you have to exercise your options after leaving the company if you haven't already. The most common exercise windows are 3 and 6 months.
This means that if you leave the company before it has been bought or gone public, you have to decide to:
Exercise your options. In order to do this, you have to be able to afford to buy them in the first place (which might be a lot of money) and any potential tax consequences.
Let them go. If you really feel like you want to leave the company and you can't afford to buy any of your options before the exercise window is up, you lose out on them completely.
However, it's not a binary decision – you can choose to exercise some and let the rest go.
And this is why they call it golden handcuffs. If you leave, you either have to spend some money or lose out on the value you earned from your hard work. It seems pretty unfair!
Indeed, some people thought that the problem of golden handcuffs was so unfair that they started companies to help. Companies like ESO Fund and SecFi provide no-risk financing to employees at select companies to exercise their stock options. Pretty cool!
It's possible for the equity part of your job offer to provide a life-changing financial outcome. This is by no means guaranteed, but some people love the thrill of the potential. Others prefer to manage their finances more conservatively. There's no right answer – you have to figure this out for yourself.
Equity is quite complicated, so don’t worry if you’re feeling a little lost here. If you need more help, you can work with a Career Coach through Placement who can help guide you.
If you want to go deeper on this topic, you can check out the following resources: