Receiving a job offer from an up-and-coming startup is exciting. It can also be confusing, especially when it comes to determining what their proposed compensation package is actually worth. Often times, early-stage startups are balancing cash offers with equity – this means they are offering partial ownership (typically a very small portion) of the company.
If the company continues to grow and increase profits, the shares you received in your compensation package could become very valuable. Let’s take a closer look at how equity compensation works and how to calculate yours so you’ll know exactly what you’re dealing with.
Startup Compensation – The Basics
The structure of most startup compensation packages typically involves some combination of equity and salary. The latter part is straightforward and easy to understand. The equity portion, however, can be much more challenging to evaluate. Startup equity usually comes in the form of a grant of stock options, which is basically a specified number of shares an employee can buy (exercise) at a predetermined price (strike price) upon satisfying certain vesting conditions.
Here’s where things get a little trickier, however. That’s because the number of stock options you have and their strike price do not necessarily convey what that portion of the package is truly worth. For instance, other factors, such as the number of shares that are currently outstanding, play a role in determining the value of those options. Likewise, if the company decides to sell additional shares, your ownership can become diluted. And, of course, there’s always the risk of the startup not making it.
Let’s say the company sold 25% of their $1,000,000 valuation. That would be $250,000, or 1,000 shares worth of stock outstanding. If they offer you 10 of those shares, your ownership would initially equate to 1%, which would technically be valued at $10,000 based on the current valuation.
Now, let’s say a year or two down the road, the company needs more money so they sell additional shares, making $50,000 on a $2,000,000 valuation. These additional shares would dilute your ownership from 1% to .8%. But, because the company is now valued at $2 million, the value of your shares would increase to $16,000.
The last factor to consider is the risk and potential for payoff. With startups, there is always a risk of failure. If the company were to sell, you would receive $16,000, but only if it were to sell for the amount it is valued at ($2 million). So, you’ll need to determine the likelihood of that happening. Let’s say there’s a 5% chance. In that case, the actual cash value (equivalent to salary amount) of your equity would only be $800.
Keep in mind also that you may not get all of your allotted shares at once. For example, you may be required to meet a specified vesting period, such as one year. Or, the total may be divvied up and distributed to you in portions according to a specified vesting schedule, the most common being 25% per year. This is one way the company can incentivize you to stay on for longer.
Questions to Ask
When evaluating a compensation package, it can be helpful to know what key questions to ask your potential employer. This can clear things up and make it easier to calculate the value of the offer into real cash terms.
- How many shares are outstanding?
- What’s the company’s current valuation?
- What is the vesting schedule?
- What will happen if the company is acquired?
- What will happen if I leave?
- When, if at all, do you plan to raise your next round of funding?
- What is your exit strategy?
Of course, there are other things to consider when assessing a job offer, such as benefits, retirement plan options and other perks. You’ll also want to determine what type of income security you need. If you are looking for more stability, have a lot of financial obligations (i.e. student loans, a mortgage, a family to support, etc.) or you are simply risk-averse, prioritizing salary over equity might be a wiser decision.
If you’ve recently received a job offer that includes an equity offering and you’re not sure how to
value it, this startup equity calculator can help! Simply plug in your numbers and it will automatically translate your equity into its salary equivalent. Give it a try here!