If you’ve accepted a job at a startup, one of the benefits you might enjoy is receiving equity as part of your compensation package. Sounds exciting – and it is – but it can also be a little tricky to understand exactly how equity works, whether or not it’s right for you, and the potential risks and rewards. We explain all in this comprehensive guide.
What does it mean to have equity in a startup?
Having equity means you own a stake in the business you’re helping to build and grow. As a startup grows and becomes more valuable, the value of your equity increases. This can happen through various stages of funding, such as seed rounds, Series A, B, and so on, as investors inject capital into the company in exchange for equity.
Why do startups offer equity to employees?
If a startup is in the early stages, funds can be limited, and companies will often go through the ‘bootstrapping’ phase – spending frugally to conserve capital. Because of this, startups unable to compete with large corporate salaries will often offer equity to create a more enticing benefits package. There are a few other reasons, too:
- Giving employees equity means they own a small part of the company. This helps them feel more connected and motivated to contribute to the company’s success.
- When employees have a stake in the company’s success, they are more likely to work hard and go the extra mile to help the business grow since their own financial benefit is tied to the company’s performance.
- Equity encourages employees to stick around for the long term. Since the value of the equity grows over time, team members are more motivated to stay with the company and contribute to its growth and success.
In essence, offering equity is a way for startups to share the potential success of the company with their employees, fostering a sense of ownership, motivation, and loyalty.
(Bamboozled by startup jargon? Check out our guide to the most common startup words and phrases!)
How does startup equity compensation work?
Equity compensation will often vary on a case-by-case basis, but typically involves offering employees ownership in the company in the form of shares or stock options. Equity is often subject to what is known as a ‘vesting’ schedule, which means employees earn their equity gradually, and if they leave before a set period, they may not receive any equity. Equity can be realised through events like IPOs or acquisitions, providing financial benefits to employees as the company grows.
Different types of startup equity compensation
It’s important to understand the type of equity compensation you’re being offered, as some may require you to make a purchase decision and some won’t. Your company will also have a contract with terms and timelines which explains how your equity compensation works. If you don’t understand your options, it’s important to speak to your new employer so they can explain in more detail.
Here are some common options:
- You’ll have the choice to buy company stock at a set price, called the ‘strike price’, which you’ll be able to exercise in the case of a buyout or IPO.
- You’ll usually need to wait for a certain period (known as ‘vesting’) before you can actually buy the stock.
- A common vesting schedule is four years, where each year 25% of the options vest. If you leave before those years are up, you forfeit any options that have not vested.
- You don’t own the stock by default – you’ll need to exercise your options to receive any equity.
Restricted stock units (RSUs)
- You’re promised a certain number of company shares, but you can’t own them right away. Instead, shares become yours over time following a set schedule.
- This is a more popular option for more established startups, when stock options might be too expensive for employees to purchase outright.
- Once they’re yours, you can sell them or keep them.
- RSUs usually come at no cost, aside from tax liabilities.
Restricted stock awards (RSAs)
- You’ll receive a grant of company shares as part of part of your compensation, but they’ll be subject to certain restrictions and conditions.
- Like RSUs, RSAs may have a vesting period during which the employee must meet certain conditions to retain full ownership. However, the employee has legal ownership of the shares even before they fully vest.
- These types of shares are typically issued to managers and executives only if a company meets certain milestones.
- Performance shares might be granted, for example, when regulatory approval is secured for a product or when the company’s stock attains a certain value.
How much equity do startups typically give to employees?
This will vary by sector and can be impacted by economic factors, but on average, the figure is 10-20% of total capital.
Should you join a startup with private equity compensation? Pros and cons
Accepting equity as part of a compensation package isn’t for everyone, so it’s important to weigh up the pros and cons before making a decision.
Pro: You have a chance to own a part of the company through equity, which means as the company succeeds, so do you.
Pro: Equity ties your success to the company’s success, motivating you to work hard and contribute to the company’s growth.
Pro: If the startup does well and goes through a successful exit (like an IPO or acquisition), the value of your equity could significantly increase.
Con: Startups have a higher risk of failure compared to established companies, which means there’s a chance your equity might not be valuable.
Con: Until the startup experiences a liquidity event (like an IPO or acquisition), the value of your equity remains theoretical, and you can’t easily convert it to cash.
Con: The future of a startup can be unpredictable, and factors outside your control, such as market changes or funding issues, may affect the success of the company and the value of your equity.
At GR4, we work with some of the most exciting and innovative tech companies across Europe and the US, and are always looking to expand our network. You can search all our positions here, or get in touch with a member of our specialist team for a confidential discussion.