If you’re in the middle of a negotiation with a potential employer, the conversation eventually leads to a choice between equity and cash. Determining how much you want of each and why is sometimes hard because knowing their value can be complicated.
Luckily, App Academy’s team of career counselors provided us with tips to help you make the decision between cash-money respeck-on-my-check or to get paid in equity.
What is at stake with your stake?
Equity is a piece of a company you own. At most companies, the amount of ownership you have is determined at the beginning of your employment. As time passes, equity can be renegotiated based on such things as your performance or the company’s external financial position.
There are different types of equity packages. Most are determined based on a company’s investment structure set up early in its business life. For example, if you’re employee number 100 of a company that gives you one percent equity in the company at the time of the agreement, the value of your stake may change based on the amount of money put into the company by investors, how much profit the company makes, and other factors. If you decide to buy into the company by exercising your stock options, you can get more equity.
A stock option gives an option holder the right to buy a set number of shares at a fixed price, and according to the Carta investment blog, “encourage employees to stay with a company longer” to have “the right to purchase the shares over time.” This earning model is called vesting and helps encourage people to stay with a company.
But most important is that value and timing of the options you have to buy into the company determine the overall value of your compensation package. If the pure cash number you get in an offer letter is more than an expected windfall from equity, counselors say you always should take the cash.
Basic equity versus cash concepts you need to know
According to App Academy career coach Eli Blair, the following are the most important aspects you need to know about equity stakes.
Equity usually vests over four years with a one-year cliff. This means that it takes awhile for your presence in the company to build value with an equity package. The cliff “means that the vesting schedule will not be enforceable until one year from whenever it was initially granted.”
Income is taxed. Yes, income you make based on investments will be taxed, though if those investments are based off on-staff salaries rather than freelance, you’re taxed at lower rates.
Equity can be diluted. The percentage of your stake in a company can change based on the number of investors, profit, and other factors. If you work for a company that appears to have a bright future, you want to have an employment equity agreement that protects you from dilution.
Equity = gambling. Most startups don’t win big, and based on recent reports from the financial arms of major corporations including high-flying tech companies, fewer are expected to go public, so few big-money equity valuations and exits will lead to big money.
Get runway and valuation from any startup. You need to consider the long-term value of an equity package to properly compare it to investments you could make on your own if you just get more cash.
How to Value Equity
There are many ways to value equity packages. And the most important way is through percentage ownership, according to the Carta blog.
“If Company A offers 100,000 options out of 100 million shares outstanding and Company B offers 10,000 options out of 1 million shares outstanding, then the second offer is 10 times as attractive. That’s right — the smaller share offer in this case is much more attractive, because if Company B is acquired or goes public then you will be worth 10 times as much (for anyone lacking in sleep or caffeine, your 1% share of the company in that latter offer trumps the 0.1% of the former).”
So you have to make sure the percentage ownership is defined in your offer letter.
Another way to value equity versus cash includes making sure the company uses fully diluted shares outstanding to calculate the percentage shares. These shares include common stock/restricted stock units, preferred stock, options outstanding, and unissued shares remaining in the options pool. All these share types are sometimes removed from an offer letter to make an employment offer appear more attractive than it really is. And you should probably get really mad and think twice about joining a company trying to trick you into accepting less money.
Our career coaches and the Carta blog both say potential employees during a negotiation need to determine whether the fixed price to buy one share of stock makes sense based off available market prices. You can find out market prices of companies, even those that aren’t public, based on valuations by independent analysts, banks, and even investment apps.
How to approach negotiations in an equity versus cash discussion
In a negotiation, you need to think hard about how you see yourself at the company. Do you want to move into management or want to pump out the best widgets for years? And how long will it take you to accomplish those goals? These are all important questions connected to the larger equity versus cash conversation because values of stock packages are based on time.
With time frames vesting on stock options usually taking four years, prospective employers must therefore be asked about them. App Academy career coach Anne-Marie Russo says you shouldn’t even consider getting stock options for a company, for example, if you don’t believe you’ll work for less than four years or longer there. She says you will have to forfeit any stock options before then.
“Basically stock options aren’t worth it if you’re only staying one or two years,” she told us.
Another thing to consider is the likelihood of getting stock option payouts based on the type of company you work at, such as a startup versus an established player. Since startups tend to exit at the four-year mark, Anne-Marie says, divesting at that time is an advantage only if the company is solvent.
“The majority of startups fail so deciding to take a job primarily on stock options isn’t recommended. But a larger company on the rise and ready to go IPO is [a good option.]”
As a result of the high unlikelihood of payouts through equity in startups, then, Anne-Marie recommends students approach negotiations of equity versus cash as the difference between a sure thing and playing the lottery. And since cash is king, it’s smarter to get cash via a sign-on bonus or a negotiation leading to a bump in salary.
But what if you really want to get in on an equity play and take your chances with a good lottery ticket? Then you should ask the employer further questions, such as finding out the market rate for your position (based off seniority, location, and job function), comparing the proposed option grant compared to the market, and finding out when you can exercise your option.
Overall negotiation drawbacks and benefits
A negotiation on cash versus equity terms sometimes can help you determine more about the company than anything else, say our experts.
On the positive side, seeing how they approach your insightful questions can help you find whether they really want you to be a part of their company. If they don’t want to engage and push back without any significant cash or equity giveaways, then you’ll know they don’t think you can be that integral to their operation. Similarly, if their communication isn’t respectful or professional, it can show you how they do business there with each other and other partners. And of course, the ultimate benefit is financial. Good negotiation always leads you to get more of what the company has in either cash or equity benefits.
On the negative, it’s possible some companies will not want to negotiate at all and may see your attempts as grandstanding or arrogant. But counselors at App Academy say that if done correctly, with respect and confidence, any negotiation with a good company will eventually lead to good results.
Good luck with your negotiations, and see you at the trading table.
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