How to Negotiate Equity in a Startup
Working for young, ambitious companies, the so-called startups, can be exciting, refreshing and teach you a ton of valuable experience. However, there’s no doubt that joining one is, to some extent, a gamble. For example, choosing to work for equity, meaning for a stake of the business itself, instead of or in addition to your salary, is certainly a risk.
After all, statistics show that around 90% of startups fail, and of those only 1% reach the “unicorn status" of Airbnb or Uber. If you pick right though, you might very well hit the jackpot. Whether you want to ask for startup equity or it’s all that’s on offer, in this article we share our tips on how to negotiate equity in a startup job.
What is Startup Equity?
While startups usually offer relaxed dress codes, flexible hours, and room for growth, they can rarely provide employees with competitive salaries and benefits packages at the beginning. At seed level, company founders might be running them as side projects or going all in and investing all their time and savings in it.
Frugality is imperative, but to progress in their vision they also need highly talented professionals. If they’re not yet able to pay a fair market price, they may offer equity (also referred to as stocks or shares), which is a stake of ownership in the very same business you’d be helping to build. Equity could be offered in place of your salary or to bolster a low base salary.
At this point, it’s important to clarify that until the company is either sold or taken public, your equity is nothing more than a promise of future value. In other words, if the business only breaks even or fails, your share is worth nothing. “If I have to jump into such a transaction, it better be worth it”- you might think. And you’re very right. Hence, why it’s so important to know how to negotiate equity in a startup and reduce your risk.
Why Do Startups Give Out Equity?
While offering equity in a company is primarily about filling the compensation gap with a tempting alternative to a salary to make it worth the risk, that’s not the only reason startups opt for this course. Distributing shares is also great to increase:
- Motivation. By holding a stake in the business they work for employees are technically partial owners too, which pushes them to perform better and engage more. This is because they can directly benefit from the difference in the company’s success that their contribution makes. This is critical to creating a great team mindset, especially in the early stages of a startup’s expansion when staffing is limited.
- Retention. Unsurprisingly, stock packages are created to be more beneficial to those that stay in the company for longer. In many cases, to even have access to such shares you have to work in the company for at least a certain amount of time, which is called the vesting period. This is a powerful incentive for employees, but also something important to keep in mind when thinking about how to negotiate equity in a startup.
How Does Equity Compensation Work?
A typical startup equity structure varies, however, it generally follows the following phases:
Seed Level to Early Stage
The earlier you enter a startup workforce, the higher the chances you’ll only be paid in shares instead of cash. And it’s no surprise since payroll is the highest cost in startup budgets, averaging $300,500 per year for just five employees. However, if you consider that usually only 10% to 20% of total shares are destined for employee equity and that with every fundraising round, they are diluted, this is a great time to jump on board.
Growth Stage
As the business grows and cash flows in from crowdfunding or Venture Capitalists and Corporate Venture Capital firms, it becomes more common to receive a combination of cash salary and equity as your compensation.
Expansion to Exit Phase
Finally, once the company can afford full salaries, stocks become extra benefits that are thrown into the pay package negotiation process to make the offer more appealing to employees.
When looking for tips on how to negotiate equity in a startup, you’ll surely be wondering “how much equity should I ask for?” It first depends on the startup’s current stage. Keep in mind that the earlier you join a startup, the higher the risk, so the more equity you should receive.
Your job title and sector play important roles as well. Various data show that at seed level, VPs and other directors can expect on average 1% to 2% equity, just like senior engineers in IT companies receive 1% compared to the 0.35% for other business employees.
Is Owing Equity in a Company Right for You?
Before considering how to negotiate equity in a startup yourself, it’s essential to understand if such a transaction is even worthwhile in your personal situation. If you choose to work for equity, you should:
- Firmly believe in the product or service the startup is trying to create and in the founders’ vision. Think about it in this way - would you invest money in it? Working for limited or no monetary compensation at all is in fact essentially
- Be in a financially stable position whereby if the startup was to fail it wouldn’t cause you distress. Maybe you have enough savings to keep you afloat in the worst-case scenario, or the partial salary the company offers is enough for you to take the risk. Or, perhaps you already have another full-time position, and this would only be a side project to you.
- Understand how typical startup equity works and your specific equity offer. For instance, stock grants mean you own the stock outright and can sell it after it vests and receive 100% of the sales price, whereas stock options mean the company agrees to sell you stock at a set price in the future. During your job interviews and salary negotiation, ask about what kind of stock options they offer, how they calculate the shares, your vesting schedule, what would happen if you left, and how to liquidate your equity in the future.
- Inform yourself about how owning stocks would impact your tax situation. Always refer to a professional tax advisor to identify possible liabilities.
How to Negotiate Equity in a Startup: Practical Tips
Striking a deal involving startup equity might seem intimidating. However, the trick to mastering how to negotiate equity in a startup is to approach it the same way you would with any regular salary negotiation. In particular, you should:
- Research. If you have to enter into a negotiation, knowing how much similar roles are making both in terms of salary and equity is a must. This gives you a more powerful base from which to make certain requests. Get help from your network as well as take legal advice if necessary.
- Don’t reveal all your cards at first. Just like with cash compensation, you don’t want to be the first to name a number when it comes to equity either. Let the company make a proposal first. If they are serious, they’ll have a certain stock distribution structure in place already.
- Understand which parts of the deal are negotiable. Don’t be afraid to ask. There might be parts of the deal that the startup are more willing to work around, such as vesting schedules and the type of stock you can get. If their equity options are set in stone, test what they are willing to offer in terms of a higher salary, a signing bonus or other benefits instead.
- Know your priorities and don’t be afraid to walk out. Whether you feel more comfortable with more cash and less equity in your salary package or the other way around, don’t feel pressured to make a decision that goes against your risk tolerance or priorities.
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