Five questions to ask about equity when joining a startup for the first time
Joining a startup isn’t the crapshoot it used to be. It can be a very real way to build wealth.
This wealth will probably come from equity or options in the company. If you are considering joining a startup for the first time, you need to understand your equity package to make the most out of it.
Startup equity is not like other equity
The first mistake is thinking of startup equity as similar to equity in an established company. It isn’t.
- It is riskier.
- But that risk is partially yours to control.
- Any growth will bin in multiples and not incremental.
Startups offer these packages to align the employee with the company’s core need to deliver growth. If you do that together, you both win.
The five questions
Ask these questions at the interview.
#1 — Is there an equity or options package?
Not all startups have equity packages. Understand this upfront. If the company is very new, you may have the opportunity to own shares directly in the company. If the startup is established and has value, you may be offered participation in an Employee Share Option Pool (ESOP) instead. This allows you to acquire shares at some future point at a certain (hopefully much lower) price. These schemes allow the employee to hold the value and control when tax is paid.
#2 — How are the shares or options valued?
Companies will have a policy for how they value your options or shares. This is usually the share price established by the last financing, but other methods are also used. Companies try to offer employees the lowest possible price to get the biggest possible uplift when they sell their shares.
#3 — How does the vesting work?
Both shares and options are generally vested. This means that you earn the right to keep them over time. Sometimes they vest through hitting performance goals. I don’t like this because startups need to be able to change strategy if they learn a better way, and misalignment happens quickly if employees need to hit other targets to vest their equity. It is more common and easy to manage if vesting happens over time. The longer you stay, the more equity you get.
- How long is the vesting? A normal package will be four years.
- Is there a cliff? This is a period of time that you need to work at the company before the vesting clock starts. Normally this is 12 months, at which point 12 months of equity immediately vests.
- Is there accelerated vesting on an exit? Sometimes there is the ability for all vesting to instantly happen on an exit. Employees sometimes want this so that they can leave with all of their equity on an exit. This is also why companies don’t like it.
#4 — What is a ‘bad leaver’?
It matters how a company defines a ‘bad leaver’ and this matters for your options because bad leavers are normally forced to sell their options back to the company for a nominal value.
Ensure your ‘bad leaver’ clause describes bad behaviour such as fraud rather than simply resigning.
#5 — Can you walk me through where I could end up at an exit?
It can be hard to understand the possible wealth creation from your options. Having 1,000 options at $1 per share tells you very little. Ask the company to walk you through how this might pan out over time if the company’s plans are successful.
Ask them what needs to happen for this to be true. Do you believe in the plan?
Of course, you can’t hold the company to it but soon, you will be on the team, making it happen.
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