In the fast-paced world of startups, the allure of equity has been a driving force for many prospective employees. Beyond the appealing perks and flexible work environment, the promise of equity in what you’re helping to build has the potential to reshape your career trajectory and financial future. But nothing is guaranteed, and even if your startup succeeds there is a lot to consider.
Equity has often been thought of as a golden ticket with no downside, but that’s not necessarily true. Just ask ex-employees who have exercised their options and seen their company’s value decline.
We are also in an interesting time in regards to startup equity as we are seeing vesting structures change and become more employee-friendly. For example, Brex allows employees to determine the split they want between a salary and equity options giving them the flexibility to balance the decision between financial stability today and the potential upside in the future.
Equity, in the context of startups, refers to ownership in the company. It's a piece of the proverbial pie that entitles you to a part of the company's value and, hopefully, future success. As a startup employee, oftentimes you're not just a worker; you're a stakeholder with a vested interest in seeing the company’s growth and profitability. This shared ownership is intended to align your personal goals with the company's objectives, hypothetically creating a symbiotic relationship where your hard work directly impacts your personal gain.
While a traditional salary provides immediate financial stability, equity introduces the prospect of exponential financial growth. Startups, by nature, operate in a high-risk, high-reward environment. This means that if the company takes off and becomes the next big thing, your equity stake could skyrocket in value. Equity is more than just a financial instrument; it's a motivational force that aligns your interests with the company's long-term vision. As a startup employee, you're not just clocking in and out – you're invested in the company's success. This alignment fuels a unique level of dedication and commitment, as every effort you contribute directly impacts the growth of your equity stake. Imagine being part of a company that experiences rapid expansion and eventual success – your initial equity grant could turn into a substantial windfall.
Consider the stories of legendary startups like Airbnb, Uber, and Zoom. Early employees who held equity positions in these companies reaped monumental rewards as they grew from scrappy startups to global giants. Their equity stakes, granted as a form of motivation and compensation, provided them with life-changing equity events. These examples showcase the potential of equity as a powerful wealth-building tool for startup employees.
However, it’s not all sunshine and rainbows. It is often cited that tech and venture-backed startups have a failure rate of 75-90%. To put that in perspective, Michael Jordan had a career free throw percentage of 83.5%. Meaning, a startup is as likely to fail as Michael Jordan is to make a free throw.
Equity Terms to Know
Vesting period - a predetermined timeline during which you gradually earn ownership rights. Most startups follow a 4-year vesting schedule with a 1-year “cliff”, meaning that 25% of your options grant will vest at the 1-year mark but if you leave before then you walk away with nothing.
Fair Market Value (FMV) - also often referred to as the 409a valuation, refers to the estimated value of the company's equity or assets on the open market. It represents what a knowledgeable, willing buyer would pay and what a knowledgeable, willing seller would accept for the company or its ownership interests
Exercise price - also referred to as the “strike price” this is the per share cost that you can buy company options at. Typically set by the FMV of the company’s options at the date of the grant issue.
Liquidity Event - Also referred to as an exit event, this allows equity holders to realize the value of their ownership. Common exit events include an initial public offering (IPO), an acquisition of the company, or a company-sponsored tender offer. At this time, equity holders may have the opportunity to sell their shares and receive monetary returns based on the company's valuation.
There is a lot to consider and by no means am I providing you with direct, actionable insight for your specific scenario (consult your own financial advisor for that) but just trying to generate more overall awareness. You will need to consider the price per share you have to pay, the current fair market value, how long it might be before there is a liquidity event, and any associated tax implications that will come about as a result of exercising your options.
Having equity undoubtedly transforms you from an employee into a stakeholder, a co-builder of the startup's future. It shows your belief in the company's vision, your willingness to invest your time, and the company’s bet on you to help them get to where they want to go. As you embark on the startup journey, the potential for substantial financial gains, alignment of interests, and unparalleled motivation await.
About the Author - Ries McQuillan is a Boston native with a decade of experience as a GTM & Partnerships leader with previous stints at HubSpot, Zerto, and WeWork. . He is currently the Director of Business Development & Growth Operations at Vested, a seed-stage FinTech firm. In his free time, he helps early-stage Founders & teams grow across the Boston startup ecosystem.