Equity Decoded: Helping Candidates Understand Their Compensation Package

When job hunting, it is easy to look at the salary number alone. But for many roles, especially in tech, equity or stock options can actually make up a huge chunk of total compensation.

Equity is complicated. Terms such as grants, vesting periods, and liquidation preferences can leave candidates scratching their heads.

This article simplifies key concepts to help both hiring managers and candidates evaluate the overall comp package. Clear explanations of how stock and options work empower readers to negotiate and make smart decisions about their career moves.

What Is Equity and How Does It Work?

Equity refers to stock options or shares in a company that employees receive as part of their compensation. Instead of just earning a salary, employees get ownership in the company. As the company's value increases over time, the equity becomes more valuable. Employees can then sell the equity for a profit.

For startups, equity is often a large part of an employee's total pay. The company may not have much cash to pay high salaries, so they offer equity to attract top talent. Employees take a risk by accepting equity in a new company. But the potential reward is huge given that the company succeeds.

Equity usually comes with vesting periods of 4 years. This means employees earn the right to their equity over time to inspire them to stay at the company. Leaving before the vesting is complete forfeits the remaining equity. Vesting protects the company by ensuring employees who get equity provide long-term value as well.

For employees, equity is a chance to share in a company's success. But it does come with risks when the company struggles or fails. Employees must know how equity works before accepting an offer. In this way, they can properly value the entire compensation package. With the right mindset, equity can be very rewarding.

Equity Vesting Schedules Explained

Companies offer equity to help attract and keep top talent. But employees often do not fully understand how equity vesting schedules work.

Vesting periods

Employees earn the right to exercise their stock options or receive shares over time through a vesting schedule. Companies use either time-based vesting or milestone-based vesting tied to company or individual performance. Vesting gives employees an incentive to stay with the company long-term as they earn more equity.

Exercise windows

Once equity is vested, employees have a window to exercise their options or sell shares. Windows are often 3-5 years for options and longer for shares. Employees must act before windows close, or they forfeit the equity. Companies hope vesting and windows motivate employees to drive business outcomes that increase share value.

Equity can be highly rewarding but complex. Knowing vesting schedules and exercise windows help employees make the most of the opportunities and rewards companies offer.

Becoming a “Unicorn” Company: What It Means and What Is Next?

When a company becomes successful and achieves “unicorn” status with a $1 billion valuation, the equity becomes very valuable. Early employees receive stock options or restricted stock units at a low price. As the company’s value increases dramatically, the equity stake becomes worth a lot of money.

The higher the valuation, the more the equity is worth. Of course, there is a lot of risk that the company may not reach such a high valuation, or any liquidity event at all. In this case, the equity may be worth little or nothing. But patience and hard work pays off when the company does become a “unicorn.”

Impact of Vesting Schedule: How Much Equity an Employee Receives?

A vesting schedule dictates when and how much equity an employee gets. Companies use a vesting schedule to ensure that employees who receive equity stay with the company long enough to contribute value before their shares are fully vested.

For instance, a company may implement a 4-year vesting schedule for equity, with 25% vesting after the first year and the remaining vesting monthly over the next 36 months. This means that when an employee leaves after 2 years, they walk away with 50% of the equity. Vesting schedules keep valuable employees at the company by locking them in for a certain period of time before they fully own their shares.

The vesting schedule is a vital consideration when evaluating a compensation package that includes equity. Make sure to understand the specific details of when the equity will vest and any clauses which impact how much equity an employee receives.

Negotiating a shorter vesting schedule will allow an employee to have more control over the equity stake sooner. But for early-stage companies, longer vesting periods are more common and reasonable.

Holding a Piece of the Company and What It Means

Securing equity in a company means obtaining partial ownership. The amount received depends on factors such as position, experience, skills, and negotiations. Understanding the equity package involves knowing what percentage of the company an employee holds and how much control or voting power comes with it.

For candidates and employees, equity often comes in the form of stock options, restricted stock units (RSUs), or outright stock grants. The specifics of each offering differ. But they all represent a stake in the company that can become quite valuable as the company grows. The value of any equity package comes down to the company’s prospects and an individual’s risk tolerance.

How to Value Your Equity Compensation

When companies offer equity compensation, it can be difficult for candidates to know how much their shares or options may be worth. Candidates must first understand the fair market value of the company’s shares. The company will determine a valuation based on factors, including revenue, profits, growth, and the value of comparable companies. Candidates can then estimate how much the value of their shares may increase over time as the company grows.

Candidates must consider the vesting schedule as well. This determines when they can own and sell the shares. The longer the vesting schedule, the more risk the candidate is taking on. But more time allows for potentially greater appreciation in share value.

Understanding the tax impact is critical. When shares get sold, capital gains taxes may apply. The amount of tax equates to the holding period of the shares. Candidates must work with a financial advisor to develop a plan to pay any taxes due.

Equity is quite valuable, but there are many factors to consider in defining how valuable it may be for any one candidate. Doing thorough research and working with experts can help candidates make the best choice when negotiating and accepting a job offer that includes company shares or stock options.

Conclusion

Breaking down compensation packages into bite-sized pieces empower candidates and employees to make informed decisions. Equity is complex, but with the right tools and education, it does not have to be so scary. Next time you are reviewing an offer or thinking about your career path, remember to factor in the whole picture - not just base salary. Knowing the ins and outs of equity gives you power.