I get asked from a lot of folks who are considering startup employment if x% is sufficient equity. As with so many things, the answer is, “it depends”. Below is one rough framework for coming to a number. But, you should also seek other methodologies, such as finding averages for comparable roles at similarly sized companies in the same geographic region.
Disclaimer: I am not a lawyer, and I cannot be held responsible for accuracy of the information below. Use at your own risk.
- How much cash compensation will you be giving up by working at the startup instead of at Large Company? As this number gets higher, your equity compensation becomes more important.
- What do you think the likelihood is that the company will have a liquidation event (e.g. being sold to Microsoft) before your options expire? Note: Stock options often expire as a result of termination of employment.
If your answer to 1 is a high number and your answer to 2 is a low number, then think hard about passing Go.
Note: One thing I have not considered in this post is that the acquiring company (if your company is acquired) will often offer lucrative compensation plans to retain the top employees.
Next step: the math
To roughly determine your cash payout on liquidation:
Payout = (company value at liquidation – company value represented by option strike price) * ownership percentage * dilution
Then, to roughly value your yearly compensation (Note: You should discount future cash payments, but we’ll leave that out for simplicity):
Comp = salary + bonus + (Payout / number of years to payout)
Note the importance of the company value represented by option strike price in the above equations. If the company value at liquidation is not at least the same, you will receive no payout from your options.
- Marc’s strike price reflects a $1M valuation.
- The company sells for $40M after 3 years. Marc is still working there, and his options have not expired.
- Marc’s option package represents 0.5% of the company, but he is only 3/4 vested.
- There has been an investment round that diluted everybody’s ownership by 30%
- So, we get:
- Payout = ($40M – $1M) * (.75)(0.005) * (1 – 0.3) = $102,375
- Yearly Comp = $85,000 + $10,000 + $102,375 / 3 = $129,125
- Marc thinks this 3-year compensation package is better than he will get at Large Company, and he looks forward to the learning experience, so he takes the job!