How to Negotiate your Equity Compensation in VC-Backed Startups

May 20, 2012 How to Negotiate your Equity Compensation in VC-Backed Startups

In our work at venture-backed startups, we are amazed at how hard new employees will negotiate pay, benefits, workspace, duties, titles, etc. and just totally accept their equity compensation.

So, we have prepared six questions that will make you look really smart and help you understand your equity compensation.  It may also make you a lot richer when your Company is acquired.

Assumption: You have been offered an incentive stock option for 100,000 common stock shares at an exercise price of $0.05 per share that vests 25% after the first year and then monthly for the next three years.

Questions: 

1.    How many shares are outstanding on a fully-diluted basis?

2.    Can I receive restricted stock, rather than incentive stock options?

3.    Based on the current burn rate, when does the Company plan to raise the next round of equity?

4.    Will the Company refresh when the next round is raised?

5.    What is the liquidation preference that is in front of the common shares?

6.    Is there any acceleration of vesting upon a change in control?

                             

Analysis:

1.    Your slice of the pie.  Obviously, there is a huge difference in the size and value of your slice if the pie (total shares outstanding) is 1M shares vs. 100M shares.  Fully-diluted just converts all preferred stock shares and warrants to common stock shares.

2.    The answer will probably be no, but ask the question anyway.  Restricted stock just means that you actually own the stock (vs. an option to purchase the stock) with restrictions (vesting schedule).  It is a much better deal for taxes.

3.    The answer to this is important, as it is a back-door way to ask when does the Company run out of money?

4.    When the Company raises additional equity, they issue more shares, so the pie grows and your slice shrinks.  This is just an intelligent sounding way to ask if they plan to make you whole by issuing you additional options.  This is worth negotiating.

5.    Preference is the amount paid to the investors when the Company is acquired, before any amount is paid to stockholders.  It is often 1X which means if there was $10M invested in the Company, that amount (plus dividends) is the first money paid, before anything flows down to stockholders, including option holders.

6.    Sometimes, companies will accelerate your unvested stock options upon an acquisition.  This can be huge to negotiate if you anticipate an acquisition in the near future.

Good luck and remember if you have gotten to the point where there is an offer on the table, the Company wants you and this will be the best­ and maybe only time to negotiate your equity compensation.

 

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IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

 

12 Comments
  • Joe Faris, CPA
    Posted at 15:20h, 01 June

    {n}

  • Patrick
    Posted at 16:23h, 01 June

    Great read!

  • piracetam
    Posted at 22:30h, 07 December

    Ordinary shares are also known as equity shares and they are the most common form of share in the UK. An ordinary share gives the right to its owner to share in the profits of the company (dividends) and to vote at general meetings of the company. The residual value of the company is called common stock. A voting share (also called common stock or an ordinary share) is a share of stock giving the stockholder the right to vote on matters of corporate policy and the composition of the members of the board of directors .

  • silver account
    Posted at 14:47h, 10 December

    The stock of a corporation is partitioned into shares , the total of which are stated at the time of business formation. Additional shares may subsequently be authorized by the existing shareholders and issued by the company. In some jurisdictions, each share of stock has a certain declared par value , which is a nominal accounting value used to represent the equity on the balance sheet of the corporation. In other jurisdictions, however, shares of stock may be issued without associated par value.

  • silver account
    Posted at 18:03h, 12 December

    The value of a company as measured by the total number of stock shares outstanding times the market price of each share. For example, if company ABC has 20 million shares outstanding, and each share is currently worth $100, then the market cap for ABC is $2 billion. In general, stocks are classified as large cap (over $5 billion), small cap (under $1 billion), or mid cap (anything in between).

  • silver price
    Posted at 05:23h, 15 December

    The terms “equity,” “stock” and “shares” are all related and, in many ways, they refer to the same thing in a business. Equity is the broadest definition, referring to a more conceptual perspective of business value, while shares is a much more specific term that defines a physical unit of value. Understanding the difference between the three terms makes it much easier to understand company strategies and investment options.

  • gold price
    Posted at 20:41h, 19 December

    The terms “equity,” “stock” and “shares” are all related and, in many ways, they refer to the same thing in a business. Equity is the broadest definition, referring to a more conceptual perspective of business value, while shares is a much more specific term that defines a physical unit of value. Understanding the difference between the three terms makes it much easier to understand company strategies and investment options.

  • Idebenone
    Posted at 03:24h, 20 December

    Common stock is a component of shareholder equity on a company’s balance sheet which represents the interest of the company’s owners.

  • silver price
    Posted at 08:31h, 20 December

    When a company acquires some of its own stock and holds it rather than retiring it, such shares are called treasury stock. The shares continue to be authorized shares and may be used by the company again at a later date but they are not currently in the hands of owners. Although the treasury shares were authorized (in the articles of incorporation) and had been issued to owners, they are not outstanding because they are not being held by owners. Continuing the above example, if the company acquires 500 common shares and does not retire them, its authorized shares remain at 40,000, its issued shares also remain at 10,000, while its outstanding shares fall to 9,500 (10,000 –500). Thus, when a company has treasury stock, its issued shares differ from its outstanding shares. Since treasury stock shares are not in the hands of owners, such shares are not eligible to vote on any stockholders’ issues, nor are such shares eligible to receive cash dividends. Many companies use treasury stock for employee stock purchase plans to provide incentives to employees. The companies acquire their own shares, hold them until employees achieve certain goals, and then distribute the shares to employees. More advanced accounting courses will discuss the accounting for treasury stock and employee benefits.

  • gold price
    Posted at 06:02h, 22 December

    When you own shares of stock you become part owner of a company. If the company does well, the value of your stock should go up over time. If the company does not do well, the value of your investment will decrease.

  • gold account
    Posted at 09:26h, 23 December

    When a company acquires some of its own stock and holds it rather than retiring it, such shares are called treasury stock. The shares continue to be authorized shares and may be used by the company again at a later date but they are not currently in the hands of owners. Although the treasury shares were authorized (in the articles of incorporation) and had been issued to owners, they are not outstanding because they are not being held by owners. Continuing the above example, if the company acquires 500 common shares and does not retire them, its authorized shares remain at 40,000, its issued shares also remain at 10,000, while its outstanding shares fall to 9,500 (10,000 –500). Thus, when a company has treasury stock, its issued shares differ from its outstanding shares. Since treasury stock shares are not in the hands of owners, such shares are not eligible to vote on any stockholders’ issues, nor are such shares eligible to receive cash dividends. Many companies use treasury stock for employee stock purchase plans to provide incentives to employees. The companies acquire their own shares, hold them until employees achieve certain goals, and then distribute the shares to employees. More advanced accounting courses will discuss the accounting for treasury stock and employee benefits.

  • idebenone
    Posted at 21:53h, 27 December

    Illiquid listed or private company shares, restricted or unregistered shares, minority or majority share blocks. Limited partnership interests (hedge funds, private equity, venture capital). Common stocks are equity securities issued as ownership shares in a publicly held corporation. As a group, common stock shareholders can exercise control due to having voting rights, which allows them to elect a board of directors and vote on corporate policy and, based on their proportionate ownership, they may receive dividends as well as enjoying any capital appreciation. If the company goes bankrupt, the common stockholders are junior to all other classes of securities so will not receive their money until the bondholders, preferred shareholders and other debt holders have been paid in full from the leftover assets. This makes common stock riskier than debt or preferred shares. The upside to common shares is that they usually outperform bonds and preferred shares in the long run. Also, in the U.K. common stock is sometimes called “ordinary shares”.