Understanding Risks of Employee Equity Compensation

This might be a controversial hot take, but I don't think the idea of employee equity (in most cases) makes sense. After several experiences, including being an early employee at companies that have IPO'd through a SPAC and a founding member of a company that exited, my view on this has changed completely. I want to caveat, that I do believe, in many cases, equity packages make sense for senior executives and very early employees. However, for the most part, I believe equity compensation for junior and mid level employees in lieu of pay is a bad idea. A few reasons: 1) Misunderstanding Equity: Most junior employees have no idea what equity actually means. They believe that owning a piece of the company will make them rich upon an exit and that taking "more shares" in lieu of higher pay is a guaranteed payday. This is such a gamble and so misleading. Most companies don't exit. It's a huge risk that may never pay off. 2) Logistics of Options: Many junior employees don't understand the logistics of "options." While many of us know that being granted options doesn't mean owning them, this is typically elusive for younger, more junior employees. 3) Exercise Price, Spread, and Taxes: The reality of the exercise price, spread, and taxes makes it impossible for those who aren't wealthy to buy the options upon exit (within the typical time period). They are unaware that they will have to shell out a significant amount of money and feel the pressure of the clock ticking. 4) Stock Purchase Reality: When junior employees do make the purchase, they may not realize they are simply buying stock at a discounted price to what they believe the long-term value will be. This is equivalent to buying Meta stock at its IPO because you believe there is tremendous upside that isn't currently reflected in the price. This isn't to say that equity grants aren't great for senior executives and very early employees. It's to say that most people given equity simply don't have all the facts, and using it as a replacement for equivalent compensation no longer makes sense, especially in a cooler market where multiples are no longer 40x revenue. Happy to be challenged :)

When I took my first role that offered equity, I just accepted it, no questions asked. I didn't understand how equity worked, and was just excited for the opportunity to own a piece of the company. I've learned a lot since then, and would do things very differently if I could go back. Here are some of the the things I wish I knew about equity back then: 1) Equity is often negotiable. Just like cash compensation, many organizations allow the opportunity to negotiate the amount of equity you receive as part of your offer, how much time you have to exercise your options after you leave, the ability to early exercise your options, etc. Not all companies will allow you to negotiate the terms, but it's worth giving it a shot. 2) Options and RSUs are different. It's too much information to go into here, but it's worth taking time to understand the differences in terms of tax treatment, what happens when you leave the company, etc. 3) Companies have different ways of valuing their equity. Don't accept at face value if a company says "X number of shares, which has a value of Y." Ask questions to understand how they calculated the value. Is it based on the value of shares at the last fundraise? What they think they could raise at today? Something else? Understanding this is key to understanding the value and potential future value of your equity. 4) There can be serious tax consequences to exercising stock options. It's worth consulting a tax advisor before making any decisions to exercise. 5) Many companies fail, and often, stock options can end up being worth nothing. Choose where you work wisely, especially if equity is a significant portion of your compensation!

If you work for a startup or are evaluating a job opportunity with a startup, your equity grant is likely a significant portion of your overall compensation. Therefore, it is in your best interest to understand what this means for you today & the potential that your equity stake could become in the future. ⏩ The number of shares or options granted are just one piece of the pie. 🥧 There are a lot of ways to structure your equity grant that can: 1️⃣ Save you a significant amount in taxes 2️⃣ Create additional financial flexibility 3️⃣ Mitigate the risks involved with private equity As Stephen Covey states, "begin with the end in mind". This is especially true at the beginning of your startup journey. 🛣 Here are a few provisions that I advocate individuals look into: 🔹 Post-Termination Exercise Period - Even if you don't intend to leave your company anytime soon, understanding how long you have to exercise your options once you leave your company (voluntarily or involuntarily) is incredibly important. The standard window is 90 days following your final day with the company. If you don't exercise within 3 months, you forfeit your options. Negotiating an extended exercise period on the front-end can give you extra runway to evaluate how the business is performing before you are forced to put money into exercising your options. 🔹 Early Exercise - When you join a startup, it's likely you will receive your option grant on a vesting schedule (4 years is most common). Simply put, you will obtain the right to purchase shares in your company over time. The term "early exercise" gives you the ability to exercise your options before they have vested. Why would one want to do this? In a hyper-growth startup, the company's valuation may grow exponentially over the course of 4 years. As the company's valuation increases, the spread between the Fair Market Value and your Strike Price widens, therefore causing an increase in your tax liability. Exercising prior to a fundraising event or 409a revaluation can save you significant taxes. (If you are able to early exercise, don't forget to file an 83(b) election within 30 days ‼). 🔹 Liquidity Opportunities Pre-Exit - There are multiple ways for startup employees to obtain liquidity for the value of their equity, even if the company remains private. ⁉ Two common methods are by participating in a tender offer (company-sponsored) or selling shares on a secondary market (independent of the company). Having the ability to receive liquidity for the value of your private equity can accelerate your ability to achieve financial goals OR provide the necessary proceeds to exercise additional options & cover your tax exposure in a lower risk manner. These three are just a few of the opportunities to structure your equity package in a way that provides additional flexibility and increases your opportunity to own some of the value you work hard to create. 💪