Equity 101 please?
June 30, 2011 3:01 PM   Subscribe

I'm an 18-year-old designer looking to join a start-up, they said they are interested in giving me equity in addition to my salary. I know nothing about this. Where to start? What to negotiate for? I've heard tons of warnings about shares before but I'll be happy to hear them again. Thanks all!
posted by ejfox to Work & Money (19 answers total) 2 users marked this as a favorite
I probably can't answer this. Anyone who can will probably need to know how the company is set up. Partnership? LLC?
posted by Mr. Yuck at 3:08 PM on June 30, 2011

I'm going through this myself. Read about unregistered Class C LLC shares and dilution. Basically, the equity is a big gamble in whether or not you think the company can be successful.

As more people are added with equity, your shares will be diluted accordingly.
posted by Raichle at 3:10 PM on June 30, 2011

In all likelihood, the equity will be worth nothing. Either you won't stay there long enough for your options to vest (I once got laid off from a startup one day before my first batch of options were due to vest), or the company will fail (this happened to me at my second startup), or they will accept so much additional investment that your options will be diluted into oblivion (this happened to me at yet another startup I worked for).

So assume that any equity they offer you will be worth nothing. Negotiate an acceptable salary for the position and consider any equity you're offered to be a lottery ticket that could, if you're lucky, eventually compensate you for all the unpaid overtime you'll be putting in.
posted by kindall at 3:13 PM on June 30, 2011 [20 favorites]

I'd say treat the equity the way you would a free bet on a horse. If the salary seems ok, and you like the job, then take it on that basis. If the company does well, the equity may (eventually) amount to a bit of extra money, but unless this is the next Facebook or Google, it's not going to make you rich.

I've had equity in two companies I've worked for. In both cases the partners in the company owned the vast majority of the equity and employees got a minor share that didn't in either case turn out to be worth anything much at all.
posted by le morte de bea arthur at 3:13 PM on June 30, 2011

Kindall has it, as far as I'm concerned (done one startup right out of university). Your equity is worth nothing. Do not count on it.* Get a salary you consider fair, and the equity is a bonus.

*There are exceptions, notably if it's your startup, but that's not the case here.
posted by Lemurrhea at 3:24 PM on June 30, 2011

Thirding Kindall. I actually exercised my options from one startup when I quit, just in case they might someday sell the company. I am 99% sure I wasted $400. I occasionally get a letter in the mail from a law firm telling me how they have created millions of new shares out of thin air, thus diluting any value my shares might have had into nothing anyway.
posted by drjimmy11 at 3:31 PM on June 30, 2011

Chiming in for kindall's advice. Also, if this is for a graphic design / motion graphic / creative firm...chances are the company will go bust before you can vest your options. As a creative professional myself I can tell you that the viability of startup graphic design/motion graphic/creative firms are tentative at best and I can't tell you how many of these firms often use equity as a carrot / stick routine for potential good artists. These companies come and go like waves on the sea. Do NOT let sweet talk of equity let them low ball you on salary...or let it substitute a good benefits package. I'd take solid benefits any day over equity.

And, just to be the devil on your shoulder...you're 18 now but will eventually realize that the best way to work in design is on a freelance / contract basis. In the creative industry, unless you're a core art director or lead, salary simply translates to "No overtime." If you're good enough for staff at a design firm, you're good enough to be paid a high rate with higher overtime pay for the crazy hours you will work.
posted by jnnla at 3:56 PM on June 30, 2011 [1 favorite]

Long answer, read this: http://www.scribd.com/doc/55945011/An-Introduction-to-Stock-Options-for-the-Tech-Entrepreneur-or-Startup-Employee

Short answer: your options will never be worth anything.
posted by outlaw of averages at 3:57 PM on June 30, 2011

If you got actual shares, from the get go, that would be one thing, and you'd have a taxable form of compensation in the form of shares with some (generally arbitrary, based on your company's representations) non-market value. But if your shares are in a non-traded organization (meaning a company whose stock is all privately held, and doesn't trade on any of the major markets, including over-the-counter), generally you can only sell them back to the company, or to another approved investor, with company permission, at prices the company will generally set, under a stock grant and shareholders agreement. Basically, you'll have a kind of not-very-liquid "funny money" you can't easily value or spend, the ownership of which will complicate your tax returns, if ever the company does pay dividends, or go public, and which may cost you money out of pocket in additional taxes, even before you get any dividends or are able to sell the stock.

It's more likely that what you'll actually get are options to buy some shares at a later date, at some beneficial price, which you can choose to exercise, or not, at some later date. Options are an even more ethereal kind of "funny money," that generally require professional tax advice, based on the specifics of the option offer, and your personal situation, to evaluate properly. But generally, unless the company is already publicly trading when the options are issued, stock options mean almost nothing, financially, and can create significant, immediate tax liabilities when exercised, even in the rare cases where they do have value at time of exercise.
posted by paulsc at 4:06 PM on June 30, 2011

Everyone is pointing to Kindall's answer because he/she is spot on. To a first approximation, your equity is worth zero dollars. On the balance sheet of salary/benefits negotiations, set that line to zero when you're evaluating the deal. The people trying to hire you will work very hard to convince you that it's non-zero, but in fact 99.999% of the time it is zero. They're selling you the idea of equity so they can pay you less.

Be nice, but do your research and don't accept magic beans for your work. You're worth more than that.
posted by introp at 4:09 PM on June 30, 2011

What they said, a million times. It's like lottery tickets in your birthday card and you should give them exactly that much weight. Do not take less than the salary you want and need, do not let them distract you with Imaginary Foo Foo Dollars.
posted by Lyn Never at 4:34 PM on June 30, 2011

tl;dr negotiate an hourly rate as a contractor (start at 3 times what your base salary would work out to and settle for 1.5 to 2) and find a good tax preparer within 2 months of getting hired (they should not charge you more than $500 for the entire year).

Nthing kindall's post because s/he is right.

I started my career in tech as a designer at a startup back in the go-go bubble days and learned very quickly that cash on the barrel-head was the only way to go.

I was lucky in that my manager at the second failed startup I worked at counseled me to sign on as a contractor at an hourly rate that looked (based on a 50-hour week) like a lot less than a salary+options (also based on a 50-hour week).

I took his advice and when the 80-hour weeks (and one very blurry 360-hour month) happened I raked it in (and was useless for a week after).
posted by dolface at 5:04 PM on June 30, 2011

Equity is a lottery ticket with long, long odds. Do not factor it into any calculation of the value of the job, the salary, if you can live on what you are paid, etc.
posted by L'Estrange Fruit at 5:16 PM on June 30, 2011

Hey all- thanks so much, I appreciate the advice.

I'm happy to report that I wasn't taking the options into account in terms of my salary, I was more asking in regards to what sorts of terms they are going to be talking about.

When they offer options are they offering a percentage? A certain number of shares? Obviously that's not worth very much now, but it could be later, should I ask for more? How much is reasonable? What if I think this company is going to do great and I really want some options?
posted by ejfox at 7:06 PM on June 30, 2011

I am about to offer options to my employees, and I treat them as "gravy" for them. If they are worth something after a time (which we all will contribute to, and have a relatively high chance of achieving) that will be great. But one can't eat options, so salary is important.

When negotiating, ask what the current value of the company is estimated at, what is the TOTAL number of shares, and how many options you're getting. It always surprises me that people ask about number of options but not the percentage of the company those represent. It's very likely that as a junior starting employee you will get an option which is a tiny fraction of one per cent of the company.

Other things to ask them is how much they plan to increase the value of the firm and how. Will they raise additional capital? If they plan to raise money, you will get diluted. But maybe it's a firm with large growth potential-and then your options could be worth something down the road. If they will stay a "mom and pop" shop, you're better off with profit sharing.
posted by Yavsy at 8:00 PM on June 30, 2011

On the mechanics of the offer, they will offer you some number of shares, or options to purchase shares at some set price. You will receive these at intervals, typically 20-25% of your grant after each year you have been there.

The offer will be meaningless to you without knowing how many shares are outstanding, so if you really care, ask about that and you can then figure out what minuscule (and getting smaller) percentage of the company you may eventually own. Then, I don't know, just assume they are lowballing and counter with, oh, twice the number of shares. Might as well ask for two lottery tickets instead of one, I guess.
posted by kindall at 8:59 PM on June 30, 2011

There are no completely solid rules, but typically the number of shares you are offered in a small early-stage startup (one that has not yet raised much investment money) will range from 5-10% of outstanding shares if you are one of the very first high-level employees in a very critical executive-level role, down to around 0.1% to 1% if you are a lower-level or later employee - possibly less depending on the structure of the company.

Your contract will specify a certain number of shares, say 1000 shares. If the company happens to have 1,000,000 shares outstanding, then that is currently 0.1% of the company. As people mentioned above, if the company issues more shares to raise money then it will dilute all the current shareholders; essentially the current shareholders are selling part of their portion of the company to the new investor in exchange for cash to pay for operations. If the company has issued another 1,000,000 shares by the time you sell your stock, then you will still have your 1000 shares but they will represent only 0.05% of the company at that point.

And yes, equity in a startup is mostly likely worth zero in the long run. I've received stock options at two different software startups, and will likely never see any value from them.

If you do take the job and receive shares or options, then be sure talk to an accountant or someone else with experience in this area when they are about to vest. Whether or when you choose to exercise your options can have very big tax consequences. Doing it wrong can cause you to owe taxes on "income" that never actually reaches your wallet.
posted by mbrubeck at 9:15 PM on June 30, 2011

The specifics of your question have been addressed well, but I want to add something more general about startups (which comprise most of my work history).

According to the partners, you be perpetually on the ground floor of tremendous success; and aren't you lucky to be along for the ride? It's going to make it big really soon, get bought out by a prestigious company that they're definitely not just name-dropping to stall you; just be patient, disable all your cognitive faculties, and act as though you stand to benefit the same way the shambling founders would. Sure, just because their personal sacrifices are in the service of their baby, and they'll reap the lion's share should they succeed, that's no reason for you to reject unpaid overtime.

It'll look great on your portfolio -- those projects that were like pulling teeth -- so don't worry about compensation, because it'll pay off down the road.

Just saying, use your judgement. Shares are but one gimmick used by companies without enough capital or profit for proportionate compensation. I'm not trying to rain on your stuff -- it might be a good company. But personal sacrifices, unless you truly understand why you're making them, will embitter you. That was my experience, anyway. Good luck.
posted by evil holiday magic at 10:14 PM on June 30, 2011 [1 favorite]

This blog post was infinitely helpful in figuring things out: http://venturefizz.com/blog/how-find-perfect-startup-job-part-iv-negotiating-startup-offer
posted by ejfox at 9:39 AM on August 2, 2011

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