How to Make Sense of Startup Equity Programs
Startup culture has an energy all its own. Many companies are known for their all-in, fast-paced culture, as founders and employees alike hustle to make the most of whatever capital they have. At a startup, the future can be a bit more precarious than working for a big public company, but the payoff can be worth it if the company ultimately finds success and is acquired or goes public.
So how do these new, growing companies keep employees motivated and on board, especially since most aren't in the position to offer cushy salaries and big bonuses? Enter startup equity programs, which offer employees an ownership stake in the company and are often part of an employee’s overall compensation package. Understanding the basics about how equity works (especially equity at a startup) can help you make more informed decisions when negotiating compensation with a current or potential employer.
What are startup equity programs?
Equity (and startup equity) programs are exactly what the name implies.
"[It] means everyone who receives an equity award has a stake in the value of the company, and if the value of the company goes up, presumably everybody's going to be happy because they're going to be wealthier," says Martin Staubus, executive director of the Beyster Institute at UC San Diego’s Rady School of Management.
There are a number of ways to deliver an equity interest; stock options are perhaps the most common. While interviewing with a startup, you may be offered equity in lieu of a bigger salary. Roughly 9 million U.S. employees were taking advantage of stock option ownership plans as of 2014, according to the Stanford Center for International Development. That represents almost a quarter of all employees in companies with stock.
Why do startups offer equity?
If you don’t understand how they work, offering stock options can have limited value. Since the structure of the offering plan varies from company to company, Staubus recommends that management teams devote energy to educating their employees, especially on basics such as how equity is being offered and how employees can eventually cash in. In order for startup equity programs to be successful, this information needs to be communicated clearly.
"What this is all about is getting everybody on the same team with shared goals," says Staubus. "The whole idea is you have this stake in the value of the company, so now we all have a reason to pull together and collectively make this thing successful because we'll all benefit from it."
In other words, if employees have skin in the game, they'll theoretically have more incentive to work harder and stay with the company longer.
How do employees cash in on equity?
Again, it depends on the equity-sharing structure of the individual company. The goal of most startups is to become successful enough to eventually get bought out by a bigger company or to go public. If that sale happens or the startup goes public, your equity represents your dip into that pot of gold.
"The company may be increasing in value, and investors are realizing what they're doing and noticing their potential, but that doesn't mean they have money in the bank to pay you out," says Staubus. "The payday comes whenever they go public."
Startup equity programs provide built-in motivation for employees to stick around and help make the company as successful as possible. After all, a payday for the company is a payday for them. In 2014, Facebook spent a staggering $19 billion acquiring WhatsApp! But most startups adopt some sort of vesting schedule to keep employees from leaving prematurely; a dangling carrot, so to speak.
"Most companies will have a vesting requirement saying whatever we give you is only given to you provisionally with the idea that if you leave, any unvested equity would essentially disappear," says Staubus. "The company can make whatever rules it wants, but typically it's what they call time-based vesting; the longer you stay, the bigger percentage of your award becomes really yours."
With a four-year vesting schedule, for example, you may get 25 percent more for every year of service. You're fully vested after four years. So what happens if you leave after, say, two years? The 50 percent that's unvested essentially vaporizes. As for the half that is vested, Staubus says the rules depend on the company. For instance, some may pay you for the value of what you have now, using some kind of conservative valuation system, while others require that you purchase your shares if you want to keep them. Again, it pays to get clear on the stipulations from the get-go.
Getting startup employees on the same page
What's really gained from startup equity sharing, from a management perspective, is establishing a culture where everyone has their eyes on the same prize.
"It makes the everyday experience of coming to work a different experience when you know what's going on, you've got teammates, and you're all keeping score off the same scoreboard," adds Staubus.
Keeping the lines of communication open and prioritizing equity education is what motivates employees to go all in with a shared vision and values system.