As startups gear up for a big stock market splash, it may potentially result in a big payday for some of their employees.1,2 How do you negotiate equity compensation so that you may one day end up in a similar position?
Many people think that equity compensation is automatically equal to a windfall but the truth is this is usually not the case for the majority of us.
Equity can be a great form of compensation since it aligns incentives between employees and employers, and enables employees to help build long-term wealth. However, while equity compensation may provide significant upsides, beware: It can create complications relative to cash compensation. That’s why it is so important to understand what kind of equity you are being offered — and how much to see how it impacts your overall net worth and future financial plans.
Here are some questions to ask a potential employer when negotiating equity compensation:
Who is offered equity compensation?
First, let’s get some misconceptions out of the way.
Oftentimes, people think that they only need to aggressively negotiate equity compensation in a startup environment.
However, equity compensation is applicable in both the startup and corporate worlds. But the scenarios are not all equal, and not all recipients find themselves on a path to riches, contrary to popular perception. The extent to which you will benefit from an equity compensation package depends not only upon the performance of the stock, but also on how well you can manage key decisions relating to your equity.
In particular, understanding the type of equity you have and the associated tax implications is critical to your success — as is understanding the risk of investing in an individual stock versus a diversified portfolio.
The first step to making sense of your equity compensation package and its impact on your overall financial picture is asking clarifying questions about the offer before you accept the package. It’s important to fully understand what you are being offered and how it will affect you before you sign on the dotted line.
How to negotiate equity compensation
Consider asking these questions when speaking to your employer.
What type of compensation are you offering?
Each type of equity compensation comes with its own restrictions and tax ramifications — all of which impact what it could ultimately be worth to you. Make sure the type of compensation you’re receiving is clearly expressed.
What is the current valuation of the company?
It’s worth noting that private companies may not be able to give you a straightforward answer on their valuation, but they can at least give a good starting point. If you feel like they are being cagey in their answer, then you may want to view that as a potential red flag.
How many outstanding shares are there?
This number directly impacts the value of your equity. After all, an offer of 1,000 shares might sound good on paper — but if there are 3 million shares, then that doesn’t necessarily equal huge value to you.
Can you walk me through my stock documents?
When considering a new position, you should always feel comfortable asking the hiring manager or the recruitment team any outstanding questions you may have. One of the best resources to gauge the ultimate worth of what you’re being offered are the people offering it. It’s perfectly acceptable to ask for a member of the company to walk you through the details.
When it comes to employee equity compensation, you’re oftentimes putting yourself into a speculative position.
Sure, you have the chance of potentially coming into a big windfall, but keep in mind that you’re also placing a bet that the employer who signs your paycheck is going to be successful.
That’s why it’s important to understand what awards you are being offered, what the vesting schedule is in your situation, and what tax consequences you might have so you aren’t unnecessarily overpaying, while also managing concentration risk within your overall allocation. Also, you should understand that while taxes are an important aspect to consider, they should not be the underlying reason a diversification strategy isn’t implemented.
If you want extra clarity, talking to a professional may be worth it. The more information you are armed with, the more you are prepared to understand what your ultimate compensation is — and the better prepared you are to start planning and achieving your long-term financial goals.