Understanding Equity Compensation
In Part 1 of our series on compensation, we offered guidance on how to ask for a raise, with a focus on cash compensation. Of course, equity is a piece of the puzzle for many folks as well.
Unlike cash compensation, however, equity compensation can feel complicated and difficult to understand. We hope to demystify equity for you in this second part of our three-part series on compensation.
Specifically, we will help you answer the question, "How many shares should I be asking for in compensation discussions?"
Unfortunately, there is not a magic, one-size-fits-all formula to answer this question, but we have pulled together some resources to give you a good idea and foundation for your negotiations.
Triangulate + Frame
Before we get started, a few key things to keep in mind. Just like with cash compensation, it’s important to triangulate. The methods we present below will provide one data point in terms of what equity you should be asking for. It will be a good data point, but you should gather a few others if you can, by asking friends, recruiters or seeing what other companies are paying.
Also take care to frame this correctly. A lot of folks talk about equity in terms of a percentage ownership of the company. The problem with that is, each company has a different amount of outstanding shares – one might have 40 million shares, one might have 60 million. And having more shares doesn’t mean that each of them is worth less or vice versa. We always want to think about equity in terms of dollars because that’s the common denominator – it will allow us to compare apples to apples.
Be Prepared With Preferred Price, Strike Price and Multiplier
Employees can be offered equity compensation in the form of stock options or restricted stock units (RSUs), but for the sake of this article, we’ll speak mainly to stock options, which give employees the right to purchase company stock at a specific price known as the strike price.
Before you can get started on determining what to ask for in terms of equity compensation, you’ll need to track down that strike price as well as your company’s preferred stock price. (This assumes you work at a private company. With public companies, generally, all stock typically converts to common, and pricing information is readily available on Google Finance.) You’ll also want to land on a multiplier to use.
The preferred price is the last price investors paid for a share of a company. Preferred shares differ from what employees typically get in that they carry certain protections for investors. For example, investors might want to have approval over a budget, or they might want to get their money back before anyone at the company profits off their shares. Investors pay a preferred price to get those protections, meanwhile employees typically get common shares.
Most private companies don’t disclose the preferred price, so you’ll need to get it from the company or find out another way. Normally we just look back and ask, what was the last arm’s length transaction that happened? If investors have invested, it’s typically preferred stock. So, in most cases, you’re going to use the price that was paid in the last round of financing. Or, if you have the last valuation of the company and how many shares are outstanding, you can divide the valuation by shares and get preferred price that way.
The next piece of information you need is the strike price for common shares (what employees typically get). The strike price is what you have to pay to get your shares – it’s usually a fraction of the preferred price, but you do need to pay, so it needs to be factored in. (Keep in mind, if you’ve had multiple grants, you’re going to have multiple strike prices.)
Typically you don’t have to pay for your shares while you’re still at your company and vesting, but when you leave, there’s usually a deadline by which you need to exercise the option. There are certain exceptions where doing an early exercise is beneficial from a tax perspective, but we’ll get to that in Part 3. For this purpose we’re assuming you’ve got options for common shares and you’ve got a strike price. You need to know what that strike price is to figure out how many shares you should be getting.
Strike price is easier to find than preferred price. If your company uses an equity management software to distribute e-shares (Carta, for example), that will tell you the strike price. If your company doesn’t use software for this purpose, you can simply ask your manager or someone in the finance function of your company.
You’ll also need to settle on a number to use for your multiplier, that is, how much of your annual compensation should be awarded in equity based on your role and position in the company. Think about multipliers as percentages. If you’re a senior team member, and your multiplier is 0.5x, then 50% of your annual comp should be awarded in equity.
So, how do you figure out your multiplier? That can get tricky. Multipliers are not set in stone – far from it. There are general frameworks out there (and we have shared some with you below), but multipliers can change quickly, and they will also vary based on factors such as industry and market. For example, San Francisco and NYC will be expensive from a company standpoint but are good places for employee equity. If you’re in, say, Austin or overseas, equity might make up a smaller percentage of your overall compensation, and that is normal.
Resources and Methods
Managing partner of Union Square Ventures Fred Wilson offers a methodology to size employee equity grants. Use this article for the method, not the multipliers. Wilson himself offers the caveat that his multipliers are far out of date since original publication, but the process by which he uses them holds up.
Wilson also points to this framework by Skillshare CEO Matt Cooper. This article will be great for a step-by-step walkthrough and updated multipliers. Remember, not everyone is going to cleanly fit into these categories of multipliers (and if you’re not in SF or New York, the numbers should be lower), so use the most conservative estimate, and triangulate.
- Multiplier: Let’s say you are an individual contributor, and your multiplier is 0.25x.
- Salary: You’re making $100,000 in salary. That means you should be getting about $25,000 worth of stock-based compensation.
- Preferred Price: You’ve done your homework and identified the company’s preferred share price. Let’s assume it’s $1.10.
- Strike Price: You’ve identified the strike price to be $0.10.
- The Math: You’re going to be paying the company to exercise those options, so you need to deduct that from the total value. Subtract that strike price from the preferred price. $1.10 - $0.10 = $1.00 per share.
- We just said you should be getting $25,000 worth of stock-based compensation, so divide that number by the price per share. $25,000 / 1 = 25,000 shares.
And of course, this is not set in stone. It’s merely a good starting place to figure out if you’re in the right place, in the ballpark at all.
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Read Part 3 in our compensation series on exercising stock options.
Highrise coaching can help you understand compensation and tackle negotiations with your company. Schedule a time to learn more here.