By Andy Rachleff
Nothing positively impacts your financial lifestyle more than owning equity in a successful company. Unfortunately, most people really don’t know how to evaluate the equity portion of their job offer, which is why Wealthfront recently published our Guide to Equity and IPOs. Anyone in the U.S. can use our guide as a resource to help them at each phase of owning equity; here, we’ve pulled out the top 10 questions you should ask about the equity in your offer.
Far too many employees fall into the trap of solely focusing on the number of options they were offered, but as you’ll see from this article, what really matters is the percentage of the company the options represent, what the company could be worth, how long the options take to vest, and when you have to exercise them.
- What percentage of the company do the options offered represent?
This is the single most important question. When it comes to options, a larger number may seem better than a smaller number, but percentage ownership is what really matters.
For example, if Company A offers 100,000 options out of 100 million shares outstanding and Company B offers 10,000 options out of 1 million shares outstanding, then the second offer is 10 times as attractive. That’s right — the smaller share offer in this case is much more attractive, because if Company B is acquired or goes public then you will be worth 10 times as much ( your 1% share of the company in that latter offer trumps the 0.1% of the former).
- Are you including all shares in the total shares outstanding for the purpose of calculating the percentage above?
Some companies attempt to make their offers look more attractive by calculating the ownership percentage your offer represents using a smaller share count than what they could. To make the percentage seem bigger, the company may not include everything it should in the denominator. You’ll want to make sure the company uses fully diluted shares outstanding to calculate the percentage, including all of the following:
- Common stock/Restricted stock units
- Preferred stock
- Options outstanding
- Unissued shares remaining in the options pool
It’s a huge red flag if a prospective employer won’t disclose their number of shares outstanding once you’ve reached the offer stage. It’s usually a signal they have something they’re trying to hide, which I doubt is the kind of company you want to work for.
- How much could the company be worth?
Not all companies have the same potential upside. It’s important to ask your potential employer what they think they could be worth in four years (the length of your likely vesting). It’s more important for you to evaluate their logic than the actual number. Generally speaking people make more money on their options from increasing company value than they do from securing a larger share grant offer.
- How does my proposed option grant compare to the market?
A company typically has a policy that sizes its option grants relative to market averages. Some companies pay higher salaries than market so they can offer less equity. Some do the opposite. Some give you a choice. All things being equal, the more successful the company, the lower percentile offer they are usually willing to offer.
For example, a company like Uber is likely to offer equity below the 50th percentile because the certainty of the reward and the likely magnitude of the outcome is so great in terms of absolute dollars. Just because you think you’re an excellent candidate doesn’t mean your prospective employer is going to make an offer in the 75th percentile. Percentile is most determined by the employer’s attractiveness (i.e. likely success). You’ll want to know what your prospective employer’s policy is in order to evaluate your offer within the proper context.
- 5. What is the vesting schedule?
The typical vesting schedule is over four years with a one-year cliff. If you were to leave before the cliff, you get nothing. Following the cliff, you immediately vest 25% of your shares and then your options vest monthly. Anything other than this is odd and should cause you to question the company further. Some companies might request five-year vesting, but that should give you pause.
- When do I have to exercise my options?
The vast majority of companies require that you exercise your options within 90 days of your departure from the company. This can create quite a challenge if your potential employer is more than a few years old and successful, because the amount of shares you will have vested times your options’ exercise price per share will likely represent a significant amount of money, and you may not have a market into which you can sell for at least a few years. Some more forward thinking companies are starting to either base the required exercise period on the length of your tenure or even eliminate the requirement completely, which is a huge benefit.
Most companies allow employees to exercise their options before they have vested, which can be a tax benefit to employees by giving them the opportunity to have their gains taxed at long-term capital gains rates.