The rest of your friendship group is seeking stable jobs in large companies with soft salaries and benefits. Meanwhile, you are considering joining a startup with no proven product or clear path to profitability. It could collapse in a year or two if things don’t go well, and resources are very scarce to pay as well as big companies.
This is where equity comes in – a way to motivate employees of startup companies, by giving workers a direct stake in the company’s success. In this article, we’ll explain what it means to acquire equity in an early stage startup, how much you should expect and some of the potential risks employees should look out for.
What is equity in business?
Owning stock in a company means that you own a small portion of that company. They are usually offered in the form of stock options (we’ll break that term down later), and while they may not be of much value when given to you, if the company is doing well, you could get a significant payout.
Staff in the range like Klarna And the Revolution They saw the value of their shares jump into millions of euros as employer valuations rose. These employees are known as “paper millionaires” because while their stock options can be worth a million euros or more, they are not able to cash them out easily – because the companies are still privately owned.
Employees are usually able to cash out their shares in two ways:
- When a company is bought by another company (acquisition);
- Through a public listing (where a company lists shares and sells them on a public stock exchange).
These are known as “exit” or “liquidity events” and they represent the moment when a startup’s employees are rewarded for their hard work, and for taking the risk of joining a startup. Even if you own a fraction of a percentage of the business in equity, it could mean a seven-figure payout if you join the right company in its early stages.
How do startup equity work?
When the founder or founders of a startup start planning how to divide up their company’s ownership, there are three main groups they need to consider: founders, employees, and investors.
“The founders may have 30% of the company, and then they have some investors who are often fellow gamblers,” says David Rubin, director of London-based law firm Postlethwaite Partners. “And then you have a so-called ’employee pool’ and that will be a number of shares that are primarily allocated to employees.”
Rubin says it’s typical for employee stock option pools to represent 10 to 15% of a company’s total equity available — although in some cases it can be as high as 20%.
Data from SeedLegals, a UK platform for pre-founders and investors, shows that the vast majority of UK startups hold between 10 and 11% of equity for their group of employees.
What equity ratio should you expect?
The amount of capital you will have as an employee of an early stage startup company will depend on how advanced you are when you join.
Hugo Fedez. Mardomingo, co-managing partner at Bilbao-based All Iron Ventures, is laying out what he sees as a standard offering for startup employees.
“Let’s say 1% is for C Suite non-founders roles, and 0.5% is for Senior Vice President roles, and then it’s up to the candidate’s profile and experience,” he says.
Fortunately for today’s employees, there is a wealth of benchmark data available to show how much equity you should expect from an early stage startup. One of these comes from London-based Index Ventures, which published Stock Calculator This shows what founders have to offer.
This was the go-to tool she used to put together her company’s options personalization package when she joined the company, says Erin Nixon, vice president of strategy at workplace mental health firm Oliva.
“There are a lot of good standards out there, so I don’t think it’s something founders or employees need to figure out for themselves,” she says. “When I came and said, ‘Okay, let’s sort this out,'” [the Index Ventures calculator] It’s what I used to check out what we already had, and there are a few other things you can also use to tap and triangulate.”
The index calculator determines the different stock expectations that corporate employees should have at the initial stage, as a percentage of salary, seniority and job role type (technical employees usually receive more shares).
To help expand the database, SeedLegals combined data from Index and Balderton, another London-based venture capital firm, to show typical percentages of equity that employees can expect from early-stage startups (those with up to 50 employees).
Typical equity ratios that employees can expect
- Sea Sweet – 0.8%-2.5%
- Cum – 0.3%-2%
- Managers – 0.5% -1%
- Managers – 0.2% -0.7%
- Other employees – 0.0% -0.2%
Rubin adds that early-stage startup employees should be prepared to dilute the equity in their stock options as the company continues to raise more money in subsequent VC rounds. This basically means that you own less of the company because more shares have been made available to new investors – but the value of that stake increases along with the valuation of the startup.
Suppose an employee owns 1% of the company, then there is an investment that brings money into the company. But it also means that instead of owning, let’s say, 1 million shares in the issue, there will be 1.5 million,” he explains. “The 1% owner now has 0.6%, but it’s a bigger pie. As long as this investment comes at a higher valuation, the value of employee equity will increase.”
Questions to ask before accepting a job offer
Job offers will not always contain all the information about the stock deal you will get when you join. Sometimes they will only share the value of the stock options offered, without mentioning the percentage of the value of the company they represent.
Yoko Spirig is the founder and CEO of Ledgy, a stock management platform for startups, and says employees should demand transparency from potential employers.
“As an employee, I would really encourage you to ask ‘what share of the company is that going to be? “What is it worth today, based on the assessment that came from the last fundraising round?”
A startup isn’t likely to make many appointments before the angel round or pre-roll round, but employees coming into the pre-assessment stage still have to ask what percentage of the company their stock offering represents, and check that it aligns with the criteria Industry.
And while more senior employees will naturally receive more shares than their younger counterparts, Mardminio says less experienced employees should push for increased performance and a promotion-related stock upgrade.
“For less experienced candidates, it will be difficult to get a lot of shares up front. The main thing is to ask how this will be re-evaluated in the medium to long term.
The other main question employees should ask, according to Robin, is whether stock options are tax-enhancing. This article From Stock Based Comp a useful breakdown of the tax requirements for stock options in different European countries.
Basic terms you need to know
When it comes to fully understanding your employment contract and what stock-based compensation actually looks like in practice, there’s a whole host of terms and conditions you need to know.
- the difference between Involved And the stock options. to have Involved In a business, that means you actually own a percentage of the value of that business. stock options It differs from stock in that it does not actually mean that the company is giving away a share of the company now. Employee stock options granted Selection To buy those shares at a fixed price (known in “strike price”) later down the line. If all goes well with the startup, the value of your stock options will increase significantly from the strike price by the time you can convert them into real shares.
- The process of converting stock options into shares is called Exercise your options. To exercise their options, the employee would have to purchase them from the company at the strike price.
- The next term to know is “merit”, which refers to the process of earning an employee to view his stock gradually, as he spends more time in the company. The startup won’t give you 1% of your capital on the day you join – you’ll receive a portion of it every month, usually over four years, which is known as a “maturity schedule”/
- The next term to know is “cliff” – This refers to the minimum period of time an employee must work in the company to gain any equity at all. The standard shelf for European startups is one year.
Startup Equity: What Can Go Wrong?
Spirig says there is one area of stock option employees should be aware of, which can leave them with few options to convert their stock into cash.
“I was [recently] Chat with an employee of a well-known European scale. The person has received stock options but is now considering leaving. But the company only offers three months for the employee to actually exercise his stock options. And now the employee is in a situation where he actually needs to pay about 100,000 euros to buy it.”
This time period is called the “exercise window,” which indicates the amount of time you must exercise your options after leaving the company. In the example provided by Spirig, an employee is forced to pay for their equity very quickly, possibly years before they receive anything in a liquidity event.
Spirig says startups should really give a minimum five-year internship, to allow employees the best chance of getting value from their stock options.
Another potential pitfall that early-stage startup employees need to look for is something called “repurchase rights,” which allow companies to buy back shares from employees without them even saying it.
“Sometimes there are cases where companies have the right to buy back shares, and that’s not good at all,” Spirig says. “I would really like to pay attention to these buy-back rights as an employee and would like to understand: What is the thinking behind these types of clauses?”
Why understand the importance of employee rights
As the startup sector in Europe matures, stock options standards and benchmarks are now being set. But Oliva’s Nixon — who started her career in Silicon Valley — says European tech workers tend to be less aware of the importance of their stock package than those in the United States.
“My understanding is that a lot of people, especially if they’re younger, don’t even ask questions about it in Europe,” she says. “I would highly advise people to get their standards on because that, like I said, is the best way to really be a part of the massive value creation of these fast-moving startups.”
Spirig agrees that staff literacy in Europe is rather low, but says the task is made more difficult by the fact that standards are less well established than in the United States.
“These kinds of policies are not yet standardized in the European ecosystem, for example, in the United States, where these kinds of things are more standardized,” she says.
For Nixon, it’s hard to overstate the importance of offering a good stock options package to employees: “For us, it’s about saying, ‘You matter so much to us, you build so much value with this company, we want you to have every option to set up a life-changing financial event with us’.” .
Tim Smith is Sifted’s reporter in Iberia. Tweet from Tweet embed