So you’ve received a job offer from an early-stage startup, and they’re offering you a 1% equity stake. As you read that number, you might think, “1% of Microsoft’s market cap is over $19 BILLION!” While that sounds exciting, it’s important to set realistic expectations. The odds of achieving that kind of return are incredibly low. In fact, you’d have better luck winning the lottery while being struck by lightning.

However, between nothing and $19 billion lies a sweet spot where you can still make meaningful money. How much or how little can vary significantly depending on how you negotiate your compensation. In this post, I’ll share insights on startup equity that might impact the ultimate value of your compensation package. Along the way, I’ll provide suggestions on things you can negotiate to increase your returns.

Equity Stakes and Dilution

When you join a startup, you’re often granted equity in the form of stock or stock options. Initially, you may be offered a significant percentage of the company. Especially if the company is in it’s early stages. However, as the company raises more funding and issues new shares, your ownership percentage can decrease—a process known as dilution.

Understanding Dilution

Dilution occurs when a company issues new shares, reducing the ownership percentage of existing shareholders. Think of it like slicing a pie: the pie might get bigger, but your original slice becomes proportionally smaller unless you get more pie.

A Real-World Scenario

Seed Stage

Let’s say you accept a CTO position at a seed-stage startup valued at $7 million, and your compensation includes a 7% equity stake. Here’s how the ownership might look at this stage:

At this point, your 7% stake is worth $490,000 on paper (7% of $7 million). Not bad for starters.

Series A Funding

Now, suppose the company raises $15 million in a Series A round at a $50 million post-money valuation (the value after the new investment). The Series A investor now owns 30% of the company, diluting existing shareholders accordingly. Your ownership percentage decreases:

Calculating Dilution:

New Ownership Percentage = Previous Ownership Percentage × (1 - Dilution Percentage)

Dilution Percentage = New Investor's Ownership Percentage

Your New Ownership = 7% × (1 - 30%) = 7% × 70% = 4.9%

Here’s the updated ownership table:

While your ownership percentage has decreased from 7% to 4.9%, the overall value of your equity has increased. Now, your stake is worth $2.45 million (4.9% of $50 million). This seems like a win—your slice of the pie is smaller, but the pie itself is much larger.

However, it’s essential to remember that these valuations are often on paper. They represent potential value, not realized cash. Until there’s an exit, such as an IPO or an acquisition, the increased valuation doesn’t translate into money in your pocket.

The Reality of Startup Exits

Statistics show that a significant number of startups either fail or never reach a substantial exit. According to CB Insights, approximately 67% of startups fail or don’t exit. Of those that do, only about a third exit for over $50 million.

This reality means that while your equity’s paper value might look impressive, the odds of realizing the full amount are relatively low. Therefore, it’s crucial to consider strategies that can help you maximize the potential value of your equity, even if the company doesn’t become the next tech unicorn.

Strategies to Mitigate Dilution

Understanding how dilution works enables you to take proactive steps to protect your ownership percentage.

Negotiating a Higher Initial Grant

One effective strategy is to negotiate a larger initial equity grant. By securing a higher percentage upfront, you cushion the impact of future dilution. When discussing this with the company, it’s helpful to:

• Use Industry Benchmarks: Research typical equity grants for your role and the company’s stage. This information strengthens your case.
• Highlight Future Dilution: Explain how expected funding rounds will dilute your ownership and how a higher grant now mitigates that effect.
• Demonstrate Your Value: Articulate how your skills and experience contribute to the company’s success, justifying a larger stake.

Securing Equity Refresh Grants

Another approach is to negotiate for regular equity refresh grants. These are additional equity awards provided over time to offset dilution and reward ongoing contributions.

To negotiate refresh grants:

• Discuss the Company’s Policy: Inquire if the company has an existing policy on equity refreshes.
• Propose Specific Terms: Suggest receiving additional grants at set intervals, such as annually or upon achieving certain milestones.
• Tie to Performance: Align the refresh grants with personal or company performance metrics to make the request more reasonable and mutually beneficial.

Navigating Vesting Schedules and Triggers

Perhaps you took my advice above and you managed to negotiate yourself the largest equity stake possible and you’ve mitigated the impacts of dilution with guaranteed refresh grants. The next question is how do you make sure you get to realize the full value of that equity if a liquidity event happens (e.g. the company is sold).

Understanding Vesting

When you’re granted equity, it’s typically subject to a vesting schedule. This means you earn your equity over time, incentivizing you to stay with the company.

A standard vesting schedule in startups is:

• 4-Year Vesting Period: You earn your equity over four years.
• 1-Year Cliff: No equity is vested until you’ve completed one year, at which point 25% vests.
• Monthly Vesting Thereafter: The remaining equity vests monthly over the next three years.

What this means is two years in you may only have 50% of the equity promised. And if the company sells? Sadly your unvested equity will likely go to 0. So now you see our second dilemma. Even if you negotiate more equity there is still a reasonable chance you will only walk away with half the value.

Strategies for Mitigating Loss of Unvested Shares

The obvious strategy for mitigating the loss of unvested shares would be to negotiate a faster vesting schedule. However, this structure protects the company by ensuring that employees don’t leave shortly after joining with a significant equity stake. So they’re unlikely to negotiate vesting schedules. Then how do you protect against losing your unvested equity? With triggers!

The Concept of Triggers

To protect against losing unvested equity, you can negotiate acceleration clauses in your vesting schedule. These clauses specify conditions under which your unvested shares vest immediately.

Single-Trigger Acceleration

A single-trigger acceleration means that your unvested shares vest immediately upon a change of control, such as the company being acquired.

• Advantages for You: You receive all your equity at once.
• Disadvantages for the Company: Acquirers may worry about employee retention if key staff suddenly own all their equity and have less incentive to stay.

Because of these concerns, single-trigger acceleration is rare and can be challenging to negotiate.

Double-Trigger Acceleration

A more common and company-friendly option is double-trigger acceleration. This requires two events to occur:

1. Change of Control: The company is acquired.
2. Termination Without Cause or Significant Role Change: You’re laid off, or your job responsibilities are substantially reduced.

With double-trigger acceleration, if the acquiring company decides not to retain you in your current capacity without cause, your unvested shares vest immediately. This protects you from being let go shortly after an acquisition without receiving the full value of your equity.

Something worth calling out is that many double trigger clauses are written in such a way that they may be worthless. Since termination will happen after the change of control it’s possible that the original equity was already canceled and hence there is nothing to accelerate. This can easily happen if your company is acquired by a private entity that doesn’t have an equity compensation program. To counter this you will want to negotiate specific language in your double trigger clause that calls for immediate acceleration at close if the shares will otherwise be canceled. You can read a more detailed post on the pitfalls of double trigger clauses here.

Negotiating Trigger Clauses

When negotiating acceleration clauses:

• Express Your Concerns: Explain that you seek protection for your unvested equity in the event of changes beyond your control.
• Be Open to Solutions: If the company resists single-trigger acceleration, focus on negotiating a robust double-trigger clause.
• Clarify the Language: Ensure the clause specifies that if your unvested shares would otherwise be canceled upon a sale, they vest immediately. Ambiguous wording can render the protection ineffective.

It’s advisable to consult with a legal professional to review the clause and confirm that it fully protects your interests.

Deciphering 409A Valuations, Option Strike Prices, and Equity Value

If you’ve made it this far you’ve already negotiated the largest share of the pie possible and you’ve protected yourself from losing any equity. But there is one last thing to consider! What is the actual dollar value of your equity and how do you maximize it.

If your stock grant comes in the form of Restricted Stock Units (RSUs), calculating your equity value is easy (just multiply the number of shares by last preferred price). And when it comes to RSUs there really isn’t much you can do to maximize the value beyond asking for more shares. However if your grant came in the form of Incentive Stock Options (ISOs) there are several important considerations that might impact the final dollar value of your equity.

Understanding 409A Valuations

A 409A valuation is an independent assessment of a private company’s fair market value (FMV). It determines the strike price for stock options granted to employees. The strike price is the price at which you can purchase your options and is set based on the company’s FMV at the time of the grant.

This valuation is separate from the preferred price, which is what investors pay during funding rounds. Typically, the preferred price is higher because investor valuations are based on future potential and investors often receive additional rights and preferences.

The Significance of the Strike Price

The potential financial benefit from your stock options depends on the difference or spread between the company’s preferred price and your strike price.

Calculating Potential Equity Value:

Equity Value = (Preferred Price - Strike Price) × Number of Options

A lower strike price increases the potential gain from your options. Therefore, understanding and potentially influencing the timing of your option grant can have significant financial implications.

Maximizing Your Equity Value

To ensure you’re getting the most value from your equity:

Ask the Right Questions

When discussing your offer:

• Current 409A Valuation: Find out when the last valuation was done and what the current FMV is.
• Timing of the Next Valuation: If a new 409A valuation is imminent, the strike price could increase.
• Preferred Share Price: Understand what investors are paying and how that compares to your strike price.
• Expected Changes: Inquire about any expected events that might significantly change the company’s valuation.

Negotiate Timing

If a new valuation is upcoming and expected to raise the strike price, you might negotiate to have your options granted before the new valuation takes effect. And if that is not possible you may want to ask for additional shares.

Consider Tax Implications

There are numerous tax implications when it comes to equity offers. While I’d like to offer advice on minimizing any future taxes, I am not an accountant. Equity compensation can have complex tax consequences. Consulting with a tax professional can help you make informed decisions and potentially save money in the long run.

Final Thoughts on Negotiating Your Startup Equity

Negotiating your compensation package is a critical step that can significantly impact your financial future. Here are some approaches to help you navigate the process effectively.

Prepare Thoroughly

Before entering negotiations:

• Research Industry Standards: Know typical equity grants and compensation packages for your role and the company’s stage.
• Assess Your Needs: Determine your priorities, such as equity percentage, vesting terms, salary, and other benefits.
• Evaluate the Company’s Potential: Understand the company’s business model, market position, and growth prospects.

Communicate Your Value

Articulate how your skills, experience, and vision align with the company’s goals. Provide examples of how you can contribute to critical areas, such as technology development, strategic planning, or operational efficiency.

Be Collaborative

Approach negotiations as a partnership rather than a confrontation. Express enthusiasm for the company’s mission and a desire to find a mutually beneficial agreement.

Address Potential Objections

Anticipate concerns the company might have, such as budget constraints or equity pool limitations. Be prepared to discuss creative solutions, like:

• Performance-Based Grants: Propose additional equity contingent on achieving specific milestones.
• Flexible Compensation Mix: Adjust the balance between salary and equity to align with both parties’ preferences.

Questions to Discuss with Potential Employers

Open dialogue about key aspects can lead to a clearer understanding and a better agreement.

Equity Structure

• Total Shares Outstanding: Knowing the total number of shares helps you assess your ownership percentage accurately.
• Option Pool Details: Understanding how the company manages its equity compensation pool can provide insights into future dilution.

Vesting and Acceleration

• Vesting Schedule Specifics: Clarify any nuances in the vesting terms.
• Post-Exit Treatment of Unvested Shares: Confirm what happens to unvested shares in various scenarios.

Company Outlook

• Funding Plans: Discuss anticipated funding rounds and how they might affect dilution.
• Exit Strategy: Understand the company’s goals regarding IPOs, acquisitions, or staying private.

Conclusion

Negotiating startup equity requires a blend of knowledge, strategy, and confidence. By understanding the mechanics of equity, dilution, vesting, and valuation, you empower yourself to make informed decisions.

Remember, it’s not just about securing the highest numbers. It’s about aligning your compensation with your contributions and the company’s potential, while also protecting your interests in various outcomes.

Employers who recognize your value will respect your diligence and willingness to engage in thoughtful negotiation. If they don’t, it might be a sign to reevaluate whether the opportunity aligns with your career aspirations.

1. For more information on modeling ownership and dilution read “How to model ownership & dilution, and how pro rata works in venture capital deals” and and leverage the free calculator ↩︎