When evaluating whether or not to join a company in a technical role—especially if that company is an early stage startup— Ernest Grumbles, a startup IP and business attorney at Adams Grumbles, LLP, recommends thinking of yourself as an investor.
“A lot of times [technologists] are a critical component of the company without which the company would make no forward progress,” he said. “They need to think of themselves as an investor. Their time is their check.” This includes evaluating any equity options in your compensation package.
Get All The Information
Before negotiating for equity, you’ll want to know the basics:
- If there’s an existing equity-based compensation setup
- What kind of plan it is
- What are the conditions under which equity will accrue
- When you can exercise equity
The answers to those questions will help you determine the actual value of the options. For example, phantom stock options have many limitations and restrictions that can be easy to miss for someone not well-versed in that particular option. “It sounds good to get the right to buy equity, but the value of it really depends on what conditions are imposed,” Grumbles said.
Smaller companies without mature equity programs may prove easier negotiation partners than those with standardized terms. Those without a “standard” equity plan document could choose to send you an agreement document, which is the company’s agreement on stock options with past employees. While companies aren’t compelled to show such a document to you, if they don’t have a list of standard options offered to all new employees, they may show you an agreement document instead.
Do Due Diligence
If you’re considering taking equity from a company as part of your compensation, make sure to look closely at the company and its finances. This is especially true for startups.
“Non-technical cofounders may or may not have an appreciation for how difficult the technical hurdles are going to be, and there’s a lot of optimism in startups,” Grumbles said. “Sometimes it’s based on reality and sometimes it’s not.” Looking closely at a company’s strengths and weaknesses, its founders’ backgrounds, its business plan projections, income forecast, and so forth will help you assess the risk and chance of success.
“If you’re getting paid half in stock and half in real money, and it turns out the company is on its last legs, then basically the equity is worthless,” Grumbles added. Sometimes companies pay in equity because they don’t have the cold, hard cash to pay talented people. Having a good understanding of what you’re getting into from a risk standpoint will help you determine when to avoid an equity component and ask for straight-up dollars instead.
One option with startups strapped for cash is a deferred compensation package. That way, if the company engages in fundraising, a preset amount of the proceeds will end up in the employee’s pocket. “They’re not getting the cash now and they may never get it, but if the company fundraises they’re protected and can at least get some back-pay for the work they did,” Grumbles explained.
During negotiations, some new employees can also convince companies to shorten the vesting period for stock. That means you may have to wait only a year or two, as opposed to three or five or even ten, for your stock options to become available to you.
Of course, you may be negotiating equity as a cofounder. The amount of equity you receive often depends on what role you play, whether or not you’re investing money in the company, and how many hours you work. If you’re coming in as a technical cofounder for a company with no revenue and no internal technical resources, you may ask for a larger percentage of equity.
Avoid Tax Pitfalls
An accountant can help you sort through the tax implications of various equity options, Grumbles suggested: “The company could grant them equity directly in such a way that the employee has to take the tax hit immediately.”
He added: “If you get 20,000 shares of a C-Corp, even at $1/share, you may have to pay taxes on $20,000 of income when all you got is stock in a company that may be pre-revenue and is not on a public market of any kind.” There are sometimes qualified stock options that are granted exclusively to employees that accrue income-tax benefits. An accountant can give you advice on which options are the best for you.
In addition to consulting with an accountant, locking down the services of an attorney can be tremendously useful. Though a company lawyer can provide factual explanations of the plan, your own attorney can look over paperwork and give you negotiating points, or even negotiate on your behalf.