Joining an Early Stage Startup? Negotiate Your Startup Equity and Salary with Stock Option Counsel Tips
Startup equity negotiation tips for early stage founders, executives, employees, consultants and advisors.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Startup Equity @ Early Stage Startups
"Hey baby, what's your employee number?" A low employee number at a famous startup is a sign of great riches. But you can't start today and be Employee #1 at OpenAI, Discord, or one of the other most valuable startups on Earth. Instead you'll have to join an early-stage startup, negotiate a great equity package and hope for the company’s success. This post walks through the negotiation issues in joining a pre-Series A / seed-funded / very-early-stage startup.
Q: Isn't startup equity a sure thing? They have funding!
No. Raising small amounts from seed stage investors or friends and family is not the same sign of success and value as a multi-million dollar Series A funding by venture capitalists.
Carta’s data team published an update in December of 2023 showing the “graduation rates” from Series Seed to Series A within 2 years. They affirm that it’s not a sure thing to graduate from Series Seed to Series A and, therefore, even have the chance to make it all the way to a successful acquisition or IPO. In hot years of 2021-2022, the graduation rate hovered around 30% across all industries. In 2023, it ranged from:
23% for FinTech
20% for HealthTech
19% for Consumer
17% for SaaS
16% for Biotech
Here's an illustration from Dustin Moskovitz's presentation, Why to Start a Startup from Y Combinator's Startup School on the chances so "making it" for a startup that has already raised seed funding. These 2nd Round “graduation” numbers are higher than Carta’s numbers, as this data was from 2017 (a hot hot time for startup funding).
What are the chances of a seed-funded startup becoming a "unicorn" (here, defined as having 6 rounds of funding rather than the classic “unicorn” definition of a $1 billion valuation).
Q: How do you negotiate equity for a startup? How many shares of startup equity should I get?
Don't think in terms of number of shares or the valuation of shares when you join an early-stage startup. Think of yourself as a late-stage founder and negotiate for a specific percentage ownership in the company. You should base this percentage on your anticipated contribution to the company's growth in value.
Early-stage companies expect to dramatically increase in value between founding and Series A. For example, a common pre-money valuation at a VC financing is $8 million. And no company can become an $8 million company without a great team.
Imagine, for instance, that the company tries to sell you on the offer by insisting that they will someday be worth $1B and, therefore, your equity worth, say, $1M. The obvious question would be: Does it feel fair to you to make a significant contribution to the creation of $1B in value in exchange for $1M? For most people, the answer would be “no.”
Or, consider that the company is insisting that an offer of 1% is “worth” $1M because the company expects to raise a Series A - based in part on your efforts - at a $100M pre-money valuation. Leaving aside the wisdom (or lack thereof) of evaluating the offer based on its future value, you would want to ask yourself: Does it feel fair to you to make a significant contribution to the creation of $100M in value in exchange for $1M in equity (which would presumably be only partially vested as of the Series A)?
That would depend, of course, on how significant your contribution would be. And it would depend on the salary component of the offer. If the cash compensation is already close to market level, that might seem more than fair. If the cash offer is a fraction of your opportunity cost, you would be investing that opportunity cost to earn the equity. The potential upside would need to be great enough to balance the risk of that investment.
Q: Is 1% equity in a startup good?
The classic 1% for the first employee may make sense for a key employee joining after a Series A financing, but do not make the mistake of thinking that an early-stage employee is the same as a post-Series A employee.
First, your ownership percentage will be significantly diluted at the Series A financing. When the Series A VC buys approximately 20% of the company, you will own approximately 20% less of the company.
Second, there is a huge risk that the company will never raise a VC financing or survive past the seed stage. According to CB Insights, about 39.4% of companies with legitimate seed funding go on to raise follow-on financing. And the number is far lower for seed deals in which big name VCs are not participating.
Don't be fooled by promises that the company is "raising money" or "about to close a financing." Founders are notoriously delusional about these matters. If they haven't closed the deal and put millions of dollars in the bank, the risk is high that the company will run out of money and no longer be able to pay you a salary. Since your risk is higher than a post-Series A employee, your equity percentage should be higher as well.
Q: What is typical equity for startup? How should I think about market data for startup equity?
Data sets on employee and executive offer percentages for early stage startups can be misleading and encourage companies to make unrealistically low offers to early hires. There’s two reasons for this. First, these data sets are for employees who are earning something like market level salaries along with equity. Second, these data sets exclude anyone classified as a “founder” from the data set for employees. They keep different data sets for founders! So the gray area between the two classifications makes the use of data tricky. Who is a founder for purposes of the data set? Depends on the data set. Carta, for instance, excludes anyone with 5% or more from the employee/executive data set and classifies them as founders! Even if they are earning market-level cash from their start date.
Here’s the bottom line:
If you are joining before you are being paid startup-phase-market-level cash salary, you are a late stage founder. You should evaluate your equity percentage relative to the other founders within the company or within the market data set.
If you are joining for a combination of cash and equity at an early stage startup, the offer should make sense to you. Simply pointing to market data for the right % ownership is not enough. You’ll want to consider the market data for % ownership in conjunction with the dollar value of the equity based on how investors have most recently valued the company.
Q: How should early-stage startups calculate my percentage ownership?
You'll be negotiating your equity as a percentage of the company's "Fully Diluted Capital." Fully Diluted Capital = the number of shares issued to founders ("Founder Stock") + the number of shares reserved for employees ("Employee Pool") + the number of shares issued to other investors (“preferred shares”). There may also be warrants outstanding, which should also be included. Your Number of Shares / Fully Diluted Capital = Your Percentage Ownership.
Careful, though, because most startups do not issue preferred stock when they take their seed investment funds from their seed investors. Instead, they issue convertible notes or SAFEs. These convert into shares of preferred stock in the next round of funding. So if you negotiate for 1% of a seed stage startup funded with notes or SAFEs, the fully diluted capital number used as the denominator of that calculation does not include the shares to be issued for those seed funds.
How can you address this? First, make sure you know what’s included. You can ask:
How many shares are outstanding on a fully diluted basis? Does this include the full option pool? Are there any shares yet to be issued for investments in the company, such as on SAFEs or convertible notes? How many shares do you expect to issue upon their conversion?
If you are comparing your offer to other seed stage offers or to market data for seed stage offers, you would want to take that into consideration. The number the company provides is only an estimate, of course, but it’s a way to address this in your evaluation.
“Fully Diluted Capital” includes only issued shares and reserved shares. For an early stage startup, that would include founders shares, the option pool, and any preferred shares issued to investors in a priced round. It will not include shares to be issued upon conversion of SAFEs and convertible notes. Therefore, you will want to include some estimate for the conversion of those investments when you are understanding the percentage ownership in an early stage startup offer.
Q: Is there anything tricky I should look out for in my startup equity documents?
Yes. Look for repurchase rights for vested shares.
If so, you may forfeit your vested shares if you leave the company for any reason prior to an acquisition or IPO. In other words, you have infinite vesting as you don't really own the shares even after they vest. This can be called "vested share repurchase rights," "clawbacks” or "non-competition restrictions on equity.”
Most employees who will be subject to this don't know about it until they are leaving the company (either willingly or after being fired) or waiting to get paid out in a merger that is never going to pay them out. That means they have been working to earn equity that does not have the value they think it does while they could have been working somewhere else for real equity.
According to equity expert Bruce Brumberg, "You must read your whole grant agreement and understand all of its terms, even if you have little ability to negotiate changes. In addition, do not ignore new grant agreements on the assumption that these are always going to be the same." When you are exchanging some form of cash compensation or making some other investment such as time for the equity, it makes sense to have an attorney review the documents before committing to the investment.
Q: What is fair for vesting of startup equity?
The standard vesting is monthly vesting over four years with a one year cliff. This means that you earn 1/4 of the shares after one year and 1/48 of the shares every month thereafter. But vesting should make sense. If your role at the company is not expected to extend for four years, consider negotiating for a vesting schedule that matches that expectation.
Q: Should I agree to milestone or performance metrics for my vesting schedule for startup equity?
No. This is a double risk. Not only is there a high risk that the company will not be successful (and the equity worthless), there is a high risk that the milestones will not be met. This is very often outside the control of the employee or even the founders. More on this issue here. The standard is four-year vesting with a one-year cliff. Anything else is off-market and is a sign that the founders are trying to be too creative and reinvent the wheel.
Q: Should I have protection for my unvested shares of startup equity in the event of an acquisition?
Yes. When you negotiate for an equity package in anticipation of a valuable exit, you would hope that you would have the opportunity to earn the full number of shares in the offer so long as you are willing to stay through the vesting schedule.
If you do not have protection for your unvested shares in the stock documents, unvested shares may be cancelled at the time of an acquisition. I call this a “Cancellation Plan.”
Executives and key hires negotiate for “double trigger acceleration upon change of control.” This protects the right to earn the full block of shares, as the shares would immediately become vested if both of the following are met: (1st trigger) an acquisition occurs before the award is fully vested; and (2nd trigger) the employee is terminated after closing before they are fully vested.
There’s plenty of variation in the fine print of double trigger clauses, though. Learn more here.
Q: The company says they will decide the exercise price of my stock options. Can I negotiate that?
A well-advised company will set the exercise price at the fair market value ("FMV") on the date the board grants the options to you. This price is not negotiable, but to protect your interests you want to be sure that they grant you the options ASAP.
Let the company know that this is important to you and follow up on it after you start. If they delay granting you the options until after a financing or other important event, the FMV and the exercise price will go up. This would reduce the value of your stock options.
Early-stage startups very commonly delay making grants. They shrug this off as due to "bandwidth" or other nonsense. But it is really just carelessness about giving their employees what they have been promised.
The timing and, therefore, price of grants does not matter much if the company is a failure. But if the company has great success within its first years, it is a huge problem for individual employees. I have seen individuals stuck with exercise prices in the hundreds of thousands of dollars when they were promised exercise prices in the hundreds of dollars.
Q: What salary can I negotiate as an early-stage employee?
When you join an early-stage startup, you may have to accept a below market salary. But a startup is not a non-profit. You should be up to market salary as soon as the company raises real money. And you should be rewarded for any loss of salary (and the risk that you will be earning $0 salary in a few months if the company does not raise money) in a significant equity award when you join the company.
When you join the company, you may want to come to agreement on your market rate and agree that you will receive a raise to that amount at the time of the financing.
I sometimes see people ask at hire to receive a bonus at the time of the financing to make up for working at below-market rates in the early stages. This is a gamble, of course, because only a small percent of seed-stage startups would ever make it to Series A and be able to pay that bonus. Therefore, it makes far more sense to negotiate for a substantial equity offer instead.
Q: What form of startup equity should I receive? What are the tax consequences of the form?
[Please do not rely on these as tax advice to your particular situation, as they are based on many, many assumptions about an individual's tax situation and the company's compliance with the law. For example, if the company incorrectly designs the structure or the details of your grants, you can be faced with penalty taxes of up to 70%. Or if there are price fluctuations in the year of sale, your tax treatment may be different. Or if the company makes certain choices at acquisition, your tax treatment may be different. Or ... you get the idea that this is complicated.]
These are the most tax advantaged forms of equity compensation for an early-stage employee in order of best to worst:
1. [Tie] Restricted Stock. You buy the shares for their fair market value at the date of grant and file an 83(b) election with the IRS within 30 days. Since you own the shares, your capital gains holding period begins immediately. You avoid being taxed when you receive the stock and avoid ordinary income tax rates at sale of stock. But you take the risk that the stock will become worthless or will be worth less than the price you paid to buy it.
1. [Tie] Non-Qualified Stock Options (Immediately Early Exercised). You early exercise the stock options immediately and file an 83(b) election with the IRS within 30 days. There is no spread between the fair market value of the stock and the exercise price of the options, so you avoid any taxes (even AMT) at exercise. You immediately own the shares (subject to vesting), so you avoid ordinary income tax rates at sale of stock and your capital gains holding period begins immediately. But you take the investment risk that the stock will become worthless or will be worth less than the price you paid to exercise it.
3. Incentive Stock Options ("ISOs"): You will not be taxed when the options are granted, and you will not have ordinary income when you exercise your options. However, you may have to pay Alternative Minimum Tax ("AMT") when you exercise your options on the spread between the fair market value ("FMV") on the date of exercise and the exercise price. You will also get capital gains treatment when you sell the stock so long as you sell your stock at least (1) one year after exercise AND (2) two years after the ISOs are granted.
Q: Who will guide me if I have more questions on startup equity?
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
VIDEO Startup Stock Options: Negotiate the Right Startup Stock Option Offer
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
RSUs - Restricted Stock Units - Evaluating an RSU Offer at a Startup
Working for a startup? Here’s how to think about Restricted Stock Units or RSUs.
Originally published February 10, 2014. Updated March 27, 2017 and July 5, 2023.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Working for a startup? Here’s how to think about RSUs.
What are RSUs?
Restricted Stock Units ("RSUs") are not stock. They are not restricted stock. They are not stock options. RSUs are a company's promise to give you shares of the company's stock (or the cash value of the company's stock) at some time in the future.
How Many Shares Do I Have?
One RSU is equivalent to one share of stock. The number of RSUs in your grant determines how many shares of stock (or the number of shares of stock used to determine your cash payment) you will receive when they are "settled" on the Settlement Date.
You’ll receive one share of stock (or the cash value of one share of stock) for every vested RSU on the Settlement Date. For startup (private company) RSUs, the Settlement Date is usually a company Liquidity Event. A company Liquidity Event might include (i) a Change of Control (aka Merger or Acquisition); (ii) after an IPO, when post-IPO lockup on employee sales expires or (iii) a company choice to have an early settlement in shares.
When are Startup RSUs Taxed?
Most startup RSUs are structured elegantly to defer taxes until after the shares can be sold to cover the taxes. That’s achieved with a two-tier vesting schedule. Before the RSUs fully vest (so they can be “settled” in shares or cash on the Settlement Date), two triggers must be met:
Time-Based Vesting AND
Liquidity-Event-Based Vesting
Time-based vesting is the classic vesting concept. You will meet the time-based vesting requirement over a set period of time of service (called the "Vesting Period"). The most common time- vesting period is quarterly vesting over four years with a 1-year cliff.
The liquidity-event vesting requirement is the tax-deferral concept. The shares will not be settled / fully vested for tax purposes until the company has a Liquidity Event. A company Liquidity Event might include (i) a Change of Control (aka Merger or Acquisition); (ii) after an IPO, when post-IPO lockup on employee sales expires or (iii) a company choice to have an early settlement in shares.
Without this liquidity-event vesting requirement, RSUs could become vested for tax purposes before there is a market to sell the shares (or even before shares are officially received in exchange for the RSUs at settlement). That would be very unappealing for startup employees and executives, as they would need to pay taxes out of their own funds based on the FMV on the vesting date.
[Careful! This two-tier vesting structure (sometimes called double trigger vesting) is a tax deferral mechanism. It is not the same thing as double trigger acceleration upon change of control! Those are often confused so be careful there.]
Do Startup RSUs Expire?
Yes! There’s two issues to watch out for w/r/t expiration / forfeiture of startup RSUs.
All startup RSUs include a deadline, so that if the Liquidity Event is not achieved by a certain date, all RSUs will be forfeited without payment. That is usually 5 or 7 years from the date of grant. Therefore, most RSUs are designed to be forfeited if the company does not go public or get acquired within 5 or 7 years of the employee or executive’s start date even if the RSUs have already time-vested by that date. Unfortunately, this term is not negotiable as it is a tax-driven deadline. The RSUs must be designed with a substantial risk of forfeiture in order to defer taxation.
In addition to this tax-driven deadline, some RSUs include a forfeiture clause. This is similar to the dreaded clawback for vested shares, even though it is technically part of the vesting schedule. Here’s how it works. If an employee or executive leaves the company, they forfeit any time-vested RSUs that have not yet been settled / vested at a Liquidity Event. In other words, the employee or executive has to survive all the way through a Liquidity Event to get anything for their time-vested RSUs. This type of forfeiture term greatly reduces the value of an RSU grant because it is not really "earned" even after the time-based vesting period.
Will I Receive Annual Refresh Grants of Startup RSUs?
Probably not! Most private companies do not make substantial refresh grants either annually or at the time of future financings. In my experience, approximately 90% of the equity individuals receive at startups is in their original, at-hire grant. This likely would be refreshed only after it is close to meeting its full time-vesting requirements.
This is usually a surprise to employees and executives coming from public companies, where regular refreshes are the norm. The reason for the difference is that startups are hoping for huge increases in valuation. If that happens, the original grant would be sufficiently valuable to retain employees and executives. If you are evaluating a job offer, there is a big difference in the value of your offer between a company that grants RSUs only at hire (and after they have vested) and a company that plans to make additional refresh grants regularly.
How Do I Value Startup RSUs?
There is no precise "value" for startup RSUs since they are not liquid (aka easily sold). But employees and executives who are evaluating startup RSUs offers do think about value when their considering how much equity makes sense for their role.
When evaluating the number of RSUs in an RSU grant, employees and executives use one or both of these approaches:
Current Valuation Method (Fact-Based): For startup stock, most hires use the price per share paid by venture capitalists for one share of preferred stock in the most recent financing as a proxy for the value of their RSUs. This is the closest number you can find for today's value. It tells you that X Venture Capitalist paid $Y for one share of the company's stock on Z date. The usefulness of this approach is somewhat limited for stale valuations, especially in the 2022-2023 market. For more on this approach, see Venture Hacks' post on startup job offers.
Percentage Ownership: Executive hires also consider their percentage ownership compared to market for their role at this stage of company. Individuals often struggle to find good resources for startup compensation data since subscriptions to the primary startup compensation data sources are only available on the company side. Here’s a blog post with publicly-available startup compensation data links that readers have found helpful.
Future Valuation Method (Guesstimate Based): To look forward and define a future payout for your RSUs, you have to do some guesswork. If you could guess the startup's value at exit and dilution prior to exit, you would know how much the stock will be worth when you receive it at settlement/post-IPO. Be careful, though, not to use price/share in isolation as stock splits would affect that in unpredictable ways.
Employees and executives often consider these facts to build those approaches of analysis:
Recent VC price per share of preferred stock
Current number of fully diluted shares in the company or the offered percentage ownership in the company
Possibilities around expected dilution, exit scenarios, exit timing and future valuation?
Need More Info?
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Uber IPO - Lessons for Negotiating Startup Equity Offers - Spring 2019 Newsletter - Stock Option Counsel, P.C. - Legal Services for Individuals
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Hello Startup Community!
Uber's IPO is a great lesson for startup employees on negotiating their startup equity. Unicorn startup recruiters have been telling hires for the past few years to value the offered RSUs at many multiples, even 10X, of the most recent investor valuation in negotiating their compensation offers. Since Uber's value has not risen even 2X in that time, any hires who accepted offers based on this calculus have lost significant value compared to their opportunity cost.
Individuals need negotiate for enough shares in a startup to balance their risk. The calculation for the right number of RSUs at a late-stage startup with a public-company-size valuation is the current investor value per share, not the potentialfuture value.
Shira Ovide explored this issue in Bloomberg Opinion last week with input from Stock Option Counsel:
Uber's example shows that employees at startups – particularly those who come aboard when the company is more mature – often don't get rich, even when the companies are successful. Many workers are at the bottom rung of stock holders and tend to have less information about their company's value and prospects than just about anyone else who holds shares. ... Mary Russell of Stock Option Counsel, which advises employees on compensation at startups, said people evaluating job offers at more mature startups should analyze only what the proposed equity is worth at the time of negotiation, not what it could possibly be worth in a dreamy future. That’s not always easy, because Russell said startup recruiters sometimes suggest that a 10-fold increase in valuation in the past is an indication of what prospective employees can expect from their wealth.
For more on using current value to evaluate startup equity offers, see this video from the Stock Option Counsel blog.
Stock Option Counsel, P.C. - Legal Services for Individuals. Thank you for your enthusiasm for my practice and for the Stock Option Counsel Blog! I will continue to send quarterly updates on important topics in the market for startup equity for individual founders, executives and employees. Please keep in touch.
Best,
Mary
Mary Russell | Attorney and Founder
Stock Option Counsel, P.C. | Legal Services for Individuals
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Negotiation Rhythms #2: Best Alternative to Negotiated Agreement
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
We know we want to push beyond our limits to capture as much value as possible in a negotiation. But how do we define those limits? It takes a five-word phrase to bring this concept into focus: Best Alternative to Negotiated Agreement (“BATNA”).
The BATNA for a car buyer might be the same car at a nearby dealership for $20,000. The BATNA for a home seller might be an offer from another party for $1 million. The BATNA for a child trading baseball cards might be to hold onto his favorite cards and enjoy looking at them rather than to trade them away.
Salary Negotiation Method - Identify your BATNA, or best alternative to negotiated agreement, to find out if there is a ZOPA, or zone of possible agreement.
Any agreement below (or, for a maximum limit, above) a BATNA would leave the negotiator worse off than in the absence of that particular agreement. Said another way, the negotiator would be better off with some other option – their BATNA – than accepting an agreement on those terms.
Salary Negotiation Method - Identify your BATNA, or best alternative to negotiated agreement, to find out if there is a ZOPA, or zone of possible agreement.
To properly identify a BATNA, we must do a lot of calculating, daydreaming, and going out in the world to test alternatives. But this creative process is necessary. When we believe that the only alternative is the one at hand, our negotiation position is dangerously weak. It is also dangerously ineffective because it leads to an arrangement that does not, in fact, make the negotiator better off than without it. And any deal that is not in both parties’ best interests is unstable and likely to collapse after it is made.
Countless factors go into naming and ranking one’s alternatives to arrive at a BATNA, and even then it is impossible to do so clearly as those factors cannot all be outlined in numerical format. A better offer might be less certain of being completed, so it might be more advantageous to make an agreement on less favorable terms today. For example, the other job offer might not be certain even though it appears it would be more advantageous if it were finalized. This is the old saying that a bird in the hand is better than two in the bush, and this can be dangerous for those who optimistically negotiate as if their imaginary alternatives are already in the hand. In the other extreme, this is very limiting for those who are very fearful of uncertainty, as they will accept disadvantageous terms for the simple purpose of having certain terms when a bit of risk in pursuit of a better alternative could have led to greater results.
Timing is important in other ways as well, as a negotiator with more time to come to an agreement will have more chances to find alternatives to the agreement at hand. "Wait and see" becomes a BATNA in itself. The opposite of this would be a party who must have resolution today, which would, of course, limit the alternatives.
Beyond hard limits on time, some people do not enjoy the back and forth process of negotiating. They might prefer to take this deal, and even to accept much less of the middle than is possible to capture, than to continue to seek alternatives or negotiate deals. For these people, the process itself inhibits the growth of BATNAs.
We’ll see in the next post – Negotiation Rhythms #3: Sales & Threats – how brainstorming or eliminating BATNAs changes the ZOPA and improves or weakens our force in negotiation.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.