In the world of tech jobs, it’s common — and often expected — for companies to offer their employees at least some part of their compensation package in the form of stock options.
For the company, this is an attractive opportunity. It means paying out less cash in employee salaries in the short-term and incentivizing employees to help the company do well in the long run.
But what does it mean for you as an employee? And how should you weigh the tradeoffs between the two forms of compensation? This goes for whether you’re choosing between two different job offers or a company has offered you a choice of salary packages.
Before diving into the decision between salary and equity, it’s important to understand how they differ in the short-term and they may pay off down the road.
Salary is the easier one. It’s simply cash in your pocket today, which you can use how you’d like. Whether for your living expenses or investments, it’s crystal clear how much a salary is worth today. You can even estimate how much money an investment will be worth in a number of years.
Equity is a bit trickier. At a high level, owning equity in a private company is a bet on the company’s future success. You can think of yourself (the employee) as a mini-VC fund, accepting equity in replacement for the value you provide to the company.
For a VC fund, that value is capital in the form of cash, while employees provide human capital and accept equity as a (partial) replacement for a cash salary.
Options are usually granted on a four-year vesting schedule with a one-year cliff. This means you won’t actually have the option of owning equity in the company if you leave within your first year of working there.
On the common vesting schedule, only 25% of the options are available to you after the first year, and the remaining shares typically vest incrementally each month or quarter thereafter.
As their name implies, options don’t actually denote ownership in the company – it’s the option to purchase a specified number of shares.
If you decide to buy the shares in the future, they’ll cost the “strike price” set when the options were granted, which should be significantly lower than the market value of the shares when you sell. The ultimate hope is that the value of the company’s shares increases significantly during the time you work there.
If you do purchase the shares, they’re not actually worth anything until some sort of exit event, like an IPO or acquisition. The unfortunate reality? 90% of startups fail, rendering all shares worthless.
If you’re joining an early-stage startup, the risk can be even greater. Sadly, the Bureau of Labor data shows that 20% of all businesses fail in their first year of operations.
Even if the startup does succeed, an exit could take years to occur and you’ll likely have to hold onto the shares for a long time in order to capture any value from them.
Finally, it’s not the number of shares that counts, but the percent ownership those shares represent. When weighing multiple offers, determine the number of outstanding shares at each company to calculate the percent ownership each offer would represent. Compare these numbers – not the number of shares – when weighing competing offers.4 questions to ask when deciding between salary and equity
While being offered stock options is never a bad thing, it can make for a more difficult decision-making process. Here are some points to consider as you evaluate the different choices at hand:
Joining an early startup can be exhilarating, not to mention a great learning experience. However, you’ll typically see lower salaries paired with higher equity stakes—the smaller the company, the lower the chances they’ve raised (or earned) tons of capital.
Calculate your own expenses to determine the minimum salary you’d be able to accept, particularly if you’re living in an expensive tech hub like San Francisco, where living expenses can eat up a large chunk of your income.
If your equity is on a typical four-year vesting schedule, you won’t have the option to purchase any shares before year one, and the remainder will take an additional three years to vest. If you know you have a big move ahead, you’re planning on going back to school, or otherwise don’t expect to be with the company for long, be sure to factor that into your considerations.
Before accepting a lower salary for more equity, ask yourself: How optimistic am I about this company’s future and exit prospects? Of course, this is much easier said than done, and even paid professionals (like venture capitalists) struggle to accurately predict a startup’s success.
However, it’s still an important factor to consider. If you foresee the company going far, you might want to trade a higher salary for more stock options in hopes that a little risk up front will result in an outsized reward down the line.Looking for your next tech or sales role? Create your free profile on Hired to get started. Interested in more insights to help you land the salary you deserve? Download this eBook!
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