20 Equity questions every operator should ask at THE offer stage to maximize their potential upside and decrease their future tax liabilities
Note: I’m not an expert on this stuff. I’ve had to learn myself along the way, as a venture-backed founder dealing with RSU’s, ISO’s, NSO’s, Phantom Stock (yes… you heard that right), as an employee at a high-growth venture-backed company (Drizly), and at a public company that dealt with RSU’s and then public stock (Wayfair). It’s something I still continue to learn about from my VC buddies, my tax accountant, and fellow Operators by listening to their stories. There are MANY stories… many ways you can win… and many ways you can get fucked. I will update this post as I learn more. But for now, this is probably better than what most tech employees know about, so here you go.
My thoughts on equity (for employees): When you’re younger, you can take bigger swings on accepting a discounted salary for larger equity. HOWEVER… be careful with this. It is relatively easy to actually figure out how much compensation that equity equates to IF the company were ever to be acquired for $X amount of dollars (or IPO). I would recommend to every person that they approach equity in the private markets just like how you’d approach equity in stock in the public markets: It’s gambling. Period. Many a confident company has believed they would sell for $1 Billion, only to implode within weeks. Many unconfident companies that have been on the brink of bankruptcy have sold for several million. It’s gambling, and while you may feel emotionally attached to a company, you have to remind yourself of that. Some founders and Operators are exceptionally talented. Some founders and Operators get exceptionally lucky. And some exceptionally talented founders get exceptionally unlucky (ex: COVID decimating businesses). You can control a lot in life… but not everything. And sometimes you can get unluckily fucked. Don’t get fucked. Get educated.
Here are the questions you should ask to determine the relative value of your equity:
Stock Class: What's the class of stock I’m being given? → Are they Incentive Stock Options (ISOs), Restricted Stock, Nonqualified Stock Options (NSOs), Restricted Stock Units (RSUs), etc? More often than not at VC-funded companies, you’ll be receiving ISO’s. But ASK! Don’t assume. Remember! ISO’s are options. You are able to exercise (purchase them) as you vest them. This obviously costs money to do (which goes to the company), but it also creates a tax event between the Fair Market Value (FMV) and your exercise price. For those options you do not exercise along the way, the remaining ISOs you have vested must be exercised within 90 days of you leaving the company. There are occasions in which a CEO will be willing to convert the ISO’s you do not exercise into Nonqualified Stock Options (NSOs), which you can change the exercise period to a number of years (often times 10 years). But your tax rate will change here as well… to ordinary income tax levels (it will go up… sometimes by a lot). VERY IMPORTANT. Ping me with questions if you need help in this area. There’s a lot more to this depending on the class.
Number of shares: Obviously this is something you’ll want to know.
% Ownership: What % of the company do I own on a fully diluted basis? → When you know this, you can put your # of shares (the numerator) and divide by the full diluted share count (denominator) to see what % of the company you own. If you are offered 10,000 shares and there are 1,000,000 shares on a fully diluted basis, then you own 1% of the company. If you own 1,000 shares out of 1,000,000, you own 0.1% of the company.
What’s the valuation of the company? → If you know this, and you multiply it by the % of the business you own, you now know what your equity is worth. If someone isn’t willing to answer this question, ask them what the current value of the preferred shares is.
Strike Price: What is the current strike price? → This is the price you’d have to pay to exercise your stock options. The lower the better obviously. To determine how much you’d have to pay to exercise all of your options… multiply your number of shares by the strike price. Google it to learn more. Note: If you are cofounding a company, your strike price will often be valued at $0.00001. You are able to file an 83b election at this stage to purchase the shares and incur your tax liability on day one, which creates massive, massive benefits down the road. But if you do not file an 83b election… you get fucked (talk to me about this if you’re a founder so I can talk you through it).
When was the most recent 409a valuation done and when is the next one expected? → A 409a valuation gives you your strike price. These must be done every year (changing the price of the stock). This is good to know so that you can get additional mental safety in your mind that the exercise price of your options and the value of the stock are the same as what you were told when you signed the offer letter. There have been occasions when an employee was told a valuation of stock… then a 409a evaluation was done the next week… and when the stock options were approved by the board… the new valuation and exercise price (often times higher) has now stuck.
Have you raised capital with greater than 1x liquidation preferences? → This will help you understand if your fully diluted ownership is 1-to-1 or 1-to-(not 1). This will impact your potential upside… sometimes greatly… particularly if the company doesn’t have a great exit.
Stock option early exercise: Do you allow early exercise of my options? It is VERY important for you to read up on this stuff. There are situations where if you early exercise you will need to file an 83-b election for tax purposes within 30 days of exercise. If you don’t do this, you can get destroyed tax-wise down the road. There’s also a world where you may want the ISO’s to be Nonquals (NSO’s). My biggest advice: seek tax advice from people who know their stuff.
What is the exercise window for employees? → The IRS allows ISO’s to be exercised up to only 90 days after termination from the company (whether you leave of your own free will or are fired). Some companies allow their employees to convert their ISO’s to NSO’s and get a 10-year exercise period.
Vesting Schedule: What is the vesting schedule? → 4-year vest, 1-year cliff? Probably. That means you’ll vest 25% of your shares on the 1 year anniversary and then 1/48 of your shares will vest monthly after that. After four years, unless you received any additional grants, you own everything you possibly could.
Acceleration Trigger: Single trigger or double trigger? → Google it, or ask me for more info on this.
Acceleration: Is there any acceleration of my vesting if the company is acquired? Most typically this will NOT be written into the stockholder agreement beyond “board discretion.” Boards like having the ability to determine this b/c it’s often a negotiation point with a possible acquiring company.
Can I sell my exercised stock on the secondary market? → This is becoming increasingly popular. Back in the day, it was much rarer. But ask. Ya never know.
Bonus:
Does everyone in the company have the same class of stock? → I like this question because it will let you know if there are preferred shares in the company (what investors typically own). And while most founders I know have Restricted Stock or some preferred share class, there are founders I’ve heard in town who purposely made their shares common shares from the start, along with their employees, to give the “we’re all in this together” play.
Does everyone in the company have the same vesting schedule? → Good to know b/c if the answer is no, you can use it as a negotiation point, or at least a talking point. If there are employees who have different vesting schedules, their stockholder agreement would have had to be altered. It’s something to know from an equality standpoint.
More advanced questions you can ask, especially if you’re an executive:
Outstanding ownership: What convertible securities are outstanding (convertible notes, SAFEs, or warrants), and how much dilution can I expect from their conversion?
Exit valuation: What exit valuation will need to be achieved before the common stock has a positive value (that is, what are the liquidation overhangs)?
Retention grants: Do you have a policy regarding follow-on stock grants? Some companies, like Gusto, have built this into the agreement. All employees who stay two years at the company receive a retention grant, and then each year after. (I believe it was Gusto… I’ll check).
Vesting: Does the company have any repurchase right to vested shares?
My point on equity: Get informed. Yes, it’s confusing. Yes, there’s a lot to it. But the more you try to learn, the more confident you’ll be in negotiating. Keep your head up, and ask questions on this stuff. And if you want someone to help teach you up, or even do the negotiation for you… I know a guy. ;)