How to Negotiate your Equity Compensation in VC-Backed Startups

In our work at venture-backed startups, we are amazed at how hard new employees will negotiate pay, benefits, workspace, duties, titles, etc. and just totally accept their equity compensation.

So, we have prepared six questions that will make you look really smart and help you understand your equity compensation. It may also make you a lot richer when your Company is acquired.

Assumption: You have been offered an incentive stock option for 100,000 common stock shares at an exercise price of $0.05 per share that vests 25% after the first year and then monthly for the next three years.

Questions:

1. How many shares are outstanding on a fully-diluted basis?

2. Can I receive restricted stock, rather than incentive stock options?

3. Based on the current burn rate, when does the Company plan to raise the next round of equity?

4. Will the Company refresh when the next round is raised?

5. What is the liquidation preference that is in front of the common shares?

6. Is there any acceleration of vesting upon a change in control?

Analysis:

1. Your slice of the pie. Obviously, there is a huge difference in the size and value of your slice if the pie (total shares outstanding) is 1M shares vs. 100M shares. Fully-diluted just converts all preferred stock shares and warrants to common stock shares.

2. The answer will probably be no, but ask the question anyway. Restricted stock just means that you actually own the stock (vs. an option to purchase the stock) with restrictions (vesting schedule). It is a much better deal for taxes.

3. The answer to this is important, as it is a back-door way to ask when does the Company run out of money?

4. When the Company raises additional equity, they issue more shares, so the pie grows and your slice shrinks. This is just an intelligent sounding way to ask if they plan to make you whole by issuing you additional options. This is worth negotiating.

5. Preference is the amount paid to the investors when the Company is acquired, before any amount is paid to stockholders. It is often 1X which means if there was $10M invested in the Company, that amount (plus dividends) is the first money paid, before anything flows down to stockholders, including option holders.

6. Sometimes, companies will accelerate your unvested stock options upon an acquisition. This can be huge to negotiate if you anticipate an acquisition in the near future.

Good luck and remember if you have gotten to the point where there is an offer on the table, the Company wants you and this will be the best­ and maybe only time to negotiate your equity compensation.

___________________________________________________________________________

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.