This article was originally posted on the levels.fyi blog here.

“Your employment will be on an at-will basis. Either you and the company may terminate your employment at any time, with or without cause or prior notice. My employment-at-will status cannot be changed except in writing signed by the president of the company…”

“Yada, yada, yada…”

Reading offer letter legalese can feel like someone explaining the rules of a board game before you start playing. When it’s Saturday night and you’re sitting around the table with a group of friends, typically someone will say:

“Just deal me the cards and we’ll figure it out as we go. The first hand can be practice.”

Turns out that a lot of people have this perspective on the equity for startup job offers too.

Maybe you think it’s not important, or maybe you assume everyone else knows about this stuff already. Whatever the reason, a lot of people rush through their offer letter and treat their first (or second, or third) startup offer as a “practice hand”.

What people don’t realize is that this “practice hand” takes up several years of their life and getting it wrong can mean losing 6 or 7 figures of value. In this case, reading just a bit of the instruction manual is worth it. We’re talking “life-changing sums of money” worth it.

This guide covers the equity section of your tech company offer letter. You’ll walk away with a clear understanding of:

• The information you need to understand your equity
• The basics of equity compensation in job offers
• How to develop a plan for maximizing the value of your equity

There are, of course, other sections to your offer letter. It likely contains four components:

• Equity - Your exposure to the company’s upside potential.
• Cash - Annual salary, annual bonuses, signing / relocation bonuses – it’s all in this bucket.
• Benefits - healthcare plan, 401k matching, paid holidays and other benefits.
• Intangibles - this is all the “other” stuff like the quality of your manager or the impactfulness of the problem you are solving.

The latter three—cash, benefits, and intangibles—are critically important, but from an offer letter perspective, they should be rather straightforward to understand.  

The equity section is where an overwhelming alphabet soup of terminology often appears. Remember: you are not stupid for not understanding the financial jargon. Most people don’t understand it. However, it is still stupid unwise not to invest the time in understanding the basics. It could be the most lucrative time you ever spend – let’s get into it.

This article is written by Compound, a full-stack financial management platform for technology founders and employees. We serve 1,000s of clients from companies like Stripe, Figma and Coinbase. We specialize in helping employees understand their illiquid company equity and have a free modeling tool to help you here.

Step 1: Collecting information

Going into a negotiation, remember that you’re at an information and experience disadvantage. Growing companies have given out countless offer letters; this may be only the second or third offer letter you’ve ever received. To help bridge the gap, you should begin the process by collecting and clarifying information.

Consider using the following email adapted as needed based on what the company has already provided to you (I’ll explain the terms in a second):

Hiring manager,

Thank you so much for the offer. I’m really excited by the opportunity to build UNICORN into a long-term successful business.

I’ve been reviewing the offer with my financial advisor. I need clarification on a few variables in order to understand the basics of the offer:

1. What is the type of equity (ISOs, NSOs, RSUs)?
2. What is the latest strike price and timing of the most recent 409A valuation?
3. What are the number of options and/or stock units?
4. What is the vesting schedule?
5. What is the number of fully diluted shares outstanding?
6. What is the exercise window?
7. What is the post-termination exercise window?
8. What are the liquidation preferences for existing investors?
9. Does the company conduct regular liquidity events?

Your name

You may find the information collection process frustrating—many companies are unwilling to share appropriate context, and the terminology can be confusing. I hear you, but it’s still worth spending the additional time upfront since the reward is substantial.

Note that the last few questions on the list above (#5-9) are “nice to haves” – you should ask for them, and push to get them answered, but some companies are more reluctant than others to share the details. However, no matter what, you should absolutely have the following questions answered before accepting a job offer:

• What is the type of equity (ISOs, NSOs, RSUs)?
• What is the latest strike price and timing of the most recent 409A valuation?
• What is the number of options and/or stock units?
• What is the vesting schedule?

If your company is very reluctant to provide this information, remember to always act professionally during this process. It’s possible that your recruiter and hiring manager are not experts in startup equity. Or perhaps the company doesn’t want to give out that information to candidates. While it can be easy to get frustrated, keep your cool. That being said, how a company acts during the negotiation may also tell you something about the culture.

Step 2: Understanding your equity

Now that you have the information – what does it all mean? Let’s walk through each question one-by-one.

1. What is the type of equity (ISOs, NSOs, RSUs)?

Equity in private technology companies generally comes in two forms:

• Stock options: Stock options give you the right to purchase shares at a predetermined price known as the strike price. Stock options are typically granted at earlier stage companies (<100 people). Options come in one of two forms: incentive stock options (ISOs) or non-qualified stock options (NSOs).
• Stock units (RSUs): This is when the company grants you shares directly. Unlike options, you do not need to purchase RSUs – you own the shares.

Why does this matter?

While you rarely have a choice of which options or shares you receive, each kind has a different tax treatment. There’s not a clear “best” type of equity; there are pros and cons of each category. The basics are overly technical to work through, so if you want more information, see this deeper equity guide.

2. What is the latest strike price and timing of the most recent 409A valuation?

Purchasing your shares is also known as “exercising your options”. The price that you pay for  exercising your options is known as the strike price (sometimes also referred to as the “exercise price” if you see that).

The strike price is fixed (meaning it doesn’t change over time). It is equal to the Fair Market Value (FMV) at the time you were granted your options. So if the FMV of your company’s equity was $1.50 when you were granted options, your strike price will likely be $1.50.

The FMV is generally determined by an independent accounting firm that audits private technology companies to determine their value through a process known as “409A valuation.”[0] Companies conduct a valuation at least annually (“at least” because companies sometimes must also conduct a valuation when they fundraise). A lower strike price means it will be less expensive to purchase your stock options. Since companies ideally are growing, the earlier in the company journey, the lower the strike price and the cheaper it is to exercise your options.

Note: the 409A valuation is different from the company valuation you see in the headlines (the latter is often referred to as the preferred valuation because it includes the value of Preferred Stock). You’ll want both numbers; the FMV is for tax and equity purposes and the preferred valuation is optimistically what you’ll want to sell your equity for in the future in a positive exit event).

[0] The terms “FMV”, “Fair Market Value” and “409A price” all mean the same thing – it's the share price that the auditors determined your company was worth. Finance folks just like to confuse everyone else by having multiple names for the same concept.

Why does this matter?

Importantly, it’s very common for you to sign an offer letter and start work before your options are granted. This is not necessarily a bad thing – this is common because most legal structures require that the board of directors approve the issuing of every option grant. If you get an offer when there isn’t a board meeting immediately after, there’s a good chance you might not know the strike price of your options – or even receive your options – until the board meeting happens (typically once a quarter).

There’s not much you (or your company) can do about this, but it’s worth proactively asking your company when they’re planning to grant the equity and change the 409A price next so that you can factor in exercise costs to your decision-making.

Finally, remember that if you receive options instead of shares, you’ll have to invest your own money to purchase them. So if you get $50k worth of options, that means you’ll have to invest $50k of your own money just to own them. This is very different from being granted shares that you don’t have to purchase!

On the flip side, these options can have immense value. If you end up working for a startup that gets acquired or goes public for a large amount, the personal financial rewards can often be life changing. And if that happens, the amount you pay to exercise your options will be a fraction of what you end up earning. (Remember that this small chance of success is one of the main reasons people choose startups – which typically have lower cash compensation – over larger companies!)

3. What are the number of options and/or stock units?

What really matters for equity is two things: the share price and the number of shares. At the end of the day, you want the share price to go up, and the more of them that you own, the more value you’ll own. So you should demand to know the number of shares (or options)!

Why does this matter?

Well, at this point I’m just wondering if you’re still reading. I think it should be pretty obvious why the number of shares are important :)

4. What is the vesting schedule?

You earn the right to purchase your options over time through a process known as vesting. Your vesting schedule is the timeline of how quickly the options become “yours”. The standard vesting schedule is 4 years with a 1-year cliff, meaning that 1-year after you start you can buy 25% of your shares and that for each month then on, 1/48th more of your shares are purchasable.

Why does this matter?

Some companies (kindly) offer something known as early exercising, which allows you to exercise your options before they vest, typically resulting in lower taxes. Note, however, that A) most companies don’t offer early exercising and B) if you do early exercise your shares, you’ll have to file a special tax election called 83(b) letting the IRS know that you’ve done this.

5. What is the number of fully diluted shares outstanding?

Sometimes companies will offer you equity grants in a silo: “you’re being offered 100,000 stock units of Unicorn Company.” 100,000 can seem like a big number, but you need to balance it out with something. As mentioned above, the share price is one way to understand the value – number of shares multiplied by the share price. Another way to understand it is with “fully diluted shares outstanding” (FDSO).

While the six-digit number appears large, it’s easy for companies to have millions, tens of millions, or even more shares. Owning 100,000 shares of a company that has 1,000,000 FDSO is a lot different than owning 100,000 shares of a company that has 50,000,000 FDSO.

Thus, you want to ask for the fully diluted shares outstanding. This is the denominator—it’s the total number of shares. Fully diluted just means that if the company has any stock options or convertible notes or warrants (i.e. investments that will turn into shares in the future) they should include them in the sum calculation.

Why does this matter?

The real question is: should I focus on the number of shares or the percentage ownership of the company?

There’s no perfect answer, but having your grant count alongside the Fully Diluted Shares Outstanding enables you to calculate your Percentage Ownership of the Company. If you own stock options, know that you don’t technically own shares—you own the right to purchase shares.

Recognize that your Percentage Ownership is likely to change over time. Every time your company raises money, they are granting new equity onto the cap table and thus diluting your ownership. The idea is that new capital will help the company “pie” grow, even if the existing shareholders’ slice of the pie is a bit smaller than before.

6. What is the exercise window?

Your exercise window (or exercise period) is the amount of time you have to exercise your options (purchase shares) at the strike price you were offered. This is typically something like seven to ten years as long as you are working for the company.

Why does this matter?

Mostly it doesn’t matter, but it’s one of these “make sure to check the box” things that could negatively impact you in an unlikely circumstance. If your company doesn’t go public for ten years and you haven’t exercised your options, you may be in trouble (being forced to pay lots of money to exercise options plus the tax bill, or lose them all).

As an example – imagine a Stripe engineer who joined early on and has been there for nine years. Because Stripe hasn’t gone public yet, if the exercise window on her shares was ten years and she hasn’t exercised yet, she could find herself in a tough situation: come up with a lot of cash to exercise her shares plus the associated taxes or risk losing the equity.

Bottom line – it’s rare that this impacts you, but you’ll want this window to be as large as possible in case it does.

7. What is the post-termination exercise window?

A post-termination exercise window is the amount of time between when you leave your private company and the date when your unexercised stock options expire.

Why does this matter?

Most people have no idea this is true! Let me repeat the definition: if you leave a company (under your choosing or theirs) and you haven’t exercised your options, those unexercised stock options will expire.

The standard post-termination exercise window is 90-days long. This means that if you leave the company, your unexercised stock options will expire 90 days from your termination date.

Some employee-friendly companies have instituted longer post-termination exercise windows (e.g. 7 years) which makes it a lot less likely for employees to find themselves in tough situations. There are some odd rules here though (for example, if you have ISOs, they legally either expire after 90 days or convert into NSOs) so be sure to check the fine print in your offer letter.

8. What are the liquidation preferences for existing investors?

The liquidation preference is a clause that refers to the ordering and amount of payment investors will receive during a liquidation event. It is expressed as a multiple (a 2x liquidation preference means the investor has the right to 2x their original investment before any founders or employees receive a cent). The multiple—in 2022—is generally 1x but depends upon the company’s fundraising history.

Why does this matter?

If your hiring manager or recruiter comes back and says “the liquidation preference is 1x”, that’s a reasonable answer. If they come back and answer something like “2x” or higher, that’s a red flag and often creates problems for the company and employees.

Liquidation preferences exist to protect investors. A quick example – say a company raises $1M, selling 20% of their company at a $5M valuation. If there was no liquidation preference, instead of using the money to hire engineers and get customers, the entrepreneur could immediately sell the company for its assets ($1M) and keep 80% ($800k) while the investors walk away with $200k (20%). This obviously doesn’t make sense because the entrepreneur didn’t do anything valuable, so investors commonly include liquidation preference to protect their capital.

You can read more about this topic here.

9. Does the company conduct regular liquidity events?

Some private companies—pretty much exclusively at a later stage (>100 employees)—give employees regular opportunities to sell their equity (in exchange for cash). (Public companies – by definition – have a liquid market for their shares, and so, if you own vested shares in a public company, you won’t have to worry about regular liquidity events).

There’s often a lot of nuance to this:

• Only certain tenured employees are eligible
• Employees can only sell a certain percentage of your shares
• Employees can only sell during a particular window
• The company may dictate the price and to whom you can sell your shares

Why does this matter?

Understanding if there will be an opportunity to potentially sell your shares before a material exit (e.g. initial public offering (IPO) or acquisition) can help you frame your equity on the liquidity spectrum. On one side there’s, “this is basically like owning stock in a public company that you can trade at will” and on the other side there’s, “this is a lottery ticket that I need to hang onto for at least the next five years.”

Step 3: Projecting the future value

Now that you understand the basic terms – how much could your equity actually be worth?

It’s impossible to guarantee the future value of your illiquid startup equity. It is possible however to get a rough idea of where the company may be headed. Later-stage businesses in particular will start looking more mature (from both a financial and product perspective) and easier to predict – though recent history shows that post-IPO prices for startup equity can vary wildly in the public markets.

Consider asking yourself (and/or the company) questions such as:

• Is the industry growing? Is it something that is clearly going to be Much Bigger like the internet in the 1990s or mobile in the 2000s? How does the market value public competitors? What does this company’s revenue need to be in order to garner similar results?
• What do you think about the people? When you look around do you feel that nervous energy like you need to keep up with others because of how talented they are, or do you feel that you’re able to coast?
• What about the company culture? Culture is something that is hard-wired into the organization even though you can’t touch or feel it. Also, keep in mind that company culture is unique: some cultures could be good for your friend or peer but not good for you.
• How quickly is the company growing? You can ask, of course, for the company’s revenue and growth rate. But you can also usually feel if the company is growing (customers begging for your product, etc.).

You can use some of the above estimates to get a directional idea of what your equity may be worth. As discussed before, there are two primary ways of coming to an answer: either predict the value based on share price, or predict the future value of the company and multiply it by your percent ownership.

Method 1: Predict the share price.

First, predict the future value of the share price. There’s a few ways you can think about this – you could apply an annual growth rate to the current 409A price, you could look at how quickly similar companies have grown, or you could come up with your own method.

Once you have the projected future share price, you can multiply it by the total number of options or shares you’ve been granted. Once you take out the cost to exercise your options (strike price * number of options), the result is the potential pre-tax value of your equity (assuming you stay at your company for the full vesting period and exercise all of your options).

Method 2: Predict a future value for your company.

The other method is to predict the future valuation of your company and back into your ownership.

To do this, first divide the number of options you’ve been granted by the number of fully diluted shares outstanding. This will give you your percent ownership.

Then, multiply your percent ownership by a predicted future valuation for the company (e.g. $X billion). A common way to estimate this value is to look at companies that have a similar growth rate, size, and industry to your company and use their valuation as a proxy for what your company could be.

The result of this calculation is the potential pre-tax value of your equity (again, this is assuming you stay at your company for the full vesting period and exercise all of your options).

Using this second method, be wary of dilution. Dilution is when your company raises a round of funding and issues new shares, lowering the percentage ownership of existing shareholders. Dilution is common and will reduce your percentage ownership of the company – sometimes by several percentage points depending upon how many rounds of financing you have between the time you join and a future liquidity event. That said, the number of options that you hold isn’t set in stone – some companies offer employees “equity refreshers” (usually because of strong performance) to continue to inventize employees.

While you could spend hours playing around with projection models and building sensitivity tables, the most important part is that you get it directionally right. (And for full transparency, Compound specializes in helping you with these decisions through our modeling software).

Step 4: Forming a negotiation plan

Negotiation

If you have arrived at the negotiation phase (i.e. you have an offer), it means the company wants you to work for them.

It also means that they’ve likely spent thousands or tens of thousands of dollars talking to you, talking to other engineers, not talking to even more engineers, and giving you your offer. Keep in mind that the company has many, many more resources than you do – a $10k increase in your salary, for example, might make a difference to you, but for a company that makes millions of dollars every month, it’s not much at all.

Also, remember that your hiring manager isn’t going to take this personally – they are certainly working hard and want to succeed at their job by hiring you, but they aren’t handing you dollars out of their pocket. They are doing business, making a deal. Don’t be shy about asking for more.

One great way to negotiate a higher salary is to use data. The tech industry prides itself on data-driven decisions, so having data to backup your negotiations will go a long way. Levels.fyi offers negotiation coaching services, which will pair you up with an industry recruiting expert to help you learn how to use data to your advantage in negotiations. Every situation is different, so the recruiting experts will be able to help you with personalized suggestions for your needs, whether you’re negotiating a Series A offer or an offer from a public company.

Maximizing the long-term value

There’s no “right” way to approach your career—and you likely have reasons that you’re joining a company beyond financial reasons (i.e. you care a lot about the mission or prioritize healthcare benefits / remote work). I’d encourage you to open up a document and write yourself a memo titled: “What do I want out of my job?”

List the variables you find important today (knowing these may change over time) and file that document away as soon as you start work.

Revisit your document every so often to ask yourself: “Am I fulfilling this vision? Have my criteria changed? What comes next?”

You likely know people (or might be one of those people) who start a new job every year. There’s some valid logic to doing this: you likely get a new signing bonus, you get to diversify your exposure, and you get to meet new people. There’s also the case for concentration: stick at one job, build tight relationships, and watch your equity compound over time.

Consider betting on yourself.