If you have been offered a job at a fast-growing startup, you will surely receive equity as part of your compensation package. Equity compensation entails awarding a portion of your company’s ownership to an employee in exchange for their contributions to the company’s success. Stock options or other legally enforceable financial instruments are granted as part of equity-based pay to align employee and corporate interests.
Equity is influenced by two factors: the company’s stage and the employee’s function and level. You are bound to receive higher equity, depending on your skills, the designation you hold in the company and how young the company is.
For example, a seed stage business will usually offer new recruits more equity than a late-stage startup. The stages simply refer to the size of the company and the amount of capital (i.e., assets) available. Because the contribution level of early employees is substantially higher than if the company were at a later stage, new hires will receive more stock in a seed stage startup.
Coffeemug.ai has prepared a detailed guide on why equity compensation matters, types of equity compensation, and how late stage startup equity is calculated?
Importance of equity compensation
- Save your cash: Startups frequently use equity-based compensation as an appealing choice to lure top talent. This is because many businesses are cash-strapped, but they can issue shares at any time, giving them equity. This structure provides a significant benefit for the company: it eliminates the need to pay a salary, which could negatively impact the company’s initial cash flow.
- Improve employee retention: Employee longevity is a goal of startup equity pay. Vesting periods, which bind employee equity to a set of constraints, are almost always included in equity pay. To earn ownership of their shares, employees must meet certain time and performance goals.
- Increased employee involvement: Because startups have fewer employees than their larger competitors, they must guarantee that staff are involved early on. Also, a startup’s growth is fueled by loyalty and work ethic. Employees are more motivated when they believe that their contributions will directly increase the value of their stock.
Types of late-stage startup equity compensation
An equity compensation plan usually comes with certain conditions. Due to unexpected employee activities that could adversely affect the company’s finances, it is unusual for a company to distribute stock completely.
Startups mainly issue equity in three ways: stock options, restricted stock awards, or restricted stock units (RSUs).
Stock options: A stock option gives a shareholder the right to buy a certain number of business shares at a predetermined price.
Restricted stock awards: Restricted stock is a type of stock in which shareholders are unable to transfer their shares until specific conditions are met. A startup frequently chooses to set restrictions on the stocks that are issued, such as
- Vesting: Before receiving their stock reward, the employee must work for the company for a specified amount of time.
- Transfers: Employees must request permission to transfer their stock in order to modify its nature.
Due to the high tax implications of this sort of equity, companies often limit restricted stock awards to early employees or top executives.
Restricted stock units (RSUs): A restricted stock unit is a contract between the company and the employee to issue stock at a future period. RSUs and restricted stock awards are not the same thing. Each unit is equal to one share of stock or the cash value of that stock.
The employee must vest in order to receive the share or cash for their RSU. The settlement date is the date on which they will get their compensation. The settlement date might be established in advance or linked to a specific event, such as the startup’s IPO (IPO). RSUs are regularly issued by small private enterprises in favor of its employees.
When are startups allowed to offer equity?
Typically, startups must wait until they have completed a 409a valuation before they issue any stock. The process of determining the fair market value of your company’s common stock is known as a 409a valuation. The market value you receive may differ from the valuation given to your company by investors throughout the fundraising process.
As a result, after raising funds, you will need a new formal valuation, and that figure will influence how much equity you may offer to advisers, workers, and others.
If you don’t issue stock in accordance with a 409a valuation, you risk facing legal and tax consequences from the IRS.
How late stage startup compensation is calculated?
It can be challenging for a startup to calculate the specific equity compensation package. There are a number of factors that affect the potential compensation percentage such as the employee’s role, etc.
For example, a late stage startup compensation can be calculated as follows:
- Senior Engineer: 1%
- Mid-Level Engineer: .45%
- Senior Business Development Employee: .35%
- Mid-Level Engineer: .45%
- Junior Engineer: .15%
- Junior Business Development Employee: .05%
Conclusion
Coffeemug.ai recommends joining late stage startups that offer a substantial equity compensation plan for people whose risk tolerance is low. We at Coffeemug.ai completely understand what it takes to be a true partner and mentor to entrepreneurs who are working extremely hard to make their business successful. Join our community today and get connected with professionals that have vast experience in knowing how to run a successful business.
FAQs
Q. What is a late stage startup?
A. A late-stage startup usually has reliable funding sources and is following through with its business plan. This usually indicates that the startup has all of the core sales, deployment, and support teams in place.
Q. What does late stage venture funding mean?
A. Late-stage venture capital funding is for established businesses that may or may not be successful, but have demonstrated growth and revenue generation.
Q. How much equity should a startup employee get?
A. Depending on the growth of your startup, the equity compensation for an employee can range from 5% to 30% of astartup’s equity.
Q. How is equity paid out?
A. The majority of equity pay has a vesting schedule, which means you’ll only acquire your stock when a certain amount of time has passed.
