Three things you need to know about negotiating equity compensation before joining a startup
One of the most exciting aspects of working as an early employee of a startup is potential for building a solution that has an outsized impact, and large financial reward. Employees, founders, and investors are rewarded at an exit according to their equity stake in the company. Early employees often work below market cash rates in exchange for equity. Before negotiating a equity package, it’s important to understand the basics. I recently read an article by Mary Russell at Stock Option Counsel, a Palo Alto firm that represents employees and founders on compensation issues. Here are a few highlights.
1. What’s considered normal vesting in a startup, and what you can negotiate
Normally, employee shares have a four year vesting schedule with a one year cliff. This means that if you leave the company before one year, you won’t have the opportunity to buy any shares. After your first anniversary at your job, you will vest on a monthly basis for the next three years. Of course, if you are promoted, you should expect to be granted more shares with a new vesting schedule.
Because many founders aim for acquisitions, employees need to be protected if their company is acquired and they are terminated as a result of the acquisition. To prevent this situation, you can negotiate for what’s called a “double trigger acceleration upon change of control clause.” This basically says that if a company gets acquired, and you are terminated as a result, that all your shares vest immediately.
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2. Watch out for repurchase rights in your contract
Sometimes, buried deep in an offer letter will be a clause giving the company the right to repurchase an employee’s vested shares if they leave the company. The effect on the employee is that you are essentially subject to “infinite vesting,” where you never really have control of your shares.
Mary advises asking, “Does the company maintain any repurchase rights over my vested shares or any other rights that prevent me from owning what I have vested?” If the answer is yes, it’s a good idea to have a lawyer review your contract.
3. Make sure the company does not delay setting your exercise price
The exercise price is the price at which you will buy your shares. This price has the potential to increase significantly if the company closes a financing, or goes through some other event that will increase their valuation. It’s fair to ask when the company will set the exercise price of your shares, and to make sure that date is not too far in the future or after a valuation event. Mary advises letting your new employer know that setting the exercise price immediately is important to you, and following up on this after you start.
Nothing in this post should be construed as legal advice.