How to Know if You Have Startup Equity
As startup acquisitions and IPOs become more high-profile and high-dollar, the promise of startup equity is spreading like a gold rush across the country, from Silicon Beach to Silicon Prairie to Silicon Alley. But as the name “startup equity” spreads and is used by companies that don’t meet the “gold standard of startup equity,” employees have to take the initiative to find out if the equity they are earning is true startup equity that will allow them to share in the value at an acquisition or IPO.
The startup community is now engaged in a breakthrough public conversation on employee equity, and employees are asking the key questions: What is startup equity, and how do I know if I have it? Now, expert voices are answering them in the public forum in a blog-to-blog conversation to define the gold standard. This emerging clarity and empowerment in startup culture could not come soon enough.
Gold-standard startup equity meets these three standards:
- Ownership: Employees who own shares can keep them when they leave the company.
- Risk/reward: Employees earn enough shares to reward their risk in joining the company.
- Tax benefits: Employee shares are structured for potential tax benefits of tax deferral and capital gains rates.
These standards empower employees to ask three precise, professional questions to evaluate any equity offer:
- Can the company take back my vested shares?
- What information can the company provide to help me evaluate the risk and reward of the equity?
- Is this equity designed for capital gains tax rates and tax deferral?
This emerging clarity and empowerment in startup culture could not come soon enough. Employees are left jaded when they join companies that simply promise to make equity grants in the future, and don’t keep their promises to reward the risk once their companies are successful. Others are turned off by the story of Skype employees with large holdings of vested equity receiving $0 in a $2 billion acquisition because of tricky, nonstandard equity terms pushed by East Coast-style investors. And startup employees who are burdened with huge debts from surprise tax bills will never see equity in the same way.
In this culture of uncertainty about what is and is not the real thing, the stories of fool’s gold can dilute the incentive power of even true startup equity and undermine the startup world’s long-standing movement to bring together great people to solve great problems. Standards and open dialogue have been so lacking that one Silicon Valley veteran compared the discussion of the startup equity standards to the first wave of sex education in the 1950s.
Employees who use the gold standard can find out if their equity is of the type that allows them to share in the value of a possibly lucrative exit event — acquisition or IPO — and share in the startup dream of an alternative company culture that values individuals and their contributions.
If they know they have true ownership in their company — that that they continue to hold their vested shares after they leave the company — they know that their company will not have the right to buy their vested shares at a discounted price when they leave. They also know that their company wants them to share in the value and growth of the company.
If they know they receive enough shares to reward their risk in joining the company — risk/reward — they know that their upside at the time of an exit will be significant enough to reward their risk. They also know that their employer is transparent enough to give them the information they need to value the offer and make a thoughtful choice.
And if they know their shares are designed for tax benefits — early exercise opportunities or other structures that allow for capital gains tax rates and tax deferral — they know that their gains will be taxed far more favorably than cash bonuses or RSUs offered by the public companies. They also know that their companies consider them the equals of founders and investors, as those founders and investors would never be asked to accept a high-tax equity offer.
Most startup equity does measure up to the gold standard of startup equity, and the smart companies describe it to their employees with transparency and professionalism. This illuminates much more than numbers for recruits and employees. It illuminates the values of an excellent startup company culture, which will shine much brighter in their daily lives and work than any dream of an exit event.
Attorney Mary Russell, founder of Stock Option Counsel — Legal Services for Individuals, is available to counsel individual employees and founders on negotiating and evaluating equity offers and employment agreements, making stock option exercise and tax decisions and identifying their rights and opportunities to sell startup stock. She regularly writes on these topics at the Stock Option Counsel Blog.