Mistakes to Avoid When Choosing Equity: A Guide for Employees‍

Casey Fenton

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November 7, 2023

Imagine this scenario: Mark joined a small startup in its early days, excited by its innovative vision. Like many employees, he was quickly handed an equity offer. Overwhelmed and without much thought, he accepted. Five years later, that startup flourished, becoming a market leader. But while his colleagues reaped substantial rewards from their equity, Mark realized he'd made a grave mistake in his haste. He hadn't understood the ins and outs of his offer, leaving substantial money on the table. 

Don't be like Mark. Navigating the world of employee equity can be intricate, but with the right guidance, you can make informed decisions that align with your financial goals.

Understanding Equity Compensation

Equity compensation is more than just another line on your employment offer. It represents trust, an investment in you by your company, and vice versa. While traditional salaries pay for the work you do, equity is a bet on your future contributions and the company's growth.

In a nutshell, equity compensation is about partnership. When a company offers you equity, it's essentially saying, "We believe in our joint future." They're providing you with a tangible stake in the company's fate, aligning your interests with theirs. It's an invitation to grow, innovate, and strive together, with the understanding that when the company thrives, you will too, not just as an employee, but as a stakeholder.

Yet, the complexities of equity offers often lie in their structure. Are you being offered a percentage of the company? A fixed number of shares? How do these shares compare to the total number of shares in the company? The specifics matter. For instance, 1% equity in a startup with substantial growth potential is vastly different from 1% in a mature, slow-growing firm.

Additionally, it's essential to understand the symbolic nature of equity. Yes, there's potential financial gain, but it also represents a company's culture, ethos, and its vision for the future. A firm that regularly offers equity to its employees is one that values transparency, shared success, and collective ownership of both its triumphs and tribulations.

Remember Mark from the beginning of this article? He missed the basics, and then the deeper understanding. Don't view equity merely as a monetary bonus waiting to be unlocked. See it as a sign of trust, a shared journey, and a commitment to a collective future. As you venture further into equity compensation, ensure you grasp not just its financial implications, but also its deeper meaning in the context of your professional journey.

Why is Equity Compensation Important for Employees?

At a surface glance, equity compensation might seem like just another perk in the package, but its significance goes much deeper. It's an intricate blend of financial strategy, personal alignment with a company's vision, and a manifestation of professional value.

Employee Empowerment

Equity instills a sense of ownership. It’s not just about monetary gains; it’s about being part of the bigger picture. When you hold a piece of the company, your stake goes beyond daily tasks. You’re intrinsically motivated to contribute innovatively and proactively, knowing that the company's success is, in a way, your success too.

Long-Term Alignment

Unlike a fixed salary which is transactional, equity binds you to the long-term trajectory of the company. This fosters a mindset of sustainability and growth. Instead of short-term gains, you start thinking about where the company could be in five or ten years. This alignment can be a catalyst for innovation and dedication, two pivotal drivers for professional growth.

Flexibility in Compensation

Especially in startups or companies in their growth phase, cash flow might be limited. A competitive equity offer can balance a lower initial salary, ensuring that you're compensated not just for your present efforts but also for the future potential you bring. It's a mark of trust, a promise that as the company grows, so does your share of the pie.

Risk and Reward Dynamics

Equity introduces employees to the world of investment without needing to inject personal capital. While there's an inherent risk—not all companies succeed—the potential upside can be life-changing. This dynamic can shape your risk-assessment skills, encouraging you to view challenges and opportunities through a holistic lens, a valuable skill in any professional setting.

Professional Legacy

Holding equity is a testament to your role in the company's journey. Long after you've moved to other endeavors, your equity serves as a reminder of your contributions, of a time when you played a part in shaping a company's future. It's not just about financial gains; it's about leaving a mark, about being part of a story larger than oneself.

Types of Equity Compensation Offered to Employees

The landscape of equity compensation is diverse, with each type carrying its distinct features, advantages, and considerations. Here’s a closer look at the common forms:

1. Stock Options

Stock options grant you the right to purchase company shares at a predetermined price, often referred to as the "strike price." Think of it as a window of opportunity. If the company's value increases over time, you have the chance to buy at that lower, predetermined price and benefit from the growth. This potential difference between the market price and your strike price can lead to significant gains. However, it's worth noting that stock options may have expiration dates, meaning you need to exercise them within a set timeframe to reap the benefits.

2. Restricted Stock Units (RSUs)

Restricted Stock Units (RSUs) represent a company's promise to give you shares or the cash equivalent of shares after a certain period, usually contingent on specific milestones or a vesting schedule. Unlike stock options, there's no purchasing involved. Once vested, the RSUs become like regular shares, which you can hold or sell. Their primary advantage is the certainty they offer: even if the company's stock price decreases, RSUs retain intrinsic value.

3. Stock Purchase Plans

Employee Stock Purchase Plans (ESPPs) offer a unique avenue for employees to invest directly in their company. Typically, through payroll deductions, employees can buy company stock, often at a discounted rate. This method serves dual purposes: it allows employees to become shareholders and benefit from potential appreciation, and it fosters a sense of shared ownership and commitment to the company. Given the discount and the convenience of purchase, ESPPs can be an attractive method of acquiring shares, especially if you believe in the company's long-term growth.

Can You Choose Which Equity Plan to Participate In?

The realm of equity compensation is not a one-size-fits-all scenario. Depending on your position, the company's stage, and its compensation philosophy, the types of equity offers can vary. But can you choose which to participate in? It depends on the following scenarios:

1. Company-Defined Offers

Most commonly, companies have a standardized equity compensation structure, especially for entry and mid-level roles. In such cases, the type of equity—be it Stock Options, RSUs, or any other form—is predefined. Here, your room for negotiation may revolve more around the quantity or the terms rather than the type of equity itself.

2. Senior Positions and Unique Roles

If you're stepping into a C-suite role or a position that's pivotal for the company, there might be more flexibility in the equity structure offered. Due to the significance of these roles and the expertise they bring, companies often customize offers, aligning them with the candidate's preference and market standards. In such scenarios, you might be able to choose or even propose a specific type of equity compensation.

3. Startups vs. Established Companies

Startups, given their fluid nature, might be more open to discussions regarding equity type. If they're in their early days and cash flow is tight, they might lean heavily toward stock options. However, if you bring a unique value proposition to the table, they might be amenable to discussions. Established companies, with set HR policies and larger employee bases, tend to have more rigid structures, making it less likely for individual employees to choose their equity type.

4. Employee-Driven Choices

Some companies offer programs where employees can choose how to receive a portion of their compensation, be it as cash bonuses, RSUs, or stock options. For instance, a company might provide an annual bonus choice: take it as cash now or as RSUs that vest over time. In such models, the choice rests with you, allowing you to align your compensation with your financial goals and risk appetite.

Examples:

Scenario 1: A tech startup might offer its developers stock options as standard. However, when negotiating with a potential CTO, they might offer a mix of stock options and RSUs, considering the strategic importance of the role.

Scenario 2: An established corporation offers its middle management RSUs as part of its annual bonus. However, when hiring a new CFO, the company provides a choice: a higher percentage of RSUs or a blend of RSUs and stock options, allowing the CFO to choose based on their financial strategy.

In other words, while there are standardized practices in equity compensation, scenarios exist where choices can be made. It's important to understand your position, the company's stage, and its approach to equity to gauge where you stand.

Mistakes to Avoid When Choosing Equity

When it comes to equity compensation, the stakes are high. A misstep can lead to financial consequences or missed opportunities. By being aware of common mistakes, you can steer clear of them and make decisions that align with your career and financial goals.

1. Not Understanding Vesting Schedules

Vesting schedules dictate when you'll actually own the equity you're being offered. A common error is assuming that an offer of, say, 1,000 shares means you'll receive all of them immediately. Always understand the vesting terms. If you leave before a certain period, you might walk away with much less than you expected.

2. Overestimating Equity's Current Value

It's easy to look at a company's current stock price and project potential earnings. However, stock prices fluctuate. Especially in startups, there's a risk of the company not growing as anticipated. It's essential to see equity as a long-term play and not just a quick financial win.

3. Neglecting Tax Implications

Equity compensation has tax consequences, and they can be complex. Whether it's the point of exercising stock options or when RSUs vest, there might be a taxable event. Not planning for these can lead to unexpected financial burdens.

4. Undervaluing One's Worth

Especially in startups or fast-growing companies, equity can be a significant part of compensation. Not understanding the market standards or undervaluing the unique skills you bring can lead to accepting a subpar equity offer. Always benchmark against industry standards and similar roles.

5. Over-relying on Equity

While equity offers the potential for significant financial growth, it should be one part of a diversified financial plan. Basing major life decisions on anticipated equity returns can lead to challenges if the company doesn't grow as expected.

6. Not Considering Company's Financial Health

When evaluating an equity offer, delve into the company's financials. Is the company profitable? Are there any significant debts? An equity offer from a company with unstable financials is vastly different from one with a robust economic standing.

7. Ignoring the Bigger Picture

Equity should be considered as part of the overall compensation package, alongside salary, benefits, and work culture. Don't be so enticed by an equity offer that you overlook other essential aspects of a job offer.

By sidestepping these common pitfalls, you position yourself for success. Equity decisions should be made with a blend of optimism and pragmatism, considering both the potential rewards and inherent risks.

Situational Examples Depicting Common Employee Mistakes in Choosing Equity

The Hasty Decision-Maker: Jake's Over-Reliance

Jake, a software developer, was thrilled when a budding startup offered him stock options as part of his compensation package. He saw colleagues in other firms cashing in on their equity and was eager to do the same. However, without researching the startup's financial health and prospects, Jake took a lower salary for more stock options. Unfortunately, the startup didn't gain the expected traction, and his stock options remained underwater. Jake's over-reliance on equity, without considering other factors, left him with less financial security.

Sara's Vesting Misunderstanding

Sara, an experienced marketing strategist, received an offer from a well-established tech firm. She was offered 2,000 RSUs, and without delving into the vesting schedule, she assumed they'd be hers immediately. However, the company had a four-year vesting plan with a one-year cliff. Sara left the company after 11 months for a better opportunity, walking away with none of her RSUs vested.

Tax Troubles with Robert

Robert, a senior executive, was offered a lucrative stock option plan at a rapidly growing e-commerce company. When the stock price soared, Robert exercised all his options. However, he didn't account for the tax implications of this move. When tax season arrived, Robert found himself with a substantial unexpected tax bill.

Emily's Undervaluation

Emily, a seasoned data scientist, was offered equity in a health-tech startup. While she did her homework on the startup's potential, she failed to benchmark the equity offer against industry norms. She later discovered that peers in similar roles at comparable startups received considerably larger equity offers, making her realize she had undervalued her worth.

Tom Ignores the Bigger Picture

Tom, a product manager, received two job offers. One from a well-established firm with a good salary, comprehensive benefits, and a moderate equity offer. The other is from a startup, with a lower salary but a significantly larger equity offer. Blinded by the potential of the equity, Tom chose the startup. However, he soon realized that the company's work culture wasn't fit, and the lack of benefits took a toll on his work-life balance. His focus on equity made him overlook other critical aspects of the job.

By understanding these real-world scenarios, employees can better navigate the complexities of equity offers, ensuring they make decisions that align with both their financial and professional aspirations.

Don’t Get Lost in the Process

In the labyrinth of equity compensation, awareness, and informed decision-making are your best guides. As you've studied, the stakes are both promising and precarious. While the allure of equity—be it in RSUs, stock options, or other forms—can be captivating, it's essential to balance optimism with due diligence. One way to ensure this balance is by leveraging an efficient and transparent equity compensation platform. Such platforms simplify the intricate dance of managing equity grants, ensuring that what you're offered, earned, and vested is clear, trackable, and in your best interests. As the landscape of compensation continues to evolve, having the right tools and knowledge at your disposal will definitely benefit your financial growth and security.

To know more about how Upstock delivers equity compensation management trusted by reputable brands and startups, book a demo today.

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ABOUT THE AUTHOR

Casey Fenton

Founder, Upstock & Couchsurfing, AI and Equity Innovator

Casey Fenton, the founder of Upstock & Couchsurfing and an AI and equity innovator, has revolutionized how we perceive and implement equity in the workplace. His foresight in creating platforms that not only connect people but also align their interests towards communal and corporate prosperity has established him as a pivotal figure in technology and community building. Casey speaks worldwide on topics including ownership mindset, worker equity, With Upstock and Couchsurfing, he has demonstrated an unparalleled expertise in harnessing technology for the betterment of community interaction and organizational benefits.

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