A Rising Equity Ecosystem
It’s no secret that start-ups are relatively strapped for cash. As such, it is common and often expected of them to offer low salaries and high perk packages, such as equity, to preserve cash and generate business operations. But this doesn’t mean a high return on investment is out of the picture. It’s quite the opposite.
Equity compensation is frequently offered to compensate for an initial lower salary in the GreenTech startup ecosystem. This means employees are given a partial stake in the company, issued in the form of shares, stock or options. In Hired’s 2021 State of Tech Salaries report, this is seen as a favored option, with 76% of candidates willing to accept a lower base salary for equity.
But it doesn’t come without weighing the trade-offs. Whether you’re choosing between a salary package offer or an equity package offer, it is integral to understand what equity compensation is, how it is different from a salary package, and most importantly, whether this aligns with your needs. To find out more about what it means for you as an employee and whether you should base your decision on a salary or equity package, read on!
Salary Vs Equity: The Difference
The most important balance in negotiating an offer sits with both equity and salary. It’s easy to think that a lower salary means you are undervalued, but in reality, it’s a package that incentivizes employees to help the company do well in the long run whilst allowing the start-up to conserve cash flow to grow and prioritize other plans.
As simple as cash in your pocket, a base salary is a fixed regular payment that should cover living expenses and necessities. This package means an employee is not tied to the company in the same way when you own equity, and you keep whatever you earn when you earn it. Most large firms in any industry impose salary range structures or pay grades, that cap the most you can earn, even after multiple years of service.
Equity is a type of non-cash compensation, giving an employee part-ownership of the company. At a high level, this is essentially a bet on the company’s future success, meaning you can benefit monetarily from its growth and success. Take a look at the early employees of Google or Facebook to see how their bets turned them into millionaires.
What Exactly Is Equity?
Defined in finance terms as the value attributable to a business, equity is becoming an increasingly popular offer from start-ups. Despite the many variables that can influence an equity stake, it holds a huge upside for the start-up to conserve cash flow, whilst giving employees an intangible amount of potential wealth. For example, if a Chief Technology Officer is hired in a Series A GreenTech start-up and offered a salary 35% below the market rate, the start-up may provide a certain % of equity to offset that.
Equity compensation typically has a vesting schedule, which outlines when and how an employee becomes entitled to shares or options. For example, when you receive stock options on a specified grant date, you can’t exercise those options until they fully vest. Most vesting schedules follow a 3-5 year plan, though the structure can vary by employer.
Employers use vesting schedules as a tool to encourage employees to remain with the company for longer periods. When 100% of your assets vest, they are yours and cannot be taken away from you for any reason. However, if you leave the company before some stock is fully vested, you may forfeit some of your assets.
The Types Of Equity Available
There are a variety of different employee equity compensation options that can be offered. What is offered is generally the most suitable type for the company at the time. What is important here is to figure out if the type of equity being offered aligns with your needs. The three main types of equity compensation are:
Arguably the most renowned equity type on the market, stock options give employees the right to purchase a particular amount of company share for a set price, also referred to as strike or exercise price. Only after the pre-set vesting period will the shares be accessible.
Or also known as restricted securities or letter stocks, is company stock which becomes available to transfer after certain specified restrictions have been met. Examples of such restrictions are timing or performance related, similar to the restrictions you will find in stock options. Some argue that this type of equity compensation should be considered as an extra bonus reward rather than cash.
Restricted stock is a great alternative to other equity compensation types, especially stock options.
This is especially true for executives and directors, which in most cases this type of equity is reserved for due to their favourable income tax treatment and accounting rules. The two main types of restricted stock options to be aware of are Restricted Stock Units and Restricted Stock Awards.
Employee Stock Purchase Plans
The third type of equity compensation is through purchase plans, which are solely restricted to employees (they cannot be issued to contractors, consultants, corporate board members or shareholders whom founders don’t employ). This option allows companies to offer employees the chance to buy their shares for discounted rates. In addition to this, employee stock purchase plans are only restricted to a $25,000 limit per employee, per year. Generally, people buy the units or shares through payroll deductions, giving this option a unique tax advantage.
At certain parts of the year, employers utilize the funds they accumulated to buy stock for their employees.
So, Should You Choose Equity Or A Higher Salary?
For some, the stage of which they are at in their career could mean immediate cash (salary) is more important than the promise of returns in the future (equity). Salary compensation is incredibly reliable compared to other forms of compensation as employees know the amount of money they will get and the date they will receive it on. It is a major reason this type of compensation is a dependable, steady payment form that lets you plan for saving and spending in the future.
On the other hand, if you are in a fortunate position where you can forgo the immediate pay-off for the ROI to come, there is a high chance that if the company is to succeed, stock options may provide a large pay-out compared to a regular salary.
That being said, there are risks associated with both compensation options, which could pull you towards one pathway more than the other. Equity compensation relies heavily on the company’s and market’s performance, which varies significantly depending on the particulars and structure of the organization providing the compensation. For salary compensation, there aren’t any opportunities for higher pay-outs than what is documented on the company’s official paygrade, as well as the risk of the organization going under or job layoffs.
It is also important to consider the tax implications brought on by equity compensation and its impact on future earnings.
Factors To Consider When Evaluating Salary And Equity Options
Having the option to choose between compensation packages is never a bad thing; it is a testament to the skillset you bring to the table and the value-add you are in the business. However, it can be confusing to know what is best and what move is right for you. Consider the below points to evaluate your options.
Can you survive on the lower-salary offer?
It can be invigorating and a great learning experience to join an early startup, particularly if your experience has been in the corporate world. However, this typically comes with lower salaries paired with higher equity stakes.
Take a look at your expenses to determine the minimum salary you would be able to accept. This is critical in expensive tech hubs in the US and Europe, where living expenses can eat up a huge chunk of your income.
What is your four-year plan?
If your equity is on a typical four-year vesting schedule, you will not have the option to purchase any shares before year one, and the remainder will take an additional three years to vest.
Factor in any future plans that you may incur, for example, relocation, further education or the role only being a stepping stone for the time being.
How strongly do you believe in the company?
Hopefully, you’re excited about the prospects of joining a new company, but trading off between salary and equity is a time to think critically about how optimistic you are about the company’s future, as well as its exit prospects, which will ultimately determine what your equity will be worth.
Of course, this isn’t easy, but it’s an important factor to consider if you’re leaning towards a lower salary but a company you’re excited about.
What is the percent ownership?
Rather than evaluating the number of shares, look at the percent ownership that those shares represent. Ask the hiring manager for the company’s number of shares outstanding for each role and calculate the percent ownership each offer would represent. Compare these numbers between your offers.
What are the shares worth today?
Even if you do purchase the shares, they’re not worth anything until an exit event, like an IPO or acquisition. The unfortunate reality is that a large percentage of startups fail, rendering the shares worth nothing.
Particularly if the company is early-stage, keep in mind that even if its future looks bright, an exit could take years, meaning you’ll have to hold onto the shares for a long time in order to capture any value from them.
Do the alternatives make financial sense?
If a company has offered you two different packages, one with more equity and the other with a higher salary, it’s worth running some quick calculations to figure out if the two numbers are reasonably equal. The numbers will never be foolproof, but it’s a good idea to create estimates for a more informed comparison.
Get in Contact
As the GreenTech industry continues to grow, so does the need for talent to enable this. At Storm4, we are also on the same growth trajectory as many of the GreenTech players we partner with, having received $11M in Series A investment. As such, we understand the tribulations and hurdles that come with what to offer employees concerning salary and equity. For any advice on how to attract such talent and grow your teams, please don’t hesitate to get in touch to see how we could support your journey.