Is your human resources team getting flooded with questions about all things equity from wondering employees?
Did you spend hours and hours putting together a lunch and learn on equity that nobody understood?
We feel your pain.
In the last several years, people ops teams have been taking on a lot of responsibility that they’re not used to shouldering:
Comp planning, merit cycles, total awards, and of course, explaining equity to candidates and employees? Whew. Now you have to ensure everyone on your team has a crystal clear understanding of what total compensation is worth. Particularly during The Great Resignation when retention is paramount.
Here at Pave, we work with numerous startups of varying sizes, from fifty employees to five hundred employees. And one comment we frequently hear from our customers is, our new hires don’t actually know what equity means!
You’re not alone. And your employees are not alone either.
To be fair, understanding one hundred percent of the nuanced details of their stock options is complicated, seemingly overwhelming, and can get buried under the pile of onboarding and training tasks employees are working through in their first few months working for you.
Full transparency, I’ve worked at five startups before, all of which were well capitalized. And between you, me and the internet, equity never made sense to me. It wasn’t until I got hired at Pave that I finally began to understand what this complicated currency meant to my future.
This type of confusion isn’t uncommon at startups, so we want to assure you’re equipped to discuss equity with your team effectively. Let’s start with some of the nuts and bolts in the form of an equity glossary:
In your grant, you are given the option to buy, aka, exercise a set number of shares at a given price. In the future, if your company does well, and there is a liquid market for your shares via a merger or IPO, you should be able to sell your exercised shares and pocket a profit if the then current Fair Market Value (FMV) exceeds your exercise price.
On this date, your employer specifies the theoretical price of your stock options. This is when your vesting usually begins, and this is also known as the sticker price. You get a fixed number of shares at your grant price.
Vesting is the process of earning your stock options over time, typically through continued service with your company. Once an option vests, you then have the option to exercise it, subject to all of the terms of your grant. Check out our post, The Evolution of Stock Options, to dive deeper!
Employers want to incentivize you to stay around longer, so they deliver your shares over a vesting schedule rather than giving them all up front. A typical vesting schedule is four years long. And as companies get later stage, quarterly vesting becomes more common.
When you exercise shares, this means that you have paid for ownership of them. You pay the grant price for the shares. And you may or may not be able to sell your shares when you exercise them, depending if a liquidation event has occurred
This can happen if there has been a qualifying liquidation event such as an IPO. The timing of when you decide to sell impacts whether or not you pay ordinary income tax or long-term capital gains tax. In order to pay long-term capital gains tax, you must sell at least one year after the exercise date and two years after the grant date.
When the first portion of your grant vests. Frequently, for a new hire grant, this will be one year after you join the company.
Usually this is no longer than 10 years from the grant date or 90 days after you leave the company.
Post Termination Exercise Windows
How long you have after cutting ties with the company to exercise your options. If you are terminated, this can be different than if you leave voluntarily.
This refers to when you’re able to sell your vested equity. Liquidity events may include IPOs, acquisitions, company buy-backs, tender offers, or secondary sales. Publicly traded companies do not have a liquidity event: vested shares can be sold on the market per the limitations of the grant.
Vesting is the process of earning your stock options over time, typically through continued service with your company. Once an option vests, you then have the option to exercise it, subject to all of the terms of your grant.
Options that vest are able to be exercised. Grants typically vest in regular intervals, such as monthly or quarterly, beginning after your cliff date.
When you exercise your options, this is the predetermined price you pay. The strike price employees pay increases each year that a company waits to grant them more equity.
Non Qualified Stock Options
Also known as NSOs or NQSOs, these stock options are available to anyone, oftentimes advisors, contractors, etc. They're typically given to non-US employees, and aren't tax advantageous.
Incentive Stock Options
Also known as ISOs, these stock options are generic and the most common. They're only available for full time employees, and are tax advantageous.
Shares for investors, which get paid out first.
Shares for founders and employees, paid out after preferred stock. This is usually what is given to public company employees versus ISOs, or for preIPO startups.
Your ownership percentage is equal to your shares divided by the fully diluted shares outstanding. As the company issues more shares, fully diluted shares outstanding gets larger, so your ownership percentage gets smaller.
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That's a lot of equity language to take in at once, but now you (and your new hires) are well on your way to demystifying compensation.
Ultimately, if you want candidates and employees to dream big about their potential at your company, knowing what their equity might one day mean to them is critical.
With this glossary, you and your team are one step closer to making sense of the otherwise ambiguous world of startup equity. We’re confident this guide will empower your employees to speak a language that supports their career goals.
Pave’s tools can help explain equity to your team. If you work in human resources and need help explaining vesting, preferred pricing, refresh worth and grants to your company, set up a demo with us today.