Stock compensation is complex, and there are many hidden rules. This guide will help you understand the value of your equity compensation and the rules that guide it.
The most basic way to understand the value of equity grants is to know what percentage of the total outstanding shares your grant represents. Basically, what percent ownership of the company will you have? Understanding the percent ownership gives you 1 an understanding of the current and potential cash value of the equity, and 2 helps employees compare equity grants to see how their stock package compares with others.
Ask your company what percent ownership the shares represent when being hired. Over time, there are two primary mitigating factors to your percentage ownership. First, as the company raises more money, your percent ownership will go down. As long as you know 1 how many shares you were granted and 2 how many total shares the company has issued and reserved for additional equity awards, you can figure out your current percent ownership. Another important factor to understand is the type of liquidation preferences if any that sit on top of your equity.
The exercise price, or strike price, should be at least equal to the fair market value of the stock at the time of grant. Companies fight to keep the strike prices as low as possible for their employees. The hope is for the strike price to be a fraction of the price of the shares underlying the option when the option is exercised. The earlier you join the company the lower your strike price will typically be. Each successive round of capital the company takes in typically raises the strike price of the stock options.
The exercise period is typically 10 years for an option. This sometimes puts a burden on departing employees who may not have the cash to buy the shares, even at a drastically lower strike price. When employees receive stock options, they are put on a vesting schedule, this means they have to be with the company for a period of time before they earn their shares which still need to be exercised. The most common vesting schedule has typically been four years, with a one-year cliff.
Most companies then put employees on monthly vesting schedule going forward for the remaining three years, but some companies do a year-long cliff before each full year of employment. Large scale growth companies like Snapchat and Uber often have policies like these to be able to retain their top talent longer. ISOs can prove beneficial to employees because 1 regular federal income tax is not triggered upon exercise of ISOs although the alternative minimum tax may be and 2 qualifying dispositions of ISOs selling your stock enjoy long term capital gains treatment.
In order to qualify for long term capital gains, the option must be exercised during your employment and the shares issued upon exercise must be held for at least one year after the exercise date and at least two years from the date the option was originally granted. ISOs can only be granted to employees not to advisors, consultants or other service providers. Non-Qualified Stock Options NSOs are taxed upon exercise as opposed to when the underlying stock is sold based on the difference between the strike price of the options and the fair market value of the stock at the time of exercise.
Also, NSOs are taxed at ordinary income rates as opposed to capital gains. But since the equity is being cashed out and not in accordance with ISO rules, it will be taxed as ordinary income.
However the potential tax benefits need to be weighed against the possibility that the shares may never be liquid and have no value. In that case, the price paid to exercise the shares would be losses the individual would take. Your Ultimate Guide to Applying for a Patent. While the Board of Directors can issue more stock the pool if it runs out, that would mean dilution for all existing shareholders.
The board of directors must approve all stock grants, and so the negotiation for equity compensation is a bit more complicated and involved than cash compensation, which is approved by the officers of the company. In many cases, companies set the expectations with their team that the original grant will be the extent of their equity compensation. Also additional equity grants are often offered as retention for top talent, company leaders want to retain.
Those refresher grants typically have 4 year vesting schedules, although many companies in that situation, forgo a one-year cliff on the refresher grant and keep to all monthly vesting. In some cases, equity grants will include acceleration provisions for the employee.
Single trigger usually refers to acceleration upon a sale of the company. Founders sometimes negotiate for single trigger acceleration in rare situations; it almost never granted to other employees.
Double trigger is the most common type of acceleration. It requires the occurrence of two separate events: For example In this case: Double triggers are most often reserved for senior executives in a company.
Just like they underlying equity grants, acceleration provisions need to be approved at the Board level. The Right of First Refusal means that prior to selling vested shares an employee must give the company the ability to purchase the shares on the same terms as a third party that would like to buy the shares. Jason Nazar is the founder and CEO of Comparably, an online platform that aims to make compensation and workplace culture more transparent. By Jason Nazar September 27, You should ask what percent of the outstanding shares your equity grant represents.More...