There was a pretty enlightening trend on Twitter a few days ago, where folks in tech were sharing and comparing their compensation. For me, it cemented the idea that compensation in the tech industry is highly situational. What an employer may offer in base salary, equity, bonuses, and other benefits, largely depend on the role being filled, and where the company and employee are located. There is no one size fits all. To say the least, company strategies for compensation can be far from simple. Considering this, most tech companies offer equity as part of the compensation package, but employees rarely understand the value or how it fits into their financial plan. If faced with the opportunity to negotiate a better offer, how do you decide between salary and equity?
Salary vs. Equity: What’s The Difference
The advantage of being paid a base salary is that its a fixed amount of income that you can expect and plan your future around. Alternatively, in the context of compensation and investment, equity represents ownership in the company in the form of stock. Generally, the return on equity is often linked to company growth and performance. The purpose of equity compensation from an employer’s perspective is threefold: to attract and retain talent, align incentives, and reduce cash spending.
- Attract and retain talent. When a company demonstrates or has good predictability to manifest financial success, employees are incentivized to work for the company in hopes of their equity being worth a substantial amount of money in the future.
- Align incentives. Startups are usually strapped for cash, but even companies that can afford to pay higher salaries may prefer to give employees equity. The idea is that employees will work harder to achieve financial success for the company and increase the future value of their equity. In this way, equity can align employee incentives with company interests.
- Reduce cash spending. By awarding equity, a company can often pay less in salary compensation to employees now, with the hope of rewarding them with equity later. The cash savings can then be allocated toward other investments or operating expenses.
Types of Equity Compensation
Both private and public companies offer equity compensation for myriad reasons. Equity compensation can be granted in many forms, each with unique characteristics, benefits, challenges, and importantly varying tax implications. These characteristics will impact your overall financial plan, so you’ll want to identify your specific equity compensation type to understand its benefits and potential challenges.
From my experience, most Pre-IPO startups offer equity in the form of incentive stock options and non-qualified stock options. On the other hand, most Post-IPO and mature companies grant equity in the form of Restricted Stock Units (RSUs) and Employee Stock Purchase Plans (ESPPs). Recently, I’ve seen a few companies offer cash as an alternative, RSUs, at-the-money stock options, and out-of-the-money stock options — and gives the employee the choice to select what best fits their needs.
For instance, let’s say you have a low-risk tolerance, and you’re starting a family or planning a wedding, the cash alternative would likely be the best choice. But if you’re in a financial position to take on more risk, taking the RSUs or even a mix of RSUs and stock options is likely the best strategy. Though I haven’t seen it in many plans, it’s a fantastic opportunity to further align your equity with your financial plan, and I sure hope it becomes widely adopted.
With that said, if you’re deciding between salary and equity here are some things to keep in mind:
Can you maintain your lifestyle on a lower salary?
Although they’re not mutually exclusive, equity compensation often goes hand-in-hand with a below-market salary. It’s critical to know your minimum number. If you can reshuffle your priorities and costs, so your reduced salary doesn’t make a significant difference in your lifestyle and ultimately your goals, then you’ve mediated much of the pay cut. It’s worth noting that cutting down might be a bit more challenging to do if you live in a high-cost city like New York City or San Francisco, where living expenses can put a dent in your income.
What does your four-year career plan look like?
Awards of equity compensation are almost always subject to a vesting schedule. Vesting simply means that an employee is required to wait a specific amount of time before gaining full rights to the shares in the equity grant. The most common vesting schedule I’ve seen is four years, on a monthly basis, with a one year cliff. In essence, this means that 25% of stock vests each year for the first four years of that employees’ time at the startup, in monthly or sometimes quarterly increments. Generally, if an employee resigns or is terminated immediately, they get no equity. If they stay for years, they’ll get most or all of it. In any event, be sure to keep your career plans in mind when deciding between salary and equity.
How strongly do you believe in the company and its mission?
The main risk associated with equity compensation is that there is no guarantee that you’ll gain from your equity’s appreciation in value. Many variables can influence whether your equity stake will actually pay off. Is it worth it to sacrifice a portion of your salary for the potential at winning big in the future? You’ll have to put your VC hat on because the answer will come down to how optimistic you are in the company’s future.
Negotiating Your Offer
Everyone wants to walk away from the negotiation table with the feeling like they’ve won. When deciding between salary and equity, the key is to win at the right things. After you’ve done your research, take some time to determine what matters to you.
For startups, cash is the most precious resource, and founders may welcome individual requests to trade salary for more equity. Assuming you are offered a market rate salary and equity, and your employer is willing to make some trade-offs, you will need a framework to help you judge how much equity makes sense.
Your strategy will depend on the stage of the company you plan to join.
For early-stage startups, you’ll want to find out the company’s current valuation as well as the amount of shares outstanding. If you divide the company’s valuation by the number of shares outstanding, you will derive at the price per share. You can then divide the amount of salary you’re willing to sacrifice by the price per share to determine the number of stock options you should receive.
For example, imagine you’re offered $100k to join a promising early-stage startup and choose to forgo $10,000 of your salary for more equity. Assuming the company can raise at a $5 million valuation and there are 1 million outstanding shares, the company can raise money at $5 per share, and you can receive 2,000 additional shares for your willingness to sacrifice $10,000 of your salary.
For mid-stage Pre-IPO startups, the trade-off should be based on the number of shares an employee could purchase at the current stock option price. Let’s say an employee wanted to forgo $10,000 of salary for the opportunity to buy more shares, and the current option price was $2 — the company will likely advocate granting an additional 5,000 shares.
As I mentioned beforehand, tax ramifications of equity can be far more complicated than salary earnings. Equity compensation can be quite convoluted — but with the appropriate resources and a viable strategy in place, you may be able to leverage your equity within your financial plan to meet your goals sooner than you know.