This is Part One in our series on startup equity compensation .
Startup life isn’t easy. But the perks often make up for it. Casual dress, free beer, and dog-friendly offices are drawing more employees away from the corporate world. “Work hard, party hard” philosophy aside, startups offer something America’s megacorps don’t—equity.
By giving out equity, startups can, in theory, align employees’ incentives with those of the company where those those long hours could lead to a much bigger payoff. But just how much perceived value does equity have to employees? How much does it matter when it comes to evaluating a job offer?
As part of our commitment to bringing more transparency to both professionals and employers, we decided to write our first article on the nebulous topic of employee equity and stock options. We polled over 200 professionals with startup experience, and interviewed several to find out how they feel about it. Not only did equity rank low on the list of reasons for joining a startup, but most didn’t fully understand it. Startups just aren’t forthright with information, with the majority not even disclosing the number shares outstanding to prospective employees. And that lack of understanding seemed to affect the perceived value of equity, as those that did understand it placed more importance on it.
Equity Ranks Second to Last
We asked people to rank the factors driving their decision to join a startup, and we were surprised to learn that that equity ranked as low as it did. Equity came in second to last, just above investors.
Top reasons for joining a startup
The chance to work on something great, the team, and career advancement landed among the top reasons for joining a startup. Unlike an established company, a startup offers the opportunity to help shape the product, company culture, and public image while learning the ins and outs of the business.
As Donnie, the marketing director of an online gaming platform told us, “I always wanted to start my own business, and working at a startup seemed like a good compromise. It seemed like a good way to learn about running a business before trying it myself.”
Limitless possibilities and quicker career advancement are also part of the appeal. “It was the company’s potential that attracted me,” said Michael M., the director of an online media company. “I was also interested in working somewhere in the early stage because there are so many different areas of business that you get to touch.”
Most Employees Don’t Understand Equity
But why don’t more employees see equity as an added bonus? It may be because they don’t fully understand it. Surprisingly, over half of our respondents, 54%, didn’t fully understand their equity offer.
Why? Most said they didn’t know what to ask, nor did they know what the company should tell them. But shouldn’t startups be more forthright with this information? As YC’s Sam Altman wrote on his blog, “Most startups do a bad job of helping employees think about the value of their options. At a minimum, any startup should tell a prospective employee what percentage of the company the equity grant represents (number of shares is meaningless).”
Our survey reflects Altman’s statement. While most employees knew their equity terms before joining a startup, only about 39% were told the fully diluted shares outstanding and how much of the company their equity represented. Considering how little information companies provide, it makes sense that employees, with or without startup experience, are unsure about their offers.
Transparency Makes a Major Difference
When companies are transparent about salary and equity, 45% of employees say they were confident that their compensation package was fair compared to 8% of those at companies that did not disclose the information.
After digging into the data further, we found huge gaps in the level of transparency provided to senior and junior employees. Executives and directors are at an advantage when it comes to equity because they’re typically given more information. In fact, half of our senior respondents said that the company told them the number of fully diluted shares outstanding. Only 25% of junior employees were given the same information.
Employee confidence in understanding their equity offer
Maybe this is why more executives, about 59%, understood their equity offer. Conversely, only 14% of junior employees reported understanding their equity offer. Senior employees also tend to view equity more favorably, with 38% of executives and directors seeing it as a chance to make a lot of money compared with just 14% for junior employees. If given the choice, just 18% said they would have negotiated a higher salary in exchange for less equity. Of the junior employees who responded, 56% said they would prefer more salary and less equity.
What equity means to employees
This may be because senior employees generally have more experience with equity and know what to ask, giving them a better understanding of their equity grants. 67% of executives and directors we polled had previous startup experience. Michael M. told a similar story. Before accepting his most recent position, he worked at another startup for nearly five years and went through the company’s acquisition. “I didn’t know much about equity the first time, but I was more informed the second time and was willing to take the risk,” he said. “I was also in a better [financial] position to take on more risk the second time around.”
However, lack of transparency seems to be the norm at startups. In part two, we’ll explore company transparency and how you can learn more about an offer before you accept.
Cash Is Still King
Lack of transparency may explain why salary ranks above equity in the decision to join a startup.
Over the last five years, compensation structures have shifted to favor cash over equity. According to Tomasz Tunguz of Redpoint Ventures, some non-founder startup executives have seen up to a 26% increase in cash compensation, while their equity grants have dropped by as much as 31%. Tunguz notes that this trend may be due to the recent cash rich startups or demand by new hires for a greater cash/equity split. Our respondents rank salary above equity, which seems to support the latter explanation.
This was definitely Michael N.’s experience. Michael, who works in operations and logistics at a social media company, told us, “One thing I’ve noticed is how different Silicon Valley is from when I first started out. Employees no longer need to sacrifice anything at a startup. They don’t have to take a hit on salary, and they still get equity. If I started a company in Silicon Valley, I’d have to offer higher salaries to stay competitive.”
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