Startup Equity 101

Startup equity compensation can give you ownership now, or the right to acquire ownership later, depending on the instrument.

That is different from cash compensation. You are not being handed a fixed amount of money. You are being given an interest whose future value depends on what the company becomes, the rights attached to your security and whether a liquidity event ever occurs.

A large-sounding grant can still be worth nothing. A smaller grant in a company that becomes valuable can be worth a great deal.

The first rule is therefore simple:

You need to understand what the instrument is, what percentage of the company it represents and what could happen to that percentage and value over time.

A startup equity offer can take several forms.

You may receive shares outright, options giving you the right to buy shares later, or another form of equity award such as restricted stock or restricted stock units. The exact instrument matters because ownership, exercise and tax treatment differ.

For an option grant, the option itself is not the same thing as owning the underlying shares. You normally become a shareholder only when you exercise vested options and acquire the shares.

The raw number is also not enough.

Ten thousand options could represent a meaningful stake in one company and a negligible stake in another.

“Fully diluted” is the basis most useful for comparing an equity grant with the company’s broader capital structure.

A fully diluted share count typically includes outstanding shares plus securities and equity awards that can become shares, such as outstanding options, warrants and the option pool. Convertible instruments may also be included depending on the company’s cap-table methodology and the stage of the financing.

That last point matters.

There is not one universally useful number if two companies are calculating the denominator differently. Ask what is included.

One basis point is one hundredth of one percent.

1 basis point = 0.01%

So:

Basis points are simply a convenient way to discuss small percentages. They are not a different type of equity.

Vesting determines when you earn the right to keep the equity award.

A common startup arrangement is four-year vesting with a one-year cliff. Under that structure, nothing vests during the first twelve months. At the first anniversary, 25% vests, and the remainder then normally vests in regular instalments over the following three years.

That is common, not universal. Read the actual grant documents.

The cliff matters.

If you leave before the cliff date, you will typically leave with none of the grant vested. If you leave later, you usually keep only the portion that has vested, subject to the terms of the plan and any exercise deadline.

Also ask what happens if the company is acquired.

Some grants include acceleration provisions. Others do not. Where acceleration exists, it may depend on both a change of control and a subsequent termination rather than the acquisition alone.

If you receive stock options, the exercise price, also called the strike price, is the amount you must pay per share to exercise the option and acquire the underlying shares.

For US private-company options, the strike price is commonly set at no less than the fair market value of the common shares on the grant date, often using a 409A valuation.

That is not the same thing as the price investors paid for preferred shares in the latest financing round.

Those are different securities with different rights.

Ask for both numbers:

Also ask how long you have to exercise vested options after leaving the company. The deadline can materially change the practical value of the grant.

Dilution happens when the company creates additional shares or securities that become shares.

Your number of shares or options may stay the same while the total fully diluted share count grows. Your percentage ownership therefore falls.

That is normal in venture-backed companies. A financing can dilute existing holders while also giving the company capital to become more valuable.

Suppose you receive 50,000 options when the company has 10,000,000 fully diluted shares.

Your starting ownership is:

50,000 / 10,000,000 = 0.50%

Later, assume a financing and related cap-table changes increase the fully diluted share count to 12,500,000 shares.

You still hold 50,000 options, but your percentage becomes:

50,000 / 12,500,000 = 0.40%

You have been diluted from 0.50% to 0.40%.

That does not tell you whether you are economically better or worse off.

If the company’s headline valuation also increased materially, the arithmetic “paper value” attached to the smaller percentage might be higher than before. But that figure is still not what you would necessarily receive in an exit. It ignores the strike price, share class, liquidation preferences, tax and the actual terms of any future liquidity event.

A headline financing valuation is not a cash price for your employee equity.

The latest round usually prices a particular class of preferred shares. Employees commonly hold or acquire common shares, which may have different rights.

Investors may also have liquidation preferences. Those preferences can affect how exit proceeds are distributed, particularly when the exit value is not dramatically higher than the capital invested.

Treat paper value as a scenario, not a promise.

Future financing can change the cap table in several ways.

A round may:

The exact ranking of investor rights varies. Do not assume every new round simply sits “ahead” of the previous one in the same way.

What matters to you is understanding the current shape of the cap table and asking how your grant is expressed within it.

If the company expects to raise substantial additional capital, assume further dilution is possible.

That is not automatically bad. The relevant question is whether the capital increases the probability and scale of the outcome enough to justify it.

A strong company should be able to explain the grant clearly without pretending it knows what the equity will eventually be worth.

Before accepting the offer, I can answer all of these:

Nothing here is legal, tax or financial advice.

Equity treatment varies materially by jurisdiction, company structure, award type and individual circumstance. Tax rules can also change over time.

Use this guide to ask better questions. Use a qualified adviser to make decisions about your own equity, exercise timing and tax position.