Kyle Holm is the vice president of total rewards advisory at Sequoia Consulting Group, which works with clients on designing their compensation programs. He said in the technology and life sciences industries, offering a grant of options is a very common scenario.
“For a new hire, it’s probably a 90% practice,” he said. ”Equity is a huge component of the overall total rewards package at a company these days.“
But what exactly are those stock benefits even worth?
For companies that are already public and selling shares of stock to the public, it’s easier to understand their value. But for a company that has not yet undertaken an initial public offering (IPO), figuring out the value of stock benefits is “more art than science,” said Gianna Driver, chief human resources officer at Exabeam.
“You do have to take a little bit of a leap of faith,” she said. “Public companies, you know what that value is, because that’s what it’s being bought and sold at right now on the open market. With a non-public company, it’s hypothetical. Technically on paper today, it’s worth nothing.”
“When you receive equity instead of cash, there’s more risk but there’s also more upside.”
– Daniel Lee, director of financial planning at BrightPlan
For early startups that cannot afford to pay new hires competitively high salaries, it’s common to offer new employees stock benefits in lieu of more cash. In a best-case scenario, the company does really well, its value goes up, and its share price skyrockets. You make a generous profit when you choose to sell your stake, because your strike price — or the set price at which you can purchase the stock — is lower than the market value of what your stock options are worth.
In the long run, getting equity in a company can be higher risk, but it’s also higher reward, too.
“When you receive equity instead of cash, there’s more risk, but there’s also more upside,” said Daniel Lee, director of financial planning at BrightPlan and a personal finance instructor at University of California, Berkeley Extension who teaches students about stock compensation. “When I’ve worked with some of the instant millionaires that have come out of IPOs, that’s 99.9% a result of their equity, not their cash compensation.”
But how can you tell what’s a good deal or a red flag when a recruiter or hiring manager is pitching you about their company’s stock benefits? Here are some critical questions to ask yourself and hiring managers before accepting a compensation package with stock options.
1. Are these RSUs or stock options?
First, it’s important to understand what kind of stock benefits you have. One big difference is whether you are being offered stock options or restricted stock units (RSUs).
If you are joining a company after it’s gone public, you are likely getting RSUs, which are the most common type of equity award. One 2018 survey of 150 publicly traded technology companies found that 99% of the companies were giving time-based RSUs to employees.
A stock option is the option to buy your company’s stock at a certain set price in the future. Conversely, you don’t have to spend any of your own money to get an RSU: Your company sets you up on a vesting schedule — predetermined intervals at which your RSUs become available to you —and assigns a fair market value once your RSUs vest. That’s why RSUs are seen as less risky than private company options; once your RSUs vest, they are yours to keep, whereas, with a stock option, you have to buy the option, Lee said.
“They [RSUs] are almost always going to be worth something,” Lee said.
With RSUs, “it’s the same thing as getting a bonus at the end of a year, but instead of giving you cash, they are going to give you shares of the company. And they typically vest over four years, so you get a quarter after one year, and then you might get one portion of it every quarter,” he explained.
2. Is the raise or salary offer below your market value?
You don’t want to sacrifice too much of your salary for stock benefits.
Ask yourself: “Can I live without this money?” said Ramona Ortega, founder of My Money My Future who is working to bring financial education to underserved communities. “You don’t want to be taking stock options if you are not getting a base salary that’s going to cover your necessary expenses,” Ortega said.
She said you should always try to get the market rate of your salary, unless you are independently wealthy or if you really believe in the company and are willing to take on the risk.
“The worst-case scenario is you just take way too much risk,” Lee said. He outlined an example where a person takes on debt to cover their cost of living, because their cash salary is not enough to cover basic necessities like rent. In this situation, “you are just hoping and praying that all these stock options you’ve been getting will be worth billions of dollars, but most companies don’t IPO … Statistically, your options are not going to be worth anything.”
Holm said it’s important for employees to understand the long odds of getting liquidity with stock options.
“It really is a long shot — it doesn’t matter which company it is — that you will actually see liquidity. Maybe 1% of companies actually go public, if that, especially in the current environment. We’re just not seeing a wide-open IPO window,” he said. “Most employees are probably going to be looking at the cash being more appealing, especially with the equity markets where they are at.”
3. How long do you plan to stay at this company?
Reflecting on whether you see a future with this company is key to deciding if an employer’s stock benefits are worth it in the long-run.
Both stock options and RSUs usually vest over several years. Often, there is what’s known as a one-year cliff waiting period, where you are required to stay at the company for at least a year before you receive the benefits.
“Let’s say I was hiring you,” Ortega outlined as an example. “You’re going to get 200,000 options over four years. But you’re not going to get the first drop of those until a year later. You have to stay with the company for a year before you even get any of it. That’s the cliff.”
You typically have to exercise your options within 90 days of leaving the company. As you are weighing the timeframe, you also want to consider whether you could raise enough money in time to buy those options before they expire if you quit or get laid off, Ortega said.
And even if the equity rewards are amazing, you won’t be staying around long enough to enjoy them if you’re driven out by a toxic work environment.
“There’s a saying in HR that people don’t leave jobs, they leave managers,” Driver said. “Yeah, you can throw money at people, you can throw equity at people, and that’s all great and wonderful. But at the end of the day the job does needs to be one that is fulfilling to the employee … That matters a lot.”
4. What is the stock worth today and what do employees and investors think it will be worth in the future?
Once you get a job offer with stock benefits, you have the right to ask more questions about it.
If it’s a private company, you should ask to see its 409A evaluation, which is an independent appraisal of the organization’s stock that determines fair market value by analyzing financial statements, assets and cash flows.
“That’s the latest value of each share of their company,” Lee said, noting that every time the company raises money, they get a new evaluation. “If they’re saying they are going to give you 10,000 options, you don’t know what that is worth unless you know what the price of the shares is.”
Lee estimates that more than half of employers would give you that 409A evaluation if you asked, and if they don’t want to disclose, you should consider that a red flag.
“Where do you see the stock going before it IPOs?” is another good question to ask hiring managers, Lee recommended. “At least you’ll understand what the founder or the company’s mindset is as to where they would like to see the stock go,” he said. “They might say, ‘Shares are worth five dollars today, but we’re targeting the shares to be forty dollars by the time we IPO.’”
Ask how many outstanding shares there are to find out the number of shares investors, employees and executives currently own. This can determine how big of a slice of the pie that you have, Holm said.
“You can give me a number of shares but without the context of how many shares are outstanding, I don’t really know what it means,” he said.
Of course, you can do your own online research to figure out the state of your company’s industry, too. Look at what kind of equity packages people with similar jobs and titles are getting on AngelList. You can also go to Blind, a forum where professionals can anonymously share their compensation packages, to compare what your peers are getting, but as with most review sites where it’s hard to verify claims, you should take what they are saying with a grain of salt.
“It’s incumbent upon candidates to do their homework and diligence to really understand, ‘OK, what sort of media and news coverage is coming out?’”
– Gianna Driver, chief human resources officer at Exabeam
Driver recommends that job candidates look at similar companies that have gone public in the last six months or years.
“It’s incumbent upon candidates to do their homework and diligence to really understand, ‘OK, what sort of media and news coverage is coming out?’” she said. “Is this space that this potential company is playing in, is it a secure space? Is it going to be growing or is it legacy and going to be made redundant over time? What are the multiples [in stock value] of the other companies? Do I believe in this management team? … Many companies have great products, but they don’t have the right leadership to execute on that.“
Know that once you are working within the company, you will gain a better sense of the true value of the organization, for better or worse, Ortega said.
“If they are out there raising money and saying they have the coolest new gadget and are bringing in users, and you know from the inside that it’s a shitshow … At that point, it’s just a matter of [thinking], ‘Well, I don’t know if I really believe this,’” she said.