Paid in Equity: The Good, the Bad, and the Ugly

Landing a job at a startup often means getting paid in equity rather than cold hard cash. For ambitious job seekers, it can seem like an exciting opportunity with huge upside potential. But before signing that offer letter, it is crucial to understand exactly what they are getting into.

Paid in equity can mean hitting the jackpot when the company takes off. But it also means ending up with nothing at all. Equity pay is risky, but with the right opportunity and the right mindset, the rewards can be life changing.

What Is Equity Compensation?

Equity compensation means getting paid in actual stock or options in a company instead of cash. For startup companies without payroll budget, it is a way to attract top talent. For employees, it is an opportunity to own a share of the company.

• The Good: Big Payout Potential

When the company takes off, equity can be valuable. Pioneer employees at tech giants like Facebook and Google became millionaires. The payout for equity at a startup that succeeds can be life changing.

• The Bad: Risk of Worthlessness

The flip side is equity can end up worthless when the startup fails. There is no guarantee of a big payout, or any payout at all.

• The Ugly: Complex Terms and Dilution

Equity deals often come with complicated legal terms around vesting, dilution, and liquidity. Equity can get diluted when the company raises additional funding through new share issuances. And equity may be hard to sell until there is an initial public offering or acquisition.

Types of Equity Compensation

Stock options are the most well-known form of equity pay. Employees holding stock options have the right to buy company stock at a pre-set price known as “exercise” or “strike price.” It allows them to take actual ownership of granted options over a fixed period.

Restricted stock units (RSUs), on the other hand, represent shares of stock that companies grant to employees for free upon meeting certain conditions. RSUs have more inherent value since employees receive the full share price when the units vest.  This means employees must pay income taxes on the entire value of vested RSUs in the year they vest.

When stock options or RSUs vest or get exercised, employees incur taxes on the difference from the initial price. This is based on the current market value of the shares. Equity pay can be rewarding when the share price grows over time. But employees paid in equity must plan for potentially large tax bills to avoid unwanted financial strains.

Pros and Cons of Equity Compensation

Employees paid in equity must weigh its pros and cons.

One of the biggest benefits of equity pay is the potential for high returns. When the company grows, the worth of equity stake rises. Equity gives employees a personal stake in the success of the company, fostering increased motivation.

Equity pay comes with risks as well. The company may struggle or fail, leaving the equity worthless. Equity stakes come with vesting schedules. Employees must stay at the company for a certain period to get the full value.

Equity pay offers the possibility of big rewards. But employees paid in equity must weigh the risks and downsides it brings. Mostly, the pros outweigh the cons, especially at growth-stage startups, but equity pay may not be ideal for everyone.

Behaviors of Employees Paid in Equity

Employees paid in equity often show different behaviors and mindsets compared to those earning a usual pay.

• Dedication and motivation

Employees paid in equity show higher dedication and motivation. They have a personal stake in the company’s success and growth. Their pay depends on it, motivating them to work harder and care more about outcomes and results.

• Long-term thinking

Paid in equity, employees tend to think more long-term. They realize their equity may take years to fully vest and become liquid. So, they have an incentive to make choices that benefit the company over time. This long-view thinking is valuable for company strategy and progress.

• Ownership mentality

Employees paid in equity develop an ownership mentality. They feel a genuine sense of responsibility for the business like actual owners or shareholders. This leads them to behave in ways that protect and improve the company, as if it were their own.

• Risk tolerance

Employees paid in equity tend to have a higher tolerance for risk. Tying their pay to company performance motivates them to support bold moves or changes that impact the business. While higher risk brings higher reward potential, it brings the possibility of setbacks or losses as well. Employees paid in equity understand and accept this trade-off.

Structuring Equity Compensation

Companies can structure equity pay in diverse ways and it involves a series of steps, including:

1. Define Objectives: Determine the purpose of offering equity pay and how it aligns with company goals.
2. Choose Equity Type: Select the appropriate equity based on company needs and employee preferences.
3. Grant Size and Distribution: Decide the amount of equity to allocate to employees, considering factors such as role, tenure, and contribution.
4. Vesting Schedule: Create a vesting timeline outlining when employees gain ownership rights to the granted equity.
5. Exercise Price: For stock options, set the price at which employees can buy shares.
6. Eligibility Criteria: Establish criteria determining who qualifies for equity pay.
7. Communication and Education: Clearly communicate the structure, terms, and potential value of equity pay to employees to ensure understanding and appreciation.
8. Legal and Tax Considerations: Work with legal and financial experts to ensure compliance and minimize tax implications for both the company and employees.
9. Regular Review: Periodically reassess and adjust the equity pay structure to reflect changing business needs and market conditions.

Structuring equity pay is a complex process crucial for aligning employee incentives with company goals. This involves not only designing equity pay plans but also fostering a shared ownership mindset. It  promotes employee engagement and cultivates a workforce driven by the company's long-term success.