May 29, 2015
If you’re a startup employee reading this article, you may have received equity in your company. Company ownership gives you a stake in your company and can result in an important portion of your overall compensation. However, while most people are very aware of their paycheck, and check their bank account regularly to ensure they were paid for their hours worked, many individuals take a passive role in their stock compensation.
Here are three reasons you should be watching your equity like a hawk from the day you receive it.
1. It’s Compensation
You should view your equity in the same way that you view your salary; both are compensation for the work you are contributing to your company. This is ESPECIALLY true if you are taking a below-market salary and your equity is meant to fill in the gap.
If you have options, you should understand the mechanics of your option agreement. Details such as:
- strike price (also called exercise price).
- vesting schedule (when you can exercise the option)
- type of grant: ISO or NSO (there are VERY different tax implications)
- change of control triggers (if the company is acquired, what happens to your options)
- expiration policy (after leaving the company, how long do you have to exercise your options)
Additionally, you may wish to know the percentage of the company you own. As an employee, you don’t necessarily have a right to this information, so any conversation with your employer should be handled delicately; but if you are taking a substantial pay cut to go to an early-stage startup, it’s not unreasonable to ask your potential employer this question.
2. Mistakes Can Be Made
Most companies use automated payment software to handle their employees’ paychecks. Sadly, when it comes to their employees’ equity, many companies aren’t using anything more advanced than Excel spreadsheets.
Excel is a very flexible tool, but it is not transparent, is prone to errors in input and formulas, and lacks any audit log of changes and updates. So, just as you wouldn’t trust your employer to be the steward of your bank account, you shouldn’t trust them to be the steward of your equity. You should keep a record (either paper or electronic) of your signed option agreement and any stock certificates you own.
Fortunately, more and more companies are moving to cloud-based tools such as Capshare, which significantly helps with transparency and error reduction.
3. It Needs to be Managed
When managing your bank account, you may need to move funds between your saving and checking accounts, purchase a CD from your bank, etc. Similarly, you should stay on top of equity position.
You should know how many shares you have vested and exercisable. When you choose to exercise options is important, as you will only receive the long-term capital gains tax rate if you hold a security for a year before selling. But there are risks to exercising before sale of a company too. In the case that the company’s value decreases after you have exercised, you will have paid more taxes than needed.
Additionally, you should understand accounting ownership in a company doesn’t necessarily equal economic ownership. If your company has raised money, the preferred shareholders will get their money out before common shareholders. In the case of a fire sale, this could mean you get nothing.
As you can see, it can be unclear what your exact financial position is at any given time, and it can always change. But acknowledging this fact is a good first step towards making smart decisions. Once you understand the uncertainties, you can better understand the potential upside or downside to any scenario.
Many people don’t take the time to understand their equity because it can seem difficult and confusing. However, that’s really not a good reason. If need be, you should consult with a lawyer or certified public accountant that has experience with these issues – $200 today could save you a lot more down the road.
Lastly, I found the team at Capshare to be very knowledgeable and helpful as I was writing this article. They deal with these issues on a daily basis, and so it’s worth checking out their blog for more information.
Image Credit: Flickr/frankieleon
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