We proudly present this guest author blog post on Equity Agreements by Equity FTW, the inaugural Knowledge Partner for Ask Ginkgo and the best resource for learning about equity.
Anytime a company is willing to grant equity to an employee or prospective employee, it’s kind of like receiving an invitation to take a ride on a rollercoaster. You can expect twists and turns and fun and excitement, but the ride could also give you whiplash, make you nauseous, or be missing safety inspections.
By knowing what to look out for in your equity agreement, you’ll be able to prepare for the ride, spot areas that can be improved, get the best seat possible, or simply decide not to climb aboard the ride.
The purpose of this article is to examine 8 things you should look out for when evaluating your proposed equity agreement so you can feel confident you’re making the most out of that agreement.
Employers want the equity they share to incentivize employees. By knowing what to look out for, you’ll be able to communicate your preferences and describe what will incentivize you. Most employers/prospective employers have some room to negotiate terms, all you have to do is discuss it with them.
Type of equity that you’re being granted
Your employee equity agreement should state in big bold letters somewhere on the page the exact type of equity being offered.
You don’t have to know the ins and outs of all the possible types of equity that can be granted, but you’ll want to make sure that you spend some time Googling and learning about the equity proposed in your agreement.
There are many forms of equity compensation and this list is far from comprehensive, but it gives you a sense of the possibilities:
Restricted Stock Awards (RSAs)
Stock Appreciation Rights (SARs)
Performance Stock Units (PSUs)
Phantom Stock
Sometimes employers like to call equity by a different name. For example, Google calls their Restricted Stock Units, Google Stock Units (aka, GSUs).
If you notice a name that doesn’t come up when you do a Google search, we’d recommend asking those in charge of the equity plan what they are most similar to.
There can be some room to negotiate the type of equity. The most common forms of equity to negotiate between are RSUs and NSOs.
Vesting conditions
Once you know the type of equity, the next thing to look out for in your equity agreement is the vesting conditions.
For those unfamiliar with the term, vesting is when you officially own the equity you’ve been granted.
It shouldn’t come as a surprise, but companies usually don’t just give equity away without requiring something from their employees. These prescribed vesting conditions that a company requires in order for equity to vest, need to occur before the equity is actually yours.
The two most common vesting conditions are (1) requiring that employees work for a certain length of time after receiving their equity grant and (2) requiring that the employees stay employed by the company until an IPO or acquisition.
Whether it’s just one of these conditions, both, or more, you’ll want to know the vesting conditions before accepting your equity agreement.
Value of the grant itself
Another thing to look out for in your equity agreement is the value of the equity being granted. You will need to determine whether or not you know the actual value of the equity.
Following this advice may require more effort when evaluating an equity agreement from a private company than from a public company. This is because a private company’s most recent valuation may or may not be public knowledge, whereas a public company’s stock value can be easily found by doing a quick Google search.
Sometimes in offer letters or communications with recruiters, companies will say things like, “As part of your offer, we’d like to grant you [some number of] RSUs.” The difficulty with this phrasing is that unless the company is publicly traded, the value of those RSUs isn’t known unless they also tell you the current price per share.
We highly recommend confirming with the recruiter or the hiring manager what the value currently is and how recently that value was set. This way you can figure out just how much your equity is actually worth without being wowed by some seemingly large grant that’s actually not worth much.
Since equity isn’t the only factor when considering an offer, you’ll want to familiarize yourself with other elements of an offer letter. Ask Ginkgo wrote a great article discussing things to look out for in your offer letter and we recommend giving it a read.
Do you need to pay anything for the equity? How much?
The next thing you’ll want to look out for in your equity agreement is if there will be any exercise costs associated with the equity you’re going to receive.
With some forms of equity, the company gives you the ability to purchase shares at a set price, no matter how high the company's stock price goes (commonly referred to as the “Exercise Price” or “Strike Price”). The ability to purchase at a price that’s lower than what the company is actually worth is a massive benefit if the company performs well. The catch is that you need the company’s stock price to go up or there’s not really any value.
This “Exercise Price” is typically based on the company’s value at the time they grant you the equity, but sometimes it can be higher.
Regardless of the price, you’ll want to know exactly what that exercise price is since you’ll eventually need to pay it if you want to purchase company shares.
When is the expiration date?
The next thing to look out for in your equity agreement is the expiration date. Most equity agreements have expiration dates that are a full 10 years out, but companies can make them shorter.
For example, Spotify lets employees choose how they’d like to receive their incentive compensation. If they choose the NSO option, the NSOs vest over 4 years and expire after 5 (that’s a pretty short window!).
Shorter expiration dates aren’t necessarily a bad thing, but it is something you’ll want to keep an eye out for since it directly impacts your strategy for managing your equity.
Note: If you quit with vested options like ISOs or NSOs, the expiration date will usually switch to being the sooner of the actual expiration date or 90 days. Companies that are trying to be a little more employee-friendly offer longer time periods than 90 days. Sometimes companies offer up to 10 years after termination!
Repurchase conditions
The next thing to look out for is if there are any repurchase conditions within your equity agreement.
Repurchase conditions refer to the circumstances in which the company has the right to buy back or "repurchase" your equity.
These conditions can vary depending on the specific agreement, but a couple common examples of repurchase conditions are:
Termination of employment: Many equity agreements contain a repurchase condition that allows the company to buy back your vested equity if you are terminated for cause or leave the company voluntarily before a certain date.
Change of control: If the company is acquired by another company or there is some other big change in ownership, the equity agreement may allow the company to repurchase shares from you.
Another hugely important note here is that you will want to know what price the company will use if there is to be a repurchase. A company can determine this price in a number of different ways. They can calculate the price using a formula, use the current market price, or use the value of the stock when you first received the grant.
The price and the specific conditions are very important to be aware of because oftentimes there’s a little bit of wiggle room if there’s language you don’t like.
Repurchase conditions are usually added to protect the company’s interest, but they aren’t necessarily a bad thing. For example, if you leave a company that is still private, it might actually be nice to cash out some of the equity you have. What’s important here is that you’re aware of what’s in the equity agreement from the very beginning.
Restrictions on selling to other parties
The next thing to look out for in your equity agreement is if there are restrictions on your ability to sell to other people besides back to the company.
It’s pretty common for an equity agreement to restrict the sale of shares to outsiders or to people who don’t already own company stock. It can also be written in a way that requires the approval of a certain percentage of shareholders before a sale can take place, or it can just not be allowed outright.
There are websites like Forge Global or Equity Zen that allow employees at private companies to sell shares of their company stock even though the company isn’t public yet. It can be a nice service, but in order to take advantage of something like that, you’d need to have the ability to sell in the first place.
Whether or not you have the ability to early exercise
The final thing to look out for in your equity agreement is whether or not you have the ability to early exercise any of your equity.
The ability to early exercise gives you the power to pay the exercise cost upfront rather than wait for your equity to vest. You will still technically have to wait for the vest date until it truly becomes yours, but early exercising in conjunction with filing an 83(b) election is a very powerful tax savings tool if executed properly.
So long as you haven’t received more than $100k of value in ISOs, it usually won’t hurt you to have the ability to early exercise and then never use it. If it’s possible to get it added, you may as well just in case it makes sense for you to early exercise at some point.
Final Thoughts on Equity Agreements
We understand that learning all the ins and outs of equity agreements can seem pretty overwhelming, especially if it’s your first time receiving an equity agreement. You may find it helpful to submit any proposed equity agreement to Ask Ginkgo. It will generate high-level bullet points of everything we’ve discussed above.
The whole purpose behind employers granting equity is to incentivize their employees to bring their A-game. That can’t happen if employees don’t understand the equity agreements they’re signing and/or the equity agreements aren’t written in a way that actually provides that incentive.
We encourage you to discuss any proposed equity agreements with your prospective employer. Equity agreements are an important component of any compensation package. Having these discussions will give you a better sense of how a company values the equity they’re granting to employees and will also give you insight into how they value their employees generally.
We hope you’ve found this article helpful and if you have any questions, please reach out to team@equityftw.com!