Silly Money • by Ankur Nagpal

One of the best parts of working at a startup is you typically have the opportunity to own a piece of the business.

If the startup ends up being massively successful, you directly participate in the upside as a small owner.

However, almost every startup employee has absolutely no idea how to actually value their equity.

The information employees do receive about their equity reads like complete jargon.

Founders sometimes intentionally withhold important data that anyone joining the company should know.

And, employees remain in the dark about a huge part of their compensation since they don’t even know what questions to ask!

This article is written to change this. I’ll walk you through:

• How to think about equity

• How to value your equity

• Other considerations in evaluating equity

• How to negotiate your equity

I also created a free startup equity calculator to help you run the math. Let’s go.

How to Think About Equity

Equity is ownership of a piece of a company.

When you buy shares of a company in the stock market, you own equity in the public company. When a startup gives you shares or stock options, you own equity in the startup.

Almost every wealthy person made their money by owning equities that substantially increased in value.

You also typically pay a much lower tax rate when you sell equity versus the salary you earn.

As a startup employee, here are some of the important considerations as you think about the equity part of your compensation.

Business Quality

The single most important factor in valuing your startup equity is the quality of the underlying startup.

A tiny piece of a phenomenal business is worth infinitely more than a large piece of a company that goes to zero.

When startups get massively big (think Uber or OpenAI or SpaceX), almost every single equity holder ends up making a lot of money.

Equity does not pay the bills

While equity presents one of the best opportunities for asymmetric upside, you cannot pay your bills with equity.

Startup equity is a highly speculative asset.

Even if you own many millions of dollars of stock options in a startup, it’s prudent to think of it as paper money until you see actual liquidity. This means you should not spend real money based on your paper net worth.

Think like an investor

As a startup employee, you are not that effectively a startup investor with one major caveat:

You can only “invest” your time in one startup at a time.

Investors can afford to take a portfolio of bets, while you get only one bet at a time — and a handful of bets over your entire career.

Working for a company that you think has a really high probability of being worth a lot of money someday is a solid approach to equity.

How to value your equity

Most employees of early stage startups receive stock options.

For the next two sections, I’ll be assuming you own stock options, though restricted shares work very similarly with slightly better tax benefits.

Understanding Startup Math

The most important equation to learn is:

Company value = Number of shares in the company * Share price

If you ever know two of the three numbers above, you can calculate the third with simple arithmetic. This equation works for tiny startups, and large public companies alike.

The tricky thing is early-stage startups typically have two distinct prices at any given time. These are:

The “Internal” Price or 409a Price

This is the share price at which the company grants you equity.

When you receive stock options, you will see reference to a “strike price” — this is what you would have to pay to exercise or buy your stock options.

Companies need to hire third-party auditors once a year to calculate this internal share price.

Since this is the price employees have to pay out of pocket to buy their shares, companies typically want to drive this price as low as possible.

The “External” Price or Preferred Price

This is the share price at which the company raises money.

Companies want this price to be as high as possible since the cost of the capital becomes cheaper the greater the valuation.

Technically, investors receive a different class of shares for this higher price called preferred shares. These shares have a couple of important benefits I’ll talk about later.

Calculating The Value of Your Equity

You can use the difference between these two prices to calculate the present value of your equity today:

Value of your equity = Number of shares you own * (External Price - Internal Price)

In order to calculate the value of your equity, you need to ask your employer for the share price at which the most recent funding round was conducted.

If the startup has not raised a priced round yet, they may not have an official preferred share price. But, you can use the valuation of the last SAFE note to approximate what this can be.

There are a few other important factors to consider when valuing your equity:

1. How long you have to stick around to earn this equity

Most equity has to be earned out over a period of time - this is referred to as “vesting” your equity.

You can take the total time period over which your equity vests to calculate exactly how much you are earn in equity every single year:

Annual value of your equity = Value of your equity / Total years of vesting required

Pay attention to the “cliff” in your vesting schedule — this is the minimum amount of time you have to stick around to receive anything at all.

2. Every time the company raises at a higher valuation, the value of your equity goes up

When the company raises a new round of financing, the preferred share price moves to a new higher price.

This can substantially increase your equity compensation without you receiving more shares.

If you join a startup when it’s tiny, and it grows to be worth billions of dollars, this can end up being a dramatic amount of equity.

3. Companies raising at a lower valuation can be catastrophically bad

If your startup has a “down round” and has to raise money at a lower valuation, this can sometimes wipe out the entire value of your equity.

While it rarely happens, if the startup ever raises money at a share price lower than your strike price, your options are entirely worthless or “underwater” and you need to talk to your founders about it ASAP.

Startup Equity Calculator

I spent 30 minutes playing around to build a very useful Startup Equity calculator. You can use this tool to plug in your numbers and see exactly how much your equity is worth.

You can input your vesting schedule and see exactly how much you end up vesting every year.

It also supports scenario modeling at different exit prices, so you can see what youe equity could be worth in the future too!

Other Considerations in Evaluating Equity

Beyond calculating the dollar value of your equity, there are a few other considerations to be aware of.

All of these can dramatically affect the final outcome in how much your equity actually ends up mattering.

Percentage Ownership

Every employee has the right to know what percentage of the startup they own.

In order to calculate this, you need to know how many total shares exist at any given time. This is the equation:

Percentage ownership = Your shares / Total number of shares in the company

If you find that your company or founder is reluctant to share this information, I’d consider this a major red flag.

Two important notes on percentage ownership:

• Use it to benchmark your compensation

  Ownership percentage is the best way to benchmark if you are being compensated fairly, particularly for senior roles.

  You can typically find data on how much equity people at similar-sized companies with the same title are receiving.

• Your ownership will change with time

  Your percentage ownership will keep changing with time as the company raises more money.

  Every time the company fundraises, the total number of shares increase.

  This means you will get “diluted” as your shares now represent a smaller percentage of the business. This is totally fine as long as the dollar value of your equity keeps growing.

Liquidation Preference

When investors invest in a startup, they typically receive preferred shares that have slightly different rights over common shares that employees receive.

The most important right they typically get is a liquidation preference. This allows them to receive their initial investment back before ANY common shareholder (including you) ever get paid out.

The upshot of this is the company needs to sell for AT LEAST the total liquidation preference before any common shareholder receives any money.

How do you calculate the liquidation preference?

This is usually the total amount of capital the startup has ever raised.

But, you should always ask for confirmation as sometimes companies owe a multiple on the dollars raised, which can make seeing a return quite challenging!

Typically, the liquidation preference does not matter much when a company has a successful exit.

But if you are evaluating working for a company that has raised hundreds of millions of dollars, it’s certainly worth factoring in.

Post-Termination Exercise Period (PTEP)

Choosing to exercise your stock options can be quite expensive.

To convert your options into actual shares, you need to buy them for the strike price multiplied by the total number of shares. Based on how much equity you have, this can cost tens or even hundreds of thousands of dollars!

This is also a very risky investment as startup equity is a highly speculative asset. If the company fails, you end up with nothing.

Most people tend to wait until an exit is around the corner and only exercise their options when they are guaranteed to make money.

If you still work at the company, this is a great strategy.

However, if you don’t still work at the company, most companies have a clause that give you only a fixed number of days after terminating employment to come up with the cash to exercise your stock options!

This amount of time is called the Post-Termination Exercise Period (PTEP).

Historically, companies had a PTEP of only 90 days. This meant if you quit your job, you had to scramble for the cash in 3 months if you wanted to keep your equity.

Thankfully, most modern startups are electing for much longer PTEP windows. This is definitely something you should ask about if your stock options cost a meaningful amount of money to exercise.

At my startup Carry, we give everyone 10 years after employment to exercise their stock options.

Company Financial Health

Startups succeed for lots of different reasons, but every startup fails because they run out of cash.

As you are evaluating startup equity, ensure you ask the founders for a snapshot of the company’s overall health.

Some things I would ask about:

• How much cash the company currently has in the bank

• How much cash the company is burning every month (net of revenue) - you can use this to infer how many months of “runway” they have

• Company revenue numbers and growth rates

If you have friends that are VC investors, it can be very helpful to get their perspective on how they would value a company with these specific metrics.

How to Negotiate Your Equity

Let’s bring this entire article together.

Here’s a step-by-step guide on how you should negotiate equity before accepting a job offer.

Step 1: Find a startup you believe in

This is the single most important step in the process.

Great companies are rare, and you’d rather own a small piece of a phenomenal company than a big piece of anything else.

One strategy for finding great companies can be asking prolific investors what startups in their portfolio they are most excited about.

Step 2: Ask for the information you need to calculate the value of your equity

At the job offer stage, ensure the company shares the following information with you:

• How many total shares are outstanding

• Your percentage ownership (you can use the total shares to calculate this)

• The most recent fundraising valuation and preferred share price

• The vesting schedule

Plug those numbers into the Startup Equity Calculator and see what your equity could look like at different exit scenarios.

Also, ask about the liquidation preference, company health and the post-termination exercise window to look for any potential red flags.

Step 3: Pull equity benchmarks and see how you stack up

This is more relevant for senior roles, but look for equity benchmarks for your specific role by company size and location.

If you don’t have access to compensation data, ask the hiring manager or founder to share their data and how they derived the equity grant.

You can also find equity benchmarks by how early a hire you are at a startup:

Step 4: Negotiate for what’s important to you

There are many different levers for negotiating equity — but I’d focus on what is specifically important to you.

If you are more excited about equity and don’t need a lot of cash to support your current lifestyle, most startup job offers will let you trade some of your cash compensation for more equity.

Don’t forget that equity doesn’t pay the bills!

If a company is refusing to budge on the quantity of equity, it may be worth seeing if you can push on some of the other terms like the vesting time period or post-termination exercise period.

Step 5: Revisit this annually

While companies typically do not offer refresher grants every year, it’s worth keeping track of how much equity you are vesting annually.

If the company raises money at a much higher valuation, the value of your equity could noticeably appreciate.

If your role has a bonus component, you could ask your startup if they would consider granting part of the bonus in equity.

If you ever receive a significant promotion, you should push to see if you can also receive more equity as part of that move.

Ultimately, the best way of owning more equity is to do a phenomenal job. Companies like to generously reward top performers with a meaningful amount of equity.

Whew! That was a lot to cover, but this should provide a strong overview of how to evaluate your equity.

Share it with any friends that are negotiating a new startup job offer.

There’s even more nuance that I did not cover here to keep this article concise. I’ll expand on related topics like tax considerations of startup equity in a later post.

If you have any questions about your equity, leave a comment below and I’ll get back to you ASAP.

Until next week.

P.S. I’m hosting a live chat with my buddy Andrew Yeung where we share some of our hot takes on building wealth, startups and personal brands.

It’s on May 1st and live-only (no replays!), so make sure you sign up here.