Equity - What is it, and why should I care about it?

Equity - What is it, and why should I care about it?

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Carly Williams


In life, sometimes there are these 'things', which few people understand fully, but equally nobody wants to ask questions about. In my experience, equity is one of those things.

When I found myself joining a startup stage business early on in my career, I was offered equity as part of the package. This came as a complete shock - having previously worked in a much larger corporate, my perception of equity was that it was something that was only accessible at Director level and above - I was wrong. Whilst the business I worked for did a great job of explaining how the scheme worked once I joined, there was a distinct lack of 'no nonsense guides to equity' out there from a quick Google for me to read before joining.

If you're lucky enough that your first role offers you equity, or if you simply want to learn the basics of equity for your future career, this one's for you. Whilst it's by no means an exhaustive guide, I'll give an overview, signpost you towards some other useful resources, and even include a 'cheat sheet' of questions you may want to ask around equity offerings for the future. Cue no nonsense guide to equity...

What is it?

Put simply, equity is the value of the shares issued by a company. A share is a division of a company's capital, which entitles the holder to a portion of any profits. Think of a pie sliced into many equal pieces.

Within a startup environment, equity will likely be awarded by the founders upon joining the business, in exchange for investment. As an employee, you invest your time and hard work into helping a business grow, and in exchange receive shares or stock options. Investors give the business capital to help it grow, and in exchange receive shares, which they hope to get their return on investment on when they eventually sell them down the line.

How would a typical scheme work?

Typically your shares are awarded at the point of joining a business, and then vest (earn value) over time. Essentially, the longer you're with the company, the more value you 'earn'.

For example, your shares may vest on a quarterly basis, over a four year period. But you may also have a one year 'cliff', meaning your shares don't begin to vest until you've been employed by the business for this long. So in this case, following a year of employment with the business, on a quarterly basis your shares would vest in equal installments, until fully vested at four years of employment.

The grant amount will vary business by business, but for many businesses works much like salary - depending on department and seniority. There may well be other ways you can increase your equity allocation over time. Some businesses award additional equity to high performing employees who they feel have added real value to the business. Alternatively, I've seen some businesses offer a 'salary sacrifice' scheme - if an employee is awarded an increase in salary (whether by annual salary review or promotion), they're able to take some or all of this additional compensation in equity.

What's the difference between shares and options?

Of companies that offer equity to their employees, most choose options over shares. Buying shares typically offered to founders and investors) means immediately becoming a shareholder, gives voting rights, and are taxed. However, granting someone options (typically offered to employees) gives them the right to buy these shares later down the line, at a pre-agreed price, and can hold tax benefits. Essentially, you are a shareholder once you've exercised your options - they are now shares.

Are there different types of share incentives/option schemes?

Yes, and different schemes will work best for different businesses depending on what stage they are in their growth. A couple of the most common are:

● EMI options - a share option scheme which is government-backed, and is typically used by small to medium businesses. This is an attractive scheme as it offers tax advantages, but there are restrictions on which businesses can utilise this scheme (up to a certain number of employees and value of assets).

● Growth shares - allow the holder to benefit from any increase in the value of the company beyond a set hurdle valuation. For example, this may be the value of the business at your time of joining. This is a huge incentive for a new joiner to a company, to work hard, add value, and see the business grow.

What happens when I leave the company?

In short, the terms are up to the business to decide. And it also depends on the type of options you're holding.

If you leave a business and some of your equity options have vested, you'll likely be able to 'exercise' your options. This means you'll be able to purchase them at the strike price per share (the fixed cost that you'll pay per share when you exercise your options, so that you own them).

And what then? Whilst your strike price is fixed, the market value of the shares can change over time. This can become profitable for you if you're in a situation where you can sell your exercised shares for more than the strike price. You could capitalize from any growth in the value of your shares in either the event of an exit (initial public offering, where shares in a private business are offered to the public for the first time), or through a liquidity event (perhaps through an acquisition or merger, allowing some or all of your shares to be cashed out).

With growth shares however, you won't need to exercise - they're yours once they've vested. Typically employees pay a very small nominal purchase price to acquire these at the point of joining, which is deducted from payroll. Then, at the point of exit, if your shares have cleared the assigned hurdle, you'll make money on how big this 'gap' is.

How do I consider equity when setting package expectations, or when negotiating? I'm firmly wearing my recruiter hat for this section.

It's unwise to rely on getting cash out of your equity.

When negotiating package for a role, if your offered salary is £50,000 with equity of a current value of £10,000, your total package is not £60,000.

It's worth considering the fact that it's the equity value, divided by the vesting schedule that accounts for what is added to your compensation year on year. Additionally, equity schemes are based on projected growth, which is just that - a projection.

Don't get me wrong - equity is a hugely exciting benefit which you could go on to capitalize from in the future, but it's not a guarantee - don't treat it like one. There are many factors out of your control that could impact the return you may make.

Having said that, if you're deciding between two offers both paying £50,000, both equally exciting, and one offers equity, having genuine investment into helping a company succeed may well swing the balance for you.

Equity schemes will likely differ from business to business, and the great thing about this is that there's potentially scope for negotiation. I'd advise spending some time trying to understand the equity scheme of the business you're joining in full before trying to do this. And I've even made a little cheat sheet with the key questions I'd advise you ask:

Question Cheat Sheet

● What type of share/option scheme am I part of, and why?

● What schedule do my shares vest to, and is there a cliff period?

● Will I have an opportunity to either purchase more shares down the line, or to have these awarded to me?

● What type of shares do your investors hold? **

● Will you provide me access to a platform to track my equity as it vests?

● Can you tell me some more about your funding history, and what this means for projected growth?

● Does the business have a long term plan for exit?

Useful Resources

A lot of equity tracking platforms offer some brilliant (and free) resources. Try - Capdesk, Ledgy, SeedLegals or Vestd as a good starting point.

** A side note here on preferred shares. Preferred shares give their holders rights to specific dividends, 'in preference' to ordinary shareholders. This seems unfair to ordinary shareholders, right? The reality of the situation is that a lot of young businesses need capital, and some investors will only be willing to put forward funding if they have preferential rights to a potential successful outcome. It's worth noting here that this isn't always the case - some businesses are extremely passionate about alignment of incentives, and won't allocate preferred shares to investors. By allocating both employees and investors ordinary shares (where each shareholder has the same rights to any value that the business may create), you're protecting your employees from the effects of equity dilution (reduction in existing shareholders' equity ownership each time you issue additional shares). The COO of Codat, the business I currently work for, wrote a great article on this, which you can read here.

Carly Williams is a Talent Acquisition Manager at Codat.

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