04 Dec Lifestyle Calculator Series | Chapter 3: Participation
This is part 3 of our 5-part series in which we break down the 24 unique elements you may want to consider when entering a job offer negotiation.
This is part 3 of our 5-part series in which we break down the 24 unique elements you may want to consider when entering a job offer negotiation. For all 24 items, check out The Lifestyle Calculator, a tool that can be used by job candidates to weigh what it most important to them in a compensation package.
Our previous chapter touched on negotiation topics related to logistics, like location of work, budgets, and expense accounts. As we’ve mentioned before, different topics are important to different people, so make sure to check out all chapters in this series to learn what you care about most.
In this chapter, we’ll be talking about participation as it relates to work arrangements. Whenever negotiating a job offer, your future at that company should be considered. If you receive equity, how long will you need to stay (or “participate”) at that company in order for it to vest? What type of equity is it? How long do you have to exercise your options?
These topics (and more) will be covered throughout this post. We hope the following provides you insight so as to make your next (or current) job offer negotiation more successful than your last.
Instrument of Equity
Common Shares, Preferred Shares, Options, etc.
When we talk about “equity,” it is largely an umbrella term. Equity takes on many forms, so in this section we’ll briefly discuss some of the different “instruments of equity” of which you should be familiar. Keep in mind we’ll just be scratching the surface here, as details on equity can get very nuanced.
We wrote about equity back in Chapter 1 of this series, so that might be a post worth reading if you’re educating yourself on the topic. As with any discussion on equity, a fundamental distinction must be made before diving into details: Equity can be liquid or non-liquid.
First, let’s talk about non-liquid. Non-liquid equity is most commonly distributed at smaller, privately held companies. In order for this type of equity to become liquid, the company must either sell or go public.
That brings us to our first instrument of equity: Restricted Stock Units (RSUs).
At a privately held company, a certain number of RSUs are set aside and distributed to employees over time. Your ownership in the company is represented by however many RSUs you own. Once the company sells or goes public, your ownership becomes tangible and liquefiable.
In some instances, companies might be open to buying back your equity, but this is much less common. A number of reasons exist as to why a company might do this, but as a shareholder, you would be paid the market value of the stock price.
At some startups where money is tight, equity might be granted in the form of profits interest. This is an agreement that promises an employee the right to a certain percentage of future company profit. Profits interests are used by companies that are taxed as partnerships, such as LLCs.
For details on stock options, skip to the section on “Exercise Term Length.” In summary, options give you the right to buy a stock at a later date. Until you exercise your options, you don’t actually own any part of the company. Options by themselves represent non-liquid equity.
Common stocks are typically what people are referring to when talking about stocks in everyday conversation. When you buy 10 shares of Apple on E-Trade, you’re buying common stock. When you’re given common stock as part of your job offer, there is little guessing game involved. A quick look at the stock’s trading price will tell you what your equity is worth. Having this clarity is a key benefit of liquid equity.
Preferred stocks are a bit different. They are more exclusive and harder to obtain. Founders and early employees are typically the lucky few who enjoy the added benefits of preferred stock… the biggest of which being fixed dividends that typically pay out more favorably than common stock dividends.
Length of Vesting
The Length of Time it Will Take to Receive Your Equity
As we just touched on, equity can be distributed in a number of different ways – from stock options, to common shares, to preferred shares, and more. But rarely is equity immediately granted all at once. Welcome to the concept of vesting.
Vesting represents an employee’s right to some level of ownership participation in the company, once a certain period of time has transpired. From an employer’s perspective, vesting is a necessary tool to ensure employees actually earn their way to a slice of ownership. It’s also used as a way to limit churn and increase commitment levels of valued employees. The longer you stay, the more equity you receive.
From an employee’s perspective, the shorter the vesting period typically the better. Why wouldn’t you want the right to buy your stock options in 2 years as opposed to 4? Length of vesting is certainly a negotiable item when hammering out the details of your employment agreement. By securing a shorter length of vesting, you’re essentially entering a lighter commitment, assuming your goal is to eventually see the entirety of your equity. Currently, four year vesting periods are very common.
Most vesting clauses include a “cliff,” which states the length of time it takes until the vesting actually begins. A one year cliff is pretty standard. To paint the full picture, here’s an example:
You’ve just signed a deal with an equity agreement that includes 4 years vesting and a 1 year cliff. This means you won’t see the entirety of your equity until 4 years after signing. The equity will kick in after one year, and it will likely be accrued periodically throughout those following 3 years.
Vesting provides a fundamental sense of structure to any equity agreement. Without it, people would be able to bounce from company to company, securing bits of ownership and leaving before having to actually earn it. Considering how likely you are to encounter vesting at some point in your career, it’s important to know the different elements of a vesting clause. With a full grasp on the concept, maybe you negotiate for a shorter vesting period, no cliff, or a certain distribution structure (i.e. 25% in year 1, 25% in year 2, 50% in year 3).
Exercise Term Length
The Length of Time You Have to Purchase Your Options After Leaving
Again, it’s important to remember that stock options by themselves are NOT equity. Rather, your options grant you the right to secure equity – but that equity will have to be purchased.
Stock options come with a defined strike-price, which states the price at which you will be able to buy the stock at a later date. If all goes according to plan, the company will do well while you’re there, and you’ll be able to buy the stock for cheaper than market price, allowing you to profit on the delta between the two.
It doesn’t always go this way, of course. The company might go bust and then your options have no value (nor would the stock if you had exercised them).
Along with a defined strike price, stock options also come with an exercise term length. This is the amount of time you have after leaving a company to decide if you want to exercise the options and actually turn them into actual stock (aka equity).
Obviously, the longer the term length the better for someone trying to decide whether or not to purchase. If you worked at Amazon until 2009 and had a 10 year exercise term length on your options, you would’ve benefited greatly from being able to watch the company’s stock soar more than 900% over the decade. Then the decision to exercise is a no brainer.
However, if you only had a 30 day term length, it would’ve been anyone’s guess as to how good of an investment that would end up being. Essentially, a longer term length reduces the level of uncertainty and risk involved in your exercising decision.
There is nothing worse that earning your sweat equity in the form of options and then being left to decide if and when to exercise them with no clarity on their future value. Longer option periods help avoid this predicament.
Always remember there will be various tax consequences with each scenario related to stock options. We recommend consulting a tax professional in assessing those matters.
Buyout of Existing Business
Relevant for an Acqui-Hire or if You’re Leaving a Business Behind
A central part of any job offer negotiation is the concept of opportunity costs. By dedicating your time, effort, and energy to one company, you’re technically giving up other opportunities to which you will no longer be able to commit.
This won’t apply to everyone, but if you’re leaving behind a company or business in order to work somewhere, there might be reason to bring this up in your negotiations. If nothing else, it is an effective way to gain some leverage.
For example, if you’ve spent 5 years building a consulting company, a lot probably went into developing your client list, branding, and overall operation process. And if the business is running smoothly, giving that up is a major opportunity cost. A company that wants you badly enough would be wise to reflect this opportunity cost in your offer – whether that’s through an attractive salary, equity, favorable hours, a buyout, or something else.
Now, if you’ve built a business that is in some way related or relevant to a company looking to hire you, an “acqui-hire” might be in the cards. The idea here is that the company will pay a premium to get you (and your team, if relevant). Companies might do this even when they don’t want your company or product. If a buyout is what it takes to get your skills and effort, they might be forced to do so.
This situation is unique, so there is only so much we can offer from a general advice standpoint. However, some key things to note: Make sure to understand what your business is actually worth, where you own intellectual property, what the acquisition means for the business you’ve built, etc. Hiring a company like ours or an attorney is certainly warranted if your negotiations venture into this territory.
Conclusion on Participation in Job Offers
We made a point in the first chapter of this series when covering the topic of equity: It can be the fastest way to a life-changing payday. Find yourself at the right place at the right time, and your ownership in a company could be the reason you retire early.
With this in mind, it’s clear why this chapter is so important. For some, the details of an equity agreement end up shaping a road to riches. Granted, this should never be expected, as it doesn’t happen often. But given the possibility, you should stay well informed whenever entering a negotiation on the topic. We hope that at the very least, this post acts as a good starting point.