Your Startup Equity Isn’t What You Think It Is
In this episode of Money Rehab with Nicole Lapin, Lapin breaks down the often-misunderstood world of startup equity compensation. She explains the critical distinction between stock options and actual ownership, clarifying that receiving equity typically means getting the right to purchase shares at a predetermined price—not immediate ownership. Many employees build financial plans around equity they don't actually possess yet.
Lapin addresses common misconceptions about equity buyouts and explores the financial consequences employees face when exercising options, including significant tax bills on shares they can't sell. The episode covers the 90-day exercise window most companies impose after departure, liquidation preferences that can leave employees with nothing during exits, and practical strategies for negotiating better terms. Lapin emphasizes the importance of asking the right questions before accepting an equity package, when employees have the most leverage to protect their interests.
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1-Page Summary
Understanding Stock Options and Ownership in Private Companies
Stock Options Grant Purchase Rights, Not Immediate Ownership
When startups offer equity, they typically provide stock options—the right to purchase shares later at a predetermined strike price—rather than actual shares. Until you exercise the option by paying the strike price, you don't own any company shares. This structure protects employees from immediate IRS taxation on unsellable private company stock.
Stock options vest over a set schedule, commonly four years with a one-year cliff. Vesting doesn't equal ownership—it simply means you've earned the right to buy shares. Actual ownership only occurs when you exercise the options by paying the strike price.
Equity Misconceptions: Confusing Vesting With Ownership and Expecting Buyouts
Many employees misunderstand what startup equity actually means. They equate vesting with ownership, building financial plans around assets they don't yet possess. The essential lesson: you don't own shares until you've exercised your options and bought them.
Another widespread myth is that companies buy out departing employees' equity. In reality, most stock option plans give employees just 90 days after leaving to exercise their vested options. If they don't pay the strike price within this window, the options revert to the company for redistribution. Data shows only about a quarter of employees ever purchase their vested options.
Employees also misunderstand cashless exercise as an immediate solution. This mechanism only works during exit events like acquisitions or IPOs, allowing employees to exercise and sell shares in one transaction. Without a liquidity event, cashless exercise offers no benefit to departing employees.
Financial Consequences: Exercise Costs, Tax Bills, and the 90-Day Problem
Exercising vested options triggers a taxable event. The government taxes the difference between the strike price and current market value, meaning employees owe taxes—potentially thousands of dollars—on shares they cannot sell for years, if ever. This burden hits hardest during the 90-day exercise window when employees are losing their regular paycheck.
To address this, new equity funding platforms like Equity B provide employees with capital to cover both exercise costs and taxes. Once an exit occurs, investors recoup their money plus a share of gains, while employees keep the majority of profits. If the company fails, the investor absorbs the loss—the employee owes nothing. This structure allows employees to preserve hard-earned equity without draining personal savings.
Exit Scenarios and Liquidation Preferences
At startups, investors receive preferred stock while employees get common stock, establishing a payout hierarchy. Nicole Lapin explains that preferred shareholders are paid first during exits, often recovering their full investment before common stockholders see anything.
Investors frequently negotiate liquidation preferences with multiples such as 2X or 3X. Tracy DiNunzio notes that if investors have a 2X preference, they receive double their investment before employees get paid. For example, if a company raises $50 million and sells for $100 million with a 2X preference, the entire $100 million goes to preferred shareholders, leaving employees with nothing. Lapin emphasizes these situations aren't rare.
IPOs differ from acquisitions because preferred stock converts to common stock, putting all shareholders on equal footing. However, most startups don't IPO—they sell for modest amounts or fail altogether. By one estimate, three out of four startups never return investors' money, making meaningful employee equity rare.
Practical Strategies: Ask Questions, Negotiate Terms, and Understand Investor Structure
Before accepting an equity package, ask three key questions: First, determine the fully diluted share count to understand your options as a percentage of the company. Second, find out your strike price and the company's latest valuation to calculate what your options are actually worth. Third, clarify what happens to your options if you leave, including the exercise window length and whether cashless exercise is available for former employees.
You have the most leverage to negotiate before joining, not after leaving. Some companies now offer extended exercise windows of five, seven, or even ten years, though most still provide only 90 days. Asking for an extension before signing can transform equity from an unaffordable benefit into a genuine wealth-building tool.
Additionally, ask whether the founder remains on the same equity class as employees, keeping interests aligned. Inquire about the investor base to assess the probability of your equity realizing future value. All these questions are standard investor due diligence, and companies should provide clear, transparent answers without defensiveness.
1-Page Summary
Additional Materials
Clarifications
- Stock options are contracts giving the right to buy company shares later at a fixed price. They do not grant any ownership or shareholder rights until exercised. Exercising means paying the strike price to convert options into actual shares. Only then do you become a shareholder with voting rights and potential dividends.
- Vesting is a schedule that determines when you earn the right to buy stock options over time. It ensures employees stay with the company to gain full benefits, preventing immediate full ownership. Ownership only happens after you exercise vested options by paying the strike price. Vesting itself does not grant any actual shares or shareholder rights.
- The strike price is the fixed price at which you can buy shares when exercising stock options. It is set when the options are granted and usually reflects the company's valuation at that time. Exercising options means paying the strike price to convert options into actual shares. The difference between the strike price and the current market value determines potential profit or tax liability.
- A "one-year cliff" means no options vest if you leave before completing one year at the company. After one year, a lump sum of options typically vests all at once. This protects companies from granting equity to very short-term employees. It also motivates employees to stay at least a year to earn any equity.
- Exercising stock options means buying the company shares at the predetermined strike price. This requires paying cash upfront to purchase the shares. Once exercised, you become a shareholder with ownership rights, including voting and dividends if applicable. Exercising can trigger tax obligations based on the difference between strike price and market value.
- Cashless exercise allows option holders to buy shares without upfront cash by simultaneously selling enough shares to cover the exercise cost and taxes. It typically occurs during liquidity events like acquisitions or IPOs when shares can be sold immediately. This method avoids the need for employees to pay out-of-pocket to exercise options. Without a liquidity event, cashless exercise is not feasible because there is no market to sell shares instantly.
- The 90-day exercise window is a limited period after leaving a company during which you can buy your vested stock options. If you miss this deadline, you lose the right to purchase those shares, and the options expire. This short timeframe often forces employees to pay significant money quickly without guaranteed liquidity. Many find it financially challenging because they must cover exercise costs and taxes without a steady income.
- Exercising stock options creates a taxable event because the IRS treats the difference between the strike price and the fair market value as income. This income is subject to ordinary income tax rates and may also trigger payroll taxes. For incentive stock options (ISOs), alternative minimum tax (AMT) can apply, which is a separate tax calculation. The tax owed is due even if the shares cannot be sold immediately, causing potential cash flow challenges.
- Preferred stockholders have priority over common stockholders in receiving dividends and assets during liquidation. They often have fixed dividend rates and may have voting rights or special privileges. Common stockholders typically have voting rights but are last in line for dividends and liquidation proceeds. This hierarchy affects how and when investors and employees get paid in exit events.
- Liquidation preferences determine the order and amount investors get paid before others during a company sale or liquidation. A 2X preference means investors receive twice their original investment before common shareholders get any payout. These preferences protect investors by ensuring they recover their money first, often reducing returns for employees. They can be "participating," allowing investors to get their preference plus a share of remaining proceeds, or "non-participating," where they choose the higher of preference or share.
- In an IPO, preferred stock typically converts into common stock, eliminating the payout priority of preferred shareholders. This conversion equalizes all shareholders, giving them the same rights and claims on company assets and profits. The process simplifies the capital structure, making shares more attractive to public investors. It also allows employees and early investors to sell shares on the public market.
- The fully diluted share count includes all shares currently outstanding plus all shares that could be created through options, warrants, and convertible securities. It represents the total potential ownership if all possible shares were issued. This number helps investors and employees understand their true percentage ownership after all dilutions. It provides a clearer picture of company ownership than just counting current shares.
- Equity funding platforms like Equity B provide employees with upfront capital to cover the cost of exercising stock options and associated taxes. They act as investors who recoup their investment plus a share of profits only if the company has a successful exit. This arrangement reduces financial risk for employees by eliminating the need to use personal savings. If the company fails, the platform absorbs the loss, and employees owe nothing.
- Exit events are significant company milestones where investors and shareholders can sell their shares for cash or stock in another company. An acquisition occurs when another company buys the startup, often paying cash or shares to existing shareholders. An IPO (Initial Public Offering) is when a private company offers its shares to the public on a stock exchange for the first time. These events create liquidity, allowing shareholders to convert their equity into money.
- Most startups fail because they cannot achieve sustainable growth or market fit, leading to business closure or acquisition at low valuations. This results in investors losing their capital since returns depend on successful exits with high valuations. Employee equity often becomes worthless in these scenarios because common stockholders are last in line during liquidation. Consequently, employees rarely realize financial gains from their stock options in failed startups.
- Negotiating equity terms before joining is crucial because once you accept the offer, your leverage to change terms diminishes significantly. Early negotiation can secure better exercise windows, strike prices, or equity percentages, directly impacting potential financial gains. It also allows you to clarify rights and protections, reducing future surprises or losses. Employers expect these discussions upfront, so asking early signals professionalism and protects your interests.
- Founders typically hold common stock with special rights or restrictions that differ from employee stock options. Their equity often has voting power or anti-dilution protections not granted to employees. Employees usually receive stock options that convert to common stock upon exercise but lack these enhanced rights. This separation aligns founders’ long-term interests with the company’s success while managing employee incentives.
- Investor due diligence in employee equity means thoroughly researching the company's financial health, ownership structure, and legal agreements before investing or accepting equity. It involves verifying the total number of shares, understanding investor rights, and assessing risks related to liquidation preferences and exit scenarios. This process helps employees gauge the real value and potential of their stock options. It ensures transparency and informed decision-making about equity compensation.
Counterarguments
- While stock options do not confer immediate ownership, some startups offer Restricted Stock Units (RSUs) or actual shares, especially at later stages, which do grant ownership upon vesting.
- The 90-day post-termination exercise window is common in the U.S., but some companies and jurisdictions offer longer windows or different structures, reducing the pressure on employees.
- Although only about 25% of employees exercise their options, this statistic may not account for employees who leave before vesting or those who choose not to exercise for personal financial reasons, not solely due to structural flaws.
- The risk of significant tax bills upon exercise is mitigated in some countries with different tax regimes or through the use of incentive stock options (ISOs) in the U.S., which can defer or reduce tax liability under certain conditions.
- Not all startups have aggressive liquidation preferences; some investor agreements are more employee-friendly, and increasing awareness has led to more balanced terms in some sectors.
- The assertion that meaningful employee equity is rare may not apply universally; there are notable cases where employees have realized substantial gains, particularly in high-growth or successful startups.
- Some companies proactively educate employees about equity mechanics, reducing misconceptions and improving financial planning.
- The prevalence of extended exercise windows is increasing, especially in competitive talent markets, making equity more accessible to employees than suggested.
- In some cases, founders and employees may hold different equity classes for legitimate governance reasons, not solely to misalign interests.
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Understanding Stock Options and Ownership in Private Companies
Stock Options Allow Future Share Purchase Rights
When a startup offers equity, it's almost never giving actual shares. Instead, it offers stock options, which are the right to purchase shares later at a price set today—usually called the strike price. An option grants a promise to buy, not actual ownership. Until you exercise the option by paying the company the strike price, you don’t own any company shares. You simply own a coupon that gives you a right in the future.
IRS Stock Options Shield Employees From Immediate Tax on Unsellable Compensation
If a company simply handed you shares, the IRS would treat the value as income, and you would owe taxes—even though you couldn't sell those shares since there’s no real market for private company stock. Stock options were designed to protect employees from this: nothing is taxable until you choose to buy, meaning until you exercise the options.
Vesting Schedules Dictate When Employees Can Buy Options, Not Ownership
Stock options typically vest over a set schedule, most commonly four years. T ...
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Understanding Stock Options and Ownership in Private Companies
Additional Materials
Clarifications
- The strike price is the fixed price at which you can buy the company's shares in the future. It is usually set based on the company's fair market value at the time the options are granted. This price does not change, even if the company’s value increases later. The strike price ensures you pay a predetermined amount when exercising your options.
- Stock options are contracts giving you the right to buy shares later at a fixed price. Actual shares represent ownership in the company with voting rights and dividends. Options have no ownership value until exercised by purchasing shares. Shares can be sold or transferred, while options cannot until exercised.
- To "exercise" stock options means to buy the company shares at the predetermined strike price. This requires paying the company the strike price for each option you want to convert into shares. Exercising turns your right to buy into actual ownership of shares. After exercising, you may hold shares that could increase in value or be sold later if the company goes public or is acquired.
- Private company shares are "unsellable" because the company is not publicly traded on a stock exchange. There is no established marketplace or liquidity for these shares, so finding buyers is difficult. Transfers often require company approval and may be restricted by agreements. This lack of a market means shares cannot be easily converted to cash.
- When you receive direct share grants, the IRS taxes the fair market value of the shares as ordinary income immediately, even if you cannot sell them. Stock options delay taxation until you exercise them, meaning you pay tax based on the difference between the strike price and the fair market value at exercise. Incentive Stock Options (ISOs) may offer favorable tax treatment if holding requirements are met, while Non-Qualified Stock Options (NSOs) are taxed as ordinary income upon exercise. This tax deferral helps employees avoid paying taxes on illiquid shares they cannot sell.
- A vesting schedule is a timeline that determines when you earn the right to buy stock options. It encourages employees to stay with the company longer by gradually granting these rights over time. If you leave the company before fully vested, you may lose unvested options. This system aligns employee incentives with company growth and retention.
- A "cliff" in vesting is the initial period during which no options vest. Typically, this period lasts one year. If you leave the company before the cliff ends, you get no options. After the cliff, a lump sum of options vests all at once.
- Vesting is the process by which you earn the right to buy stock options over time, but it does not mean you own the shares yet. Ownership only happens when you exer ...
Counterarguments
- While stock options are common, some startups do grant restricted stock units (RSUs) or actual shares, especially at very early stages or for key hires.
- The tax deferral benefit of stock options can be overstated; exercising options can still create significant tax burdens, especially with alternative minimum tax (AMT) for incentive stock options (ISOs).
- Employees may face financial risk if they exercise options and the company’s value later declines or if there is no liquidity event.
- Vesting schedules can be used as a retention tool, but they may also limit employee mobility and bargaining power.
- The complexity of ...
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Equity Misconceptions: Thinking You Own Shares, Expecting Buyouts on Exit, Misunderstanding Cashless Exercise Options
Many employees misunderstand what equity in a startup actually means. Smart professionals may claim they own part of their company, but often, they only have the right to buy shares in the future—a distinction that's crucial but rarely explained. These misconceptions lead to false expectations about financial gain and the realities of startup exits.
Employees Mistakenly Believe They Own Company Shares With Vested Options
A common confusion arises when employees equate "vesting" with ownership. They hear they have vested options and assume it means those shares are theirs. In truth, vesting only grants employees the right to purchase shares, typically at a predetermined price called the strike price. Unless employees exercise this right, they don't own any equity.
Misunderstanding the difference leads people to build life plans and financial futures around assets they don't yet possess. Only after clarifying questions do many realize they've been counting on something that doesn't exist unless they spend cash to realize it. The essential lesson is: you don't own shares until you've exercised your options and actually bought them.
False Belief That Companies Buy Departing Employees' Equity Contradicts Startup Agreements
Another widespread myth is that when employees leave a company, the company must "buy them out." Many expect a financial payout when they depart, imagining their equity exists as a pile of ownership ready to be cashed in. This is incorrect.
Employee Departure and 90-day Option Purchase Window
The reality is found in the fine print of most stock option plans: when employees leave—whether by quitting or being fired—they typically receive a 90-day window to exercise their vested options. If they fail to write a check for the strike price within this window, they lose the options entirely.
Unexercised Employee Options Revert After 90 Days For Redistribution
If the options remain unexercised after 90 days, they revert to the company and are recycled into the option pool to be granted to new hires. This structure favors founders and investors, as unexercised options cost the company nothing and can be re-issued. According to data, only about a quarter of employees with vested options ever purchase them—three out of four walk away from years' worth of potential equity without financial return.
Cashless Exercise Misunderstood as Immediate ...
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Equity Misconceptions: Thinking You Own Shares, Expecting Buyouts on Exit, Misunderstanding Cashless Exercise Options
Additional Materials
Counterarguments
- Some companies, especially in competitive talent markets or later-stage startups, offer extended post-termination exercise windows or alternative equity arrangements that mitigate the 90-day exercise risk.
- Certain jurisdictions or company policies may provide more employee-friendly option terms, such as early exercise or restricted stock units (RSUs), which can grant actual ownership earlier or with less risk.
- While most companies do not buy back options upon departure, some do offer buyback programs or secondary liquidity opportunities for employees, particularly in mature startups or unicorns.
- The prevalence of employees misunderst ...
Actionables
- You can create a simple spreadsheet that lists your vested options, strike prices, expiration dates, and the cash required to exercise each batch, so you always know exactly what you own and what it would cost to convert options into shares. This helps you avoid confusing options with actual ownership and prevents unrealistic financial planning.
- A practical way to avoid missing your exercise window is to set up calendar reminders for key dates, like your vesting milestones and the 90-day post-departure deadline, so you never accidentally forfeit your options due to oversight.
- You can draft a personal checklist of ...
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Financial Consequences and Tax Issues: Option Exercise Costs, Tax Liabilities, and 90-day Window Problem
Stock options can be a path to wealth, but departing employees often face major financial obstacles, especially around option exercise costs, tax bills, and strict time limits.
Exercising Vested Options Triggers Unexpected Employee Tax Bill
When an employee leaves a company, they may have vested options that allow them to buy company shares at a fixed “strike” price. For example, a person with 10,000 vested options at a $1 strike price would need to pay $10,000 to purchase their shares if the company’s current valuation puts the share price at $10. However, this transaction triggers a taxable event.
The government taxes the difference between what the employee pays and the current market value of the shares. In this scenario, the $90,000 gap between the $10,000 strike price payment and the $100,000 current value may be taxed as income or trigger the alternative minimum tax, depending on the option type. This means the employee owes taxes now—potentially $9,000 or more—on shares they cannot sell for years, if ever.
90-day Exercise Period Causes Financial Hardship For Exiting Employees Losing Income
Employees leaving a company, often due to layoffs or resignation, typically face a 90-day deadline to exercise their vested options. This means they must decide quickly whether to spend thousands of dollars to preserve their equity—money that’s due as they are losing their regular paycheck.
The cost is immediate: the employee must come up with the exercise amount and cover taxes, all within 90 days of departure. This financial barrier deters many employees from exercising their options, even if they spent years earning them. Data shows that only about a quarter of employees moving on from a company ever buy their vested options; most walk away, losing the potential wealth they helped create.
Equity Platforms Ease Exercise Cost and Tax Burden For Departing Employees
To address this costly burden, new equity funding platforms have emerged. Services like Equity B provide employees and executives with the capital needed to c ...
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Financial Consequences and Tax Issues: Option Exercise Costs, Tax Liabilities, and 90-day Window Problem
Additional Materials
Counterarguments
- Equity funding platforms, while helpful, often require employees to give up a significant portion of their potential upside, which can substantially reduce the financial benefit compared to exercising options independently.
- The non-recourse nature of these funding arrangements may lead to higher costs or less favorable terms for employees, as investors price in the risk of total loss.
- Some companies have begun to address the 90-day exercise window by extending post-termination exercise periods, reducing the need for third-party funding solutions.
- Exercising options and paying taxes upfront, even with outside funding, still exposes employees to the risk that the shares may never become liquid or valuable, potentially resulting in no financial gain.
- The complexity and legal implications of using equity funding platforms can introduce additional risks or complications for employees, ...
Actionables
- you can create a simple spreadsheet to estimate your potential tax and exercise costs for vested options under different scenarios, so you’re never caught off guard by a sudden deadline or job change; include columns for strike price, current market value, number of options, estimated taxes, and deadlines, and update it whenever your company’s valuation changes.
- a practical way to avoid last-minute stress is to set a recurring calendar reminder every six months to review your equity situation and check for any changes in company policy, valuation, or your own employment plans, so you can plan ahead for possible exits.
- you can talk with a tax profe ...
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Exit Scenarios and Liquidation Preferences: How Preferred Stock and Sales Can Leave Employees With Nothing
Investors Get Preferred Stock, Employees Get Common Stock, Creating Pay Hierarchy During Exits
At startups, investors typically receive preferred stock, while employees and most founders are granted common stock. This distinction establishes a hierarchy of payouts during company exits. Nicole Lapin explains that preferred stock means investors are paid first—before any distributions are made to common shareholders, which include employees. In almost every venture deal, investors recover at least the amount they invested before common stockholders, such as employees, see a dollar.
Preferred Stockholders Paid First In Liquidation
Whenever a company is sold or liquidated, preferred shareholders are at the front of the line to get paid. Only after their investment is returned do common stockholders receive anything.
Investors' Structural Advantage: Full Recovery Before Employee Equity
This structure gives investors a significant advantage: they can fully recover their investment—and more—before employees begin to benefit from equity, even if the company is sold for a large sum.
Liquidation Preferences May Leave Employees With Nothing Despite a Substantial Sale
Investors often negotiate liquidation preferences—special terms in their investment agreements—including multiples such as 2X or 3X. Tracy DiNunzio notes that if preferred stockholders have a 2X liquidation preference, they get two times their investment back before anyone else, including employee common shareholders and any less-preferred investors.
Negotiation of 2x or 3x Liquidation Preferences by Investors Before Common Stockholders
Nicole Lapin points out that, in some cases, investors receive multiples of their investment before common shareholders get paid at all. This can leave employees with no proceeds, even in seemingly successful sales.
Company Sold For $100 Million; $50 Million Invested, 2x Liquidation Preference; All $100 Million to Preferred Shareholders, None For Employee Common Stockholders
A typical example is a company that raises $50 million and is later sold for $100 million. If a 2X liquidation preference is in place, the preferred shareholders—in this case, the investors—would be entitled to $100 million (2 x $50 million) before any money goes to common shareholders. In this scenario, employees holding common stock would receive nothing, despite a large acquisition headline.
Liquidation Preferences Often Leave Employees With No Proceeds
Lapin emphasizes that these situations are not rare; liquidation preferences frequently result in employees’ equity being worth nothing when exits occur below or only slightly above the total invested amount.
Ipo Scenarios Differ From Acquisitions As Preferred Stock Converts To Common Stock
When a company goes public through an IPO, the structure chang ...
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Exit Scenarios and Liquidation Preferences: How Preferred Stock and Sales Can Leave Employees With Nothing
Additional Materials
Clarifications
- Preferred stock grants investors special rights, such as priority in receiving dividends and liquidation proceeds before common stockholders. Common stock represents ownership with voting rights but typically lacks these financial preferences. Preferred stock may also have conversion rights to common stock under certain conditions, like an IPO. Common stockholders, including employees, benefit primarily from company growth and profits after preferred stockholders are paid.
- Liquidation preferences are contractual rights that determine the order and amount investors receive when a company is sold or liquidated. They protect investors by ensuring they get their initial investment back before common shareholders receive any proceeds. These preferences can include multiples, meaning investors get a set multiple of their investment before others are paid. They are negotiated during funding rounds and can significantly affect how sale proceeds are distributed.
- Payout hierarchy means the order in which shareholders get paid when a company is sold or liquidated. Preferred stockholders have contractual rights to be paid before common stockholders. This order protects investors by ensuring they recover their investment first. Common stockholders, including employees, receive any remaining funds only after preferred shareholders are fully paid.
- Liquidation preference multiples like 2X or 3X mean investors get two or three times their original investment back before others receive any payout. These multiples compensate investors for higher risk or delayed returns. They are negotiated during funding rounds and written into the investment agreement. This increases the amount owed to preferred shareholders upon exit, reducing what remains for common shareholders.
- Investors receive preferred stock as a form of protection for their financial risk. This stock includes contractual rights that prioritize their repayment before common shareholders during liquidation or sale. The priority ensures investors can recover their investment, encouraging them to fund startups despite high failure rates. Employees hold common stock, which is subordinate and only pays out after preferred shareholders are fully compensated.
- Preferred-to-common stock conversion means that preferred shares held by investors are exchanged for common shares before the IPO. This eliminates the special rights and preferences of preferred stock, making all shares equal. It simplifies the company's capital structure for public trading. This conversion aligns the interests of investors and employees by giving them the same type of shares.
- In an IPO, preferred stock automatically converts into common stock, eliminating payout priority differences. This means all shareholders sell their shares on equal terms in the public market. Unlike acquisitions, there is no liquidation preference that prioritizes investors over employees. This conversion aligns incentives and allows employees to realize the value of their equity.
- "Recovering their investment" means investors get back the exact amount of money they originally put into the company before anyone else receives any payout. This protects investors from losing money if the company sells for less than expected. It ensures investors are made whole first, reducing their financial risk. Only after this repayment do remaining funds get distributed to other shareholders like employees.
- Employees might receive nothing because their common stock is last in line after preferred shareholders during payouts. Preferred shareholders have c ...
Counterarguments
- Liquidation preferences are a standard mechanism to attract investment by reducing investor risk, which can make it possible for startups to raise the capital needed to grow and create jobs in the first place.
- Employees are often compensated with equity as an additional benefit, not as a guaranteed payout, and are typically aware of the risks and terms associated with startup equity.
- In some cases, companies offer employee stock option plans with additional protections or incentives, such as accelerated vesting or carve-outs, to help ensure employees receive some value in exit scenarios.
- The payout hierarchy reflects the higher financial risk investors take by providing capital, often at early and uncertain stages, justifying their priority in returns.
- Not all liquidation preferences are structured as multiples; many are 1x non-participating, which can be less punitive to common shareholders.
- In h ...
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Practical Strategies: Queries Before Signing, Negotiating Exercise Windows, Using Equity Funding Platforms to Preserve Equity
When considering an offer with an equity package, it’s essential to ask targeted questions, leverage negotiation opportunities before signing, and learn how investor dynamics impact your equity’s value.
Ask These Before Accepting an Equity Package
Before signing anything, there are three questions every prospective employee should ask:
Determine Diluted Share Count to Make Option Grants a Meaningful Percentage
First, ask how many fully diluted shares are outstanding. This converts your stock option grant into a percentage of the company, helping you assess if the number of options is as valuable as it sounds on paper.
Determine Strike Price and Company Valuation to Calculate Options Worth
Second, find out your option’s strike price and the company’s latest valuation. Knowing the strike price and where the company was last valued tells you what your options are actually worth today versus what their future value may be.
Options Upon Departure: Exercise Window Length and Cashless Exercise Availability For Former Employees
Third, clarify what happens to your options if you leave. Specifically, ask about the length of your post-departure exercise window and whether a cashless exercise is possible for former employees. Some companies now offer five, seven, or even ten years to exercise options after leaving, though most still provide only a 90-day period.
Negotiating Exercise Terms Before Signing Creates Leverage That Disappears After Leaving
You have the most leverage to negotiate favorable equity terms before joining, not after leaving. Extended exercise windows—for example, five, seven, or even ten years—are increasingly offered by forward-thinking companies. While most still provide only 90 days, if you ask for an extension before signing, you have a stronger position. Employees have succeeded in obtaining more time when they raise the issue ahead of acceptance. This shift can turn equity from an often unaffordable benefit into a genuine wealth-building tool, as it eliminates the pressure to pay a large sum to exercise options within a short window after departure.
Questions About Founder Alignment and Investor Structure Provide Context on Equity Value and Safety
Asking about founder alignment and the company’s investor structure gives important context on the stabil ...
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Practical Strategies: Queries Before Signing, Negotiating Exercise Windows, Using Equity Funding Platforms to Preserve Equity
Additional Materials
Counterarguments
- While understanding the fully diluted share count is important, companies may be unable or unwilling to disclose this information due to confidentiality or competitive reasons, especially at earlier stages.
- The strike price and latest valuation may not accurately reflect the true value of options, as private company valuations can be volatile, opaque, or subject to manipulation.
- Extended exercise windows, while beneficial to employees, can create administrative burdens and potential tax complications for both the company and the employee.
- Not all companies are able to offer extended exercise windows due to legal, financial, or cap table management constraints, and insisting on them may not always be practical.
- Extended exercise windows can increase the risk of option overhang, potentially diluting existing shareholders and complicating future fundraising.
- Founder alignment through equity class may not always be feasible or desirable, as founders often require different voting rights or protections to attract investment or maintain control.
- The investor base’ ...
Actionables
- You can create a simple spreadsheet to track and compare equity offers from different companies, including columns for fully diluted share count, strike price, latest valuation, exercise window length, and investor details, so you can visualize and weigh the true value and risks of each offer side by side.
- A practical way to prepare for equity negotiations is to draft a list of clear, direct questions about equity terms and rehearse asking them out loud, either alone or with a friend, to build confidence and ensure you get the information you need without hesitation during interviews.
- You can set ...
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1-Page Summary- Understanding Stock Options and Ownership in Private Companies
- Equity Misconceptions: Thinking You Own Shares, Expecting Buyouts on Exit, Misunderstanding Cashless Exercise Options
- Financial Consequences and Tax Issues: Option Exercise Costs, Tax Liabilities, and 90-day Window Problem
- Exit Scenarios and Liquidation Preferences: How Preferred Stock and Sales Can Leave Employees With Nothing
- Practical Strategies: Queries Before Signing, Negotiating Exercise Windows, Using Equity Funding Platforms to Preserve Equity
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