Founders know that equity is a powerful commodity for a startup; used effectively, it allows you to attract top talent and save on cash. But, simply giving employees equity isn’t enough. Your equity compensation needs to be a part of a broader strategy that fits with your company culture and goals. 1871 workshop leader Iman Malik of Carta gives us the low-down on equity trends.
Guest Author: Iman Malik, Carta
At Carta, we see thousands of stock options, vesting schedules, and equity grants. The data we have on private companies has illuminated four interesting trends.
- An increasing demand for equity education
As options become a more common benefit to employees, there’s a need for comprehensive education. Even just the basics can be foreign to a startup hire. And it’s not just employees who long for clarification. A survey taken by our customers showed that both VPs and senior managers feel like they don’t fully understand their equity.
The most common questions are relatively basic: What is a stock option? How does my stock option gain in value? How and when should I exercise? What are the difference between common shares and preferred stock? And finally, what are the compliance and tax rules to be aware of?
To address these questions, we are seeing more companies set up a quarterly education on equity best practices. These are ideal for educating employees as you scale. They can cover everything from “What is early exercise,” to “How to file your 83(b).” Feel free to use our equity education resources part 1, part 2 and part 3 to help you.
- More transparency around the value of equity
For employees to have a sense of how much their options are worth, they need to know how much your company is worth. At Carta, we are now seeing the top startups share more information with their employees about their options.
The standard used to be sharing only the number of shares owned by the employee and the strike price. This is the bare minimum and offers little to no insight on how much an equity package is worth.
As transparency has increased more companies have started sharing additional information like the current fair market value (FMV) of the company, total outstanding shares, liquidation preferences, and more. While this doesn’t completely answer the question of worth, it does help employees better determine the tax implications of exercising their options.
At Carta, we share everything possible with employees and do so in a unique way. When we make an offer to new employees, we go through a hypothetical payout due to an IPO or acquisition in order to demonstrate how much the company must exit for employees to see a reward. This serves as education and realistically sets expectations for employees on the value of their shares.
- Longer Post Termination Exercise (PTE) periods
The third important shift we see is to longer PTE periods. PTE is the amount of time after an employee leaves the company where they are allowed to exercise their shares. 96 percent of companies on Carta have a standard PTE window of 90 days or less.
Some of the biggest private companies have extended these windows to five or even ten years; giving employees more time to collect the funds to exercise their options. They won’t have to miss out on cashing in on the value they worked hard to build.
However longer PTE periods come at a cost to the company. The longer an option is outstanding the greater the expense on a company’s balance sheet. Also, most employee options are Incentive Stock Options (ISO). These have tax benefits but will expire in 90 days, prompting the 90-day PTE periods. If your company decides to offer a longer PTE window you will need to convert these options to Non-qualified stock options (NSOs) after the 90 days have past.
Either way, longer PTE is a trend for leading tech companies and another benefit to offer your employees.
- Increase in demand for liquidity
Due to some underwhelming tech IPOs in recent years, as well as higher valuations and the ability to more easily raise capital in the private market, we are seeing companies stay private for longer. This means IPOs are slowing. Combine that with the volume of equity being given out to employees and the demand for liquidity has sky rocketed.
We have seen private companies start to perform more frequent tender offers as a way to give employees a chance to sell their options. Instead of waiting for a IPO that might never come, secondaries and buy backs give employees a chance to get a lump sum of cash for a down payment on a house, luxury vacation, or pay off those last student loans. They also give founders a chance to bring on a new investor or clean up their cap table by consolidating some ownership.
From a small startup to a massive unicorn, these trends are fundamentally changing the way private business operate. Companies spearheading these revolutions are prioritizing employees and creating a better culture inside their company’s walls.
About the Author
Iman Malik is a content marketer at Carta (formerly eShares, Inc.) focusing on building content for the company and SEO related guest posts for various establishments. Her articles can be seen on DreamIt Ventures, Zenefits, Carta, etc. She has also ghost written countless articles for accelerators and incubators.
The opinions expressed here by 1871 guest writers are their own, not those of 1871.