Ep 33 | Navigating Equity Comp 101
If you've ever looked at a startup job offer and thought, “This sounds exciting… but what does any of this actually mean?”, this episode is for you.
Priya sits down with fintech veteran and former VC partner Liran Amrany to demystify startup equity. Together, they break down what you're being offered (ISOs, NSOs, RSUs, and more), how to evaluate the value of equity compensation, and the lifestyle tradeoffs that come with betting on a startup.
Whether you're negotiating an offer or just want to understand how startup equity works, this episode gives you the tools and questions to confidently navigate it all.
Takeaways
What all those acronyms in your offer letter mean (ISOs, NSOs, RSUs, etc.)
How to ask smart questions about valuation, cap tables, and strike prices
The tradeoffs between cash comp and equity—and how to make that decision
Why “You have 90 days to exercise” is a big deal
How to make startup equity enhance your financial plan; not be your only plan
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Transcription
Equity should enhance your financial plan. It should definitely not be your entire financial plan. Absolutely.
Hey guys! Welcome back to The F Word, where I help ambitious 30-somethings get their financial sh*t together so they can live well now and build wealth for later. Today we're tackling one of the most confusing and potentially lucrative topics out there: startup equity. Whether you've been offered options, RSUs, or just a whole lot of promises, today we're gonna help you get clear and make sense of what you're being offered.
Joining me is my very good and insanely credentialed friend, Liran Amrani. Liran has a master's in financial engineering from Berkeley. He then spent nine years on Wall Street for JP Morgan. For the last 11 years, he's been heavily involved in the FinTech community—founding and incubating companies, advising companies, investing in companies.
Most recently, he was a partner at Team Eight, a $1 billion venture capital fund based out of Israel. He works with a lot of early stage founders, and in full disclosure, he's on the Stash Vault Advisory Board. Thank you so much for joining me, Liran.
Thanks for having me, Priya.
Alright, let's get into it. So I wanna demystify the concept of startup equity so that people can really understand the value in terms of their portfolio and also the compensation that they're being offered directly for taking on these types of risks.
So obviously a lot of our clients get offers with a lot of confusing acronyms, which I really wanna demystify with you today. So let's start with: what is equity compensation? Maybe then we could touch a little bit on the most common types being offered to professionals in their thirties these days. So can you take us through it? Just start with: what is equity compensation?
So the high level: equity is how companies—not just startups—will incentivize their employees. One, to prioritize the well-being of the company. And two, to stay. So typically, there will be a vesting period of up to four years with startups. That encourages you to stay for the full length, especially if the startup is doing well and you want that equity to become more valuable. You wanna stay for the full vesting period.
But more than that, they want everybody focusing on company value creation. And the best way to do that is by making part of your bonus, your salary, or your income based on the value of the company itself.
Got it. Okay, so like aligning incentives between the employee and the company's goals so that everyone's pushing harder to help the company become more valuable.
Exactly.
Okay. And let's talk about—that’s typically more possible in a smaller company. You can have more of an impact on how well the company does. When I worked at JP Morgan and got paid in equity, I wasn’t directly influencing the value of JP Morgan equity. But it was still a way for them to have us sort of aligned with shareholders and sticking around long enough for it to vest.
Basically it was peanuts is what you're telling me.
Okay, cool. That's helpful. So typically equity compensation is more of a consideration and becomes a larger decision when the company is in its earliest stages. Can you talk me through some of those stages and what are some of the common types of equity compensation starting with, like, seed?
So the upside/downside is much higher the earlier the stage of the company. When I was at JP Morgan and got paid equity, certainly the stock fluctuated a lot during the financial crisis, but like—JP Morgan wasn’t going bankrupt. Some other banks did go bankrupt, unfortunately. But with a startup, your equity can go up a hundredfold, it can go down to zero, and both of those are not that crazy. That doesn’t take a once-in-a-lifetime financial crisis for that to happen.
So most startups will issue what’s called ISOs: Incentive Stock Options. And what that does is it allows employees the ability to purchase stock at a predetermined strike price. The strike price is usually determined at the time of issuance, and you don't have to exercise it until either the company has an elimination event—so it goes public, it sells, and you wanna sell the stock—or if you leave the company. Typically they'll give you 90 days to exercise.
And that’s where some of the complications get into as well, that I’m sure we'll talk about a little bit—taxes, things like that.
Yeah. That costs money to exercise the options, and like some people don’t have that money.
Right. That’s a really… and let’s go there.
So you talked about ISOs. Let’s just break that down. Those are very common, we see them a lot. Let’s talk about what an option is. What is it really? Explain what an option is.
An option is a contract that lets you buy stock at a predetermined price.
Now, typically the way it works with startups is you have the valuation that is publicly disseminated in press releases around funding deals and things like that. And then you have the 409A valuation, which is the valuation assigned to the common stock.
So investors, when they invest, are getting preferred stock—there’s usually a higher value there. As a startup employee, you’re getting an option to buy common stock. Usually there’s not much of a difference. The difference happens when there’s maybe a liquidation event that’s not great, and the preferred investors have the ability to recoup their money first.
But in the outcomes you’re hoping for as a startup employee, the company goes public, everything gets converted to common, and your equity will be worth the same. So it’s actually a good thing from that perspective that the common equity is worth less when you’re getting the option, because that means your strike price is lower.
So the price that you have to pay to exercise—to buy that stock when you decide to do it—will be lower. It’s usually tied to that 409A valuation. And that’s typically just a regulatory type of procedure that companies will do, where they get a third party to value the company. That way they’re not issuing equity at prices that are too low or too high, and they have a third party they can point to: “This is how much they said the company was worth—the fair value of the common equity at that point in time.”
Yeah. Okay. So what about in terms of how many options? I think that’s a confusion a lot of people have. They’re given their options in terms of like a thousand options or ten thousand options, and that just seems so confusing as to how you tie that number to the valuation. Can you maybe talk a little bit about that?
Yeah. There’s a few moving parts that can get a little bit complicated. The number of options can be misleading because at the end of the day, you don’t know how many outstanding shares the company has.
So, you know, 10,000 options in a company that has one million shares outstanding can be worth more than 50,000 options in a company that has a billion shares outstanding. The number of shares outstanding can vary widely, and it is typically very, very large.
So one of the things you should ask when you’re being offered equity or options is: what is the current number of fully diluted shares outstanding for the company? That way you can understand what percentage of ownership this means if you exercise.
And that’s one important thing because you want to know: okay, if the company goes from maybe today it’s valued at 25, 30 million, and you think there’s tons of potential—or you just want to map out what happens if it goes down to zero, what happens if it exits for 50, what happens if it exits for a billion—what’s important from your perspective is what portion of the company you can own.
And then the other thing is: how much money is it going to cost you to exercise the option? That’s where the strike price and the number of options do come into play.
So you might say, okay, I have 10,000 options, there are one million shares outstanding, so if I exercise, I would own about 1% of the company. Again, there could be more dilution in the future. That number is not set in stone, but ballpark—if you’re trying to do the math—if the company is worth a billion dollars, that’s 10 million dollars of potential equity that I own. But I have to know what that strike price is.
So if the strike price is $100, I have to pay $100 times 10,000 shares just to get those shares in my name. And so you’re talking about going from—that’s a million dollars right there. So I have to pay a million dollars to get those shares, and then it’s worth 10 million dollars, which is still a great outcome. But it’s important to understand, obviously, the dynamic between the number of shares, the strike price, and the percentage ownership that you would have in the company.
You’re one of those rare people who can just do math in your head, aren’t you?
I try to use easy numbers.
That was helpful. We just covered a lot of ground there, so I want to back up and talk about what you can and cannot ask. So just hitting on a couple ideas: the 409A, fully diluted share count. Let’s start with those. Can you ask about the valuation, and how do you make sure they’re not telling you something that is out of date or looks better than it actually is?
From the valuation perspective, that part’s tricky. You simply have to trust the company. You’re building a trusting relationship there, right? When you’re joining—especially an early stage startup, even a growth stage startup—you’re putting your faith that these people know what they’re doing and they’re gonna do the right things by you, by the shareholders.
I think you want to believe in the founders in more ways than one. I think that’s very important for any job you’re taking: believe in the people you’re working with and working for. But in terms of what you can ask, you should feel free to ask everything. Most of the stuff they should be able to tell you.
It might be in different terms—maybe it’s, “What is the current valuation?” or “What percentage of ownership would this represent if I exercised all the options?” You can just straight up ask them. All these numbers tie in together.
So, like, if you ask, “What is the strike price on these options? What is the number of options? And what is the current public valuation of the company?”—public meaning the last capital raise—you can figure out the rest. You can figure out the percent ownership.
But you need the 409A. There’s the 409A valuation, which is the common equity, and then there’s the preferred equity valuation, which is what you read when you hear, “This company just raised at a 10 billion dollar valuation.” That is what the investors are getting when they’re buying preferred equity. The 409A valuation for the common equity that employees are getting is going to be a little bit lower.
Yeah, you’re right—that is a good distinction.
Anyway, we mentioned OpenAI. They might be public because they announced it, but the equity is not public. It’s still private equity—it’s not traded publicly. The valuation itself is public, but in many cases it’s not. Many companies will raise a lot of money and just not issue press releases.
So the number that matters is the valuation at the most recent capital raise—when they sold equity most recently. All the numbers tie in together, so you can back into some of them from others. If you know the percentage of the company that you have, then you’ll know how many fully diluted shares are outstanding, because you’ll know the percentage you have and the count that you have. That allows you to figure out how many are total outstanding.
Okay. That brings me to the next thing—fully diluted. Can you talk a little bit more about this concept?
When a company is formed, they set aside a bunch of shares. This is just a technical, legal kind of framework. Then they start issuing shares. They’ll issue shares initially to the founders—so the founders get founder equity. Then they’ll issue shares every time there’s a priced equity round, when investors are buying into the equity.
As part of those funding rounds, there’s usually an option pool. Out of that option pool, they issue options to employees. Typically, once you start maxing out these numbers, you have to do another round of issuing more shares.
So the fully diluted shares outstanding is just the total number of shares that have been issued to founders, investors, and those that would be exercised if all the employee stock options were exercised.
Can you put that into an example for us? Typical, easy numbers.
Sure. So let’s use 10 million shares outstanding. Typically, the founders after one round maybe have 7 million of those shares. The seed investors that came in maybe own 2 million shares. Then 1 million shares have been set aside for stock options, and maybe so far they’ve only issued 500,000 of those.
From a plain-English perspective, it’s how many shares would there be if everybody exercised their options. That helps you determine what percentage of the company you would own. That’s why I said they all sort of tie into each other.
Okay, so fully diluted means the number of shares that would be outstanding if everyone exercised their options?
Exactly. If everyone exercised their options, if there were other warrants outstanding, too. But basically, it’s not counting shares that haven’t been issued yet.
Right. So one option to one share—is that how that works?
Yes, in this framework, yes. If you’re trading options in your Fidelity account, it’s a little different.
Okay. So in the startup context of what you’re typically being offered, one option translates—if you exercise that one option, you end up with one share in the company.
Exactly. The idea behind understanding your portion of the fully diluted shares is: what happens if there was an exit tomorrow? Because presumably, if there was a good exit tomorrow, everybody would exercise their options. That would tell you how much you own.
But you don’t know what’s going to happen in a year or two years. There’s no way to say, “What portion of the company am I going to own when we exit in five years?” because you may do three more rounds of fundraising, you may do none. There’s a whole bunch of different factors that go in there. More shares could be created as well, and all that will dilute you over time.
So you should expect to be diluted over time. But that’s not a bad thing—it means the company’s growing and raising more money. Your percentage of the pie may be getting a little bit smaller, but the pie itself is getting a lot bigger and more valuable.
Beautiful.
I should say: your percentage of the pie is getting smaller, but your portion—your slice—is still getting bigger.
Are we talking about pizza? I’ve totally lost track.
Are you hungry?
I am always hungry for pizza.
Okay, we’ve talked a lot about seed and early stage. If your company’s a little bigger—say Series A, B, C—what are some of the common equity compensation types that might be offered? At those levels, maybe still options, but what else gets introduced?
So ISOs are still the most common. For later-stage companies, and this is much more common in public companies than private companies, they’ll just issue restricted stock units.
This is, for example, what I got when I was at JP Morgan. In this case you’re getting actual stock—so there’s no opt-in. You don’t have to buy or sell, you just have to wait until it vests. Then you own some shares in the company.
There can be other things like NSOs and phantom shares. NSOs used to be a lot more common. There’s basically just a small tax difference between the two, but it’s a small tax difference that can end up being very big in certain bad situations. It really impacted a lot of people during the dot-com crisis in the early 2000s.
Maybe I’ll explain a little bit on the tax difference.
Sure. Please.
With an incentive stock option, when you exercise, you don’t pay any taxes. When you sell the stock—because exercising means you’re buying the stock—you might hold onto it for a day and then sell, you might hold onto it for a year and then sell.
When you sell the stock, assuming you’ve held onto it for at least a year and it’s at least two years since the original grant of the stock, then you pay taxes on the gain from the strike price—where you paid—up until the price that you sold. And that’s all long-term capital gains, which is a lower, more preferential tax rate.
With NSOs, what happens is when you execute the option, you pay ordinary income on the difference between the strike price and the fair market value at that point in time. Then, when you sell the stock, you pay capital gains—long-term or short-term—on the difference between the fair market value at the time of exercise and the sale price.
So ISOs sort of have a more delayed tax consequence.
Exactly.
And the issue that happened in the 2000s is that people executed their NSOs. As I mentioned earlier, if you leave a company, oftentimes you have 90 days to decide whether you want to exercise. If the company’s doing really well, you definitely want to do that.
But then that generated a tax liability because the fair market value at the time of the exercise might have been, say, $1,000 per share, while their strike price was $100 per share. So the value of the company went up 10x since they joined.
Now all of a sudden they had millions of dollars in taxable income—but then the market completely crashed. Either while the company was still private or even after it went public, but before they had a chance to sell.
So all of a sudden, you had a lot of employees of tech companies who had a million dollars in tax liability, but they didn’t have a million dollars worth of shares to even liquidate and pay. And it’s a big deal, because you can’t just write off tax liability. It’s something that will chase you for years.
So the incentive stock option is meant to alleviate that issue so you don’t pay taxes until you sell, and only if there’s a profit from the fair market value when you were issued the shares, as opposed to when you exercised the options until you sold.
So the one difference with ISOs, where you don’t have to pay taxes until you sell, is that there’s one loophole—if you’re subject to AMT. So when you exercise the options, you’re not paying capital gains or ordinary income, but it could trigger some additional tax within the AMT framework. Which is way too complicated for us to get into.
The takeaway here feels like: bring in a tax expert if you’re in that situation, where you’re trying to figure out how to decide. It’s not so much about deciding how much it’s worth to you—it’s more of a planning decision.
Exactly. A long-term planning decision around when you should exercise. Usually, you’ll wait until you’re ready to sell. In most situations, you’re going to prefer ISOs to NSOs. I think most companies offer ISOs. I don’t know too many that still do NSOs these days.
Okay, that’s helpful. So let’s talk a little bit about planning. When you’re getting equity compensation, you should consider it as part of your total compensation: part cash, part deferred—this leveraged aspect, right? You’re getting equity that can be worth more in the future than it is today.
So how should someone think through how much equity they take relative to cash?
There’s no hard and fast rule. The easiest way to look at it—but I’ll explain why it’s not necessarily the right way—is to look at the current valuation of the company.
If the current valuation of the company is $10 million, and the strike price because of the 409A valuation is maybe $3 million, and you’re getting 1% of the company, then you’re getting about $100k worth of value in options at today’s valuation. But you have to pay $30k to exercise that. So you’re really getting $70k of value in these options at today’s valuation.
Spread that out over four years, and you could say that’s equivalent to about $18k a year for the next four years. But the thing that’s important to know is: nobody’s taking startup equity because they think it’s going to remain static over the next four years. It’s either going to go up or it’s going to go down.
As an employee, you have the option to stay or to leave. You sort of have to map out the different scenarios.
If the company ends up not lasting and goes out of business in a year—fine, you spent a year and you didn’t get any equity at all. If you’re there for four years, it’s probably because the company is doing well. If the company’s not growing that much, you always have the option to leave.
So you could say, “It’s worth $18k a year, but there’s a scenario where in four years it’s worth $700k instead of $70k.” And as a person who has equity vesting on a monthly basis, starting after year one, you can stay for that first year, get that first 25% of equity, and then decide if you want to stay or if you want to go.
Not that I’m suggesting people just hop around every year. You’re going to get questions in your next interview. But in terms of valuing it, you don’t know what the startup is going to be worth in a few years.
So you want to join a company you really believe in, that you think is going to do well. It’s almost impossible to put a number on it. But you should know you’re not making a decision today based on where the valuation’s going to be in four years—you have decision points all through the next four years where you can decide: do I stay, do I go, do I ask for more equity?
Hopefully the company does well and it’s not an issue.
Yeah. And so the trade-off there is: what is the cash today? Can you live on it? The more you believe in the company, the more you want to trade cash for equity.
Exactly. It very much depends on your financial situation. Do you have a family? Do you have kids? Maybe you don’t have as much flexibility. Are you single, with money saved up? Maybe you can afford to live on a little bit lower salary and roll the dice more with equity.
But you should know: you are taking a risk. This is like angel investing—but with your time. Anytime you write an angel check into a startup, you should know there’s a good chance it’s going to be worth zero. But if you’re really good at picking and choosing, and you really believe in a company, as an employee you have some agency to actually help the direction and success rate.
That excites a lot of startup employees—that possibility it could be worth a lot more in a few years.
Okay, so helpful. One more thing just before I let you go. You’ve touched on vesting and talked about the standard vesting. Can you explain vesting? What do you mean when you say “standard vesting schedule,” and why is vesting a thing?
That part’s easy. Vesting is a thing because companies don’t want to give you a ton of equity and then have you leave the next day. So, in order to incentivize you to stay for a reasonable amount of time, they’ll make sure that equity vests over a period of time.
At startups, the standard is four years. Four years with a one-year cliff.
What is a one-year cliff?
That means you’re not getting any equity at all for the first 11 months. If you leave or you’re fired in those 11 months, you walk away with nothing. After month 12, you get a quarter of the total equity. From then forward, typically every month you vest another one-forty-eighth—because there are 48 months in those four years. So it’s a quarter every year, but in monthly installments starting after year one.
Gotcha. Thank you, that was helpful.
A lot of people talk about the cliff as in staying until that first year so they can at least get some of the equity they’ve worked for. And a lot of people will stay for four years to get all of it. If the company’s doing really well, you don’t want to leave that equity on the table. But maybe you’re just ready for a different challenge.
A lot of people will wait until the end of the four years because they got equity when the company was worth $10 million and now it’s worth $200 million. At that point, you can put a value on how much that last year’s equity is worth, and you might not want to leave for another job where you’re not getting paid as much, or where there’s just a lot more uncertainty.
The better the company’s doing, the harder it is to leave—because you’re leaving money on the table.
Yes. Okay. Wonderful.
We always tell clients: you can take a bet when you’re joining a startup, but you want to do it with your eyes wide open. You made an excellent point about the fact that you have agency. Unlike angel investing, when you join a startup you actually have agency to help increase the value. If you have confidence in yourself to do that, it increases the potential value of the equity.
But at the end of the day, equity should enhance your financial plan. It should definitely not be your entire financial plan.
Still. Cool. Okay, so helpful.
I’m just gonna recap some of those questions, and help me here. When you’re negotiating or in those early interview conversations, once you feel like you’re talking money:
Ask for the most recent public valuation.
Ask for the fully diluted share count.
Use those numbers to back into your ownership in the company.
Or just ask them, “Alright, what ownership does this represent if all the options are exercised?”
One other thing I just thought of. A lot of times you’ll want some legal counsel, and whoever’s legally representing the company cannot also help the person who’s joining the company. So what are the tips there? Who should you look for? Who can help answer some of these questions?
Any employment lawyer will know this space pretty well.
Cool. Employment lawyer it is.
Liran, thank you. Before I let you go, we have a little tradition here. It’s called Best Bite. As you know, because you are too a big foodie. Here’s how it works: every guest leaves a food recommendation for the next guest. One drink or dish from any restaurant. Doesn’t have to be in New York City. You won’t know who you’re recommending it to, though, so that makes it kind of fun.
Your bite was recommended by our last guest, Ian Steinberg, who is a prenup expert. His Best Bite—curious if you’ve had it, since you live in New York—it was the Supreme Pizza from Rubirosa. Have you ever had it?
I’ve been to Rubirosa. I’ve not had the Supreme Pizza, to the best of my recollection.
That is your recommendation from Ian. And if you had to pick one dish or drink from any restaurant—take your time.
I’m gonna cheat a little bit because, I don’t know when this will air, but it’s 98 degrees today in New York City, and it was close to that yesterday. I had some salted cashew ice cream from Anita’s Flatiron, and that was really good.
Wow. That sounds incredible.
Of course I don’t eat ice cream in a cup. I don’t understand that. Fresh-pressed waffle cone.
Regular cone?
Yes.
Okay, so say that again.
Salted cashew ice cream from Anita’s Flatiron.
Love. That is going on my list. Amazing. I can’t wait to try it.
Okay, thank you so much for spending time with us today.
Thank you for having me.
To my listeners—if you’ve ever stared at a startup offer and thought, “This sounds exciting, but I don’t actually understand what I’m signing”—I really hope this helped.
A big thanks to Liran for helping us break it all down. And as always, please share this episode if you have a friend who’s interviewing at a startup. If you’re wondering how equity fits into your big picture, we’ve got a lot more coming your way.
Thanks for listening to The F Word. Alright—see you next time.
