Equity-based pay is often used by the founders of young start-ups who want to grow their businesses but cannot offer big salaries to qualified professionals. Typical arrangements seek to either partially or fully compensate service providers with stock in the company in exchange for hard work.
Depending on where you are at (career- and age-wise), as well as where the company is at –and where it is going– this offer could either be an amazing opportunity, or it could be a total waste of your time and potential. Below are some helpful tips and suggestions to keep in mind when contemplating whether or not to take an equity-based position.
Gauge The Company’s Ability To Sell
Equity compensation can be a lucrative investment of your time if you work for the right business. When deciding whether to accept such an offer, you must perform a sort of risk assessment of the company, including their ability to become profitable, access funding (if necessary), and eventually, to sell.
In business, the most common type of risk analysis one can perform on a company is known as the SWOT analysis. QuickMBA defines a SWOT analysis as examining an organization’s Strengths, Weaknesses, Opportunities, and Threats. A firm’s strengths and weaknesses are determined by factors inside the company, whereas opportunities and threats refer to environmental factors (such as competition and alternatives) outside of the business. After fleshing out this analysis, you should have a better idea of the risk level of the company offering you the position.
You are even are justified in requesting to see some financial reports in order to judge the health of the organization. Run from any executives offering equity-based pay who have a problem showing candidates evidence of company financial success, as they likely have something to hide.
Has This Company Been Funded?
As part of your risk assessment of a company, determine whether the company has been funded. Funded companies are typically a safer bet than bootstrapped ventures for two important reasons. First and foremost, a funded company has more money to work and compete with. Developing a cutting edge product and marketing it effectively is not a cheap process, and having investors to make sure the bills get paid is a great asset for any new business to have.
Second, funding is a seal of approval from a professional investor. This is not to say that all funded companies are bound for success, however venture capitalists are trained to assess businesses by their strengths and weaknesses. If the company was funded, it mean that a professional evaluation was performed on every aspect of the start up and it was determined that they were likely to do well.
Sweat Equity Or Equity With Compensation?
The arrangement of pure equity without additional compensation is considered a fairly risky agreement. The potential pay-out could be quite large since you will likely be offered significant equity if no money is involved. However if the company does not succeed, or takes very long to start making money, you might squander years of time on a botched investment.
A less troublesome arrangement is that of equity with compensation. In this scenario, your expected salary is reduced and augmented with equity. Online start up resource GrowThink.com gives an example of this, stating that if your services are worth $80,000/year, you might be offered $60,000 in salary and $20,000 worth of equity.
Equity As a Performance Incentive
Equity pay can be an powerful motivating force for those working in areas that directly affect the revenue of the business. If your special skills and knowledge have an impact on the sales of goods or services, an equity stake with compensation (as discussed above) is sometimes preferable.
The harder your work the more your equity will be worth. At a certain point, your stock might be valued at far more than your full salary could have ever provided you.
Is The Equity Appropriate For Your Position?
Another way to sniff out a good deal is to see if the equity you are being offered is appropriate for your position. Exceptionally high offeres may be indicative of a hurting company looking to lure in a rescuer without having to pay them money.
Guy Kawasaki, a technology venture capitalist, compiled a list of typical equity amounts for common positions. These are:
- Senior engineer: 0.3% to 0.7%
- Mid-level engineer: 0.2% to 0.4%
- Product manager: 0.2% to 0.3%
- Head Architect: 1.0% to 1.5%
- Vice presidents: 1.5% to 3.0%
- Chief Executive Officer: 5.0% – 10%
If your equity offer falls within these figures, Kawasaki’s research would deem it a reasonable offer. This is not to say you shouldn’t still proceed with caution, however it does give you guidelines to help you spot unreasonable or suspicious requests.
Before accepting an equity-based pay arrangement, you should determine if the equity is vested, or granted all up front. Vested equity is paid out in increments over time. If you are to receive a 2% equity stake vested over the course of four years, you might receive 0.5% per year along with your regular pay. GrowThink.com reports that this strategy is often used as an incentive to keep employees in their positions for that period of time, with the promise of more equity as a motivating factor to continue working hard.
In order to intensify this motivation, some companies have even taken to offering scaling equity, such that you earn progressively bigger stakes per year until you earn your total amount. Under this arrangement, a 4.5% stake vested over two years might be paid out as 0.5% in the first year, 1% in the second year, 1.2% in the third year, and 1.8% in the fourth year.
What Stage Are You At In Your Career?
Equity-based pay (especially full equity pay), must be considered in the context of your current career. If you are a young professional who has the time and energy to work lots of overtime hours to effectively grow your equity stake, this sort of pay arrangement might be best for you.
Conversely, those have already established themselves in their careers and earn strong salaries might have trouble taking a serious pay cut and working more hours for an equity share. Since equity is only a wise investment if you plan to put long, hard work into raising its value through your actions, these sort of arrangements are befitting of those seeking to establish their career and begin building wealth.
This article was written by Allison Canty.