Startups have a reputation of being cash-strapped. They seek to reinvest the majority cash inflows into improving services and expanding their base.
Therefore, startup compensation is structured differently to matured organizations.
Startups tend to offer low salaries and worker benefits together with a higher percentage of equity during their growth stages.
This article will explain the common differences among the different compensation types at startup companies and help you determine which option is right for you.
Salary Compensation vs Equity Compensation
Decide whether equity or salary is more important for you in both the short and the long-term. You have the freedom to do whatever you wish with your salary. This makes it easy to manage.
It’s a more difficult task to determine equity. When you own stock in a company, it’s almost like making a bet on the company’s future success. As an employee, equity can be thought of as a payment for the services that you provide to the business.
Stock ownership in the company can be used as a partial compensation for employees. These are the main two types of compensation available to employees when they join a start-up: equity compensation and salary.
What is Equity Compensation at a Startup?
This is non-cash compensation which gives you a percentage of the company’s equity. This allows companies of all sizes, public or private, to save their cash and put it to good use for the company’s future growth.
Many startups also use this to reward their employees who perform well. This encourages employees to stay motivated and builds loyalty to the company.
These equity percentages are dependent on the startup’s financial position and net worth. Every equity reward comes with its unique set of benefits and challenges.
Types of Equity Compensation
Equity compensation confers a percentage ownership towards company stock. However it is further divided into different types. It is offered in accordance to the company’s policies.
- Employee stock choices: This option allows employees to buy a certain percentage of the company’s shares at a preset price. This is commonly known as the strike- or exercise price. The vesting period is a period that the employee must wait before they can make the purchase. This period is usually between three and five to five years. Stock options are a good option for leveraging and can carry some risk. For a correct analysis of the exercise price, do a 409A evaluation.
- Restricted stock: Sometimes called letter stock, fixed securities, or letter stock. This stock cannot legally be transferred unless it meets certain conditions. These restrictions could relate to a specific work time or performance.
You could consider this stock an additional bonus and replace cash. This option is especially appealing to company executives, as it has a number of benefits related to income tax treatment and accounting regulations. This stock type has two parts: restricted stock units and restricted stocks awards.
- Employee stock buying plans: These purchase plans allow employees to purchase shares from a company at a reduced rate. The stock options are also limited to a set amount of stock per employee every year (in most cases $25,000). An employee can buy these units through payroll deductions. Employers can often use the funds they’ve saved to acquire stock for subordinate employees.
Pros & Cons of Equity Compensation
It sounds great to be eligible for equity in a company. But, everything comes with specific terms regarding stock redemption. It is important to remember that equity does not come to employees. Employees only get stock options. Equity can be purchased at a steep discount.
This means that there’s a good chance that these stock options can return in the shape of a big pay check at the end. It won’t happen with regular wages.
Let’s not forget about the pros. But let’s also consider the pitfalls. First and foremost, buyers are at risk of being affected by the performance and market conditions. Risks are increased further by the uncertainty of future performance. If your company performs poorly, you may end up with a large stock crash.
Also, equity compensation comes with a vesting program. If you don’t agree to give up your shares, you cannot leave the organization. Sometimes, these benefits can also be forfeited when an employee is fired. You need to be aware.
Final note: Even though you may think that cashing out stock options could yield a significant payout, most people forget about tax deductions. These can make up a significant amount of the payout.
Example of Equity Compensation
Let’s say you get a new job with a newly founded startup. They may offer equity compensation depending upon your performance. Employers can promise significant compensation to new employees if the company does well. They might also offer these stakes as a reward if they are successful.
Remember that each form and type of compensation comes with different tax consequences. Equity compensation is determined by how your employer structured it.
All tax implications must be understood if you intend to cash out the stock. For example, if the company share price drops after exercising your options, you could be subject to taxes. To maximize your return, we recommend cashing in shares at the correct time.
What is the salary in a Startup?
Salary Compensation is the sum total of an employee’s base pay, bonuses, or other compensation for performing specific job roles. A salary compensation package may include bonuses, retirement benefits, incentives, short-term disabilities insurance, and health insurance. This type compensation is generally beneficial as it doesn’t fluctuate in line with market fluctuations.
Pros & cons of Salary Complementary
Security and certainty are key. If you know what amount you will receive in a particular timeframe, you can plan your finances in accordance with that information without worrying about fluctuations. Simply put, a stable pay structure will allow you to plan for your future without worrying.
You will receive fewer rewards if you take a higher level of risk. These payouts won’t bring any additional benefits for the future. Your company’s success is not possible despite having better job opportunities that pay high salaries.
Salary Compensation Example
Excellent example of salary payment is the base pay that you receive in a start-up without equity or stock options. If you are hardworking and getting promoted, the only way to climb the ladder is to work hard.
The compensation for well-known organizations, private or public, may rise beyond the base pay. This can be done by offering health plans, bonus opportunities, transportation costs, and other perks.
How to Choose Between Equity Compensation and Salary Compensation
The ability to choose from additional salaries when you join a company is a great benefit. The decision can be confusing, though, as there are so many options. These are the main points to consider when evaluating what you offer.
Reduced or High Salary
A study of the industry shows that inclusive equity deals are often less than the standard pay for a given role. A startup can offer a rewarding learning experience, but lower salaries are not unusual.
In such cases, it is sensible to determine your expenses. Then decide the minimum amount that you need to live. You may have different expectations depending on where your home is located or the industry in which you work.
All equity offers will require that you remain in the company for a set period of time before you are able to purchase shares or cash them. Your equity options with long vesting periods will not be of any great benefit if your plans include moving or leaving the company. You should plan your future carefully before agreeing to a settlement.
Trust and Beliefs in the Company
Because the value of the company’s stock market valuation is a major factor in how large your final payout, you should thoroughly research it and believe in its future prospects.
You should carefully consider the operation of the company as well as the service they offer. You may also seek out a venture capitalist for more information on the potential exit value of an investment.
Alternatives with better Financial Sense
It is always a good idea for you to review the value of each package provided by the company.
What should employees do to negotiate their startup offer?
You should be aware of these tips before you begin to negotiate compensation at a start-up. These are their key points:
Know your market value
Before applying for any job, you need to understand your worth. You can make use of online tools such Glassdoor as well as PayScale to see the average value for the job post you are interested. Doing your research in advance can often help you avoid low-value positions.
A Salary Range
It is important to have a range when answering questions from hiring managers about the expected salary for that role. It is important to ensure that you have all expenses covered, including travel and 401k (a retirement system that allows employees a certain percentage of their salary). Also, a range will show flexibility and allows for more negotiation opportunities during the hiring process.
Consider the Equity Package
Be sure to take into account all the extras. Your company might cover healthcare, retirement funds or equity compensation. Don’t be afraid to ask when you negotiate such matters.
Funding can help you ensure a pay increase
A written contract must be signed that clearly states that your pay will increase if the company’s market values go up. For a smaller cash flow, you may be offered a lower salary.
Determine which one is best for you
The security of a salary in a start-up is greater than equity, as you can plan a set amount. However, there’s a risk.
You will be responsible for any losses incurred by your company, as well as possible termination of employment.
If things go according to plan, an employee may be able to enjoy significant long-term benefits from a large equity interest.
Another important fact is that if a company is joined early, your benefit percentage is significantly higher because you can purchase many stocks at a lower price.