In the world of tech jobs, it’s common—and often expected—that companies offer their employees at least some part of their compensation package in the form of stock options. For the company, this is an attractive opportunity both because it means paying out less cash in employee salaries in the short-term, as well as incentivizes employees to do their part to help the company do well in the long run. But what does it mean for you as an employee, and how should you weigh the tradeoffs between the two forms of compensation—whether you’re choosing between two different job offers or a company has offered you a choice of salary packages.
First things first: The nuts and bolts
Before diving into the decision between salary and equity, it’s important to understand how they differ in the short-term, as well as how they may pay off down the road.
Salary is the easier one, as it’s simply cash in your pocket today, which you can use how you’d like. Whether it’s put towards your living expenses or invested somewhere, it’s crystal clear how much a salary is worth today, and you can even estimate how much money invested today will be worth in a number of years.
Equity is a bit trickier. At a high level, owning equity in a private company is a bet on the company’s future success. You can think of yourself (the employee) as a mini-VC fund, accepting equity in replacement for the value you provide to the company. For a VC fund, that value is capital in the form of cash, while employees provide human capital and accept equity as a (partial) replacement for a cash salary.
There are a number of more detailed points to keep in mind when you’re offered employee stock options:
- Options are usually granted on a four-year vesting schedule with a one-year cliff, which means you won’t actually have the option of owning equity in the company if you leave within your first year of working there. Further, on the common vesting schedule, only 25% of the options are available to you after the first year, and the remaining shares typically vest incrementally each month or quarter thereafter.
- They’re called ‘options’ for a reason, as stock options don’t actually imply ownership in the company, but rather the option to purchase the specified number of shares. If you decide to buy the shares in the future, they’ll cost the ‘strike price’ when the options were granted, which should be significantly lower than the market value of the shares when you sell (otherwise you’d have no reason to buy them in the first place). The ultimate hope is that the value of the company’s shares increases significantly over the time you work there.
- Even if you do purchase the shares, they’re not actually worth anything until some sort of exit event, like an IPO or acquisition—and the unfortunate reality is that a large percentage of startups fail, rendering the shares worth nothing. Particularly if the company is early-stage, keep in mind that even if its future looks bright, an exit could take years, meaning you’ll have to hold onto the shares for a long time in order to capture any value from them.
- It’s not the number of shares that counts, but the percent ownership that those shares represent. Ask the hiring manager for each role for the company’s number of shares outstanding and calculate the percent ownership each offer would represent. Compare these numbers, not the number of shares, between your offers.
How to decide between salary and equity
Having options when it comes to compensation packages is never a bad thing, but it can be confusing to choose between them. Here are some points to consider as you evaluate your alternatives.
Can you survive on the lower-salary offer?
It can be exhilarating—not to mention a great learning experience—to join an early startup, but you’ll typically see much lower salaries paired with higher equity stakes, as the smaller the company, the lower the chances they’ve raised (or made) tons of cash. Take a look at your own expenses to determine the minimum salary you’d be able to accept, particularly if you’re living in an expensive tech hub like Lagos where living expenses can eat up a huge chunk of your income.
What’s your four-year plan?
If your equity is on a typical four-year vesting schedule, you won’t have the option to purchase any shares before year one, and the remainder will take an additional three years to vest. If you know you have a big move ahead, you’re planning on going back to school, or otherwise don’t expect to be with the company for long, be sure to factor that into your considerations.
How strongly do you believe in the company?
Hopefully, you’re excited about the prospects of any new company you’re joining, but trading off between salary and equity is a time to think critically about how optimistic you are about the company’s future, as well as its exit prospects, which will ultimately determine what your equity will be worth. Of course, this isn’t easy, and there are professionals (like venture capitalists) who get paid to do this and still get it wrong a lot of the time, but it’s an important factor to consider if you’re leaning towards a job with a lower salary but a company you’re more excited about
Do the alternatives make financial sense?
If a company has offered you two different packages, one with more equity and the other with a higher salary, it’s worth running some quick calculations to figure out if the two numbers are reasonably equal. Wealthfront has a helpful blog post about how to do this—the numbers will never be foolproof, but it’s a good idea to generate some ballpark figures to make a more informed comparison.