Startup Equity Explained: What Your Offer Letter Really Means

You've received a startup offer with equity. The letter mentions stock options, vesting schedules, and strike prices. Your friends tell you stories of startup equity making people rich—or becoming worthless paper.

What does your offer actually mean? Is it good? What questions should you ask?

This guide explains everything you need to understand about startup equity, from the basics to the nuances that could mean the difference between a windfall and a write-off.

The Basics: Types of Equity Compensation

### Stock Options

Stock options give you the right to purchase shares at a fixed price (the strike price or exercise price). They're the most common form of startup equity.

**How they work:** - You're granted options to buy X shares at $Y per share - The strike price is typically the fair market value when options are granted - Options vest over time (usually 4 years) - Once vested, you can "exercise" by paying the strike price to get shares - If the company's value increases, you profit the difference between current value and strike price

**Example:** You receive 10,000 options at a $1 strike price. After vesting, if the company's stock is worth $10/share, your options are worth ($10 - $1) × 10,000 = $90,000 in potential profit.

### Restricted Stock Units (RSUs)

RSUs are grants of actual shares that vest over time. Unlike options, you don't pay to exercise them—you simply receive shares when they vest.

**How they work:** - You're granted X RSUs - RSUs vest over time according to a schedule - When RSUs vest, you receive shares (or their cash equivalent) - You owe taxes on the value of shares at vesting

RSUs are simpler than options but offer less upside in high-growth scenarios. They're more common at later-stage companies.

### Incentive Stock Options (ISOs) vs. Non-Qualified Stock Options (NSOs)

**ISOs** get preferential tax treatment but have restrictions: - Only available to employees (not contractors or advisors) - Must be exercised within 90 days of leaving the company (in most cases) - Subject to Alternative Minimum Tax (AMT) considerations - Annual limit on favorable tax treatment ($100K worth of vested options per year)

**NSOs** are taxed as ordinary income but have more flexibility: - Available to anyone - May have longer exercise windows - No AMT complications - Simpler tax treatment

Understanding Your Grant

### Number of Shares

The raw number of shares is meaningless without context. 10,000 shares could be generous or insulting depending on the total shares outstanding.

**What to ask:** - What percentage of the fully-diluted company do my shares represent? - How many shares are outstanding in total? - What's the latest 409A valuation?

### Percentage Ownership

Typical equity ranges by role and stage:

**Early employees (first 10):** - Engineers: 0.5% - 2% - Non-technical roles: 0.25% - 1% - First engineering hire: 1% - 2%

**Post-Series A:** - Engineers: 0.1% - 0.5% - Managers: 0.2% - 0.75% - Directors: 0.3% - 1% - VPs: 0.5% - 1.5%

**Post-Series B and beyond:** - Individual contributors: 0.05% - 0.2% - Managers: 0.1% - 0.3% - Directors: 0.15% - 0.5% - VPs: 0.25% - 1%

These ranges vary enormously by company, market, and negotiation.

### Strike Price

Your strike price should equal the company's fair market value (409A valuation) when options are granted. A lower strike price means more profit if the company succeeds.

**What to ask:** - What's the current 409A valuation per share? - When was the last 409A assessment done? - How has the valuation trended over time?

Vesting: When You Actually Own Equity

### Standard Vesting Schedule

The most common vesting schedule: 4 years with a 1-year cliff.

- **Cliff:** You get nothing until you've been there 1 year - **After cliff:** 25% vests at 1-year anniversary - **Monthly vesting:** Remaining 75% vests monthly over years 2-4 - **Fully vested:** 100% vested after 4 years

### Why Vesting Matters

Vesting protects the company from employees leaving early with significant equity. It protects you by ensuring long-term commitment is rewarded.

If you leave before the cliff, you get nothing. If you leave after 2 years, you keep 50% of your grant. Only shares that have vested are actually "yours."

### Variations to Watch For

- **Longer cliffs:** Some companies use 2-year cliffs (less employee-friendly) - **Back-loaded vesting:** Some schedules vest more in later years (less employee-friendly) - **Acceleration provisions:** Some offers include acceleration upon acquisition or termination

The Exercise Decision

### When to Exercise

For stock options, you must actively "exercise" to convert options to shares. This costs money—you pay the strike price for each share.

**Early exercise:** Some companies allow exercising unvested options. This can have tax advantages (83(b) election) but means paying cash for shares that might not vest.

**Exercise at vesting:** Exercise options as they vest. Simpler but may have higher tax burden depending on value appreciation.

**Wait until exit:** Hold options until acquisition or IPO, then exercise. Lowest risk but potentially highest tax bill.

### The 90-Day Problem

Most ISOs must be exercised within 90 days of leaving the company, or they expire worthless. This creates painful situations:

- You leave a company before it exits - Your options have significant value - Exercising requires substantial cash (strike price × shares) - Holding shares in a private company is illiquid and risky - But letting options expire means walking away from potential value

**What to negotiate:** Extended exercise windows (1-10 years) are increasingly common and extremely valuable.

Dilution: How Your Ownership Shrinks

### What is Dilution?

When companies raise money, they issue new shares to investors. This increases total shares outstanding, reducing each existing share's percentage ownership.

**Example:** You own 1% of a company with 1M shares (10,000 shares). The company raises money and issues 1M new shares to investors. You now own 10,000 of 2M shares = 0.5%.

### Expected Dilution by Stage

Typical dilution at each funding round: - Seed: 15-25% to investors - Series A: 20-30% to investors - Series B: 15-25% to investors - Series C+: 10-20% per round

After several rounds, early employee equity can dilute 50-70% from the original grant.

### Is Dilution Bad?

Not necessarily. Dilution is worth it if company value increases faster than ownership decreases.

**Example:** You own 1% of a $10M company = $100K value. After a round, you own 0.7% of a $50M company = $350K value. You're better off despite dilution.

Evaluating Your Offer

### Calculate the Range of Outcomes

**Current value:** (Number of shares × Current share price) × Your vesting percentage

**Exit scenarios:** Model different exit valuations and calculate your payout:

Low exit: What if the company sells for 2× current valuation? Medium exit: What if it sells for 5× current valuation? High exit: What if it sells for 20× current valuation?

Factor in dilution (assume 30-50% dilution between now and exit).

### What Percentage of Total Comp?

Consider equity as part of total compensation:

- Base salary: $X - Equity value (current or expected): $Y - Annual equity vesting: $Y ÷ 4 years = $Z per year

If equity is a significant portion of your compensation, you're taking compensation risk in exchange for potential upside.

### Compare to Alternatives

What would equivalent roles at established companies pay? That delta represents your "startup discount"—compensation you're foregoing for the equity lottery ticket.

Is the potential equity upside worth the discount? This is a personal calculation based on your risk tolerance and financial situation.

Questions to Ask Before Signing

1. What percentage of the company do my shares represent on a fully-diluted basis? 2. What was the latest 409A valuation and when was it done? 3. What's the current preferred stock price (last round valuation)? 4. How many funding rounds has the company raised, and how much total? 5. What's the company's runway? 6. What's the standard exercise window if I leave? 7. Are there any acceleration provisions? 8. What's the vesting schedule? 9. Are these ISOs or NSOs? 10. Is early exercise available?

Tax Implications (Consult a Professional)

Equity compensation has complex tax implications:

- **ISOs:** Favorable capital gains treatment if holding period requirements are met, but AMT may apply at exercise - **NSOs:** Taxed as ordinary income at exercise - **RSUs:** Taxed as ordinary income at vesting - **83(b) elections:** Can lock in lower taxes on early-exercised shares - **State taxes:** Vary significantly by state

Consult a tax advisor before making exercise decisions, especially for significant amounts.

The Bottom Line

Startup equity can be highly valuable or completely worthless. Most startup equity, statistically, ends up worth nothing—companies fail, get acqui-hired, or exit at valuations that don't benefit employees after preference stacks.

But the upside when things work can be life-changing. Approach equity with clear eyes: understand what you're getting, what it could be worth in different scenarios, and what you're giving up (in guaranteed compensation) to get it.

Don't join a startup only for the equity. Join because you believe in the company, the team, and the work. If those are right and the equity pays off, that's a bonus. If not, at least you spent your time on something meaningful.