How to Weigh Equity Compensation as Part of an Employment Offer

Most people evaluate a job offer the way we were all taught to: start with the salary, check the benefits, factor in the commute, and make a decision. Equity compensation, if it appears at all, often gets treated as a potential bonus that may be difficult to value.

This can be a costly mistake, because for new hires at startups and growth-stage companies, equity is often the most significant financial component of a compensation package. It is also the part that can be the most difficult to evaluate as it is frequently presented in a way that obscures rather than clarifies its actual value.

With this in mind, well-informed candidates should know how to read an equity offer clearly, ask the right questions, and understand how to weigh the unknowns against the true facts of the offer before they sign.

The Topline Number Is Not the Value

With equity compensation, think in terms of percentages, not numbers of shares. An offer of 10,000 stock options or restricted stock units (RSUs) might sound generous. However, without knowing how many shares exist in total, you can’t tell how meaningful that grant really is.

The denominator you need is the fully diluted share count, or the total number of shares outstanding, including all issued shares, all options granted, and all shares reserved for future grants. This is the number that converts your grant from an abstract figure into an ownership percentage. A grant of 10,000 shares in a company with 10 million fully diluted shares is a 0.1% stake. In a company with 100 million fully diluted shares, it is 0.01%.

Any company that makes an equity offer should be able to tell you its fully diluted share count. If the answer is unavailable or vague, that is meaningful information about how the company thinks about transparency with its employees.

What Happens Before You Get Paid

Owning equity in a company is not the same as having cash in the bank. Before your equity converts into anything you can use, a liquidity event must occur. This might be an acquisition, an IPO, or some other transaction that creates value for your equity, and it might be years away or never come at all.

But, even when a liquidity event does happen, what you receive depends on more than the company's headline valuation. Most venture-backed companies have investors holding preferred shares with liquidation preferences. These are contractual rights to receive their money back before the common shareholders receive anything, which includes most employees.

Before you assign value to an equity offer, ask what the liquidation waterfall looks like. How much has the company raised, and at what terms? What preferences exist? What does a realistic exit scenario mean for someone holding common shares?

Understand What You’re Getting, Not Just How Much

The type of equity that’s included in an offer matters as much as the amount. With stock options, one aspect to consider is the strike price. This gives you the right to purchase shares at a fixed price at some point in the future. If the company's value rises above that price, you profit from the difference. If it does not, the stock options expire worthless. RSUs, by contrast, are a promise to deliver shares according to a vesting schedule regardless of price.

Each instrument comes with its own tax treatment, too. RSUs are taxed as ordinary income when they vest, which is the point at which you officially own them. Incentive stock options, or ISOs, may qualify for more favorable capital gains treatment if you hold the shares long enough, though exercising them can trigger the Alternative Minimum Tax (AMT), even before you have sold anything. Conversely, non-qualified stock options (NSOs) are taxed as ordinary income at exercise.

These distinctions affect the real value of what you are being offered, and they affect the decisions you will face, when to exercise, whether to hold, what leaving the company would cost you. 

Weigh the Equity Against What You Are Trading for It

Equity at early-stage companies almost always comes with a tradeoff. You are potentially accepting a below-market salary in exchange for upside that is real but uncertain. That tradeoff is not inherently bad, though it deserves to be evaluated directly when considering an employment offer.

The question to ask is, at what outcome does this equity compensate me for the salary I am giving up? What’s the break-even point? If the answer requires a billion-dollar exit for a company currently valued at $20 million, the math may not be in your favor. If the answer requires a two or three times return on the current valuation with realistic growth assumptions, the tradeoff may be reasonable.

Your financial situation matters here, too. Someone with significant savings, no dependents, and high risk tolerance can accept more equity-heavy compensation than someone with a mortgage, a family, and limited runway.

Model a Realistic Outcome

The most useful exercise you can do with an equity offer is to run the math on a scenario that is plausible, not just possible.

Start with your ownership percentage on a fully diluted basis, and then consider the liquidation preferences that sit above you as a common shareholder. Next, apply a realistic exit valuation. This is not the headline number from the last fundraise, but rather a range of outcomes from modest to strong. Finally, estimate the tax on what remains.

These estimates may not give you a precise value, though they will help you see which assumptions the offer depends on. If the numbers only look appealing in the strongest scenario, you could be making a bigger bet than the equity grant’s headline value might suggest.

Equity can be one of the most meaningful parts of a compensation package. Whether it is the right solution for you depends on what you’re looking for and how clearly you understand what you have been offered. Getting there means asking the right questions before making any decisions.

Composition Wealth, LLC (“Composition Wealth”) is a registered investment adviser. Advisory services are offered only to clients or prospective clients where Composition Wealth and its representatives are properly licensed or exempt from licensure. The content is for educational purposes only and should not be considered investment, financial, tax, or legal advice. It should not be treated as a solicitation to buy or sell securities and does not consider individual investment objectives, strategies, tax status, or horizon. Please consult your own tax, legal and accounting advisors before making any related decisions.