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Congratulations, you’ve just landed a job at a tech startup. All the perks you have read about are true: there are free snacks, you can wear jeans to work, and you have an unlimited amount of vacation.
When you get your offer letter, you diligently negotiate your offer (Sheryl Sandberg said to, after all) and the company counters with an offer for more cash, less equity. Or perhaps more equity, less cash.
Whatever the offer, now you have to choose between dollars in your account today and stake in the company that could pay off big time tomorrow — or not at all.
How do you evaluate which of the two is worth more, and ultimately, which to take?
Make Sure It’s Even Possible to Pay Your Expenses with Less Cash
If you’re considering a pay cut as a trade for more equity, the first thing to consider is whether you can actually pay your monthly expenses, like rent, food, transportation, and other life costs, with the amount of cash you’re offered. Chances are if you’re headed to a technology startup, you may be living in San Francisco or New York City where rent is high and the offer should reflect that high cost of living.
In February 2016, the average rent for a one-bedroom apartment in San Francisco was $3,096; the average rent for a one-bedroom in a non-doorman building in Manhattan was $3,071.
Think About How Long You’ll Be at the Company and Investigate the Vesting Schedule for Stock Options
Most companies will offer you stock options with a four-year vesting schedule and a one-year cliff. The cliff essentially means that you won’t have the ability to purchase any of your options before your one-year anniversary with the company.
At the one-year mark, you’ll typically be able to purchase 25% of your options (if you choose) and the remaining equity will vest either monthly or quarterly for the next three years. In most cases, you’ll have the option to purchase 100% of your stock after four years with the company, or some percentage of that if you leave between one and four years.
The takeaway here is that the longer you stay with the company, the more equity you’ll have (up to a certain amount).
Evaluate the Company’s Potential for Success
If you’re joining a startup, let’s hope you believe it will be successful. Regardless, it’s important to keep in mind that stock options aren’t worth much unless something happens such as an IPO or an acquisition.
If it’s a company whose mission you can see carrying it places, more stock is a good way of making sure you get in on a good thing early. On the flip side, if you don’t know enough to evaluate the business, or you’re accepting the position as more of a career stepping stone, extra cash may be your move.
If the business doesn’t turn out to be successful, that hard-earned equity will be worth nothing. Think about factors such as the size of the market the company addresses, the business model, and whether or not they are profitable.
Figure out If the Alternate They’ve Offered Makes Financial Sense
Calculating the tradeoff between stock options and salary can be tricky because it depends on a number of assumptions. Automated investing service Wealthfront explains how to calculate the amount of equity you should trade for salary, or vice versa, based on the stage of the company you’re joining.
Before you make a decision, know whether the cash-for-equity number the company is offering is a fair exchange–and the company should be willing to share the information you’ll need to calculate that.
When it comes down to it, you’ll need to make a well-researched decision when choosing between additional salary and equity for your new startup job. Know what you can actually afford, whether this job will last you, at least, a few years, and whether the alternative compensation package you’ve been offered is actually comparable–as well as how much risk you’re willing to take on the company.