Afaik equity is normally paid on a vesting schedule over say 3 years. What happens if an employee leaves after those three years?
For example, if I got 1% equity in Facebook vesting over 3 years back in 2004, worked for 3 years then decided to move to a different startup:
a) would I keep my equity?
b) would the value of the equity scale with company value i.e. would I have 1% of facebooks market cap now
thanks!
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It depends on the kind of equity and what you decide to do. Companies can issue options (ISOs or NSOs) or RSUs. If you had ISOs, you typically have up to 2 months after your end date to exercise your options (though that means you have to use your own cash to buy those options at the exercise price, and if the company is not yet public, you won’t have the option to do a “same day sale” to pay for all or part of the shares you exercise). Depending on the strike price, that could get costly, and if the company isn’t public, and the company fails, you lose the money you used to purchase those shares.
As far as dilution, if the company raises more equity while you hold those shares, your percentage of the company will shrink with each equity raise. If the company is still private, the dilution could be around 20% with each raise, depending on how the company is doing. And that assumes the company is doing fairly well. If not, the dilution could be much worse (down rounds, cramdowns, recaps all could make your common shares close to worthless). And again, if the company is private, your common shares have less rights than the preferred shares that investors hold, such as liquidation preference. The company could be firing on all cylinders through several rounds of financing (which would still be dilutive for your shares), but if they then end up being acquired or even go public for less than the market cap of the last round, all of the prior preferred shareholders would get paid first, with the common getting paid last with whatever is left over (which could be nothing depending on how the waterfall pans out and the terms of the liquidation preference).
Thank you.
with this in mind (particularly regarding dilution), what is the point of taking equity as an early employee? Say you get 1% surely by the time you exit (even if it is a unicorn) it will be worth nothing. Why would a founder make sure you equity doesn’t get diluted?
I believe this thing happens in ‘The Social Network’ movie - Saverin looks at the contract where his shares gets diluted. Why wouldn’t a founder do this to anyone but themselves?
That's not necessarily true. Say I get 1% equity at the seed stage worth $100K ($10M valuation) and the strike price is so low that maybe you're paying $10K to exercise. If the company is a unicorn, let's say my equity gets diluted 90%, so now I only own 0.1% but IPOs at $1B valuation. Now my equity is worth $1M (10x increase). That's not worth nothing even with massive dilution.
Generally though, if you join a start up super early you should value the equity at $0, but still ask for as much as you can get. That way it's all upside and your expectations are low.
You’re pretty much right, without an insane outcome your 1% post dilution is likely worthless. However, if you’re a company in a massive TAM, those 10,000x outcomes can exist (think of someone like Austin Geidt at Uber). However if you’re going to join a startup as employee 0-4, you’re probably better off being a founder yourself. The work will look similar, albeit the founder will be trying harder, but your risk adjusted returns for joining that early are capped and unlikely, whereas starting your own company you at least own a significant portion of the cap table. Early stage startups can be great learning environments and if they’re a rocket ship, they’ll also be a rocket ship for your career, I just wouldn’t expect that 1% pre-dilution to be worth a ton (10M+) unless you’re looking at a 10 figure+ outcome for the company.
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