How to Negotiate Equity in a Private Company

Equity compensation in private companies presents a unique opportunity to share in a company’s growth and potential success. Unlike publicly traded companies where stock values are readily available, understanding and negotiating equity in a private setting requires a deeper dive into various financial and legal concepts. This guide helps navigate private company equity, from understanding its forms and value to the negotiation process and formalizing your agreement.

Understanding Private Company Equity

Private company equity represents an ownership stake in a business not traded on public stock exchanges. This compensation aligns an individual’s interests with the company’s long-term success, as equity value grows with performance. Several common forms of equity compensation exist, each with distinct mechanics.

Stock options provide the right, but not the obligation, to purchase a company’s shares at a predetermined price, known as the strike price, within a specified period. If the company’s value increases and its share price exceeds the strike price, the options become “in-the-money,” allowing the holder to buy shares at a discount.

Restricted Stock Units (RSUs) represent a promise from the company to deliver shares of its stock at a future date, usually upon specific vesting conditions. Unlike options, RSUs have inherent value once granted, even if the share price does not appreciate. Restricted stock involves the immediate grant of actual shares, but these shares are subject to forfeiture until vesting conditions are met. Phantom stock, also known as stock appreciation rights, does not grant actual ownership but instead provides a cash bonus equivalent to the value appreciation of a hypothetical number of shares over a set period.

Understanding key terms is fundamental to evaluating any equity offer. Vesting refers to the process by which an individual gains full ownership of their equity over time or upon meeting certain conditions. A common vesting schedule is a four-year period with a one-year “cliff,” meaning no equity vests until the first anniversary of employment. After the cliff, a portion vests, and the remainder vests monthly or quarterly over the subsequent three years.

The strike price, specific to stock options, is the fixed price at which shares can be purchased. Dilution occurs when a company issues new shares, decreasing the percentage ownership of existing shareholders. This can happen during new funding rounds or when additional equity is granted to employees. Common stock represents basic ownership in a company, typically carrying voting rights, while preferred stock often carries preferential rights, such as priority in receiving payments during a liquidation event.

The exercise window for stock options is the period during which vested options can be converted into shares. While employed, this window can extend for many years, up to ten years from the grant date. If employment terminates, the post-termination exercise period (PTEP) is often 90 days, after which unexercised vested options may expire. A liquidity event refers to an event, such as an acquisition, merger, or initial public offering (IPO), that allows shareholders to convert their equity into cash or publicly tradable shares.

Valuing Equity and Your Role

Assessing the true value of equity in a private company requires understanding the company’s financial health and its potential for future growth. Private companies do not have readily available market valuations, making this assessment more complex than for public companies. Company valuation involves concepts like pre-money and post-money valuation, which indicate the company’s worth before and after a new investment round. A higher valuation in a recent funding round suggests greater investor confidence, potentially increasing the perceived value of your equity.

Understanding the company’s stage of development (e.g., startup, growth stage), its funding history, and its growth trajectory are crucial in estimating the potential future value of your equity.

A capitalization table, or “cap table,” provides a detailed breakdown of a company’s ownership structure, listing all shareholders, their shareholdings, and the types of shares they own. A cap table reveals how ownership is distributed among founders, employees, and investors, and how new equity grants might impact existing shareholders through dilution.

Quantifying your skills, experience, and expected impact on the company’s growth is essential for justifying a desired equity stake. Your expertise should align with the company’s strategic objectives, and your contributions should directly translate into value creation. Documenting specific achievements and projected outcomes can strengthen your position during negotiation.

Factors influencing the amount of equity a company might offer include your role and seniority, the market demand for your skills, and the trade-off between cash compensation and equity. More senior roles or those with specialized skills often command higher equity grants. Companies may also offer more equity in exchange for lower base salaries, especially in early-stage environments, to conserve cash and align incentives.

Negotiating Your Equity Stake

Negotiating your equity stake maximizes your compensation in a private company. The optimal time to discuss equity terms is after a preliminary job offer but before formal acceptance. This timing allows you to evaluate the overall compensation package, including both salary and equity, and to negotiate from a position of leverage.

Several elements of an equity offer are negotiable. The percentage of ownership or the specific number of shares offered can be adjusted. Understanding how to convert between the two (e.g., knowing the total outstanding shares to calculate your percentage) is important. The vesting schedule is negotiable; you might propose accelerating vesting, such as a shorter cliff or faster pace, to gain ownership sooner.

For stock options, the strike price is usually set at fair market value at the time of grant and may not be directly negotiable, but other terms can be discussed. The exercise window post-termination is a significant negotiable point; extending the standard 90-day period to a longer duration, such as one to three years, provides more flexibility if you leave the company.

Acceleration clauses are also key. Single-trigger acceleration vests equity upon a single event, like a company sale. Double-trigger acceleration requires two events, such as a change of control and involuntary termination without cause, to fully vest equity. Negotiating for double-trigger acceleration can provide greater security.

Repurchase rights or buyback provisions, which allow the company to buy back your shares under certain circumstances, should also be reviewed and potentially negotiated. Understand the conditions and valuation methods for such buybacks. When negotiating, thorough research into industry standards for similar roles and company stages can provide valuable benchmarks. Clearly communicate your understanding of the offer and your proposed adjustments, backing them with your value proposition to the company. Being prepared to walk away if terms are not satisfactory can also strengthen your negotiating position.

Formalizing Your Equity Agreement

Formalizing your equity agreement involves understanding and carefully reviewing the legal documentation that outlines your ownership stake. This step ensures that the negotiated terms are accurately reflected and that you are aware of all associated rights and obligations. Several legal documents are involved in private company equity grants.

The Offer Letter generally provides an initial summary of your compensation, including the proposed equity. However, the detailed terms are found in more specific agreements such as the Stock Option Agreement, which outlines the terms and conditions for stock options, or the Restricted Stock Unit (RSU) Agreement and Restricted Stock Purchase Agreement, which detail the terms for RSUs and restricted stock, respectively. A Shareholder Agreement may govern the rights and obligations of all shareholders, while Company Bylaws establish the internal rules of the corporation.

Clauses within these agreements require close attention. Confirm that the vesting schedule accurately matches your negotiated terms, including any specific cliff periods or monthly/quarterly vesting increments. Verify the exercise period for options, particularly the post-termination rules, to ensure they align with your understanding. Liquidation preferences dictate the order in which shareholders are paid out during a liquidity event, such as a company sale. Preferred shareholders, typically investors, have priority over common shareholders (employees), receiving their investment back, sometimes with a multiple, before common stockholders receive proceeds. Understanding these preferences is important as they can significantly affect your payout.

Voting rights, which determine your ability to influence company decisions, should be clear. Transfer restrictions are common in private companies, limiting your ability to sell or transfer shares. These often include a right of first refusal (ROFR), where the company or existing shareholders have the first option to buy your shares. Co-sale or tag-along rights allow you to sell your shares alongside larger shareholders if they initiate a sale, ensuring you receive the same price and terms. Drag-along rights, conversely, can compel you to sell your shares if a majority of shareholders agree to a sale.

Clawback provisions allow the company to reclaim previously granted equity or compensation under certain conditions, such as financial restatements, regulatory violations, or misconduct. Understand the triggers for these provisions. Finally, tax implications are important. For restricted stock, consider the Internal Revenue Code Section 83(b) election, which allows you to pay taxes on the fair market value of the stock at the time of grant rather than when it vests. This can be advantageous if the company’s value is expected to increase, potentially leading to lower overall tax liability. This election must be filed with the IRS within 30 days of the grant date. Given the complexity of these documents, it is advisable to have an attorney review all equity-related agreements before signing.