Series A, B, and C equity compensation are the three main stages of equity compensation that startups offer their employees and founders. Equity compensation is ownership in the company, typically granted through stock options or restricted stock.
Equity compensation is a powerful tool for attracting and retaining talent and aligning the interests of employees and shareholders. It allows employees to share in the company’s upside potential and benefit from its long-term value creation.
This article will explain the differences between Series A, B, and C equity compensation, how they are typically structured and valued, and what factors to consider when negotiating or accepting an equity offer.
What is equity compensation?
Equity compensation is a type of non-cash compensation that gives employees ownership of the company. It is typically granted in the form of stock options or restricted stock.
Equity compensation can be a valuable way to attract and retain top talent and to reward employees for their contributions to the company’s success.
It can be a great way to align employees’ interests with the company’s interests. When employees own a piece of the company, they are more likely to be motivated to work hard and help the company succeed.
Series A, B, and C Equity Compensation
Series A, B, and C equity compensation are the three main stages of equity compensation that startups offer their employees and founders.
Series A Equity Compensation
Series A equity compensation is typically granted to early employees and founders who have helped get the company off the ground. The company is still unproven at this stage, so equity grants are typically higher to compensate for the risk and uncertainty.
According to a 2023 survey by Holloway, the median equity grant for a CEO at a Series A startup is 7–10%.
Series B Equity Compensation
Series B equity compensation is granted to employees and founders who have helped the company achieve product-market fit and are scaling its operations. The company is more valuable at this stage, so equity grants are typically lower than at the Series A stage.
Series C Equity Compensation
Series C equity compensation is granted to employees and founders who have helped the company reach scale and expand into new markets or develop new products.
The company is very valuable at this level, so equity grants are typically lower than they were at the Series B stage. However, even small equity grants can be worth a lot of money if the company is successful.
How Does Equity Compensation Work at Different Stages of Growth?
Equity compensation works differently at different stages of growth for startups. In the early stages, such as Series A and B, startups are still relatively risky and unproven.
As a result, equity grants are typically higher to compensate for the risk and uncertainty. However, equity grants typically decrease as the company grows and becomes more valuable.
Here is a detailed overview of how equity compensation works at each stage of growth:
1. Series A
Series A startups typically focus on developing their product and finding their target market. The company is still very risky at this stage, so equity grants are typically higher to compensate for the risk.
Equity grants for Series A startups are typically within the range of 1-5% of the company’s fully diluted ownership, meaning they include all the shares that are issued or reserved for future issuance.
2. Series B
Series B startups have typically achieved product-market fit and are focused on scaling their operations. The company is less risky at this stage, so equity grants are typically lower than at the Series A stage.
Equity grants for Series B startups are typically in the range of 0.5-2% of the company’s fully diluted ownership.
3. Series C
Series C startups have typically reached scale and are focused on expanding into new markets or developing new products. The company is even less risky at this stage, so equity grants are typically lower than they were at the Series B stage.
Equity grants for Series C startups typically range from 0.25-1% of the company’s fully diluted ownership.
4. Later Stages
At later stages of growth, such as Series D and E, equity grants are typically even lower. However, even small equity grants can be worth a lot of money if the company is successful.
However, the actual equity compensation you are offered will depend on several factors, such as your role, your experience, the company’s valuation, and the overall startup market conditions.
It is also important to note that the value of your equity compensation is not only determined by the percentage of ownership but also by the price per share and the liquidity of the stock.
The price per share is the amount that investors pay to buy a share of the company, and it usually increases as the company raises more funding at higher valuations.
The liquidity of the stock is the ease with which you can sell your shares for cash, and it usually depends on whether the company is public or private and whether there are any restrictions or vesting schedules on your shares.
Hypothetical Scenarios on How Equity Compensation Works
Scenario 1
Assuming you join a Series A startup with a 1% equity grant when the company is valued at $10 million, The company raises a Series B round at $50 million and a Series C round at $200 million. The company then goes public for $500 million.
In this scenario, your 1% equity grant would be worth $5 million at IPO (assuming no dilution). However, you could not sell all your shares immediately because they would be subject to a vesting schedule (typically four years) and a lock-up period (typically six months after the IPO).
Therefore, you would have to wait until your shares are fully vested and unlocked before you can cash out.
Scenario 2
Assuming you join a Series C startup with a 0.25% equity grant when the company is valued at $200 million, The company raises a Series D round at $500 million and a Series E round at $1 billion. The company then gets acquired by another company for $2 billion.
In this scenario, your 0.25% equity grant would be worth $5 million at acquisition (assuming no dilution).
However, you could not sell all your shares immediately because they would be subject to a vesting schedule (typically four years) and an earn-out period (typically one to two years after acquisition).
Therefore, you would have to wait until your shares are fully vested and earned out before you can cash out.
As you can see, the value of your equity depends on many factors, and it is not guaranteed that you will make more money by joining an earlier-stage startup. You should always do your due diligence and understand the terms and conditions of your equity offer before you accept it.
What Are the Different Types of Equity Compensation?
The type of equity compensation offered to employees will vary depending on the company and the employee’s role. For example, stock options are often granted to executives and other senior employees, while RSUs and ESPPs are often granted to rank-and-file employees.
There are different types of equity compensation, each with its own advantages and disadvantages. Some of the most common types are:
1. Stock options: These contracts give the right to buy or sell a certain number of shares at a predetermined price within a specified period. Stock options can be either vested or unvested, meaning they can be exercised only after meeting certain conditions or immediately. Stock options can also be either incentive or non-qualified, meaning they have different tax implications.
2. Restricted stock: These are shares granted to employees or contractors but subject to restrictions such as vesting or performance goals. Restricted stock can be forfeited or clawed back if conditions are unmet.
3. Restricted stock units (RSUs): These are similar to restricted stock, but instead of granting actual shares, they grant the right to receive shares or cash equivalents at a future date. RSUs do not have voting rights or dividends until they are settled.
4. Stock appreciation rights (SARs): These contracts give the right to receive the difference between the current market value and a fixed price of a certain number of shares. SARs can be either settled in cash or shares.
5. Phantom stock: These agreements give the right to receive cash or shares equivalent to the value of a certain number of shares. Phantom stock does not grant any ownership rights or benefits but only mimics the value of the underlying shares.
While equity compensation can be a powerful tool to attract, retain, and motivate employees or contractors and align their interests with the company’s, it also involves complex legal, financial, and tax issues that must be carefully considered and communicated.
How Much Equity Compensation Should I Ask For In A Job Offer?
The amount of equity compensation that you should ask for in a job offer will depend on a number of factors, including:
- Your role and experience level
- The stage of growth of the company
- The company’s valuation
- The overall startup market conditions
To get an idea of how much equity compensation you should ask for, you can research the equity compensation ranges for your role and experience level at different stages of growth. You can also talk to other people who have accepted startup equity compensation offers.
What Are the Tax Implications of Equity Compensation?
The tax implications of equity compensation vary depending on the type of compensation and how it is granted and exercised.
Nonqualified Stock Options (NSOs)
These are the most common types of stock options, where the employee is given the right to buy a certain number of company shares at a fixed price (called the strike price) within a specified period.
The employee is taxed on the difference between the fair market value of the shares and the strike price when they exercise their options. This difference is treated as ordinary income and subject to income tax and payroll tax withholding.
The employer can deduct this amount as a compensation expense. The employee is also taxed on any capital gain or loss when they sell their shares, based on the difference between the sale price and the fair market value at exercise.
Incentive Stock Options (ISOs)
ISOs are a special type of stock option that has more favorable tax treatment for the employee but not for the employer.
The employee is not taxed when they exercise their options as long as they meet specific holding period requirements (at least two years from the grant date and one year from the exercise date).
The employee is only taxed when they sell their shares, based on the difference between the sale and strike prices. This difference is treated as a long-term capital gain and subject to lower tax rates.
However, the employee may have to pay alternative minimum tax (AMT) on the difference between the fair market value of the shares and the strike price at exercise, which can reduce or eliminate the tax benefit of ISOs. The employer cannot deduct any amount as a compensation expense.
Restricted Stock
This is where the employee is given company shares, but they are subject to vesting and may be forfeited if the employee leaves the company or fails to meet performance goals.
The employee is taxed on the fair market value of the shares when they vest. This is treated as ordinary income and subject to income tax and payroll tax withholding. The employer can deduct this amount as a compensation expense.
Restricted Stock Units (RSUs)
RSUs are where the employee is promised company shares, but they are only issued once they vest. The employee is taxed on the fair market value of the shares when they are delivered. This is treated as ordinary income and subject to income tax and payroll tax withholding.
Stock Appreciation Rights (SARs)
This is where the employee is given the right to receive cash or stock equal to the increase in value of a certain number of shares over a specified period. The employee is taxed on the amount received when they exercise their rights.
This is treated as ordinary income and subject to income tax and payroll tax withholding. The employer can deduct this amount as a compensation expense.
Phantom Stock
This is where the employee is given a hypothetical number of shares that track the value of the company’s stock, but they do not actually own any shares. The employee receives cash or stock based on the value of their phantom shares at a certain date or event.
The employee is taxed on the amount received when they receive it. This is treated as ordinary income and subject to income tax and payroll tax withholding. The employer can deduct this amount as a compensation expense.
Conclusion
Navigating equity compensation can be intricate, but it offers a unique opportunity to share in a company’s success. To maximize this benefit, consider the timing of exercises, your overall financial plan, and tax strategies.