Understanding Startup Equity Compensation w/ Malcolm Etheridge

a product. And if you don't have the money, you can probably find or theoretically you should be able to find an engineer that can help you build a product. Uh. And then so even if it's an m v P uh, you know, a minimum viable product or the alpha version of what you're building. Uh, it's gonna be a lot more helpful and you will stand out that much more if you have that already built before approaching a potential investor.

I'm well, Luke, it's Mrs Black Tech, Green Money. I wanta introduce you to some of the biggest names, some of the brightest minds and brilliant ideas. If you're black in building or simply using tech to secure your back, this podcast is for you. Malcolm meth Bridge is a certified financial planner, speaker and bloggers in these areas of expertise and glue retirement planning, investment, portfolio development, tax planning

and insurance, stock options, and other executive benefense. He leverages that expertise to help senior managers and tach workers make sense of some of the most complex financial situations that working professionals tend to face. On a recent lunch table live discussion, what You're about to Hear, I asked Malcolm about what exactly equity is and if there are any unique traits of equity when you work for a tech startup. Yes. So, so equity camp used to be unique to the tech industry.

I'm I'm learning as time goes on that millennial specifically, right, we got folks who are twenty eight, thirty thirty, two

thirty five, let's say twenty to thirty five. I'll give us the window who are working for companies right now who maybe aren't in tech, but they have uh friends who are, and they're seeing the money that their friends are making and the fortunes that are being created from owning equity in the company that they work for, and so they're starting to demand themselves regardless of what the

shop is that the company pay them in equity. So a lot of companies outside of the text Fear are also jumping on the bandwagon now and offering that, but in Silicon Valley, right, I'll use Silicon Valley as the general broad right, uh grouping, even though folks in tech are working in Texas and Florida and god knows where

else at this point. But like it used to be that that was something that was reserved for those people in Silicon Valley in tech companies, and they refused to work for a company they didn't offer them a piece of the pie, right, And so I want to own a piece of the work product that I am hoping to create. I saw and all these agreements when I come in the door. Let's say I can't take any of the work product with me, right, if I create some service or some features some app. Google lets you

do your ten percent time. Right, if I create Google Maps or Gmail during my ten percent time, I can't take that with me. Google owns it. But at least I get to participate in the upside and the value creation that that add on I created happens to generate over time. By owning equity in the shop, and so it's kind of you know, everybody's happy right on both sides. When when you say, let's say I created a feature in email and I work for Google, and let's not

just leave its Google. Let's say any startle I create a feature that becomes a thing. How valuable could that be? You know, both to the company and to me as an individual who's on the payroll here, Like, how talk? Can you talk about some instances where that could actually provide a serious windfall? Oh my god? Yeah, So I'll

give you a real specific, if example. I won't give too many details to to not tell anybody's life story for them, But I happen to have a client who worked for a coin base for a while, right we all know coin based iPod recently and uh two big acclaim right on on day one. I can't remember what the starting price was supposed to be, something like forty bucks, and it shot all the way up to like close to three hundred on on this first day of trading.

So this particular person, his net worth was about a hundred thousand dollars before coin based I p O coin based I p O s and he's now an eight millionaire so like, just think about like how life changing that money is for somebody in their thirties who like, had student loans, Suddenly they don't, didn't own a home, suddenly they do. Didn't even have the word legacy anywhere close to the tip of their tongue, and now they do. Right. So, like, those kind of things are what happens from being that

close to value creation. So the rule, I won't call it a rule, but one of the things I always tell people who are like, you know, I want to get rich, right, I want to work and get rich. You can save your way to about two to three million dollars over the course of a thirty five or so year career by diligently saving, not spending anything crazy.

Like I've seen it happen to have clients that are in their sixties now, they've been working really hard, they command a high salary, they don't spend anything crazy, and they have about two and a half to three million dollars that they've saved over time doing it. The quote unquote right way you want to go beyond that three million dollar threshold, you're either gonna have to be attached

to some sort of value creation, right. So you're one of the first employees at a company that ends up doing something big, or you're gonna have to do it in real estate by holding onto assets for a very long time and allowing them to appreciate until one day you look up and on paper you're worth a time and you start liquidating that stuff. Those are the two ways that I personally have seen where clients have like

significant life changing lineage changing money that happens. And more to the point you were making when we first started, one of the ways that that that allows you to be attached to that value creation that it's happening is you own uh an interest in the company that you're working for. So if I'm at you know, Microsoft, I'll use as an example because it's a popular enough company and I own shares of Microsoft. I worked there for five years. I accumulate you know, half million dollars worth

of shares in the five years that I'm there. I leave, but I don't sell them. I hang on to them. And then we all have seen what the fang stocks Facebook, Amazon, Netflix, and Google have have done. Microsoft included in that bucket. They've you know, quadrupled over like that that tenure span that the NASDAC has been on this run. That's life

changing money for some people. Right, your five hundred thousand dollars worth of equity you had as part of your total comp package that came to you when you came on board is now two million dollars by you going along for the ride. That's life changing money. Versus you work as a software engineer. I pay you a hundred and eighty thousand dollars, the I r S takes half

of it, depending on what state you live in. Right, and your hundred and eighty turns into ninety thousand, and it's up to you to decide how to spend that ninety thousand and make sure you keep a piece of it. But it's really not likely to continue to grow at the ridiculously outsized rate as you owning equity and something where constantly new products are being created, new ideas are being kicked around. All that is happening while you're sleep

frankly like you're not contributing anymore. You left the company, but the value creation is still happening without you, but because you were tied to it at one point, you still get to reap the benefits. That's how the game is one. So who I'm gonna ask two questions and one which I hate to do but I think you can handle. This is who has leverage to ask for equity when working out a startup? And do I have to be an engineer? Awesome questions, So you don't have

to be an engineer. I'm gonna ask the answer the last one first because it's easier. You don't have to be an engineer. I have seen administrative assistance who administrative assistant early enough on that they got a piece of the pie, and they even are attached to that that wealth creation at at the end of the day and are walking away with some decent cheers. So no, you can be you know, I won't say you can be the staff who works in the cafe as an example,

because those people are usually contractors. But if you're one of those people and you can work your way into write a conversation about it, by all means do it. But you know, the average employee from the lower part of the totem poll to the very top can actually participate in the equity pool at almost any company at this point, So you don't have to be an engineer to participate. The second part you said, how do I get equity as part of the conversation, Um, you gotta

ask for it. That's really, that's really it. So one of the things that I always encourage people to focus on when they negotiate this compensation package is not just how much can I get in salary? Right, that's important, but there comes a point when enough is enough, and every incremental dollar you have them pay you has a

diminishing rate of return. Right, So you hit you know, two hundred thousand dollars, let's say, and you live in a place like you know, New York or California, where after taxes, again, fift of that's going out the out the window. Where if I were to to ask instead for shares in the company, as long as I hold onto those shares for an extra twelve months after you know they vested and been issued to me, I'm paying that long term capital gains. So long term capital gains

tax rates. My ordinary income tax rate I just told you is fifty after state and federal get done with me. Right, that's at delta that you've now been able to find just by getting paid in that equity versus having them pay it to you in in actual cash money. So just having a longer vision to be able to see the way the game is played in one will help to keep you know, a few people at least from

asking for the wrong thing at the wrong time. Do you find that younger folks beginning their careers working at startups and tech companies are more and more sophisticated and know to ask for equity versus the larger paycheck? And or if you find those who aren't who just said they want the bag today, how do you have that conversation with them to convince and that look, the better play here potentially is to take less up from capital

and to go for equity. Yes, So one of the challenges that I have as a financial planner is helping people figure out there enough point. That's one of the things that I really like about this work is that there's a book that I read and I always recommend to people called Your Money or Your Life. It's the book that's credited with helping to to launch the fire movement,

the financial independence retire early movement um. But essentially the key tenant of the book is figuring out your enough point, Like how much house is enough? How much car is enough? How much vacation is enough? How much you know? All these things, we get on the treadmill and run this race four to constantly be chasing at some point enough is enough and you have enough luxury and you have enough like whatever, figuring out what that enough point is

and then planning beyond that. And so I always try and help people see the forest for the trees that yes, you could get an extra dollars by joining company X, right, but if if it means then that you're gonna be working one point two times is hard right to to to be a kind of specific what could you be doing with that extra of your time versus the twenty dollars that you're gonna earn because you already make enough money to pay your mortgage, pay your kids daycare, You're

driving nice enough car, you're live in a nice enough neighborhood. Like you're not chasing safety at this point, we're just chasing access. And so helping people figure out like enough is enough and the difference now is pay me an equity instead. And one other negotiating piece that I would encourage people to consider is companies are a lot more willing to part with shares of equity than they are

with additional cash. If you just think of it from the CFOs perspective, Right, if I have if I commit to a salary that I owe you, that's every day, every year, that's a line item that goes against the P and L that I got to count for. Right, I owe you two hundred thousand dollars. You're asking me for an extra twenty That twenty grand is going against the P and L. Every year you asked me for

dollars worth of shares. That's a totally different equation because those shares are sitting on a spreadsheet somewhere in in you know, in in somebody's like hard drive. They're not an actual thing I've got a hand over to you. So yes, they still have to be accounted for, but we don't hold onto them and keep them as tightly guarded as we would if you're asking for cash. Also, if you're thinking from the HR person's perspective, I gotta be able to to justify why I gave you to twenty.

But the software engineer who sits next to you is getting too, And then the next person who comes in the door is gonna want to know what they can actually get as far as cash comp and now I've got to do I all for that person to twenty two because I just gave it to you. Whereas with the shares, it's a little bit different than a little bit more fluid. And I'm speaking broadly right, every company

is different the way they treat this. But what I've seen and and also talking to hire uh recruit technical recruiters personally, like they're way more willing to come up off of additional equity shares versus cash money. So for folks who and obviously the startup side of the table would understand this, but I want to make sure the engineer, the talent, the HR person, the legal person understands this side. Legal people might give it, but let's under let's talk

about what the cliff means. So if I come in as an engineer and I say, hey, I'm gonna give you a hundred thousand shares with a three year cliff, what does that mean? Perfect perfect setup? So the cliff best that you're talking about, it's how long you have to be at the company before you actually take ownership of those shares. So to to keep from being too super nerdy er super technical, the I r S and and the company have this trade that happens, which is

called constructive receipts. So you have constructively received at the end of a three year period those shares, which means with it you also have taken on the tax liability for those shares and and whatever they're worth at the time.

So a hundred thousand dollars worth of shares, you wait the three years that you have to vest, right, you have to be at the company three years before those shares vest, and technically now you own them at that point the moment they get issued to you, regardless of whether they're restricted stock or non qualified stock options or performance share units or whatever. Once you take ownership of those shares, you also take ownership of the tax liability.

Prior to you taking ownership of the shares, you don't own anything. You also don't own the hundred thousand dollars, right, because you don't have the shares, but you don't own the tax liability. So with that additional cash also comes the additional tax liability. So just something to be aware of at at the exact same time. But to answer your question very specifically, companies as retention tool will put a time clock on how long they have to be able to get work product out of you before they

give you those shares. That that it kind of gives you your walking papers to right. If I think about it purely from the company's perspective, I know I've got you on the hook for three years. If you've got a three year vesting requirement. Beyond three years, you're a free agent. Every year. I gotta constantly be doing things and bringing things to you to make you feel good about staying with this team and want to be here. Right, But for that three year period you're on that that

rookie contract, if you will. If you think about it in terms of the NFL, you're gonna play and perform regardless of of what's happening, because you've got to hit that three year that number before we can issue you, you know, the shares. That's good for me to know and playing around as the company. So that's something to also kind of think about. They'll also issue you UH shares not only as as investing based on tenure, but also as a retention and tool. So you get past

that three year window. Maybe I'm worried that that somebody is gonna compote you right. Tech companies are a bit incestuous at this point about stealing talent from one place to the next, and the same people kind of moving every three years or so, and so one way that I can keep you from making that jump is to offer you additional shares as a retention bonus every single

year that you stay. And maybe those shares just have to you gotta be here one year after you get them in order for them to vest, or there's no investing timetable on them. Those are all things you want to know and negotiate going in the door so that you can give yourself the most flexibility and freedom to be able to maneuver however you want to and still get you know, the majority of those shares, if not

all of them, before making any other moves. I do have people watching the chat on Facebook and lunch table, so if you do have questions, I want to make sure I get to those, um so it makes sure go feel free to drop your questions in the chat and we will get as many of them as we can. And in the meantime, going down that road of investing periods and cliffs and etcetera. I wonder if let's say this remarkable opportunity happens, you know, which is doesn't happen

all the time. But you give me a hundred thousand shares on day one. I have a two year let's just still just to get easy map, a two year investing period, so I can't get my full amount of shares for that two years. In that two years time, those shares go to the moon. So these are Google numbers, Apple numbers, Amazon numbers, Facebook numbers. So I'm on paper, super duper wealthy on paper, but I don't have any

of that liquor cash. How does my life change in the meantime while or how could it change in the meantime or does it so? Uh? Two separate answers, because that goes to separate ways. Right, So if you're talking I work for a private company, I work for a startup and they've made an announcement that they plan to go public at some point. Right, I'm thinking about door

Dash as a really good example of this. Tons of people who started at different rates COVID happens, those shares are now gonna be to the moon, like you said, because like all of a sudden, door Dash is posting the best numbers they've ever posted. Nobody in the company is doing any work anymore because everybody's imagination is flying around.

I'm gonna be like super super wealthy because I'm gonna get those shares and I'm gonna go buy this beach house and I'm gonna and I mean literally like can't get anybody off Zello, can't get anybody off. Everybody is spending that money. But there's also this thing called a lock up where you've got to wait six depending on where you are in the food chain right the hierarchy,

and how close you are the privileged information. There's also this thing called a lock up where you've gotta wait six months after the company goes public before you can do anything, So those shares could come crashing back down the earth in that time before you're legal allowed to sell anything, because they don't want you moving the stock

price around, which I've seen happen unfortunately. But also to your point, with a publicly traded company like a Facebook or an Amazon or Google or whoever who's going on this run, the more advantageous way to work out your equity grants is to have them coming to you on a monthly basis instead of annually for that reason right there.

So if I get a new uh tranches the word that we use, or slice or whatever of shares that come to me every single month, then as the price is doing what it does, I can plan my own life around what else I need to do financially and whether I'm gonna sell this month or not. If I've got to wait an entire year to make that cell or whole decision, then I'm at the mercy of wherever the company is in that moment. It may not even make a difference with a company like Amazon, like you said,

who can't seem to go but in one direction. But for a company who does take a very nasty dip at some point, I'm kind of at the mercy of

whatever the market does. And so developing that plan in advance of when and how to sell is going to be super helpful to turn you from a paper millionaire, as you're saying, into an actual millionaire, as in exchanging those certificates for actual dollars at some point, so that you can take some chips off the table and not just kind of follow the ticker wherever it takes you. What typically happens in the in the tech company specificist.

But let's say just companies across the board where equities involved and they go public or they sell or otherwise, and early employees don't get a financial winfall what typically happened. Um, that's a tough one man. People get real stings you around liquidity events. Um. You know, founders start trying to renegotiate their founder shares. Uh, you have key employee that aren't satisfied with their contract the way it was initially written and where they sit on the cap table when

they look at their slice versus others. Like those kind of things, it gets It gets kind of ugly, honestly at some point, Um, the short answer to your question is, if you aren't on that cap table before the liquidity

event happens, you're probably not gonna get on it. Um. What does happen in some cases where you are valuable enough to the company that they're worried about like hurting your feelings and they're worried about losing you, is you can get a gross up as we call it, where they issue you a one time bonus allotment of shares to make you whole, as they say, so that you feel like you're included and you're participating, but those shares

are not going to have the same Uh. Value is not the word that I wanna, I want to use it. It's not gonna have the same like sweetness to it as the folks that were there on day one, two, three, ten. Funny you know that kind of thing because even with like incentive stock options as an example, that have a bit of a look back kind of feature. They allow you to look at yesterday's price and decide if you're gonna uh sell it now and take today's price as

your your exchange value. Uh. Even if I would have granted you incentive stock options at today's price, you're not gonna get that super low basis that somebody got who started with the company ten years ago when it was literally in somebody's living room. What are what would you say? I like the top three to five things a start up employee should be paying attention to in their work contracts regarding conversation. Know what happens to your shares if

and when the company has a liquidit event. That's huge. Uh. To your point about people dancing around excited because they're about to be a millionaire, some people don't realize that if the company sells X happens right. There's a lot

of SPACs happening right now. The word spack is flying around all over the place, and a lot of people's equity agreement doesn't include language around UM, what happens if the company changes hands, what happens if there's a change of ownership before the I P O. So that's the major one. But also like knowing the schedule of when your your shares vest right, so you don't walk away on accident and leave some chips on the table. UM. That's what we call the forfeit value. What happens if

you forfeit those shares? UM also setting up plan for win and how to get out of those shares because until you actually trigger a sale, you're only a millionaire on paper. So you know, deciding how much and when to sell is a very big key component in there.

UM Also understanding that just because you're inside of your vesting table, your vesting timetable, doesn't mean that other companies won't match you to make you whole right, give you some shares to match what you would stand to lose from the company you're considering leaving to entice you to move sooner. So I've seen that happen where I'm going to use two completely made up examples. Google wants to

uh employee from Amazon. Google will say, instead of you waiting the extra year and a half a year shares to best, We're gonna match the shares that you would lose and give you an extra ten percent on top of that to get you to leave today instead. So don't be afraid to ask. Don't be afraid to ask questions because you'd be surprised, like what people are willing to how flexible people are willing to get, you know,

to to make it happen. You asked me for five I don't know if that was five three to five three or five. You got that? You got there? Um, you know not everybody is going to be a founder, and UM, talk to me about some of the benefits that could be uniquely available to senior level people at a startup. Um, whether I'm coming on as a chief operating officer, I'm coming like, what are some things outside

of equity as part of my benefits package? If I'm on the career trajectory, should I be paying attention to so one super unique thing and this is not me like to my own horn. But we have companies as clients who pay for financial planning on behalf of their senior leaders. They don't give that to everybody across the board. So you are c OO and you step into Now the company's accountant is now your accountant. The company's financial advisor is now your financial advisor. The company may even

comp you a car, right because I can. I can have a corporate lease and and assign it to you. Um, your your travel budget starts to look a little bit different. Um. All those kind of things are are different and unique to not even necessarily just the C suite. I've seen it at the director level, of the senior vice president level, that sort of thing. Um. But also real quick you you said not just equity, but as far as equity is concerned, your shares look different too in the C

suite or at the senior director level. So incentive stock options are usually held just for the super top of the organized organization chart. Everybody else gets what's called restricted stock units, those that have two completely different tax treatments in the way that you can actually plan around them and ultimately what how valuable they are. So that's another difference that that gets thrown in there between the two

tiers of employee and UM. I want to talk about retirement accounts and how important they are too because we we we have so many conversations around funding startups, because we have this big disparity with you know, black minority owned, women owned startups being funded. How can they if they can, retirement accounts be used to put some early capital into

starting my thing. I'm really glad you asked that. So I normally will see people take out a loan from the company that the four one K playing the company they work for, use that loan to to get access to capital to start the company. When you leave the company, that outstanding loan gets turned into a distribution, which means ordinary income tax treatment, right, so you're paying taxes on

that distribution. Or you could just straight up say kick me the cash, I'm gonna pay the taxes on it, and it is what it is, and we use it to start the company. But there's actually UH plans out there within the tax code that allow you to convert those shares in that you know, your investment in the company into UH shares in the company are starting. So instead of being invested in the SMP five index. In

your four own K plan. You now have a four own K plan that is your new company, shares of the company that you started that you're investing now back into the Company's why you probably saw the article from pro public about Peter Tile having a five billion dollar roth ira funded from PayPal stock. It's because he had really great lawyers twenty years ago when they started the company that told him, don't take that money out of your four when K plan to start, you know the shop,

sell yourself shares of PayPal. Convert your four owen k uh dollars into shares of PayPal, and then as they grow, they live inside this roth ira which will never pay taxes on. So there are other ways to to to use your four one K assets other than taking a direct distribution and like paying the taxes today and you know, hoping for the best going forward. Malcolm, where can people learn more about you and your work? I'm at Malcolm on Money on all social media platforms. I encourage them

to check out the tech Money podcast. Um we go into a lot more detail on these kinds of topics, you know, with with tons more times. So those are the two main places I would say that to find me. I'm also heavy on LinkedIn, so happy to spark up a conversation there too. Yeah. Black Tech Green Money to production of Blackvity, Afro Tech, The Black Effect podcast Networking I Heart Media was produced by Morgan the Bone on In Me Well Lucas, with additional production supported by Love

Beach and Marissa Lewis. Special thank you to Michael Davis since the car savan ya you know, like the wine. Yes, that's his real name. Learn more about my guests and other tech disruptres and innovators at afro tech dot com. The video version of this episode will drop the Black Tech Green Money on YouTube next week, So tap in enjoying Black Tech Green Money. Leave us a five star rating on iTunes. Go get your money, Peace and love,