The market for software engineers is so competitive that companies will do anything they can to attract the right talent. It used to be that having a ping pong table and bean bag chairs in the office was cool enough to attract great talent, but not anymore.
Now the common trend between large FAANG companies and startups is to offer candidates a great base salary along with either equity or RSUs to sweeten the deal.
But which is actually better?
Get ready to talk money, because we’re going to dive into RSUs and Equity so that you can understand what they are and how they put money in your pocket!
So, the term equity compensation basically boils down to granting partial ownership of a company in the form of shares to someone in exchange for work they’ve done. It was a practice born in the tech infamous Silicon Valley and made a reality by the first computer chip startup company, Fairchild Semiconductors.
As they didn’t have available cash, giving away partial ownership to employees in the form of stock options as payment was a radical idea for the time, but one that gave employees the option of buying at the lower strike price to then later sell once the initial public offering was made as the company was listed on the stock exchange. Or they could just keep the stocks, with the expectation of an increase in value over the long term.
When it works, paying an employee in equity can give them a vested interest in the company’s success and lead to innovative solutions across years of employment. But when it doesn’t work… well, at least you have the memories…
WHAT’S A FAANG?
FAANG is just a term used to describe the big 5 companies in American technology – Facebook, Amazon, Apple, Netflix, and Google (or Alphabet as it’s now known). These giants of industry are some of the largest companies on Earth, with a combined market cap of over $5.6 trillion! As you’d expect, stock options from a FAANG are almost a sure thing in terms of future increased value – it’s all about strength, growth, and momentum.
WHAT’S A STARTUP?
Basically, a startup is an early-stage company, usually founded to develop a unique product or platform that delivers a specialized service. The end goal is to make the company’s offering irresistible and irreplaceable to customers once it hits the market – with this innovation and assessment of a gap in the market rewarded in success and more importantly, money. Startup usually leverage investments from venture capitalist or angel investors to grow quickly so they can either sell the company or go public.
Just remember – every FAANG was a startup at one point in time.
To give you a better idea of what a startup is here are a few examples:
Udemy, Poshmark, Chime, Brex, Robinhood, and Doordash are all up-and-coming startups that are tackling big issues.
WHAT ARE RESTRICTED STOCK UNITS?
Restricted Stock Units or RSUs are an agreement between a company and an employee regarding the issuing of stocks or the cash value of a stock at a later date. Now these are neither stock, nor options to buy stock at the strike price. They’re units, with each representing a single share or a single share cash payment that the employee will be awarded at a certain date in the future that is written into the contract as a settlement date.
This process of ownership generally occurs over time in a process called vesting. A contract will have a vesting schedule, outlining how the ownership of the RSUs changes over time – but the kicker is that vesting only accrues when you’re working for the company.
There are strings attached, for instance, if a worker is fired immediately or quits then they get nothing. However, if they stay with the company for years then they will be paid a pro-rata amount according to the settlement date…which is usually the date of the company’s IPO. Where staying for years will result in them being paid a pro-rata amount according to the settlement date – generally the date of the company’s IPO.
WHAT ARE STOCK OPTIONS?
Stock options are entirely different. As we touched on, this is a time-bound agreement from the company where an employee gets to purchase shares at the presently set or strike price. Their value at grant is naught, their value during vesting is naught, and they only have value if that employee chooses to buy the stock at the strike price at the time of the company’s IPO. You literally have to use the right to buy those shares when it becomes available or they expire, just like you get the option to sell at the IPO price or hang onto the stock until it grows.
FAANG RESTRICTED STOCK UNITS
RSUs are a great option when a software engineer is working at a FAANG, particularly if they envision a long career there. The longer the time served, the greater the vestment and handing over of stocks or stock cash value – culminating in the complete transfer of the amount in full on the settlement date.
As a result, because the employee is never paying an exercise price for the stock and the value of the stock equivalent is effectively free, they never run the risk of the stock being underwater – that is, worth less than its notional value. Companies can also more accurately predict and report hits they take to earnings as these RSUs vest. Likewise, jobs within the company can be budgeted with an RSU cost instead of a dollar cost, with the total divided by the number of members in the team working on the project to work out how much each software engineer gets paid.
There is one big downside, and that is the other inevitability besides birth and death – taxes. Generally, an RSU will always be taxed at a high-income tax bracket upon vesting, though there is an option in most countries to apply for a 5-year tax payment deferral where regular income tax is still due, but the RSU gains in value become eligible as capital gains.
Regardless of whether the RSUs are sold or not, the value is still added as income – so be careful. If you’re being paid in shares, you still have to pay real money in taxes!
RSU’s are generally not the best option for startups, as RSUs don’t begin vesting until the date of the IPO, and RSU options typical expire in 5-7 years with no obligation to the company to re-issue them. There is definitely room to make some serious money being part of a startup at the grassroots level, and then having the stock worth skyrocket – but only when you actually get paid the full amount of RSUs before the expiry limit.
Stock options are a much better choice if you’re a software engineer looking to build a product from the ground up and are bought-in to the company’s mission. Typically, a start-up will offer an employee way more shares as stock options, compared to RSUs on a vesting schedule. Because the strike price is so low compared to the IPO price, there ends up being very little difference in relative value between an RSU and a stock option – but the amount of stock differs greatly.
A little-known fact is that a stock option can be turned into a paid share and then sold off again while the company is still private – though it requires permission, something an RSU can’t do. Then again, the stocks can be retained to appreciate in value and defer paying tax which is a win/win situation really.
The downsides are that exercising stock options can trigger a lot of taxes if exceeding $100,000 in value, and the options themselves generally expire 90 days after leaving a company – whether voluntarily, or involuntarily. Additionally, the employee may find that their stock is underwater and worthless if the fair market value is well under the agreed strike or exercise price – resulting in negative value.
A startup, by definition, is a company that’s not publicly traded so they don’t have the ability to offer RSUs the way FAANG companies do. Instead they offer their employees equity.
Equity is different in that it’s a percentage of ownership or a stake in the company.
If you’re familiar with the popular TV show Shark Tank then you may be familiar with terms like valuation and the frequent bantering over a company over-valuing themselves and offering a ridiculously low amount of equity.A startup receives a valuation – which is an estimate of what the company is worth. This can range from tens of thousands of dollars to millions or in rare cases, billions.
Startups will eventually either be sold, like Whatsapp was bought by Facebook for $16 Billion, or the startup will go public by selling shares in the stock market. In either case, the employee will be able to sell their equity and receive a payout at that time or hold onto it and sell at a later point.
The problem with equity is that a startup’s success isn’t guaranteed (nor is any company for that matter). As any great investor will tell you — if you want large, fast rewards you’re going to have to make riskier investments. Betting on a startup can be a risky investment where the company failing means you never realize the value of the equity you were promised, but on the other hand…it’s success could be better than winning the lottery.
For example, Beyond Meat, the vegan food company, had its shares priced at $25 per share when it went public. Its shares went up 163% on the first day! Within 3 months it was trading between $160-200 per share, that’s more than a 600% increase, and current valuation of $10 billion!
Let’s take a moment to crunch some numbers.
Beyond Meats original valuation was $1.5 billion; at that valuation alone, a Founding Engineer with 1% equity would stand to make $15 million.
The same Founding Engineer could hold onto their equity and sell when shares were up 600% at around $170 per share and the company valuation had jumped to $10 billion. That same 1% equity is now worth $100 Million.
So Which Is Better?
At Kofi Group, we typically see startups offer software engineers a base salary of $150-200k per year, plus an additional 0.1% to 1% value in equity or stock options.
Deciding between RSUs and equity in a startup can be difficult but we hope this video helped you to better understand the difference between the two. In our opinion, if the salaries and other comp benefits are the same, it’s better to take the risk on startup equity as it could yield massive returns. Going the safe route with RSUs is still a good option but there’s no chance for that massive return like you would get in a startup and who’s to say if you’ll last through the vesting period to even get that much?
However, we do not recommend any positions that attempt to pay you with stock options exclusively with absolutely no base salary attached. Your base salary should always be competitive, and the equity is just the cherry on top. In this competitive market, you can have your cake and eat it too!
Let’s take a look at some numbers to better understand how this plays out in reality.
For the sake of the hypothetical, we’ll compare two identical roles, both with a base salary of $150K but for different business types with very different options attached.The first offer comes from a FAANG company, let’s use Amazon for this example.
Amazon offers Software Developers anywhere from 50-200 RSUs depending on the stock value at the time and level of engineer or type of in-demand engineer receiving the offer. They have a slightly complicated vesting situation in which the stock vests over the course of 4 years starting at 5% the 1st year, 15% the 2nd, 40% the 3rd year, and the final year at 40%.
All in all, you can expect to receive an RSU offer from Amazon valued anywhere from 20k-400k/yr. More commonly between 30-60k. Not bad for sticking around 4 years!
The second offer is by a brand-new tech startup, offering 0.5-1% equity on top of your base salary. With this kind of offer, the sky really is the limit. If the startup is geared towards hypergrowth and is successful in scaling up, 40% growth within a year is a target that many startups can actually achieve. When a successful startup eventually goes public or gets acquired, that equity can translate into insanely high numbers. Co-founders, founding engineers, and early team members within startups frequently find that their equity stake soon outgrows their base salary, all from choosing the riskier option.
For example, if you had 1% equity in a startup valuated at $500 million at time of IPO. You could sell your shares and make $5 million. Now there are a lot of other factors like taxes, but you get the idea!
Questions to Ask
And finally, when it comes to determining which option is better for you, there’s a few things to consider and/or ask your prospective employer.
Questions about Equity:
- What percentage of the company do the shares represent?
- What set of shares was used to compute that percentage? Is it outstanding shares or fully diluted?
- What convertible securities are outstanding, and how much dilution can I expect from their conversion?
Questions about Stock Options:
- Do you allow early exercise of my options?
- Am I required to exercise my options within 90 days after I leave or am terminated?
- Does the company extend the exercise window of the options of employees that depart?
- Do you have a policy regarding follow-on stock grants?
- Does the company have any repurchase right to vested shares?
It really does pay to ask these questions because even if you don’t understand them, your accountant is most definitely going to want to know the answers to give you the low down on whether this contract will be lucrative, or whether your future employer wants to take you for a ride!
We hope this article helped you learn more about FAANG RSUs and startup Equity so you can make the best decision for your career.
If you enjoyed this article you may also enjoy The Truth About Being A Software Engineer at a Startup or FAANG vs Startup: Is the Risk Worth it For Software Engineers.