A Guide to Valuing Equity in SaaS Sales Compensation
Commissions and bonuses aren’t the only way salespeople earn serious money in the software industry - with so many new market entrants launching in the SaaS space, many companies offer some form of equity as a way to attract top talent.
But how do you calculate the value of equity in a compensation plan, and should it outweigh job opportunities offering more in guaranteed earnings when choosing a new role?
The allure of equity isn’t hard to understand.
When a software company is acquired for head-spinning sums or makes the headlines with a jaw-dropping IPO, the shareholders pocket life-changing amounts of money from the proceeds.
Who wouldn’t want to be along for a ride like that?
It’s the reason equity has such a magnetic appeal as part of any compensation package, and many ambitious SaaS sales professionals will be faced with a difficult choice more than once in their careers:
Take the ‘safe route’, and go with a job that offers a high salary and a proven track record of creating successful sales reps
Share some risk with an up-and-coming employer who sweetens their lower pay package with an enticing equity piece
Going for the equity could be your ticket to fortune, but it could also leave you kicking yourself for not taking the ‘bird in the hand’ if things don’t work out how you’d hoped.
So what to do?
When it comes to equity, there are no crystal balls that can show the future.
But there are some basic steps to follow to gauge of how much faith you should place in your opportunity to participate as a shareholder, not just an employee.
For anyone trying to get a clearer understanding of how to qualify equity offerings, read on.
Grants vs Options
First things first, what are you even being offered? A grant means you are being given shares in the company. An option means what it says – you are being the option to buy shares, under a specific set of conditions.
Share options are the most common type of equity offered to employees joining start-ups.
They give you the right to purchase company shares at a predetermined price, and often within a fixed time window. The price is known as the strike price or exercise price, and when you choose to purchase some or all of your allocated shares, this is known as exercising the option.
The concept is simple – early employees get a chance to buy shares at a low price, below the value on the open market. They can then either sell these shares privately, or wait until the company is acquired or goes public to reap the rewards of the difference between the strike price and the eventual sale price.
For both grants and options, the details on what you can and can’t do with your shares (such as selling them to someone else, what happens after you leave the company etc.) is usually detailed in a separate agreement.
Shareholders agreements are of critical importance and should be weighed in the balance along with more obvious factors such as how many shares you have the chance to own.
Most options will include a vesting period or vesting schedule. This means that although you have a contractual right to your equity, you can’t have it all at once.
Vesting schedules typically mean that you have to ‘unlock’ access to your allocated shares either through employment tenure or performance.
It’s common for vesting schedules to include a ‘cliff’, often one year in duration. This means that your shares don’t vest when you start work, but only once you are a year into the job. If you leave before this, you’ll leave empty handed.
Vesting isn’t only based on time. Some employers will offer you the chance to accelerate your vesting schedule by hitting performance goals, or the vesting for those participating in equity plans might be linked to the performance of the company as a whole – say hitting a certain revenue threshold.
It’s important to know not only the number of shares you are being offered, but the total shares outstanding. The relationship between these two determines how much of the company you own.
Most companies will have a fixed employee equity pool of 10-20% of total shares outstanding.
It’s also important to be aware of share dilution, which is what happens when a company issues more shares. When new shares are issued, there are now more available and the percentage owned by existing shareholders therefore decreases.
While it’s an obvious point, it’s surprising how often employees fail to investigate a company’s exit strategy and time-frame.
Although the board is unlikely to share its full strategic secrets with a new hire, it’s reasonable to expect some frame of reference to help put the value of your equity in better context, especially if you’re being offered equity to compensate for a below-market guaranteed pay package.
It’s also possible to get a read on a company’s valuation, often based on previous investment. Ultimately, share price market value is where the magic happens in equity programs, and if you’re able to see a rising trend in valuation through sequential fundraising rounds then you may be onto a winner.
After all, owing 0.01% of a booming software business is better than owing 50% of a sinking ship.
The Wealthfront blog includes some great articles dealing with the complexities of employee equity.
AngelList also has a great tool to help job-seekers sort salary and equity compensation by various job filters.
You can also check out this helpful calculator used by shared inbox application developer Front.