Evaluating Equity Compensation

Once you understand the types of equity and their tax implications, you have many of the tools you need to evaluate an offer that includes equity compensation, or to evaluate equity you currently have in a company.

In summary, you have to determine or make educated guesses about several things:

• Equity value. This can be estimated by the value the company may have in the future, and the number of shares you may own.

  • Percentage ownership. As we’ve mentioned, knowing how many shares of stock or stock options you have is meaningless unless you know the number of outstanding shares. What matters is the percentage ownership of the company the shares represent, including the details of how the total is counted.

  • Risk. It is critical to understand risk in the business and dilution to ascertain the possible future value of equity. This article from Leo Polovets provides some additional thoughts.

• Vesting. Understand when you will receive the equity, as well as whether you’re able to exercise stock options (and pay the associated costs and taxes), and whether you can do all this before your exercise window expires.

• Liquidity. Determine when you will be able to sell your shares, and if that is likely to be for a profit at that time. (We talk about liquidity of private stock next.)

• Tax. Tax concerns are inseparable from the value of equity. Know the tax implications of your possible grant, exercise, vesting, and sale, in terms of ordinary income tax, employment tax, long-term capital gains, and alternative minimum tax.

That’s a lot, and even so, decisions are uncertain, but it is possible to make much more informed decisions once you have this information.