Startup contract issue - What exactly is meant by 1.5% equity in a company?

startup_employee

How does the notion of equity relate to the notion of option shares? Are they one and the same? I am looking for a precise definition of equity and how it relates to option shares (and strike price). I would like to know how people here interpret having 1.5% equity in a company.

I joined a startup in a European country recently as an early stage employee. Before I joined we had some negotiations regarding my salary and equity. We ultimately agreed that I would receive 1.5% equity.

The CEO of the company told me during the negotiations that they were waiting to see if the new government in the country changed the law regarding options taxation, as that would allow them to offer the equity as options, which is something they wanted to do.

I had no issue with this, I figured my 1.5% equity would be the ultimately the same thing whether it was in the form of options or not.

The government did indeed change the law, and the company has now given me a contract to sign for my 1.5% equity.

However, it is not what I expected. I assumed that since we had agreed upon 1.5% equity, that at the time of our agreement, if the company was hypothetically sold the very next day, I would receive 1.5% of the net profit. But the contract I have been given to sign stipulates that I get 1.5% of the total shares in the company at a certain strike price. And here is where the issue arises.

I assumed that the strike price would be nominal, e.g. something like €0.01, so that 1.5% of the total shares translates into owning 1.5% of the company, and thus I would stand to receive 1.5% of the net profit if the company was immediately sold. Instead the strike price has been set so the total number of options times the exercise price of the options equals the current market value. For example, suppose the current market value is €6.5M. 1.5% of this is approx. €100K. But since I have been given 60000 options at a strike price of €1.60, the total cost to exercise the option is also approx. €100K. So I would receive zero if the company was immediately sold. This was not what I had in mind when I agreed to join the company. I assumed that 1.5% equity would mean that I receive €100K if the company was immediately sold for €6.5M.

So can anyone clarify this situation for me? Have I made a mistake in my interpretation of having equity in a company? Do you think I am being unreasonable, or is the company being unreasonable? I agreed with the company that I would get 1.5% equity - does this options agreement equate to 1.5% equity? Or am I getting the short end of the stick?

silver2020

Equity is not about net profit. That's your first error.

It is about the company and the ownership.

Effectively you are being offered 1.5% of the company at the initial share price and at the allocated share level.

My company has 100,000 share issued at €1 each. I invested €75,000, I own 75%

You need to pay a good financial advisor on this and get proper advice as if you don't understand it, it will lead to problems down the road

Peregrinus

Your interpretation of the agreement was that you would be given 1.5% of the issued share capital for free.

The employer's interpretation is that you would be given the right to acquire (i.e. an option over) 1.5% of the issued share capital at a price reflecting its value on the day the right was given (or the day you joined the company?)

You'd need to look at what exactly was said to see which interpretation is the more accurate. You do have all this in writing, I assume?

It might be worth adding that the employer's interpretation is much closer to what is usual in the market. If you were given 1.5% for free, you would effectively be handed 1.5% of the value created in the company before you joined it - value in whose creation your efforts, obviously, played no part. That's not usual. The company's interpretation gives you 1.5% of the additional value in the company created after you join/after the option is granted, on the rationale that you will have contributed to the creation of that extra value.

Gloomtastic!

From what I understand the way most of these share schemes work, you will have an option to buy 1.5% of the company’s shares at today’s price of x. But no money actually changes hands.

Then, due to you and your colleagues efforts, the share price will increase to y. You can then sell your shares and you get the difference between x and y. You will have to pay tax on them as well unfortunately.

As advised, talk to a professional about this. Little details like if you no longer work at the company, for whatever reason, needs to be made clear.

Good luck to you!