Equity is one of the most important factors when developers choose a new job. The idea of getting “upside” in your work, where you make lots of money if the company wins big, is tantalising to anyone.
Unfortunately how startup equity works in South Africa is complex and the most important information is not publicly available. We’re doing a multi-part series on startup equity, to make the best practises in South Africa more transparent. We want to help employees and companies understand how equity works in South Africa.
We’re collaborating with some top startup insiders to publish the most accurate and up to date information on equity in South Africa.
- Justin Stanford - Angel investor and founder of one of South Africa’s leading venture capital firms.
- Adrian Dommisse - Founder at Dommisse Attorneys, Adrian’s corporate practice is entirely dedicated to helping startups set up, fund, grow and exit.
- Malan Joubert - Malan is a founder of OfferZen. He is writing the equity post series with the help of Justin and Adrian.
What is equity?
“At the end of the day equity is just a special kind of bonus incentive” - Justin Stanford
Having equity (usually shares) in a company means that you get a portion of the money if the company is sold or pays out a dividend. Share options give you the right to buy equity in a company in the future. Equity aligns your financial interests with those of the other shareholders in the company; you make money if they make money.
Equity is different from most other bonus schemes in that it is unbounded; there is no limit to how much your equity could be worth. A company might pay you a 13th cheque as a bonus, but equity is probably the only way you’ve got a reasonable chance of getting a few years worth of income at once.
Getting the most out of equity
The promise of great returns makes equity very appealing, but of course most of the time it doesn’t work out quite like that. While there is a large luck factor involved in equity, there are some things you can do to improve your chances of making a good return.
Typically employees receive equity in exchange for taking a reduced salary. So it’s not a “freebie”, but a serious investment you make into the company that needs to be evaluated carefully.
If you are considering a job that promises equity, there are a few things you need to consider:
- How much equity are you getting?
- How much risk, in terms of reduced salary, are you taking?
- How does your vesting work?
- What are the odds that the company will get an “exit” or declare dividends?
We’ll explain each of these concepts in this post.
How much equity should I get?
It’s very difficult to prescribe absolute percentages, as each situation is heavily affected by the current value of the company, the amount you’re “risking” by taking a reduced salary and the maturity (“stage”) of the company.
We compiled some data for mid-stage companies, as they are the most frequently encountered by developers in South Africa. For a South African company that has raised a series A funding (typically greater than R10m) or has more than 10 employees the following ranges are typical:
If you’re a really experienced developer taking a salary cut and joining as employee number 10, you could expect to typically get one percent of the company.
Important note: some companies only tell you the number of shares you’ll receive, and don’t tell you what % of the company you’re getting. This is a very common trap. The number of shares you’re receiving is meaningless without knowing the total number of shares. You need to know what % of the company you’re getting.
Shares are a long-term (4 to 5 year) incentive: a startup wants to give shareholding to team members who’re in it for the long-run and will be adding great value for a long time. Shares are generally seen as a reward for improving the future value of the Company, not past effort in getting it to where it is now.
For this reason equity is typically “vested”. What that means is that the commitment for equity is made upfront, but you only receive it as time passes. The amount of time depends on how long the Company needs you to commit to it.
The most typical structure (and the one you should expect) is four year vesting with a one year cliff.
In practise this means that your shareholding in the company will vest as follows:
Assume Company X has decided that you will add a lot of value and are very committed and want to give you 1% of the company. Four year vesting with a one year cliff would work as follows:
You’ll receive 0.25% after the first year - if you leave (or are
fired) before the year is over, you are legally entitled to no
shares. This is the cliff, before the 1 year point, you’re not
entitled to any shares
After that you’ll receive an additional 1/48th of one percent every month for the next three years, to reach a total four year vesting period. If you leave at any point, you only get to keep your vested shares. So if you leave after 2.5 years, you’ll have 2.5/4 = 0.625% of the company
Sometimes, some of your unvested shares can vest early if the exit comes along before the four year period ends. This is to protect the employees who stay behind after the exit if, for example, the new owner retrenches you. In that case, it is common to allow for some of the unvested shares to vest.
Making money from equity
“Expect your shares to be restricted - this means that you won’t be able to sell them for a period of time. So even if they vest, you won’t be able to sell them for, say, five years or until the date of the exit.” - Adrian Dommisse
There are basically only two ways to make money from equity; the company gets acquired or pays dividends. If neither of those two happen your equity will most likely be worthless. So if you’re thinking of taking a job with equity, you need to make sure that one of those two options is likely.
It’s really difficult to figure this out, and mostly you’ll have to go on gut feeling. Good VC’s typically base most of their decision on the team (most significant factor) and the quality of the product.
If the company is passionate about building great products, the team are friendly and committed it’s a very good sign. Furthermore VCs tend to care a lot about the response from early customers in the company’s target market.
One way to figure out if a company has a good chance of getting acquired is to cheat, by looking at who’s already invested in the company. Venture Capitalists typically only invest in companies that they think have a good chance of being acquired in the future. So if a good VC has invested in a company, you know there is a decent chance that the company could exit in the future.
If the company hasn’t got funding, then you’d expect them to be making enough money to be profitable. So, have they ever paid out dividends before? Ask them. If they have, it’s likely that they would do it again in the future.
If you’re taking equity, make sure you see a “path to liquidity”, where the company is either sold or pays out dividends. Without either of those two happening, having equity is not really valuable.
- Equity (shares) is a special kind of bonus incentive that give you potentially unbounded upside in a company
- Typically you receive shares in exchange for taking a reduced salary
- The amount of equity given is a factor of the amount you’re “risking” by taking a reduced salary and the company’s maturity and valuation
- Shares can’t just be sold; they generally vest over a four year period, and even once they’ve vested they tend to be restricted
- To get an idea of the value of getting shares in a company, ask:
- Has the company received investment from a top VC firm?
- Has the company ever declared dividends?
- Make sure you see a “path to liquidity”, where the company is either sold or pays out dividends
What’s coming next in the series
This post gives an overview of the basics of equity, next up we’ll delve into some of the more advanced topics that could affect your equity.
We’ll look at:
- Types of equity (shares, share options, trusts, phantom shares)
- The effects of dilution when the company gets more investment
- Differences between South Africa and Silicon Valley
- Tax considerations
If there are specific things you want more information about, please email me email@example.com to let me know!
Angel investor and founder of one of South Africa’s leading venture capital firms, 4Di Capital - will be providing insights from the VC world. Justin, a startup founder himself, has invested in some of the most promising South African startups and helped those companies set up fair and effective equity structures for their employees.
Founder and partner at Dommisse Attorneys, will share his experience and knowledge on structuring and managing equity. Adrian’s corporate practice is entirely dedicated to helping startups set up, fund, grow and exit - he has advised on the legal and tax structuring for over a dozen startup companies. His firm has helped a number of South African companies with exits, including being the legal representative for WooTheme’s $30 million exit to Automattic.
Malan is a founder of OfferZen. He is also the CEO of FireID, a startup studio that has incubated a number of leading South African startups including; Pondering Panda, Journey Apps, SnapScan and BitX. He is writing the equity post series with the help of Justin and Adrian.