Startup Equity Evaluation

Pattern: A named solution to a recurring problem.

A five-question method for translating a startup equity offer into probability-weighted value, so candidates can compare its uncertain upside with certain cash.

A recruiter sends an offer: a salary 15% below the public-company alternative, plus “0.5% of the company” in options. That percentage sounds valuable but says almost nothing alone. Half a percent of which share count, at what strike price, after how much dilution, and behind what investor preferences? The offer letter rarely answers those questions. The gap between its headline number and the amount an employee might realize is where most disappointment in startup equity begins.

Context

This decision sits on the talent side of startup equity. A candidate or early employee is weighing a startup offer against a market-rate alternative. The decision applies to anyone trading cash for equity: a first engineer, an early product hire, a senior operator joining before Series A, or a candidate choosing between startups at different stages.

The offer is the output of the founder’s total compensation architecture, viewed from the other end of the table. The founder priced the grant against a salary band and an option pool. The candidate has to decode it into expected value with less information and more time pressure.

Problem

A candidate needs an estimate that makes the equity offer comparable with cash: the grant’s expected value after tax, weighted by the probability of each outcome. Yet the company has no liquid market or guaranteed exit, and the candidate hasn’t seen its cap table. The offer’s headline percentage or last-round dollar “value” omits dilution, investor preferences, vesting risk, exercise cost, and the base rate of startup failure. People accept grants they can’t value, discover the gap years later, and conclude that startup equity is a lottery. It is uncertain, but its expected value can be estimated.

Forces

• Percentage versus dollar value. A percentage decays with every round of dilution. A dollar “value” assumes a price that may never recur. A useful comparison projects both against the company’s likely future share count.

• Upside versus base rate. The grant can be worth a great deal in the least likely outcome. Weighting only the upside ignores that most startups return zero to common stock. Weighting only the base rate erases the reason for taking the risk.

• Information asymmetry. The company knows the fully-diluted share count, the preference stack, and the option-pool size. The candidate often receives only a percentage and a valuation. Closing that gap requires knowing which questions to ask.

• Negotiating equity costs goodwill at the worst time. A future employer may read requests for the share count and preference terms as distrust. Yet accepting a number you can’t value defers the tension until it’s harder to fix.

• Cash now versus equity maybe. The salary cut is certain and immediate; the equity is contingent and years out. The tradeoff isn’t abstract; it’s rent, runway, and how long the candidate can personally afford to bet.

Solution

Translate the offer into a probability-weighted expected value by answering five questions, and treat any number the company won’t give you as a finding in itself. The headline is the company’s most flattering view. The candidate needs a realistic one.

The five questions that turn an offer into a number:

1. What fraction of the company is this, fully diluted? Not shares, not last-round dollars, but the percentage of the fully-diluted share count, which includes all options, warrants, and unconverted SAFEs and notes. A grant quoted in raw share count with no denominator is unanswerable until you have the denominator.

2. What is the strike price, and what will it cost to exercise? For options, the strike is what you pay to convert them to shares. A large grant with a high strike and a short post-termination exercise window can be functionally worthless to someone who leaves before a liquidity event and cannot afford to exercise.

3. How much dilution is ahead? Each future round issues new shares and shrinks existing percentages. A 1% grant at seed is routinely a fraction of that by exit. Model the rounds the company will plausibly raise; the dilution is not a risk to the grant, it is a certainty.

4. What is ahead of you in the stack? Common stock pays only after every liquidation preference is satisfied. In a modest exit, a heavy preference stack can route most of the proceeds to investors before employees see a cent, regardless of the valuation the offer cited.

5. What is the realistic distribution of exits? Weight the outcomes that happen, not the one in the pitch. Acquisition is the path most venture-backed companies that exit at all actually walk, usually below the billion-dollar outcome in the pitch; many return nothing to common stock. The expected value is the sum across outcomes, each multiplied by its probability, not the best case in isolation.

A workable shorthand for the calculation:

expected value = Σ (exit_proceeds_to_common × your_diluted_% × P(outcome))
                 − exercise_cost − tax

The inputs are uncertain, so the calculation produces a range rather than a precise forecast. An offer that still beats the cash alternative after this translation is a real opportunity. One that only looked good in the offer letter is easier to decline.

How offers obscure value: Three framings recur. A grant quoted as a percentage with no fully-diluted denominator hides its pre-existing dilution. A dollar value multiplies the share count by the last round’s price, which may never recur. A four-year value presented as if it vests on day one ignores that the employee earns it over time and forfeits the unvested remainder after leaving. These framings aren’t necessarily dishonest, but each flatters the offer. The candidate has to deflate them.

How It Plays Out

Consider two offers a senior engineer is weighing. The first is from a Series B company: 0.15%, fully diluted, with a strike set at the last 409A valuation, vesting over four years. The second is from a seed-stage company: “1% of the company,” quoted as a percentage with no denominator, with a salary 20% lower.

The seed offer’s 1% looks like nearly seven times the stake. If the company succeeds, however, it may raise three or four more rounds before an exit, diluting the grant each time. A seed grant landing near 0.2–0.3% by a late-stage exit is unremarkable. It also sits behind the preferences carried by those rounds, at the stage with the highest failure rate.

The Series B grant is smaller but later in the dilution path. That company’s preference stack is larger but known, and it has survived its riskiest years. The headline numbers don’t reveal which offer has the higher expected value. That comparison requires the share count and preference terms.

An employee accepts a generous-sounding option grant and works four years. At acquisition, a 1x participating preference and a modest sale price leave common stock with little after investors are paid. The valuation was real, but the liquidation preference claimed the proceeds first.

Another employee exercises early at a high valuation, owes alternative minimum tax on the paper gain, and then watches the company fold. The tax bill is real; the shares never became cash. Both outcomes were answerable from the cap table and term sheet when the offers were made. The failure was the missing evaluation, not bad luck.

Consequences

Benefits. A candidate who runs the five questions can compare two startup offers or weigh one against a public-company alternative. They can decide how much certain salary to forgo for a contingent stake they’ve sized. The questions also test the company. A founder who states the fully-diluted percentage and preference terms plainly signals a clean cap table and a culture of candor. Deflection signals the opposite.

Liabilities. A probability-weighted number creates false precision when mistaken for a forecast. The calculation disciplines the decision; it doesn’t predict the outcome. Asking hard questions can also strain a new relationship with a future employer, so a candidate has to judge how hard to press. Even the best evaluation can’t overcome the base rate: most startup equity is worth little. The calculation won’t identify the offer that pays off. It lets a candidate size the risk before taking it.

Contrasts with: Total Compensation Architecture — This is the candidate reading the same numbers the founder used to build the offer; the employer-side framework prices the grant that this one decodes.

Depends on: Equity Compensation Types — Valuing a grant starts with knowing the instrument — ISO, NSO, or RSU — because the form determines the tax treatment and the exercise mechanics that a dollar figure hides.

Depends on: Four-Year Vesting with One-Year Cliff — The grant is a ceiling earned over time, so the vesting schedule and the cliff decide how much of the offer a departing employee actually keeps.

Downstream of: Liquidation Preference — An employee's common stock sits behind every preference in the stack, so the preference terms cap what a grant returns before the headline valuation ever reaches it.

Informed by: Cap Table Hygiene — The fully-diluted share count and the option-pool size that an honest evaluation needs are exactly the numbers a clean cap table records and a messy one obscures.

Uses: Acquisition Exit — Expected value depends on the exit, and acquisition — the realistic outcome for most venture-backed companies — sets the scenario the candidate should weight most heavily.

Uses: Dilution — A grant's percentage is a snapshot that shrinks at every future round, so reading an offer means modeling the dilution the headline number ignores.

Sources

• Carta’s equity and compensation data — the benchmark source for grant sizes by role and stage, dilution across rounds, and the share-count and option-pool figures an evaluation needs as reference points.

• Andy Rachleff and the Wealthfront startup-equity guidance — the widely-cited articulation of why fully-diluted percentage, strike price, and exit scenarios, not headline dollar values, are the terms that determine a grant’s worth.

• Frederic Kerrest and the early-employee equity literature — the practitioner case that the post-termination exercise window and the AMT exposure on early exercise are the mechanics that most often turn a paper-valuable grant into a real loss.