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If you're reading this, you probably have a job at a startup (or you’re considering joining one). You may even have an offer in hand—possibly multiple offers. Understanding your compensation is the foundation to making informed financial decisions for you and your family. However, startup compensation is a complex can of worms, and employees are often unclear on the full implications of their deal. To make sure you understand the ins and outs of your compensation, this article is a great place to start.

We'll explore everything from the many ways equity can be structured to how offers from public and private companies differ. If any of the terms look alarming or don't make sense just yet, don't worry - we'll explain them later.
There's no right answer to how compensation should be structured. Every offer comes with tradeoffs. A company’s goal is to structure offers that are attractive to the types of employees they want to attract at that point in the company’s maturity. As a company grows and changes, the types of employees it tries to hire change and the structure of its offers change too.

The goal of this guide is ultimately to help you develop a toolkit to think about what's right for you.

There are two useful frameworks for how to think about the different types of compensation:

How you earn it - do you get it for staying employed or is it dependent on a metric?

What form does it take - cash, equity, tokens, or benefits?

Compensation awarded for just staying employed with the company is less risky - it might look smaller on paper, but you’re guaranteed to get it. Compensation tied to performance is "at risk" - it might look bigger on paper, but the value is offset by the risk that you may not earn it.

There are four common forms of compensation - salary, bonus, equity, and benefits.

Salary is cash compensation received on an ongoing basis for “staying employed.”

Bonus is compensation tied to performance. It is most often cash but could also be equity.

Equity is partial ownership of the company. You may also hear equity referred to as stock or shares in the company. The many ways equity can be structured is an in-depth topic we explore here.

Benefits are additional non-cash perks that you can receive. Typical benefits include health insurance, paid vacation, maternity/paternity leave, and a 401(k). Less typical but still common perks include commuter benefits, paid-for meals, and ongoing education stipends. The list of possible benefits is limited only by a company’s creativity and desire to attract talent.

All in, a total compensation package for a new employee could look like the following:

Equity: 5,000 options at a $10 strike price, with 4 years vesting and a 1-year cliff

Benefits: fully paid health insurance, unlimited vacation, 401(k) with 5% match, $1,000 per year ongoing education stipend, bi-annual company offsite 

What ultimately matters is how much cash you take home. States and local tax codes and the choices you make can have a big impact.

Taxes will form the bulk of the difference between your headline salary number and how much you take home in cash. Taxes can happen at the federal, state, and local levels in the US depending on where you live and vary significantly. Just looking at the state-level income taxes - a handful of states have no income tax, some have a flat income tax for all residents, and most have a graduated-rate income tax that increases the more you make. Even the top graduated rates range by as much as 10% between states.

After taxes, your pre-tax deductions will make up most of the remaining difference between your salary amount and take-home pay. By spending pre-tax, you reduce the amount of taxes you ultimately pay. How much you spend pre-tax is in your control. Typical examples include health insurance premiums, health-related savings accounts, life insurance, disability insurance, and a 401(k) retirement account.

If you want to calculate the net take-home pay for yourself, check out SmartAsset's nifty Paycheck Calculator where you can plug in all of your own numbers including salary, where you live, and deductions.

Salary is ultimately a tradeoff. Total compensation that includes a larger bonus and/or equity component tends to have smaller salaries and appear more valuable on paper. You have to determine for yourself whether that compensation is still as valuable when it's risk-weighted - the bonus might look large, but if you think there's only a 75% chance of getting it, a compensation package that has a larger salary and smaller bonus may be more valuable.

Bonuses are compensation that's not guaranteed, it's at risk. While bonuses can be paid in cash, equity, or even company paid-for amenities like sporting events tickets, it's generally understood to be cash unless it's specified otherwise.

The two critical considerations for bonuses are timing and terms. Timing is both when it gets awarded and when you'll be paid. Terms can vary significantly. If you're unsure, talk with a lawyer.

Also, keep in mind that bonuses are taxed differently than your salary. You'll see the bonus tax referred to by its more formal name, the supplemental tax rate. Some states and localities like New York City may make you pay additional taxes on supplemental income in addition to the federal taxes.

Equity typically has the biggest potential upside. If the company does well and becomes more valuable over time, your partial ownership will become more valuable too - it's great! It can quite literally be life-changing. But equity is also riskier. Most startups fail and the equity becomes worthless. Keep both in mind as you think about your total compensation.

The value of equity is a more complex question than it first appears. There can be many different share classes at companies. This is especially common for startups.

You'll often hear the classes referred to as common and preferred. Common is almost always the share class with the least rights, it's what employees receive. Investors typically receive preferred shares that have additional rights. There can be many classes of preferred.

The price for preferred shares is typically determined when a company raises a round - it's whatever the investors were willing to pay. When you see an announcement for a funding round (e.g. Seed, Series A, Series B …), that's typically a sale of preferred shares.

The price for common equity is typically determined through a process called a 409A valuation, a value appraisal conducted by a third party that the IRS accepts as a "fair basis" for value. The price for common equity is almost always less than the preferred price because the common equity has fewer rights.

There are many ways to structure equity. Depending on the stage of the company you're joining, you're more likely to see some structures than others. The most common structures are restricted stock awards (RSAs), incentive stock options (ISOs), non-qualified stock options (NSOs), and restricted stock units (RSUs). It's an alphabet soup of structures! RSAs are typically only usable during the creation of a company. Options tend to be used throughout a company’s pre-IPO lifecycle, but many companies start to replace options with RSUs as they mature and valuation growth slows. 

Most equity is subject to vesting - earning ownership rights. Vesting is most commonly time-based but can also be tied to performance or other metrics. A typical time-based structure is 4-years monthly vesting with a 1-year cliff. That means you take ownership of 25% of the award at the end of year 1, then take ownership of an additional 1/48th of the total award for the remaining three years.

Restricted stock awards (RSAs) allow you to take ownership of equity now, but the equity comes with restrictions. Founders shares are often structured as RSAs.

Vesting for RSAs typically manifests a buy-back right for the company - if you leave the company before the RSAs vest, the company can repurchase the unvested equity from you. Once the shares vest, they're completely yours even if you leave the company.

Taxes are dependent on how you take ownership of the shares. If you pay the full price for the share, you won’t owe taxes. If you paid anything less, including if they were awarded to you as compensation, you'll likely owe taxes.

RSAs are common when companies are not yet very valuable. As the shares become more valuable, they can be expensive to purchase or result in a large tax bill if they're awarded. The other structures we'll explore help solve those challenges.

Incentive Stock Options & Non-qualified Stock Options

Incentive stock options (ISOs) and Non-qualified stock options (NSOs) are the right - but not the obligation - to purchase equity. It's the most common form of startup equity.

Strike price - the price you can pay to actually purchase the shares. Also known as the exercise price. When you actually make the purchase, it's known as exercising the options.

Bargain element - the difference in price between the strike price and the then-current value for the shares. As the company grows and becomes more valuable, the bargain element grows as well.

Once the options vest, you own them. That means you own the right to purchase equity at the strike price. You don't get any of the rights that come along with owning equity until you exercise the options.

Owning options versus equity is a critical difference. Companies can write term limits into your options agreement. When the term is up and the options expire, you forfeit the right to purchase equity. Secondly, the company can force you to exercise your options - or forfeit them - when you leave the company. The timeline for exercise when you leave is typically as short as three months.

Exercising options triggers ordinary income taxes on the bargain element at the time the option is exercised. As the company gets more valuable and that bargain element gets bigger, the taxes also get bigger.

If you need cash to exercise the options or pay the tax bill, Prism may be able to help.

ISOs give you a helpful “freebie” on ISOs - the IRS won't tax the first $100K of that bargain element income per year. Above the $100K threshold, any remaining options are automatically taxed as NSOs - you owe ordinary income tax on the bargain element.

There's a lot more that goes into taxes. Exercising ISOs can trigger the Alternative Minimum Tax and you may be able to early exercise your options to reduce your tax bill. You can find out more about options and taxes here.

Options are the most common form of startup equity compensation. As the company becomes more valuable, the cost to exercise options and associated taxes can become prohibitively expensive. Restricted Stock Units can become a more attractive construct.

You can find out more about ISOs and NSOs here. 

Restricted stock units (RSUs) are an agreement from the company to issue you shares or the cash value of shares at a future date.

Vesting for RSUs is similar to options - you earn the right to receive shares or the cash value, but you don't actually receive the equity itself. RSUs typically have a trigger event for when the company will issue you your vested equity or the cash equivalent. Like with options, you typically forfeit your rights to the equity if you leave the company before the trigger.

The most common trigger event for RSUs is a liquidation event - when the company is either acquired or becomes a public company through an IPO, direct listing, SPAC, or another method. The reason for the trigger is taxes.

When the trigger event happens and you receive the shares, you're taxed on the full value of those shares at the time you receive them. That value is treated as ordinary income. If the company has been successful, it can mean a very large tax bill.

If the company's been acquired or is now public, you'll either have the cash needed to pay the tax bill or have the ability to sell some of your equity to pay. It's why that trigger is typically tied to a liquidation event - to ensure you can pay your tax bill.

There are nuances involved in RSU taxes that we may explore in a future piece.

RSUs are most common in late-stage, valuable startups and in public companies. For companies intending to go public or be acquired in the near future, RSUs enable employees to take ownership of the equity without paying the option strike price. For companies intending to stay private for many years to come, RSUs avoid the 10-year expiration limit on options.

Comparing Equity at Private and Public Companies

All of these equity structures - RSAs, ISOs, NSOs, and RSUs - can be issued by both private and public companies.

When you receive equity at a private company - including venture-backed startups - there's no market for that equity. You cannot sell it without company approval. That could be the company offering to buy back your shares to give you some cash or the company going public.

At a public company, there's a market for your equity. That means if you have a large tax bill or need money to exercise options, you can get cash.

Prism is helping bridge that gap for startups, giving equity and option holders access to cash before the company goes public.

It's a lot of moving parts and it can be a bit overwhelming! Here are the key things to keep in mind.

There's no "right" offer - that's up to you. Every offer comes with tradeoffs that may or may not fit your preferences. Think it through and talk with family and friends to explore what makes sense for you and your goals.

Salary and benefits are the least risky part of the total compensation. You'll generally receive them as long as you stay employed. Salary will typically be smaller than what you can receive in a comparable offer that doesn't include a bonus or equity.

Bonuses are riskier than salaries. They're typically tied to performance. A bonus might look big on paper, but bear in mind the likelihood of whether you'll actually receive it.

Equity is riskier than salaries. It's tied to overall company performance. If the company does well it may be worth a lot. But if the company doesn't do well, it can be worth nothing. Equity also comes with many structural and tax considerations that can meaningfully affect the ultimate value you receive.

If you have questions about the offer - ask the company! They can help clarify terms, equity valuation, and more. It can be uncomfortable to ask, but the company will want to help. Your total compensation is an agreement between you and the company - they get a super valuable employee and you get compensated for helping them grow. You both need to be comfortable with the agreement.

Fast-growing private companies can compensate their employees in many ways. Learn how to compare options and RSUs to standard cash-salaries.

Startup Compensation

Startup founders and employees dream of a big liquidity event that changes their fortunes. Learn about the variety of possible exit events and what they mean for you.

A liquidity event is when your startup shares transform into cash or publicly tradable shares that can be sold for cash. If the company is IPOing, it’ll continue on as an independent entity. If the company is being acquired, it’ll be folded into the acquirer.

Liquidity is the key term. Something is liquid if it's cash or easy to sell for cash. Something is illiquid if it's difficult to convert into cash. A liquidity event is when your illiquid startup shares transform into something more liquid.

An Initial Public Offering (IPO) is when a startup registers with the Securities and Exchange Commission (SEC) as a publicly listed company and the shares can now trade freely. A direct listing and merging with a special purpose acquisition vehicle (SPAC) are common alternative ways to "go public."

An Acquisition is a sale of a company to another company. The acquiring company may be private - like a startup or private equity backed company - or may be publicly listed. Acquisitions are often referred to as mergers when the companies are of similar size.

A Secondary Market Transaction is the sale of shares before the startup goes public. This could either be the startup buying back shares in a tender or a sale to a third party. You'll often hear it referred to as just a "secondary."

Your experience as an employee can be different depending on the type of event.

An IPO is often seen as the ultimate mark of success for a startup. It's an opening up to the world. The previously private financials and governance of the company are now publicly available. Any investor can buy shares and become a shareholder. Existing shareholders can sell their shares for cash after years of investment and hard work.

The U.S. averaged about 200 IPOs a year from 2008 through 2020. 2021 was an atypically active year for IPOs, boosted by almost 600 SPACs.

As a startup employee or investor, you typically cannot sell your shares immediately upon IPO. While not required by law, most startups institute a lock-up period of about 180 days. There are often modifying terms where the lock-up ends early if the new share price stays elevated above the IPO price for a period of time. After the lock-up ends, you're free to sell your shares.

Keep in mind: if you own the shares for longer than a year - including while the company is still private - you may owe less in taxes when you sell. At the federal level, shares that are held for at least a year before they're sold are taxed at a lower capital gains tax rate. Shares held for less than a year are taxed as ordinary income. You can learn more about taxes here.

The point of the lock-up is to prevent existing shareholders from selling their shares en masse on the public market. It can take time for a robust trading market to develop. A lock-up gives the market time to develop so it can absorb new sales without a material impact on the share price.

Once a company goes public, future employee compensation will often change. Taxes are one of the biggest reasons that startups structure employee equity as options and RSUs - other structures like equity grants and RSAs can trigger large tax bills that employees may not be able to afford.

Once a company goes public, employees can sell shares for cash to pay for taxes and other obligations. Total compensation often reflects that shift - employees typically receive shares as they vest and the company will withhold the amounts necessary to pay the tax bill.

Airbnb was among the largest IPOs in 2020. The company went public on Thursday, December 10th, 2020 just over twelve years after it was founded. The company sold 51.5 million shares at $68 a share for $3.5 billion. The IPO valued the company at $47 billion, a value known as market capitalization that’s calculated by multiplying the total number of the shares outstanding with the price per share.

Day-of the IPO, the share price skyrocketed as high as $165 per share before closing the day at $144.71.

The lock-up period for Airbnb fully ended 180 days after IPO. The company permitted windows where shareholders could sell portions of their holdings in advance of the expiration. The share price dropped more than 6% the day the lock-up period ended, closing at about $132, about 8% below where it closed the day of the IPO. Such price drops the day the lock-up period ends is not unusual - it reflects many new sellers coming into the market all at once.

A SPAC is a special type of public company designed to acquire another company. They're complex structures whose full details go beyond what we'll cover here. You can review PwC's overview for more details.

The terminology for SPACs is a bit loosey-goosey. You'll hear of companies "getting SPAC'd" or of a "reverse merger." It all means the same thing - a publicly listed SPAC is acquiring another company.

For an employee, a SPAC can be similar to an IPO. You will exchange your startup shares for public company shares that can be sold for cash. Like with a traditional IPO, most SPACs will have a 180-day lock-up period for the acquired startup shareholders. Keep in mind that there is another, unrelated lock-up period for investors in the SPAC that does not impact you as an employee.

That said, there were many SPACs in 2021 with non-standard terms that may have resulted in more complex considerations for the acquired employees. When in doubt, talk with the company or a tax advisor if you're unsure.

Lucid was SPAC'd on Monday, July 26th, 2022. The electric-vehicle startup was acquired by Churchill Capital Corp IV, a SPAC, for $4.4 billion under terms agreed to in February of that year. After the acquisition, the SPAC changed its name to Lucid and trades under the ticker LCID.

SPACs have come under increasing regulatory scrutiny by regulators. Lucid was subpoenaed by the SEC in December 2021 for documents pertaining to an investigation related to the company's merger.

When your company is acquired, you'll become a part of the acquiring company. A lot goes into an acquisition and different employees at the acquired company may have different experiences.

The terms of the acquisition are up to the two companies. They not only have to agree on the price but also on whether it will be paid for in cash or shares and if there will be any restrictions. If the acquirer is a public and/or regulated company, some of the restrictions may be so they can continue to meet their regulatory obligations.

A common restriction for senior executives at the acquired company is called "golden handcuffs" - you only receive payment for your shares if you stay at the acquiring company. A less common but highly impactful term is an "earn out" - additional bonuses that can be earned post-acquisition depending on performance. The goal of both is to retain key employees after the acquisition.

Depending on how the acquisition is structured, it can trigger tax liabilities for the acquired employees.

If an acquisition is all-cash, then employees are "cashed out." Shares and options are converted to cash and you'll owe taxes. If you owned shares for longer than one year, you'll be taxed at the long-term capital gains tax rate. If you owned shares for less than a year, the proceeds will be taxed at the ordinary income tax rate.

If an acquisition is all-stock, then the tax liabilities can become more complex. It depends on several factors including the cost basis of the shares you previously owned versus the cost basis of your newly acquired shares. Talk with the company or a tax advisor about your situation.

If the acquisition is a blend of stock and cash, then you'll be taxed separately on each component. Refer to the bullets above for each component.

Most of the time an acquirer is interested in purchasing the entire company - products, services, and the team. Occasionally, they only want specific parts of the company. If the acquisition is primarily to acquire just the product or patents, we informally call it an IP Acquisition. If the acquirer primarily just wants the team, we call it an Acquihire.

An IP Acquisition is essentially a big, complex sales deal. The selling company receives cash or equity for the sale, which it may or may not distribute to its investors and employees. Unless there are additional deal terms like licensing of the IP, the two companies go their own ways.

Acquihires are more complex and will likely have bigger implications for you as an employee.

Most acquihired companies are smaller and the outcome is less lucrative for investors than a full acquisition. For retained employees, acquihires can be very lucrative.

Most of the deal structure focuses on how to appropriately incentivize and retain key employees. Employees ultimately get to choose whether or not they want to stay at the acquiring company.

An acquirer is particularly sensitive to the risk that the exciting new employees they’re trying to bring onto the team may leave soon after the deal closes. Deal terms often include both upfront compensation in recognition for work already done and additional compensation that vests over time to encourage the employees to stay.

Sometimes that “over time” compensation is structured as an earnout. Earnouts sound like what they are - additional payments that can be earned if the acquiring company achieves agreed upon metrics. Keep in mind that earnouts can be bigger on paper but are riskier - you might not meet metrics and won’t earn the payment.

A secondary means you’re selling your shares. It enables you to get access to cash without waiting for an IPO or acquisition. Unlike with shares you may own in public companies, your shares in the startup are likely subject to restrictions.

Secondaries can typically only happen if permitted by the company. If allowed, the company will likely set up a formal process through which sales can happen. That may be a one time event when you’re allowed to sell or it may be a regular, recurring event.

Unlike in the public stock markets where millions of participants bid on shares, the number of participants in a secondary is typically much more limited. Sometimes there’s just one allowed buyer - the company itself - a process called a tender. The more limited pool of buyers makes price discovery - determining the price for the shares - more difficult. Secondaries will often be scheduled concurrent with a capital raise to help provide more information on the correct price.

A secondary is a sale. If you sell all of your shares, you’ll no longer have the benefit of being a shareholder in the company including any potential increase in the share value as the company grows. You may also incur significant taxes at sale which could cause you to sell more shares than you had planned. You can learn more about the taxes at sale here.

Prism is a different way to access cash without selling your shares and without the tax headaches. 

Liquidity Events

Companies are taking longer than ever to IPO. Learn about opportunities to receive liquidity before your company goes public.

Up until just a few years ago, if you held shares in a privately held startup, you had to wait for an IPO or acquisition until you could convert those shares to cash. It's a model that worked when the average time for a startup to IPO was just 7.3 years like it was from 1995 through 2005. But that time has gotten longer and longer. For the past five years, the average startup age at IPO never dipped below 11 years old and the average has been 12 years old.
Twelve years is a long time to hold shares that you can't convert to cash. Most of what we do in our normal lives requires cash, and it's not just the day to day needs like groceries. You may have student loans that you need to pay off. Maybe you joined the startup fresh out of college and now you're thinking about getting married or buying a home or starting a family. You can't pay for those things with equity. You need cash.
It's a situation many early startup employees find themselves in - equity rich and cash poor. Thankfully, a robust market for early liquidity options has emerged to help.

Most startups tightly control early liquidity options. Well-structured early liquidity can be a major perk for startup employees that also helps the company attract and retain key talent. Poorly structured, it can cause problems for the startup and investors alike.

Startups have three main concerns around early liquidity:

Shareholders - startups want to be deliberate about who they invite in as shareholders. They often put restrictions in place to prevent shares from ending up in unknown hands.

Employee alignment - startups want to incentivize employees to think and act like owners who benefit as the company grows. If the employees no longer own equity, that alignment disappears.

Regulatory - depending on how a startup raises capital, it can be subject to different restrictions including minimum holding periods before shareholders can resell their equity and a limit on the total number of shareholders. Poorly structured or unrestricted liquidity programs can land a startup in hot water.

Before a startup establishes a formal liquidity program, it’ll typically focus on preventing possible problems. The most common way to do that is to prohibit sales or pledges without company approval. Pledging includes committing shares to a loan and signing an agreement today to sell the shares in the future.

Beyond outright prohibition, two other restrictions are common:

A right of first refusal is a startup's right to buy back your equity at the same price a buyer is willing to pay. Even if you've already agreed to sell to a third party, the startup gets to jump in front and buy your shares instead. A right of first refusal is so common that it's typically referred to as an abbreviation - ROFR, pronounced "roh-fur". While you are still able to sell with a ROFR, some buyers will not engage unless the startup preemptively agrees to waive their right to jump in front. A buyer’s bid - the price they’ll pay for the shares - can be valuable information. They may not want to give that away unless they’re reasonably certain they’ll close the deal.

A right of co-sale requires that when one shareholder attempts to sell, they must first notify all other shareholders who then also have a right to participate in the sale. It both slows down any potential transactions and gives shareholders confidence they'll all get equal access to early liquidity if it becomes available.

Once a company chooses to offer early liquidity, there are three main options:

A secondary market sale - often shortened to just secondary, is a sale of your shares for cash. When the buyer is the company rather than a third party, we call it a tender.

A forward contract is an agreement today to sell shares in the future. Most forward contracts for startup equity are structured as prepaid variable forwards, meaning you receive cash today and sell the buyer an agreed-upon number of shares in the future. The variable comes from the fact that the future value of those shares is indeterminate at the time the contract is signed.

An asset-backed loan is a loan secured by the shares themselves that typically does not have to be paid back until a liquidity event. Different than the other two options, you get to keep your shares.

Each of the options comes with tradeoffs for both the company and its employees.

Secondary market sales are by far the most common of the three options. In 2021, the four largest marketplaces for secondaries facilitated over $20 billion in sales.

We call it a secondary market to differentiate it from the primary market. The primary market is how a startup raises money from investors - it sells shares of the company in return for cash. The equity compensation you receive is also a primary market. The startup is "selling" you shares instead of more cash compensation as payment for the services you provide to the company.

Secondary markets are different. A secondary market is one where the seller is an existing shareholder, not the startup. That means the shareholder receives cash rather than the startup.

For a startup, secondaries can be relatively straightforward to facilitate with the right partner but invite challenges related to all three key concerns - shareholders, employee alignment, and regulatory risk.

For employees, the experience is frequently sub-optimal despite massive improvements in the market over the past decade. Secondaries are generally high cost and high friction, a particularly bad combination.

Costs manifest in two forms - transactional costs and taxes. Transactional costs on the leading secondary market platforms are typically 5%. Taxes are dependent on how long you've owned the shares. You can learn more about taxes here.

The exception to high cost, high friction secondaries is a tender. When there is just one buyer - the company - most of the challenges evaporate. The exception is taxes. You'll incur the same taxes in a tender.

The biggest upside for employees is the simplicity. Once a secondary is completed, there is no further relationship between employee and buyer. And the employee gets immediate cash.

Prepaid variable forward contracts are complex instruments. It sort of looks like a sale and sort of looks like a zero-interest loan. It inherits attributes of both.

A word of warning - many startups do their best to prohibit forwards. Secondary sales and asset backed loans are often simpler transactions that achieve similar outcomes and give the startup greater control over equity.

A forward is an agreement between a buyer and a seller to transact in the future under terms agreed upon today. Prepaid variable forwards are a subtype with nuances specific to when they're structured for startup equity.

The buyer delivers cash to the seller today, but the seller won't deliver the shares until a future date. For startup equity, that future date is usually defined as a liquidity event.

The number of shares that the seller will deliver is agreed upon today. The value of the shares is variable - it'll be dependent on the price of the shares at the future date.

There are critical points here. First, this is a long-lived agreement between two parties. Unlike with a sale that's over once it's completed, both parties remain exposed to one another until the shares are ultimately delivered. Second, a seller may end up transferring a lot more value in the future than they had intended if the shares become very valuable.

Like with most forward contracts, the seller's loss exposure is limited to the shares that are pledged. In a worst-case scenario for the buyer where the startup goes bankrupt and the shares are worthless, the seller is off the hook and the buyer takes the loss. As a result, forwards for startup equity tend to be priced very conservatively - not a lot of cash compared to the potential value of the shares.

Forwards like this do come with a tax advantage for the seller - they don't have to pay taxes on the sale until the future date when the shares are delivered to the buyer. Be careful though. While it's great to defer taxes, it does mean that a seller can be caught out with a big tax bill for cash that was delivered much earlier.

Asset backed loans enable employees to get access to cash and keep ownership of their equity. That's a particularly powerful combination. They're most often used to help employees get access to the cash needed to exercise options and pay the associated taxes, although they're increasingly being used to get employees early access to cash for general expenses.

Loans can be structured in many ways. Asset backed loans for startup equity tend to be consistent in how they're structured, but there can be exceptions. Most are collateralized by the startup equity, do not have personal recourse, and the loan repayment is triggered by a liquidity event. Let's unpack what each of those means.

Collateralized means what's at risk if the loan isn't paid back. In the case of a mortgage, the loan is collateralized by the house. In this case, it means the lender gets to take ownership of the startup equity if the employee cannot pay back the loan.

Personal recourse is when a lender can go after a borrower's assets generally, not just the loan collateral. Most asset backed loans for startup equity do not have personal recourse. Be extremely careful if a company offers you a loan that does.

Loan repayment at a liquidity event means that the borrower doesn't have to pay anything until there's a liquidity event for the startup. Any interest payments accrue to be paid later.

For employees, what this all means is that you can get loaned cash today that you don't have to repay until there's a liquidity event. The only thing at risk is the equity. If the startup does well and the liquidity event is a success, you'll be able to sell the shares needed to pay back the loan and any interest. If the liquidity event is not a success, you forfeit the equity. If the company goes bankrupt, you're off the hook and the lender takes a loss.

What this means is that asset backed loans, while potentially a great option for employees, may not be available. Lenders tend to only lend against those companies they think have a high likelihood of completing a successful liquidity event in the next five years or so.

If you're considering an asset backed loan, there are many more important details to explore. You can find out more here.

The right liquidity option depends on your wants and needs. Assuming your company allows you to pursue any of the three models, you should consider the risk and cost tradeoffs.

We've put together a cheat sheet that compares all three:

Early Liquidity Options

You may not realize that you've encountered asset-backed loans before with a mortgage or car loan. Learn how company equity can back personal loans as well.

Asset backed loans are everywhere. Asset backed means that if the borrower doesn't pay back the loan, there's an asset that can be seized (and presumably sold) by the lender. A mortgage is an asset backed loan. A car loan is too.

Asset backed loans are now available to help startup employees get access to cash before their company IPOs or is acquired. Before diving into the specifics of how those loans are typically structured, it's helpful to detail how these instruments work generally.

Asset backed loans are built around collateral - the assets that can be seized if the loan isn't paid back. When a loan or one of the interest payments isn't paid on time, we say that the loan is in default. What constitutes default for any given loan is dependent on the terms in the loan agreement. Once in default, the lender can seize collateral.

Some loans also allow for personal recourse where the lender can seize other borrower assets to compensate for any loan losses. Non-recourse loans are inherently riskier for the lender - and less risky for the borrower - because there are fewer options to limit losses if the borrower doesn't pay.

Lenders typically manage that risk in three ways - being deliberate about the collateral, limiting the loan-to-value ratio, adjusting the interest rate, and charging fees. The keys to collateral are both its stated value and the ability of the lender to rapidly sell it for cash if needed. If the value of the collateral fluctuates a lot or it's hard to sell quickly, the lender will need to be more conservative with the loan.

Loan-to-value (LTV) is how big the loan is relative to the value of the collateral. An LTV limit of 30% is not uncommon for startup equity loans. That means that if the equity is worth $100, the lender will lend up to $30.

An interest rate is usually expressed as an annual percentage rate (APR), the yearly rate charged for a loan. A lender will charge a higher APR to offset risk. 

Fees generally come in three flavors - originating, servicing, and exit. As their names imply, originating fees are charged when you open the loan, servicing fees are charged over the life of the loan, and exit fees are charged when the loan is closed. Different loans may have a different mix of fees and some - like servicing costs - may be bundled into the interest rate and essentially invisible to the borrower.

Asset backed loans for startup equity are unusually risky loans for a lender. They're relatively new instruments so the few specialist lenders that offer them have generally issued loans with very conservative terms. For a borrower, that has meant these loans are more expensive than you might expect if you're already familiar with more mature markets like mortgages or auto loans.

Prism is changing that with loans that are a better fit for startup employees. 

Asset backed loans for startup equity tend to be consistent in how they're structured, but there can be exceptions. Most are collateralized by the startup equity, and the loan repayment can be triggered early by a liquidity event (e.g. IPO, SPAC, acquisition) for the startup. When a liquidity event for the company takes place, the borrower pays back the loan in full, using proceeds from the liquidity event.

For employees, this means you can borrow cash today that you don't repay until there's a liquidity event for your company.

Relative to more mature markets like mortgages, loans for startup equity tend to be at low LTVs, higher interest rates, and only made against equity from startups that the lenders think have a high likelihood of completing a successful liquidity event in the next five years or so. It's a balancing act for any lender - they want to extend more loans, but they need to manage risk carefully.

It depends (of course). An asset backed loan can be a wonderfully powerful tool, but it comes with risks. 

Asset backed loans are among the very few ways that startup employees can use their startup equity to get cash pre-IPO and keep ownership of their equity. That means they continue to share in the upside as the company grows and becomes more valuable. It can be a powerful tool to help employees exercise options earlier than they may have otherwise and materially reduce how much they pay in taxes. You can learn more about how much it can help here (hint: a lot).

Ultimately, there's no free lunch. The loan is a bet by the borrower that the future share price, when the liquidity event happens, will be large enough to allow them to sell some shares to pay back the loan. There is always a possibility that the share price will be depressed at exactly the wrong time and the borrower will be forced to sell more than they had intended, possibly all of the shares they own.

The borrower’s bet cuts both ways - if the company goes bankrupt before the liquidity event, then the borrower may be off the hook, depending on the structure of their loan.

It's up to you to determine if that's a reasonable risk. You have to weigh it against your need for cash and the other ways you may potentially get access to cash , all of which come with their own tradeoffs.

If you decide that an asset backed loan is a good fit for you, Prism is here to help. 

Asset Backed Loans

VCs invest in startups with the aim to make outsized returns on a few investments. Learn how the Venture Capital business model creates high expectations for your startup.

Startups are a special type of new company. They're different because of how they're funded and the growth expectations that come along with that funding.

There are three ways for a new company to fund itself - revenue, debt, and equity. Many will pursue a combination of all three over time.

Revenue funded means that your customers buy goods or services from the company and there's enough money left over after expenses that the business owners can reinvest it back into the business. For a founder, the biggest advantage is that they own 100% of the company. The challenge is that growth is usually slower - there may not be enough money available to grow faster. Mailchimp was famously revenue funded from its 2001 founding through its $12 billion sale to Intuit.

Debt funded means that the company borrows money from lenders to accelerate growth today and will pay back that money over time. Lenders traditionally only lent against hard assets like buildings and machinery, which hindered early-stage companies' ability to access debt financing. In recent years, many new forms of debt and debt-like funding have emerged. Pipe, for instance, facilitates financing against recurring software revenue. It helps startups get cash today for customer payments that may not happen for many months.

Equity funding means selling part ownership of the company. Depending on how big and mature a company is, the risks of being a part owner change. Venture capital focuses on buying equity in early-stage companies, sometimes even as early as just someone with an idea. Growth equity focuses on later-stage companies that are already well established. They're both trading cash today - which the company needs - in return for shares that they expect to be worth a lot more in the future.

With revenue and debt funding, founders retain full ownership of the company. They typically choose to grow the company at a slower pace which reduces the likelihood that the company will run out of cash.

By contrast, startups are equity funded - founders sell part ownership to venture capitalists. The new part-owners typically emphasize faster growth. It's a model that increases the probability the startup becomes really big, really quickly but it also comes with an increased likelihood that the startup runs out of cash. Startups typically grow faster than can be funded by revenue or debt alone. 

The way to avoid running out of cash is to raise more money from venture capitalists. It's this need for cash that gives rise to the Pre-Seed, Seed, Series A, Series B, and so-on dynamic - it's the repeated raising of new money from venture capitalists.

Venture capitalists are companies themselves. Specifically, they're funds with fund managers and investors.

There are many ways to structure a venture capital fund. The simplest is a single closed-end fund.

A sponsor is someone who helps the venture capital fund get off the ground. Just like how a startup sells a portion of itself to a venture capitalist, a venture capitalist can sell a portion of itself to a sponsor.

The fund managers themselves are known as general partners (GPs). They're typically the same people that run the management company. The differences between the two typically aren't relevant to the startups they invest in.

Each one of the boxes on the page is technically a separate company. When we say "venture capitalist," we typically mean the combination of the management company, general partner, and fund. Most venture capitalists have only one management company and one general partner but will launch many funds over time.

Investors - also known as limited partners - invest in the fund. The fund, at the general partner's direction, then invests in startups. Most venture capital funds are closed-end - they raise money from investors once at the launch of the fund and then return money to investors as the startups get acquired or go public.

You can learn more about acquisitions and other liquidity events here.

The goal of any venture capital fund is to return more money to the investors than they originally put in. Most funds target about a 10-year life - they anticipate returning money to investors over 10 years. The math on how venture capital generates returns helps illuminate why they emphasize rapid growth for startups.

Let's assume that an investor invests into the fund on Day 1 and whatever proceeds the fund generates from successful investments are returned to the investor after 10 years. This is a bit simpler than reality but it makes the math easier to understand.

The public stock market returns ~7% a year on average and investors can get their money back anytime they request it. Because venture capitalists lock up investor money, they have to generate an even bigger return to compensate investors. Let's assume that the venture capitalists have to provide an additional 3% annual return as compensation for a total of 10%..

A startup that grows at 7% a year for 10 years will double (2x) in value. A startup that grows at 10% a year will be 2.5x more valuable after 10 years. So at a minimum, venture capitalists need their startups to increase by 2.5x in value over 10 years.

But that doesn't account for the venture capitalist fees or the startups that fail. To get back to a minimum 2.5x return for investors, we have to add those onto the growth rates for the startups that survive.

The most common fee structure for venture capitalists is 2-and-20: an annual management fee of 2% of investor money under management and 20% of all fund proceeds from when the startups get acquired or go public.

Adding on the 2% annual fee to the required rate of return (now 12% a year) means that the startup needs to triple in value. Adding in the 20% performance fee means that the startups need to quadruple in value, a growth rate of 15% a year.

But not all the startups the fund backs will be successful, some will fail. Let's assume half of the startups fail. To compensate for the failed startups, the remaining startups need to grow by 24% a year, almost a 9x increase in value over the 10 years.

It's this math that drives why venture capitalists crave growth. To generate a rate of return for investors in excess of what's available in the stock market and compensate them for locking up their money, an average venture capitalist needs their portfolio companies to aim for at least 900% growth in just 10 years.

If the fund has a longer time horizon than 10 years - for instance, if they're funding just someone with an idea - the companies will need to grow even more. If more of the startups will likely go bankrupt, the same thing. Later stage venture capitalists do the reverse - shorter time horizons and fewer startups failing. They typically don't need startups to grow as much to generate the same returns for investors.

Learn

Startup Compensation

Liquidity Events

Early Liquidity Options

Asset Backed Loans

Startups and Venture Financing

Stock Options 101

Taxes and Options

Startup Valuation

Looking For Liquidity?
Prism Can Help.

Liquidity For Startups. Access The Ultimate Employee Benefit.

Liquidity For Startups. Access The Ultimate Employee Benefit.

Liquidity For Startups. Access The Ultimate Employee Benefit.

Liquidity For Startups. Access The Ultimate Employee Benefit.

Learn

Startup Compensation

Liquidity Events

Early Liquidity Options

Asset Backed Loans

Startups and Venture Financing

Stock Options 101

Taxes and Options

Startup Valuation

Looking For Liquidity?Prism Can Help.

Liquidity For Startups. Access The Ultimate Employee Benefit.

Liquidity For Startups. Access The Ultimate Employee Benefit.

Liquidity For Startups. Access The Ultimate Employee Benefit.

Liquidity For Startups. Access The Ultimate Employee Benefit.

Looking For Liquidity?
Prism Can Help.