How Equity Works
In the past week, the Windsurf deal has put employee equity in a spotlight. Judging from the public discourse, it seems that the majority of employees and public don’t really understand how equity works.
Since my Twitter poll overwhelmingly thought it would be beneficial to do a write-up here it is.
This write-up is from a silicon valley / technology sector centric view.
Forms of equity
Generally there are three types of equity:
Restricted Stock Units (RSU). Generally speaking, this is effectively granting common stock to employees but with a vesting schedule attached (meaning you must be employed to earn).
Stock Options. Gives employees/executives the right to purchase numbers of shares at a specific price thats fixed at the point of grant.
Performance Stock Units (PSU). Generally reserved only to senior management where the vesting is a combination of several performance factors such as stock price, revenue/margin/growth targets vs. just the passage of time.
Bonus: Employee Stock Purchase Plan (ESPP). This is not an equity compensation per se but rather offered as an employee benefit which allows employees to set aside a portion of their paycheck (usually <10%) to purchase employer stock at a discount which typically ranges between 5% to 15% to the market price on the day the purchases are made. Employees will defer their paycheck amounts (it is not tax advantaged) then the employers will purchase the stock once or twice a year in an account for the employees.
Evolution of Equity Compensation Overtime
Overtime, the majority of publicly traded companies and growth stage private companies have migrated the equity program away from stock options to RSUs. Here is an example from Salesforce comparing equity grants in 2005 vs. 2025. Options today are largely reserved for C-level management and RSUs are the primary mechanism for equity compensation. While options can offer significantly more upside as stock price increases overtime they also have higher risk for employees when the stock price < strike price, RSUs offer a predictable stream of income for employees that they can count on each year that is generally more applicable to the larger employee base.
Mechanics
Company plans are governed by a plan document. For publicly traded companies, these plans are filed with the SEC. There is usually one umbrella plan and the board will authorize additional grants when the ceilings are hit. These plans govern the terms, conditions, vesting, acceleration, etc. For example, here is GitLab’s equity plan document. Plan documents are generally written in a way that provides management with some level of flexibility in vesting terms for individuals but largely governs the rights and forfeitures under the plan.
For the majority of employees today, RSUs will be the primarily equity participation mechanics. In the GitLab example, employee RSUs will vest 25% in the first year anniversary, the monthly for the next 3 years. An employee is taxed at ordinary income at the point of vesting. He/she may choose to hold that stock but run the risk of the stock decreasing in value but having paid the taxes at the higher value.
Typically there are two vesting models
Even vesting anywhere from 3-5 years and the first year vesting generally requires a full year of service (called a “cliff”). Then either annual vesting or monthly vesting thereafter. This is the vast majority of companies.
Back-end loaded vesting. Certain employers will have a gradient vesting over time. This could be 10% vesting in the first year, 15% vesting in the second year, 25% vesting in the third year then the rest in the fourth year. This is obviously a much more employer friendly vesting schedule but in a competitive hiring environment, the companies may need to supplement the income gaps in the first few years with “cash vesting” to bridge competitive offers. Amazon and Alibaba historically employ this approach but it is much less common.
General Employee Protections
Generally speaking, RANK AND FILE EMPLOYEES HAVE NO PROTECTION. I am always surprised when rank and files are surprised when they find out that when they are laid off or terminated, all of their unvested equity goes away. Going back to the GitLab example: “6.3. Termination of Service. Except as may be set forth in the Participant’s Award Agreement, vesting ceases on such date Participant’s Service terminates (unless determined otherwise by the Committee).”
Unfortunately that is the risk that a tech worker takes when switching to a new company. What usually happens is lets say an employee worked at Google and has 3 years left of vesting thats worth $200K, he/she would negotiate a new package so that he/she is made whole when that Google award is forfeited. However, 6 months in, he/she gets laid off, guess what you’re shit out of luck. The only equity protection that many employers will provide employees is to allow some level of vesting in the event of death or disability (typically they would get to vest the next year’s equity awards but not the entire unvested balance).
The only protection typically afford to broad base employees is some level of cash severance tied to your salary based on years of service. The baseline is set by statutory requirements and certain employers may offer enhanced severance as a benefit.
Executive Protection
Executives, on the other hand, are afforded significantly more protection. For a public company, these are generally disclosed in a proxy statement (filing is called a DEF 14A). The GitLab proxy is here.
There are generally 2 levels of protection for senior executives: (1) What happens if you got terminated in the ordinary course of business without a Change of Control (CoC) and (2) What happens if you got terminated after a Change of Control.
Commonly, what usually happens is an executive will get a year of their salary in severance + either their pro-rata bonus or 100% of on-target bonus + a year of health benefits without a CoC. With a CoC, it is common to expect that the executives equity will fully vest upon termination or resignation for Good Reason. Good Reason basically means a set of actions or circumstances a buyer took to make it hard to the executive to continue with the job. This typically includes: (1) Moving him/her certain distance away from where he worked before, (2) Significant diminution of duties (i.e. the CEO is now a janitor), (3) material decrease in pay. If you are curious, Good Reason definition is usually either in the proxy statement or in the offer letter for the executive filed with the SEC.
Single Trigger vs. Double Trigger
The “trigger” refers to what triggers an executive’s equity acceleration. Single trigger simply means that the CoC transaction itself would cause the equity to accelerate. Double trigger means that both a CoC needs to happen AND the executive is terminated without cause or resigned for Good Reason.
In silicon valley, both public and private, single trigger has become less and less common. It is generally considered bad hygiene to provide single trigger protection.
Why?
Think about it from the buyer’s perspective. If a buyer wants to retain an executive that has, say, $20M of unvested equity with 3 years of vesting left. In a single trigger scenario, that executive will have a wind-fall as soon as the deal closes and in order for the buyer to induce him/her to keep working, they would have to pay up more. In a double trigger scenario, that executive has to work 3 more years to earn the $20M or forfeit the remaining when he/she quits. On the flip side, if the buyer decides to terminate the executive, he/she is protected by his acceleration provision. This is much more balanced and fair.
Customary
In the valley tech world:
Customary
Lack of broad based employee equity acceleration
Double trigger executive acceleration
Enhanced severance for executives
Time-based RSU vesting for broad based employees
Mix of RSU/options/PSUs to incentivize senior executives
ESPP programs for all employees
Not Customary
Single trigger acceleration
Back-end loaded vesting for employees
Option program for rank and file employees in more mature companies
Of course what’s customary varies by industry and region. Tech/biotech are generally the industries where equity is used as the primary compensation model. But if you look at older industries or other geographies, these can differ dramatically. For example, Australia’s public markets grew from mining/natural resource roots where equity award to everyone is simply not common. In the tech industry in Australia, because the equity granted to rank and file employees is low, many companies will offer single trigger acceleration in connection with a CoC broadly.
Hope this helps!