Startup equity is the most misunderstood form of compensation in tech. Founders and employees routinely overvalue equity because they don't model dilution, preferences, or probability of outcome.
How Dilution Works
Every time a startup raises money, existing shareholders get diluted. The mechanics:
Pre-money = company valuation before the investment Post-money = Pre-money + investment
Example:
- You own 10% of a company valued at $5M pre-money
- Company raises $2M at $5M pre-money ($7M post-money)
- New investor gets: $2M ÷ $7M = 28.6% of the company
- Your ownership: 10% × (1 - 28.6%) = 7.14%
Raising $2M diluted you from 10% to 7.14% — but your shares are worth more (company now worth $7M vs $5M):
- Before: 10% × $5M = $500,000 paper value
- After: 7.14% × $7M = $500,000 paper value (same)
Dilution doesn't hurt if valuation increases proportionally. It hurts if it doesn't.
The Cumulative Dilution Stack
Most startups raise 4-6 rounds before exit. Cumulative dilution from typical rounds:
| Round | Dilution | Founder ownership (started at 90%) |
|---|---|---|
| Pre-seed | -20% | 72% |
| Seed | -25% | 54% |
| Series A | -25% | 40.5% |
| Series B | -20% | 32.4% |
| Series C | -15% | 27.5% |
| Option pool expansion (cumulative) | -15% | 23.4% |
A founder who starts with 90% ownership typically exits at 20-30% after a full venture path.
Vesting: What It Means in Practice
Standard vesting: 4-year vesting with 1-year cliff
- 1-year cliff: No shares vest until 12 months
- After 12 months: 25% vests immediately
- Remaining 75% vests monthly over next 36 months
If you leave at month 11: $0 equity (haven't hit the cliff) If you leave at month 13: 25% + 2 months = 27.1% of your grant
Acceleration:
- Single trigger: All equity vests upon acquisition (uncommon for employees, sometimes for executives)
- Double trigger: Requires BOTH acquisition AND termination/role change
For employees, double-trigger is standard. Single-trigger is primarily a founder/executive negotiation point.
Liquidation Preferences: The Exit Math That Surprises People
Most VC investment includes liquidation preferences — investors get paid before common shareholders (employees/founders) in an exit.
1x non-participating preferred (most common): Investors choose the better of: (1) get their money back, or (2) convert to common and participate pro-rata.
Example: Company exits for $20M. Investors put in $15M total (1x non-participating).
- Option 1: Investors take $15M → employees/founders split remaining $5M
- Option 2: Investors convert and share proportionally
If investors own 60%, they'd get $12M by converting (60% × $20M) vs. $15M by taking preference. They choose $15M. Employees split $5M.
2x participating preferred (aggressive, becoming less common): Investors take 2× their money first, then participate in remaining proceeds.
Example: $20M exit, $10M invested at 2x participating, investors own 40%:
- Preference: $20M (first)
- Participation: 40% × remaining $0M = $0
- Employees get: $0
This is why startup equity requires understanding the preference stack, not just the ownership percentage.
Employee Equity: What's Realistic
Stock option grants at different stages:
| Role | Seed grant | Series A grant | Series B grant |
|---|---|---|---|
| VP Engineering | 0.5-1.0% | 0.3-0.6% | 0.1-0.3% |
| Senior Engineer | 0.1-0.3% | 0.05-0.2% | 0.02-0.1% |
| Mid Engineer | 0.05-0.15% | 0.02-0.1% | 0.01-0.05% |
| Director (non-eng) | 0.1-0.3% | 0.05-0.2% | 0.02-0.1% |
| Product Manager | 0.05-0.2% | 0.03-0.1% | 0.01-0.05% |
The expected value calculation:
Senior engineer, Series A company:
- Grant: 0.1% of company
- Company current valuation: $15M
- Expected exit multiple: 5x (50% probability) or 0 (50%)
- Expected value: (0.1% × $75M × 50%) + (0 × 50%) = $37,500
That's before dilution (apply 30-40% dilution factor) and before preferences (apply 20-50% haircut) and taxes (apply 25-35%).
Realistic net: $37,500 × 0.65 × 0.7 × 0.7 = $11,989
For senior engineers evaluating startup equity, this math suggests treating equity as a lottery ticket on top of fair market salary — not as compensation worth taking a salary cut for.
Use the Startup Equity Calculator to model your specific equity grant under different exit scenarios and dilution assumptions.