The worst thing that can happen at an early company is that it sort of works.
I like the deal where I roll the dice and don't have to work again if I win. I'm fine with the deal where I take a barely-passable salary and do something wacky for a year.
The worst deal I can imagine is that the startup slowly grinds its way to profitability over 3 years, can't raise, and grows 15% / year.
Every company I've seen do that never fixes the salary issue. Everybody's still making their seed-stage base, or maybe +25%, which is still a 30% pay cut from the last job they had. Their equity is worth nothing. There's no career advancement, because there's 2 staff jobs and 3 EM jobs and 1 VP job.
There's lots of ink spilled about how founders expect early employees to work hard, perhaps too hard for what they're paid. It goes the other direction, too: early employees should expect founders to succeed, because there's always another startup to join.
> grinds its way to profitability over 3 years, can't raise, and grows 15% / year.
You've been a part of some successful ventures! I've worked at places that grind their way to an uneventful shutdown over 3 years, can't raise, can't hire, can't scrape together a GTM plan, can't land on an MVP, and grow 0% / year.
Yes, it’s a big problem I’ve seen in my circles: early employees are expected to work like "we’re all in this together!" - but you're really not. You aren’t an owner, you aren’t a founder. If and when money does come in to play, human nature is terrific about justifying selfish behavior. "Oh well it was was my idea." Or "Gee, I didn't take a salary.." (says the trust fund kid). Dilutable shares, etc.
Calculations like this article neglect the far more common case where the liquidity event, if it ever happens, is years in the future, much longer than average employment times.
Companies used to go from garage to IPO rapidly. Now a decade from founding to IPO is not uncommon. Unless the employee plans on committing their life to the startup that just hired them, they will most likely move on somewhere else before that decade-later liquidity event happens.
When they leave, they have to spend after-tax $ to buy non-liquid shares of a still-high-volitility pre-IPO company, because almost all options have a 90 day exercise clause. If they were early enough that their shares are 409a valued at pre-seed valuation, that might make sense. If they are a significant employee, the kind of employee the company most wants to retain, and their shares are valued at Series B or C, that tends to be a very big check they'd need to write to their former employer to turn those options into non-liquid shares that may well end up at zero valuation, all at a time when they no longer have any ability to help the company succeed.
The original motivation for offering options was to encourage employees to stay, but what happens is the precise moment the company most wants those options to do their thing and retain the key employee is the moment when the employee starts doing the above calculation, realizing the company is years from IPO, it's still risky even if it looks promising, and the options are actually worth zero unless the employee either (a) stays at the company for a decade or (b) pays back a non-trivial fraction of their takehome pay to buy a risky illiquid asset. The employee realizes neither of those scenarios are likely to happen, so boom the moment when the company wants the options to drive retention ends up being the moment when the employee realizes the options are not just worthless, they could actually have a negative EV if exercised. Suddenly those options aren't very effective at retaining the employee.
There was a time when options had value like the OP suggests, because the timescales were shorter. Today, not so much. Yes, outliers happen, but in general they don't.
The company where I last worked went public 10 years after founding. It would've been life-changing at peak, except the price slumped in Dec '21 before end of lockup. I should've sold it on the slide down as it never recovered, but was too bought into what could've been. Still grateful for how it turned out as the job paid pretty well and the equity helped with financial independence but given the vagaries of implementation, timing, and psychology it feels like less of a motivating factor now. To think that life would be completely different having started months earlier still stings.
At the startup I'm at, we were founded 12 years ago. Still no IPO.
Last year, we had a couple rounds of layoffs, and shortly after, a few of our top people voluntarily left. The company started issuing RSUs to try to keep people since they can't afford to give the raises they deserve, but even RSUs are only marginally better than ISOs.
Unfortunately this author has no idea about how equity works in real life, 2 things that stand out from experience of being very early employee 8 times:
1. If startup raised money at some point in the past and they are at 50M valuation then there is no chance average employee will get offer of 1% (you would need to be someone special to get that)
2. There will be many more dilution rounds before they get to 1B valuation so chances are that 1% will get cut to 0.3% over that time period
You give two critiques relating to the exact numbers the author has choose (equity package at join, valuation at exit), neither of which is really related to the authors hypothesis that people misvalue EV from equity.
You can slide these numbers around however you want and the point still stands, even if you disagree with it for other reasons
you can get 1% as a founding eng at seed, and its not uncommon for a 5 at 50 seed
dilution is also dependent on the opex, founder negotiating power, and growth of the company. There are startups raising monster rounds at <5% dilution a round
If you are an employee however and your co is raising highly diluted rounds with poor growth probably best to jump ship
The value of employee equity is approximately zero, but sometimes people get lucky. Don't let these arguments fool you into thinking you're definitely in that 5%, because in the absence of information about the market, the product, and the other people you're working with you're probably in that 95% that makes nothing. By all means update your priors but arguments about expected value assume that all things are equal, and they are manifestly not equal.
It is worth about what it's worth, and that's not zero, but the difference between the median realized value and the mean realized value (upon which the price is set) is much higher than for public equities.
The above means it can be an irrational bet to take the startup equity if the price you pay in opportunity cost is high relative to your bank. This problem gets worse the longer you stay after that first vesting, but is mitigated by the extrinsic option value of your options (which goes away when you leave and exercise)
obviously vol is not the end all be all but one of your main advantages as a startup employee is access to the insider info and being able to walk away
The obvious other factors in this reframing of equity compensation effectively render it a useless take.
The disparity in expected value calculation is due to assuming you can predict the future after joining a company, which is obviously not true. If you can always tell a company is going to succeed after 1 year of working there, you should leave, as you are clearly destined to be the most successful venture capitalist in history
Not to be overly negative, I think this perspective is somewhat misleading as it lets one rationalize valuing startup equity as anything more than a gamble. Which it is, and always has been. Sometimes gambles work out though.
> If you can always tell a company is going to succeed after 1 year of working there, you should leave, as you are clearly destined to be the most successful venture capitalist in history…
Except that "after 1 year of working there" is not how VCs work.
It's the opposite, the author is saying is that you have to consider the dynamics of how you're getting the money. In his view, an opportunity to work 5 days for an assured $500 may be worth less than the opportunity to work 5 days for a 50% chance of even $900, even though $500 > $900/2. If you expect that 50% chance to be resolved by the end of day 1, you can just quit the second job, and if there's a third job that will pay you just $200 for the remaining four days (half the job 1 rate) then the EV increases to $550.
The worst thing that can happen at an early company is that it sort of works.
I like the deal where I roll the dice and don't have to work again if I win. I'm fine with the deal where I take a barely-passable salary and do something wacky for a year.
The worst deal I can imagine is that the startup slowly grinds its way to profitability over 3 years, can't raise, and grows 15% / year.
Every company I've seen do that never fixes the salary issue. Everybody's still making their seed-stage base, or maybe +25%, which is still a 30% pay cut from the last job they had. Their equity is worth nothing. There's no career advancement, because there's 2 staff jobs and 3 EM jobs and 1 VP job.
There's lots of ink spilled about how founders expect early employees to work hard, perhaps too hard for what they're paid. It goes the other direction, too: early employees should expect founders to succeed, because there's always another startup to join.
> grinds its way to profitability over 3 years, can't raise, and grows 15% / year.
You've been a part of some successful ventures! I've worked at places that grind their way to an uneventful shutdown over 3 years, can't raise, can't hire, can't scrape together a GTM plan, can't land on an MVP, and grow 0% / year.
Yes, it’s a big problem I’ve seen in my circles: early employees are expected to work like "we’re all in this together!" - but you're really not. You aren’t an owner, you aren’t a founder. If and when money does come in to play, human nature is terrific about justifying selfish behavior. "Oh well it was was my idea." Or "Gee, I didn't take a salary.." (says the trust fund kid). Dilutable shares, etc.
Calculations like this article neglect the far more common case where the liquidity event, if it ever happens, is years in the future, much longer than average employment times.
Companies used to go from garage to IPO rapidly. Now a decade from founding to IPO is not uncommon. Unless the employee plans on committing their life to the startup that just hired them, they will most likely move on somewhere else before that decade-later liquidity event happens.
When they leave, they have to spend after-tax $ to buy non-liquid shares of a still-high-volitility pre-IPO company, because almost all options have a 90 day exercise clause. If they were early enough that their shares are 409a valued at pre-seed valuation, that might make sense. If they are a significant employee, the kind of employee the company most wants to retain, and their shares are valued at Series B or C, that tends to be a very big check they'd need to write to their former employer to turn those options into non-liquid shares that may well end up at zero valuation, all at a time when they no longer have any ability to help the company succeed.
The original motivation for offering options was to encourage employees to stay, but what happens is the precise moment the company most wants those options to do their thing and retain the key employee is the moment when the employee starts doing the above calculation, realizing the company is years from IPO, it's still risky even if it looks promising, and the options are actually worth zero unless the employee either (a) stays at the company for a decade or (b) pays back a non-trivial fraction of their takehome pay to buy a risky illiquid asset. The employee realizes neither of those scenarios are likely to happen, so boom the moment when the company wants the options to drive retention ends up being the moment when the employee realizes the options are not just worthless, they could actually have a negative EV if exercised. Suddenly those options aren't very effective at retaining the employee.
There was a time when options had value like the OP suggests, because the timescales were shorter. Today, not so much. Yes, outliers happen, but in general they don't.
The company where I last worked went public 10 years after founding. It would've been life-changing at peak, except the price slumped in Dec '21 before end of lockup. I should've sold it on the slide down as it never recovered, but was too bought into what could've been. Still grateful for how it turned out as the job paid pretty well and the equity helped with financial independence but given the vagaries of implementation, timing, and psychology it feels like less of a motivating factor now. To think that life would be completely different having started months earlier still stings.
At the startup I'm at, we were founded 12 years ago. Still no IPO.
Last year, we had a couple rounds of layoffs, and shortly after, a few of our top people voluntarily left. The company started issuing RSUs to try to keep people since they can't afford to give the raises they deserve, but even RSUs are only marginally better than ISOs.
Unfortunately this author has no idea about how equity works in real life, 2 things that stand out from experience of being very early employee 8 times: 1. If startup raised money at some point in the past and they are at 50M valuation then there is no chance average employee will get offer of 1% (you would need to be someone special to get that) 2. There will be many more dilution rounds before they get to 1B valuation so chances are that 1% will get cut to 0.3% over that time period
You give two critiques relating to the exact numbers the author has choose (equity package at join, valuation at exit), neither of which is really related to the authors hypothesis that people misvalue EV from equity.
You can slide these numbers around however you want and the point still stands, even if you disagree with it for other reasons
my 2nd point says that due to dilution rounds your 5% chance is not 10M but about 3M so
5% * $3M = $150k expected equity value
$150k / 1.15 = ~$130k/year
which is same as you started with
you can get 1% as a founding eng at seed, and its not uncommon for a 5 at 50 seed
dilution is also dependent on the opex, founder negotiating power, and growth of the company. There are startups raising monster rounds at <5% dilution a round
If you are an employee however and your co is raising highly diluted rounds with poor growth probably best to jump ship
The value of employee equity is approximately zero, but sometimes people get lucky. Don't let these arguments fool you into thinking you're definitely in that 5%, because in the absence of information about the market, the product, and the other people you're working with you're probably in that 95% that makes nothing. By all means update your priors but arguments about expected value assume that all things are equal, and they are manifestly not equal.
It is worth about what it's worth, and that's not zero, but the difference between the median realized value and the mean realized value (upon which the price is set) is much higher than for public equities.
The above means it can be an irrational bet to take the startup equity if the price you pay in opportunity cost is high relative to your bank. This problem gets worse the longer you stay after that first vesting, but is mitigated by the extrinsic option value of your options (which goes away when you leave and exercise)
the article takes this into account with EV
obviously vol is not the end all be all but one of your main advantages as a startup employee is access to the insider info and being able to walk away
An option won't fire you 1 day before cliff.
The obvious other factors in this reframing of equity compensation effectively render it a useless take.
The disparity in expected value calculation is due to assuming you can predict the future after joining a company, which is obviously not true. If you can always tell a company is going to succeed after 1 year of working there, you should leave, as you are clearly destined to be the most successful venture capitalist in history
Not to be overly negative, I think this perspective is somewhat misleading as it lets one rationalize valuing startup equity as anything more than a gamble. Which it is, and always has been. Sometimes gambles work out though.
> If you can always tell a company is going to succeed after 1 year of working there, you should leave, as you are clearly destined to be the most successful venture capitalist in history…
Except that "after 1 year of working there" is not how VCs work.
Not true, there is a growing class of "operator" VCs that both fund and help run early stage companies.
Isn't this the standard case of paying a premium for risk? An assured $500 dollars is worth more than 50% chance of 1200 dollars.
It's the opposite, the author is saying is that you have to consider the dynamics of how you're getting the money. In his view, an opportunity to work 5 days for an assured $500 may be worth less than the opportunity to work 5 days for a 50% chance of even $900, even though $500 > $900/2. If you expect that 50% chance to be resolved by the end of day 1, you can just quit the second job, and if there's a third job that will pay you just $200 for the remaining four days (half the job 1 rate) then the EV increases to $550.