Hacker News Reader

Comment by kohanz | Hacker News Reader

In this scenario, the amount of equity being offered is in lieu of market-level compensation. I know typically you want to get full market compensation + equity, but the claim is the company can't afford it at this moment (common startup situation, I'm sure).

So say that I have given a quote as a consultant for $100k worth of development. They can only afford to pay $50k. They claim their seed round gave them a valuation of $10M, so therefore they offer 50k / 10M = 0.5% in equity in addition to the $50k cash. This is why the valuation matters - it is directly determining the amount of equity in the offer.

Is that a reasonable arrangement? Should I ask for proof of valuation and, if so, how?

View on HN

That startup's stock is not liquid, and that %0.5 is subject to a large amount dilution on top of it if it ever becomes liquid. For example, it's often not worth it to work for a startup, even if you get that %0.5 equity at the $10mm valuation, since even if it gets to a $1 billion valuation, it doesn't mean you can sell it.

Dilution would then make that $50k into $500k instead of the $5 million you would expect. $500k / 4 = $125k / yr (vesting), which is the same as working at google / apple if you could sell all of your stock. But you cannot so you probably will not get that money back. So a very good case scenario for startups can lead to getting the same money as working at google.

With the current trend of 8+ years to liquidity if the company is successful, it will be a long time before you get your $50k back. Then you have to compare putting that held up $50k in to an index fund over the same 8 years.

As a result, you should probably be demanding something like %5 of the company. Dividing your missing compensation by the probability that you would actually get that missing compensation will lead to a calculation like that.

They will predictably balk at the %5 suggestion, so it's up to you to figure out if you can make more money working for someone else keeping your sales costs in consideration. If not, then go ahead and work with these people, and just treat the equity as the lottery ticket it is.

http://techcrunch.com/2011/10/13/understanding-how-dilution-...

This post is too pessimistic. If this startup gets to a $1b valuation, you will likely have some avenues towards liquidity. 10x dilution would be extreme.

Not really. If your are a current employee, you usually can sell %10 of your vested stock during secondaries, which amounts to about $20k until you reach full vesting at the $1b valuation. The secondaries come up every one or two years. If your not working there anymore, you cannot enter the secondary. Most of your stock is still illiquid, and GooFaceSoft is still the better idea.

Finding sellers outside of employer sponsored secondaries can be pretty hard and involves a lot of labor. Time better spent making money directly with new consulting clients. Usually the corporation wont be very helpful in selling your stock. ESO fund & others can be pretty picky and you have a good chance they might change their mind a few months later as you try after you have gotten all of your required documentation.

As an employee / contractor, you won't have investor level access to financials, reporting or the resources to fully understand them.

That dilution level does happen. It's happened to friends as they climbed from a $5m company to a $1b company.

Also if you get options or equity of some sort, make sure that the options do not expire until at least 20 years later. You do not want the 90 days after termination problem a lot of people have. 20 years seems long, but there are stories of people's 7 year stock options expiring because the company hasn't gone public in those 7 years!

And make sure you have easy access to these required documents, since they are often required to sell your equity when the company is private: http://www.slideshare.net/KeyvanFirouziCFACPA/equity-101-for...

Thank you. This is a clear explanation of some of the considerations I need to be aware of (but was not).

> So say that I have given a quote as a consultant for $100k worth of development. They can only afford to pay $50k. They claim their seed round gave them a valuation of $10M, so therefore they offer 50k / 10M = 0.5% in equity in addition to the $50k cash. This is why the valuation matters - it is directly determining the amount of equity in the offer.

The valuation matters, of course, but if I was in your shoes, my biggest concern wouldn't be validation of the valuation:

1. A $10 million valuation is well above the median valuation for seed stage companies[1]. What's strange here is that the startup doesn't even have a technical team, so what was the justification for the valuation?

2. Despite the fact that this company was somehow apparently able to raise at a premium valuation, it apparently didn't raise enough to pay for the development that's needed. That implies it raised too little. Whatever the reason, that's a huge red flag.

In a scenario like this, I wouldn't consider equity to be at all attractive.

[1] http://www.theventurealley.com/series-seed-the-new-series-a/

If you're just doing a short term job as opposed to sticking with this company for the long term, consider thinking about it as you investing $50k as a convertible debt note.

Have the $50k convert to equity at your option based on their next round of funding with a discount of 15%, with a cap of 2.5% equity based on a typical rule of thumb initial valuation of $2M for a company at such an early stage, and 2.5% equity by default if they fail to raise a second round or sell the company within the next 2 years.

This may be a bit on the aggressive side, but what you're really doing is giving them an investment of in-kind labor.

> If you're just doing a short term job as opposed to sticking with this company for the long term

To expand, this is also being discussed. They have made overtures to bring me on as CTO, but we both agreed it would be best to try each other out through a consulting arrangement (as I am currently an active consultant). I understand that the considerations as a long-term early employee are much different (e.g. I should expect more equity and for it to vest gradually).

So I could see me doing the consulting gig for X months and then being hired on as CTO/Engineer #1. At that point I suppose we would negotiate a new agreement. That probably complicates things, right?

I'm in a very similar situation in terms of discussing a short term consulting + possible CTO role. I don't know if we will proceed with it, but based on my plan my advice is:

First do the consulting gig, charge a proper market rate (cash, no equity) for the work and do a great job of it. Define an visible and achievable target for this, rather than starting to implement an open-ended project that you won't finish in the time.

At the end of this, if everything goes well and you like the company, negotiate terms for the full-time role. This will be the right time to do it: You will be in a strong position having demonstrated your skills up close and produced something of value to the company. You've charged a good rate for your work so if you don't agree terms you also aren't "down" financially.

During your consulting period, apply for other jobs (if that's what you want instead of your current consulting work). If you have some other good offers on the table, you will be able to walk away if their terms aren't good enough and you will have a good floor for your market value.

I would red flag on this. They may sweet talk you with optimistic scenarios, flatter you with C level job titles... but apparently you are the entire tech team right now, and they're not prepared to even pay you market rates.

Factor in the pessimistic view: if they can't afford you now, is the business growing or struggling? What if that equity is worthless, or unable to be liquidated? What happens if they decide down the track to "replace" you with someone else, will you get to keep your equity or does that evaporate? Do you really see this company as your life's work, or would you be happier consulting for different companies at increasingly higher rates and doing your own thing instead?

I really hope I'm being overly pessimistic, I just feel I've heard this story before.

In my experience in startup culture, CTOs are in high demand. A lot of "entrepreneurs" just don't appreciate this aspect of the supply/demand in finding technical people to work with.

IMO, if you haven't already, spend an unpaid day or two fleshing out the overall business from a technical perspective. Most likely, the leader will have some invalid assumptions. How does the leader react to these assumptions? Are you able to steer each other in a better direction?

If you are going to do a short-term consultant role before becoming CTO; it's primarily to protect each other. If things fall apart, you walk away with cash, and it avoids equity problems for the company. (Lots of different people having tiny amounts of equity can complicate things.)

Therefore, you should only get equity once you all agree that you're CTO. When you're a consultant, you should get cash. Specifically, you should agree on what your rate should be, and then what you're "I like you guys" discount is. You could even put in some kind of clause like "Your discount is good until [date]" to protect yourself in case they decide that they like your labor, but want someone else as CTO.

Ask them to loan the 50k from a bank instead of from you.

If they seed round give them a valuation of 10M, it means they must have got at least something like 1M for 10% or 500k for 5%, so it seems weird they can't find the money to pay you.

Even if 10M valuation is confirmed, you should get more equity to compensate for the risk. Usually, startups without tech co-founder tends to fail so your might want to take account of that when you are accepting equity. If the startup fails, the equity is worthless.

> They can only afford to pay $50k. They claim their seed round gave them a valuation of $10M, so therefore they offer 50k / 10M = 0.5%

Certainly not for such a low % and at a seed round and at such a low salary to market.

Also, since you would be certainly investing in the company, you should ask for preferred equity that vests each month (as your paycheck would be paid)

It's not really reasonable, because what one investor or syndicate thought the company was worth at one moment in time is neither what the company is worth now nor what anyone else thinks it's worth. And it's certainly not what it will be worth if and when you are able or forced to liquidate your shares.

If you're trying to assess the value of the equity you're being offered, the last round's terms are perhaps worth knowing, but they're not the result you want. What you need to figure out is not what someone else thought the equity + terms was worth to them, but what the equity + terms you are being offered is worth to you.

This applies to all situations in which you're being offered anything other than cash, whether it's a contract gig with a startup or a dude on Craigslist offering to trade you a stereo system for your laptop.

Accept that the valuation isn't particularly relevant at this phase, and negotiate on terms you care about: a contractual term of employment, 9/80 work schedule, and 20 days of paid vacation, for instance.

I agree that valuation is not real relevant, but what is a 9/80 work schedule?

A day off every other week. Typical work week is 40 hrs/week. With 9/80, you split 2 weeks of work over 9 days and take the 10th off.

Exactly - a friend of mine had that at Chevron. In addition to the obvious benefits, she also felt more productive the Fridays she was there since the other half of the office was out.

Thanks for the explain action - we call this a nine day fortnight here :)

Well I ten to look at it like this. To get true value for your 50k worth of work. True equity pay out is :

(1/Probability of Startup Success) * (50k/10M)

So if they have a 25% chance at success, then you should be getting 4*.5 = 2%. Otherwise, you are not taking the expected value, you are taking probability of success = 1. To make matters worse, assume you wont see the pay out for atleast 5 years. One in the hand is better than two in the bush, so there is a discount there as well.

Am I missing anything here?

There's more to it because "valuation" does not mean that the investors actually thought the company was worth that much post-investment. They almost certainly got other terms as well and those clauses probably constituted the bulk of the value they received, not the equity itself. Without understanding exactly how the deal was structured and what the terms were, you have no way of even guessing what the investors thought the equity was worth.

There's also the fact that the round didn't close 10 seconds ago; things have undoubtedly changed since it did. Those changes could positively and/or negatively affect the value of the equity.

Once you're past that, your approach is basically ok. It's a bit like the Drake Equation, though, in that it's several unknowns multiplied together to achieve a very precise result that has such large accumulated error bars as to be meaningless. The best you can do with this approach is try to avoid taking a worse deal than the last investors, which doesn't mean much.

Also, no one has a 25% chance of success unless they've filed an S-1. But that's just a detail.

Probability of success is already factored into the price the investors paid.

You can come up with a different factor but all you are doing is effectively negotiating a different price. Your example thinks it is a $2.5MM company instead.

Reply on news.ycombinator.com