How to Evaluate Startup Offers
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I have been through one of these scenarios and it's incredibly taxing and stressful: all that work, company selling for a boatload, and all I got was a lousy T-shirt.
https://marker.medium.com/my-company-sold-for-100-million-an...
“Start-up” is a bit of a disingenuous term when using to compare with FAANG, because one refers to a class of high performing public tech companies, and the other is a catch all for small businesses.
I know chronically broke start up folks, faang millionaires, and a group of people who seem to to know how to play the startup game and are extremely wealthy, so YMMV.
Are people getting enough info for any kind of due diligence? Do people know how to play the game or did they get lucky?
As for luck, of course there’s some risk component there, otherwise the ROI wouldn’t be higher, but it’s not a dice roll unless you let it be.
I’m biased. I was part of lackluster exits, failed startups, and dead-end startups that will forever raise more money. I learned a lot of valuable lessons the hard way on how to evaluate companies, and have since been able to pick winners when I look to change jobs. The other thing that goes unmentioned is once you “win” once, your risk tolerance might change, or your patience to wait for the exact right next opportunity may increase significantly.
I think you can ask yourself if you’d invest 500k in this company (or whatever assets you have up to that), and if you value your time more than your money, that should tell you something.
Down rounds and preferential stocks are not fun
Then one recent startup was championing transparent salaries but wouldnt share anything about the cap table which seemed odd to me.
My current company the CEO answers questions about the stock outlay but not specifics but also doesnt claim to be transparent.
I just assumed from my earliest experiences most small companies were happy to explain the cap table and walk folks through dilution events.
Cant make good decisions without full information.
A cap table is a representation of ownership. Saying a company doesn’t have one is like saying I don’t have a height.
What I meant is that the cap table was not disclosed and changed so often that nobody really knew what it was at a given moment in time.
Startups mint multi-millionaires. FAANG does it at scale day in and day out.
Startups exits sometimes make a handful of people mega-rich, but as this thread has revealed, making ordinary employees rich is quite rare. Not so rare are the people who hang out at FAANGs, collecting large amounts of equity, and riding the industry up. And yeah, the wealth in this case is typically not of the level to buy $10M homes, but $2M homes?
Once in a while you have a founder who strikes it rich, but that effect is overwhelmed by the more numerous folks just riding $GOOG, $AAPL, $FB, etc. to multi/deci-millionaire status.
This is basically legalized gambling with a house that's allowed to have a rigged table. If you want to do well, become a senior engineer at a FAANG.
The company was sold to a large tech company for like 350mil but what happened first is the VCs/founders created a new company and sold the IP from old company to new company and sold the new company for the 350mil leaving the employees with a worthless company.
So also trusting the founders and the VCs they choose are in my opinion more important then any equity grant offer
I’ll stick to RSUs.
Saying you helped exit a company seems to go over well in interviews though.
You can get RSUs in private startups which doesn’t mitigate the risks being discussed here. That said there are still benefits to having RSUs over options (i.e., 90 day exercise window).
If you join a company that just had a seed or Series A, the par value would be much higher, and if you were granted RSUs, you would need to buy the shares at whatever they’re valued at, which can be a lot if you’re buying 1% of a $10mm company (compared with a stock option which is simply the option to buy stock at a later date).
RSUs have voting rights and is usually the same stock founders have.
That’s said, an investor (or a founder for that matter) can come in at any time and rework the whole ownership structure by simply increasing the authorized share pool in a company from (let’s say) 10 million shares to 100 million shares, and then grant all of the newly created shares to other entities, thereby cutting the value of all other shares by 1/10.
A lot of it comes down to what investors force startups to do when they accept VC money, and also how ethically and morally the founders act from the perspective of employees with stock interest.
I’m a CEO and when I hire people, I’m very generous with stock options, but I tell people upfront they’re just lottery tickets. That’s really what they are.
One is that "just create a bunch of shares and only give them to the founder" is true, but has tax consequences. (In your example, you just gave ~90% of the company to the founder at valuation $XM. Whether as options or as Restricted Stock, there's going to be a tax consequence to that either at grant or during vesting). A dishonest founder might do that, but they'd have to believe it was going to work out in their favor beyond just "I already have 40%, let's increase the value of the company".
Second though is that the Founders, usually as CEO and Board Directors, have a fiduciary duty to their shareholders. Even if you have full control of the voting rights, reallocating all the equity is a violation of that fiduciary responsibility. The injured parties have to sue you for it, and that might make the company equity worthless, but just because a company is private doesn't mean "anything goes".
This is largely true at any smaller seed maturity or even Series A maturity.
As a sibling commenter mentioned, companies do have a fiduciary duty. But realistically, if the shareholders are composed of relatively unsophisticated investors/employees, you can do anything without being sued.
I obviously don’t subscribe to this kind of behavior at my own company, but being in the position it has opened my eyes the extent to which one could go if you were very greedy.
I remember a conversation when we got new ISO grants, that they might be worth $X, based on blah-blah-blah, but they’ll be worth at least $2X soon because we’re growing, so really you’re getting $2X! Which doesn’t even make sense to me if we’re going to view today’s price as a discounted future cashflow. Anyways, we’re finally trading at $X today, years and years after IPO.
Moral of the story is that the people budgeting how much to pay you will engage with incredibly wishful thinking when deciding how much to pay you if they can. “Sure, Z shares seems super generous, right? We’re a rocket ship!” But when the market decides how much a share is really worth, they can’t screw you by pretending they’re paying out more.
I’m only working for public companies from here out. And none of those 1 year grants that seem to be popping up.
I think the days of people getting rich from working for a successful startup are over.
https://steveblank.com/2019/04/10/startup-stock-options-why-...
also, anecdotal, I've seen it happen. I was at a recent startup that got bought. I was employee 15. Somehow, the ISOs got set to $0 worth but the founders made out like bandits with their preferred stock.
Always discount those options to 0, and make sure you're getting a good salary.
Is it a euphemism to give early non-founder employees a title that sounds like founder but with minimal corresponding equity?
The 1st engineers join pre-series A, get pretty low salary with the promise of making it big when the company goes public or is bought. Then more engineers come on board when the company has more resources after a few other rounds of funding and they get a salary much closer to the market.
But yes, it's not worth that much more than joining a startup later, and it'd be foolish to evaluate it differently. It's fun, but if you don't have real founder equity don't trick yourself into working longer hours than you would at a regular job.
As for preference shares, most VCs try to get that. They can be negotiated away by the company management sometimes. If they remain, they come into play in situations where the company isn't successful - where the shares are sold at a lower value than they were bought for. The preference gives the VCs to get their money out first, and leave the scraps for the others. Usually the others includes the founders who are similarly shafted - but then again they evidently didn't build the value of their company very successfully and they signed the deals.
The problem is that if a company has a lot of shares outstanding with a high liquidation preference then outcomes that look like success to employees or founders may not result in those employees making much money, and the employees generally don’t know the relationship between how much the company is sold for and how much they get paid because it is confidential to the senior executives or investors.
The National Venture Capital Association (NVCA) benchmarks[1] show that over 95% of term sheets across all funding rounds include a 1x liquidation preference.
[1]https://nvca.org/model-legal-documents/ (it's in the Enhanced Model Term Sheet v2.0)
You're right that employees with options don't get enough information to understand the value and potential value and mechanisms of their options in private companies. That's what I was driving at (poorly) in a separate comment.
3x would mean something is wrong with the company.
The second problem is that companies are never transparent about any of these things. If you ask, you get funny looks or continued evasiveness, and candidates are left with only part of the full picture anyways. From other comments here it seems that even if you run through a checklist of questions, the company’s structure could drastically change in a subsequent funding round of some such event. And if that’s the case, does knowing the current state of affairs matter at all?
Other rough heuristics:
- Down rounds tend to punish employee shares.
- Pivots that require large equity tend to be bad for employee shares.
- Large rounds relative to valuation ($700mm for a post money valuation of a billion) make a much higher future hurdle to clear - bad for employee shares.
- PE rounds tend to be worse than VCs. (VCs tend to worry more about upside, while PE firms push for downside protection)
All of these general rules have many exceptions.
Is that a scenario where the company has a pre money valuation of $700m and accepts $300m in funding? Why is that a bad thing? Sorry if this is a naive question.
> PE rounds tend to be worse than VCs. (VCs tend to worry more about upside, while PE firms push for downside protection)
Is this a binary thing or do investors exist on a spectrum? I’ve also heard another label, “growth equity”, which sounded a lot like venture capital to me.
And are those rounds necessarily worse? Is it about the PE firm selecting deals to fit their risk appetite or is it more about them inserting clauses that are harmful to common share holders (not sure what the right term is but I mean regular employees).
Scenario 1 is $300mm pre, $700mm in investment, $1bln post. If there’s are strong preference rights, you need a multi billion dollar exit for employees to get anything.
PE vs VC isn’t binary, it’s a spectrum. VC firms generally don’t care about so-so outcomes. So they give up downside protection for upside. (They give up preferences to get a higher share of the company, which reduces valuation)
On the flip side, PE firms are trying to make as return on every investment. So they’re ok with crazy high valuations as long as they get liquidity preferences. Which means in so-so exits they get most of the money.
Honestly, I think this just comes down to the moral character of the founder(s) in the company. If you have a good way of assessing that in the interview process, then maybe take it into account? Doesn't sound easy to do though.
For instance, a usual shady tactic to hire talented developers -that would otherwise be recruited by a larger company- is to claim that they are on their way to receive some substantial investment in the near future, which will improve your working conditions overnight. The CEO will then discuss your future salary by giving you some figures.
Beware that usually these claims are complete bollocks, and the company is not even close to entering a seed round. Startups are fun and a great learning opportunity, but make sure their promises are actually binding.
Two months later they cut more than half the staff and becoming an IP bundle looking for a buyer.
What I’ve found in my own analysis and with friends looking to join a new place is we tend to undervalue the established, current company and overvalue the startup. It’s difficult to calculate the odds of success at a startup and everyone has a different current arrangement with their existing company but in many cases I’ve calculated that the startup would have to be valued at many billions 7 or 8 years down the road to break even in total compensation. Especially so if your current role is at a post-IPO success story (that will add a lot of value over the next 8 years) where the RSU’s are fully charged, have great benefits (yay for matching 401k’s!) and a very good salary.
It not getting there means fairly bad returns so you really need to be going for the “right reasons”. Seeing startup gold is not it.
Of course the other side of it is the startup is a huge success in 8 years and your cumulative ISO’s are worth a fortune. And that dream is so alluring to people. And so unlikely.
Indeed yay for matching 401(k)s, but that benefit is only a high-four figure sum per year for most people. In the scheme of SWE comp, that’s about a needle’s width on the gauge.
So you add that to the formula plus assumed salary differences in that time and whatever income you’ll receive from RSU’s and the increase in the current company’s market cap over the time. You may even consider what your current salary allows you to invest after taxes and how that will compound and if the startups lower salary will still allow that or if you’d have to pause that.
So add that all up and that is what you’re discounting. In essence the ISO’s from the startup need to at least equal that after 8 years (or however many you are assuming until exit. 8 is average) to break even. It’s possibly in the many millions for some people.
It’s a hard calculation with a lot of variables and assumptions. But it’s helpful to see how much of a risk you may really be taking.
I’d say I’ve seen a trend towards better compensation at A and especially B startups in recent years VS the more traditional large equity grants to early rank and file. Maybe VC money has just gotten so easy and early deals so big that there’s the money for it?
An offer from an established company has a fairly clear value - a chunk of cash and some relatively-well understood stock. A startup offer amounts to a chunk of cash and a box of lottery tickets. Given the wide variety of possible outcomes, it’s essentially impossible to assign any value to them - so they might as well not exist for the purposes of evaluation.
I tend to think of this kind of choice as one that you’d make based on the company and work environment, rather than the compensation - so long as the startup can pay enough cash to maintain a standard of living you want. Then it’s a case of deciding if the work environment, team, product, mission etc. are something in which you’re interested enough to give up the stability and income from an established company. If it does work out and you get rewarded through an exit, then that’s great! But if you’re going in to it with the expectation of becoming wealthy, you’re almost certainly going to be disappointed.
YMMV of course, I’m personally quite risk-averse!
I feel a little dumb for not digging harder but the offer was already a big improvement.
That doesn’t mean you shouldn’t due your due diligence and get all the info you can before joining a startup. IMHO the most important thing is the character and financial savvy of the founders, because it’s one thing to fail but it’s another thing to essentially succeed but then get screwed because of investor shenanigans. The founders are your only hope against this scenario.
For a small startup, I recommend asking the CEO tough questions about the viability of the business and planned exit strategy. If they get upset about it, walk away. If they don't get upset, that's good. At that point, ask them to get you in contact with an early investor to ask them questions. If they aren't willing to do that, then walk away. Once you do have an offer, do an analysis. Unless you think they are giving you an abundance, then do a round of negotiation. Negotiating can only help you. Keep it fair and reasonable, though. If it's your first job and you have no experience, for example, don't expect them to budge much if at all.
Obviously there are other stories that see employees become fantastically wealthy, but that’s a rare exception not the norm. Equity comp at a publicly traded company (via RSUs) is very different than equity comp in a privately held venture. With RSUs you’re still at the mercy of the market but you know how much they’re worth literally second by second.
At a startup as an employee you should generally assume those shares are worth nothing and be OK making what you’ll be making then. Anything above that is a nice windfall bonus.
That means you could have executed those options 5 years ago (to prevent a windfall tax), and just get you money back at acquisition time. Zero interest five year loan. Thanks!
Instead of responding “not interested”. I’m just gonna start saying “show me the cap table”. Love this idea
Agreed that liquidation preference would be helpful, too, but if at the time you're signing on you think the liquidation preference will come into play you shouldn't join them.
This is something that I have been thinking about lately and I am just not well versed enough to know what inputs I need to build this.
I would like to be able to have a some sort of data driven risk assessment.
I would love some input here and would like model this and track when it's time to say goodbye.
Maybe they had “some” idea? I guess time will tell and hope this sentence does not simply serve to cast one’s own fears about having made the wrong choice.
Left FAANG knowing that money would be better there. My new opportunity is (so far) a lot more fun, a I'm learning a lot more about the things I want to learn.
I’m right in the middle of assessing opportunities so what you wrote is very timely and helpful. Thanks for taking the time to put this out in the world.
World A: And they were wrong! I was able to turn those $100k into $5M.
World B: And they were wrong! I may have lost all my savings but I still would have gotten a massive ROI if I had played my hand better.
Do 5% of startups actually reach 1B valuation in 4 years? No. Uber took 10 years to IPO. I don't know the average, but I would imagine based on a cursory search that it's closer to 7 or 8 years for highly valued companies in the past decade. And 5% seems extremely high for billion dollar IPOs.
Also, only 2 startups are compared in the NPV calculation. What about joining a BigCo / FAANG? That would really put it into context.
On the other hand, the math gets slightly better if you assume you leave after some amount of vesting. I thought danluu had a post about this, but can't find it. Staying in a startup until the bitter end is almost never the optimal choice, especially if you have inside knowledge of its progress.
https://tldroptions.io/ - This was posted a few years back, and while it doesn't give tell you the likelihood of a particular size of exit, it does help give an idea of the type of dilution and final equity value (with no discounting though).
> could be more helpful if it included more realistic numbers.
Any ideas on where to find these? While there's a lot of info out there on valuations most datasets have the problem of hindsight bias, especially missing data at the pre-A round.
> only 2 startups are compared in the NPV calculation. What about joining a BigCo / FAANG?
My original model was actually a FAANG vs two startup model (I left Apple) but it gets too complex to try to explain it in a post that's aimed at the stock options 101 crowd.
> the math gets slightly better if you assume you leave after some amount of vesting.
100%, although that's tough to model without just adding an arbitrary cutoff.
Thanks, I did not know about this tool!
I've only been part of one startup, and it went nowhere, but it's very common (ubiquitous?) for prospective employees to be sold the "if we IPO for $1xB" line when that likelihood is laughably small; hence my suggestion to lower the expectations with some lower numbers.
But props for getting this all down!
Treat stock options in an early stage startup as if they are worthless. Don't make salary/equity tradeoffs and instead, negotiate for both the "high salary" and "high equity".
Stock options have a number of "gotchas" that may not be immediately obvious:
1. Exercise price and exercise window. It takes a lot longer for a startup to exit than than most people would like to think (if it exits at all). 10+ years is my experience. You're probably not going to stay with the company that long, so when you leave the company and want to keep your shares, you only have so much time to exercise them (this is the exercise window - typically 3 months). It could cost you many $thousands to exercise and there is no guarantee your stock will be worth anything. You are essentially now an investor in the company and you are afforded none of the protections that the company's venture investors received.
2. Liquidation preference. In a liquidity event, the company's venture investors get paid back some multiple of their original investment (typically 1-2x) before any common shareholders get paid (which includes options holders). If the company is not valued above a certain threshold at liquidity, then common shareholders get nothing. As the company takes on new investors, this liquidation preference starts to add up, and as an employee you are not going to be told what this amounts to. You could exercise your shares, pay the company money, have the company exit for an apparently attractive amount, and then get nothing because the liquidation preference threshold wasn't met. The company exits, and you lose money.
3. Tax treatment. Assuming the company exits while you are still an employee (i.e. you have not exercised your shares) or the company has an attractive exercise window (10 years is not uncommon nowadays), and the valuation is high enough not to trigger liquidation preference, then you will make some money. Unfortunately, the amount you earn will get taxed as income, not capital gains, and the difference is significant. To be taxed as capital gains, you have to exercise your options and hold on to the shares for at least a year before selling them. Some companies offer early exercise benefits, but if you do this then you could potentially lose money as I described above.
RSU's on the other hand (essentially just plain stock like founders get) do not have to be exercised and are taxed as income on their value the moment they are vested (or on the value of the entire grant on the data of issue, assuming you file an 83(b) election with the IRS). These have value, and I would be comfortable with a salary/equity tradeoff for them. This is something you should ask about during negotiation. If RSUs are off the table, then you can try asking the company to pay the [early] exercise price for you as a signing bonus.
This is excellent advice, especially given the risk you described in (2).
And when it comes to the idea of working at a startup that might be able to actually fix some of those said problems, instead of just taking money from big tech and chilling.…the comments flood in with negativity here as well.
Gotta give the community credit, because the one thing they are is consistent.
I joined a small but rapidly growing team at Amazon and it feels very different from my previous corporate job. I’m wearing many hats, learning lots of different technologies, and in many cases driving initiatives in a way I didn’t expect.
I was expecting a lot more red tape, meetings, silos and bureaucracy and thankfully that has not yet been the case.
Even still, I’m not suggesting that the feeling of accomplishment would compare to building your own company. This article was informative to me should I ever go that route.
I'm planning to write a more advanced version of this article in a few months, discussing tax implications, the "should I exercise my options" question, etc.
Other than that, very good post.
It is not impossible outside the "luck factor", but in this point in time things are refined and well executed and this "get lucky" is usually propagandist in his nature.
I am on different spectrum. I live in 'qualified personal' territory. Everything that I fight for is measured in Hourly Wage. Nothing more, nothing less.
In reality we all are "just a cogs" in a somebody "value extraction" plan. And as such we must demand fair wages and clear career paths.
P.S. Downvotes don't remove the reality of my statement.