Correctly value your startup job offer

Converting from options to cash at current valuation seems like it should work but it actually doesn't. That's because options are precisely what they say they are: options. Basic finance states that an option on a purchase is more valuable than the purchase itself and the value of the option is dependent on the volatility of the underlying asset.

Let's use a simple example to illustrate the point:

Assume you have a market worth of $100K per year and you're offered a job at a $5M valuation startup for $50K per year + 2% vesting over 4 years.

Using the naive math, 0.5% of $5M = $25K so your total compensation is $75K which does not make this a financially preferable deal.

However, let's say you estimate the startup to have a 90% probability of being worth $0 in 1 year and a 10% probability of being worth $50M in 1 year.

We can draw out 3 scenarios:

  You don't work for the startup: You earn $400K in 4 years
  You work for the startup and it fails: You earn 50K + 0.5% equity in your first year, then $100K the next 3 years at another job, for a total of $350K + 0.5% of nothing.
  You work for the startup and it succeeds: You earn 200K of salary + 2% of $50M = $1.2M.

Your total expected value is 90% * $350K + 10% * $1.2M which is $435K or $108,750 a year, aka: slightly financially preferable.

Using option pricing instead of valuation pricing makes this deal seem 45% more valuable.

Note: I've deliberately ignored issues like dilution, preferences, non-linear utility of money and a bunch of other things in order to simplify the example. These also need to be taken into account if you're debating an actual offer.

The math is missing another important point:

"Given that your stock options are valued at the current company valuation"

That's a bad assumption for an employee. The current valuation is for what investors get per share. Keep in mind they have preferred, not common stock, which generally comes with liquidation preferences. Their shares are worth quite a bit more each than yours. This means if you're getting $50k of the company at current valuation, you really should assume you're getting more like $10 or $20k.

When I made the leap from BigCo (ClearChannel) to startup, I got a 37% raise, better hours, more freedom, and the chance to learn more exciting things. True, the stock options may not amount to much, but I will consider them a gift if they do. The benefits are not the greatest...no 401k, only 2 weeks vacation, free basic health coverage, but isn't much worse than ClearChannel (aside from the 401k).

tl;dr ~ Don't work at a startup for the money. Most of you knew that.

great post, but the math at the end is illogical. when you join a startup, the mean/average/net/etc all don't matter, as you aren't joining "all startups". so realistically, the 0.5% of $100M exit is worth $500K, period (though yes, divided up over four years).

THEN, you adjust the above based on your own odds of the company winning. if you think you have an 80% shot, then you are playing for $400K. if you think its a 20% shot, its $100K. etc.

FURTHER, you really should go back into the space and look at what the exits there are like. does that industry see a lot of quick $20-$40M flips? does it see infrequent, but not impossible $500M exits? or is it mostly just acquihires?

having worked at/joined/founded 4 startups (plus a half-dozen side projects), i can say they are all different, and each exits radically differently...

In the very first paragraph, the author derides people for not making these types of decisions from a mathematical standpoint. He then goes on to say that 15% of $125,000 is $25,000.

The article points out that you "should know what you are worth". That seems like a great idea, but how?