First employee of startup? You are probably getting screwed
blog.dinkevich.com
blog.dinkevich.com
But mess with the numbers just slightly - a $4M premoney valuation, and 2% of the company - and suddenly you're getting $100k/year in equity for a $50k/year paycut.
Now of course that equity is risky. It still might not be a good deal, unless you think you have at least a 1 in 2 chance of success.
But the point is: you can obviously get a very good deal as a first employee without taking on the risk of quitting your job with no paycheck. Make sure that it IS a good deal first though!
The first employees of all the startups I know personally have gotten very good deals.
If there's a 50% chance of a positive outcome (which, obviously, is an extraordinarily high chance), aren't you getting a ($100k50%) / ($50kyrs) risk-adjusted payout? If so, you should just take the $100k.
And, this analysis assumes the company doesn't go back to the VC market for capital; when it does (most will), you have to factor in the (strong) risk of dilution. We're also glossing over other risks, like participating preferred stock for investors.
I got a great deal from one startup, watched people get a reasonable ("worked out to the equivalent of years of good-but-not-amazing bonuses") from another, had a positive outcome from one that was still under what I would have gotten from salary, and nothing from 2 more. Equity is a decidedly mixed bag.
If you have the choice (and in this market, developers do), opt for money over equity. If you can mentally partition the "extra" money into "investment" and invest it for a return in something more liquid than startup equity, so much the better.
The fact of future dilution is irrelevant, since this impacts the investors as much as the employee.
This analysis does ignore liquidation preferences. It also ignores the fact that the options have a non-zero strike price (though probably substantially below the preferred stock with those liquidation preferences). But in the end, startup outcomes tend to be binary: very high or nearly zero. In both of those cases, liquidation preferences and strike prices wash out in the noise.
I agree though: equity is almost the definition of a mixed bag. That's why, as an employee taking substantial compensation in equity, you need to take an investor mindset in choosing where to work.
The 50% risk thing came from you: you suggested calculating based on a 1 in 2 chance of successful outcome. If you're forecasting based on a 1 in 2 chance, you divide by two, right?
Second: as an employee, what do I care whether investors take a haircut? We're computing my outcome, not some notion of fairness.
Now, since you personally are investing in the company (albiet with your labor rather than capital, but it's still an investment since you're paid in equity), you have to decide if it's worth investing in this particular startup. You do that by thinking about whether the startup is going to succeed or fail, since outcomes are pretty much binary.
I disagree, though, that startups have binary outcomes. In fact, one of the big problems in "investing" in startups (cash or labor) is the misalignment of incentives. It's common for the founding team to pursue outcomes that will enrich them but zero out common stock holders, and it's common for investors to push back on exits that would enrich everybody but not satisfy fund goals.
Don't startups fail at a rate of 90% or so? All of the sudden that $100k/yeah in equity looks not as great.
Now of course most owners think it won't fail. But then even out of those that are rational, and understand they will probably fail, a large % will still try to convince the first employee that the startup won't fail.
Trying to decide whether the startup will fail is almost the whole game. In the end that has a much larger impact than your exact equity percentage.
[1] though if you apply a simple filter like "only YC startups" it's way less than 90%
Can you elaborate?
If you're a smart founder, you will offer a very good deal to your first N employees. They are by far the most important hires you'll make. Even if you could trick someone into taking too little compensation, you'll regret it in a year when they find out they were snookered.
val (stake,salary) = f( valuation,employeenumber)
What's a reasonable f ?
If the company is strong, paying you appropriately won't make or break it. If the company really can't afford to pay you appropriately, you should be a cofounder.
You should always make sure you're getting what you're worth when entering any business relationship, and make sure that any gravy (stock options, bonuses, etc.) is exactly that. Gravy.
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2. Yes. 4-year vesting with a 1-year cliff is typical. Sometimes single- or double-trigger acceleration.
3. 60/25/15 seems really unbalanced. Is the product built and launched yet? Do you have users? If you haven't launched yet, I'd do 33/33/33 or close to it, since most of the work is ahead of you. If the other guys have raised money beyond techstars, launched, or gotten traction, then you can do a less even split. In general, just having the idea isn't worth anything on its own. The hard work is to build the product and get people to use it.
2. Yes. Standard is over four years, the first quarter of the equity cliffs at one year.
3. Most common is splitting equally. But this is really up to you. If you think the business guy is a really impressive person, worth four times what you are, then go for it. But this could be years of your life you're talking about. It's reasonable to say that you're only interested if it's an equal equity split - most of the work is still ahead of you.
Equity vesting for founders is a good idea, and very common. (If the developer quits in a month, you don't want him to own 25% of the company.) The business guy can make a case that he should have accelerated vesting, since he's been at it for longer. Cliffs are possible ("no shares for the first year"), as is accelerated vesting on change of control (basically, you get your shares faster if the company is sold; this makes it easier to leave, which is bad for the buyer, which lowers the price (s)he'll pay; so this is somewhat hard to negotiate.)
The "fair" distribution of shares depends very heavily on what everyone brings to the table; you may want to "Ask HN" with more details. (For 60%, he'd better be good.) (EDIT: also, if he just wants to be able to out-vote both of you, you can easily create a class of shares with extra voting powers.)
That said, I agree that $50k/1% is a low offer. Lots of startups (at least in the SF bay area) are offering 50-100% higher than that, and these are good startups with experienced founding teams, funding from top investors, paying customers or traffic already, etc. So definitely explore your options! There are great deals out there.
I'm not saying your statement is wrong, but am I the only one who thinks something is wrong here? Are most startups worth 5-10M right after seed? I would say no.
Conservatively, I would tend to agree with the author. 2M is high for a company that only has seed money.
And that's the average; many were higher. There are probably amazing startups out there that raise at a $2M valuation, but it's definitely at the low end of the range in the current funding climate. If you're looking to join a startup, I wouldn't fixate too much on valuations, but I do think it helps to be aware of what the current market is like.
(Note that it varies by region. Silicon Valley and NYC are probably comparable, but other regions have less investment and so have lower valuations on average.)
Try this thought experiment: Mark Zuckerberg (or whoever your favorite entrepreneur is) comes to you and says he's quitting Facebook. He's going to start a new company, and he'll let you invest at a $20M valuation. Do you accept?
We're all sat here, reading about "average seed round valuations" and the like, but that concept tells you nothing about what the next startup you meet "should" be valued at. Claiming that it does means acknowledging that business fundamentals have been thrown out of the window, and what are you left with then? Gambling.
Your argument is fully general against valuing equity in any early stage business ever at any price. It equally says that the investors are "gambling" and the founders are "gambling", as much as anything about employees.
Yes, everyone who is being paid in equity is taking a risk. It is possible to attempt to assess that risk. The key to being an early employee is bringing an investor mindset to the table: do I think this company is going to be successful or not?
Simple thought experiment to make this obvious: when a company raises convertible debt with no cap, are they infinitely valuable?
-Type of company(do you like the product, is it something you can see yourself wanting to wake up for?)
-Type of founders (like-minded, fun having, professional but not bureaucratic - comes to mind as possible wanted features)
-Equity(literal percentage wise and decision making-wise, are you going to be leading a team in a year? or still grinding away all day?)
-Perks(Gym in workplace? What about sports area? Video game room? Movie theater spot?)
-Location(Where will you get to work, a nice second story office overlooking the bay? a park?)
-etc...
These are just off the top of my head. I'm sure there's more.
Edit: Fixed my line spacing.
Point being, yes it's "just business", but if you're not setting things up to be awesome for that first hire, are they going to be sufficiently awesome do as to be worth spending so much time together? And if they're that great, how much do you wish to ensure that you guys are likely to choose to work together again?
I'm likely way over reacting, but still, it's a matter of some importance, exercising choice over who you spend time with, so why settle for less than awesome or treating them awesomely?!
That said, the experience I gained in the year helped me land better paid contracting gigs after, so... swings and roundabouts.
But then again, every other startup would have given me the same deal or worse, and the alternative would have involved me still being in college taking out student loans. I think I'll stick to my mediocre salary and nonfounder equity[1].
[1]: Since day one, the company has done quite well and my pay is no longer mediocre, and my equity would be a nice 6-7 figures bonus if the company sold today.
Quit focusing on the injustice of an employee share versus a founder or investor share. Quit comparing yourself to others, and instead focus on whether the numbers offered to you make sense for you, personally.
Not true. I talked to a bunch of my entrepreneurial friends about this when I encountered this situation again and again. Their own hirees were treated more like I'd expect - a clear advantage to taking the offer - lower pay meant higher equity although it was never as bad as this case.
Glad things worked out for you though. There are winners in the industry and it's nice to see it when it happens!
But now I just calculate my expected return based on a 10% chance of a buyout for $100M or so (cockily I'm assuming I can screen the obvious losers out with common sense alone though that is of course debatable) and if it's not a net uptick from the current gig, I pass on it. And up to now, I've always passed on it, and none of them succeeded.
Other than that, the only startups I'm interested in are ones where I have one of those nifty 3 letter titles and 5% of the company in my pocket.
Have you tried to characterize how likely it is that your filter is actually good enough that 10% of the companies that pass it are successful?
Just seems to me that 10% could be something of an overestimation and needs some validation.
Also, in many cases, the employee is getting value that the investor is not. Specifically, the employee (i.e. me) likely doesn't have a ton of start up experience and is able to leverage the work as employee #1 to then start his or her own start up later. The investor on the other hand has likely been involved with many start ups and isn't as much interested in learning or experience. They just want a return on their investment. So, from that sense, this article is sort of comparing apples to oranges.
You couldn't be more wrong. $50K saved is the same as $50K invested. They have the same impact on revenue, profitability and life expectancy of the company. Sorry to get personal, but the fact that you don't understand that is probably why you're ‘employee #1’ and not ‘co-founder’.
Another point: companies are generally disinterested if you tell them that you have eventual plans to leave. As much as both parties know it's unrealistic, hiring managers generally prefer a long-term commitment without a hint of an 'exit plan'.
> The employee [...] is able to leverage the work as employee #1 to then start his or her own start up later.
Not if they/you don't get access to the company financials, or investor meetings, or insights into the decision-making process (let alone a part in it).
Cash is king.
You should familiarize yourself with the concept of opportunity cost[1]. As an employer, every dollar I save on a developer salary is a dollar I can put towards a copying machine. As a developer, every dollar I forgo by accepting a sub-market rate is a dollar I can't spend on something else.
'Saved' and 'invested' are both changes in bank balance. One is just a lot more visible than the other.
In the real world, you can't spend a negative balance even if it is higher than an alternative negative balance.
I agree, though, that once you do have sufficient cashflow, then the two are equivalent.
But startups do not run that way. You might want to familiarize yourself with startup finances. They run on cash flow - and its all negative. When investor dollars run out, everybody goes back to working for the man.
An example might make it clear. If you compare spending $100,000 on a developer's salary vs $50,000 and stock, you might be fooled into thinking you've saved $50,000.
But there never was $100,000, at least not for salary. Its a false comparison. What you can really do is, either hire a guy for $50,000, or don't hire him.
If you hire him, you're getting another man-year of development done in the next year. But your out-of-cash-and-failing condition is brought $50,000 closer. Its a gamble - will that man-year of development get us to another milestone before the now-closer deadline of 'broke' arrives? Who can tell - you just make your best guess and close your eyes, hope you found the right guy and sign the employment papers.
If you don't hire, then you spent $50,000 less, which means you can last longer but now depend upon the founders to get All the development done. While starving, neglecting their health and generally undergoing tremendous stress. IF they can devote say half-time each (2 founders in the example given) then maybe its a wash (except for the suffering and depression part), cash-wise.
But there's also risk associated with being 1 year later to market. Things change, your partner may change, your spouse may get fed up.
So, yes, when your Markov chain of money-events include 'broke' then it makes a very big difference whether you spend money or save it. Its all in the risk, time and stress equation, and involves probabilities that can be hard to estimate.
The only thing you might not see is acquisition offers, but you can assume those are constant noise and meaningless until a certain point.
There are too many variables to consider in order to make a generalization like that. Even if you have a firm handle on the financial variables (how much you're earning, what your opportunity costs are, what the company will be worth, etc.), it doesn't at all consider the intangible value. So your friend is going to get 1/2 pay for 1%... maybe the experience alone in being able to evaluate his self-worth in the future or in being able to start up his own company will more than make up for a couple of years at 1/2 salary? Who knows. I'd be willing to bet that this blogger doesn't.
Also, people don't know how to measure opportunity cost.
There's also a lot of weight behind the "this is how it's done". 1% used to be very generous when founders had to roll the dice with 12+ months of their life to get seed funding and take big dilution when they did. Nowadays, it's cheaper/easier/faster to start a company, easier to get early stage funding, etc. It might make sense to reward employee #1 with a bit more equity... IF you can't pay them market rate (you buy equity by taking risk-- if you aren't underpaid, you aren't risking much beyond opportunity cost).
However, the biggest muff that people in this position do, is that they don't understand options and how they work, a little what this guy was saying. Take the options, why not, but treated as money and not sweat equity. You might not be able to get preferred shares and deep informations about the company, and you probably shouldn't, but you can ensure that whatever happens the money you put in vests without strings attached every 6 months until they pay you what you are worth.
(wow, this is a lot longer than I expected it to be)
1) Who are the investors?
Before I joined VA Linux in 1998, I knew they were super close to closing the Intel Capital deal, so I knew (to a certain degree of accuracy) that they were close to having money in the bank. I agreed to take less salary for equity and a promise from the CEO that salary would improve as the company got more solid funding. The CEO was good to his word, too. I might have taken the job without the vc funding, but knowing what was up there was really helpful.
There is more knowledge now about the equity picture of a private technology company today than ever before in history. It's very easy to get an idea of a companies valuations and then if you agree with those values and if you think they'll increase.
Some VCs also have a reputation for screwing early employees and pancaking out those that might leave before an exit. This is very important to know if you're going to be valuing a potential equity stake. So, your equity could disappear without any regard for your feelings on the matter.
2) How far along are they towards going public/another exit.
I joined Google the week before it went public (in 2004), meaning my initial strike was the ipo opening price. Considering that made Google more stable than competing offers from younger startups, and more fun than some of the other companies I had offers from. The former was important as I had just come out of a failed startup and some time consulting, and I wanted stable more than I wanted fun. I got both, but that's pretty rare in companies of Google's vintage (I still have it, which is one of the reasons why I stay).
The point of this is to understand what the future of a company looks like. I knew what Google looked like, and for other companies when considering/working with them, I asked myself what do similar 'exits' look like. That leads to understanding of what an equity position means.
You can look at an offer and ask yourself: Will the company actually increase in value before an exit that makes this equity worth it?
3) Is there an established bonus system?
A lot of companies have no bonus and weaker benefits/salaries pre-ipo. They have the equity stake offer and so these other considerations are sidelined until they become larger and those equity offers stop attracting good people by themselves. These differences can mean 70 to 80k less per year for a senior employee. So, know what you're worth and decide if it is worth the risk.
4) Are the people running the company any good? Are they ethical?
This is actually hard to answer, but I've seen plenty of acquisitions become less lucrative than a similar job in an established company. I won't mention the company, but I've seen large companies (not Google that I know of) end up giving less in financial terms to acquired employess than they give a new hire wrt equity participation. It's kind of sad how little people know about the companies they join.
I'll say it again: I often see companies on HN get acquired, but for many of the employees, and not a few founders , of startups, this is a much worse deal financially than taking a job with an established firm. Your mileage may vary, and take it with a grain of salt, but remember you are trading money now for the chance of much more money later.
There's so much more I'd like to tell people here about considering offers, but I've already blathered on a bit much on this. I also readily admit I have a different approach to risk as a husband and father (2004) than I did as a single developer (1998)...
Can I ask for acceleration of my options if the company gets acquired before my cliff? Can I ask for a guaranteed contract with a buyout, in case they want to let me go before my options vest?
Keep in mind, though, that founders have a lot more discretion with respect to how much they pay you than with respect to your options contracts. Garbage options contracts (no triggers, no guaranteed contract, huge cliff, etc.) are generally insisted on by VCs, in order to prevent employees (read: you) from negotiating an agreement which makes the company a less appealing acquisition target. Pay is generally more flexible.
So I'd suggest asking those questions, having an informed conversation with the company about the way options are structured, and then insisting on a good, solid salary and treating the options as gravy. By the time you get diluted, you end up in a locked up IPO gone south, or the acquirer comes up with some creative stock-and-cash acquisition with employee pool conversion that scams you, there's a very low chance of your options being worth anything anyway.
http://auscillate.com/post/238
Curious what the HN community's take on that is. The conclusion is basically the same, but I attempted to be a bit more rigorous with the numbers.
different markets different rules I guess.
If people take a step back from the situation and compare the "ground floor startup opportunity" against a full salary job, they might realize the 50% salary reduction is more complicated than the absolute dollars foregone. Startups tend to demand more overtime than established companies, and quickly, the already reduced effective hourly rate starts dwindling down into fast-food employee territory.
Sure, the startup work might be fun, but you could get the same or more money from another job and do fun things after work.
Also, be prepared to add some risk to account for the chance that the currently well-intentioned startup owners will screw you over if things get bad.
Once you factor in the failure rates of startups, standard vesting times, etc., all that money you're giving up translates into one very expensive lottery ticket.
So if you go in with your eyes open, i.e., you're willing to forego that salary difference with a possibility of a zero return, then yeah, knock yourself out, because if you do win the lottery, it's a huge pay day. If you don't win the lottery, you knew it was a gamble, so no big deal.
Before jumping into bed with a startup for a huge salary cut though, a person might do well to ask him/herself if they'd be better off at a job with full pay and using half the salary to play the stock market.
It is obvious that it is much better to get the package "2% of company shares, Priority on exit, Invest small part of his capital" for the same $50k (i.e. the programmer's guaranteed lost income) when you are paying the money directly.
Further, investing $50k directly does not even involve working full-time or part-time (except on financials related to the round), and has an equal chance of both lost money (company doesn't get on sure footing), and returns on the money, that the programmer faces.
So bottom line. If you have identified a company that you think has good chance of success, you should simply decline to work for them for equity and a lowered wage: instead, find a source of great personal wealth, and invest a small part of it directly in the company.
Working for your equity means you're getting screwed. Being very rich gives you a lot better deal.
Even if you were accredited, virtually all startups are closely held and selective about who they'll take capital from.
Private company equity vehicles are one of the least attractive asset classes you can hold; they're among the most illiquid and volatile places you can put your money. Startup investing works almost exclusively for people who can (a) afford to spread money around lots of startups and (b) have startup investments be a small part of their portfolio. That's a description that matches very few professional developers.
Your exposure to the upside of startups is going to come from starting or working at startups, not from investing in them yourself.
A good thread:
Yes, the upside potential can be huge, and you get to play with some bleeding edge technology, but you're also dealing with a lot of inexperienced owners/managers, VC's with their own agendas, overworked employees, and an unhealthy amount of greed.
Yes, there are startups that manage to avoid this, but like in any industry, good companies are the exception rather than the rule.
Private Placements and Intrastate Offerings are the two primary exemptions to Reg D, and they swallow up the rule in general practice. Reg D does not affect most companies; indeed, it is only an issue in the startup world because some lawyers have tried to make it an issue in an effort to drum up business.