First, I disagree that early employees of startups are "probably" getting screwed, but it definitely can happen, and often does to people who don't know their real value.
The part of this that resonates with me isn't the mathematics. The math isn't very relevant because there's a really large unknown: the eventual value of the company. One percent could be a lot of money, or it could be nothing. There's also the matter of dilution: is he protected against dilution from investor and employee stock grants over the next N years? I would guess not. His 1% could be 0.2% or less by the time an exit happens.
What is obvious is the emotional undercurrent to this very common anti-pattern. It sounds like he's not a real co-founder, he's "just a coder". They seem to be trying to sell him on a rotten deal because they think it's just such a privilege to work on their golden idea that they don't need to compensate properly. He's going to bust his ass to make the code work, for a salary half of his market rate, and in return he gets a tiny sliver of the company that gives him no real control, on a 4-year vesting cycle. I'm sorry, but these two guys are not (after 4 years, after he's done some real work) worth 79 times what he is just because they had the connections to raise money.
Prospective employees tend to view equity grants in a pre-employment context, when a 1% share seems extremely generous because the employee hasn't done anything yet. But that's what vesting's for! Vesting allows companies to compensate based on future contributions, with the knowledge that if the employee quits or is fired before the 4-year period is up, they won't have to pay for all 4 years of work.
At the least, if still thinks it's an "exciting" opportunity worth pursuing, he should recognize that he probably can't value the company better than the market, that we are in frothy times, and that the equity is worth more to an investor than to him (different risk profiles). So the value of 1% (post-money) of a $2.5 million company is $25,000 at most. That's $6,250 per year, far less than what he's giving up.
The first employee of a startup is not necessarily getting screwed. If that employee gets appropriate respect for his skill set, and reasonable compensation for the risks inherent in a startup, then it's a fair trade. A lot of people go into startups as early employees knowing the risks and upsides and that's fine.
What he should do if he actually wants to work on the startup: First, he needs to value his contribution to the company over the next 4 years appropriately and put a number on his "sweat equity". Let's say his market salary is $100,000 and he's being paid $50,000. Now add to his base salary: benefits (15% for health insurance, 401k matching), job-loss risk (25%, since typical severance offers are 1/4 tenure at current salary), career risk and opportunity cost (15%), and overage hours (30%, assuming a 50-55 hour work week). That's $185,000 per year. Take that, less the $50,000 he's making, and his sweat equity is $135,000 per year. Over 4 years, that's $540,000. The company's valuation is $2.5 million, "pre" to his contributions. He should be getting about 16% of the company, assuming he remains for 4 years. This number seems high, but if he's there after 4 years he will have been there almost as long as the founders, so it's about right.
First action: he needs to ask for 20% and settle for no less than 12%. If they say, "but you haven't done anything yet", he should point out that the equity grant is subject to vesting and that he won't get anything if he doesn't do any work.
Second action: he needs to demand the right to listen in on investor and client meetings. Otherwise, the other two founders will hold all the power in the organization because they, and they alone, hold that special knowledge of what investors want. If they think he's "just a coder", they'll show it by saying (in effect) that no, he's not "good enough" to be in the investor meetings.
The most likely outcome of his making these two demands is that they'll tell him to get lost. If that's the outcome, it's also the best outcome because it means the startup's a tarpit.
I don't understand why all these people are responding to this post so positively. Overage hours? Job-less risk? Career risk and opportunity cost? What? You seem to be including those numbers as his 'cost', are you assuming he's not getting benefits, or that he's going to work only 40 hours a week at this mythical 100k / year job?
Also, the advice is just wrong. No startup is giving away a 20% equity slice to their first employee after they've already raised a round. The chance of a startup even creating a 20% options pool for employees hired after series A is slim, and even slimmer is them giving their entire pool to the first employee. You're essentially saying you expect nearly the same equity slice as the people who invested their time to validate the market and build a prototype, which is absurd.
I'd love for someone to prove me wrong by pointing out a startup that's given 20% to their first employee after raising a seed round.
EDIT : To clarify, the dude in the original post is definitely getting screwed, but this is way too far in the other direction to be at all useful.
That's a very good point. But I think the problem is that we're blurring the distinction between founder and employee.
I remember an old quote "founders get rich, early employees get screwed, and late employees get paid." I've worked for startups where I received a miniscule percentage of the company. But they paid me market rate and provided me with a health plan. The equity was nice, but this was really just a job... ok, it was more than "just a job", I did pursue it with more passion, and there was less stability (and one of them did tank leaving everyone scrambling), but the equity was really a bonus in exchange for the lack of stability and perhaps a more passionate workforce, but it wasn't a stand-in for a substantially below market rate paycheck.
So I agree, 20% equity is a massive amount to give to an "employee" who is not a founder. But a 50% pay cut is a massive amount to ask of an "employee" who will not be treated as a founder. That sounds more like the kind of arrangement that might normally be worked out between a couple of founders, where one needs an income and agrees to lower the equity share in exchange, whereas the other goes without income at all.
In this case, it does sound like the early employee may be getting a little screwed, because his deal is the worst of both worlds - working for "free" (well half the time) like a founder, but receiving miniscule equity, like an employee.
But a 50% pay cut is a massive amount to ask of an "employee" who will not be treated as a founder.
The term "employee" is not a good way to look at this. The employee is not a subordinate; he's a free economic entity, the startup is another economic entity, either it makes sense for these two entities to collaborate for mutual benefit, or it doesn't. Make it symmetric not asymmetric and what you should do becomes crystal clear.
Overage hours? Job-less risk? Career risk and opportunity cost? What? You seem to be including those numbers as his 'cost', are you assuming he's not getting benefits, or that he's going to work only 40 hours a week at this mythical 100k / year job?
There's nothing at all mythical about a 100k / year job where you work 40 hours a week. There are plenty of coders out there making at least that much by pumping out enterprise Java 9 to 5 for insurance companies and banks. You don't even have to be very good, you just need to not completely suck, stick around for long enough, and know when and how to ask for more money...hell, if you go the consulting route, you can make that much on a 20 hour work week at $100 an hour, which is not very difficult to get to if you're good and pick the right clients.
I'd love for someone to prove me wrong by pointing out a startup that's given 20% to their first employee after raising a seed round.
You won't likely find that. But what you will find is startups that are willing to offer their early employees wages fairly close to market rates (though to be fair, we don't know in this situation whether the person in question's salary was near typical market rates, we just know that he was deciding whether to take a 50% cut in it), which is (if I'm reading correctly) what the article is suggesting people look for rather than settling for shitty wages and delusions of Facebook-level growth.
I can't think of many people in real life that have ever seen much more than a nice bonus as the result of employee-level ownership in a company, and I think that's the lesson to take away from this - equity should not usually be a deciding factor in your employment decisions, nobody's typically going to offer you enough for it to matter very much.
There's nothing at all mythical about a 100k / year job where you work 40 hours a week. There are plenty of coders out there making at least that much by pumping out enterprise Java 9 to 5 for insurance companies and banks. You don't even have to be very good, you just need to not completely suck, stick around for long enough, and know when and how to ask for more money...hell, if you go the consulting route, you can make that much on a 20 hour work week at $100 an hour, which is not very difficult to get to if you're good and pick the right clients.
Those are not the people we're discussing. Those people aren't deciding whether to work 9 to 5 writing java for an insurance company or go work for a startup as employee #1. Yes, you can make lots of money consulting. I spent a year doing nothing but consulting. It's mind-numbingly painful work. Apples to oranges.
But what you will find is startups that are willing to offer their early employees wages fairly close to market rates (though to be fair, we don't know in this situation whether the person in question's salary was near typical market rates, we just know that he was deciding whether to take a 50% cut in it), which is (if I'm reading correctly) what the article is suggesting people look for rather than settling for shitty wages and delusions of Facebook-level growth.
I think you'll find this is much rarer than you think. Most startups, especially YC companies for what it's worth, are offering exactly what's mentioned in this article at that stage. While it's totally ridiculous, it's currently the state of the world. Sure, it sucks, but asking for 20% is going to get you laughed out the door.
While it's totally ridiculous, it's currently the state of the world. Sure, it sucks, but asking for 20% is going to get you laughed out the door.
If getting laughed out the door is a problem for you, you're not cut out for startups. Not getting a job when it's a lowball offer is nothing major to worry about.
> pumping out enterprise Java 9 to 5 for insurance companies
This is true, but it's also true that startup founders can make a lot more money working some equally shitty job.
No reasonable person should join a startup based purely on financial comparison with other jobs. For me, I'm doing it because I learn more, have more control, put up with less bullshit, and have more chance of making a difference in the world.
Look, if I'm going to work somewhere, it needs to have a expected ROI that's equal to or greater than my current job. That can be done via equity, bennies, cost of living, salary, and a few other knobs.
I'm a pretty cynical guy, so if you were hiring me as an early employee, you'll have to work on a better presentation than expecting your company to be warm, fuzzy, and grow faster than Facebook. That probably means you load me down with cash or equity. If you don't have the cash, then I expect equity or bennies.
I don't expect more than market rate, mind you... just... fair treatment.
If you want your employee to take a pay cut they'd best get rewarded as much as an investor who put in the same amount. Look at the numbers, if you want a dedicated tech genius on call, and loyal, in his market, $700k for four years is very reasonable.
The hypothetical founders want someone to pass up being an employee for $100k/y, and costing the company at least $50k more, to work as a contractor for $50k per year - something that saves the company $400k, more than $200k of which comes out of the employee's pocket. If you think anyone should keep their mouth shut so as to not jinx that deal you need to go back and read the article again. Taking that deal is horrible. Especially because when you show yourself to be dumb enough to take it the company will really start treating you like crap.
At that, how is the founder really worth $500k in your average startup? The idea? I find it a little ridiculous that people who have no clue how to implement their idea think they deserve so much for it. Why wouldn't the key employee be worth as much as that?
For the record, I'm currently turning down a $150k 2y offer. On the face of it it's not too bad ($75k/y) but it has an optional buyout of my stake after two years at that $150k price, so that's the best it could ever get even if the company got huge. And that's instead of a wage, so I'd be doing the work free until, hopefully, it got big. So I'd have been, after all that, making a regular wage for someone doing this sort of work at a regular company, someone who has benefits, decent hours, etc, but I'd have taken all the risk.
Anyways, long story short, I agree with the article. Years ago they'd have had me at "So we'll be valuing your shares at $150K!"
I advised him to start the negotiation at 20%, not demand it. Going as low as 10-12% makes sense if he really likes the concept. If he's getting single digits, he should expect to be paid.
And yes, he will most likely be rejected when he asks for this much.
If they give him 10% out of an options pool of 20%, he just cut the options pool in half for future employees. This will make it harder to attract future staff, who will be needed to grow the company enough to make the equity worthwhile. Isn't taking too much post-financing risky too?
Not sure why somebody downvoted you; that is definitely correct. VCs have some very clear notions about the correct size for employee equity pools. They insist on creating one as part of the initial funding, so it doesn't come out of their share. For similar reasons, they will resist increasing it later.
If you draw your line at 12%, you will simply never get a job at a post-funding startup as a non-executive. Even as an executive, it's unlikely. (reference: http://venturehacks.com/articles/option-pool-shuffle - see the chart 2/3 of the way down).
I agree this isn't a stellar deal. He's giving up $50k for one year. His vested options after that 1 year of risk should be at least $50k in value at the current valuation (though it's possible they've made considerable progress since the valuation was established). I'm not going to touch the fact that you've tossed in severance and "career risk" into your formula. And adding 30% for overtime?! Most 6-figure jobs are >40h/week. /boggle
Of course, a lot of startups can't match BigCo dollar for dollar and don't try-- because they win on other fronts (work environment, autonomy, etc).
This is a great point. The general approach of thinking of the job-after-next that you want to get, and looking at how your potential next job does (or doesn't) position you for it, is extremely useful.
I've seen a lot of recent college graduates work at a startup for a year or two as a cto. I would still hire them as junior developers. Working with engineers with a lot more experience and tech stacks is an invaluable experience.
I agree with you. Not that there's any way to control this, but I think it's always best to be the 3rd or 4th most advanced programmer on a team. You want to be good enough to get decent projects, but it's always good to have at least two people better than you. I say two because if there's only one "mentor", you'll absorb her biases.
Startup and large company programming jobs are very different. In large companies, being a good programmer is about knowing the tech stack and knowing how to maintain and leverage the code. In startups, new development is more important. I think the better way to go is the reverse of what you described: start at a big company for the learning experience (and seeing, in legacy horrors, what not to do) and then do a startup having learned those lessons. There certainly are lessons about engineering that are hard to learn except in a mature, already-scaled company.
Great post, one of the better I've read here.
What you have written makes sense if the founders actually view employee one as a truly "key" hire, in it for the long haul. In my experience, the early employees are key hires only in the sense that they are the best people the founders could hire right now. They are only key in getting the company to the first round of funding, when they can be replaced by better, more expensive key hires.
This is an excellent post, and I'll use it as a guideline when it comes time to hunt for jobs. That said, I'd like to disagree with a few of your assumptions:
1. You've overvalued overtime, as 30% is probably too high for overtime relative to a bigco job, which is what he would arguably take instead of this.
2. Drop career risk (which is beyond immeasurable) and opportunity cost (this is captured by his foregone market rate).
I also have a question about the expected value of the company's valuation. We've got that down at $2.5 million, and base our equity calculations off of that. However, is the valuation the expected value of all outcomes, as calculated by investors? I assume so, but if not then he will need to consider the average value of all possible scenarios (or, more simply, the likelihood that the company sells for $2.5 million).
There's a high probability the company fails or does not sell for $2.5 million, and he needs to factor that risk into equity valuation (if the company valuation does not already incorporate that risk).
EDIT: funny that I was downvoted--I don't believe I said a single disagreeable thing here (maybe the overtime?)
This is one of the most interesting comments I've seen on the issue of early hires and equity. Thank you.
However, from the founders' perspective they can't have these kinds of negotiations with many early employees. How much equity could they realistically give up to get the key hires (and leave enough for an option pool for later employees)? This is obviously a complicated issue and it would be good to hear a founder talk about how they dealt with it.
Either give up real equity, give up real money, or give up on hiring employees smart enough to realize what's going on. There's no fourth option. Having a startup doesn't entitle you to free labor.
You can still manipulate smart employees via their psychological/emotional weaknesses to get them to work for a poor-mediocre deal. In fact I think this is the most common path.
"Geeksploitation The act of taking advantage of twentysomething digital workers who are flushed with pioneer enthusiasm and willing to work very long hours if bolstered by junk food, flexible work schedules, and no dress code. Gareth Branwyn, "Jargon Watch," Wired Magazine, February, 1997"
This is really just an extension or a new way to exploit the fact that a lot of nerds are doormats, and are completely unable to negotiate market salary. Happily, there are some who see the shenanigans for what it is.
I tried to phrase my third clause carefully. That would be hiring employees not "smart" enough to realize what's going on. (In hindsight, that's a leading term, but I can't edit it now.)
In my view they should be paid market rate. That's the real issue here. Even with that magical "first hire" you're now a company who is hiring employees. It's PRECISELY this problem that angel investing is designed to solve (and why pure boot-strapping is so incredibly difficult).
Equity for an employee should be viewed as a bonus and nothing more. Equity is a powerful tool for a company, and it shouldn't be parted with so easily. What if you need to raise some (non-dilution) bridge financing? You've limited your options if you've already committed huge equity to employees. It just doesn't make a ton of sense.
Pay market rate and benefits. Hold on to your equity for dear life.
I agree a lot with this, I think the very first employees may get high percentage of shares for half salaries, but very fast employees should just get regular salaries (& benefits if possible)
I'm not a founder so can't talk from experience, but my gut feeling is that there are not many key hires (in an early startup there are not many hires altogether, but this just reinforces my point if true.)
The best strategy is to realize which employees are key to the success of the company and give them proportionately higher equities. Not every early employee deserves a 12-20% even if they're "not just coders".
I think your broad point is good: startup employees should definitely negotiate for a fair share. But your math is loony tunes.
First off, he won't be on reduced salary for 4 years. Seed-round startups may pay below-market salaries, but with later rounds they typically bump people to market rates. The same applies to things like health insurance, 401k, and the like. He's betting maybe a year of reduced income.
Second, the notion of 3 months severance is... very generous. And unnecessary. At least here in San Francisco, the time between jobs for startup-loving engineers is approximately zero. (Or negative. We just hired somebody from a failed startup and would have been happy to bring her on board early if she needed to work part time to responsibly close out her last gig.)
Third, I'd call the career risk negative. In recruiting, I look for people with past startup experience, failed or not. And one shouldn't account for opportunity cost here. If he has a better opportunity, he should take it. If one comes up, he might; he's not chained to the desk or anything.
You're also ignoring time. It's not like the developer is putting in cash early on as founders and investors do; his contribution comes gradually, and he can quit at any time. Seed money buys much more equity than A or B round money, and for good reason: the risk declines over time.
Developers should definitely negotiate, but only with a clear idea of the negotiating landscape, including how the funding structure of typical startups looks. The should also some notion of the marketplace. If a developer wants 20% of the company when somebody as good will do it for 2%, then they're going to be out no matter what math they use to justify their demands.
Are you talking in general, or for very early employees? My understanding is that a 1-year cliff is standard (with monthly vesting after that). That's what everyone (including employee #1) got at a startup I worked for. (Of course I'd never consider that company a good example to follow wrt to treating employees with respect.)
If it's customary at least for early employees to get better terms, that'd be (awesome) news to me.
If you consider risk-adjusted returns (the payoff for an employee working at a startup is much riskier than the payoff at a large corporation), the employee should demand more equity from the startup.
The part of this that resonates with me isn't the mathematics. The math isn't very relevant because there's a really large unknown: the eventual value of the company. One percent could be a lot of money, or it could be nothing. There's also the matter of dilution: is he protected against dilution from investor and employee stock grants over the next N years? I would guess not. His 1% could be 0.2% or less by the time an exit happens.
What is obvious is the emotional undercurrent to this very common anti-pattern. It sounds like he's not a real co-founder, he's "just a coder". They seem to be trying to sell him on a rotten deal because they think it's just such a privilege to work on their golden idea that they don't need to compensate properly. He's going to bust his ass to make the code work, for a salary half of his market rate, and in return he gets a tiny sliver of the company that gives him no real control, on a 4-year vesting cycle. I'm sorry, but these two guys are not (after 4 years, after he's done some real work) worth 79 times what he is just because they had the connections to raise money.
Prospective employees tend to view equity grants in a pre-employment context, when a 1% share seems extremely generous because the employee hasn't done anything yet. But that's what vesting's for! Vesting allows companies to compensate based on future contributions, with the knowledge that if the employee quits or is fired before the 4-year period is up, they won't have to pay for all 4 years of work.
At the least, if still thinks it's an "exciting" opportunity worth pursuing, he should recognize that he probably can't value the company better than the market, that we are in frothy times, and that the equity is worth more to an investor than to him (different risk profiles). So the value of 1% (post-money) of a $2.5 million company is $25,000 at most. That's $6,250 per year, far less than what he's giving up.
The first employee of a startup is not necessarily getting screwed. If that employee gets appropriate respect for his skill set, and reasonable compensation for the risks inherent in a startup, then it's a fair trade. A lot of people go into startups as early employees knowing the risks and upsides and that's fine.
What he should do if he actually wants to work on the startup: First, he needs to value his contribution to the company over the next 4 years appropriately and put a number on his "sweat equity". Let's say his market salary is $100,000 and he's being paid $50,000. Now add to his base salary: benefits (15% for health insurance, 401k matching), job-loss risk (25%, since typical severance offers are 1/4 tenure at current salary), career risk and opportunity cost (15%), and overage hours (30%, assuming a 50-55 hour work week). That's $185,000 per year. Take that, less the $50,000 he's making, and his sweat equity is $135,000 per year. Over 4 years, that's $540,000. The company's valuation is $2.5 million, "pre" to his contributions. He should be getting about 16% of the company, assuming he remains for 4 years. This number seems high, but if he's there after 4 years he will have been there almost as long as the founders, so it's about right.
First action: he needs to ask for 20% and settle for no less than 12%. If they say, "but you haven't done anything yet", he should point out that the equity grant is subject to vesting and that he won't get anything if he doesn't do any work.
Second action: he needs to demand the right to listen in on investor and client meetings. Otherwise, the other two founders will hold all the power in the organization because they, and they alone, hold that special knowledge of what investors want. If they think he's "just a coder", they'll show it by saying (in effect) that no, he's not "good enough" to be in the investor meetings.
The most likely outcome of his making these two demands is that they'll tell him to get lost. If that's the outcome, it's also the best outcome because it means the startup's a tarpit.