
Startup options are better than they look (2017) - mercutio2
https://www.benkuhn.net/optopt
======
howon92
Having worked at an early startup, I share the opposite view: startup options
are much worse than they look. The expected cost of not working at a big
company is much larger than mere 10% (go check levels.fyi if you're curious)
that the author calculated. The upside of stock options is also bound by the
slim chance of any startup's successful exit and dilution that comes after
each round. Here's a good calculator
([http://optionsworth.com/](http://optionsworth.com/)). If you have 1% equity
(rarely given) of a company that exits for $100M, you gross ~$1M. That's
before dilution and tax. Aside from the financial cost, you also sacrifice
your career mobility because you are forced to exercise your options if you
leave the company before a liquidation event (rarely happens before an exit).
Do not work as an employee at a startup if your primary motivation is making a
lot of money.

On the other hand, if you want to start your own startup, I think working at a
startup is a great way to minimize your own risk while maximizing learning if
you're like me ;)

~~~
zenlikethat
Your last point is really relevant. You can actually get paid to learn all
kinds of things at startups including which company destroying mistakes to
avoid. Not to mention there aren’t very many roles at FAANG where you can work
directly with the C Suite and see how the sausage is made.

------
6gvONxR4sf7o
This is a cool analysis with a bunch of giant caveats. The author lays them
out at the end.

The most important seem to be that it assumes people are risk-neutral and
optimizing their expected wealth, instead of trying to reach goals like
maximizing the probability you'll be able to buy a house in SF. If that were
the goal, I think early stage startups would fare incredibly worse in this
analysis.

The next most important seems to be that there's no way for a company to fail
in this model. The companies that become worth less can't become worthless.
Since these early private companies' stock aren't liquid, you can't cash out
before they fail. You get zero dollars from those, which is a huge difference
from the model.

And the whole crazy tax thing. If you quit as this model suggests, you almost
always have to exercise within 90 days (spending a bunch of your money for an
uncertain future). Then the IRS sends you a huge bill if you left a successful
company where you might get more than zero dollars. But you still haven't
earned any cash from the stock.

~~~
zenlikethat
FWIW, re: taxes - TrumpTax raised the AMT thresholds so aggressively that the
% of folks to whom this applies is probably a lot smaller than it used to be.

~~~
delinka
And even if you are pushed over the AMT threshold, and if the only reason you
went over was due to purchase of ISOs, and if you don't go over the threshold
in the following year, you can get credit in future years for that extra tax
you had to pay.

~~~
zenlikethat
Correct. You can claw back a chunk every year until you have that AMT paid
back so depending on your inflation and investment opportunity cost
expectations you are not actually risking that much money, just the cost of
the shares.

I think that really speaks volumes to how relevant it is to join early stage
if you want to play the options game - later stage companies _seem_ safer but
may not actually be that much safer if you consider everyone already in the
investment aggressively driving the price of the shares up and forcing you to
risk more on exercise.

------
evmar
FTA: "For instance, if the company is worth $1m, and you are granted options
on 1% of the company, then this basic model says that the expected value of
the options is 1m * 0.01 = 10k."

The options are _options to buy_ , so if you are granted 1% options of a $10m
company your options are worth just above zero -- you can pay $10k to get $10k
of stock back. You only make money if the company value goes up relative to
your strike price, and the amount of money you make is proportional to that.

E.g. if the company literally doubles in value, you now can pay $10k to get
$20k worth of shares. Only then do you profit the $10k in the above model. So
the model only makes sense if you get in and the company _doubles_ in value,
and even after that you still only make $10k.

~~~
drinkzima
This isn't actually true, because 409a valuations (where your options are
struck) sit at what most would consider a meaningful discount to the actual
value of the company (often 30-50% of the preferred, below where secondary is
even happening in late stage companies).

That said, the strike does reduce the value of the options vs something like
RSUs, but less than this comment infers.

~~~
jdc
Not only that, but it's kind of a nominal value. There's some shares you'd be
lucky to find a buyer for.

------
noaccntforhotpw
So, huge mistake in the article right away... It assumes total comp at Google
is 110k..... The reason startup pay is nonsensical for many people isn't
because startups don't have big upside, but that the upside didn't keep up
with the massive increases in pay the bigcos have driven. Eg starting sde I
comp at Google is 180k... , Or 60% more than the article assumes.

There is also value that bigco provides in terms of stability, benefits,
professional hr (hr isn't your friend, but bigco hr will probably at least
follow the law)....

Dan Lu's articles on startup vs bigco pay are well worth looking in to.

~~~
cameronbrown
Is this base comp or final comp?

~~~
citrablue
180 is mid senior according to levels.fyi.

~~~
fnbr
For Google, that's entry level (L3). L4 (between fresh graduate and senior)
makes $250k TC.

L4 is ~2 years out of school.

~~~
ttul
It is pretty near impossible to beat that at a startup...

~~~
lonelappde
The startup can get you hired at bigcorp at a higher level than if you joined
and crawled up the ladder. This is never mentioned when discussing comp
comparisons.

~~~
fnbr
Yeah, but it's still a gamble. Unless you become a VP/Director it's tough to
get to a sufficiently high level to make it worth it. It's rare, for instance,
for someone from a start-up to come in as a Staff/Senior Staff engineer
(L6/7).

------
undefined3840
I’m glad someone said it. So tired of the advice I constantly hear on HN to
assume your grant is worthless.

I forward exercised my stock options when I started a job for $7k in 2013.
Last December I was able to sell some that valued my initial grant at $1.3m
(still private but probably will raise at higher value or go public soon).
Because I forward exercised I paid taxes at the 2013 value of the company,
which was basically nothing. And I only pay long term capital gains when I
sell, which is less than the earned income tax rate.

Of course there is a certain element of luck involved, but to say that the
mathematical probability of building wealth from your share of equity in a
startup is the same probability as winning the lottery is completely
disingenuous.

~~~
lostdog
I don't think you understand how rare your situation is.

All these things are unusual:

1\. You joined early enough that you can early exercise for such a low price
($7k)

2\. Your company allowed early exercise (still unusual these days).

3\. The startup 20x-ed in value (my conservative estimate)

4\. You stayed in the job for 6 years!

5\. Your startup let you sell some of your shares before exit (This is
extremely unusual still).

Still, even with those assumptions this turned out only ok. Assuming you sold
everything in December, you made $1.3 million over 6 years, so $217k per year.
Considering that for a typical senior software engineer, the equity portion
needs to make up about at least $150k of compensation (conservative estimate
of a Google L5 from levels.fyi), I would say you did roughly ok, making an
extra $67k per year. That's pretty good, but not amazing. Getting promoted to
L6 would be more than twice as good.

Sorry for being so negative about your good situation, but I really think
current equity compensation is far too low and tricky, and that workers, and
especially new workers, should not be optimistic about the benefits.

~~~
undefined3840
I didn’t stay for 6 years. I don’t work there anymore. And like I said, the
company will likely raise soon, potentially at a much higher valuation. There
is a comparable company that is already public that is trading at a much
higher valuation.

I also didn’t say my experience is/was common, but it certainly was not the
same as winning the lottery. That is my point.

~~~
Judgmentality
> but it certainly was not the same as winning the lottery

I am happy that things worked out so well for you, but you're not sharing any
data to back up this claim. I mean someone could literally win the lottery and
say how great things worked out - it's anecdotal evidence.

[https://xkcd.com/1827/](https://xkcd.com/1827/)

For many people, and I _strongly_ suspect most, startup options are a losing
bet. The worst part is you have to wait years before you know whether or not
they're worth anything.

~~~
undefined3840
The odds of winning the CA lottery is 1 in 42 million. There are fewer than a
million residents in SF. I don’t know the exact number of startup winners
(both founders and employees who made more than $1m) living in SF at this
moment but I would conservatively estimate something in the 5k range.

~~~
Judgmentality
The odds of winning the minimum $38 MM payout in California are 1 in 42
million. The odds of a smaller payout are orders of magnitude higher. And you
can play twice a week, instead of having to wait a minimum of 1 year between
potential payouts. You're also allowed to buy other lottery tickets in that
period of time.

To put things in perspective, of the dozens of people I know who joined
startups, almost all of them felt the stock wasn't worth it.

------
parsimo2010
"Startup options aren't so bad"..."adding risk aversion would decrease the
offer value by a huge amount"

So the author shoots his main premise in the foot by not including one aspect
of human behavior that we see in just about every worker. Sure, young people
with no family are less risk averse than old people with families, but just
about anyone seeking a salaried job is risk averse when considering jobs. Risk
seeking individuals aren't very common in the standard job market.

Ben's articles are usually well informed, especially when it comes to
probabilities and decision analysis, but not factoring in indifference curves
in an analysis that is already this complicated is a pretty big miss. The
bottom line is that working for a startup is a pretty big gamble, and expected
values are misleading in terms of how people actually make decisions.

~~~
lonelappde
Eh, not really. I could be risk-taking but self aware enough to know I am a
far better engineer than businessperson. I'd join a company and dive into an
experimental projects that might fail or get me a huge bonus. Or I
might....join a startup!

------
hota_mazi
> Estimate the valuation of the company

Good luck with that.

Also, you need to factor in that the probabilities of the start up becoming
significant (IPO / become profitable / survives) are probably way below 1%.

At the end of the day, you don't go to a start up for the money but for the
experience. Any other intention is guaranteed to not work out.

------
dasil003
There's a real danger for young tech employees to put too much faith into
models like these. A nice probabilistic graph appeals to our logical and
mathematical sensibilities by appearing to cover the range of possibilities
and giving some well-reasoned projection of likelihood, but it doesn't account
for the human element.

Picking a successful startup with growing valuation is just the prerequisite,
if you are lucky enough to do that then the likelihood of getting a good
payout from stock options becomes dominated by the behavior of the board of
directors and the founders. So actually the number one question is: do you
trust the founder(s) to look out for their employee's interests? Number two
question is: are the founder(s) savvy enough to avoid investors triggering
scenarios that totally screw early employees (dilution, liquidation prefs,
etc)? These are super hard questions to answer even for savvy veterans, and
probably totally outside the depth of the inexperienced young people flooding
into tech right now.

I don't think its responsible to advise young people to give significant value
to options based on spurious models. Instead I'd recommend they go read Steve
Blank: [https://medium.com/@sgblank/startup-stock-options-why-a-
good...](https://medium.com/@sgblank/startup-stock-options-why-a-good-deal-
has-gone-bad-5e711d9819b7)

------
jedberg
This whole thing fails to account for the fact that on every subsequent round
of funding, your percent ownership goes down. Even if the company is doing
well, at the next round of funding, you'll pretty much be reset to the
original value if you're lucky. If you're _very_ lucky your options might be
worth more.

VCs have gotten too good at extracting value from a company. In this day and
age, I consider startup options to be worth $0.

If I'm looking at a startup, it's because I am either super excited about
their idea, or super excited about having a lot more responsibility/learning
opportunities than at an established company.

Those are the factors I'm valuing in my head vs. the actual dollar opportunity
cost.

~~~
the_svd_doctor
Can you explain "on every subsequent round of funding, your percent ownership
goes down" ? Maybe a naive question. But if you are given say 50% of a
company, how can your percentage of ownership decrease if someone funds it ?
What's the mechanism for this ?

~~~
cedricd
Say you have 50% of the company and your cofounder has the other 50%. That's
all the stock, right?

If you want to raise money you need to sell some stock. So the company creates
new stock and sells that -- increasing the total number of shares. You don't
get any of that new stock yourself, so your total ownership percentage goes
down.

~~~
patrickthebold
What you are saying is true, but at least in theory you don't lose any
'value', because the money raised makes the company worth more. It's like
going from 50% of a $1m company to 25% of a $2m company.

Of course in real life things are much more complicated. And, if I was a
cynic, I'd say they are purposely complicated in an effort to screw people
over.

~~~
munchbunny
Two ways this happens are liquidation preference and "participation". In both
cases (they work differently but mean similar downsides for employee stock),
your stake's value becomes conditional on a best case scenario exit and
investors in practice gain more ownership than the numbers immediately reveal.

If the company fails, all that means nothing. If the company goes big, it
won't matter. But in the most likely exit case where the company sells for
less than everyone was hoping, now you get into the interesting territory
where the investors might make their 1.5x return before you see a cent.

It's not that founders don't understand this. It's that founders end up taking
these conditions when they're low on negotiation leverage and choose between
that and running out of funding, so it's an understandable decision. However,
they also avoid talking about it unless forced to because it changes how you
will value your stock, which changes how attractive your offer or current
compensation is. As a rule I ask about it when I talk to startups about job
offers.

------
al2o3cr
A model that assumes every engineering hire is given 1% of the company but
also ignores the risk of dilution would seem to only apply to a very small
part of parameter space...

~~~
rwilson4
It also seems to ignore strike price and the scenario of an acquisition where
only the VC and founders get paid.

~~~
jefftk
Footnote 1: "You may be asking yourself, 'what about the strike price'? The
answer is that, because almost all of the expected value of the options comes
from a very small fraction of scenarios in which you exercise them, the strike
price doesn’t contribute very much to the expected value."

------
AbrahamParangi
Another (very) important consideration is the tax you will be liable for _at
the time of exercise but possibly before liquidity_ in the event of success
and the information asymmetry between most engineering hires and the founding
team.

It's for this reason that I believe 10 year exercise windows are the right
thing to do, and young engineers should be encouraged to avoid startups with
~90 day post-employment exercise windows.

P.S. Hi Ben!

~~~
agrajag
The 90 day post-employment exercise window is a requirement for them to be
treated as incentive stock options, which have significant tax advantages over
non-incentive stock options.

It's not a clever thing that startups do to try to increase retention.

~~~
mercutio2
Are the tax advantages meaningfully different for ISOs vs. NQSOs if you 83b
your NQSOs?

It seems to me anyone who really is banking on their startup having huge
valuation growth (and can afford to do it) should 83b their options, either
way.

------
MobileVet
This model focuses on numerous secondary factors while ignoring two of the
most important variables, dilution and probability of success.

Dilution will continually decrease your stake... Likely at the same rate you
vest (year).

Most important of all... The entire upside needs to be multiplied by the
likelihood of success. No matter how much the company is 'valued' today, more
often than not it will be worth 0 in 5 years.

Pouring one out for the WeWork employees this weekend...

~~~
rjdagost
You are correct- probability of success is (in my opinion) the single most
important factor when evaluating options. Even if on average employees did
well with stock options, the fact of the matter is that the distribution of
payouts is very lopsided, not unlike professional athletes or actors. So most
start-up employees will get nothing at all for their hard-earned options.

From personal experience, I have worked as an employee at 3 start-ups, and in
only one of them did I get any payout at all from my options. And the amount
of value I got from that one "success" was trivially small after multiple
rounds of dilutive funding (financially, I would have been far better off
flipping burgers in lieu of all that overtime). Most of my peers have had
similar success rates with start-ups, with a few notable exceptions.

------
agoodthrowaway
The implicit assumption here is that you can _always_ change jobs. That’s not
true if the economy is bad. We now have a generation of people in the
workforce that have not seen a downturn. Back in 2001-2003, I was locked into
a startup that cut our already below market pay by 20% due to the poor job
market at the time. There are simply times when it is difficult to move
companies due to macroeconomic trends.

------
mercutio2
Some folks commenting seem to be missing some of the point.

Ben isn’t trying to say “startups pay $100k, Google pays $110k”. Those are
round numbers deliberately picked out of the air (which obviously don’t match
expected comp at either startups, or Google).

It’s an analysis of how to value stock options in high growth startups.

As someone who routinely tells people to value stock options at zero, this
analysis has convinced me to value them at something closer to 5% expected
return lottery ticket. So, still basically a garbage deal, but I’m convinced
by his argument.

I’ll note one other downside I haven’t seen anyone else mention: BigTechCo
managers (including me) won’t hire people who appear to job hop every 1-2
years. Why would I invest in you, when your contribution to the team is barely
positive for the first 6 months, if you’re going to change teams in such a
short time.

I understand it’s different in startup land, but job hopping more than once is
a red flag for most hiring managers I know at big tech companies.

------
graphicsRat
Stock options in the UK are a near fraud. Your a ability to excercise them is
contingent on an exercise window opening at the next funding round (a long
time) and you lose said options on your last day of employment. Unscrupulous
management trying to claw back options can force employees out.

I do not take stock options in UK companies seriously and neither should you.

~~~
loeg
It's no different in the US.

------
wolco
I was in a situation where the company was trying to sell itself. I was 1.5
years into 4 year vesting schedule. I decided to leave for 10k more and not
buy my options and a few months later it sold with all employees getting
vested. If I would have stay that would have worked out to 100,000.

But I ended up much better off. The extra 10k allowed me to qualify to buy a
house. The house was 1/2 a million and rose to a million in 4 years. During
those 4 years I would be stuck at the new company (those were the terms
because they fully vest everyone). I avoided the endless flying trips to hq to
train them. I kept my freedom to move to other opportunities.

Options do payoff but salary is worth more because your purchasing power
increases. Real estate (single detacted houses) in a world class growing city
always goes up.

------
5Qn8mNbc2FNCiVV
What this leaves out is salary spikes by job hopping. If I get 100k at the
startup and 10k more at another company and the startup gives me options of
20k, (regarding both give me similar raises for simplicity) it seems the
startups offer is easier.

However if after 2 years I quit my job and take another offer for 150k and the
startup won't counter, its a loss of 20k I get by being the 2 years at a
startup instead of at another company. Even worse when regarding that the
early stages (unless you love that lifestyle) of startups is stressful I'd
always go to another non-startup company unless I do actually like the product
at a startup and see myself in it.

If money isn't a purpose then the way should be. People as purpose is an
argument but honestly I'd just not work somewhere with ass people

------
ummonk
You also get to quit publicly traded companies based on how much your unvested
RSUs have increased or decreased in value since you signed on to the job. So
this isn't really an advantage for startups, except to the extent that startup
volatility is higher.

------
sjg007
This all sounds nice but it ignores the issue of liquidity... You can't afford
to exercise your options because you can't sell them. The secondary market
sounds nice in principle but I never had success with it. And if you can
afford to buy them you have to budget for the tax bill that will hit you with
the AMT truck. The move to the 10 year option exercise period helps though so
you should only consider companies that offer that. 30 days, 1 year.. not long
enough.. 10 years might be enough.. For example, Palantir has been in business
for 16 years with no IPO in the near future. So the "deal" here, or the
implicit bargain isn't great.

------
williamDafoe
The number of startups that reach a liquidity event is about 1%. a liquidity
event is the company gets sold to a bigger company or an IPO. 99% of companies
fail to be sold and fail to IPO. about another 9% of companies become zombies
which means they don't die but they don't thrive. Options or RSUs are stranded
and not saleable due to SEC rules. The other 90% fail.

the numbers reaching liquidity events are higher in Silicon Valley maybe 5% of
companies reach liquidity events but the Outlook is still poor for most start-
up companies.

------
tschellenbach
Startup stock options are good when: \- there is no liquidation preference
overhang \- you feel confident your contributions will significantly move the
needle for this startup \- you're not giving up much in terms of salary \-
you're ready to take on a bigger role/build up experience

A friend of mine managed to get this right 4 times in a row. (joined 4
companies, made solid return on all of his stock options). so it's definitely
not impossible. obviously a large ammount of risk involved though.

------
localhost3000
The opportunity cost is not just the lost wages, it needs to also factor in
the _years_ of having less-known or no-name/failed startups on your resume.
This absolutely will impact your career opportunities. Having 3 early-career
years at Google on your resume has a compounding effect for the rest of your
life (sorry, but it’s true). That opportunity cost is way, way higher than the
n 5-digit dollar value this article rather blithely assumes.

------
tschellenbach
There is a lot of content like this on HNews. There are many factors that go
into startup options. Definitely worth more than 0 on average though.

On the other hand, many startups nowadays pay market level comp + stock
options. So in terms of opportunity cost it's just plain upside. (unless you
are getting FAANG level offers, thats a whole different game. those are above
the majority of startups)

~~~
npo9
Established tech companies that have IPOed are offering market level comp +
stock as well. They also, in my experience, give out better bonuses, have
better benefits, and offer better work/life balance.

~~~
toomuchtodo
Indeed. It would be...suboptimal to work for anyone not offering what you
described. Anything else is undervaluing/short changing yourself, while
enriching someone else.

------
brianpgordon
> You receive a job offer from a startup currently valued at $10m, with a
> strike price of $2.5m.

Isn't backdating employee stock options like this kind of sketchy/illegal? If
the company is worth $10m and you accept a job offer and get an option grant,
you don't get options priced as if you accepted the job offer back when the
company was worth $2.5m.

~~~
sk5t
Backdating to skirt FMV is not allowed, but the valuation is ordinarily based
on the last funding round--for preferred stock, with some terms favorable to
the investors--and what you're getting options for is common stock, with no
terms.

------
feifan
This is a compelling mental model, but not practical — one person can't _live_
expected values. If you want to actually realize expected values on options,
the best option might be to become an accredited investor as fast as possible
and invest in high-volatility companies :P

------
acroback
No they are not, speaking from experience.

One debt financing round and your golden stocks lose 90% of its value. It's
worse when you have exercised your options.

Plus you won't get class A stocks, class B or worse, which means you won't
make much unless company goes public and goes big like FB or Google.

~~~
spullara
This makes 0 sense except in a failing startup where the stock isn't worth
much to anyone, including the founders and investors.

~~~
acroback
Well it does makes sense because this is the ground reality, not all startups
make it. Engineers never get preferred shares no matter how hard we try to
think so.

Class shares are a thing to protect investor money not engineer interest.

~~~
spullara
But they are irrelevant in a successful startup and no one really wins in an
unsuccessful startup. At most preferred shares get invested funds back unless
the startup took some really bad deal with multiple liquidation preferences.
What I would say is that in an unsuccessful startup engineers are likely to
make out better in an acquihire than the investors do.

------
crb002
Curious. I hadn't thought too much about startup hopping, since there is a
large opportunity cost to staying in a startup that doesn't take off.

------
tartavull
I think is interesting to apply this reasoning to entrepreneurship. When you
are receiving no salary and possibly even investing your money on a company.

------
payne92
TL DR: The author argues that startup options are "better than they look"
because you can quit (and keep your options) at any time.

The model is extremely naive: it doesn't account for (a) dilution due to
continued investment, (b) investor preferences, and (c) (perhaps the most
important), most options need to be exercised (or forfeited) shortly after
departing.

A departure situation can trigger a significant out of pocket payment: from
the actual exercise price PLUS a possible tax trigger (AMT in the US) that
gets larger as the company value increases.

Many employees that leave with vested options often can't afford to exercise
them (or all of them).

------
purplezooey
Plenty, _plenty_ of startups will have options that are worth 0.

------
kleinsch
Numbers in the example don’t line up with what I’ve seen of Bay Area trends.
$110K TC at Google is low for a new grad, and good luck getting 1% of a
company valued at $10MM straight out of college.

More realistic numbers for me would be:

early career: $125K TC bigco job vs $100K + 0.1% at $10MM startup

Experienced: $350K TC bigco job vs $150K + 1% at $10MM startup

When you run these numbers it’s real hard to make the case that startups are
the best move financially. Plenty of other reasons to work at startups, but
increased comp at big companies + founders giving less equity to employees has
changed the equation.

------
Ozzie_osman
Though I agree with the general analysis, one important point anyone joining a
startup should consider is exercise windows. Obviously if the company is
worthless this doesn't matter, and if it's a rocketship you'd probably want to
stay around anyway, but if it's somewhere in the middle and you're stuck with
a three month exercise window it's a really hard decision to leave.

