
Ask HN: When compensation includes equity, can I ask proof of valuation? - kohanz
Say a startup (early stage, no technical team yet) wants you to do consulting work or become their first technical employee and offers you a compensation package that includes cash + equity. The equity is based on a valuation that they (verbally) claim was established from their initial seed round. Is it appropriate to ask for confirmation&#x2F;proof of that valuation and, if so, what would be the polite way to go about it? What would be other important things to ask&#x2F;consider.
======
JamesBarney
One thing to always remember is that a valuation is dependent on the terms.
For instance I might pay $10,000 for 1% of the company if it's pure equity.
But if you throw in terms like I get extra shares in the event of a down
round. Then I might pay $20,000 for that same 1%. (I would also pay more if a
board seat is included or I'm guaranteed the option to be in any future
rounds.)

The valuation of the company is $2M with one set of terms, but only worth $1M
with the other.

So just make sure that if you are getting paid based on valuations given to
investors that you are getting the exact same terms the investors got.

~~~
kohanz
This is a useful response not because I'll ask for the same terms as
investors, but because I think that's a good negotiating tool to ask for more
equity. I doubt they want to give me the same terms as their investors, nor do
I want them because I'm not an angel investor, but that's a tangible way to
state that the type of equity I'm awarded has less value and therefore should
be calculated differently.

~~~
ChuckMcM
You will be safer/happier if you simply value the equity offer at $0. This is
especially true of pre series A companies.

If you do that, and it ends up being worth nothing (common case) you will not
feel a "loss", but if you have been imagining it was worth something, and was
now worth nothing, you will grieve that loss, irrational as that is. I have
seen it again and again, where the stock price of a company hits some value,
the employee does the math of "option price x quote" == $some number, and then
when the stock price goes down feels bad about how much they have 'lost'.

You protect yourself from that by setting the value to $0 and making your
decision based on that. If it happens to be worth something later, bonus! if
not, well you didn't count on it anyway.

~~~
tarr11
Won't this method discourage you from working with startups at all? Generally,
they offer less cash, longer hours in exchange for more equity.

If you value the equity at zero, the rational thing to do is avoid working for
a startup at all.

~~~
sanderjd
I think from a purely financial calculus, that's right, but most people make
decisions based on non-financial incentives as well, and startups sometimes
score highly on that front. There are tons of variables here where startups
can be more attractive than big companies: bureaucracy, job self-
determination, responsibility relative to experience, passion / cynicism, etc.
And the biggest one is probably learning how startups work so that you have a
huge leg-up if you start your own one day.

~~~
ChuckMcM
Exactly this, you work at a startup because you are passionate about the
mission, or you want to learn something outside your basic skills training,
you want to work with someone you respect, or you like to challenge yourself.
Never ever ever work at a startup because you feel it is a way to financial
success.

You believe in the mission - often startups will take on business or social
challenges that are unserved by larger companies. This can be very rewarding
to be part of a solution to an otherwise unserved or underserved customer.

You want to stretch your boundaries - titles in startups are rarely indicative
of what you do, often you may participate in marketing, QA, development,
business development, sales, project management, operations, and product
management just by showing up that week. Rarely do you get a chance in a large
company to "try on" a role that isn't on your resume, nor when you do get that
chance, get the leeway to try several in a short amount of time. You may want
to work at a technology company but not sure of what role you want, a startup
lets you try many roles. Further when you find one you like you can live it
for a while and then move to a larger company in that same type of role.

Work with someone you respect - Sometimes you will find a startup where
someone you know, either in person or through meetups or other social sites
that you respect and feel you could learn from. If they are at a startup you
may find it easier to get employed and work with them than you would if they
were ensconced in some high office at a large company.

Challenging yourself - startups are usually fast paced, stressful, and often
have a lot of unknowns flying around. Being able to focus and get stuff done
in that sort of an environment is a learned skill. Being able to "go with the
flow" on a project, change directions quickly, and see promising areas of
development in the midst of crashing and burning are all things people often
experience in startups. That sort of stamina can be useful in large companies
but it is hard to learn it in large companies.

Don't join a startup to "get rich." You will end up burned out and
disappointed and it can take years to get past that.

~~~
sanderjd
Thanks, this is a fantastic, detailed, expansion on the point I was trying to
make in haste.

I would also add that startups are good for "networking", which is best done
by working closely with people day in and day out. Startups give you a chance
to form much closer relationships with people much higher up the company food
chain, and those people are likely to be successful even if the startup isn't.

------
geophile
I don't see why that would matter very much. The valuation so early is going
to be highly subjective in any case. If you are willing to consider such an
offer, then the two relevant things to consider are 1) what fraction of the
company are you being offered, and 2) what is _your_ estimate of the
likelihood of this company becoming successful.

If you are sure they are going to fail, then the equity you are getting is
worthless, and why bother? If you think they have a reasonable chance of
success, then all that really matters is how much of the company you own.

~~~
kohanz
In this scenario, the amount of equity being offered is in lieu of market-
level compensation. I know typically you want to get full market compensation
+ equity, but the claim is the company can't afford it at this moment (common
startup situation, I'm sure).

So say that I have given a quote as a consultant for $100k worth of
development. They can only afford to pay $50k. They claim their seed round
gave them a valuation of $10M, so therefore they offer 50k / 10M = 0.5% in
equity in addition to the $50k cash. This is why the valuation matters - it is
directly determining the amount of equity in the offer.

Is that a reasonable arrangement? Should I ask for proof of valuation and, if
so, how?

~~~
mahyarm
That startup's stock is not liquid, and that %0.5 is subject to a large amount
dilution on top of it if it ever becomes liquid. For example, it's often not
worth it to work for a startup, even if you get that %0.5 equity at the $10mm
valuation, since even if it gets to a $1 billion valuation, it doesn't mean
you can sell it.

Dilution would then make that $50k into $500k instead of the $5 million you
would expect. $500k / 4 = $125k / yr (vesting), which is the same as working
at google / apple if you could sell all of your stock. But you cannot so you
probably will not get that money back. So a very good case scenario for
startups can lead to getting the same money as working at google.

With the current trend of 8+ years to liquidity if the company is successful,
it will be a long time before you get your $50k back. Then you have to compare
putting that held up $50k in to an index fund over the same 8 years.

As a result, you should probably be demanding something like %5 of the
company. Dividing your missing compensation by the probability that you would
actually get that missing compensation will lead to a calculation like that.

They will predictably balk at the %5 suggestion, so it's up to you to figure
out if you can make more money working for someone else keeping your sales
costs in consideration. If not, then go ahead and work with these people, and
just treat the equity as the lottery ticket it is.

[http://techcrunch.com/2011/10/13/understanding-how-
dilution-...](http://techcrunch.com/2011/10/13/understanding-how-dilution-
affects-you-at-a-startup/)

~~~
HockeyPlayer
This post is too pessimistic. If this startup gets to a $1b valuation, you
will likely have some avenues towards liquidity. 10x dilution would be
extreme.

~~~
mahyarm
Not really. If your are a current employee, you usually can sell %10 of your
vested stock during secondaries, which amounts to about $20k until you reach
full vesting at the $1b valuation. The secondaries come up every one or two
years. If your not working there anymore, you cannot enter the secondary. Most
of your stock is still illiquid, and GooFaceSoft is still the better idea.

Finding sellers outside of employer sponsored secondaries can be pretty hard
and involves a lot of labor. Time better spent making money directly with new
consulting clients. Usually the corporation wont be very helpful in selling
your stock. ESO fund & others can be pretty picky and you have a good chance
they might change their mind a few months later as you try after you have
gotten all of your required documentation.

As an employee / contractor, you won't have investor level access to
financials, reporting or the resources to fully understand them.

That dilution level does happen. It's happened to friends as they climbed from
a $5m company to a $1b company.

Also if you get options or equity of some sort, make sure that the options do
not expire until at least 20 years later. You do not want the 90 days after
termination problem a lot of people have. 20 years seems long, but there are
stories of people's 7 year stock options expiring because the company hasn't
gone public in those 7 years!

And make sure you have easy access to these required documents, since they are
often required to sell your equity when the company is private:
[http://www.slideshare.net/KeyvanFirouziCFACPA/equity-101-for...](http://www.slideshare.net/KeyvanFirouziCFACPA/equity-101-for-
engineers-togo-v04)

------
auganov
Completely fine to ask for proof that the seed round happened, especially as
the first employee. I had the [dis]pleasure of having a co-founder that would
routinely lie to people about past investment, investor interest etc. If only
I was smart enough not to trust that person myself...

Just honestly voice your concerns (rather than saying "show me the proof"
without explaining why) and any reasonable person will only have more respect
for you for asking.

------
rahimnathwani
"What would be other important things to ask/consider."

1\. What do _you_ think the company is worth today? If your net worth were
$250m, how much would you be willing to pay for 100% of this company?

2\. Does the company have any debt? If so, subtract this amount.

3\. What rights are attached to the different classes of shares (e.g.
liquidation preferences) and which class of shares will you be issued?

4\. Based on what you learned from (3), what % of the exit value will you get
if the company is sold next year for what the founders believe to be the
current valuation? What about if it's sold next year for what you believe to
be the current valuation?

Re: #4, the % will probably differ based on the sale price and how far into
the future the sale occurs. The sooner the sale and the higher the sale price,
the less of the total value you will lose due to liquidation preferences
and/or other additional rights attached to investors' shares. If the sale is
very far in the future, liquidation preferences could totally wipe out your
equity, even if the sale is at a decent price.

------
brudgers
There are two orthogonal cases: consultant and employee. The contractor case
is simpler because clients who won't pay your regular fee are almost never
good clients _and_ because someone who is paying for services with equity
_after_ being funded is creating a mess for someone [and from a tax
perspective perhaps you]. On top of that, the cash value of equity as payment
should be discounted according to both opportunity cost - those hours could be
spent with a full rate client - and because any potential payment is well into
the future (aka "the time value of money") and because the probability that
the shares can ever be liquidated at or above their value in the previous
round is less than 1.0. So the sensible thing to do is just require the cash
and don't waste time fooling with the valuation.

As an employee, you can ask for the valuation, but it doesn't mean anything.
Small equity in closely held companies is only as valuable as the people in
control have the good will to make it [this also applies to the contractor
situation]. Well it might mean something if you have the cash laying around to
actually exercise the options when they vest...e.g. the 5% options you get at
a $10,000,000 valuation require $500,000 to exercise if you leave after the
vesting.

To put it another way, the value that matters is that of the options not the
company and the value of the options should be assumed to be zero...or maybe
$1.00 like a lottery ticket in a lottery where nobody has to win.

Good luck.

------
ryanobjc
There are only effectively 2 ways in which startup equity becomes cash:

\- IPO (least likely) \- a top-10 unicorn which access to the secondary market

Unfortunately during a buy-out, your options are not actually equity and you
are not likely to participate in the M&A cash. Most companies do the right
thing and issue you a competitive offer and maybe a bonus, but honestly it's
hardly much more than that you could have gotten if you worked at
Google/whatever all along.

~~~
kohanz
Are you saying that when early employees (e.g. Engineer #1 or CTO) are offered
equity, that it is usually awarded as options and not true ownership shares in
the company?

~~~
ryanobjc
Often times yes!

First employees have an outcome differential of 10x vs founders. This is often
marked up to founders taking on substantial risk. But the way funding works
these days, with EIRs and networking, the founders are taking a lot less risk
than you'd think.

The total comp laydown of a startup has the potential of being very good, but
also, potential needs to be discounted against not hitting the huge
hockeystick.

------
bbcbasic
On top of valuation - there are lots of catches when taking equity. vesting
periods, clauses, up-front tax, requiring to exercise options (at your own
expense, could cost $100k's) when leaving the company, being fired just before
your first vesting if they do well. How long will it take to get your hands on
the money. Will you get the money if the company is brought out, or what
factors will determine if you get a share of that money or not.

You may want to get a lawyer involved.

More simply just make sure the cash is enough and the equity can be a lottery
ticket which you can view as $1 extra salary. Worth trying to negotiate any
horrid clauses though.

I would personally play it by ignoring the shares part and just ask for more
cash if you are not happy with the amount they are paying.

If you want to get rich (disclaimer I am not rich) I would suggest earning as
much $ as you can, living as cheaply as you can and invest in good stocks and
real estate in very desirable locations. Then each year concentrate on how you
can increase your income so you can invest more.

You will wake up in 20 years time and think "oops I got a lotta money" to
paraphrase Blur.

------
vladimirralev
It will be difficult to get a solid proof without lawyers involved to check
everything with the third parties.

Typically you just want to have a written statement from your founder and if
at some point the company is worth enough to justify a check, you can hire
lawyers to go back and check. If your founders lied in a written statement
they will be liable for even more. In general if your founder lies to you and
you have proof and the company goes big he is in trouble. Your lawyers will
need to see all paperwork you signed in such case, watch out for sketchy terms
you might be asked to sign later on. It is possible that crappy founders will
try to erase all prior liability at some time when the company is about to
make it big. In fact the company lawyers always go back and check everything
the founders signed before a big deal to avoid any unforeseen liability.

You have to judge if your founders act in good faith or they are taking every
opportunity to put you at disadvantage. If you don't trust the founders or the
investors, don't do business with them.

------
ThrustVectoring
You can get a quick fermi estimate of the value of the equity by multiplying
their payroll by the percentage of the company you're getting. Presumably,
payroll swaps cash for an equal amount of value provided to the company. So if
they have ten employees @ 100k per year, 1% of the company is worth roughly
$10k/yr.

Your risk profile may vary, so treat this as a starting point.

~~~
gojomo
I think this is exactly backwards for the poster's inquiry.

Yes, the company's offer has implied a valuation (and the company even says
it's based on actual investor-dollars-in). But the poster already knows that,
and isn't completely confident the offer reflects the real valuation offered
investors. So there's no more calculation to be done from the offer alone.
They instead want to know if they could/should require more formal
documentation of the company's claims.

------
AnotherMarc
In addition to the considerations others have mentioned, I would say from a
strictly expected monetary value, a successful consultant will make more money
than the first technical employee at a seed stage company. So, if you go that
route, you should have other motivations than maximizing your expected return.

As a rule, I don't even think it matters what the valuation was because
generally the seed stage companies that should rationally expect to make money
would have started with a proven team with prior successful exits.

I'm definitely not advising you away from the offer. I've been a consultant,
worked at both successful and failed startups, and preferred both types of
startups to consulting. But I still think the expected return is higher in
consulting or being a top performer at a large (tech) leader. Good luck
whatever you decide.

------
dmitrygr
Most likely (as backed by history) the equity is worth 0

Take more cash instead

------
kifler
I don't see any way that this could be counted as inappropriate. They're
asking you to come on board and they should feel comfortable with you
understanding their business.

------
simulombula
I'd be super weary of such a company. Offering equity to the first technical
employee makes a lot of sense because you intend to stay long with the guy,
but even considering such a scheme on consultancy basis is non-sense, and
doesn't bode well when a company without tech savvyness is also clueless on
the other side.

~~~
binarysolo
I had a bunch of these pay+stock arrangements as a full-time data consultant
the past 4-5 years, though they were 1) pre-angel to angel and 2) vetted
contacts/friends.

------
MalcolmDiggs
Yes and no.

Yes: I believe you're well within your rights to ask to see the financials of
a company you're about to become a co-owner of.

No: If you're asking for proof because you distrust them, that's a HUGE red
flag. Don't work with people you distrust. Even if it's just a hunch, go with
your gut and just walk away.

------
theworstshill
Ask and possibly dodge a bullet, or don't ask and screw yourself later on.
Seems like a no brainer to me.

