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Startup Equity For Employees (payne.org)
148 points by daveambrose on Jan 17, 2010 | hide | past | web | favorite | 31 comments

This is a good article, but a lot can happen between your option grant and an exit. I'd keep in mind that startups are generally for making founders rich, not employees, and that no matter how hard you push on equity, the chances of you getting meaningful money from your options is pretty minute. You may want to optimize your base salary instead.

That said, the most important concept in the entire article is "[i]f they won't tell you, go work somewhere else." Founders who are open with their employees up front are less likely to take advantage of them later.

I can vouch for this from personal experience. If you aren't getting a percentage comparable to one of the founders, then you shouldn't settle for anything less than near-market salaries.

Startups bring on employees for their expertise. You should be compensated appropriately for it...especially if you're facing as much uncertainty and risk as the founders without the potential for a big payout.

Also, when negotiating and judging a compensation package, remember that few startups have successful exits. Most of the time - statistically speaking - those options will end up being worthless. Salary (i.e. cash) has little risk associated with it.

This is good advice and a good indicator of why starting your own startup is the only sure fire way of making off like a founder.

I was offered to join the team for an early stage startup a few months ago and they offered 1% with salary upon funding. According to this article, all that risk and working for nothing for a few months until they got funding would have been a waste - I now have a few contract gigs that are paying me above market value (adjusted for sole proprietorship expenses like health &c...) for my work.

I basically work for a few months, then take a few off and do what I want - much more ideal than 9-to-5 and/or a high risk venture in which I'm not a founder...

> This is good advice and a good indicator of why starting your own startup is the only sure fire way of making off like a founder.

'Sure fire' and 'startups' do not go together.

As a counter example, there are plenty of early Microsoft and Google people who were probably much better off with their options at those companies than doing their own thing. Sure, they're outliers, but lots of things about startups in general are kind of outliers...

There's still a big advantage to holding employee-level stock during an acquisition. Even if you've only ended up with 0.5%-1.5%, that's still enough to pay off a good chunk of your mortgage and put you in a spot where you can start your own business.

In terms of a reasonable retirement plan, it can set you ahead by a decade.

There's also advantages to coming in as a non-founder. You significantly reduce the risk of failure by coming into a startup that's made it to the point where it's hiring and you can chop off a year to a year-and-a-half on the timing of an exit.

0.5% - 1.5% is where a lot of _founders_ end up, in terms of equity ownership. Depending on how many rounds of financing, how long it takes, how desperate for the money, and, how long it takes to get to profitability, it's not uncommon for a founder to own 2-3% of the company.

Employees, even at quickly growing startup, and having been hired on in the first year, may be lucky to own as much as 0.1% of the company.

A startup where founders end up < 5% is going to be one with serious issues. Assuming a two-person startup where everyone starts at 50%, you'd have to go through three really low-value rounds (say taking in 1M on a 3M post-money valuation) to get the founders below 10%. Either you are burning cash way too fast or your idea just isn't taking off.

Regardless, everything is a tradeoff in a startup - if you ever get to that point, your employees are probably either staying because they are getting equivalent salary to a non-startup position and enjoying the environment or they are expecting a massive payoff (0.1% of a $500M exit is still $500k).

If you've made it through a few rounds of dilution as an employee and don't hold a lot of stock, you should probably be weighing whether it's even worth staying.

According to Wikipedia, Max Levchin's stake in PayPal was 2.3% when it sold to E-bay. I wouldn't exactly call PayPal a failure.

There's a wide variety in how much capital various ideas take to get to fruition.

Yep. PayPal isn't necessarily an average case either. It was the merger of a company with four founders (Confinity) with a company with a single founder (X.com).

Elon Musk, a sole founder of one of the original companies, ended up with 10.7% in that sale:

ref: http://www.secinfo.com/dr6nd.33fd.htm

Thanks for filling in some details. I think you strengthen rather then weaken the case that founders might end up with what sounds like a small percentage though.

PayPal was bought by eBay after IPO. That means founders had several liquidity events.

Why would they have to be low value? Doesn't taking $50m in a $150m post-money valuation have the same effect as taking in 1M on a 3M post-money valuation?

The same applies to non-management founders as well. There's just too many ways that board members can cash out without you.

This piece gives very helpful advice about the right questions to ask concerning equity when you are about to sign up with a startup as an employee. It also gives credible explanations of most of the equity-related issues at that stage.

In my experience, very few employees who get option grants will ask the right questions to understand what their equity piece really means. That is, they won't even ask about something as basic as how many shares a company has outstanding (much less about size of equity pool, liquidation preference held by the preferred classes, etc.). When they fail to get this information, they really are going into the employment with poor knowledge about what likely will wind up being the most piece of their overall compensation.

Why don't they ask? Sometimes they just don't know how it all works and proceed out of ignorance. More often, however, I think they feel intimidated about pushing a company to disclose what they think is company confidential information, especially when the company is a big-name company that is already VC-funded and the offer otherwise seems tempting.

Because of this, startups will sometimes play games in this area, arbitrarily inflating the size of the company's capitalization structure (e.g., splitting a 10M capitalization structure 3 or 4 for 1 to turn it into a 30M or 40M-share structure). This splitting lets the company make a 100K share offer to a key employee sound like a 200K share offer and hence make it appear better than competing offers from companies working from smaller capitalization structures.

It amazes me how many times employees will simply accept such offers thinking they got better deals than they would have from other companies, when in fact they may have passed up equal or better alternative offers. This is truly a case of flying blind but it happens a lot.

And, as much as it pains me to say this, some companies have a very, very strict policy about _not_ informing their employees or candidates as to what the number of outstanding shares are in the company.

Yes. I feel your rage.

In fact, I've expressed it to the executives of those companies.

But, as long as things look good, the company is getting funding, and an IPO looks like a possible event in the future, most (all?) employees are usually afraid to make waves.

It's like PG often says - there really IS a difference between a founder/early-stage-startup employee, and employees of more established firms. I'm guessing 50% of the HN core would probably call BS and walk away from any company who refused to tell them how many outstanding shares they had, particularly after they were employees of that company.

Uh, honestly, getting diluted at all sounds like utter bullshit. Imagine being told "you will get 100,000 dollars at the end of the year," and then halfway through the year you're told "okay, now it will be 50,000 dollars instead." What's your recourse there? How is it not a ripoff?

Am I misunderstanding a crucial aspect of the system?

Here's a simple case.

Company is worth $1MM. You own 10% of the company.

Company gets a $1MM cash investment. You get diluted to 5%. But the company is now instantly worth $2MM.

10% of $1MM = 5% of $2MM

This is not bullshit, it's math.

Diluting is balanced by desire of the shareholders to keep larger portion of the company and need for the fresh funds.

I.e. seed investors + founders + pre-seed employees (+ISO pool) share all the stock between themselves. Now they are all in the same boat: additional stock is going to be issued for Series A investment and if investment is too large, all of them get diluted too match, if it's not enough, company dies. If you are employee, you can't do much about it, but founders and angels are going to look after their own interest and protect you as well. In this sense the most important number for pre-seed employee is the ratio of his stock to the founders stock.

It's possible to issue additional stock and just grant it to some parties to dilute other party, it's quite hard to do because if diluted party is dissatisfied (and it usually is), it exposes company to litigation.

Yes, your analogy is faulty.

First, what you're given is a number of shares, not a fixed percentage of the company - if you're given 100,000 options at the start of the year, you still have 100,000 options at the end of the year.

Second, the dilution that occurs through the issuing of shares to investors should make the company more valuable, not less - because the company takes that money and grows with it. Your shares are a smaller percentage of the overall company but end up worth more in absolute dollar terms. (If that's not the case, the company is wasting other people's money - the value of your shares goes down, but this is deserved.)

In other words, if you go from a 1% stake to a 0.1% stake through dilution and then get $20K of a $20M sale, you haven't been ripped off, you just overestimated the company's ability to turn your initial 1% stake into something meaningful.

Since he never answers the most burning question ("how much equity should I expect?"), I'll throw out some numbers based on my experience:

If you're being hired as a C-level executive, you might expect up to 2% - 3%. If you're being hired as an engineer, expect more like 0.25% - 0.5%. I'm sure it varies quite a bit, but that's what I've seen personally and heard from friends.

An IT Manager/First IT Employee can expect to see 0.1% of a startup with $3mm in funding and a $10mm pre-money valuation.

And, just a note - unless the strike price has increased significantly, or a lot of employees have been hired, I disagree with the premise of the author of the article that "Re-Up" aren't to maintain the same percentage of equity. In my experience, they are used to do precisely that.

The people who are diluted are those who've left the company. Sometimes very, very significantly - particularly if there is a reverse-split in the mix as well. Existing employees simply get grants to keep their stake the same.

I've heard those types of figures, too, but never read anything that backed it up with specific examples. I also understand that shares are vested over a certain period of time; i.e. 0.25% each quarter

Though it's different for each startup, anyone have any specific examples of fair compensation?

Man, this article is priceless. This would have really helped to have when I was last recruiting - although I did end up finally negotiating myself to a comfortable position... took three months though.

Valuable information, concisely explained. Thank you.

I have now learnt that I have 100 shares of preferred founder's stock in my own company which has 100 shares outstanding!

This is equally as useful for potential employees at a startup as those looking to recruit. I will certainly be referring back to this one when the time comes to talent hunt!

Lucky you, I only have 1 share of preferred founder's stock in my own company which has 1 share outstanding.

OK, technically I guess it's not a "share" if it's just 1.

Great article!

But what if I offer 1 share for 1% and then sell myself a billion new shares, diluting that 1% down to practically nothing? I'm sure this would be regulated, but it seems if something like this needs to be regulated then it indicates a flaw with the system. Why can't we just give out percentages, and have that percentage stay constant?

"... a flaw with the system. Why can't we just give out percentages, and have that percentage stay constant?"

I can't tell if this is rhetorical question or not. But I'll answer as if it was serious.

First of all, a company can do whatever it wants. So if you control a company, you can give out percentages. That's your prerogative. In reality, you wouldn't want to ever do that, because it would eliminate your ability to:

- Raise additional money.

- Hire new employees.

- File for an IPO.

- Merge with another company.

- Purchase another company.

However, if you want to start a company with a few friends, and never take additional money, and never expand beyond the founders, and never sell or merge, then you can certainly structure it in a way that each founder has a fixed percentage of shares. But that would be a very unusual business.

One way to fix this problem is with a shareholder's agreement that guarantees shareholders the right to participate in future funding rounds on a proportional basis to the shares they already hold.

So, assume you hold 99 shares and your employee holds 1 share. If you sell yourself 1B shares for $100, you'd be obligated to offer your employee ~10M shares (10101010, I calculate) for $1. If he accepts, your employee would continue to own 1% of the business.

It happens. And then lawsuits are filed if the party being diluted put real money into the deal: http://paidcontent.org/article/419-ebay-finally-loses-cool-s...

In the case of common shareholders, the opportunities for redress are substantially less.

So is there any law that says everything must be dealt like this. Is there a way to buy an actual fixed share in a company?

Yes, if you can buy enough shares that your vote will block any attempt to issue additional shares, your share will be fixed.

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