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 ;)
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.
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.
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.
That said, the strike does reduce the value of the options vs something like RSUs, but less than this comment infers.
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.
L4 is ~2 years out of school.
I think I'm now on a road of buying a house in the Bay Area sometime down the line, whereas my previous years of working brought me no closer.
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.
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.
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.
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.
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.
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.
It is still rare to be given such good terms on equity, and also rare to be knowledgeable enough to take advantage of the opportunity.
I got options priced at 12c that were valued at 35c by the time they vested, $1.50 when I quit and exercised and paid AMT, and $5 at IPO.
This transpired over a span of about 5 years.
This company was successful but not clearly profitable when I joined.
Maybe I got lucky picking a winner, but I'm not a famous (or highly talented) engineer and I didn't cast a wide net when job hunting.
OTOH, I got another job offer years earlier where the employer tried to match a $15/yr gap in salary with an offer to buy $15k strike price options! The clear deception in how the VP presented the economic interpretation of the options was a factor in my decision to decline.
Of course, we can imagine various ways in which the situation can be improved, like getting equity directly instead of options, increasing the amount of equity, etc.
But that's beyond the main point of stocks. The point of them is to align employees with founders more, get them excited and motivated about the future.
> workers, and especially new workers, should not be optimistic about the benefits.
But the same argument can be made about founders and starting new companies. Of course most startups do not succeed, but should that discourage people from creating them?
I think there is a bit of confusion in that generally it's believed that these aspects of startup industry are much different - one is a 'unavoidable state of the world' and the other is 'unwillingness of certain people to make the situation better'. But perhaps both of them are in fact state of the world... There are many variables that go into selecting the values for employee stock grants and could be just as much hard to change.
Maybe they ultimately end with 'smarter people are able to control those less smart', but that's another discussion.
I'm not against founders getting these benefits. I think VC's are the ones getting too good of a deal here. Roughly, if they pay $10 million for 10% of a company, and an employee gets 1% to offset $1 million of their reduced compensation (over 4 years, vs working at Google), looks fair, right? But oh wait, we forget the many many downsides of the employee's position (not preferred shares, had to ALSO pay to exercise them, risk of AMT, 90-day exercise window, etc). Seems to me that the VC got somewhere between a 5x and 20x better deal here.
There’s no easy answer but founder equity seems over weighted to me. If the founders want to align the interests of the company with the interests of the employees what’s wrong with having 15% instead of 30% and doling our dramatically more options to everyone else? No doubt founders take more risk and work harder but do they work 300x harder? (Usually by employee 10 or so grants are at 0.1% or less)
If you want to make a gambling analogy, I’d say making money off your equity grant at an early stage company is more like playing Roulette (with a better payout) than buying a lottery ticket. Sure, it’s uncommon to win (in this case hit your number) but it happens with decent frequency.
Perhaps it was my gambling addicted stepfather who died broke that keeps from seeing the appeal.
You’re not risking your life savings by joining a venture backed startup as an employee. In the worst case you write off a few thousand dollars you spent exercising some options while making a market rate salary (because you negotiated).
... because no startup is willing to pay competitive total comp fully in salary. Bigcos mostly aren't either, FWIW, although RSUs of a public company have a lot more liquidity and lower volatility than startup options.
Could you do it again at a different company or do you feel lucky?
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.
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.
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...
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 fundamental mechanism is that new investment is met by issuing new shares. If you hold options on a constant number of shares, and the number of shares into which ownership is divided goes up, then your fractional share of ownership goes down.
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.
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.
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.
they're purposely complicated, and recruiters and VCs will take advantage of people who don't know how to do the math or reason about the amount of value extraction they're capable of, telling folks "oh this stock could be worth 100x of what is now"
The founders and angel shares do not delute and your percentage goes down each round.
If your lucky they are worth the same.
You are correct that 50% is always 50%, but employee stock options are typically given as a number of shares, not as a percentage of the total, which is what allows for dilution. At least, that's how I understand it.
You won't stay at that percentage though, unless the founders agree to protect you from dilution. In that case, they'd compensate you with some of their own shares whenever you dilute to keep your percentage the same. It's not common for employees though.
Obviously depends on the situation and what valuation you got, but unless it's a down round, your percentage will be reduced, but that reduced amount will be worth more (on paper). Sure, you might no longer have 1% of a company valued $1m, you'll now have 0.5% of a company valued $5m.
The $5m won't come from a $3m investment, though. They'll take 20% for $1m, leading to a $5m valuation. And I don't know anyone that would give them a $3m liquidation preference in that deal. If your cash-on-paper (that is: shares vs total valuation) share doesn't grow in a round, that's a good time to think about getting out. If they were valued at $5m and are seeking investments valuing the company at $2m, run.
Yes, investors aren't throwing money around like they maybe used to, but I don't believe there's reason to be overly pessimistic. If the company becomes successful, you'll make money if you've been on board early enough (that is: if you took on risk).
It is a fool's errand, given everything that has happened in the space, to treat options as having any serious value. Unless there's a secondary market you can immediately sell your options on, treat them like lottery tickets
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!
It's not a clever thing that startups do to try to increase retention.
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.
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...
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.
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.
I do not take stock options in UK companies seriously and neither should you.
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.
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
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.
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.
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)
Average, sure. Median is possibly 0.
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.
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.
Class shares are a thing to protect investor money not engineer interest.
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).
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.