Job offer with equity from a startup - what to look for?

Question

I'm in talks with a startup founder about a job, pretty much a CTO role. At the moment it's only 3 people there, I would be the 4th one. It's all running off the founder's pocket now, he says he's got enough to support it for now from the sale of his previous startup.

Now he asks what are my expectations about money - salary + equity. I have no idea, esp about the latter.

How much equity is a reasonable expectation in this situation? And what does it mean for the salary? I know what I earn now and what I could earn elsewhere in a standard full time job. But how does that change when I'm offered some equity in the startup?

Also what happens to the equity when the startup raises capital. I read somewhere that the equity of common employees sometimes gets diluted so much that after the exit they get next to nothing, or even nothing at all. Is that normal?

Is there a way to protect against that? Not keen to work for under-market salary for years and then get no payout in the end. Assuming the startup actually succeeds and gets acquired or IPOs of course, which is a topic for another day but let's assume that it does. I just don't want to be screwed in the process.

Thanks!

Answer 1

I have no idea, esp about the latter.

I strongly recommend doing your homework on stock options. It can be a great opportunity or it can be worthless: a lot depends on the detail and the specific conditions so without understanding the fundamentals you can't make an informed decision. I recommend reading few books or doing internet research. Something like this perhaps: https://www.amazon.com/Consider-Your-Options-Equity-Compensation/dp/1938797094/ref=sr_1_1?dchild=1&keywords=consider+your+options&qid=1618666062&s=books&sr=1-1

A few points here

1. Equity is part of your compensation. To be able to compare offers you need to "valuate" the compensation component. It's worth a lot less than the "projected" amount but it's more worth than 0.
2. The valuation requires you look at the business plan: what's the product, what's the customer, how are these two connected, what's the sales projections, when and how do they expect revenue will show up. Look at all of these critically and make sure the story makes sense to you. If they don't want to share these details: walk away
3. Stock options come with a contract. Make sure you read EVERY line in this contract and make sure you understand it. Have it checked and explained to you by a financial advisor, tax advisor or lawyer if you can't do it yourself. That contract will show option type (ISO, NQ), vesting, exit scenarios, raising more capital, etc. Make sure you understand all these details and include them in your valuation. If they don't have a contract, walk away.

Not keen to work for under-market salary for years and then get no payout in the end.

That is typically the outcome, and you need to decide for yourself whether a small chance of a large payout is worth the risk.

There is more to a startup then money: It's a very different culture than a large established corporation: you need a lot more flexibility and improvisation skills, you need to learn new things (you never expected) every second day, decisions are made several orders of magnitude faster and it often feels like a roller coaster. Make sure that this is the type of environment that you really like, otherwise you will be miserable regardless of payout. If you are looking or a chill "9-5" gig: "THIS IS NOT IT"

I've worked in two startups, one tanked quickly, the other one paid very handsomely.

Answer 2

Here is my general answer.

I would expect a little higher than market rate to offset the higher risk of joining a startup, not a company with positive cashflow. Any equity is aa bonus and 0 value - MOST startups fail, why should I - as employee - risk money.

I have been in a couple of startups and especially early talk startups are - not the style that has a high chance surviving.

Venture Capital companies generally do not even avoid that - they just play a numbers game 8 of 10 companies fail? 1 makes break even? Well, the last one goes x100, so you make a TON of money. YOU CAN NOT - you can not work on 10 companies at the same time. So, 0 value.

I read somewhere that the equity of common employees sometimes gets diluted so much that after the exit they get next to nothing, or even nothing at all. Is that normal?

No, this is fraud.

See, it is normal that old shareholders get diluted. If they get "nothing at all" then either it was an emergency sale that really did not leave a lot of money left - or someone needs to be sued because they betrayed the shareholders and broke fiduciary duties.

It is normal shares get diluted, but this happens as new shares are sold at higher valuations as before. This means the share of an employee in the cake gets smaller, but the cage gets bigger. Instead of 0.1% you may own 0.05% (half), but of a company worth more than double, so the amount of value of your shares raise.

So, unless the company was failing and it was a "lets sell it before we run out of money" someone was really doing things not allowed to make sure the shareholders are scrapped out of a fair share. A board has a duty to protect ALL shareholders interests, by law in pretty much every jurisdiction with share companies.

Obviously you read different stories on the internet - mostly people are too inept to understand basic math and finances and law and put up crap stories. That is free speech for you.

Answer 3

Re: literally nothing at all? Yes it happens.

Real example: Early success, real money raised (7 figures USD, got to be mid 8 figs by end of the story). Business plan hits bumps, got 60-80% of the way there after exhausting first round of real money. But promising tech in a wealthy market. Had to go back ask for more to finish the job.

That's when founders lost control. Downhill from there. New board brings in more execs, cut costs, very top heavy now. Attempt several unsuccessful long-shot business development ventures that were peripheral to core product. Burn rate increases. Products built and sold steadily, but not enough profit to dig out of hole now. Product abandoned for new speculative product and market launched (the added value of optionality!!). On the power of this unflipped card, company sold successfully. This is 15 years in now. (I was long gone at this point).

Proceeds from exit sale were not enough for all the parties who had chipped in at various times. As a condition for finalizing the sale, shareholders with control power propose to reorganize the company to create classes A,B,C shares, and would put the tech guys from the very beginning of the company, and some other parties, into class C (with their consent!), to be paid according to an opaque formula, with the alternative that they get blamed for blocking the sale. Intense pressure to accept. They do. The formula then proceeds to pay them literally nothing!! (and class B got only partial payment I believe).

I was there years 5-10 roughly, valued the options at 0 and took some heat for it at the time. This is admittedly an extreme example, but I think it shows some of the hazards - including it dragging out for much longer than expected.

Answer 4

Options and shares in startups is an incredibly complicated field.

Seemingly tiny differences in terminology are tremendously different instruments with hugely different outcomes.

https://www.themuse.com/advice/getting-startup-equity-everything-you-need-to-know

https://carta.com/blog/equity-101-stock-option-basics/

https://blog.ycombinator.com/understanding-startup-stock-options-berbix/

https://www.kiplinger.com/article/investing/t020-c032-s014-working-for-a-startup-know-your-stock-options.html

(Interestingly, just glancing at those four articles, I see what IMO are a number of drastic mistakes. It's a tricky business.)

Tax alert:

Be aware that you may owe tax immediately, they day you get whatever it is you get.

There are tremendously different ways to treat "getting a share" in something.

In some cases it is tax advantageous, in some cases it very much is not.

If you're going to be #4, you (should) get a pretty hefty slice ultimately.

This is a serious business matter, and you immediately need an accountant/attorney who is very well versed in these issues.

You can't just casually "get 5% of a company", consider merely the liability issues.

Best of luck!

Footnote: don't forget all startups fail unless you are using five? six? digits precision in calculating the stats.