Are you thinking of taking a job in a startup? If so, this post is for you. Every employee in a startup is making an investment, but rarely do they treat it as such. Here’s 5 ways to make a smarter decision about whether or not to take that new startup job.
#1 Know How Much You’re Investing
Your maximum salary isn’t available in a startup. By definition startups are not yet profitable, so any money you get paid comes from investor’s pockets. This money needs to go as far as possible. Instead of an industry salary you might be promised other forms of compensation, ranging from stock options to the thrill of the adventure. You should evaluate any deal you are offered like an investor. For example, if you are an experienced engineer you might make €100K per year in a large company, but only €60K in a startup. You are effectively investing €40K per year into the startup. You should make sure that you are getting something fair in return.
#2 Know What You’re Investing In
Startups aren’t real companies. They are proto-companies that still haven’t found a repeatable business model. Unlike an established company, it’s not safe to assume that the job has a future. When approaching a potential job in a startup, ask about the business model. Ask the founders tough questions about the problem they are solving, who they are solving it for, how much they think it’s worth to people, how they are going to let people know about the solution, and why they think that they are the best people in the world to solve it. You need to make your own mind up about whether the startup is doing something worthwhile, and has what it takes to succeed.
#3 Know When To Cut Your Losses
Employees get stuck in startups that aren’t going anywhere. Yes, you can always quit if you see the writing on the wall, but most startup teams pull together when times get tough, unable to face up to the huge sunk cost of their collective emotional investment. Like any good investor, you should protect yourself from the potential downside of your investment: cut your losses if the business model isn’t working out.
#4 Know Your Funds Are Limited
A VC fund can raise more money, but you cannot create more time. Your time is a non-renewable resource, and with each job you take you are investing a part of it. Plan to spend half a decade in any startup you join, and you should make sure that any startup you join is worth five years of your life.
You have less than ten of these bets left. After the next one plays out you may be grayer, wider, mortgaged or babied (or all of the above). Make sure the next one counts.
#5 Know the Difference Between Shares and Options
Let’s simplify the maths and assume that you decide to work for an exciting startup, plan to do so at a €40K discount on your annual salary and hope to stick around for 5 years. This means that you intend to make an investment equivalent to €200K. Let’s take a look at what you’re getting in return.
Startup employees are normally given ownership through an “Employee Stock Options Plan” or ESOP, which is a pre-allocated pool of shares. Many startups will use the value of your shares, based on the most recent company valuation, as a bargaining chip. For example, if you are given stock options representing 1% of the company, and the last round of investment valued the company at €4M, then they will tell you that you are getting €40K in stock options.
Beware of this negotiation gambit. There’s some huge unstated caveats:
- Options are not shares. If you received €40K in shares you would be making a capital gain and need to pay tax on them (even though you can’t sell them yet). Therefore you get stock options instead, which means that you have the right in the future to buy €40K worth at today’s price and sell at the future price. What you make is the difference between the future price and today’s price, which is going to be €40K less than it would be if you had straight shares.
- Minority shareholder = higher risk You own a tiny amount of the company and have no real control. If you were a major shareholder and thought the company business model wasn’t being executed well, you could do something about it. As the owner of 1% of the company, there’s virtually nothing you can do about it. If the leadership team isn’t doing a good job, you’re screwed.
- You don’t even get your options yet. The company should have share option vesting in place. This usually means that you will earn your options monthly over the next four years. If you leave early, you only get what you earned. There may also be a “cliff”, meaning that if you leave within the first year, you don’t get anything. Finally, there will be “good leaver” / “bad leaver” provisions. Good leavers get to keep whatever ownership they’ve earned. Bad leavers lose it all. If you get fired for breach of contract you will be a bad leaver, and get nothing. Bad leaver provisions may be even broader, encompassing mental health problems or death. These terms may vary widely, so ask for a copy of the good leaver / bad leaver provisions that will affect you.
An Example Investment
So, in summary, you might be offered a €40K lower salary in exchange for €40K in stock options. If the company turns out to be the once-in-a-decade unicorn, like Google or Facebook, you will be ultra-rich. But from a more rational point of view, the you should realize that:
- The €40K is in the riskiest asset known to humanity: startups
- Cashing in the options will cost €40K, so the valuation has to double before you stand to receive that amount
- You have zero control over the company
- You don’t even have the options yet - only a promise of them should the future work out in a certain intended way.
4 Reasons to Take the Job Anyway
I love startups and I hope to be able to hire amazing people in my startups in the future.
I’m writing this because bargaining with stock options like they are cash is disrespectful to prospective employees. Options should be for incentivisation, not remuneration. Startups should be upfront with their staff, and tell them that they will be paid as well as possible, but if they just want cash to go elsewhere. Money is not the most important thing in life. You will have more earning power in the future than you have right now. Right now is the time to be having adventures and gaining broad experience.
Therefore, here’s four great reasons why you *should* join that startup:
- You will raise your game faster than anywhere else. If you want to make lots of money in the long run this is how you do it.
- You will have lots of fun. Life is short, and work is a big part of it. Don’t waste your time on Earth working on something you can’t make yourself care about. Have a startup adventure instead.
- It will equip you to become a founder too. Work with great people who’ve done it before. Next time round, it could be you.
- Money. Last of the list. If the startup works out, you will get a payout on your options (probably enough to buy a nice car or put a downpayment on a house). The acquirer will now work hard to keep you on the team, and offer you a new compensation package, probably involving a higher-than-average industry salary and golden handcuffs package, which is all yours to refuse if you wish.
November 10, 2013 at 6:59 pm, Russell Banks says:
Great post Sean, thanks for sharing your insight!
November 12, 2013 at 8:34 am, Killian Murphy says:
Great blog, Sean.
For #5, note also that investors generally (though not always) get preferred stock, whereas employee stock options are usually for common stock. The preferred stock is worth more than the common stock because it has things like liquidation preferences attached. The ratio in value between preferred to common starts high in the early days of a startup and typically declines as the risk declines (which means that the value of liquidation preferences declines, for example).
This ratio is important because, as you say, ESOP options need to be granted at fair market value to avoid capital gains taxes. If the company has only sold preferred stock to investors, how do you calculate the fair market value of common stock options? Unsurprisingly, the answer is “pay lawyers”. Wilson Sonsini has a primer here for those not yet asleep.. : http://wsgr.com/WSGR/Display.aspx?SectionName=publications/PDFSearch/CorpLawBulletin_1004.htm
March 2, 2014 at 9:50 pm, Conor Neill says:
Wonderful post, really helpful and easy to understand. I love that you finish with an upbeat end 😉 We get one go at this life and a rich boring life wouldn’t be as fun as a rich adventurous life… Since rich or poor depend so much on circumstance, we can drop it as a significant goal = hence the deal is boring or adventure!!! 😉