Joining Startups Will Probably Make You Poorer Rather Than Richer
Several of you asked me why I’m applying for startup jobs now that I’ve retired. As I wrote in my retirement post, “Taking A Leap Of Faith And Retiring On My Own Terms,” one of my goals is to “Discover New Careers.” I truly believe all of us are destined to do multiple things in our lives. We just need the courage to seek!
The other reason why I am applying for startup jobs is because I want to learn more about the startup world and provide the Financial Samurai community with more insights into the process. It’s important to write from experience. Each job only takes five minutes to apply to online. I’m sure I will be rejected from most of them, since my background is not in internet, tech, or startup. However, I’m curious to know more about the process.
One of the main misconceptions here in Silicon Valley is that joining a startup will guarantee you riches beyond your wildest dreams. We hear story after story about companies raising multiple-millions of dollars in their latest round of funding and somehow translate those millions into our own millions. It’s just not the case for the vast majority of entrepreneurs and early joiners. The round of funding is almost always used for operational expenses such as advertising, marketing, rent, equipment, and of course salaries.
The way startup culture works is that you are paid BELOW market in salary, in exchange for lots of hardwork, and options which will hopefully become multi-baggers once the company is acquired or goes public. There is a long road to walk before you find your gold. How many times did you find the leprechaun?
NOT MAXIMIZING YOUR WORTH
Every Venture Capitalist says they count on 1 out of 10 of their investments to be homeruns to make up for 5-7 of their busts. The other 3-4 companies in their portfolio just tread water, neither making or losing them money. They call them “Deadpools”. Therefore, even with as much due diligence you put in evaluating a potential employer, your chances of striking gold is also about 10%.
The problem is, your chances of getting paid below market rate is almost 100% for joining private startups. The discount to market is often in the 30%-50% range in return for stock options which will hopefully grow many fold.
Let’s say it takes on average five years for you to realize your liquidity event riches. Here is an example I’d like to demonstrate:
Work For Startup X
Title: Head Of Sales
Options: $40,000 worth struck at $10 a share.
Benefits: 401K, Dental, Health, etc.
Work For Proctor & Gamble
Title: Head of Old Spice Body Wash Marketing
Stock Grants: $20,000 a year.
Benefits: 401k, Dental, Health, etc.
In Five Years
In five years, the startup person will have earned $400,000 in salary and $200,000 in options for a total value of $600,000. In five years, the Proctor & Gamble person will have earned $675,000 in salary and $100,000 in stock grants for a total value of $775,000. The monetary difference is therefore $175,000 assuming that the startup is still alive and is one of the 3-4 companies in a 10 company portfolio that treads water. Probability: 30-40%.
Let’s say the startup is one of the 5-7 companies in the portfolio which goes bust after five years. The startup person earns $400,000 in total compensation because his $200,000 in options are now worthless. The person at P&G now has made $375,000 more in five years. Probability: 50-70%.
Finally, let’s say the startup is a raging success and grows 5X in five years. You managed to be one of the top 15 employees and also see your options grow by 5X as well. Your options are now worth $1,000,000 plus your $400,000 in salary for a total value of $1,400,000! You are now $625,000 ahead of your P&G friend on paper after five years. Probability: 10%.
Finding Out The Likely Outcome Of The Startup Employee
$600,000 X 30% = $180,000
$400,000 X 60% = $240,000
$1,400,000 X 10% = $140,000
Expected Value = $560,000 vs. $775,000 going the P&G route. The difference is $215,000.
So the questions you have to ask yourself as a startup seeker are:
1) Is the $215,000 expected value paycut over five years worth it?
2) How will I feel if after dedicating 14 hour days at below market rate, only to see my company fail?
3) Will my resume be tainted if I work for a failed startup or will it be enhanced?
4) Will I regret not having taking the risk if the startup becomes a huge success?
5) Do I love the culture of the firm, and can I gut it out for a long enough period of time to see the financial reward?
EVERYTHING IS A LEAP OF FAITH
As you can see from my real life example above, everything is a leap of faith. We can only plan and prepare for so long. Eventually we will need to take a right turn or left turn and let fate take us.
There are a multitude of scenarios I have not written about. What if you join a startup in year one over some steady eddy job that could last you comfortably for 10 years, and your startup goes bust the very next year! It happens all the time here in San Francisco. You’ve then got to look for a job all over again, and miss out on one year of where you could have been at a better startup.
Just look at the miserable employees at Zynga for example. Everybody in the Valley knows Zynga is a rough place to work. Many of those employees stuck around for IPO riches, but couldn’t cash out all at once. It takes years to be able to fully sell all your stock due to employee retainership systems. With Zynga’s stock at $2.80, the majority of options for the majority of options are worthless not even one year after IPO!
What if your “steady eddy” job at P&G decides to remove Old Spice from its product line-up? You think you can transfer divisions, but maybe not! And that startup you had an opportunity to join was named Airbnb, which ends up going public the following year at triple the value of your options.
The most important thing we can do is assess our situations honestly, enjoy the journey, work hard, and hope for the best. This is why culture is so important when joining a startup. If the company is going to fail, at least they want to fail with good people they can get a long with. And if by chance the company succeeds, then all the sweeter the glory.