Every single startup’s dream is to get acquired or go public for big bucks. In the fintech world, the acquirers are the large financial institutions like Fidelity, BlackRock, JP Morgan, and Bank of America with billions of dollars on their balance sheets. To them, spending a few hundred million is chump change. If they can find the right technology, they can easily market the product across their respective enormous platforms.
BlackRock did just that recently by announcing the acquisition of FutureAdvisor, a robo-adviser based out of San Francisco. You may recall I invited Bo Lu, the co-founder to play tennis at my club a year ago to learn more about his company and whack a few balls. Here’s the post with my Q&A. Since the hit, I didn’t hear too much about FutureAdvisor until this big acquisition.
Only the insiders know the exact price of the sale, which is to be finalized by the end of 2015. But according to The Financial Times and RIABiz, the price is somewhere around $152M. That’s a very nice 100% jump since their Series B round in 2014 where they raised $15.5M at a $75M capitalization. Their overall funding is estimated at $21.5M.
My initial reaction was one of excitement for everyone at FutureAdvisor. I believe we’re in a private company bubble and I was beginning to wonder, as I do for most money-losing startups, whether or not they’d make it. Finding a gorilla to sell to is exactly what every startup should be doing now.
A 2X return on capital in one year is pretty good for the venture capitalists, especially compared to the return of the S&P 500 during the same time period. If the two co-founders own 20% of the company, that’s a cool $30M each.
But most of us are not founders. Most of us are just employees with tiny shares in a company looking to partake in the technology boom. Let’s look at the acquisition from an employee’s perspective and learn why getting acquired might not be such a great idea.
The Dream Of Great Fortune Is Over
Unlike LearnVest, which raised ~$75M and was bought by NorthWestern Mutual for up to $250M (sources say hurdles must be reached to get to that figure), FutureAdvisor’s $21.M funding to $150M acquisition price is a much greater return. I’d call FutureAdvisor’s sale a win because it was loss making with ~$3M in revenue ($600 AUM X 50 bps) and at least double that in costs with an uncertain fundraising future.
Here’s what I’m thinking about before joining a startup.
For an early stage startup (Series B or earlier), there’s a greater than a 50% chance the startup won’t be around in five years, and a greater than 50% chance my equity won’t be worth anything either.
Given the below market salary and the high probability of failure, I must believe the company and therefore, my equity, has a chance to grow by 10X or more during my time there to compensate for all the risk. If I don’t believe there is at least a 10X return, unless I really love the product and people, why bother taking such a huge risk?
It’s important to always think about opportunity cost.
Example Of Two Employment Packages
1. Join a startup and make $100,000 a year in salary with $100,000 in options vesting over four years. There’s a 20% chance my options could be worth $1,000,000 after the vesting period is over, and a 80% chance the options will be worthless. The total compensation after four years is therefore $100,000 X 4 = $400,000 in base salary + $1,000,000 X 20% probability = $200,000 for a total value of $600,000. The reality is a bifurcated result.
2. The other option is to make $150,000 a year at a larger organization with no equity and probably much less excitement. The total compensation is $600,000 after four years (4 X $150K). The difference between the two is the startup package still has a chance to provide you a $1.4M total return, even though there’s an 80% chance the total compensation will be worth only $400,000.
I have a feeling most of us would probably shoot for the first option even though you will probably make $200,000 more with option 2. The reason? Hope. Everybody hopes they’ve got the winning lottery ticket. But as we know, playing the lottery is one of the worst ways to get rich.
No Employee Gets Much Equity
The only people who get much equity are the founders. Even if you are one of the first five employees (seed stage with the most risk), the most equity you’ll get is 5%. I’ve personally looked at hundreds of startup jobs on Angelist when I was looking for consulting gigs, and 2% equity is usually the maximum I’ve ever seen for a high quality Series Seed or maybe Series A companies. You’ll only get 5% equity if you are a superstar engineer joining a highly risky company without a proven business model. In other words, you can get 5% equity in a company that’s probably going to be worth nothing.
Let’s say you are a senior level person with 20 years of experience who decided to join FutureAdvisor after their Series A funding. A reasonable equity offer is roughly 1.5%. If you stay through your entire four year vesting period, you will be able to bank $2,250,000 gross ($150M X 1.5%), and roughly $1,500,000 net after taxes using a 30% effective tax rate. But given you could have made $100,000 a year more working at a large company, the gross return might really only be $1,850,000, or $1,000,000 after taxes. Not bad. But not the $7.5M you were dreaming of if the company sold for $500M.
Let’s say you’re a mid-level employee with 10 years of work experience after college and join during the Series B funding. Your equity package is a respectable 0.5%. If you stay for the full four years, your equity will be worth $750,000 gross ($150M X 0.5%), or roughly $525,000 after taxes. But again, we’ve got to subtract roughly $35,00 a year, or $140,000 from the gross figure due to the below market rate salary. The real gross is closer to $610,000 or $427,000 after taxes using a 30% effective tax rate. Again, not bad, but not the $5M you were hoping for if there was a $1B exit.
As we go down the totem pole, the equity share per employee get lower and lower. The reality is, the vast majority of employees own 0.25% or less at the Series B stage or later. Below is the Buffer App company equity table for some of its employees when it raised at a ~$50M valuation.
The Power Of Hope
If you’re a founder of a company that’s in existence for less than five years with 20%+ equity, and you are providing 1/10th or less in equity to lure people to work for you, you can see how it’s important to play up an employee’s hopes and dreams.
“We’re going to be so huge, you’ll never have to work again after we exit,” “We’re on our way to $1B unicorn status,” and “We’ll never sell until we dominate the industry,” are common phrases a founder will use to get an employee fired up. They might really believe their company will grow massive, but statistics are not in their favor.
Against all odds, so long as we have hope, we feel comfortable doing a lot of improbable things. You know, like jumping out of an airplane because your hope to live is strong. But what happens when your company is acquired early? Well, as an employee, the hope of making big bucks gets squashed.
If you joined FutureAdvisor at a valuation of $75M in 2014, I’m sure you hoped someone would acquire your firm for at least $500M after 5-10 years. Given the rising population of Unicorns, or companies worth $1B or more that have seemingly all come out of nowhere, that’s not too much to ask, especially for a Sequoia and YC backed company. Secretly, you probably hoped for more like a $750M – $1B takeout (10-13X) by 2019 so you ride a more certain wave.
When your company decides to sell for much less than what you’ve hoped for, there’s certainly mixed emotions. The first emotion is of jubilation because your options now have real value. The acquiring firm should offer a decent retention package. The second emotion one feels is relief. Someone else believes in what your firm is doing. You made the right move taking such a risk joining an early stage startup. The final emotion that kicks in is greed. Why didn’t we hold out for more, more, MORE?!
If anybody has ever received a financial windfall like a bonus or a severance, you realize how ephemeral the feeling is of receiving more money. The excitement might last for a couple weeks or maybe up to a couple months and that’s it. We adapt very quickly to our newfound wealth.
Acquired company employees usually don’t see all their stock options vest immediately. If they did, the employees would just walk and take a vacation or do something new. Instead most acquired employees must stick around for the remaining duration of their vesting period, with little hope of any more explosive upside. If you leave after your second year, you only get half.
The key will be what BlackRock does to retain and motivate FutureAdvisor employees to keep working hard, instead of “resting and vesting.” BlackRock (ticker BLK) is a $52B market cap company whose stock has barely gone anywhere over the past two years. Unless it’s extra free compensation, receiving BlackRock stock is not going to be a big motivator.
Because FutureAdvisor employees are all probably making less than those at equivalent roles at BlackRock, BlackRock needs to give raises to all FutureAdvisor employees. With market rate salaries plus a guaranteed 2X return on options since Series B if they stay until full vesting, now that sounds like a better place to work!
The Final Test
It may be a sad reflection of the state of the Bay Area’s high cost of living, but the final test to see if your startup’s acquisition was good for you is whether your windfall is enough for you to comfortably buy a median priced home. In other words, will your total windfall equal to ~30% of the value of the home you’d like to own some day. 20% is for the downpayment to avoid PMI, and 10% is for the liquidity buffer. You don’t have to buy the home, but it’s nice to know that you have the option to buy if you want to.
In San Francisco, the median home price is ~$1.18M. After the vesting period is over, will the typical 28-35 year old FutureAdvisor employee be able to put down a $220,000 downpayment, and have $50,000 – $110,000 cash buffer left over, assuming home prices stay static over the next several years? I use 28 – 35 years old as a benchmark, because that is the age range the typical American buys a home.
If the answer is “no,” then you might as well go back to the founders to ask them to share the wealth a little more. The alternative is to ask the acquiring company for a bigger raise! Remember, you joined a startup that was so good, it received funding from famous investors and was acquired by an established firm. If you don’t receive a large enough windfall to at least live in a median priced home, then the economics are too skewed.
From an investor’s point of view, I hate it when a good investment ends. It means I’ve now got to find a new home with the proceeds. Unless your company is acquired by an equally fast growing firm, the excitement will fade very quickly. The FutureAdvisor acquisition is still a win for everyone involved. It’s just not the home run everybody was hoping for. I sincerely hope BlackRock supports the retail side of the business for a long time to come.
For startup employees, I recommend sticking things out until all your options vest. Don’t split your Kings when the dealer is showing a 7! While you are waiting to be made whole, continue networking so that when it’s time to leave, you’ll have hopefully found a better opportunity where you can enjoy another great ride. Maybe you’ll even start something of your own!
Readers, have you ever gone through an acquisition? If so, how did that pan out? What were retention packages like? How long did the acquired founders stay? Do you believe hope is one of the key tools management uses to whip employees into shape?
Note: FutureAdvisor has assured everyone that it will be business as usual for existing and new customers on their algorithmic advisor platform. BlackRock is acquiring them to leverage their technology for their institutional platform.
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