Updated for 2020 and beyond
Ever since college graduation in 1999, I’ve had equity ownership in every single company I’ve worked for. When you get equity, no matter how small it is, you tend to pick up the litter in the hallway, champion your company outside of work, and work harder than the actual value of your total compensation. In short, having equity makes you care more!
Pride of ownership is important for maximizing employee production. There’s just one problem: sharing. If you’re a founder, you’ve got to have the generosity and foresight to let your employees share in your company’s equity. Giving up equity is one of the hardest things a founder can do because we are all naturally greedy. We want everything for ourselves despite the need for great people to make our company a raging success. Sometimes, we’d rather fail and hold onto everything than give up equity in order to succeed. Irrational.
As an owner of an online business and as a consultant/advisor for startups, I straddle both sides of the fence. And, for the first time in 16 years, I’m doing some work with no equity. Sure, it’s rare for consultants to gain stock options or RSUs, but that’s exactly what I got from my first client after 1.5 years of service. In this culture of moving around every 1-3 years, why shouldn’t a consultant who’s stuck around longer than some employees also deserve something similar?
Working with no equity feels off. It makes me want to do only 101% of what is expected, not 130%. I wonder if this is how much of the workforce feels where they don’t have any stake in the organization they are working for? Please let me know.
This post offers up some candid advice for people looking to join the startup world, either as an employee or as a founder. It’s the sexy thing to do nowadays given people want more excitement, more purpose, more control, more money (?!?) and more flexibility. Be forewarned. This post is a 2,700 word beast that will make you see the world a little differently by the end.
THE ALLURE OF STARTUPS
1) Joining a startup probably won’t make you rich. Most startups fail. Startups pay lower salaries than non-startup firms because there’s an equity component. But given most startups fail, your equity won’t be nearly worth as much as you think.
If you accept lower pay and don’t have enough equity, or any equity, you are losing. The only way you can earn “market wages” is by aggressively asking for enough equity that pays out. But in order to understand the value of your equity, you’ve got to ask a lot of questions.
Ask for the total shares outstanding. Ask what your strike price is. Ask about monthly burn and the amount of cash on the balance sheet. Ask about VC liquidity preferences. Ask what happens to your shares in multiple sale scenarios. Be aware of tax implications. Employees are too afraid to ask senior management the tough questions because they don’t want to seem like pests. This is unfortunate because employees have a right to know.
I’ve noticed that most employees have no idea what their options are really worth because they have no idea how to value companies. Valuing a company is what finance people like me do, and we still get valuations wrong all the time. If you’re joining an e-commerce startup as a designer, you probably have no clue about comparable company valuations!
Unless you join a startup like Uber, AirBnB, or Pinterest, where you know the company has massive funding for long-term survival and you know with high certainty there will be a liquidity event like an IPO, you’re probably going to be stuck for years with no windfall.
Let’s look at some more nitty gritty compensation details by a company called Buffer App, a social media startup here in San Francisco that allows you to schedule Tweets, Facebook posts, and so forth. I’m not sure how they are generating enough revenue to be profitable since there are so many free alternatives like HootSuite, but they are. They have a complete transparency model into how much they pay their employees.
Buffer’s Open Salaries For All To See
Let’s pick out Andy (#3), a senior SF Engineer who makes $124,000 a year and joined when the company was only 3-6 people. $124,000 is literally a 50% discount to what he can make elsewhere if he’s truly a senior SF engineer. Let’s say Andy ends up working at Buffer for five more years. He will have given up 5 X $124,000 = $620,000 in gross wages to work at Buffer.
I’m looking down the entire 24 person roster, and every single salary looks 50% light, except for the founders (CEO and COO) who are paying themselves a very healthy amount given the amount of equity they have (see next bullet point) and their ages (under 30).
2) Being one of the first employees is extremely risky. Let’s say there are two co-founders who each own 35% after raising a couple angel rounds with family, friends, and investors. They are looking to hire employees to make their product and generate revenue. If you look online, you’ll find that the most amount of equity being offered to early employees is around 2%. Meanwhile, the salaries are WAY below market e.g. $50,000 vs. $90,000, $75,000 vs. $150,000, $150,000 vs. $300,000 etc.
As a first employee, you are almost taking an equal amount of risk as the founders, yet you only get compensated 1/15th – 1/30th the amount of equity! To put it another way, every $1 you generate at the early stage helps the founders get $15 – $30 richer. It’s not like the company has been around for decades with tons of brand recognition, cash on hand, and profits. There’s probably a 90%+ chance the company will turn into a zombie or go under within five years.
Given these statistics, it’s much better to join a company after their Series A or Series B round. You don’t have to go through the high probability of failure, your base salary is going to be higher, and the company has probably established a scalable business model to potentially allow you to cash in on your equity. If you were one of the first few employees and got closer to 5% equity, that level would be much more aligned with the risk you are taking.
Here are the median salaries for 20 of the most popular billion dollar+ startups in 2015, with some updates. Notice how the median income levels are not that much for how much these employees have to risk and work.
Bay Area Rapid Transit janitors and elevator technicians make much more!
1. Cloudera: $142,240 (Valuation: $4.1 billion) – Valuation at $2.3 billion as of May 2020.
2. Jawbone: $130,000 ($3.0 billion) – Went bust in 2017!
3. Medallia: $121,920 ($1.25 billion) – A success! Valuation at $2.9 billion as of 2020.
4. Pinterest: $118,420 ($11.2 billion) – Raised new money in 2017 at a $12B valuation. Now public in 2020 but languishing at a $12 billion valuation. Basically dead money since 2015.
5. Dropbox: $116,840 ($10.35 billion) – Went public in 2019. Currently at a $8.5 billion valuation as of May 2020.
6. Airbnb: $116,840 ($25.5 billion) – Was supposed to go public in 2020, but missed the window. They raised money in 2017 at a $40 billion valuation, and in 2020, they raised money from Silver Lake at a reported $18 billion valuation while having to pay 10% a year in interest.
If you were to ask me in 2015 which company would do the best, I would have chosen Airbnb and willingly invested 90%+ of my net worth in the company. Nobody could have foreseen the impact of the coronavirus on the economy. On May 5, 2020, they announced they would be laying off 25% of its workforce.
7. Kabam: $116,840 ($1.02 billion) – Sold to Netmarble in 2017 for $800 million. Not bad.
8. AppDynamics: $114,218 ($1.0 billion) – Cisco bought them in 2017 for $3.7 billion. A success!
9. Credit Karma: $111,760 ($3.5 billion) – Got sold before the coronavirus pandemic to Intuit for $7 billion. Best sale ever.
10. Okta: $110,000 ($1.2 billion)
11. MongoDB: $109,728 ($1.35 billion)
12. Palantir Technologies:$105,000 ($20 billion)
13. Twilio: $105,000 ($1.03 billion) – The biggest success of them all. Valued at $22 billion as of May 2020! Stock up 40% after 1Q2020 results as more businesses move to the cloud.
14. AppNexus: $104,550 ($1.19 billion)
15. Uber: $101,600 ($51 billion) – Went public in 2019 at around a $65 billion valuation, went down to as low as a $20 billion valuation in 2020 and now is worth roughly $48 billion at $28/share as of May 6, 2020. Originally, bankers had floated the idea that Uber would be worth $100 billion in 2018.
16. Eventbrite: $101,600 ($1.06 billion)
17. Zuora: $96,736 ($1.12 billion)
18. Gilt Groupe: $95,000 ($1.15 billion)
19. DocuSign: $85,000 ($3 billion)
20. MediaMath: $80,264 ($1.07 billion)
Buffer’s Transparent Option Package
The co-founders own the lion’s share of the company (65.7%), as expected. The rest of the employees combined owned ~10% – 20% (unassigned options). The remaining 15-25% of the company is owned by investors. Engineers like Andy (1% equity) and Sunil (2%) are building the company and helping make their founders 20X richer with each minute that goes by, yet they are paid 50% below market salaries.
Founder’s exit: Let’s say Buffer sells for $100 million (a valuation 85% higher than their latest fund-raise in Oct, 2014) in 2020. After the fund-raising dilution, the founders still own about 55% of the company and will have windfalls of roughly $35 million for the CEO and $20 million for the COO gross. Not bad! That’s about $19.25 million and $11 million respectively after paying a 45% effective tax rate. If they can somehow pay a lower effective tax rate of 20%, then the windfall is closer to $26 million and $16 million, respectively.
Top employee’s exit: Engineer Sunil, with 2% equity, gets to cash in on $2 million gross (2% X $100M) in 2020. After paying a 40% effective total tax rate (remember, California is 13% at the top), he’s left with $1.2 million. Meanwhile, as a C-level executive, Sunil is making at least $100,000 less a year than he could have made elsewhere with his $163,000 salary. That’s $900,000+ in lost wages since he joined from 2010 to 2020. His $2 million gross windfall is more like $1.1 million gross ($2M – $900K in lost wages). After taxes, that $1.1 million is really only around $660,000, using a 40% effective tax rate. Even if you use a 30% effective tax rate, that’s $770,000.
$660,000 – $770,000 for Sunil vs. $11 – $26 million for the founders is a massive difference! Engineer Sunil is not living large if he stays in the SF Bay Area because the median home price here is $1.2 million. Chances are high that the cost of everything will be even higher by 2020 when he cashes out as well.
What is the windfall for other employees junior to Sunil if Buffer sells for $100 million? Their range is $179,0000 – $1 million gross, and only around $80,000 – $400,000 net after taxes and salary adjustments! We often hear about the mega billion dollar+ sales from the media, but a $100 million sale is a huge success if you compare the median $40 – $60 million exit by Y Combinator graduate companies, one of the best seed accelerator programs in the country.
In defense of the co-founders, if they never took a risk to start their company, the employees wouldn’t even have the opportunity to work at their company for any amount of equity!
Update 2H2017: Leo, the Co-Founder and Sunil, the CTO left. Their salaries were pretty good, but after 6 years and 4.5 years, respectively, it seems like their hearts were no longer into Buffer. Growth has slowed, and the equity may never amount to anything because who will buy Buffer? They are cash flow positive, which is great for surviving and earning. That’s more than many other companies can say! I asked Leo, Sunil, and Joel whether they bought their equity stakes and they didn’t respond. So much for “radical transparency.” Figuring out what to do with the equity stake when departing is a big deal.
3) Understand equity dilution. Most startups are loss-making by circumstance or by purpose (aggressive spend for growth). As a result, they must raise funds in order to survive. Each round of funding dilutes existing shareholders. You need to ask management whether your own shares are getting diluted as well with each fundraise, or whether you are getting “top-upped” from management’s pool, or an equity pool.
Have a look at this terrific equity dilution infographic. You’ll see that big exits might mean smaller payouts for investors, founders, and employees. Do NOT be seduced by huge exit sales. It’s highly likely you won’t get much of a windfall as an employee as I just explained in point #2. As a founder, you could be easily screwed as well!
4) Can you actually afford to buy your options? Now that you’ve digested the equity dilution infograph, let’s talk about whether you can actually benefit from your equity because remember, you’re getting underpaid! Let’s say you join Financial Samurai and I give you $200,000 in options vesting over four years. Your pay is $100,000 a year and you work with me for three years as a software engineer before you decide to desert me for another startup. You’ve got $150,000 in option available to you (3/4 X $200,000).
Guess what? You’ve actually got to pony up $150,000 within 90 days once you leave if you want to keep your options! Otherwise, you are SOL, much like if you spend 30 years of your life paying FICA tax and then die before you’re able to collect Social Security starting at age 62. Earning $100,000 a year is a nice salary, but how many $100,000 a year income earners have $150,000 liquid sitting around? Not many!
Not only do you have to come up with $150,000 in cash, you might have this massive tax bill based on the difference of the current value of the shares vs. your $150,000 value. Finally, even if you purchase your options, there is no guarantee the value of your options will ever be worth anything! What’s the solution? To stick around for as long as possible so you can save money and not face a 90 day deadline to buy your options.
If you see companies that are going IPO at a sub $1 billion market cap, and have been around for 10+ years, chances are high the main reason is to cash out early investors and founders instead of raise money. One piece of good news is that leading startup, Pinterest is giving ex-employees seven years to buy their options instead of the standard 60-90 days. Perhaps their announcement will result in similar changes at other startups.
5) Founders have asymmetric benefits. Zynga is one of the post IPO tech/gaming disappointments today. They IPOed in December, 2011 at $10, shot up to a high of around $14.50 within a couple months and now sits dead in the water at $2.50. In other words, practically every single employee who joined a couple years before IPO hasn’t been able to gain a significant windfall from their equity. After an IPO, there’s always at least a 6 month lockup period before being able to sell, by which time it was too late.
But guess what? In March, 2012, just four months after IPO, Zynga filed a secondary (selling existing shares, not raising new shares for the company like a primary) to sell 43 million shares worth $591 million at the time ($13.7/share, close to the all-time high). The sellers included the CEO, CFO, and COO. The CEO personally cashed out on $227 million. Did the rank and file get to sell any shares? Not at all! The common employee got to watch the stock crash from $13.7 all the way down to about $3.50 several months later!
A more recent example is the closing of an anonymous social media app named Secret. The two co-founders raised $25 million in the first year, and were able to cash out $3 million EACH without showing any revenue. One founder even decided to buy a Ferrari with his proceeds to show off his wealth. Obviously, the founder isn’t a proponent of stealth wealth and now every single media publication points out his car.
But here’s the kicker. After cashing out $6 million for themselves, the founders then announced within a year they were closing down the company! This example is one of the best get rich quick startup scenarios I’ve ever read. “A bank heist,” as one Google Ventures partner put it.
Are the founders really to blame for cashing out when hungry investors can’t get enough? No. The founders were very smart to cash out, especially since they knew their company was going down the shitter. This is the free market at work. Nobody forced the VCs to shower them with money.
Who gets screwed again? The employees who took below market pay and now have equity worth nothing. Of course the employees weren’t able to cash out early like the founders. The employees didn’t even realize the founders cashed out $6 million worth of stock until they started reading about it in the media!
EVERYBODY CAN GET SCREWED
Let me tell you one last story. For the past 10 years I’ve been playing in this VC/PE/startup poker game for some relatively decent stakes (average buy-in is around $500, and ranges between $200 – $2,000). The host was a pretty outspoken guy who seemed to have struck gold after his advertising exchange company he started in 2005 pivoted from a regular ad exchange to do Facebook ad retargeting in 2011, just when Facebook’s mobile usage and advertising platform started to explode. He moved into an office 5X bigger, hired 40 employees, and things were going great.
Before his company’s pivot, the founder invited me to invest $50,000 – $100,000 in his company, but I declined because frankly, I had no understanding of his business model. I hadn’t even started Financial Samurai yet!
If I had invested, that stake would have been worth perhaps $500,000 – $1,000,000 by early 2014! At the high point, the founder was probably worth $10 – $20 million. I was kicking myself for not investing every time I saw him on Bloomberg TV until I woke up one day to read his company was taken under by some random startup whose founder beat his girlfriend 100+ times and didn’t even sit one night in jail. The acquisition amount? Definitely less than the millions he raised.
Word has it that common shareholders got nothing and the two founders might have walked away with $1 million each after 10 years of paying themselves below market rate salaries. The founders lost control of the board and were forced to sell so the VCs could exercise their liquidation preference and salvage some money back. The founders and employees were both screwed!
Still want to enter the startup arena? Maybe it’s best to gain some experience first and save a good chunk of change before making the leap. If all you’ve ever known is working for startups, then you’re probably wondering what all the fuss is about since you’re getting raises and promotions along the way. Ignore my post because it’s better you not know how much better you can do if you fly to another planet.
Here’s an amazing letter by Mattermark founders who sold themselves for only $500,000 in cash and stock to FullContact on 12/20/2017. They start with “great news” and then say your common equity is worthless.
“Dear Mattermark Common Shareholders,
I’m reaching out to share some great news: Mattermark is being acquired by FullContact! We are happy to have found an exit for our shareholders, and are working hard to close this deal immediately. Your help is kindly requested to keep an eye out for docs in Doscusign so we can get your signature today.
This is a private stock transaction, and unfortunately the consideration for the purchase of the company did not clear the preference of Preferred shareholders so Common stockholders will not be receiving anything in this deal (cash or stock). Though this is not the outcome we all dreamed of when we embarked on this journey nearly 6 years ago, we are super grateful to have worked with you to organize the world’s business information and would appreciate your signature so we can get the majority of common holder signatures needed to close this deal today.”
And here’s a quote I found from Tara Hunt on Quora:
startups are hard.
startups are really hard.
startups are really fucking hard.
startups are heartbreaking.
startups are soul-crushing.
startups are life-shortening.
you can do EVERYTHING right and still die broke.
q. so why are we doing this again?
a. fuck if I know!
I know why we join promising startups or start companies of our own Tara. We do it because we love to dream. We think we can solve problems. We think we can take on the world! Until the numbers are called, there’s always hope that our lottery ticket might be worth something.
Start Your Own Website, Be Your Own Boss: Instead of being a startup employee, why don’t you just start your own website and be your own boss? Own your brand online and earn extra income on the side that might one day morph into full-time income. Why should LinkedIn, FB, and Twitter pop up when someone Google’s your name? With your own website you can connect with potentially millions of people online, sell a product, sell some else’s product, make passive income and find a lot of new consulting and FT work opportunities.
Financial Samurai started as a personal journal to make sense of the financial crisis in 2009. By early 2012, it started making a livable income stream so I decided to negotiate a severance package. Years later, FS now makes more than I did as an Executive Director at a major bulge bracket firm with 90% less work and 100% more fun. Learn how to start your own website today with my step-by-step tutorial guide. You never know where the journey will take you!
Updated for 2020 and beyond.