When everybody seems to be getting rich but you, it’s a disconcerting feeling. However, after 20 years of living in San Francisco, the startup capital of the world, I say that if you want to get rich, don’t join a startup.
We always hear about hugely successful startups in the news. Names such as DoorDash and Airbnb are the flavors of the month. With monster post-IPO share price performance, thousands of new millionaires will flood the San Francisco Bay Area. However, we seldom hear about the failures or the zombie startups that end up treading water for years.
Most startups either fail or have a mediocre exit. As a result, the below-average salaries employees earn to join a startup in exchange for equity often ends up being a bad trade. Employee shares are either diluted away or early investors have a ratchet clause that make them worthless.
When a startup does get bought out, it is the founder or founders who usually walk away with something meaningful. Sizable payouts typically aren’t going to the employees who helped make the founders rich. Founders know this, and sadly, they often still don’t try to take care of their employees once they receive their liquidity event.
In my quest to prevent people from entering startup purgatory, here is a new case study of how the founder of Baremetrics, Josh Pigford, walked away with millions while his employees were left with peanuts.
Pigford was very transparent, which should help future startup employees make better employment decisions.
Don’t Join A Startup: Baremetrics Case Study
First, I want to make it clear that I admire anybody who takes the risk to start a company. Without such entrepreneurs, there would not be as much innovation and opportunity for millions of employees.
Founders deserve to get rewarded. However, my goal is to help the majority of people who are not founders. Over the years, I’ve spoken to hundreds of startup employees, most of whom didn’t have extraordinary gains.
Baremetrics, a business analytics software company, was founded in 2013 by Josh Pigford. Seven years later he sold it.
Here are the acquisition details from his blog post.
- Purchase price of Baremetrics: $4,000,000 in cash
- Josh walked away with: $3,700,000 in cash
- Multiple: ~2.65x ARR (low multiple due to lack of growth and profitability)
- Buyer: Xenon Partners (tech private equity firm)
- Close Date: November 2020
- Earnout: None
- Payment Structure: 3 payments (at close, 12 months & 18 months)
Being able to eventually walk away with $3,700,000 in cash is a great achievement. I congratulate Josh on his sale.
After taxes, Josh will net somewhere between $2.22 – $2.59 million using a 30% to 40% effective tax rate. He is now one of the newly-minted millionaires in America.
Given ~90% of startups fail or fail to have a liquidity event, 99% of startups that have a liquidity event sell for less than $10 million.
The Baremetrics sale for $4 million is a common sales prices for companies that do sell. The $100 million+ or $1 billion+ exits you read about in the news, however, are rare and get all the attention.
How Did The Baremetrics’ Employees Do?
If you are considering joining a startup, this is the section that should most interest you.
Given the purchase price was $4,000,000 and the founder received $3,700,000, his 10 employees were left with $300,000. In other words, the founder received 92.5% of the final sale and his 10 employees received 7.5%.
$300,000 divided by 10 employees equally ends up only being $30,000 per employee. It is my understand Baremetrics had 10 employees or had 10 employees at one point.
After seven years of working at Baremetrics for below-market salaries plus equity, the average employee walked away with just $4,286 a year in stock compensation ($30,000 per employee / 7 years).
College interns make more than $4,286 a month at most tech companies. Clearly, receiving a payout of $30,000 per employee after seven years is disappointing. Even if there were only seven employees splitting the $300,000, that would still amount to only $42,857 each.
When you join a startup, you often have to take a 20% – 50% salary discount because you are receiving equity that will hopefully pay off big. Let’s say the average salary was $120,000. That’s a 30% discount to the $171,000 the average employee could have made working elsewhere.
This means after seven years, the employee missed out on $357,000 in wages ($51,000 X 7) and got back just $30,000 from the company sale. The net missed compensation is, therefore, $327,000 per employee.
$327,000 is a 20% down payment on a $1,635,000 house. $327,000 can pay for all expenses for four years at a private university. Missing out on more than $300,000 in compensation could result in delaying retirement for 10 more years!
Even if the missed compensation was only $100,000 or $200,000 over the seven-year stretch, that’s still a lot of money for the average person. Remember, one of original goals for joining a startup is to get rich, not lose money.
How The Founder Could Have Helped His Employees
Founders are under no obligation to compensate their employees more than what their contracts entail. Employees made their own decision to join the startup and should live with the consequences.
However, in Baremetrics’ case, there was a special situation. In 2014, Baremetrics received $800,000 in seed money from two investors: General Catalyst and Bessemer. Both are venture capital firms.
Instead of asking for their seed money back due to the sale, General Catalyst and Bessemer inexplicably forgave the entire $800,000 amount upon sale. Great news! The founder didn’t explain why the investment was forgiven. I’ve never heard of such a thing happening when the sale price is higher than the initial investment.
Forgiving the entire $800,000 seed investment is equivalent to giving up the investor’s entire equity stake. Let’s say back in 2014, the $800,000 bought a 20% stake in Baremetrics for a $4 million valuation back then. A 10% – 30% stake is usually the percentage stake seed investors get.
General Catalyst and Bessemer giving up their 20% stake now makes it more understandable how the founder was able to walk away with 92.5% of the sales price ($3.7 million out of the $4.0 million sale).
If General Catalyst and Bessemer hadn’t given up their 20% stake, the CEO would have “only” walked away with around $2.9 million, or 72.5% of the sale. 72.5% is still an impressive amount owned by a founder.
Share The Wealth (Or Not)
Given the 10 employees only received $300,000 on the sale in aggregate and given the CEO walked away with an extra $800,000 for free, what the founder could have done was distribute the seed investors’ 20% stake to the employees instead.
After all, why should the founder get to benefit 100% from the free $800,000 when his 10 employees spent years helping him build the company?
The CEO would still walk away with a handsome $2.9 million gross and each employee would walk away with a more reasonable $110,000. That would be a win all around.
Worst case, the CEO should have split the $800,000 based on a percentage ownership basis. Alas, no such thing occurred.
Employees Get Short-Changed
M people would agree that spreading the free $800,000 to employees would have been the right thing to do. This is especially true when each employee received so little after the sale.
However, it is human nature to try and maximize your own financial interests first. Self-interest is why politicians sometimes don’t follow their own rules.
One hypothesis for why the free $800,000 wasn’t share is that Pigford and his employees didn’t get along. This may have been one of the reasons why he wasn’t willing to stay for higher incentive bonuses as he wrote in his blog post. He wanted all cash and he wanted out immediately.
You can’t fault Pigford for hoarding most of the spoils. This is America where it’s every man and woman for him or herself. However, there’s a growing dissatisfaction with this type of “winner-take-all” mentality.
Maybe The Employees Were Actually Saved
There is another way to look at the non-distribution of the $800,000 to employees. Maybe Baremetrics was about to go under, which would have meant laying off all employees.
In such a scenario, finding an acquirer who promised jobs for the employees would be the best option. Further, walking away with an average of $30,000 in equity is better than walking away with zero equity and a job loss during a pandemic.
This would make for a nicer story. However, if it was the case, it would have been publicly shared. Therefore, Baremetrics going under probably wasn’t an imminent scenario.
Percentage Ownership Of The Startup Matters
There is something else perplexing. Since you can’t count on investors forgiving their investment, how do 10 employees who make up 91% of the company’s headcount only end up with 7.5% of the company?
This is one of the most asymmetric risk/reward situations I’ve ever observed. In an intimate 11-person company, you would expect the employees to own 20% – 40%, not just 7.5%.
When you decide to join a startup, you are usually taking on too much risk for inadequate compensation. Your 0.5% – 2% equity stake is not going to do much to make up for your below-market salary.
Think about it. Even if you get a 2% stake in a company that sells for $100 million, you only walk away with $2 million before tax and likely dilution. Just don’t forget that less than 1% of startups ever sell for $100 million or more. Don’t let your mind play tricks on you. Crunch the numbers.
While your startup founder may be busy telling everyone on social media he’s buying a $100,000+ Tesla Model X with ash wood interior and paying off his mortgage, you will likely just be hoping the acquiring company doesn’t lay you off.
Related: The Importance Of Stealth Wealth
What Employees Should Do Instead
If you insist on joining a startup, you must do the following:
- Ask what percentage of the company you will own after receiving your equity offer. Don’t just accept a random share count and be happy. Specifically, ask about your ownership percentage.
- Pretend you are an investor and do the math regarding how much the startup could realistically sell for and to whom. The best measure is finding comparable companies that sold. Now take your equity stake and multiply it by the potential sales price. This is your maximum take because you may be diluted over time due to new investors.
- Ask for so much more than you are being offered. Remember, most startups fail or go nowhere. Therefore, it’s best you fight for a higher salary in addition to more equity.
- Join as a co-founder for more aligned risk and reward. Or, join at the Series C or later stage where you can command a higher salary and have a much higher chance of a successful liquidity event.
The Better Way To Go
Instead of joining a startup, start your own business so you can own 100% of the equity. You don’t have to quit your job, raise funding, and hire employees immediately. Instead, start a business on the side while you have a day job and slowly work your way up.
Once you’ve gained enough momentum, then consider working on your startup full-time. From there, you can hire people to take massive risk to get you rich instead. One of the greatest ironies is seeing so many well-educated MBA types take the safe route and do business development.
Once you start a business, you might as well look for investors who have a history of forgiving their investments in other businesses as well. After all, venture capitalists are investing other people’s money, not their own. If you find such generous investors, court them, and make sure they provide the same treatment to you.
Keep Your Startup Expectations Low
So long as you set low expectations about getting rich, joining a startup is fine. You will probably receive more responsibility and do more things than if you join an established firm. This learning phase can be vital for you getting rich down the road at a new startup or established firm.
However, if you are getting paid peanuts, don’t have much equity, and are getting worked like a dog, please find another job. If there is ever a liquidity event, you will likely become one bitter cookie.
Don’t join a startup if you want to get rich. The ~6,000 employees at Airbnb and the ~3,300 employees at Doordash are the exception, rather than the rule. We will hear of more exceptions over time. However, just remember that most startups fail.
I’d rather be an investor in startups instead. This way, when the startup fails, all you lose is money instead of also your time.
Even better, for the average person, own real estate in a hot startup ecosystem. If you do, you will likely win with capital and rental appreciation, regardless of which startup hits it big!
Two More Downsides Of Joining A Startup
After publishing this post, I realized there are two more negatives of joining a startup.
The first is that a startup will unlikely offer a 401(k) match. Some startups don’t even offer a 401(k) plan. An employer can technically contribute up to $37,500 to an employee’s 401(k) for a total of $57,000 a year. When I left my employer in 2012, I was receiving over $20,000 in employer profit sharing that went to my 401(k).
Further, if you join a startup and eventually want to leave, you will unlikely be able to get a severance of any significant value. This is especially true if the startup is unprofitable and under 100 people. In such a situation, this means you may not even get the mandatory 2-3 months of WARN Act pay that larger companies must pay to laid off employees.
Over a 5-10-year period, these two benefits could equal hundreds of thousands of dollars.
Bottom line, don’t join a startup if you want to get rich. Join a startup to learn. Or, join a startup if you are already rich and want to try new things.
Readers, do you agree with my belief that you likely won’t get rich joining a startup? Do you think people are too easily swayed by the mega successes?