The Downside For A Startup Getting Acquired

Downside For A Startup Getting Acquired

Every single startup's dream is to get acquired or go public for big bucks. However, there is a downside for a startup getting acquired as well. Mainly capped upside and employees getting screwed.

In the fintech world, the startup 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.

A Startup Getting Acquired

For example, BlackRock acquired FutureAdvisor, a robo-adviser based out of San Francisco. 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.

Because we are focused on the downside of a startup getting acquired, 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.

See: Baremetrics Case Study On Why You Shouldn't Join A Startup To Get Rich

No Employee Gets Much Equity

The biggest downside of a startup getting acquired is that many to the employees get jack shit. They are either diluted away or there are ratchet clauses that screw over empoloyees.

The only people who get much equity are the founders. Even if you are one of the first 10 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.

Examples Of Not Getting Much

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.

Low-Level Employees Get Little

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.

Equity Compensation for Startup company

The Power Of Hope In Getting Acquired

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?!

Winning The Lottery

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 Of Getting Acquired

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 ~$1.6 million in 2021. 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.

Investor's Point Of View

From an investor's point of view, I hate it when a good investment ends. If you invest in private alternative investments like real estate crowdfunding, there is a point where your investments will be paid back.

Once the capital is return, 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!

Recommendation For Entrepreneurship

Start Your Own Website, Be Your Own Boss. There's nothing better than starting your own website to own your brand online and earn extra income on the side. 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! Start your own WordPress website with Bluehost today and own 100% of your equity. You never know where the journey will take you!

Recommendation For Leaving A Job

If you want to leave a job you no longer enjoy, I negotiating a severance instead of quitting. If you negotiate a severance like I did back in 2012, you not only get a severance check, but potentially subsidized healthcare, deferred compensation, and worker training.

Since you got laid off, you're also eligible for up to 27 weeks of unemployment benefits. Sometimes there are enhanced unemployment benefits, like during a pandemic or a recession. Having a financial runway is huge during your transition period. 

Conversely, if you quit your job you get nothing. Check out, How To Engineer Your Layoff: Make A Small Fortune By Saying Goodbye, on how to negotiate a severance.

I first published the book in 2012 and have since expanded it to 200 pages from 100 pages in the latest edition thanks to tremendous reader feedback and successful case studies. Walk away with money in your pocket! Both my wife walked away with six-figure severance packages.

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Updated for 2020 and beyond.

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26 thoughts on “The Downside For A Startup Getting Acquired”

  1. Do you know how many total shares FutureAdvisor had established? (not sure that’s the right term). e.g. If someone was offered 20,000 shares to join a started up, and if you didn’t ask, how many more shares are out there in total if only a Series A funding has occurred within the last 18 months? Is there a typical amount or way to estimate?

  2. Rob from Munich

    Hey Sam
    Been a while since I’ve commented but Planet Money (my most fav podcast) did an interesting episode on Netflix which is in essence a start culture. At Netflix you’re not hired for a job but as a team, once your no longer productive you’re cut. Not surprisingly a lot of negative comments my comment was this makes total sense in the tech field where today your hot and tomorrow you’re out, RIM for example, but not for the broader economy.

    Worth listening to.

  3. I think you’re overlooking another reason to join a startup – career transition.

    I just joined a very small (but profitable) startup in SF. I am being paid 20% more than my previous job, received a small amount of equity and was allowed to purchase my options immediately for pennies. I’m doing this for the experience and the paycheck. Any pay off due to the equity will be gravy – I’m not planning on it.

    I had tried getting into the field (Biz Dev) with larger companies but were ignored due to my lack of specific experience. Here in the startup world, I was valued not only for a specific skillset or background, but for my subject matter knowledge and appetite for growth.

      1. Sam, I’m 30… no kids but married. This is a last ditch effort to do something I have a passion for rather than live the cubicle life forever.

        My salary is $125k with bonus potential of another 20% on top of that depending upon performance.

        I graduated in 2007 (worked full time and went to night school – it took a while).

        1. Good stuff making the move! $125K is a great salary from $105K. If you’re making that level of income, and got a raise, then that’s not a difficult decision to make. Hope it works out.

          This post though, is about the downside of getting acquired. It’s someone gotten to the “downside of working at a startup” theme instead.

  4. Been working in silicon valley starting with Netscape in the 90s. Done startups, done the big companies.

    The likelihood of hitting a payday with an early startup are very low. There’s a reason it’s called the IPO lottery ticket by the non founders. You might hit it big, and the news is full of people doing just that. But the odds of winning are very low.

    If financial success is what you’re looking for, working a big company and having a high savings rate is the way to go. If you’re smart and good you can get a position in a fast department in the company, e.g research lab or other hot project, so you still get some far paced experience.

    Do a startup if you want, but don’t think you’re going to get rich if you’re not a founder.

  5. Great chances to take, and probably good experience gained from this type of thing early in a career. Many years to make up if things don’t pan out, and at least you can say you have no regrets (to not try the startup life).

    If I had the perfect choice, I would think that a late stage growth company would seem to be one of the best opportunities. Today, I see that as Uber, Facebook, and Amazon in the tech space. Equity is still significant, but salaries are generally at the market level so you’re not taking all that crazy risk for the wishes and hopes that the equity will give a 10x return.

    I work in corporate finance, and the best opportunities I’ve seen in non-tech areas are junior executive roles at mid sized PE-owned companies. No more unicorns, but more of companies that need to be restructured or merged in some way… as well as a very strong and motivated owner (PE company). Market salaries, plus some equity, and generally a bonus or some other incentive structure for the desired exit (IPO, spinoff/divestiture, etc.). Probably a like 1-3x return on equity plus a market salary in between. Fun times! Obviously this varies, but that would seem to be a neat area to play in someday.

    1. Actually, salaries are definitely not at market level for pre-IPO companies like Uber.

      For example, I know a 40 year old lawyer who only makes $180,000 in salary a year at Uber. He can easily make double that at an established firm or in Big Law. He gets hundreds of thousands in Uber RSUs at a $50B capitalization. Maybe it is a double or triple.. but that’s a maybe. Meanwhile, every year he works at Uber means $180,000 a year less in salary he could have made elsewhere, and he is working 70+ hours a week for sure. In five years, he will have forgone over $1 million in salary.

      I like your suggestion of a junior exec role at a mid-sized PE-owned company! I’d take a 1-3X return on equity plus market salary any day. Way more exciting.

      1. Maybe Uber isn’t quite there yet! My mistake.

        Still think small/mid-sized PE owned companies are a hidden opportunity. Wish that was a better informed area, but for obvious reasons they don’t go around advertising things. I would think people in the area probably have an idea. May also be great to get noticed by a big PE shop and they may bring you from project to project as you perform.

        So much opportunity!

  6. John Pearson

    I think another significant factor that is missing from your projections are the better benefits and retirement savings/matching offered by larger, more stable employers. Most of the benefits at startups are laughably lackluster- 3% or less 401k matching is the norm from what I’ve seen at startups, crappy healthcare, etc. where as the more successful larger enterprises offer 10% and more (in addition to pensions, profit sharing, yearly guaranteed bonuses) These additional retirement savings add up to a lot in the long-run, and also allow you to dedicate less of your paycheck to retirement than if you worked at a small start-up getting a measly 2-3% match.

    Startups tend to mask their benefits shortfalls by offering catered lunches, ping pong, etc. etc. it’s just a distraction for millennials who aren’t retirement-minded from what really matters.

    Experience? I think you can also get the same experience working for a large multi-national enterprise/Fortune 500. These are the guys startups end up hiring once they’re further along, anyway.

    In the end, nothing beats becoming a founder and owning a large stake in a successful exit. But I would agree that overall, being an employee at the startup with no significant equity is probably not ideal, and you’ll be working 60-80 hours a week.

    1. You are exactly right about the inferior benefits. Many startups I know have ZERO 401k match. That adds up over time. My old firm not only did a 3% base salary match, but also annual profit sharing that would often equate to another $20,000 a year into the 401k account. That’s $250,000+ after 10 years that can compound even further tax free for retirement.

      I do like the idea of trying both… work a higher paying job while starting your own startup on the side and seeing if it grows big enough to allow you to dedicate 100% of your time to it.

  7. The better strategy would be to take the high paying job and maintain a high savings rate. One of the uses of the surplus would be to invest in a start up or a more established company. That way you can capture on the potential upside without giving up earning power. Or course if the company becomes a doughnut then the investment is lost.


    1. That’s definitely what a lot of angel investors are doing now. The problem is, liquidity as well as those losses.

      I invested $75,000 in a company 8 years ago that is thankfully still around, but I’ve received $0 return since. I’ve written it off… but secretly hope I can at least get my money back.

  8. A start up will not guarantee you success but its a process of learning on how to become familiar of the business sequence that you are into. There would be lots of ups and downs that will harness your experience on the process. You might loss but the learning is one of the best profits that you will ever have. However considering that you will be spending an investment on your business it is much better to be prepared before jumping into it. Remember there is no easy way to success. It requires time effort and hardwork and more research to compete against the changing technology.

  9. I agree with your analysis.
    Additionally, as a risk-averse individual, the appeal of working for a well-established company outweighs the appeal of working for a newer startup for me.
    I admire people who enter and exit a startup at the right time and making it big, but I believe that working for a bigger company would both provide me with more job security and open up more opportunities down the road (who isn’t impressed when you say that you worked at Goldman for over a decade?).

    For example, paying your dues at a big corporation, then Negotiating your Severance Package (your specialty), and THEN trying to strike it rich at a startup sounds WAY more appealing to me than just starting at a startup from the beginning.

    1. Hi Elle,

      Thanks. I guess there’s many ways to cook a steak. It’s very hard to know what will make it big in startup land. Hence, whoever does get rich in startup land might very well be do to luck most of all, since the math says most don’t come close to matching a market rate compensation package over 5-10 years.

      The other takeaway after spending 2 years in startup land consulting, observing, and speaking with people is….. if you’re going to be in the startup atmosphere, you might as well start your own startup and have a large pie. Go big or go home!

  10. The intangible benefit is experience. I left a safe/large co for a startup and slaved away for a decade while I watched my ex-colleagues collect their bonus checks, patent awards, and 401K match.

    After my startup went bankrupt, I ended up joining the same large company I left as an executive managing folks who were my seniors while I was there before.

    Things work out. Go for the experience.

    1. That’s true, but at what point does the financial reward outstrip experience? A decade working at a startup for it to go bankrupt is a long time. Do you know what the financial differential is during this period?

      If one is to slave away, there should be a reward beyond just the experience I would think. Were the founders able to cash out at all during this time period?

      For example, Jawbone is a private company, but the founder bought like a 100 acres in the Yellowstone Private Club b/c he got liquid.

  11. On a purely financial level, based on those numbers, the risk adjusted return after vesting period shouldn’t be considered high enough in option 1 for most people. If they’re not doubling the return of option 2, it’s not worth it. But consideration for workplace, coworkers, perks, learning on job, etc. Makes it worth it for some folks.

  12. My startup went through strategic bankruptcy to shed an unwanted board seat voting interest, then immediately reformed and was acquired by a major auto OEM. Lost in the shuffle… my engineer’s shares. Luckily my salary was market rate, because I walked away with salary, experience, and nothing else.

    I agree with your view that hitching a ride on somebody else’s startup isn’t an optimal strategy.

    1. That is quite strategic….. does that seem OK to you? I guess, what is the alternative.

      I’d rather create my own company and be more in control of my own destiny. But of course, there are sometimes amazing rocket ships… like joining Google, FB, etc.

  13. Great analysis. I think that an employee joining a startup shouldn’t see it as a path to wealth but a learning experience for when they want to start something of their own. The probability you get to cash in that lottery ticket, even if not for the top prize, is low but you’ll learn a lot in the process.

    One other thing to consider with your two compensation packages is what happens in year 5, 6, 7, … the less exciting option 2 only becomes more appealing in future years. Boring company will continue to give you raises, more responsibility, more income. The startup is less likely to last that long before a liquidity event of some kind and, assuming you don’t stay, you start the clock over again.

    Lastly, at a certain point in your life, a lottery ticket stops feeling so exciting when that’s what you’re relying on to put food on the table for your kids. Slow and steady is fine, work can be boring and low stress, and life and family can be what excites you.

    1. Larry @ Investor Junkie

      Jim is correct, working for a startup is a lottery ticket. You should never see it more than that.

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