The company recently got $3M investment. I’m being offered $152k salary and 2% equity, vested over 4 years. Is this good?
My thinking is that 2% of $3M is about $60k, so I could treat that as an extra $15k per year. But if I look at the valuation based on that investment, it is probably worth 5x that, like an extra $75k per year. All in all it is over $200k compensation, which I’m grateful for, but it’s on par with a tech job at a big tech company. Are these reasonable assumptions, or am I missing something?
If the company recently raised $3M, it’s considered a seed stage company and is likely valued at $15M by its investors. Your 2% equity stake would actually be worth $300K on paper right now.
If things go well and the company hits $1M-$2M in annual revenue in the next 12-24 months, the founder(s) will raise another of funding, probably in the $10M range, which will be considered a Series A financing that values the company somewhere in the $50M range. Your 2% ownership stake will get diluted to 1.6%, but with the increased valuation, your paper position increases to $800K.
If the company continues to do well, say triple its revenue over 12-18 months, the founders will raise a Series B round of funding, probably somewhere in the ball park of $30M, which would likely value the company around $187.5M. You’d get diluted down to 1.3ish%, but your paper position would hover in the $2.5M range.
If the company sold at that price, this would be a great outcome for an early employee. An incredible outcome, however, would be IPOing or exiting for $1B+, where you would likely make 8 figures.
The catch however, is that only about 100 companies or so out of a couple of thousand funded every year go the distance, and something like 60-80% flat out fail… That is, your paper shares ultimately are worth zero. So you have to decide whether you really believe in the team and the opportunity enough to risk having to look for another job in 12 months because things aren’t working. At a minimum you’ll get paid to learn what it takes to get a tech startup off the ground.
This is spot on!
On top of what everyone else is saying, it’s also important to realize that as an early employee with a large equity stake, you will have a large responsibility for creating the success outlined here. This isn’t the kind of thing where you hope that the company does well and you profit. You are the company (well, a big chunk of it at least).
This is the happy path.
The unhappy path is not actually that it all crashes and burns quickly but that it grows slowly and you put years into a company that goes nowhere.
OP should make sure they have enough visibility into the business to understand how the actual business is going so that if things are not actually going well, they can bail. That should start with knowing not just the funding raised, but the total valuation. But they should ask them about their business metrics (if they have any).
Having said all that, 2% is an abnormally large chunk of equity unless they are employee #1, and unless you are actually making a big sacrifice to be here, it sounds like they value you.
Not to take the wind out of a very, very good high-level breakdown, but there are many, many ways for equity to be worthless even if the company appears to have a good outcome.
Just to add a bit of a devil’s advocate as to why options should be mentally discounted from “optimism math” scenarios
Great explanation of how startup equity works (and why early employee equity is typically “worth more” even as they get heavily diluted).
But would love better numbers around the failure case for the employee, because at seed-stage it’s probably 95% or higher.
Many successful IPOs aren’t so successful for early employees - most public companies trade below IPO price when employee lockup periods expire. If you join a year before a successful IPO, it’s not uncommon for your options strike price to be above the fair market price once you can sell (meaning your options are literally worthless). A high valuation pre-IPO can wreck employees equity.
As a seed / Series A employee, there’s a good chance you’re fired or quit and choose not to (or can’t afford to) exercise your options. Would you pay $50k to buy a lottery ticket that is probably worth $0, and you might not know for 5 years?
Pro-rata rights + dilution can obviously destroy early equity. If your company has a bad year and then recovers stronger than ever, that bad year might destroy your equity. There are a million ways for later-stage investors to fuck over current equity holders, and while your exec team doesn’t want that to happen sometimes they don’t really have a choice.
So my tips:
This is all good advice to strongly bear in mind.
I think the absolute failure rate of startups is probably 95%, but the failure rate of venture-backed startups is about 75%, pretty much in the middle of your high and my low, according to a 2022 Harvard Business School study (“The Venture Capital Secret: 3 Out of 4 Start-Ups Fail.”)
Would only add that there are a fair number of service providers these days that will help employees exercise their options if the company is up and to the right. Might have to hand over a thirdish of your shares but you won’t have to come out of pocket for them.
i did the start up thing as an early hire for a bay area based company that let me work remotely in NYC and would fly me out to Oakland every 6-8 weeks to work in person / eat burritos…
they were in an incubator and got some funding so I was their first hire…got them through seed round funding but when runway was starting to be counted we parted ways…having the experience of building something and seeing it get funding though changed my perspective on my abilities…i’m an introvert but was able to deliver shit that was well out of my comfort zone and since then it’s helped me land better / higher position jobs so it wasn’t all bad…kinda funny / small world shit because the VP of Eng at my company now was on the board of advisors for the incubator, and the prototype I built out that got funded was one of the more successful stories out of the early classes from that incubator
having the knowledge and going thru the process at least once of raising funds to turn an idea from nothing into a company was worth it though
Great post
How? Even if its a US only thing why have I never heard of this? If you own 2%, you own 2%. What if you owned 98%, are you saying the founder could just raise his magic wand and make it disappear?
Think about it this way - before a new investment, the existing shareholders own 100% of the company. In order for a new investor to get equity in return for their investment, let’s say 10%, the existing shareholders have to collectively give up 10%, and their total is reduced to 90%. After the investment, the total ownership is again 100% (90%+10%).
Thanks thats a good example I can work with. You explained this very well. So your benefit (for giving up 1% of your 10%) then is just the raised evaluation?
Yes, that is an option the existing shareholders have. However, they also have the option of issuing more shares to give to the new investors. Which is what everybody has been trying to explain here. If they have 100k shares but want to take on a new investor and say that investor wants 20%… The shareholders have the option of giving up 20% of their existing shares (20k. Leaving them with 80k) OR they can issue more shares so they don’t have to give up 20k of their shares. If that’s the case, they would issue 25k shares to the new investor bringing the total amount of shares to 125k. 100k still owned by the original shareholders and the newly issued 25k shares to the new investor. 25k shares would then represent 20% of the company and the original 100k shares would be diluted down to 80% of the company.
Issuing more shares is how dilution is done for new investment, typically. Existing shareholders give up a % of the company via dilution, but hold on to the number of shares they had before. Their existing shares just represent a smaller chunk of the company after investment. I can see how my explanation was not clear on what is being given up, and I don’t think giving up actual shares happens often, if ever.
On a side note, startups do sometimes reserve shares for future investors, i.e. hold it themselves until disbursed. Typically when a new investment round is imminent.
there may be an opportunity to sell earlier in secondary markets pre IPO/acquisition
By far the most simple explanation I’ve seen. Kudos