Thursday, July 9, 2015

Ask CJ: How much should I ask for in equity?

A respected reader writes in with this question: 
There's potentially an opportunity for me to take a job at a startup company. They're small. Currently [n < 5] employee[s] small, have been around for [n < 3] year[s]. 
Taking this would be a big pay cut (but still being paid) but I would get equity. How do you assess what is reasonable compensation in terms of equity? 
In terms of risk, obviously it could fail, my equity would be worthless, and I'm out of a job. Are there are other more subtle risks I'm not thinking of? Thankfully it's local, so I wouldn't need to move for this.
I have no idea how this sort of thing works; undoubtedly there's some sort of "what percentage of a company do founding members get" convention that readers know about that I do not.

I presume that there's two possible ways to calculate this:
  • How much is this company worth, in the best case? How much of that is the ownership willing to give me? 
  • What kind of a hit am I going to take by working here? What portion of the company's future revenues will make up for that actual hit to my salary? 
I am obviously looking at this all wrong, so readers, please correct me. 


  1. I've never done it myself, but I'm thinking similar to CJ--can you come up with some projected best-case scenario outcomes for the company over some reasonable time span (somebody there must have run numbers like that), and then make sure you would have enough equity to bring you a lot more money than you would have made at the higher-paying job over the same time span (and it should be *a lot* more, because the estimates are probably unrealistically optimistic, and the company is most likely to fail anyway).

    Another important question is do you think it would be a really fun job? If you're giving up a job you aren't that keen on and taking up something really exciting, that could make you more willing to tolerate the financial risk than if you're looking at this new opportunity solely as a money-making venture (provided the new job will at least pay you enough that you will be able to maintain an acceptable quality of life).

  2. This is a hard question to answer, nearly impossible if you're not one of the execs. There's so many confounding factors that make it hard to keep track of things. Always approach a startup as if the stocks are going to be worthless because most of the time they are. So how big of a hit is the salary? If you weren't getting stock would you walk away? That's the decision you should make.

    To elaborate a bit, the biggest factor is what the payout for the preferred stock is. Preferred stock is what the investors get, you get a share of common stock. They are VERY different and entitle you to different things. In every case, preferred stock gets paid out first. The investors will at least get their money back, but odds are they have some type of incentive that allows them 2x or more payout on their investment. Whatever is left over is what gets split between common stock holders. That means even if your startup is successful and gets bought or goes public, if the incentive on preferred stock is high you could very well still walk away with nothing. Dilution of stocks (ie; how many stocks are out there) also makes a huge difference. If you have 100,000 shares of a company that has 1,000,000 shares floating around, that's going to end up less valuable than 100 shares of a company that has 500 shares floating around. But your offer letter is just going to say "We're offering you X shares", it doesn't include the amount floating around and it can't. Knowing how many shares are floating around is something that is dynamic and changing, so it's hard to keep track of it. Keep in mind there's a vesting schedule too, so if you join the company and it's ultra successful and gets bought/goes public quickly you won't get all of your stocks, you'll get a fraction of them. Most commonly it's a 4 year vesting period with the 1st year being all or nothing and the subsequent ones being prorated (ie; if you get bought in your 1st year you have 0 stocks).

    I could go on, but this is long enough to be an unattractive read. I suggest you look into this issue, it's an important one for people who are considering joining startups.

  3. All of the above is accurate. I would add only to see a good business attorney to at least point out the language codifying what Dr. Mindbender has outlined. Not the company law firm. Unless you have founder shares or a large amount, you will not get rich.

  4. I've been in the exact what Dr. Mindbender said.

    As the company grows and more rounds of financing are secured, more shares are created, diluting down whatever you were given. And you should always lobby for more shares whenever more financing is secured. It looks good on paper, but from my perspective working in such a company is good for 1) getting in on the ground floor and advancing as the company grows, and 2) the experience, and it will be a roller coaster ride. And if you have an entrepreneurial spirit, it can be a load of fun. For all of my ups and downs, it was generally a fun ride. If you're in it for the payout, buy a lottery ticket instead.

    The downside is that when the company fails or gets Pfizered you're not much more marketable than you were before, despite whatever experience you gained. If anything, you're less valuable than you were coming out of your post-doc. This is my long-winded way of saying: If you step into the startup pool, be prepared to be there for a while, hopping from one startup to the next. Getting out can be tough.

  5. I am on the reverse side of this equation, being "sole" owner of my company. Here's what we do - if we cannot offer employees at least the median salary based on their degree, expected responsibilities, and experience (using ACS and AIChE salary info as a guide), we make them whole with equity. We calculate this using a 5-year return basis, since we will either be out of business or successful in 5-years time (the return basis for your scenario might be different based on the start-up's business plan - if you haven't seen this yet, it should be part of your due diligence effort). There is no doubt this is a risk because if the equity has no value in X-years, you've worked for all that time at a lower salary basis, which may effect earning potential for the rest of your career. Of course, if the company is bought or IPOed, you have the potential enjoy a much larger benefit than what you lost in salary. I think you need to look at other, less tangible benefits (and drawbacks) of working at a start-up in order to make an informed decision....maybe the location suits your needs (or maybe not), maybe the science is really exciting (or maybe it isn't), maybe you enjoy the rewarding, but stressful, start-up environment (or maybe you would hate a high-pressure environment), etc.... I hate to speak for my colleagues, but I think everyone here really enjoys being involved in every aspect of our business and having an impact every day they are here.

  6. Anon 658 am has a good point that if you'll enjoy the job much much more it may be worth taking the pay cut.

    As to how to value equity in a "pre-IPO" (note, I find this a very misleading term) I would suggest assigning it 0 value, or valuing it as you would a pile of lottery tickets (read: warrants). As Dr. Mind points out, from now until (if ever) the company goes public your shares will be diluted mercilessly, and you'll likely take another hit should the company prepare to go public and enacts a reverse split---and they ALL do. If possible, you could have a ratchet clause in your contract which would keep your % ownership of the company the same, but you may then need to pay for said additional equity. Also make sure to check the capital structure of the company. I'm often surprised that even tiny biotechs can have substantial (relatively) amounts of convertible debt that may or may not be included in the company's share count. When negotiating % equity be sure to specify all-in share count, including warrants, options, and converts.

    For me, if the technology were truly promising and I were the 5th employee I'd be looking at 1 to 3% of total equity.

    Of the dozens of chemists I've known who've gone to work for startups, precious few have realized any real gain from shares. When it does work, though, it can be pretty spectacular and life changing.

  7. This all was very helpful and informative!

  8. Not knowing the details of your situation, Generic - I recommend the following: If you're young and single, go for it. If you have people for whom you are responsible (wife, children) I would thing twice, three times, four times before risking their future before jumping. "Equity" does not put Kraft Mac and Cheese on the table, make co-pays for doctor's visits or put a new transmission in your car when it craps itself on the side of the road.