You’re a software engineer being recruited by a startup. They’re offering you a salary that’s a bit (or a lot) below what you should be making, but they’re throwing in equity. Seemingly a lot of equity. They say they want you to be “highly incentivized” and “participate in the company’s success” when it gets big.
Dollar signs are in your eyes. In your head, you hear “Big Pimpin’” (NSFW) playing in a loop. You can’t wait for the next high school reunion, when your helicopter blows the doors off the gymnasium.
Hold your horses, cowboy. Before you buy those shiny new boots, you owe it to yourself to do some math.
You might have been given ISO’s or RSU’s at a prior job, but those were just a nice bonus if they panned out. How do you value equity at a startup when you’re the first (or second, or fifth) engineer on the team, where the equity is being used as a significant counterweight to the lower salary?
Understanding the expected value of startup equity
In order to put a value on the equity you’re being offered, you need to understand the current percentage stake represented by the shares, the option vesting period, the company’s current valuation, odds on the possible exit values (hint: a $0 exit is very likely), odds on new dilution events (i.e., odds that the company will have to raise more money, thereby diluting your share), and even things as esoteric as “investor preference.”
I could write a very, very long post about how to value your equity offer in a startup. Fortunately for me, many such posts have already been written, and I have nothing new to add. Some of the best I’ve found are here, here, and here. You should start by reading those. They’ll sober you up to the financial realities of your options real quick-like.
Most engineers don’t study things like equity financing in depth, so most are far too optimistic about the odds of a big payday. Emotions hold sway. As a result, most startups offer less equity than is “fair” by the numbers. This is a simple effect of supply and demand: not enough engineers hold out for better equity terms, so the equity packages stay low.
Reasons you might join a startup anyway
So if the equity is lacking, and you probably can’t negotiate for much more, why would you ever join a startup?
Here are some reasons you might:
- You might want to found your own startup someday. You can evaluate a startup environment while still getting some salary. In this case, make your intentions to the founders clear and tell them you want to learn everything you can. Ask to be involved in other areas besides engineering – investment, marketing, sales, whatever. If you’re taking a salary cut and not getting massive equity, you better be getting all the knowledge you can out of the deal.
- You might want to learn a new technology stack or see a radically different engineering culture. If you’ve worked for mostly big companies, working for a startup can provide a massive positive jolt to your career arc. You’ll see tools and processes that you’ve never considered, and you can carry those with you for the rest of your working life. This is worth a salary cut for at least some period of time – but be ready to jump out the moment you stop learning.
- You might believe in the company’s mission or vision. Startups tend to be doing things that are disruptive and exciting, and sometimes the product or service even lines up with a personal passion that you have. This can be worth a huge salary cut indefinitely – if it makes you happy, what’s worth more than that?
So there are certainly good reasons to join a startup as an early employee. Just don’t let a big payday be one of them, and you won’t be disappointed.
Another option, if you can swing it…
I’ve often thought about the equity I’ve been offered in an alternative way:
“If I had the opportunity to invest in the company right now, would I commit $X per month in exchange for Y options per month for the next Z months?”
This is more or less what you’re being asked to do when you join a startup at a reduced salary in exchange for equity options. If you wouldn’t want to be a cash investor at the offered terms, why would you give up equivalent salary, which is just another form of investment?
Besides being a sobering way of analyzing the situation, it also illuminates another possibility: if you’re primarily interested in being involved in the financial success of startups and could be considered an “accredited investor,” get a higher paying job and become a startup investor. (NOTE: the JOBS Act could remove that “accredited investor” requirement soon.)
The salary difference in one year might be $20,000, and I know of small-time angel investors in Austin who spread that much among 2 to 4 seed-stage companies. The terms you’ll get as an investor will be way better than what you’d get with ISO’s.
Try asking for something crazy
In an ideal world, you’d get all the benefits of startup employment (small business education, cool tech, new ways of thinking, something you believe in) without having to give up any salary.
So just ask for it! Why not request a small equity package and a market-rate salary?
Explain that your family can’t afford to take the financial hit. Or that you have some personal obligations that are tying your hands. Or – if you want to be totally honest – that you’ve learned to not appreciate startup equity due to the low expected value but are super-duper pumped about other aspects of joining. If you sell your excitement, a smart founder isn’t going to turn you down prima facie, and you might get exactly what you want.
Of course, most startups are in a cash-strapped position. But, more than ever before, they’re in an engineer-strapped position. Demand for your services is through the roof. In the coming years, I predict that a lot of startups are going to be ponying up market salaries (and thus will be required to raise more investment capital) because they can’t get good people any other way. So give it a shot and see where it goes – then tell me how it worked out for you.