Correctly value your startup job offer
I've recently had a few conversations with friends and colleagues about whether a potential new job at a venture backed startup was worthwhile given the stock options, bonus structure, benefits and salary provided. In all of those conversations, I was surprised at how few people actually applied proper math to evaluate their offer.
It’s common wisdom in the Bay area that working for a startup is far superior to working in a large corporate environment. You're given more freedom, autonomy and responsibility often with the great advantage of reduced salary, increased stress levels, inferior benefits, longer work hours and a promise of winning the lottery via stock options. If you didn't pick up on my sarcasm, then you should probably stop reading at this point.
Working at a startup, whether you're a software engineer, product manager, sales person or designer is hard work. There is significant risk of failure and a great deal of uncertainty. Not everyone thrives in such an environment so its important to truly value your offer beyond what the hype merchants are selling you. Let’s perform a thought experiment to outline the methodology for valuing your offer.
Imagine you have a few years experience working in the latest hot programming language and framework. You live in the San Francisco Bay Area. Your current salary is $125,000 per year and your employer provides complete benefits (medical, dental, vision etc.) as well a 15% salary bonus if you perform at a high level (which you do, because you're pretty good). However, you've grown comfortable in your job, the challenges have all disappeared and you think it’s time to move on to something more challenging & intense, preferably in a startup environment. After a period of job searching you receive an offer from a hot Bay area startup.
The position offers $100k base salary, 0.5% equity in the company in the form of stock options, no bonus and a basic (but worse) benefits plan as well as catered lunch. The company is valued currently at $10m, is really sexy and appears in TechCrunch frequently. Should you take the job?
I'm not going to assess the value of taking on new challenges, expanding your professional network, and taking on more responsibility. Nor am I going to assess the value of any potential happiness you might obtain from a new job. I am going to assess the financial aspects of the job offer and how it compares to the existing compensation package.
Immediately you're taking a $25,000 pay cut (and potentially another $18,750 in bonus) in your first year. Most standard startup employment contracts provide a four year vesting period for your stock options (as does this one), so to receive the full distribution of options, you need to stay for four years. Over four years this equates to $100,000 in reduced salary. You may be able to re-negotiate salary after a year or two if the company is doing well, or you might not. Lets assume for now that you won't.
Let’s offset the reduced benefits with the catered meals for simplicity. Evaluating the bonus, you're potentially losing an additional $75,000 over four years. That might seem overly optimistic–some years your employer might not reach its revenue goals and be able to pay the bonus–so lets assume you get it two out of the first three years and you get a smaller amount in the fourth year (giving up an additional $50,000).
Over four years your loss of earnings amounts to approximately $150,000. How much does the startup have to be worth for you to recoup your lost income? Given that your stock options are valued at the current company valuation, the price of the company needs to double for you to earn $50,000 (I'm neglecting liquidation preferences and other common financing terms for ease of calculation). Over 4 years the company would need to be worth at least $40m (and have a liquidity event) for you to be able to recover the lost income. At first glance that doesn't seem so bad, and in fact seems like a pretty decent outcome given that most venture financed startups are looking for 10x growth. The question at this point is, how likely is it?
According to a Dow Jones report in 2012, on venture-backed exit activity, the mean exit valuation of a successful startup was approximately $101.9m. This was based on a pool of 522 companies exiting for a total of $53.2b. Still sounds promising right?
Let’s take this 522 to represent the ~5% of startups that succeed out of a pool of around 10,000 ventured-backed startups. Assuming that the other ~9,500 unsuccessful startups end with the same valuation that they started with (a very generous assumption), we can calculate the average valuation of our hypothetical employer in four years to be 500/10000 * $100m + 9500/10000 * $10m = $14.5m resulting in a gain of $22,500, or $5625 per year for four years. This is a fairly rough calculation, but it is sufficient to indicate that you won't be recouping your lost income from your stock options.
But what about all the other non financial benefits of working at a startup? Michael Church does a pretty good job of dispelling some of the common myths associated with working at a startup that I won't rehash or try to value financially. Suffice to say that simply taking a job at a startup isn't necessarily going to be as good as it sounds.
Ultimately, the point here is to make sure you're actually doing some basic math when you get a job offer from a venture backed startup (or any other company for that matter). Don't let hype prevent you from making rational decisions. Don’t overvalue the intangible benefits. Evaluate the job as best as you can – especially the impact on your future earnings. But most importantly, know what you’re worth.
NOTE: I am a firm advocate for working at a startup. I love risk and see a lot of benefit in the startup experience. However, its important to assess the financial aspects of the job rationally - not with extreme optimism.