The worst thing that can happen at an early company is that it sort of works.
I like the deal where I roll the dice and don't have to work again if I win. I'm fine with the deal where I take a barely-passable salary and do something wacky for a year.
The worst deal I can imagine is that the startup slowly grinds its way to profitability over 3 years, can't raise, and grows 15% / year.
Every company I've seen do that never fixes the salary issue. Everybody's still making their seed-stage base, or maybe +25%, which is still a 30% pay cut from the last job they had. Their equity is worth nothing. There's no career advancement, because there's 2 staff jobs and 3 EM jobs and 1 VP job.
There's lots of ink spilled about how founders expect early employees to work hard, perhaps too hard for what they're paid. It goes the other direction, too: early employees should expect founders to succeed, because there's always another startup to join.
Calculations like this article neglect the far more common case where the liquidity event, if it ever happens, is years in the future, much longer than average employment times.
Companies used to go from garage to IPO rapidly. Now a decade from founding to IPO is not uncommon. Unless the employee plans on committing their life to the startup that just hired them, they will most likely move on somewhere else before that decade-later liquidity event happens.
When they leave, they have to spend after-tax $ to buy non-liquid shares of a still-high-volitility pre-IPO company, because almost all options have a 90 day exercise clause. If they were early enough that their shares are 409a valued at pre-seed valuation, that might make sense. If they are a significant employee, the kind the company most wants to retain, and their shares are valued at Series B or C, that tends to be a very big check they'd need to write to their former employer to turn those options into non-liquid shares that may well end up at zero valuation, all at a time when they no longer have any ability to help the company succeed.
The original motivation for offering options was to encourage employees to stay, but what happens is the precise moment the company most wants those options to do their thing and retain the key employee is the moment when the employee starts doing the above calculation, realizing the company is years from IPO, it's still risky even if it looks promising, and the options are actually worth zero unless the employee either (a) stays at the company for a decade or (b) pays back a non-trivial fraction of their takehome pay to buy a risky illiquid asset. The employee realizes neither of those scenarios are likely to happen, so boom the moment when the company wants the options to drive retention ends up being the moment when the employee realizes the options are not just worthless, they could actually have a negative EV if exercised. Suddenly those options aren't very effective at retaining the employee.
There was a time when options had value like the OP suggests, because the timescales were shorter. Today, not so much. Yes, outliers happen, but in general they don't.
Unfortunately this author has no idea about how equity works in real life, 2 things that stand out from experience of being very early employee 8 times:
1. If startup raised money at some point in the past and they are at 50M valuation then there is no chance average employee will get offer of 1% (you would need to be someone special to get that)
2. There will be many more dilution rounds before they get to 1B valuation so chances are that 1% will get cut to 0.3% over that time period
You give two critiques relating to the exact numbers the author has choose (equity package at join, valuation at exit), neither of which is really related to the authors hypothesis that people misvalue EV from equity.
You can slide these numbers around however you want and the point still stands, even if you disagree with it for other reasons
The value of employee equity is approximately zero, but sometimes people get lucky. Don't let these arguments fool you into thinking you're definitely in that 5%, because in the absence of information about the market, the product, and the other people you're working with you're probably in that 95% that makes nothing. By all means update your priors but arguments about expected value assume that all things are equal, and they are manifestly not equal.
obviously vol is not the end all be all but one of your main advantages as a startup employee is access to the insider info and being able to walk away
The obvious other factors in this reframing of equity compensation effectively render it a useless take.
The disparity in expected value calculation is due to assuming you can predict the future after joining a company, which is obviously not true. If you can always tell a company is going to succeed after 1 year of working there, you should leave, as you are clearly destined to be the most successful venture capitalist in history
Not to be overly negative, I think this perspective is somewhat misleading as it lets one rationalize valuing startup equity as anything more than a gamble. Which it is, and always has been. Sometimes gambles work out though.
> If you can always tell a company is going to succeed after 1 year of working there, you should leave, as you are clearly destined to be the most successful venture capitalist in history…
Except that "after 1 year of working there" is not how VCs work.
The worst thing that can happen at an early company is that it sort of works.
I like the deal where I roll the dice and don't have to work again if I win. I'm fine with the deal where I take a barely-passable salary and do something wacky for a year.
The worst deal I can imagine is that the startup slowly grinds its way to profitability over 3 years, can't raise, and grows 15% / year.
Every company I've seen do that never fixes the salary issue. Everybody's still making their seed-stage base, or maybe +25%, which is still a 30% pay cut from the last job they had. Their equity is worth nothing. There's no career advancement, because there's 2 staff jobs and 3 EM jobs and 1 VP job.
There's lots of ink spilled about how founders expect early employees to work hard, perhaps too hard for what they're paid. It goes the other direction, too: early employees should expect founders to succeed, because there's always another startup to join.
Calculations like this article neglect the far more common case where the liquidity event, if it ever happens, is years in the future, much longer than average employment times.
Companies used to go from garage to IPO rapidly. Now a decade from founding to IPO is not uncommon. Unless the employee plans on committing their life to the startup that just hired them, they will most likely move on somewhere else before that decade-later liquidity event happens.
When they leave, they have to spend after-tax $ to buy non-liquid shares of a still-high-volitility pre-IPO company, because almost all options have a 90 day exercise clause. If they were early enough that their shares are 409a valued at pre-seed valuation, that might make sense. If they are a significant employee, the kind the company most wants to retain, and their shares are valued at Series B or C, that tends to be a very big check they'd need to write to their former employer to turn those options into non-liquid shares that may well end up at zero valuation, all at a time when they no longer have any ability to help the company succeed.
The original motivation for offering options was to encourage employees to stay, but what happens is the precise moment the company most wants those options to do their thing and retain the key employee is the moment when the employee starts doing the above calculation, realizing the company is years from IPO, it's still risky even if it looks promising, and the options are actually worth zero unless the employee either (a) stays at the company for a decade or (b) pays back a non-trivial fraction of their takehome pay to buy a risky illiquid asset. The employee realizes neither of those scenarios are likely to happen, so boom the moment when the company wants the options to drive retention ends up being the moment when the employee realizes the options are not just worthless, they could actually have a negative EV if exercised. Suddenly those options aren't very effective at retaining the employee.
There was a time when options had value like the OP suggests, because the timescales were shorter. Today, not so much. Yes, outliers happen, but in general they don't.
Unfortunately this author has no idea about how equity works in real life, 2 things that stand out from experience of being very early employee 8 times: 1. If startup raised money at some point in the past and they are at 50M valuation then there is no chance average employee will get offer of 1% (you would need to be someone special to get that) 2. There will be many more dilution rounds before they get to 1B valuation so chances are that 1% will get cut to 0.3% over that time period
You give two critiques relating to the exact numbers the author has choose (equity package at join, valuation at exit), neither of which is really related to the authors hypothesis that people misvalue EV from equity.
You can slide these numbers around however you want and the point still stands, even if you disagree with it for other reasons
my 2nd point says that due to dilution rounds your 5% chance is not 10M but about 3M so
5% * $3M = $150k expected equity value
$150k / 1.15 = ~$130k/year
which is same as you started with
The value of employee equity is approximately zero, but sometimes people get lucky. Don't let these arguments fool you into thinking you're definitely in that 5%, because in the absence of information about the market, the product, and the other people you're working with you're probably in that 95% that makes nothing. By all means update your priors but arguments about expected value assume that all things are equal, and they are manifestly not equal.
the article takes this into account with EV
obviously vol is not the end all be all but one of your main advantages as a startup employee is access to the insider info and being able to walk away
An option won't fire you 1 day before cliff.
The obvious other factors in this reframing of equity compensation effectively render it a useless take.
The disparity in expected value calculation is due to assuming you can predict the future after joining a company, which is obviously not true. If you can always tell a company is going to succeed after 1 year of working there, you should leave, as you are clearly destined to be the most successful venture capitalist in history
Not to be overly negative, I think this perspective is somewhat misleading as it lets one rationalize valuing startup equity as anything more than a gamble. Which it is, and always has been. Sometimes gambles work out though.
> If you can always tell a company is going to succeed after 1 year of working there, you should leave, as you are clearly destined to be the most successful venture capitalist in history…
Except that "after 1 year of working there" is not how VCs work.
Not true, there is a growing class of "operator" VCs that both fund and help run early stage companies.