Oftentimes, you will read stories about employees being screwed on stock options in a startup or founders being total jerks during the acquisition process and leaving the employees nothing. Here’s a way to put everything in context before anyone of you decide to join a startup. In short, please keep your eyes wide open before joining a startup and understand the different perspectives.
I want to ceveat the takeaway at the beginning of this post before you read further. The purpose of this article is to put in context to how and what one should do if they want to join a startup as an employee and at the same time, put in context on how founders handle their own situations and at times, may do things that might end screwing up their own employees. I caution the reader to understand the different perspectives so that everyone understands what they are getting themselves into.
Here’s a typical situation (and you can add your own complexity to the situation but they usually differ by different parameters or read this incident with Eero in detail with comments from my friend Michael Smith Jr from SeedPlus VC):
You join a startup as an employee probably being compensated about 90-95% what you would have been compensated if you are with a multi-national or regional corporation. You are given some stock options which are valued at $X. If the startup is eventually acquired or go public after various stages of funding, the value of your stock options will be priced at the valuation of $Y and if $Y is greater than $X, you make some extra money as bonus in addition to your salary. If your company is in a critical situation close to a shutdown and has to be sold at a fire sale price of $Z where $Z is lesser than $X in valuation, then your stock options are worthless, and you lose your bonus and you have earned less than what you should have. Then you are being told by the rest of the world that you have been screwed by your employer.
The problem with the situation prescribed above is that everything which an employee values about a startup is the lottery ticket and salary which they have negotiated from the start. It does not capture the different facets or complexity to why an employee might choose a startup over a multi-national corporation. There are many reasons to why an employee joins a startup. First, they have decided that the environment of a multi-national corporation are not for them. Not everyone will get free food and great perks in Google or join a brand like McKinsey or Goldman Sachs stick behind their backs and guarantee successful career tracks. Some employees decided that they are cogs in the wheel, earning good salaries but doing bullshit jobs. Hence they want an environment which they can learn the most. Of course, the startup is an environment where they can take on different roles at different times to solve company problems. The learnings and experience acquired help individuals to grow and offer another path for them to success. Sometimes, it’s about the startup culture. Some companies walk the talk and they really have the culture. Believe me, I doubt that 95% of the startups really have “culture” because everyone is in a fire fighting mode. Hence, a good startup culture might offer an environment for you as the employee to thrive. Of course, if your startup has the culture and be successful, then your lottery ticket is a bonus.
So, why do I talk about the employee from this perspective? The times when you as a startup employee think that you are screwed, is often encumbered with the following baggages: first, you hate your startup job; second, you hate the environment where the culture spoken by the founders does not exist, and three, they don’t compensate you well. So, if all three factors align and a fire sale happens with $Z < $X, then you will really think that you are royally screwed by the founders of the startup. I empathize your plight but the clear advice I will give you is that you should have quitted your job sooner and not now.
Let me explain how you should see the founders’ perspectives in a startup company. There are a couple of things which are conflated with your compensation and stock options. It’s best to decouple them. First of all, startup founders are either not compensated i.e. not taking a salary or take a salary which is grossly below the market rate, say 50% of how much they are earning. When I was a founder or CTO of a startup, I earn $5K when the company raised the first seed fund to give a runway of 18 months, and if I have gone to take a real job, it will be at least falls within $10-15K depending on the scope of the role. That financial situation changes when the company reaches at least series C funding and becomes a proper company. The founder’s only route to financial happiness happens during acquisition or the company going public, with the amount of equity in their hands. They have to live with delayed gratification and it becomes harder when the founder gets married and starts having kids. The danger for every founder is during series A-D stage where the company runs out of money or be caught in any external situations that can drive them out of business, for example, regulation. In fact, if you do a comparative basis, the lottery ticket the founders have is far worse than an employee.
That’s where the beef of the fire sale comes in where the founders are forced to sell the company at a lower price. It renders all employees with stock options zero. Let’s take the situation further and examine what founders think about when they have to do that. Most founders are human beings with at least a set of core values and principles. If not, most founders have inflated egos which they will not like their employees walking out later to tell the rest of the world that they were jerks by making all stock options value zero with their bad management of the company.
The first thing that I believe that they think on their minds is that if the company runs of money, every employee will be out of a job. The fire sale solves a few things: retain the employees with jobs, and at the same time, providing a way out for the founders to exit. In fact, the investors or the “evil VCs” might be compensated first depending on the liquidation preferences they sign. Hence if you are a founder and if you have a family, then your situation is really dire. Oftentimes, extreme situations require extreme actions. Yes, the founders might have sold at a price that might cause your lottery ticket to be zero but they kept the whole thing alive. If the company have a fostering environment for the employees, keeping it alive might not be a bad option. I do not doubt that there are founders who are jerks out there and care for themselves. In this situation, I will explain what might be going on the founders’ minds in a fire sale.
To end, if you want to join a startup as an employee, there are few things in your consideration:
- Are you compensated fairly in your own perspective?
- Has the startup provided you the environment and the right culture to succeed?
- Have the founders the right set of principles or ways of working that at least you know when in bad situations, they will not screw you over?
When you are about to accept an offer from a startup, please have a honest conversation with those three questions and forget about the lottery ticket because that is a bonus and not an entitlement.
That’s why it is important when you join a startup, please keep your eyes wide open.
Suggested follow up reading:
- Steve Blank’s “Startup Stock Options – When a good deal has gone bad“