Ask HN: When compensation includes equity, can I ask proof of valuation?
Say a startup (early stage, no technical team yet) wants you to do consulting work or become their first technical employee and offers you a compensation package that includes cash + equity. The equity is based on a valuation that they (verbally) claim was established from their initial seed round. Is it appropriate to ask for confirmation/proof of that valuation and, if so, what would be the polite way to go about it? What would be other important things to ask/consider.
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[ 3.1 ms ] story [ 94.7 ms ] threadIf you are sure they are going to fail, then the equity you are getting is worthless, and why bother? If you think they have a reasonable chance of success, then all that really matters is how much of the company you own.
So say that I have given a quote as a consultant for $100k worth of development. They can only afford to pay $50k. They claim their seed round gave them a valuation of $10M, so therefore they offer 50k / 10M = 0.5% in equity in addition to the $50k cash. This is why the valuation matters - it is directly determining the amount of equity in the offer.
Is that a reasonable arrangement? Should I ask for proof of valuation and, if so, how?
Certainly not for such a low % and at a seed round and at such a low salary to market.
Also, since you would be certainly investing in the company, you should ask for preferred equity that vests each month (as your paycheck would be paid)
Even if 10M valuation is confirmed, you should get more equity to compensate for the risk. Usually, startups without tech co-founder tends to fail so your might want to take account of that when you are accepting equity. If the startup fails, the equity is worthless.
Have the $50k convert to equity at your option based on their next round of funding with a discount of 15%, with a cap of 2.5% equity based on a typical rule of thumb initial valuation of $2M for a company at such an early stage, and 2.5% equity by default if they fail to raise a second round or sell the company within the next 2 years.
This may be a bit on the aggressive side, but what you're really doing is giving them an investment of in-kind labor.
To expand, this is also being discussed. They have made overtures to bring me on as CTO, but we both agreed it would be best to try each other out through a consulting arrangement (as I am currently an active consultant). I understand that the considerations as a long-term early employee are much different (e.g. I should expect more equity and for it to vest gradually).
So I could see me doing the consulting gig for X months and then being hired on as CTO/Engineer #1. At that point I suppose we would negotiate a new agreement. That probably complicates things, right?
Factor in the pessimistic view: if they can't afford you now, is the business growing or struggling? What if that equity is worthless, or unable to be liquidated? What happens if they decide down the track to "replace" you with someone else, will you get to keep your equity or does that evaporate? Do you really see this company as your life's work, or would you be happier consulting for different companies at increasingly higher rates and doing your own thing instead?
I really hope I'm being overly pessimistic, I just feel I've heard this story before.
IMO, if you haven't already, spend an unpaid day or two fleshing out the overall business from a technical perspective. Most likely, the leader will have some invalid assumptions. How does the leader react to these assumptions? Are you able to steer each other in a better direction?
If you are going to do a short-term consultant role before becoming CTO; it's primarily to protect each other. If things fall apart, you walk away with cash, and it avoids equity problems for the company. (Lots of different people having tiny amounts of equity can complicate things.)
Therefore, you should only get equity once you all agree that you're CTO. When you're a consultant, you should get cash. Specifically, you should agree on what your rate should be, and then what you're "I like you guys" discount is. You could even put in some kind of clause like "Your discount is good until [date]" to protect yourself in case they decide that they like your labor, but want someone else as CTO.
First do the consulting gig, charge a proper market rate (cash, no equity) for the work and do a great job of it. Define an visible and achievable target for this, rather than starting to implement an open-ended project that you won't finish in the time.
At the end of this, if everything goes well and you like the company, negotiate terms for the full-time role. This will be the right time to do it: You will be in a strong position having demonstrated your skills up close and produced something of value to the company. You've charged a good rate for your work so if you don't agree terms you also aren't "down" financially.
During your consulting period, apply for other jobs (if that's what you want instead of your current consulting work). If you have some other good offers on the table, you will be able to walk away if their terms aren't good enough and you will have a good floor for your market value.
(1/Probability of Startup Success) * (50k/10M)
So if they have a 25% chance at success, then you should be getting 4*.5 = 2%. Otherwise, you are not taking the expected value, you are taking probability of success = 1. To make matters worse, assume you wont see the pay out for atleast 5 years. One in the hand is better than two in the bush, so there is a discount there as well.
Am I missing anything here?
You can come up with a different factor but all you are doing is effectively negotiating a different price. Your example thinks it is a $2.5MM company instead.
There's also the fact that the round didn't close 10 seconds ago; things have undoubtedly changed since it did. Those changes could positively and/or negatively affect the value of the equity.
Once you're past that, your approach is basically ok. It's a bit like the Drake Equation, though, in that it's several unknowns multiplied together to achieve a very precise result that has such large accumulated error bars as to be meaningless. The best you can do with this approach is try to avoid taking a worse deal than the last investors, which doesn't mean much.
Also, no one has a 25% chance of success unless they've filed an S-1. But that's just a detail.
Dilution would then make that $50k into $500k instead of the $5 million you would expect. $500k / 4 = $125k / yr (vesting), which is the same as working at google / apple if you could sell all of your stock. But you cannot so you probably will not get that money back. So a very good case scenario for startups can lead to getting the same money as working at google.
With the current trend of 8+ years to liquidity if the company is successful, it will be a long time before you get your $50k back. Then you have to compare putting that held up $50k in to an index fund over the same 8 years.
As a result, you should probably be demanding something like %5 of the company. Dividing your missing compensation by the probability that you would actually get that missing compensation will lead to a calculation like that.
They will predictably balk at the %5 suggestion, so it's up to you to figure out if you can make more money working for someone else keeping your sales costs in consideration. If not, then go ahead and work with these people, and just treat the equity as the lottery ticket it is.
http://techcrunch.com/2011/10/13/understanding-how-dilution-...
Finding sellers outside of employer sponsored secondaries can be pretty hard and involves a lot of labor. Time better spent making money directly with new consulting clients. Usually the corporation wont be very helpful in selling your stock. ESO fund & others can be pretty picky and you have a good chance they might change their mind a few months later as you try after you have gotten all of your required documentation.
As an employee / contractor, you won't have investor level access to financials, reporting or the resources to fully understand them.
That dilution level does happen. It's happened to friends as they climbed from a $5m company to a $1b company.
Also if you get options or equity of some sort, make sure that the options do not expire until at least 20 years later. You do not want the 90 days after termination problem a lot of people have. 20 years seems long, but there are stories of people's 7 year stock options expiring because the company hasn't gone public in those 7 years!
And make sure you have easy access to these required documents, since they are often required to sell your equity when the company is private: http://www.slideshare.net/KeyvanFirouziCFACPA/equity-101-for...
If you're trying to assess the value of the equity you're being offered, the last round's terms are perhaps worth knowing, but they're not the result you want. What you need to figure out is not what someone else thought the equity + terms was worth to them, but what the equity + terms you are being offered is worth to you.
This applies to all situations in which you're being offered anything other than cash, whether it's a contract gig with a startup or a dude on Craigslist offering to trade you a stereo system for your laptop.
The valuation matters, of course, but if I was in your shoes, my biggest concern wouldn't be validation of the valuation:
1. A $10 million valuation is well above the median valuation for seed stage companies[1]. What's strange here is that the startup doesn't even have a technical team, so what was the justification for the valuation?
2. Despite the fact that this company was somehow apparently able to raise at a premium valuation, it apparently didn't raise enough to pay for the development that's needed. That implies it raised too little. Whatever the reason, that's a huge red flag.
In a scenario like this, I wouldn't consider equity to be at all attractive.
[1] http://www.theventurealley.com/series-seed-the-new-series-a/
Just honestly voice your concerns (rather than saying "show me the proof" without explaining why) and any reasonable person will only have more respect for you for asking.
- IPO (least likely) - a top-10 unicorn which access to the secondary market
Unfortunately during a buy-out, your options are not actually equity and you are not likely to participate in the M&A cash. Most companies do the right thing and issue you a competitive offer and maybe a bonus, but honestly it's hardly much more than that you could have gotten if you worked at Google/whatever all along.
First employees have an outcome differential of 10x vs founders. This is often marked up to founders taking on substantial risk. But the way funding works these days, with EIRs and networking, the founders are taking a lot less risk than you'd think.
The total comp laydown of a startup has the potential of being very good, but also, potential needs to be discounted against not hitting the huge hockeystick.
The valuation of the company is $2M with one set of terms, but only worth $1M with the other.
So just make sure that if you are getting paid based on valuations given to investors that you are getting the exact same terms the investors got.
If you do that, and it ends up being worth nothing (common case) you will not feel a "loss", but if you have been imagining it was worth something, and was now worth nothing, you will grieve that loss, irrational as that is. I have seen it again and again, where the stock price of a company hits some value, the employee does the math of "option price x quote" == $some number, and then when the stock price goes down feels bad about how much they have 'lost'.
You protect yourself from that by setting the value to $0 and making your decision based on that. If it happens to be worth something later, bonus! if not, well you didn't count on it anyway.
If you value the equity at zero, the rational thing to do is avoid working for a startup at all.
You believe in the mission - often startups will take on business or social challenges that are unserved by larger companies. This can be very rewarding to be part of a solution to an otherwise unserved or underserved customer.
You want to stretch your boundaries - titles in startups are rarely indicative of what you do, often you may participate in marketing, QA, development, business development, sales, project management, operations, and product management just by showing up that week. Rarely do you get a chance in a large company to "try on" a role that isn't on your resume, nor when you do get that chance, get the leeway to try several in a short amount of time. You may want to work at a technology company but not sure of what role you want, a startup lets you try many roles. Further when you find one you like you can live it for a while and then move to a larger company in that same type of role.
Work with someone you respect - Sometimes you will find a startup where someone you know, either in person or through meetups or other social sites that you respect and feel you could learn from. If they are at a startup you may find it easier to get employed and work with them than you would if they were ensconced in some high office at a large company.
Challenging yourself - startups are usually fast paced, stressful, and often have a lot of unknowns flying around. Being able to focus and get stuff done in that sort of an environment is a learned skill. Being able to "go with the flow" on a project, change directions quickly, and see promising areas of development in the midst of crashing and burning are all things people often experience in startups. That sort of stamina can be useful in large companies but it is hard to learn it in large companies.
Don't join a startup to "get rich." You will end up burned out and disappointed and it can take years to get past that.
I would also add that startups are good for "networking", which is best done by working closely with people day in and day out. Startups give you a chance to form much closer relationships with people much higher up the company food chain, and those people are likely to be successful even if the startup isn't.
Your risk profile may vary, so treat this as a starting point.
Yes, the company's offer has implied a valuation (and the company even says it's based on actual investor-dollars-in). But the poster already knows that, and isn't completely confident the offer reflects the real valuation offered investors. So there's no more calculation to be done from the offer alone. They instead want to know if they could/should require more formal documentation of the company's claims.
Take more cash instead
Typically you just want to have a written statement from your founder and if at some point the company is worth enough to justify a check, you can hire lawyers to go back and check. If your founders lied in a written statement they will be liable for even more. In general if your founder lies to you and you have proof and the company goes big he is in trouble. Your lawyers will need to see all paperwork you signed in such case, watch out for sketchy terms you might be asked to sign later on. It is possible that crappy founders will try to erase all prior liability at some time when the company is about to make it big. In fact the company lawyers always go back and check everything the founders signed before a big deal to avoid any unforeseen liability.
You have to judge if your founders act in good faith or they are taking every opportunity to put you at disadvantage. If you don't trust the founders or the investors, don't do business with them.
As a rule, I don't even think it matters what the valuation was because generally the seed stage companies that should rationally expect to make money would have started with a proven team with prior successful exits.
I'm definitely not advising you away from the offer. I've been a consultant, worked at both successful and failed startups, and preferred both types of startups to consulting. But I still think the expected return is higher in consulting or being a top performer at a large (tech) leader. Good luck whatever you decide.
As an employee, you can ask for the valuation, but it doesn't mean anything. Small equity in closely held companies is only as valuable as the people in control have the good will to make it [this also applies to the contractor situation]. Well it might mean something if you have the cash laying around to actually exercise the options when they vest...e.g. the 5% options you get at a $10,000,000 valuation require $500,000 to exercise if you leave after the vesting.
To put it another way, the value that matters is that of the options not the company and the value of the options should be assumed to be zero...or maybe $1.00 like a lottery ticket in a lottery where nobody has to win.
Good luck.
You may want to get a lawyer involved.
More simply just make sure the cash is enough and the equity can be a lottery ticket which you can view as $1 extra salary. Worth trying to negotiate any horrid clauses though.
I would personally play it by ignoring the shares part and just ask for more cash if you are not happy with the amount they are paying.
If you want to get rich (disclaimer I am not rich) I would suggest earning as much $ as you can, living as cheaply as you can and invest in good stocks and real estate in very desirable locations. Then each year concentrate on how you can increase your income so you can invest more.
You will wake up in 20 years time and think "oops I got a lotta money" to paraphrase Blur.
Yes: I believe you're well within your rights to ask to see the financials of a company you're about to become a co-owner of.
No: If you're asking for proof because you distrust them, that's a HUGE red flag. Don't work with people you distrust. Even if it's just a hunch, go with your gut and just walk away.
1. What do _you_ think the company is worth today? If your net worth were $250m, how much would you be willing to pay for 100% of this company?
2. Does the company have any debt? If so, subtract this amount.
3. What rights are attached to the different classes of shares (e.g. liquidation preferences) and which class of shares will you be issued?
4. Based on what you learned from (3), what % of the exit value will you get if the company is sold next year for what the founders believe to be the current valuation? What about if it's sold next year for what you believe to be the current valuation?
Re: #4, the % will probably differ based on the sale price and how far into the future the sale occurs. The sooner the sale and the higher the sale price, the less of the total value you will lose due to liquidation preferences and/or other additional rights attached to investors' shares. If the sale is very far in the future, liquidation preferences could totally wipe out your equity, even if the sale is at a decent price.