Considering a job at a start-up? Recognize the investment decision
One of the things that I have picked up on during my first year investing as a VC is that start-ups do not do a good job on educating its employees on how to value their options. For an extreme example, one of my good friends is contemplating leaving his company where he was employee #8. His Stock Options Agreement states that his options strike price is to be determined by a 409(a) valuation [a standard third-party appraisal] at a later date. Once leaving, an employee typically has 90 days to exercise an option before losing them and my friend has no idea how much he will have to come out of pocket to exercise the options.
Equity compensation, most commonly issued via options, is a key component of the start-up culture and one of the most appealing aspects of compensation packages. It helps retain valuable employees as a form of golden handcuffs (i.e., vesting schedules) and allows everyone economically participate in the company’s value creation. If you are at a rocket ship like Uber, AirBNB, Palintir or Dropbox, you should probably exercise your options as the fair market value has likely far exceeded your 409(a) strike price (but make sure you still do your work to figure out your liquidity needs, cash requirements, tax consequences, etc.). However, if you’re at a “less successful” VC-backed start-up, you should make certain that you know how the security you’re buying (most likely common stock) should be valued.
Before you accept your offer, you need to know what your compensation package is really worth. You need to find out what it costs to exercise your options and perform diligence on what the company is worth today and what it could be worth over the coming years. Be sure to familiarize yourself with how preferred stock works and the different types of securities your company has issued to investors. In an acquisition scenario, straight convertible preferred stock is MUCH less dilutive than participating preferred stock. Employees at start-ups, especially early ones, give up cash compensation in exchange for options that hopefully have significantly higher value down the road. You’re investing your career into a company and you need to arm yourself with the ability to quantify the return.