How to value your equity share

The math isn’t as simple as you think

Rob Heaton wrote a terrific post on the journey through funemployment to engineer at Stripe. It’s a great read, not only for job seekers, but also for early-stage startups on how to hire (which we are doing).

My only issue is that his approach to equity valuation is wrong. This is what he says:

If a company is currently worth $10m, options for 0.1% are worth $10k. Vesting over 4 years this is $2.5k/year. It doesn’t matter what magic you can weave in Microsoft Excel by dragging a 3x growth multiplier 5 years into the future; these options make up for less than a $2.5k delta in salary, and even-even (sic) less if you factor in a risk discount.

The missing elements: liquidity and discounting

To begin, Rob’s analysis is perfectly valid in a liquid market. For example, if you are hired at Google, your equity grants are worth exactly what the going market price is. Why? Because (company restrictions and award structure aside), there is a liquid market for Google. Furthermore, if you joined another company instead, that offered a cash bonus, there is a liquid market for you to invest that cash into Google. In markets, we call this a tight bid/offer.

In startup-land, there is no concept of tight bid/offer. The most recent “valuation” represents the aggregate bid price of the investors involved. And keep in mind, this is an aggregate of the investors that had the opporunity to invest: if the round hasn’t been shopped around, the probability of an incorrrect valuation is higher. Additionally, venture capitalists require high rates of return on their companies that succeed: as such, dramatic discounts are baked into what they pay for a company versus what they think it is “worth now”. Their investment price reflects their current risk profile, their current portfolio mix, as well as their belief in outsized returns for the company.

So the bid price can be far different from the “actual” market price. Now here’s where things get interesting, and a bit philosophical: there is value to your ability to access the equity at a company. Most of us don’t have the network or the capital to be privy to investment in many early stage companies. In other words, if this is your profile, the effective offer price is akin to Infinity: there is no price at which you can reasonably invest. Your employment is giving you rights to something that only a small percentage of the investor pool is privy to. I’m not saying that the true value of the company is infinite. Rather, I’m saying that without employment, your access to the company exhibits the same characteristics as if the valuation was infinite.

How you should think about things

In highly illiquid markets, valuation is difficult. Your risks aren’t the same as venture capitalists. As such, you risk aversion and subsequent utility function may be very different.

Here’s what I would suggest:

1. Take the last valuation round as an input.
2. Assess what you think the company might be worth, and the probability of that success. Try to be conservative.
3. Determine what you think your equity might be worth.
4. Compare this across companies that you receive offers from.

As a final quick aside, depending on whether you quality for an 83b tax election, the net money you receive over the lifetime of the equity grant can be altered even further.

Valuation is a great art, and a difficult one at that!

Discuss on Hacker News here.