On Startup Offers

Taking a job at an early-stage startup is an admirable career path, but it’s also a difficult one. It’s difficult not just because it’s hard to get hired (Apropose was only a seed stage company, and we still passed on over 99% of the people who applied), but because navigating startup offers is very nearly impossible. In a sense, this is a good gateway for working at a startup, because building a successful company from nothing is also very nearly impossible.

One early-stage company offers you $X a year in base salary and options to purchase Y shares of stock. Another offers $1.4X in salary and options to purchase 0.2Y shares. Which is the better deal?

This question sounds simple, but it’s loaded with subtlety. What percentage of the company do the options represent? What’s the strike price? How long is the vesting schedule? Are the options early-exercisable? What are the terms of the restricted stock agreement? Do you get acceleration on a change of control? Do the investors have liquidation preferences? How much runway does the company have? How big is the employee pool for the next round? What’s the TAM, SAM, and SOM?

More savvy potential hires know that they should ask some of these questions; less calibrated candidates veer towards “Y sounds like a pretty small number.” For the most part, though, neither set cares much about the answers: what they really want to know is how much money will I make if I work here?

To answer this question (and combat the “small number” problem), many startups put a table in their offer letter that looks like this:

A prospective employee, upon viewing such a table, can thereafter sleep soundly in the knowledge that their financial upside lies somewhere between the security deposit for an apartment in downtown Mountain View, and enough money to rent the country of Lichtenstein for two years [1].

It’s not surprising that these tables — like all models — are always wrong [2]. The question is, how useful are they? And the answer is…not very.

In the first place, an early-stage company has no way of knowing how much additional dilution it will face on its way to an exit, and employees never get anti-dilution protection. This means that options worth $5,000 at a $5M exit might be worth $50M at $5B…or they might only be worth $2M if the company has to take on a lot of additional capital (if this seems silly, remember that companies are now routinely raising a billion dollars or more on their path to an exit through a public market).

Throw in strike prices and vesting schedules and liquidation preferences and restricted stock agreements and tax structures, and the honest truth is that it’s more or less impossible for a normal human being to understand the relationship between their option grant and their true financial stake in a company. In the extreme, your vested options at a high-performing startup can end up being worth nothing if, say, you leave before the company goes public and can’t afford the AMT hit you’d take by exercising them, or if a sneaky private equity firm inserts a clawback clause into your thirty-page-plus option agreement [3]. Remember: no matter how much common stock you own in a company, you only really own as much as the majority shareholders want you to have [4].

In the second place, to derive any meaningful information from the table, you need to know which column you’ll fall into — how big a business the company will build — and at a startup, nobody knows that. If they did, the company wouldn’t be a startup [5], and it wouldn’t require venture capital: it could just go to a bank, hand over a business plan, and take out a loan the same way you would if you were opening a dentist’s office or a gas station. Even the offer letters that Facebook was handing out in 2010 had a table that was off by a factor of twenty (although Facebook’s case was unusual in that the high end of their table was twenty times too low).

And there’s the rub. You can certainly get rich working at a startup (in fact, it may be one of the best ways [6])…but the financial rewards aren’t only correlated with how smart you are or how hard you work: they’re correlated with how much risk you take. As the uncertainty reduces, so does the potential upside. Fortune favors the bold.

This is precisely why evaluating startup offers is so difficult for the kind of smart, rational thinkers that startups are always hoping to attract: making good decisions in the presence of uncertainty is hard [7]. Deductive reasoning doesn’t work, because there isn’t enough information to draw meaningful conclusions. Many of the cognitive biases and heuristics that serve us so well in our everyday lives are anti-patterns for situations with high uncertainty. Diversification — the standard tool for mitigating risk — doesn’t apply to the potential startup employee who can only take one job at a time.

So, what should you do? A few things.

The first is to recognize that, although startups are risky, they aren’t that risky. Most startups pay something approaching market-rate salaries, so you don’t have to divest yourself of worldly possessions and live on ramen noodles to work at one. Sure, the company might fail and you might have to find a new job…but you can get laid off at a big company [8], or re-org’d with no warning into a totally different position than the one you thought you had [9].

The second is to pick a company with a big idea that you believe in. A company that sets out to change everything may fail…but if you believe in the company’s mission and pour yourself into the work, you’ll almost certainly learn more and be happier working there than you will marking time at a ho-hum tech job [10, 11]. Moreover, what you learn there — in the long term — will likely have more financial value than the money you’d have collected at a higher-paying job [12].

The third — and perhaps most important — is to find a team that you want to be a part of. A mediocre team with a great idea will ruin it, but a great team with a mediocre idea will make it good [13]. In today’s world, almost all technical challenges are surmountable: the question is, who will surmount them? In the words of Margaret Mead:

“Never doubt that a small group of thoughtful, committed citizens can change the world; indeed, it’s the only thing that ever has.”