Startups, Show Me The Money (& Equity)
In Part I: Priti Patel shares advice on how Startup Job Seekers should think about compensation
Last year I reached out to my fellow Kellogg MBA and friend Priti Patel about her experience transitioning into the world of startups Post-MBA. In our initial conversation, I asked her about how tech startup candidates should approach the issue of compensation at an early stage company. She told me that a number of her classmates had reached out to her about this subject since it is very different than the compensation structure of your traditional marketing, consulting, or finance role out of college or b-school. So being the opportunistic guy I am, I suggested that I interview Priti on the subject from both the interview candidate and founder perspectives — since she has been on both sides in the last two years.
I originally planned for us to only to speak for about ten minutes but the advice that Priti was providing was so insightful I decided to break the blog post into two different posts. Part I is targeted to all first-time tech startup job seekers. If you are considering transitioning into the startup world, this is a must read. Part II which will focus on first-time founders who are looking to bring on new employees will come out later this week! Below is the transcript of our conversation with slight edits for context and clarity.
Earnest Sweat(ES): We’ve talked before about how you have given advice to other Kellogg friends on what to think about when it comes to your compensation from a startup. It’s a very different situation than a traditional consulting firm or traditional financial services company. So could you share some recommendations on what you believe people should do to prepare for those compensation negotiations?
Priti Patel(PP): One thing to keep in mind is that this subject is all comes down to risk. So before you even decide whether or not you’re going to work for a startup, you really have to ask yourself how much risk you’re willing to take on. In thinking about your optimal level of risk, you need to decide how much are you willing to take in equity versus cash. You should have an idea of what your willingness is to take compensation in equity — understanding that of course, the payoff could be a lot larger down the road. So that’s the cash versus equity question is key to this conversation. If you find that you’re not actually willing to take much of a haircut on your salary in exchange for equity you know that’s probably an indication that you may not ready for the plunge.
So if we assume that you get past that first issue and you feel that you are willing to take equity in exchange for a salary, the next question to ask yourself is what is the salary that I need to live. What’s the minimum that you need to pay your daily expenses? This gives you your lower bound. Then you can think about what is your ideal salary — and that can vary. You can think about your market rate based on maybe your college or grad school’s recent salary average. Your range will fall somewhere between your salary floor and the market average. Realistically startups aren’t going to pay you over the market rate because they’re not cash flow strong.
ES: I like your suggestion about having a range and understanding what it is. I agree that each startup candidate has all the information they need to determine what their floor is. But it gets a little trickier, determining what their market rate should be for their potential startup role. What resources do you suggest people go to find that information?
PP: So that’s a really good question. Just like any negotiation, I would encourage individuals to find out what the average salary is for a non-startup comparable role. This is important because that’ll tell you what your opportunity cost is. This rate can be the average of what you could get if you chose a more traditional job. Lastly, you need to know what annual rate you should be asking for from the startup. There are so many resources online that I don’t have a favorite. But, I suggest that individuals start to look at what the salaries are for the role that they are pursuing. For example, if you know you’re coming into a startup as someone who focuses on operations and there are no other operations people on the team, you should research what an average COO salary is at a startup. This will give you another range.
I wish it was a clear cut answer but finding these data points will enable you to ballpark your salary. Then there’s a whole slew of questions you have to consider on the lifecycle of the startup. Is the startup early stage or has it just completed a seed round of financing? The likelihood that startups can pay market rate range is very low at the seed or pre-seed stage. However, if a company has gone through a Series A/B round or is close to an IPO, then they absolutely can pay that rate. So it all depends on the stage of life of the startup.
ES: Ok so a candidate has done the necessary research and now has a clear idea of what their realistic range is for cash. Now they have to deal with the most mysterious part of startup compensation — equity.
PP: So true. So when you are looking online at AngelList for equity package suggestions it can be a total crapshoot because it depends on so many different factors. So I think what would be easiest for me is to just give you a couple of pointers to provide your readership on what they should consider. And then from there it’s all about negotiation. So first of all again the stage the startup is very important. Obviously the sooner you’re joining a startup from inception, the more risk you’re taking on and therefore the logic is that you should be getting more equity. This is even more relevant if you’re joining on as a co-founder or first hire.
ES: When you mentioned stage of life it made me think that individuals should really think about where they are in their lives as well.
PP: It’s so true and that’s why I started the conversation where I did. If you’re not willing to take on this amount of risk in your stage of life, then you may not even want to get to the point of negotiating with a startup. You’re taking out a lot of risk as a person. So really it’s a really valid point. So let’s say you determine you know what stage of life you’re entering the company. The other thing to ask is what milestones has the startup reached so far. A few questions to ask are: have they issued preferred stock in the past? Have they issued common stock? What is your fully diluted basis of shares that they are making? All of those are questions that can be answered very simply by asking for the cap table. People vary on this suggestion. I’ve gotten advice in the past that it’s almost like asking someone to show all their cards in a negotiation. Some others believe it is a very fair ask and that’s where I land on the issue. I feel that there is no harm in asking but you might be told no. And if you are told no, then you must ask those other questions I mentioned. How many shares you will be issued and what the startup plans to do in the future, will help contextualize the offer.
So let’s say just for simplicity the startup is offering you 10,000 shares. You have no idea how much that’s worth. If you don’t know how many shares are outstanding, you should ask that question on a fully diluted basis so that it accounts for all the potential conversions of debt that might be outstanding on their balance sheet. You also want to know the strike price. So typically equity is granted in the form of options. So it’s actually not straight up stock. It’s the option to purchase that stock. And so if you ask them what the strike price is, you will know actually your total outlay that you might have in the future to purchase the ownership in the company. So let’s say the strike price is 10 cents. Then you know for 10,000 shares you’re going to be spending 10 cents a share — that’s a $1000. You know that at any given point in the future if you exercise those options, the most you’ll pay to have that ownership is $1,000. To know how valuable that is, you can also ask how much the startup’s last round was raised at in terms of valuation. So if they issued any equity they had to assign the value to their company so that they could assign appropriate value to their options. So that is always a fair question. Again if you had the cap table you would know that as well. This is one of those questions you ask in place of not having that. It allows you to do the math and know even if I exercise in a year you can know what your cash outlay is worth.
ES: That makes sense. So when is the right time to ask for the cap table or ask the other questions you recommended?
PP: I think it really depends on your level of trust and transparency with who you’re negotiating with. I have asked these questions in my experience but I did it all after I knew that the offer was mine to take. In fact, the equity offer wasn’t made until we had gotten into a discussion of bringing on not only me but my company and its IP. So the general offer had been made and we were negotiating other portions of the package. I certainly wouldn’t recommend going into an interview asking these questions. I would only ask if you know that you have the offer and now it’s just a matter of making the numbers work.
At that point, you know these are not offensive questions. These are well-informed questions. The biggest common mistake that candidates make when joining startups is that they just don’t ask these questions. They take that the options just like it is an added benefit to their job. But if you believe what I said in the beginning that you’re taking on a huge chunk of risk, then these are essential questions that you should be asking.
ES: Great point. So we’ve discussed research that’s needed for the compensation conversation. Now assuming cash salary has been agreed on, how does one negotiate equity?
PP: Yeah that’s the less clear portion of the conversation. But first, I have one more question to add to our list that addresses how much more risk is outstanding. You might want to ask the startup founders how many more rounds of financing they think they are going to pursue?
ES: That’s a great question.
PP: They probably won’t know the answer from a definite point of view but you can at least get a sense of where their heads are at in terms of an exit strategy. The reason you want to know this is because if they’re thinking about bringing in VCs your shares are definitely going to become diluted. And you just want to have a good sense of that risk. However, this is a question to ask your accountant or your lawyer. Once you know what type of options the startup is granting you, then you want to understand the relevant tax implications. For example, in my original scenario of the $1,000 exercise — when you exercise those options, there is a tax implication on your personal return that you will have to file. That’s beyond my expertise, but it’s important that startup candidates know that they should consult a tax expert.
ES: Those are great suggestions that I don’t think many people think about when joining a startup.
PP: Ok so now to your question about how to negotiate equity. It’s really hard because there are a couple of things you really don’t have a sense of — unless your potential employer is very transparent in the negotiation. The value you assign yourself and how much you are bringing to the company is most likely going to be different than what they’re offering you. I think the best negotiations I’ve been a part of is when someone can actually argue the value they are bringing to the company and justifying that in terms of equity. Instead of just stating I want 50,000 shares and while the startup is only offering 10,000.
It becomes less debatable if you say the types of projects and value that you will produce at the startup is going to increase the value of the company by whatever percentage or quantity you have come up with. Then you can say to the founders, therefore I deserve this amount of equity. You now start talking to the negotiator in terms that they really can’t refute because all parties are talking about valuation at the end of the day. That is why I suggest startup candidates start talking in terms of what they are going to do for the company instead of what they think they deserve.
ES: That’s really great advice. I like how you mentioned that everyone is discussing the concept of valuation. It’s your value as a candidate that you are going to add to the startup compared to what valuation the founders or VCs have in mind for the startup.
Be on the lookout for Part II which focuses on what founders should consider when structuring compensation packages for early employees. #readingEarnest
Priti Patel is the Chief Practice Officer at Life Cross Training, human performance program. Priti joined LIFE XT as an acquired hire from her first entrepreneurial endeavor. She founded and operated MindPoint, a mindfulness corporate training program based in Chicago. Priti earned her MBA in Entrepreneurship & Marketing from the Kellogg School of Management.
Earnest Sweat is an Entrepreneurial Engineer for Camelback Ventures and an Investor in Residence for Backstage Capital. If you have any questions or requests please connect with Earnest through LinkedIn, Twitter, or AngelList.
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