Thursday, October 13, 2011

Is This Offer Fair - The Real Risk of Joining A Startup

It's no secret, startups are sexy again.  I've been getting calls from friends and helping them evaluate offers.  Since I just finished reading Mark Suster's TechCrunch article on dilution, which you should also read,  I'm writing this post to illustrate my POV on equity, as an entrepreneur-who one day hopes to be hiring and divvying it out.

My framework is loose, but valid in explaining non-investor risk among *venture-backed startup* operators (in both actual and perceived terms), so here goes.

*Venture-back startups are, by definition, companies that have to have to return 10X or better to be considered successful*


The greatest risk applies to the founding team.  They have left real jobs, are working unpaid (for some period of time), get to draw a significantly less than market rate salary upon raising a seed round, don't have cash on-hand to cover salaries and operational expenses for more than 3-6 months (if lucky) and are compensated for their risk with more lottery tickets, so long as they stay around and keep hitting milestone.  If you don't get passed the seed stage and go broke, the experience gained is only incrementally valuable to a handful of companies in the market at large.

Employees hired after the first priced round:

This area is dicey, because you need top talent and can't pay premium prices.  As a founder, I couldn't hire someone that early without telling them upfront how many months I can guarantee their below-market salary;  the longer I can pay them, the less risk.  There is a resume risk b/c the startup is (usually) unknown and unproven and there is an opportunity cost, which incrementally tick up the amount of risk the first (few) hires are assuming, which has to be fairly compensated.  However, most early hires are exposed to valuable experience and are assuming titles that garner both respect and greater consideration / compensation if & when they leave the startup venture, not to mention they get veteran consideration in the startup community if they choose to move on to their own venture.  And oh yeah, institutional investors are really quick to snatch up these guys and move them to other portfolio companies.

Admittedly so, quantifying and rewarding these hires is tricky.  However, generally they are brought on for comparable, if not higher, equity to the packages received by seasoned / experienced, VP-level post A / B round...which sounds like a decent benchmark for fair.

Engineer 6+ or anyone that comes in after a $3-5 A round:

Effectively, you have no significant risk, besides a below-market rate salary risk, if you are getting paid below market rate at all.  And, since your equity is priced, you know you are being compensated for the gap and an average bonus as soon as you do the math on the equity offer...but you are also getting a better work environment, solving problems you are passionate about and greater marketability later.  So, I'm not sure what the bitching is about?

Most of the posts I see or personal inquiries I get seem to revolve around perceive risk and not real risk, since most people fall into that 6+ or post $3-5 A round category.  Just because the company may not be around, you will most likely have a job for 12-18 months (minimum).  You are not entitled to get rich, a big nest egg, or anything in return (beyond the aforementioned non-monetary compensation). In the likely event that you're not apart of a home run, you worked at a really cool small business.  Newsflash, if my argument doesn't convince you a startup is worth joining, don't do it.

For everyone that is joining a company at or around series B level...that's not a startup.

Here's the good news, if the company hits the home run that it promised it would when it accepted VC money, everyone gets paid more then they were actually worth...that's the whole point.  Equity is gravy...the sooner you get it, the better off you'll be.

If you have ever seriously entertained a thought like, "If I can get a bigger piece, in the event of a not so hot exit, I'll still get PAID", while negotiating with as engineer 6+ / $3-$5 mil A round, don't make the leap. You just don't get it and the mentality won't help the team that's extending you an offer.

As you saw from the infographic in the aforementioned article, deals aren't usually optimized for not-so-hot exits...and they shouldn't be.  But then again, equity is designed to motivate for the BIG EXIT.  In the event of a fire-side sale or flat exit, you'll be lucky to be made whole in-cash, but the experience gained will ease the pain.  But then again, you knew going in what the risks were.