First employee of startup? You are probably getting screwed

http://blog.dinkevich.com/first-employee-of-startup-you-are-probably-getting-screwed/

by pajju • 14 years ago

97 67 14 years ago

blog.dinkevich.com

phillmv• 14 years ago

People don't know how to negotiate. Equity is the founder's only payoff, so they're going to be incredibly stingy about it, while playing up the intrinsic benefits.

Also, people don't know how to measure opportunity cost.

webwright• 14 years ago

"Equity is the founder's only payoff, so they're going to be incredibly stingy about it, while playing up the intrinsic benefits"

There's also a lot of weight behind the "this is how it's done". 1% used to be very generous when founders had to roll the dice with 12+ months of their life to get seed funding and take big dilution when they did. Nowadays, it's cheaper/easier/faster to start a company, easier to get early stage funding, etc. It might make sense to reward employee #1 with a bit more equity... IF you can't pay them market rate (you buy equity by taking risk-- if you aren't underpaid, you aren't risking much beyond opportunity cost).

See: http://startupboy.com/2011/12/13/why-you-cant-hire/

base6982• 14 years ago

What is a bit more? 1% more? 5%? 10%?

tribeofone• 14 years ago

Not negotiating is part of it, but also its not knowing what to ask for. Though equity is the payoff, most founders at the beginning are pretty loose with their equity because it really has no value, so throwing someone a percent or two when its worth $0 to get someone happens quite often, especially when you as a founder have the lions share.

However, the biggest muff that people in this position do, is that they don't understand options and how they work, a little what this guy was saying. Take the options, why not, but treated as money and not sweat equity. You might not be able to get preferred shares and deep informations about the company, and you probably shouldn't, but you can ensure that whatever happens the money you put in vests without strings attached every 6 months until they pay you what you are worth.

bceagle• 14 years ago

Yeah...this depresses me. I am one of those guys that is going to get screwed. The only thing I guess I would say in response is that I would be an investor instead of a first employee if I could, but I can't. I don't have the capital sitting around to play with and there is a difference between differing salary and having cold hard cash to inject into a company. In other words, an investor giving $50K is more valuable than an employee deferring $50K in salary.

Also, in many cases, the employee is getting value that the investor is not. Specifically, the employee (i.e. me) likely doesn't have a ton of start up experience and is able to leverage the work as employee #1 to then start his or her own start up later. The investor on the other hand has likely been involved with many start ups and isn't as much interested in learning or experience. They just want a return on their investment. So, from that sense, this article is sort of comparing apples to oranges.

zacharyvoase2• 14 years ago

> In other words, an investor giving $50K is more valuable than an employee deferring $50K in salary.

You couldn't be more wrong. $50K saved is the same as $50K invested. They have the same impact on revenue, profitability and life expectancy of the company. Sorry to get personal, but the fact that you don't understand that is probably why you're ‘employee #1’ and not ‘co-founder’.

Another point: companies are generally disinterested if you tell them that you have eventual plans to leave. As much as both parties know it's unrealistic, hiring managers generally prefer a long-term commitment without a hint of an 'exit plan'.

> The employee [...] is able to leverage the work as employee #1 to then start his or her own start up later.

Not if they/you don't get access to the company financials, or investor meetings, or insights into the decision-making process (let alone a part in it).

JoeAltmaier2• 14 years ago

Saved and invested are definitely NOT the same thing. They have very, very different impact on life expectancy etc. You can't buy a copying machine with virtual dollars.

Cash is king.

TelmoMenezes• 14 years ago

50K$ worth of work and 50K$ in cash are not the same thing. The former has a higher risk associated with it than the latter. For example, there are the risks that the employee becomes unable to work for health reasons, disappears or just isn't suited for the job. Also, the full value of the latter is only delivered, if everything goes well, after one year.

Too• 14 years ago

Discussion from a year ago: http://news.ycombinator.com/item?id=2949323

gaius• 14 years ago

Patio11 nails it: http://news.ycombinator.com/item?id=2950077

its_so_on• 14 years ago

(Please read this comment carefully.) The author's comparison at the end of the article is correct.

It is obvious that it is much better to get the package "2% of company shares, Priority on exit, Invest small part of his capital" for the same $50k (i.e. the programmer's guaranteed lost income) when you are paying the money directly.

Further, investing $50k directly does not even involve working full-time or part-time (except on financials related to the round), and has an equal chance of both lost money (company doesn't get on sure footing), and returns on the money, that the programmer faces.

So bottom line. If you have identified a company that you think has good chance of success, you should simply decline to work for them for equity and a lowered wage: instead, find a source of great personal wealth, and invest a small part of it directly in the company.

Working for your equity means you're getting screwed. Being very rich gives you a lot better deal.

eli• 14 years ago

Step 1: Get a million dollars...

JoachimSchipper• 14 years ago

The alternative is not "be born rich"; it sounds more like "save the extra 50K, then start your own company". Yes, this is harder than it sounds - but it's still easier than choosing your parents.

pyre• 14 years ago

If you can afford to take a $50K/year paycut, then you can afford to just invest $50K/year of your current earnings.

lectrick• 14 years ago

I did this for a bit although I got 3% of the company. The resume bullets and name recognition since I left have more than made up for the low salary, at later jobs.

tlear• 14 years ago

All depends on that first employee, for some that would be an amazing deal for others it is laughable. If I was out of the school but with some skills and liked the company in general I would jump on it. Now the idea, founders, investors would have to absolutely blow me away (order of magnitude higher then anything I experienced). I like to get payed in cold hard cash and now not later.

jeremyarussell• 14 years ago

It would seem to me that there are many more factors that go into making a decision like this worthwhile versus getting screwed.

-Type of company(do you like the product, is it something you can see yourself wanting to wake up for?)

-Type of founders (like-minded, fun having, professional but not bureaucratic - comes to mind as possible wanted features)

-Equity(literal percentage wise and decision making-wise, are you going to be leading a team in a year? or still grinding away all day?)

-Perks(Gym in workplace? What about sports area? Video game room? Movie theater spot?)

-Location(Where will you get to work, a nice second story office overlooking the bay? a park?)

-etc...

These are just off the top of my head. I'm sure there's more.

Edit: Fixed my line spacing.

loxs• 14 years ago

Yeah, they are paying half, but they can afford a Gym, or an office overlooking the bay? That sounds like an even bigger screw up...

varelse2• 14 years ago

I used to fall for this trap.

But now I just calculate my expected return based on a 10% chance of a buyout for $100M or so (cockily I'm assuming I can screen the obvious losers out with common sense alone though that is of course debatable) and if it's not a net uptick from the current gig, I pass on it. And up to now, I've always passed on it, and none of them succeeded.

Other than that, the only startups I'm interested in are ones where I have one of those nifty 3 letter titles and 5% of the company in my pocket.

scarmig• 14 years ago

How many have you passed on?

Have you tried to characterize how likely it is that your filter is actually good enough that 10% of the companies that pass it are successful?

Just seems to me that 10% could be something of an overestimation and needs some validation.

rhnoble• 14 years ago

10% might be a good rule of thumb if the old adage that "9/10 startups fail" is somewhat accurate. Is $100M the average exit though? Anyone have that data?

carterschonwald• 14 years ago

That's the thing, working as one of the first people at the startup is a pretty intimate close team (or at least should be). There's a lot of "safer" and or more compelling ways to pull folks in. a) Offer a moderately accelerated vesting schedule for early employees. b) have the initial work be as a sort of moonlighting in terms of time commitment (more suitable / appropriate when either taking a bootstrapping approach and or building out the MVP.) c) seriously, it's your first hire, you folks will likely (and perhaps unfortunately)spend more time together than you will with your respective significant others.

Point being, yes it's "just business", but if you're not setting things up to be awesome for that first hire, are they going to be sufficiently awesome do as to be worth spending so much time together? And if they're that great, how much do you wish to ensure that you guys are likely to choose to work together again?

I'm likely way over reacting, but still, it's a matter of some importance, exercising choice over who you spend time with, so why settle for less than awesome or treating them awesomely?!

moron• 14 years ago

I've decided that I am too stupid to figure out such schemes. I just figure out how much my work is worth to a company and then ask for that. As I see it, working for equity is essentially begging to get screwed by someone who understands the finance game better than me.

brandonb2• 14 years ago

His numbers are way off. 2M is not a "high" pre-money valuation--most startups nowadays raise a seed round at a 5-10M pre-money valuation. So for $50k, an investor will get 0.47-0.91%, whereas the employee in this example gets a strictly better deal at 1%.

That said, I agree that $50k/1% is a low offer. Lots of startups (at least in the SF bay area) are offering 50-100% higher than that, and these are good startups with experienced founding teams, funding from top investors, paying customers or traffic already, etc. So definitely explore your options! There are great deals out there.

zmoazeni• 14 years ago

His numbers are way off. 2M is not a "high" pre-money valuation--most startups nowadays raise a seed round at a 5-10M pre-money valuation.

I'm not saying your statement is wrong, but am I the only one who thinks something is wrong here? Are most startups worth 5-10M right after seed? I would say no.

Conservatively, I would tend to agree with the author. 2M is high for a company that only has seed money.

brandonb2• 14 years ago

As one data point, the average valuation of a YCombinator company for the last batch was $10M: http://techcrunch.com/2012/05/22/ycombinator-80-strong/

And that's the average; many were higher. There are probably amazing startups out there that raise at a $2M valuation, but it's definitely at the low end of the range in the current funding climate. If you're looking to join a startup, I wouldn't fixate too much on valuations, but I do think it helps to be aware of what the current market is like.

(Note that it varies by region. Silicon Valley and NYC are probably comparable, but other regions have less investment and so have lower valuations on average.)

emmett8• 14 years ago

Why is it "wrong" for something to be priced high?

Try this thought experiment: Mark Zuckerberg (or whoever your favorite entrepreneur is) comes to you and says he's quitting Facebook. He's going to start a new company, and he'll let you invest at a $20M valuation. Do you accept?

danshapiro• 14 years ago

No, they do not. They issue convertible debt with a cap at $5M-$10M. A debt conversion cap is not a valuation - the current valuation is by definition lower. It's lower by at least the amount of the discount, and almost certainly by much more than that.

Simple thought experiment to make this obvious: when a company raises convertible debt with no cap, are they infinitely valuable?

chasing• 14 years ago

I wrote up a similar sort of article last year:

http://auscillate.com/post/238

Curious what the HN community's take on that is. The conclusion is basically the same, but I attempted to be a bit more rigorous with the numbers.

cjrp• 14 years ago

Yep, fell for this too. Joined as their second hire, working under a senior developer... who promptly left. I assumed his role (and responsibilities), but not his pay. Not to worry I thought, stock options are coming. 11 months later I got papers for less than 1/4 percent with no vesting schedule (must stay until exit). Handed in my notice soon after.

That said, the experience I gained in the year helped me land better paid contracting gigs after, so... swings and roundabouts.

gyardley• 14 years ago

This article should probably be retitled 'Working for half your market salary? You are probably getting screwed' - but then the whole thing sounds a little obvious, no?

If the company is strong, paying you appropriately won't make or break it. If the company really can't afford to pay you appropriately, you should be a cofounder.

slantyyz4• 14 years ago

Agree. You're only getting screwed because you're willing to get screwed.

You should always make sure you're getting what you're worth when entering any business relationship, and make sure that any gravy (stock options, bonuses, etc.) is exactly that. Gravy.

anonymousq• 14 years ago

When joining a startup company that is anywhere from 5 to 50 people, what are some things I can/should ask for in a contract negotiation?

Can I ask for acceleration of my options if the company gets acquired before my cliff? Can I ask for a guaranteed contract with a buyout, in case they want to let me go before my options vest?

bri3d• 14 years ago

You can ask for these things, and I think a company's ability to have an informed conversation with you about your options will tell you a lot about the founders (both in terms of their expertise and their character).

Keep in mind, though, that founders have a lot more discretion with respect to how much they pay you than with respect to your options contracts. Garbage options contracts (no triggers, no guaranteed contract, huge cliff, etc.) are generally insisted on by VCs, in order to prevent employees (read: you) from negotiating an agreement which makes the company a less appealing acquisition target. Pay is generally more flexible.

So I'd suggest asking those questions, having an informed conversation with the company about the way options are structured, and then insisting on a good, solid salary and treating the options as gravy. By the time you get diluted, you end up in a locked up IPO gone south, or the acquirer comes up with some creative stock-and-cash acquisition with employee pool conversion that scams you, there's a very low chance of your options being worth anything anyway.

emmett8• 14 years ago

Yes, if you take a $50k/year paycut for $25k/year in equity, you're getting screwed.

But mess with the numbers just slightly - a $4M premoney valuation, and 2% of the company - and suddenly you're getting $100k/year in equity for a $50k/year paycut.

Now of course that equity is risky. It still might not be a good deal, unless you think you have at least a 1 in 2 chance of success.

But the point is: you can obviously get a very good deal as a first employee without taking on the risk of quitting your job with no paycheck. Make sure that it IS a good deal first though!

The first employees of all the startups I know personally have gotten very good deals.

keeptrying• 14 years ago

"The first employees of all the startups I know personally have gotten very good deals."

Can you elaborate?

emmett8• 14 years ago

I'm friends with founders of many YC startups (and a number of non-YC startups as well).

If you're a smart founder, you will offer a very good deal to your first N employees. They are by far the most important hires you'll make. Even if you could trick someone into taking too little compensation, you'll regret it in a year when they find out they were snookered.

tptacek6• 14 years ago

Two things:

If there's a 50% chance of a positive outcome (which, obviously, is an extraordinarily high chance), aren't you getting a ($100k50%) / ($50kyrs) risk-adjusted payout? If so, you should just take the $100k.

And, this analysis assumes the company doesn't go back to the VC market for capital; when it does (most will), you have to factor in the (strong) risk of dilution. We're also glossing over other risks, like participating preferred stock for investors.

I got a great deal from one startup, watched people get a reasonable ("worked out to the equivalent of years of good-but-not-amazing bonuses") from another, had a positive outcome from one that was still under what I would have gotten from salary, and nothing from 2 more. Equity is a decidedly mixed bag.

If you have the choice (and in this market, developers do), opt for money over equity. If you can mentally partition the "extra" money into "investment" and invest it for a return in something more liquid than startup equity, so much the better.

emmett8• 14 years ago

Unless you think you're a better judge of company valuation than the market, the current risk-adjusted value of the company is approximately the valuation set by the recent round of funding.

The fact of future dilution is irrelevant, since this impacts the investors as much as the employee.

This analysis does ignore liquidation preferences. It also ignores the fact that the options have a non-zero strike price (though probably substantially below the preferred stock with those liquidation preferences). But in the end, startup outcomes tend to be binary: very high or nearly zero. In both of those cases, liquidation preferences and strike prices wash out in the noise.

I agree though: equity is almost the definition of a mixed bag. That's why, as an employee taking substantial compensation in equity, you need to take an investor mindset in choosing where to work.

rdtsc• 14 years ago

> Now of course that equity is risky. It still might not be a good deal, unless you think you have at least a 1 in 2 chance of success.

Don't startups fail at a rate of 90% or so? All of the sudden that $100k/yeah in equity looks not as great.

Now of course most owners think it won't fail. But then even out of those that are rational, and understand they will probably fail, a large % will still try to convince the first employee that the startup won't fail.

emmett8• 14 years ago

Which is why it's $100k of risk-adjusted equity. Some high percentage will fail[1], but that's already accounted for in the price. In the case the equity is worth a non-zero amount, it will probably be worth much more than $100k.

Trying to decide whether the startup will fail is almost the whole game. In the end that has a much larger impact than your exact equity percentage.

[1] though if you apply a simple filter like "only YC startups" it's way less than 90%

SeoxyS2• 14 years ago

Sure I got screwed and the investors got a way better deal.

But then again, every other startup would have given me the same deal or worse, and the alternative would have involved me still being in college taking out student loans. I think I'll stick to my mediocre salary and nonfounder equity[1].

[1]: Since day one, the company has done quite well and my pay is no longer mediocre, and my equity would be a nice 6-7 figures bonus if the company sold today.

Quit focusing on the injustice of an employee share versus a founder or investor share. Quit comparing yourself to others, and instead focus on whether the numbers offered to you make sense for you, personally.

varelse2• 14 years ago

"every other startup would have given me the same deal or worse"

Not true. I talked to a bunch of my entrepreneurial friends about this when I encountered this situation again and again. Their own hirees were treated more like I'd expect - a clear advantage to taking the offer - lower pay meant higher equity although it was never as bad as this case.

Glad things worked out for you though. There are winners in the industry and it's nice to see it when it happens!

rdl• 14 years ago

If you're an early employee of a startup, you have better de facto information rights than any investor, even a board member. If not, you're seriously incompetent, or the company is totally dysfunctional. i.e. if things are going really badly, you'll know before the investors do, and could jump ship.

The only thing you might not see is acquisition offers, but you can assume those are constant noise and meaningless until a certain point.

crusso• 14 years ago

That looks like a post from someone who fundamentally misunderstands the dynamics involved in evaluating value in a startup environment (and likely in business period).

There are too many variables to consider in order to make a generalization like that. Even if you have a firm handle on the financial variables (how much you're earning, what your opportunity costs are, what the company will be worth, etc.), it doesn't at all consider the intangible value. So your friend is going to get 1/2 pay for 1%... maybe the experience alone in being able to evaluate his self-worth in the future or in being able to start up his own company will more than make up for a couple of years at 1/2 salary? Who knows. I'd be willing to bet that this blogger doesn't.

cdibona• 14 years ago

There are so many variables that go into valuing an offer from a startup that any general article like this can not ring true. Here's some questions I'd ask myself if I were considering an offer from a startup.

(wow, this is a lot longer than I expected it to be)

1) Who are the investors?

Before I joined VA Linux in 1998, I knew they were super close to closing the Intel Capital deal, so I knew (to a certain degree of accuracy) that they were close to having money in the bank. I agreed to take less salary for equity and a promise from the CEO that salary would improve as the company got more solid funding. The CEO was good to his word, too. I might have taken the job without the vc funding, but knowing what was up there was really helpful.

There is more knowledge now about the equity picture of a private technology company today than ever before in history. It's very easy to get an idea of a companies valuations and then if you agree with those values and if you think they'll increase.

Some VCs also have a reputation for screwing early employees and pancaking out those that might leave before an exit. This is very important to know if you're going to be valuing a potential equity stake. So, your equity could disappear without any regard for your feelings on the matter.

2) How far along are they towards going public/another exit.

I joined Google the week before it went public (in 2004), meaning my initial strike was the ipo opening price. Considering that made Google more stable than competing offers from younger startups, and more fun than some of the other companies I had offers from. The former was important as I had just come out of a failed startup and some time consulting, and I wanted stable more than I wanted fun. I got both, but that's pretty rare in companies of Google's vintage (I still have it, which is one of the reasons why I stay).

The point of this is to understand what the future of a company looks like. I knew what Google looked like, and for other companies when considering/working with them, I asked myself what do similar 'exits' look like. That leads to understanding of what an equity position means.

You can look at an offer and ask yourself: Will the company actually increase in value before an exit that makes this equity worth it?

3) Is there an established bonus system?

A lot of companies have no bonus and weaker benefits/salaries pre-ipo. They have the equity stake offer and so these other considerations are sidelined until they become larger and those equity offers stop attracting good people by themselves. These differences can mean 70 to 80k less per year for a senior employee. So, know what you're worth and decide if it is worth the risk.

4) Are the people running the company any good? Are they ethical?

This is actually hard to answer, but I've seen plenty of acquisitions become less lucrative than a similar job in an established company. I won't mention the company, but I've seen large companies (not Google that I know of) end up giving less in financial terms to acquired employess than they give a new hire wrt equity participation. It's kind of sad how little people know about the companies they join.

I'll say it again: I often see companies on HN get acquired, but for many of the employees, and not a few founders , of startups, this is a much worse deal financially than taking a job with an established firm. Your mileage may vary, and take it with a grain of salt, but remember you are trading money now for the chance of much more money later.

There's so much more I'd like to tell people here about considering offers, but I've already blathered on a bit much on this. I also readily admit I have a different approach to risk as a husband and father (2004) than I did as a single developer (1998)...

Vitaly• 14 years ago

this part about 50% of the market salary to work at the startup in US was always quite weird to me. Here in Israel I was working at startups my entire career, expect for the first 3 years spent at NetManage. Through out all those years I got above average salary. No established company ever offered me more then I could get at some hot startup needing my skills.

different markets different rules I guess.

slantyyz4• 14 years ago

Or perhaps, different markets, different willingness to gamble?

If people take a step back from the situation and compare the "ground floor startup opportunity" against a full salary job, they might realize the 50% salary reduction is more complicated than the absolute dollars foregone. Startups tend to demand more overtime than established companies, and quickly, the already reduced effective hourly rate starts dwindling down into fast-food employee territory.

Sure, the startup work might be fun, but you could get the same or more money from another job and do fun things after work.

Also, be prepared to add some risk to account for the chance that the currently well-intentioned startup owners will screw you over if things get bad.

Once you factor in the failure rates of startups, standard vesting times, etc., all that money you're giving up translates into one very expensive lottery ticket.

So if you go in with your eyes open, i.e., you're willing to forego that salary difference with a possibility of a zero return, then yeah, knock yourself out, because if you do win the lottery, it's a huge pay day. If you don't win the lottery, you knew it was a gamble, so no big deal.

Before jumping into bed with a startup for a huge salary cut though, a person might do well to ask him/herself if they'd be better off at a job with full pay and using half the salary to play the stock market.

First employee of startup? You are probably getting screwed

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