Thoughts on private equity valuation as an employee

tl;dr

no, that startup offer isn’t your ticket to big $$$.

Exploring private equity valuations

Note: This is not financial advice. It’s a synthesis of my notes, shared with others for educational and entertainment purposes.

Over the last few weeks I’ve been exploring job opportunities and many of these happened to be with early startups (seed to series B). As I was going through that I wanted to have a framework for how to evaluate the compensation of potential opportunities that include private company equity.

The ways I explored this:

• I asked in the communities I participate in including the Rands Leadership Slack, the ex-Shopify Slack about their startup experiences and how they value the equity component of compensation.
• I talked to friends and former colleagues in person, in chats and video calls.
• I searched for resources, reviewing them, summarizing them using Readwise Reader and Shortform.
• Synthesizing my thoughts in this post. I write to think.

Reactions from friends and broader community

Some of the themes I heard:

• Private company equity is worth $0.
• A lot are seeing hesitation from larger companies with frozen or delayed hiring cycles.
• Holding stock that you can’t sell without board approval, even with a ready buyer is an interesting experience. If something is only worth what you can sell it for, is it worth $0 if the board won’t let you sell?
• Early stage equity is like a lottery ticket.
• It’s OK to take a big cut to go work for a startup and take a big swing. If it doesn’t work out, people in tech understand startup failure, and as of 2022, that layoffs are par for the course.

Resources

• What I Wish I’d Known About Equity Before Joining A Unicorn
  • What: an anonymous and cautious take on the value of equity.
  • Takeaways:
    • Equity is often offered based on a highly theoretical future valuation number, and dilution can occur during fundraising rounds.
    • Equity should be valued at $0 and considered a lottery ticket.
• Startup equity basics: What to ask before you accept
  • What: walk through the basics of startup equity, the questions you should ask, and how to compare offers side-by-side.
• 33 Questions to help evaluate a startup job offer
  • What: Covers the non-equity valuation considerations you should think through.
• The Open Guide to Equity Compensation
  • What: A consolidated and shared resource for beginners and experienced individuals on different sides of compensation decisions. Covers equity in US C Corps.
• Startup options vs cash
  • What: Antoher skeptical take on options as a cash alternative in compensation.
  • Takeaways:
    • There are cynical reasons why startups prefer options to cash, such as options not being worth what startups claim they’re worth, and non-cynical reasons, such as the tax benefits of ISOs.
    • Paying people in options almost totally decouples job performance and compensation.
• Carta Equity 101
  • What: A free course on equity in private companies. Lessons cover:
    • 01 What is equity?
    • 02 What’s a cap table?
    • 03 Equity grants, explained
    • 04 How vesting works
    • 05 How exercising equity works
    • 06 How to sell your shares
    • 07 How are equity grants taxed?
    • 08 Valuations, explained
    • 09 Who can invest in startups?
    • 10 How venture capital works
• Peter Walker, Head of Insights at Carta on startup equity distribution to first hires
  • What: a post on distribution of equity among the first five hires in startup companies.
  • Takeaways:
    • Initial equity grants tend to be top-heavy, with the first hire receiving the largest percentage.
    • Significant drop-off in equity for hires 3, 4, and 5.
• Sam Altman on Employee Equity back in 2014.
  • What: A call from Sam Altman to grant more equity to employees and with more favorable terms.
• State of startup compensation, H2 2022 and the H1 2022 report from Carta
  • What: analysis from Carta on startup comp in H2 2022 and H1 2022.

Equity-specific questions

Here’s a list of equity compensations questions to ask the company. I gathered these while going through the above resources.

• What is the company’s current 409A valuation? When was it done?
• What is the vesting schedule of your employment contract? What happens if the company is acquired or I leave?
• How many outstanding shares are there?
• What is the strike/exercise price per share? What is the fair market value (FMV) per share?
• When do you plan to raise your next round of funding?
• What is the time horizon for potential sale/IPO?
• What are the previous secondary sales (by employees/founders), if any?
• What are the constraints on the ability to sell shares privately?
• Does the employment agreement give me the option to sell shares as part of future rounds of fundraising?
• Are they any debt or investments with >1x liquidation preference?
• How long after departing company do you have to excercise your options?

Will this startup offer make me the next (b|m)illionaire?

No. Well, almost certainly no. VCs are in the business of investing in a large number of companies such that a small percentage, I usually hear 1% thrown around, will lead to many order of magnitutude returns. Even with an amazing founding team, excellent hiring and luck, the odds are against you joining one of those.

Total compensation should not be the sole factor in taking a job with a startup. If the primary utility you get from a job is salary, you’re (probably) going to find a better payout by taking on a position where the total compensation is in the form of salary. Instead consider a startup offer based on things that matter to you.

What will make up compensation for you ?

Some things I value as much if not more than salary include:

• passion for the mission.
• impact.
• the ability for the company to prioritize to best further their mission.
• mutual respect.
• opportunities to be challenged and learn.
• how much I enjoy my coworkers.
• the ability to do good work and help others.
• how much I’ll be able to grow my network and build deep relationships.

Figure out what matters to you, and what you’re going to get out of that next gig. It doesn’t have to be salary and nothing else.

Good luck!

If you’re out there these days looking for a gig, my heart goes out to you, I know it’s hard. You’ll land somewhere that’s right for you even if it takes a while or isn’t what you were expecting.