7 ms·

Ask HN: When compensation includes equity, can I ask proof of valuation?

• geophile 11y ago
  I don't see why that would matter very much. The valuation so early is going to be highly subjective in any case. If you are willing to consider such an offer, then the two relevant things to consider are 1) what fraction of the company are you being offered, and 2) what is your estimate of the likelihood of this company becoming successful. If you are sure they are going to fail, then the equity you are getting is worthless, and why bother? If you think they have a reasonable chance of success, then all that really matters is how much of the company you own.
  • kohanz 11y ago
    In this scenario, the amount of equity being offered is in lieu of market-level compensation. I know typically you want to get full market compensation + equity, but the claim is the company can't afford it at this moment (common startup situation, I'm sure). So say that I have given a quote as a consultant for $100k worth of development. They can only afford to pay $50k. They claim their seed round gave them a valuation of $10M, so therefore they offer 50k / 10M = 0.5% in equity in addition to the $50k cash. This is why the valuation matters - it is directly determining the amount of equity in the offer. Is that a reasonable arrangement? Should I ask for proof of valuation and, if so, how?
    • kaffeemitsahne 11y ago
      Ask them to loan the 50k from a bank instead of from you.
    • smileysteve 11y ago
      > They can only afford to pay $50k. They claim their seed round gave them a valuation of $10M, so therefore they offer 50k / 10M = 0.5% Certainly not for such a low % and at a seed round and at such a low salary to market. Also, since you would be certainly investing in the company, you should ask for preferred equity that vests each month (as your paycheck would be paid)
    • hartator 11y ago
      If they seed round give them a valuation of 10M, it means they must have got at least something like 1M for 10% or 500k for 5%, so it seems weird they can't find the money to pay you. Even if 10M valuation is confirmed, you should get more equity to compensate for the risk. Usually, startups without tech co-founder tends to fail so your might want to take account of that when you are accepting equity. If the startup fails, the equity is worthless.
    • neltnerb 11y ago
      If you're just doing a short term job as opposed to sticking with this company for the long term, consider thinking about it as you investing $50k as a convertible debt note. Have the $50k convert to equity at your option based on their next round of funding with a discount of 15%, with a cap of 2.5% equity based on a typical rule of thumb initial valuation of $2M for a company at such an early stage, and 2.5% equity by default if they fail to raise a second round or sell the company within the next 2 years. This may be a bit on the aggressive side, but what you're really doing is giving them an investment of in-kind labor.
      • kohanz 11y ago
        > If you're just doing a short term job as opposed to sticking with this company for the long term To expand, this is also being discussed. They have made overtures to bring me on as CTO, but we both agreed it would be best to try each other out through a consulting arrangement (as I am currently an active consultant). I understand that the considerations as a long-term early employee are much different (e.g. I should expect more equity and for it to vest gradually). So I could see me doing the consulting gig for X months and then being hired on as CTO/Engineer #1. At that point I suppose we would negotiate a new agreement. That probably complicates things, right?
        • SyneRyder 11y ago
          I would red flag on this. They may sweet talk you with optimistic scenarios, flatter you with C level job titles... but apparently you are the entire tech team right now, and they're not prepared to even pay you market rates. Factor in the pessimistic view: if they can't afford you now, is the business growing or struggling? What if that equity is worthless, or unable to be liquidated? What happens if they decide down the track to "replace" you with someone else, will you get to keep your equity or does that evaporate? Do you really see this company as your life's work, or would you be happier consulting for different companies at increasingly higher rates and doing your own thing instead? I really hope I'm being overly pessimistic, I just feel I've heard this story before.
          • 11y ago
    • QandAandQ 11y ago
      Well I ten to look at it like this. To get true value for your 50k worth of work. True equity pay out is : (1/Probability of Startup Success) * (50k/10M) So if they have a 25% chance at success, then you should be getting 4*.5 = 2%. Otherwise, you are not taking the expected value, you are taking probability of success = 1. To make matters worse, assume you wont see the pay out for atleast 5 years. One in the hand is better than two in the bush, so there is a discount there as well. Am I missing anything here?
      • joshu 11y ago
        Probability of success is already factored into the price the investors paid. You can come up with a different factor but all you are doing is effectively negotiating a different price. Your example thinks it is a $2.5MM company instead.
      • fredkbloggs 11y ago
        There's more to it because "valuation" does not mean that the investors actually thought the company was worth that much post-investment. They almost certainly got other terms as well and those clauses probably constituted the bulk of the value they received, not the equity itself. Without understanding exactly how the deal was structured and what the terms were, you have no way of even guessing what the investors thought the equity was worth. There's also the fact that the round didn't close 10 seconds ago; things have undoubtedly changed since it did. Those changes could positively and/or negatively affect the value of the equity. Once you're past that, your approach is basically ok. It's a bit like the Drake Equation, though, in that it's several unknowns multiplied together to achieve a very precise result that has such large accumulated error bars as to be meaningless. The best you can do with this approach is try to avoid taking a worse deal than the last investors, which doesn't mean much. Also, no one has a 25% chance of success unless they've filed an S-1. But that's just a detail.
    • mahyarm 11y ago
      That startup's stock is not liquid, and that %0.5 is subject to a large amount dilution on top of it if it ever becomes liquid. For example, it's often not worth it to work for a startup, even if you get that %0.5 equity at the $10mm valuation, since even if it gets to a $1 billion valuation, it doesn't mean you can sell it. Dilution would then make that $50k into $500k instead of the $5 million you would expect. $500k / 4 = $125k / yr (vesting), which is the same as working at google / apple if you could sell all of your stock. But you cannot so you probably will not get that money back. So a very good case scenario for startups can lead to getting the same money as working at google. With the current trend of 8+ years to liquidity if the company is successful, it will be a long time before you get your $50k back. Then you have to compare putting that held up $50k in to an index fund over the same 8 years. As a result, you should probably be demanding something like %5 of the company. Dividing your missing compensation by the probability that you would actually get that missing compensation will lead to a calculation like that. They will predictably balk at the %5 suggestion, so it's up to you to figure out if you can make more money working for someone else keeping your sales costs in consideration. If not, then go ahead and work with these people, and just treat the equity as the lottery ticket it is. http://techcrunch.com/2011/10/13/understanding-how-dilution-affects-you-at-a-startup/ http://techcrunch.com/2011/10/13/understanding-how-dilution-...
      • kohanz 11y ago
        Thank you. This is a clear explanation of some of the considerations I need to be aware of (but was not).
      • HockeyPlayer 11y ago
        This post is too pessimistic. If this startup gets to a $1b valuation, you will likely have some avenues towards liquidity. 10x dilution would be extreme.
        • mahyarm 11y ago
          Not really. If your are a current employee, you usually can sell %10 of your vested stock during secondaries, which amounts to about $20k until you reach full vesting at the $1b valuation. The secondaries come up every one or two years. If your not working there anymore, you cannot enter the secondary. Most of your stock is still illiquid, and GooFaceSoft is still the better idea. Finding sellers outside of employer sponsored secondaries can be pretty hard and involves a lot of labor. Time better spent making money directly with new consulting clients. Usually the corporation wont be very helpful in selling your stock. ESO fund & others can be pretty picky and you have a good chance they might change their mind a few months later as you try after you have gotten all of your required documentation. As an employee / contractor, you won't have investor level access to financials, reporting or the resources to fully understand them. That dilution level does happen. It's happened to friends as they climbed from a $5m company to a $1b company. Also if you get options or equity of some sort, make sure that the options do not expire until at least 20 years later. You do not want the 90 days after termination problem a lot of people have. 20 years seems long, but there are stories of people's 7 year stock options expiring because the company hasn't gone public in those 7 years! And make sure you have easy access to these required documents, since they are often required to sell your equity when the company is private: http://www.slideshare.net/KeyvanFirouziCFACPA/equity-101-for-engineers-togo-v04 http://www.slideshare.net/KeyvanFirouziCFACPA/equity-101-for...
    • deleted 11y ago
      [deleted]
    • fredkbloggs 11y ago
      It's not really reasonable, because what one investor or syndicate thought the company was worth at one moment in time is neither what the company is worth now nor what anyone else thinks it's worth. And it's certainly not what it will be worth if and when you are able or forced to liquidate your shares. If you're trying to assess the value of the equity you're being offered, the last round's terms are perhaps worth knowing, but they're not the result you want. What you need to figure out is not what someone else thought the equity + terms was worth to them, but what the equity + terms you are being offered is worth to you. This applies to all situations in which you're being offered anything other than cash, whether it's a contract gig with a startup or a dude on Craigslist offering to trade you a stereo system for your laptop.
    • rch 11y ago
      Accept that the valuation isn't particularly relevant at this phase, and negotiate on terms you care about: a contractual term of employment, 9/80 work schedule, and 20 days of paid vacation, for instance.
      • danieltillett 11y ago
        I agree that valuation is not real relevant, but what is a 9/80 work schedule?
        • AnotherMarc 11y ago
          A day off every other week. Typical work week is 40 hrs/week. With 9/80, you split 2 weeks of work over 9 days and take the 10th off.
          • rch 11y ago
            Exactly - a friend of mine had that at Chevron. In addition to the obvious benefits, she also felt more productive the Fridays she was there since the other half of the office was out.
          • danieltillett 11y ago
            Thanks for the explain action - we call this a nine day fortnight here :)
    • 7Figures2Commas 11y ago
      > So say that I have given a quote as a consultant for $100k worth of development. They can only afford to pay $50k. They claim their seed round gave them a valuation of $10M, so therefore they offer 50k / 10M = 0.5% in equity in addition to the $50k cash. This is why the valuation matters - it is directly determining the amount of equity in the offer. The valuation matters, of course, but if I was in your shoes, my biggest concern wouldn't be validation of the valuation: 1. A $10 million valuation is well above the median valuation for seed stage companies[1]. What's strange here is that the startup doesn't even have a technical team, so what was the justification for the valuation? 2. Despite the fact that this company was somehow apparently able to raise at a premium valuation, it apparently didn't raise enough to pay for the development that's needed. That implies it raised too little. Whatever the reason, that's a huge red flag. In a scenario like this, I wouldn't consider equity to be at all attractive. [1] http://www.theventurealley.com/series-seed-the-new-series-a/ http://www.theventurealley.com/series-seed-the-new-series-a/
• auganov 11y ago
  Completely fine to ask for proof that the seed round happened, especially as the first employee. I had the [dis]pleasure of having a co-founder that would routinely lie to people about past investment, investor interest etc. If only I was smart enough not to trust that person myself... Just honestly voice your concerns (rather than saying "show me the proof" without explaining why) and any reasonable person will only have more respect for you for asking.
• ryanobjc 11y ago
  There are only effectively 2 ways in which startup equity becomes cash: - IPO (least likely) - a top-10 unicorn which access to the secondary market Unfortunately during a buy-out, your options are not actually equity and you are not likely to participate in the M&A cash. Most companies do the right thing and issue you a competitive offer and maybe a bonus, but honestly it's hardly much more than that you could have gotten if you worked at Google/whatever all along.
  • kohanz 11y ago
    Are you saying that when early employees (e.g. Engineer #1 or CTO) are offered equity, that it is usually awarded as options and not true ownership shares in the company?
    • ryanobjc 11y ago
      Often times yes! First employees have an outcome differential of 10x vs founders. This is often marked up to founders taking on substantial risk. But the way funding works these days, with EIRs and networking, the founders are taking a lot less risk than you'd think. The total comp laydown of a startup has the potential of being very good, but also, potential needs to be discounted against not hitting the huge hockeystick.
• JamesBarney 11y ago
  One thing to always remember is that a valuation is dependent on the terms. For instance I might pay $10,000 for 1% of the company if it's pure equity. But if you throw in terms like I get extra shares in the event of a down round. Then I might pay $20,000 for that same 1%. (I would also pay more if a board seat is included or I'm guaranteed the option to be in any future rounds.) The valuation of the company is $2M with one set of terms, but only worth $1M with the other. So just make sure that if you are getting paid based on valuations given to investors that you are getting the exact same terms the investors got.
  • kohanz 11y ago
    This is a useful response not because I'll ask for the same terms as investors, but because I think that's a good negotiating tool to ask for more equity. I doubt they want to give me the same terms as their investors, nor do I want them because I'm not an angel investor, but that's a tangible way to state that the type of equity I'm awarded has less value and therefore should be calculated differently.
    • blackguardx 11y ago
      I think that trading salary for equity makes you in the same league as an angel investor. In my opinion, early employees are absolutely entitled to the same terms as investors and should be treated with the same respect.
      • sanderjd 11y ago
        You're definitely in the same league, but you don't necessarily have the exact same incentives, which might affect the negotiated terms in various ways. But in general, investors are very sophisticated and aware of how to get a good deal, so negotiating for the same terms they get is a good stand-in for negotiating for good terms without needing to be as sophisticated yourself.
    • ChuckMcM 11y ago
      You will be safer/happier if you simply value the equity offer at $0. This is especially true of pre series A companies. If you do that, and it ends up being worth nothing (common case) you will not feel a "loss", but if you have been imagining it was worth something, and was now worth nothing, you will grieve that loss, irrational as that is. I have seen it again and again, where the stock price of a company hits some value, the employee does the math of "option price x quote" == $some number, and then when the stock price goes down feels bad about how much they have 'lost'. You protect yourself from that by setting the value to $0 and making your decision based on that. If it happens to be worth something later, bonus! if not, well you didn't count on it anyway.
• theworstshill 11y ago
  Ask and possibly dodge a bullet, or don't ask and screw yourself later on. Seems like a no brainer to me.
• ThrustVectoring 11y ago
  You can get a quick fermi estimate of the value of the equity by multiplying their payroll by the percentage of the company you're getting. Presumably, payroll swaps cash for an equal amount of value provided to the company. So if they have ten employees @ 100k per year, 1% of the company is worth roughly $10k/yr. Your risk profile may vary, so treat this as a starting point.
  • gojomo 11y ago
    I think this is exactly backwards for the poster's inquiry. Yes, the company's offer has implied a valuation (and the company even says it's based on actual investor-dollars-in). But the poster already knows that, and isn't completely confident the offer reflects the real valuation offered investors. So there's no more calculation to be done from the offer alone. They instead want to know if they could/should require more formal documentation of the company's claims.
• dmitrygr 11y ago
  Most likely (as backed by history) the equity is worth 0 Take more cash instead
• simulombula 11y ago
  I'd be super weary of such a company. Offering equity to the first technical employee makes a lot of sense because you intend to stay long with the guy, but even considering such a scheme on consultancy basis is non-sense, and doesn't bode well when a company without tech savvyness is also clueless on the other side.
  • binarysolo 11y ago
    I had a bunch of these pay+stock arrangements as a full-time data consultant the past 4-5 years, though they were 1) pre-angel to angel and 2) vetted contacts/friends.
• kifler 11y ago
  I don't see any way that this could be counted as inappropriate. They're asking you to come on board and they should feel comfortable with you understanding their business.
• vladimirralev 11y ago
  It will be difficult to get a solid proof without lawyers involved to check everything with the third parties. Typically you just want to have a written statement from your founder and if at some point the company is worth enough to justify a check, you can hire lawyers to go back and check. If your founders lied in a written statement they will be liable for even more. In general if your founder lies to you and you have proof and the company goes big he is in trouble. Your lawyers will need to see all paperwork you signed in such case, watch out for sketchy terms you might be asked to sign later on. It is possible that crappy founders will try to erase all prior liability at some time when the company is about to make it big. In fact the company lawyers always go back and check everything the founders signed before a big deal to avoid any unforeseen liability. You have to judge if your founders act in good faith or they are taking every opportunity to put you at disadvantage. If you don't trust the founders or the investors, don't do business with them.
• AnotherMarc 11y ago
  In addition to the considerations others have mentioned, I would say from a strictly expected monetary value, a successful consultant will make more money than the first technical employee at a seed stage company. So, if you go that route, you should have other motivations than maximizing your expected return. As a rule, I don't even think it matters what the valuation was because generally the seed stage companies that should rationally expect to make money would have started with a proven team with prior successful exits. I'm definitely not advising you away from the offer. I've been a consultant, worked at both successful and failed startups, and preferred both types of startups to consulting. But I still think the expected return is higher in consulting or being a top performer at a large (tech) leader. Good luck whatever you decide.
• brudgers 11y ago
  There are two orthogonal cases: consultant and employee. The contractor case is simpler because clients who won't pay your regular fee are almost never good clients and because someone who is paying for services with equity after being funded is creating a mess for someone [and from a tax perspective perhaps you]. On top of that, the cash value of equity as payment should be discounted according to both opportunity cost - those hours could be spent with a full rate client - and because any potential payment is well into the future (aka "the time value of money") and because the probability that the shares can ever be liquidated at or above their value in the previous round is less than 1.0. So the sensible thing to do is just require the cash and don't waste time fooling with the valuation. As an employee, you can ask for the valuation, but it doesn't mean anything. Small equity in closely held companies is only as valuable as the people in control have the good will to make it [this also applies to the contractor situation]. Well it might mean something if you have the cash laying around to actually exercise the options when they vest...e.g. the 5% options you get at a $10,000,000 valuation require $500,000 to exercise if you leave after the vesting. To put it another way, the value that matters is that of the options not the company and the value of the options should be assumed to be zero...or maybe $1.00 like a lottery ticket in a lottery where nobody has to win. Good luck.
• bbcbasic 11y ago
  On top of valuation - there are lots of catches when taking equity. vesting periods, clauses, up-front tax, requiring to exercise options (at your own expense, could cost $100k's) when leaving the company, being fired just before your first vesting if they do well. How long will it take to get your hands on the money. Will you get the money if the company is brought out, or what factors will determine if you get a share of that money or not. You may want to get a lawyer involved. More simply just make sure the cash is enough and the equity can be a lottery ticket which you can view as $1 extra salary. Worth trying to negotiate any horrid clauses though. I would personally play it by ignoring the shares part and just ask for more cash if you are not happy with the amount they are paying. If you want to get rich (disclaimer I am not rich) I would suggest earning as much $ as you can, living as cheaply as you can and invest in good stocks and real estate in very desirable locations. Then each year concentrate on how you can increase your income so you can invest more. You will wake up in 20 years time and think "oops I got a lotta money" to paraphrase Blur.
• MalcolmDiggs 11y ago
  Yes and no. Yes: I believe you're well within your rights to ask to see the financials of a company you're about to become a co-owner of. No: If you're asking for proof because you distrust them, that's a HUGE red flag. Don't work with people you distrust. Even if it's just a hunch, go with your gut and just walk away.
• rahimnathwani 11y ago
  "What would be other important things to ask/consider." 1. What do _you_ think the company is worth today? If your net worth were $250m, how much would you be willing to pay for 100% of this company? 2. Does the company have any debt? If so, subtract this amount. 3. What rights are attached to the different classes of shares (e.g. liquidation preferences) and which class of shares will you be issued? 4. Based on what you learned from (3), what % of the exit value will you get if the company is sold next year for what the founders believe to be the current valuation? What about if it's sold next year for what you believe to be the current valuation? Re: #4, the % will probably differ based on the sale price and how far into the future the sale occurs. The sooner the sale and the higher the sale price, the less of the total value you will lose due to liquidation preferences and/or other additional rights attached to investors' shares. If the sale is very far in the future, liquidation preferences could totally wipe out your equity, even if the sale is at a decent price.