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Options vs. Cash

• lostcolony 9y ago
  This is an interesting way to flip the perspective, to ask why do startups think offers of options are enticing (as compared to just cash). But for the potential employee, the advice remains the same; ignore the options when it comes to evaluating a compensation package (and only those who are informed enough to go "weeeeelll..." and have actual reasons for why in a ~particular~ instance they should do differently, should ever consider doing otherwise).
• analyst74 9y ago
  Options by definition are worthless when they are granted, because strike price is the current estimated value of the stock.
  • rileymat2 9y ago
    This is not true, the right to purchase at the current price but not the obligation has value in itself. Of course this is no where near the sum of the strike price for the options.
    • analyst74 9y ago
      Right, with options you can choose not to exercise if valuation goes down, avoiding a loss.
      • walshemj 9y ago
        With some options (Warrants of investment trusts for example) you can sell those on the open market if they are in the money its also a way of leveraging your investments.
  • harryh 9y ago
    https://en.wikipedia.org/wiki/Black%E2%80%93Scholes_model https://en.wikipedia.org/wiki/Black%E2%80%93Scholes_model
  • pkolaczk 9y ago
    Strike price is estimated through 409a valuation, which is typically very conservative and considerably lower than the fair market value of the stock, which is frequently less than the evaluation made by investors.
• rguzman 9y ago
  i think options do a couple of things: 1) they let employees invest in startups using their time instead of their money, which is handy when you aren't rich and 2) they allow the company to have a legal framework around an IOU: take less salary now, bigger payout later maybe. thought experiment: knowing everything you know about e.g. stripe right now, would you buy $100k worth of stripe back in ~2012? in 2012 it was a risky proposition to do so, but many people at the time understood why stripe was likely to be big and successful and invested money in it. i'd rather live in the world where there is a mechanism to invest in such a company besides being an accredited investor with access. many people go wrong when thinking about options in that they don't try to consider the fundamentals of the investment. working at an early-stage startup isn't just a job, it is a way to do risky investments using your time. all that said, what Dan proposes at the beginning makes a lot of sense: the startup should be willing to give you cash instead of options (provided they have the cash).
  • SonicSoul 9y ago
    knowing everything you know about e.g. stripe right now, would you buy $100k worth of stripe back in ~2012? sure but for every stripe there are 10 startups that either failed or didn't amount to a great payout. I think the point this post is making that the value of options is statistically not greater than higher salary at a competitor, given the risk an employee takes since he can't diversify his time. that said if you believe in an idea it is absolutely great to have the option to "go long" on that idea with your time
    • babuskov 9y ago
      > for every stripe there are 10 startups "10" is an understatement.
    • rguzman 9y ago
      > sure but for every stripe there are 10 startups that either failed or didn't amount to a great payout. yep. it's probably more like 100:1 don't go work at the other 99! :) i agree that the value of options is statistically not greater than the compensation package at GOOGBOOK. that said, you don't get to live 1000 lives in parallel. so, either you have to think very carefully about this one (or ~5) investments you are going to make OR you can go work at a bigger company with higher salary if that isn't for you.
• i_dont_know_ 9y ago
  I started off once thinking "yay, X% means I get X% of the company!" and then I found out the shares can be diluted. Then I learned "non-dillutable". Then I learned about vesting periods, windows for exercising options, and a whole slew of financial terms and devices; each one seemed to come with its own unique "gotcha" that, if you didn't know about, would cost you nearly everything. Everyone I talk to about these always says "well, don't do that one thing, or if you do that one thing be sure you do it in this way and you're set". The cumulative knowledge you need becomes pretty high pretty quickly though, and the chances of me doing the right legal and financial incantation at the right moment becomes lower. Nowadays I go with cash. I don't get 'golden handcuffs' that hold me to a job I don't like because it might pay off later. I can calculate the expected value and risks with cash without tons of research. I know my legal recourses if I get screwed out of cash.
  • jdavis703 9y ago
    Let's not forget the "asset only" acquisition where the company sells it's IP and employees but doesn't sell any shares. Been through one of these and this is what happened, screwing over former employees who had bought options and investors. I think the only people who profited were the bankers.
    • icedchai 9y ago
      I've seen this happen multiple times. It is by far the most common "acquisition" in my experience.
      • Wago 9y ago
        This is terrifying. How does that work out financially for the founders?
    • harryh 9y ago
      What you describe is what happens when a company fails. It's not really screwing people over as just a description of failure.
    • 9y ago
• gleb 9y ago
  Paying with options is equivalent to the start up selling stock to investors, paying employee with cash, and then having employee invest the money back into the company. As the article points out. But there are differences. Avoiding income tax. Deferral of compensation to drive retention. Giving employees a better deal than the investors. Letting employees invest into an asset class the government normally prohibits them from investing into. Those are some of the big ones.
  • analyst74 9y ago
    > Paying with options is equivalent to the start up selling stock to investors, paying employee with cash, and then having employee invest the money back into the company. As the article points out No that's not the same, options are basically the right to invest at current valuation. What you described is more like RSU.
    • gleb 9y ago
      Current common valuation - insignificant for early-stage companies. Late stage companies do RSUs.
  • s73ver 9y ago
    I don't think anyone could claim that employees get a better deal than the investors, ever.
• martincmartin 9y ago
  "...compensation package has a higher expected value..." Expected value is a good measure when you're summing over lots of instances, e.g. if you're a VC fund investing in lots of startups. As an employee, where you're working for a single startup at a time, robust statistics[1] suggests that the median is a better measure of what you'll expect to make: you have a 50/50 chance of making more/less than the median. More than half of startups either fail, or don't succeed wildly enough for options to be worth more than the equivalent salary. (If you work for 5 startups in your career, the best measure might be "sample 5 startups and sum the options payout to produce a value; repeat that many times and take the median of the result." But that's a lot harder to intuit, and is no doubt closer to the median than the expected value.) [1] https://en.wikipedia.org/wiki/Robust_statistics https://en.wikipedia.org/wiki/Robust_statistics
  • jdavis703 9y ago
    Why take the median? For me personally all I need is one year where I make a couple million bucks. What I really care about for my personal financial position is either the sum or mean, because that's what hits my bank account.
    • martincmartin 9y ago
      Because you'll only work at a handful of startups in your lifetime. You will not make the sum / mean over all startups, only the ones you work at.
    • thedufer 9y ago
      Some lotteries that accumulate when there are no winners have weeks with better-than-even odds. By this logic, you should wait until the odds are sufficiently in your favor and then dump your entire savings account into lotto tickets, for an immediate gain. Of course, even if you can pick up a 20% gain in EV, that small chance you end up a billionaire won't save you from the 99.99..% of cases when you're eating cat food in retirement.
• asah 9y ago
  I know 100+ people from a dozen companies who've made $1mm+ on equity. None of my friends would write a post like this. That said, valuing equity is complicated: - most offers include a healthy mix of cash and equity and benefits. Evaluate the whole package. - unless you can pre-exercise via 83(b), I generally avoid options. RSUs are fine and many companies are offering them. Clever hack: counter the offer with a demand that the company pay 2% of the cost of exercising for each month you're employed, grossed up for taxes. - watch out for illiquidity: whales often delay IPO which locks up employees. This compounds the exercise issue. Clever hack: counter the offer with a requirement that the company offer to buy back the equity at the most recent preferred share price, if the company accepts investment at a valuation exceeding $100mm. Stay positive!
  • harryh 9y ago
    That last idea about how to deal with illiquidity is very interesting. Never seen that suggestion before. Will definitely keep that in mind moving forward (both as an offer taker and an offer maker). Thanks!
  • htormey 9y ago
    Are you really going to be able to negotiate terms like that with a company that's at the stage where they are offering RSUs (I.e Airbnb)? I can imagine negotiating terms on options at earlyier stage companies. Wouldn't you have to be going for a job in senior management to have a shot at doing something like this? Genuinely curious to hear if you have ever successfully done something like this?
  • hobbyjogger 9y ago
    Unless you are a sought-after C-level executive, hardly any legitimate companies are going to even consider your "clever hacks." The first one blows up 409a (requires optionholder to pay fair market value for the shares). As to the second, very, very few investors are going to allow "their" money to be used for a common stock repurchase (at the same per share price) instead of going toward's the company's operations/development/whatever.
    • 9y ago
• pjc50 9y ago
  Options first really got started as a tax avoidance measure, but that loophole was closed decades ago.
• neom 9y ago
  There is so much conflation in that first paragraph I couldn't get past it. The way I think about it is that options are how you earn money for doing a (/if you do a) good job. Much like doing a good job of picking a house in a neighborhood that you believe will appreciate, doing the right amount of renovation and renting it out while waiting, if you did this well you could make money on the appreciating assets. In a startup, your two main assets are time and people. Salary is how a company compensates you for the FACT that you're doing a good job. Bonuses are how the company compensates you for going above and beyond. In our company we have standard compensation packages based on tenure, within the structure, there is no way for anyone to make any more than anyone else outside of just being at the company for a long time. When you're betting on a startup you're betting on the founders and the team, not the VC, if you want a proper salary go work for a business that is already built, don't work on building one. Hedge funds and banks pay really well.
• gtrubetskoy 9y ago
  If you're having to debate in your head "options vs cash", then the answer is definitely cash. Because if the options were worth something, that thought wouldn't even come up. Also, companies where options are of actual value generally do not give you such a choice, they give you plenty of both (provided you are worth it), the objective is to retain you because you are valuable, not to pay you the minimum possible value by presenting tricky choices of "options or cash".
• htormey 9y ago
  Working at a startup as an employee with the expectation your gonna get rich is a fools game. Negotiate for the best deal on options you can get (I.e quantity, terms like early excercise etc) but treat them as a lottery ticket. A startup is a good way to learn rapidly so focus more on the quality of the people you will be working with, technologies used, what your role will be, vcs backing it etc. In the long run the network and experience you build from doing this will probably have a greater impact on your networth. Especially if you yourself want to start a startup.
  • nwenzel 9y ago
    I'm a founder at a high-growth startup in Mountain View. I always tell potential hires, "options are worth nothing until they're worth something. And, they may never be worth anything." I think that's the opposite of the unrealistic optimism job candidates get. But I think it also helps set the stage for a culture of transparency and honesty very early. Even before that person becomes an employee. I'm curios to know what HN'ers think of that explanation vs hearing only the optimistic case. Does it make you second guess the company prospects?
    • Aqua_Geek 9y ago
      Personally, I would appreciate that level of candor (and that's how I view my options anyway). I've heard far too many pitches from desperate recruiters about how an options package is worth $$$$$$.
    • hijinks 9y ago
      I work in the DevOps/sys admin field, so I'm use to always looking at what could go wrong. I think this is a toss up depending on the persons experience with startups. I've been in mostly small sub 20 person startups for 15 years now so I've seen almost all of it. You have the people who are new to startups, who think its a ticket to financial freedom in 4 years when they have fully vested and the company sells for 1+ billion. Those people might be scared away. You have the people who have been through a few startups and have worked at a failed company or a company that the investors took all the money and left the common stock holders with nothing or little to nothing. I'm in this group and that would be a breath of fresh air to hear that. During interviews, if I hear only great things and nothing is wrong then that is a red flag to me.
• kelukelugames 9y ago
  Man I wish I knew more about options before I joined a pre IPO company. Kind of like how I wish I knew about salary negotiation before my first job out of college. It's like companies exist to scam us.
• tschellenbach 9y ago
  Options are a complex topic, this article gets a lot wrong. 1. The base offer. Many startups pay competitive or close to competitive salaries + equity. 2. The value of the options depends on your ability to pick the right startup and you believe that you can make a difference to the company. I have a friend who picked the right startup 4 times in a row. 3. Stock options are typically priced at 25% of the last round. The reason this is possible via 409a valuations has to do with the differences between common stock and preferred. 4. Issues with investors right impacting the value of your stock options are more problematic with later stage startups. Warning signs are companies that raised a lot of capital but didn't live up to their expectations. Those companies will often be under pressure to accept terms in later stage financing that could destroy founder and stock option pool upside. 5. Venture Deals by Brad Feld is a great read to understand different investment terms. 6. Yes you get more equity if you create your own company. Doing so is extremely risky, stressful and hard though. I'd guess that even with the extra equity, on average, you'll make more money working for one of the big companies. 7. So in a nutshell, starting companies, joining early stage companies. It really depends on your ability to pick the right company and perhaps more importantly your ability to make a difference. Well that, and a bit of luck :)
  • Bahamut 9y ago
    I don't think I have ever seen a startup offer a competitive salary/equity package here in the Bay Area for a software engineer. I have found that the best I could do is trade compensation for a good work-life balance since salary is not competitive and stock is so volatile for a startup, whereas at big companies salary often is much more in line with the market and stock has actual liquid value.
    • tschellenbach 9y ago
      Interesting, I typically don't see that here in Boulder.
  • nbouscal 9y ago
    1. Not even close to true, check Dan's other post here: https://danluu.com/startup-tradeoffs/ https://danluu.com/startup-tradeoffs/ 2. If you're that good at picking startups, become a VC. 3. Common shares are priced less than preferred because they're worth less than preferred. 4. Startups at every stage give liquidation preferences. Startups under pressure will give more significant preferences, sure, but they're relevant to basically every startup.
• walshemj 9y ago
  What strikes me as odd given the USA's reputation as the home of the self made millionaire that the taxation of employee options is so broken. Treating options on shares as Income when they are not is just stupid options are a high risk instrument that well be worth nothing as opposed to a higher sallery. Why is there not a PAC made up of tech industry employees lobbying for reform of Federal and state laws and arguable tech employers should be doing this. And I should point out that politicaly I am on the left here compared to 95% f the average HN reader.
  • richardwhiuk 9y ago
    The alternative is that the tax is entirely on exercise of the option.
    • walshemj 9y ago
      surly on the liquidity event when you exercise the options with out selling you have not received any income or CGT yet. What tax CGT or Income and in the UK an approved scheme is tax fee in effect - this is to encourage employees share ownership
    • URSpider94 9y ago
      It IS entirely on the exercise of the option. Granting and vesting of ISO's are not taxable events. Exercise of ISO's is taxable under the AMT rules, but only if you are above the AMT threshold (admittedly, this is true for a lot of people) If you're not hitting the AMT threshold, then you only pay tax when you sell the resulting shares.
    • TheCoelacanth 9y ago
      Wouldn't another alternative be for the tax to be entirely when the underlying stock is sold?
  • URSpider94 9y ago
    If you are arguing that grants of options shouldn't be taxed -- they are not. If you are arguing that the eventual income from ISO's shouldn't be taxed -- that would be a very odd position, since pretty much every form of income out there in the world is taxed, even illegal income. I can't think of any other income category that is un-taxed under USA tax laws, with the exception of government bonds.
• Waterluvian 9y ago
  I'm treating my options like a free lottery ticket with not decent odds. That's it. They don't exist when I plan my finances. I doubt this is optimal, as options can be evaluated to some extent and risk can be appropriately brought on and managed. But it works for me when trying to do math about my present and future opportunities.
• silverlake 9y ago
  What we need is a way to pool employee stock options across startup companies to diversify risk. Surely there's a financial engineer somewhere who can create such a thing.
• sheeshkebab 9y ago
  Start your own company vs. Cash, would be more interesting. Rambling about options is a bunch of distracting noise.
  • s73ver 9y ago
    Most of us aren't going to start our own companies.
    • stratigos 9y ago
      "Ive got a great idea, its like Twitter, but purple!!!"
      • ryan606 9y ago
        "Snapchat, but for dogs!"
        • shemnon42 9y ago
          Shazam, but for food.
          • sheeshkebab 9y ago
            So, I guess the answer is - cash? Either that or find something that people need and build it (rather than bitching about options/vesting crap).
            • stratigos 9y ago
              Have you been in the industry a long time? No one is "bitching" about options. Did you read the article? Its not crap, its maddening amounts of information completely irrelevant to the fields of Computer Science and software engineering. Yet, its a reality most of us must face, since there are a lot more job openings for startups than any other sized business. And since its in the business' interests to provide monopoly money instead of real money, this problem doesnt seem to ever go away. If you ever get into freelancing, its unlikely you will never be met with such offers. Its also likely your contract will dissolve into said monopoly money at some point too. If anything, we're "bitching" about wanting actual money for compensation, not a raffle to a lottery that is highly likely to have no prize at all, and just as likely to be worth far less than the typical compensation in cash.
• moron4hire 9y ago
  You don't have to over-complicate the analysis. The fact that they give you the options instead of cash is proof the options are worth less than the cash. This is Econ 101: bad currency drives out good as good currency gets horded.
  • draw_down 9y ago
    Well, kind of the whole idea is that maybe they will be worth more than the cash in the future.
    • moron4hire 9y ago
      When a company gives you options instead of cash, they are making a bet with you that they can make a better return on the cash than you can. They are hoping they can convince you that cash_in_your_hand_now < value_of_shares_in_the_future, but in order for them to even consider making the bet, they have to expect that value_of_shares_in_the_future < cash_in_their_hand_now.
      • draw_down 9y ago
        Yes, and things don't go as expected 100% of the time. Again, that's the whole idea here.
    • poikniok 9y ago
      Great argument for paying people in lottery tickets!
      • draw_down 9y ago
        I mean, yeah. That's what this all is, that's why people refer to options that way. Thing is, people win sometimes.
  • seanhunter 9y ago
    This is too simplistic. There is another reason - options incentivise people in a different way from cash. Say I have an option which is struck at the fair market value of the company on the day I join. When I exercise that option, the value will be the appreciation in the value of the company up to that point (ie the value I have had a role in creating). So options (when the plan is set up well) incentivise employees to maximise the value of the company for shareholders. More broadly you could say that options tend to incentivise long-term value creation ("dividend-seeking") over short-term value extraction ("rent-seeking") behaviours. Secondly, options incentivise people to stay around (until their options vest). The company also gets to cancel unvested options if a person leaves and even claw back vested but unexercised options in the case of misconduct by the employee. These are all things that are valuable for the company and more difficult to achieve using cash. Thirdly, there is a big difference to most startups between "value" and "cash". I may well want to pay someone in a cash-equivalent that has equal value to cash (or even greater) because I want to manage my cashflow. After all, I can pay my employees (some of their comp) in options but I have to pay my bills in actual cash, which may be hard to come by until I hit net positive cashflow. In the case of an option, when you exercise and sell, you turn your option into cash, but the cash doesn't come from the company, it comes from whoever buys. This may be more efficient for the company than raising the equivalent cash and paying people directly in cash (because of transaction costs around fundraising).
• mabbo 9y ago
  Oh look, the thing I should have read before joining a startup. I left [large corporation], who had been paying me very well, to go try out the startup world. I found a cool local company doing something that sounded neat. I looked at the pay (better on a per-paycheck basis) and the options (better than the stock I was getting in the corporate world) and said "this is a great idea! If the startup succeeds, the options will be worth a lot!". It's a great company with great people and I don't regret that, but the financial implications of the change are starting to sink in. I'm getting a bit more per paycheck, but on the whole I suspect my tax returns over the next few years will add up to less than I was making before, even if the startup succeeds.
  • gregmac 9y ago
    > I'm getting a bit more per paycheck, but on the whole I suspect my tax returns over the next few years will add up to less than I was making before, even if the startup succeeds. That sounds counter-intuitive -- why would that be? Did you have some expense you could claim at [large corporation] that you can no longer claim?
    • mabbo 9y ago
      Most of the big post-IPO companies hand out stock on a regular basis as a bonus or a top-up to the actual pay. The corp in question for me was Amazon. Around 1/3 of my pay (more some years) was in the form of AMZN stock that vested every six months. Stock, not Stock Options. No paying for it, no decisions, just boom, you now own X more stocks and how would you like to pay the income tax on that?
      • iaw 9y ago
        What's worth more? A $200K lump sum in 20 years or $10K every year for the next 10? The answer depends on how much interest you can earn on the $10K/year. At around ~7% the $10K/year is worth more than the $200K in 20 years. Your stock grants from Amazon are equivalent to the $10K/year, the options, if you get them, are equivalent to the $200K. The actual weighting is impossible to get precisely but the way you approach it can give you better accuracy than just comparing apples to oranges. Good news, even if it's horrible, ~2 years is the typical employee tenure so you probably wont be there long. If you are and it's going to be successful you'll be able to renegotiate based on foregone comp at Amazon.
• draw_down 9y ago
  Can't they just tell you the current share price and your strike price? The share price minus the strike price times the number of options is the value of the package when vested, no?
  • analyst74 9y ago
    At offer stage, strike price = share price, which is estimated by an independent third party at least once per year. It used to be the case that strike price is significantly lower than share price, making options much more valuable than they are today. But that was deemed a tax loophole by IRA and became disallowed some while ago.
• j45 9y ago
  Questions that come to mind.. If I do the math of taking the cash each time, do I end up close to what diluted options would provide, or more? How many people do I know where options translated to sizeable cash, even after dilution? Which statistic will I be a part of, where options have actionable worth, or little/nothing? The questions above we're proposed to me by a founder who had taken funding and was diluted to the point where he realized his worth as a consultant/freelancer/contractor may have ended up ahead.
• lamby 9y ago
  Somewhat of a social aside, CEOs don't tend to like it when you refer to one's options as a "lottery ticket."
• BCNative 9y ago
  Stock options are for kids too stupid to do the math, and young enough to make bad financial mistakes. Right around the time you hit 35 you need to remember Joe Pesci in Goodfellas. Fuck you, pay me.
• stratigos 9y ago
  Or here is a better one: "Sorry we cant actually fulfill the contractural obligations we are (sort of) legally bound to fulfill, and cant pay you like we promised. So will you take a much smaller amount of money and a bunch of worthless stock options instead? By the way our stock options are going to be worth millions in a few months, so this is actually a better deal for you." Its like some weird pathogen has infected the whole industry with this!
• linkmotif 9y ago
  $$$$$$$$$ cash cash cash cash cash cash cash cash cash cash cash cash cash cash cash now now now now now now now now or even better yesterday. $$$$$$$$$$. Time value of money!! Time value of (startup) (non-founder) options? Not so much. The expected value of your average Silicon Valley start up with golden handcuffs included must be downright negative.
  • dang 9y ago
    Please don't.
    • linkmotif 9y ago
      Pretty sincere comment. Taking options instead of cash seems like a really bad idea 99/100 times. Don't know why anyone would do it ever. Either you're a founder or you're not.
      • dang 9y ago
        More things can make a comment bad than insincerity.
        • linkmotif 9y ago
          Well if the comment seemed gauche, it was meant to reflect my opinion of the discussion. Otherwise, I just reviewed comment guidelines. Don't see what might merit the "please don't". Please don't... what?
          • dang 9y ago
            "Be civil. Don't say things you wouldn't say in a face-to-face conversation." Or, as we post frequently: Please post civilly and substantively, or not at all. "My opinion of the discussion" is already off-topic and meta. Such comments are always worse than the discussions they're criticizing, while posing as somehow better, which makes them worse still. If you have a substantive point to make about the topic, state it straightforwardly; otherwise please refrain.
• jonbarker 9y ago
  In startups your risk is that 95% of the value of your labor goes into a pool of options whose underlying security (startup stock) never achieves any liquidity event. Also, you do have to factor into your analysis the fact that the tech giants also have options, which are likely not to expire worthless, and also have some upside as well, since they are listed on public exchanges. If startups thought more like Buffett "preferred holding period is forever" they would counterintuitively actually compensate employees with cash more competitively once they achieved positive cash flow (this actually seems to be occurring in a few companies, there are just too few positive cash flow startup examples for quality analysis on this front). More startup employees I know are actually just enjoying their work and salary instead of making a giant sacrifice on a longshot bet in exchange for work they don't think is sustainable. That being said I think what Bezos wrote about amazon's work ethic will always hold true "you can choose to work harder, longer, or smarter but in our case you can't choose 2 out of 3" - paraphrased from memory. Ultimately startups and big companies are trying to design compensation packages that create maximum productivity and the best description I've heard of this is to "take the issue of money off the table". Hard to do that with under market salaries and iffy stock options.
  • arjunrc 9y ago
    Do you have a link for the comment from Bezos? It would be good to get some context on what he said.
    • jonbarker 9y ago
      https://www.amazon.com/p/feature/z6o9g6sysxur57t https://www.amazon.com/p/feature/z6o9g6sysxur57t "It’s not easy to work here (when I interview people I tell them, “You can work long, hard, or smart, but at Amazon.com you can’t choose two out of three”)"
      • circlefavshape 9y ago
        I don't understand this quote. Does he mean that you have to choose ONE of the three? Or that you have to do all three (which means his "or" is misplaced)? Or that Amazon.com chooses for you, rather than you choosing yourself?
• tristanho 9y ago
  > If you look at companies that have made a lot of people rich, like Microsoft, Google, and Facebook, almost none of the employees who became rich had an instrumental role in the company’s success. Is this true? Dan seems to kind of skim over this point without much proof or thought (which is unlike him!) I don't have any data on this either, but it seems like a pretty big assumption to take for granted. The implication is that the early employees added little value compared to investors/founders, but in my experience this is the opposite. The team is literally who built the vast majority of the product.
  • georgeecollins 9y ago
    I think he means by count of people, not amount of money made. In other words, MSFT made Bill Gates very rich, plus thousands of others became part of the one percent (multi-millionaires) without making a really amazing contribution.
• EternalData 9y ago
  Always good to break down how startup equity really works. It quickly becomes apparent that working at startups isn't a great cash game (though it is a decently good skills game).
• izolate 9y ago
  Is there any way to nicely state that you're not interested in equity and prefer cash? I haven't found it. It seems to put off employers who think of equity as an incentive. And I've met some fantastic companies who have done this, so it's not about bad employers either.
  • zone411 9y ago
    Would you be interested instead in a well-defined bonus with a bit lower salary? Let's say after each year of work. I am a believer in incentives but I agree that for employees the options are often not the best way to go.
  • asah 9y ago
    Yes, just explain that you have bills to pay, and while you wish you could participate more in the equity, you're at a point in life where you need cash. Typically, startups have a mix of employees who are skewed to more cash or more equity.
• 123aswin123 9y ago
  Cash is king any day! If you aren't in the founding team!
  • asah 9y ago
    Sadly this is too often a valid heuristic. At the same time, my friends and I did "pretty well" as employee 3,000+ at this crazy search engine company that couldn't make it because "nobody clicks on ads."
    • GFischer 9y ago
      I'd say that if you're employee 3.000, the company has already made it, although, as a counterexample, Uber has 6.700 employees and I don't know if it will bust or not.
  • asah 9y ago
    Sadly this is too often a valid heuristic. At the same time, my friends and I did "pretty well" as employee 3,000+ at this crazy search engine company that couldn't make it because "nobody clicks on ads."
• rdiddly 9y ago
  Risk and reward are proportional, unless there's somebody trying to make your risk disproportionate to their reward.
• killjoywashere 9y ago
  So, basically, start-up hires should issue their own term sheet, by which they agree to invest time in exchange for whatever else. Which suggests that human capital is coming on par with the VCs themselves. Interesting...
• zone411 9y ago
  This is a very interesting discussion for me, as I'm about to incorporate a new AI startup and I'm thinking how to spend my own seed money. The author's argument in the "Incentive alignment" section doesn't seem strong. "However, as far as I can tell, paying people in options almost totally decouples job performance and compensation." Is there any data to support this or just this author's feelings? Just because the masseuse from Google made millions, it doesn't mean that other people who did well, like their chief legal officer, business operations, and product management executives, who made $160 million, were not instrumental in its success. It just means that not all options were optimally allocated.
  • mattmcknight 9y ago
    Exactly, this ignores where options are awarded for performance.
• ares2012 9y ago
  I don't want to jump into a debate on a clearly biased post, but I feel that a few things need to be clear: - Many employees prefer options to cash, as it provides the opportunity to make a lot of money. The chances that happens are very low but many people want to take the chance. Just because it's not your preference doesn't mean it's not attractive. - Salaries increase over the life of the company, so if you join a startup today with a lower salary but many options then in a few years you'll have the salary you want AND the options. So the question is whether the difference in salary for those years is worth the opportunity for a big return. - There is a different feeling of working somewhere where you have ownership vs just a paycheck. In the early stages of a company this is important to employees who really believe in the mission. - Most companies do sell shares to investors for cash to pay employees, that is where the money for salaries come from. However, that investment comes with many terms attached, including liquidation preferences, which reduce the returns to employees long term. Giving employees options is the most direct transfer of value if the company does have an exit. Overall, it's a more complex issue than this post presents. If you don't want equity, don't accept offers that include equity. If you do want equity, then do. Simple.
  • sbob 9y ago
    The lottery is just a way of taxing poor people who don't know math. (c) :)
  • ryan606 9y ago
    Exactly. Over time, companies will try (or at least, SHOULD try) to optimize the currency they use to deliver their total reward offering. Whether it is cash, equity, PTO, health/retirement benefits, learning, etc., companies should optimize the use a particular currency if the perceived value of such currency exceeds its economic value.
• code4tee 9y ago
  Cash is nearly always better for the employee. Startups like options because: 1. They can "pay" people with "free" pieces of paper that effectively cost nothing from a cash standpoint 2. It helps keep staff onboard by slapping golden handcuffs on 3. In the event that these paper options turn into something with actual value that only happens if the founders and investors make a ton of money first, so at that point they don't really care what the options "cost". It's like writing a paycheck that can only be cashed if the founders/investors get rich. A great deal for them, not so great for you. Net net all these things benefit the founders/investors and not the person receiving the options. In nearly all cases people are getting options as part of core comp because the company can't afford to pay out all that cash. It's important potential employees understand that when agreeing to a base package that is heavily in options vs cold cash. Options should be treated as a bonus that may pay off but very likely won't, not base comp.
  • blennon 9y ago
    Startups also like options because they believe it creates an "ownership mentality" among its employees. I believe this is mostly true. I think equity compensation is also a selection mechanism. If I'm running an early stage startup, I want everyone to have a stake in the game. Equity compensation attracts employees with that mindset. Conversely, if a potential employee would prefer all cash compensation to equity, that would be a big red flag to me. One of the struggles of offering equity to employees is finding a mechanism that has no taxable value upon issue, benefits from capital gains, and is legally sound. One option is to organize as an LLC and offer a profits interest. These can be issued with $0 taxable value and benefit from the upside of the company. They can vest, and once vested they can participate in the gains of the company (including distributed income, not just a sale). I believe these are inherently more fair to the employees because there is no golden handcuff. They don't need to be exercised and once they're vested, you can walk away with them. On the downside, they are a little more cumbersome to set up.
    • maerF0x0 9y ago
      Remember that people having a stake in the game (and not current cash) gives incentives for early liquidity. That could be a bad deal for all involved (except the acquirer). If your staff/founders are going broke before the greatest gains in value of the options, they will still have to push for liquidity event before the optimal time.
• erbo 9y ago
  This shows why I've long said, "Put not your faith in stock options." Like it or not, options are basically Monopoly money. You can't get your landlord to accept them, or the grocery store, or the credit card companies.
  • shemnon42 9y ago
    Well, some land lords used to accept options for rent... http://realtormag.realtor.org/commercial/feature/article/2000/07/landlords-swap-stock-options-for-rent http://realtormag.realtor.org/commercial/feature/article/200...
• dreamdu5t 9y ago
  Both. That's what the CEO and others get. Take a fat salary and options.
• jellicle 9y ago
  Great article. The point can be distilled down to information asymmetry - the company wants FROM YOU something that is relatively straightforward and clear (your time) and wants to give TO YOU something that is complex and hard to understand (a complicated financial instrument that may or may not turn out to have value in the future). As a general rule, you should stay away from such deals. The likelihood is that the company knows more about the instrument than you do, and is using that information to underpay you.
• georgeecollins 9y ago
  "..why shouldn’t the startup go to an investor, sell their options for what they claim their options to be worth, and then pay me in cash?" Because an option held by an employee has more value because it functions as an incentive.
  • deleted 9y ago
    [deleted]
  • marssaxman 9y ago
    The incentive effect is therefore entirely dependent on the employee's degree of ignorance! Experience has shown me that "options are worthless" is a pretty good rule of thumb, and I simply ignore everything but the so-called "base" salary when I evaluate a job offer.
• pmontra 9y ago
  I've been asked today if I'd take equity instead of some cash. My answer was a polite no. If I could work at the same time for ten startups then I would hedge the risk. Most would fail, one would succeed, it could be worth it. But I can work for only one startup so it's like betting on who would win 2018 NFL. There are better choices than others, still it's down to luck.
  • ThrustVectoring 9y ago
    Would it be possible for workers to create a diversified pool of startup equity grants? You'd pay in in-kind, and receive a portion of all cash flows from group holdings proportional to what you put in. There's obvious problems with how to fairly value the in-kind options, and how to avoid making it a market for lemons. The overall goal is something like if there's 11 co-founders and one makes it big, you wind up with one person with $900M and ten worth $10M, rather than one worth $1B. It's a small enough portion of equity that you're still incentivized to make it big, and a big enough portion of enough equity slices to cut out a lot of the variance.
• allsunny 9y ago
  This isn’t my unique thought, I read it somewhere on the internet at some point where it was put much more eloquently, but it makes sense intuitively: The idea is that if you do enough start-ups, one (or if you’re lucky, more) of them will “hit.” I’ve been to a few rodeos at this point in my career. I’ve had one minor hit, and one big hit. It certainly worked better for me than if I’d worked for just cash. YMMV, but I will say not all start-ups are created equal. Sniff out the finances and product viability as much as you can before you join. I like the lottery ticket analogy because it’s true that you’re gambling a bit, I don’t like the analogy because the odds are nowhere even close to the same.
  • danyim 9y ago
    Did you mean to say the odds of striking it rich are nowhere close to a lottery in a favorable or unfavorable light?
• ThrustVectoring 9y ago
  All I want from the equity package at a start-up is for it to be non-zero. If a co-worker winds up with enough out of their equity package to become financially independent, I'm going to be very upset unless I've at least gotten enough for a car or vacation.
• justin_vanw 9y ago
  For one thing, the reason that options/shares aren't traded widely in earlier stage companies is regulatory. If you have too many investors, or something, you have more regulatory overhead to deal with. Small companies don't want to have 5000 investors for this reason. However, I personally know people who have sold their vested options at a significant profit in very early startups (just after an A round). Options are worth more than cash IF AND ONLY IF you have insights and evidence that the company is going to outperform the current valuation of the company, after being adjusted for risk. For example, if you see that it is the best team ever assembled. Most startup CEOs says their team is the best ever, but if you interact with the team for a bit and see it is probably true. For example, if the company needs you really badly, and they are able to give you options based on a valuation that based on current information is a huge underestimate. For example, a drug company that found out yesterday that they got their FDA approval for their new blockbuster drug, and for some reason they need to hire you very badly. This is iffy because they are probably not able to offer any options if they are already far along on being acquired. Overall, there are certainly startups where the signals would be available to someone thinking of working there such that they would be able to determine if it is likely that options have a promising expected value. I think this is going to be a very low % of startups where that expected value is even remotely close to what you would get at a large company, and very very few where it would be much higher.
• geoffreyy 9y ago
  Would making secondary market accessible to employees after a cliff - i.e. 2 years - solve this issue of "lottery tickets" we hear all the time? If we let employees access liquidity events by having the board organizing restricted secondary sales every year, then their options will have a higher probability to have real value? After all, VCs have lot less risk than employees... We can't diversify our portfolio like they can. They want to invest their money, we want liquidity. Giving us financial flexibility would have only pros IMO and would be a powerful recruiting tool as well. At my current company, I pushed a lot for employees to get 10yr exercise window extension, which we now have. Now we need to push to get liquidity. I feel like it is our responsibility as employees to keep things moving for a fairer future. We help adding value to the company, I think it will be fair to be able to sell our options even if the company is still private. There are also companies like Equity Zen [1] that help giving employees liquidity. I wonder if that is a good alternative too? Basically if we can unlock the value of options before an exit, options stop being lottery tickets and everyone is happy. [1] https://equityzen.com https://equityzen.com
• paul 9y ago
  "If you look at companies that have made a lot of people rich, like Microsoft, Google, and Facebook, almost none of the employees who became rich had an instrumental role in the company’s success. " 100% false.
  • birken 9y ago
    Yeah this claim I don't understand in an otherwise very good article. At the startup I worked at, a bunch of people made some money based on equity, and while it wasn't necessarily a perfect correlation between equity and contributions (and how could it be?), roughly speaking, equity and "having instrumental roles in the success" were certainly highly correlated. I'm not even sure what the idea is here. Are early employees generally considered undeserving of the success of their companies? Who is deserving? The founders? Later employees?
  • barrkel 9y ago
    Yup. I came here to write this. You don't know about how those people helped because they're not the public face of the company; but often they started the seed of something that grew into something big (like you!) or solved some critical technical problem blocking scale, or helped land a key deal, or any of a hundred factors that, if they weren't done, would have severely hit the growth of the company, and couldn't have been easily done by someone else walking in off the street with a nice CV - things that required history with the company, its codebase or market or customers etc.
  • defen 9y ago
    This article[0] from almost 10 years ago estimated that the Google IPO resulted in 1,000 people having more than $5 million worth of Google shares. So I guess it hinges on how you define "instrumental" and "almost none". It's a tautology to say that "instrumental" means "they contributed to the effort", so I would say "instrumental" means "it seems like no one else could have done it" and "almost none" means less than 5%. If you had to take a wild guess about Google, what percentage of that 1,000 would you estimate were instrumental? Furthermore, presumably there are more Google millionaires now, 10 years later. I wonder what percentage of those were also instrumental in Google's success? [0] http://www.nytimes.com/2007/11/12/technology/12google.html http://www.nytimes.com/2007/11/12/technology/12google.html
• Mikho 9y ago
  Just week ago there was discussion about options and people shared this tool (https://tldroptions.io/ https://tldroptions.io/) to calculate amount of money an employee gets based on round and % of the company as options. Despite the fact that in reality even in best case scenario the sum is rather small -- like 0.01% of a Series A startup with $1B exit will give you like $40K for your 6 year work -- more important issue is different liquidation preferences VCs get for their money. So, each of many many VCs that invested in a startup by the time of exit exercises own liquidation preferences to scrape every possible dollar -- and in many cases disproportionately more than their fair shares of the startup due to liquidation preferences. As a result there is not so much money left to share among employees after all investors in aggregate get out their money and exercised preferences. And this is best case scenario. So, a startup needs to have multi-billion exit for employees could make any real money.
  • emmett 9y ago
    If you join a startup immediately following a Series A and you only get 0.01%, you almost certainly got screwed. We were fairly stingy with equity, and an engineer joining then would have gotten around 0.5%, 50x what you're basing your math on. And over a 4 year vesting period, not a 6 year one. $2mm ($40k x 50) for your 4 years of work is substantially less bad. And employees who stayed with us tended to get new equity grants over time as well. So yeah, don't take a startup job for tiny amounts of equity. You should get significant equity for joining that early with that much risk.
• bitwize 9y ago
  I always find the "Bison dollars" analogy for options or equity vs. cash to be appropriate. The worth of Bison dollars is wholly dependent on how much faith you have that Bison will enact his evil plan of holding the Queen for ransom and forcing the Bank of England to accept the proposed exchange rate of five pounds to the Bison dollar. Similarly, the value of stock or options is dependent on your faith that the startup will grow. Whatever the case, you want to have enough cash to make your expenses, as those odds are NOT in your favor. The VCs funding the company are hedging their bets against several other similar companies in the hopes that at least ONE will blow up and become a "unicorn".
• kumarski 9y ago
  Everyone should look at http://equidateinc.com http://equidateinc.com I think it is the direction of the future.
  • mbillie1 9y ago
    Their video not playing in Chrome does not inspire a great deal of confidence.
• deleted 9y ago
  [deleted]
• zxcvvcxz 9y ago
  I've never been a fan of being an employee at an early-stage startup. The options on average have close to zero value, the salaries are lower, and the hours/working conditions are worse [than at generic big company]. So now as a startup founder I'm thinking, why even give my employees options at all? Me and my co-founder are the ones that believe most in the company's upside, so the more shares for us, the better. The plan I've come up with is to 1) try and raise those salaries as best I can to market rates, with the added perks of flexibility, and 2) create a plan for profit sharing in the future. Profit sharing agreements make more sense to me for a number of reasons. First of all, like equity, its value may never materialize. But secondly, there's actual liquidity and numbers behind it as a possible outcome. Also without the employee stock option pool, I can sell a bit more equity for more cash for better salaries. What do people think of this idea?
  • s73ver 9y ago
    I dunno. I mean, if that's your plan, why bother with VC funding at all? Why not get a small business loan, and operate that way?
  • jy1 9y ago
    "Me and my co-founder are the ones that believe most in the company's upside." This compensation scheme will just select for employees that aren't bought into the future of the company.
• bogomipz 9y ago
  Could someone explain this statement to me: >"Like most people, extra income gives me diminishing utility, but VCs have an arguably nearly linear utility in income." Specifically, what is this "utility" and how is it diminished by more cash compensation exactly?
  • 100k 9y ago
    Utility is a concept from economics: https://en.wikipedia.org/wiki/Utility https://en.wikipedia.org/wiki/Utility You can think of it as "how much benefit I get from a thing". What he is referring to is diminishing marginal utility, which is that as you consume more and more of a good (in this case, income) you derive less benefit from it. https://en.wikipedia.org/wiki/Marginal_utility https://en.wikipedia.org/wiki/Marginal_utility This is backed up by psychology research indicating that people hit a happiness plateau at some income level.
    • bogomipz 9y ago
      Ah ok utility as in utilitarian, that makes sense. Thanks for the explanation.
  • seanhunter 9y ago
    He means diminishing _marginal_ utility. Extra income always gives increasing utility on an absolute basis. An extra dollar of income gives a dollar of utility to everyone, but an extra dollar to Bill Gates gives less marginal utility than it gives to me because it's a much smaller proportion of his net worth and therefore will make less difference to his life than it would to mine.
• TimPC 9y ago
  It just goes to show that just because you think you know how to evaluate stock doesn't mean you do. I have a pretty good understanding of dilution, tax implications, liquidation preferences and so on. But that 5% of equity issued to employees => equity actually acted issued is shocking to me (I would have guessed 35-40%). A friend once told me: unless you're a founder the right estimate of equity is $0 (By which he meant: be comfortable with an offer in every other aspect, then take equity. If you only have a 1/20 chance of getting your equity I'd say that advice is more true than I initially thought.)
• drblast 9y ago
  Nobody would ever advise you to take a large percentage of your income and buy options or even stock in a single company in the hopes that that company succeeds enough to make you rich. That's gambling. Being an employee of the company in question doesn't suddenly make that a good idea. It's an even worse idea since your entire financial future is tied to the company's outcome. They should pay you more to take that kind of risk.
  • ben174 9y ago
    It is indeed gambling. But it's an opportunity to buy a lottery ticket that has a much higher payout than one you could buy off the shelf. The odds may not be great, but if you happen to hit, the payoff can be very large.
• tdeck 9y ago
  > A company that gives you 1M options with a strike price of $10 might claim that those are “worth” $10M. I've had a perspective employer make this exact claim to me. I.E. that I could value my options package by multiplying the strike price by the number of options. I had to go back and clarify that, in fact, those options are worth $0 at the current strike price. It's hard to see this as anything other than gross incompetence or deliberate deception at this point. Options aren't some new thing that only a few people are doing. Besides, if you're giving them out, you had better bother to learn how they work. I'm curious as to how common these claims are because it's pretty egregious. (and yes, they were options and not RSUs)
• fabiandesimone 9y ago
  Some folks are commenting, cash. I would personally prefer Bitcoin or ETH as I suspect the value of either will be exponential in the future. And for the company, if you buy a load of whichever say at beginning of your company that you keep only to give out bonuses to their equivalent in cash every time a new hire comes, you could actually give out the same amount of cash for less tokens in the future.
• ianamartin 9y ago
  Maybe I'm just getting old, but I'm starting to ignore companies that even bring up equity early on in the process, or flat-out state that it's calculated into the compensation package. If I want to play the lottery, then I'll choose to do it with small bills on a lark. Not gamble with a substantial portion of my regular income. If I can't clearly evaluate the total compensation package I'm getting, I will assume you are trying to screw me, and I'll probably walk away because of what that says about your management and culture. In my opinion, the value of the equity you're offering me is zero until proven otherwise. And it's not my job to prove otherwise. It's yours. Your exciting workplace, free beer, ping-pong tables, and gluten-free vegan breakfast/lunch options are all as meaningless as your equity is. The same thing goes for cutting-edge technologies (resume-driven development), and at this point, I'm starting to feel the same way about religious devotion to Agile. All 3 of those things are red flags to me when I see them talked about in job postings. At the risk of sounding like I was born in the 70s (I was), I'd like to think that it's still possible to find a job in this field where you pay me a decent salary for good, solid work, and then you get the fuck out of my way so that I can do it. In fact, I know these jobs are everywhere. They aren't sexy, they don't get talked about in the press, and they are usually not primarily technology companies. They are in-house teams where the client is the company, and the product is anything technology can improve so that the company can function better. You're not going to get rich overnight. But many of these jobs offer a lot of autonomy and flexibility (within reason) to explore new things at a reasonable pace, a good quality of life, a decent wage, and a chance at retirement at an okay time. I know this is Hacker News and the audience is mainly geared towards exciting new startups, but I want to give a shout out to the thousands of companies in the U.S. who don't try to cloud your head with delusions of getting rich quickly, don't give a shit about the latest js framework, don't bog you down with daily rituals, and just let you focus on solving problems with solid solutions and respectable code. Perhaps I'm very much in the minority here, but I'm glad to have a place at a company that does what I think is meaningful and positive work in the world, pays me a solid 6 figures, and mostly lets our team do what we think is best, so long as it accomplishes the things we promise to deliver. Equity was never talked about. There was no discussion of perks of any kind. They told me what their problems were and interviewed me to see if I could help fix them. Then they told me what I would be paid and what the benefits are. They don't need to worry about me leaving for something hotter or sexier or more exciting. The only thing that would make me leave is if there were some drastic change in management that suddenly made my life miserable.
• m-j-fox 9y ago
  Be careful with those golden handcuffs: they only work if everyone thinks they're real. A bad quarter or even a bad rumor can prompt staff to bail en masse.