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A Newbie’s Guide to Startup Compensation (or “Stock Options will Make Me Rich”)

77 points by dshah 18y ago

MicahWedemeyer 18y ago
Excellent write up! One point I would add: Options do expire, and at least where I work, the expiration is tied to when you leave the company. So, if I quit, I have 60 days to exercise my (vested) options. In plain terms, that means I have 60 days to buy the stock at strike price set in the options agreement. Until I read the agreement, I didn't realize that to make use of the stock options, I would have to spend my own money to buy the stock. I suppose this is obvious to anyone in the know, but for a first-timer like me, it took a little time to wrap my mind around. I just thought stock options were like coupons I could turn in for gold coins or something :)
- aston 18y ago
  Yeah, you technically need money to buy options, but in most cases you're buying the stock only to immediately sell it again at its current (higher) value. If there's no buyer for your stock you can probably safely let them go, since the market (private as it may be) has determined they're worth nothing.
  - tptacek 18y ago
    Not so fast. You also buy stock options when you quit the company, but want to keep the equity you worked 4 years to vest into. Many options plans will require you to buy them within 30-60 days of leaving the company. For obvious reasons, the majority of options purchase scenarios could fall into this bucket, and not the "sure thing" of selling your in-the-money liquid options after an acquisition. Another caveat about this is that there are plenty of horror stories about what happened to people with startup common shares that left their company before acquisition. You are, as you probably know if you're been reading here for awhile, last in line in a liquidity event.
- malekov 18y ago
  > I just thought stock options were like coupons I could turn in for gold coins or something :) nice
- dennykmiu 18y ago
  It is actually much worst than that. If you exercise your options while your company is still privately held, then you have no way to sell the shares which means that any gain is only a paper gain and should not be considered a taxable event. This is true until you recalculate your tax return using AMT which you are required to do by law. Currently AMT considers paper gain from options a TAXABLE event!!!! So if you are an employee and you decided to leave the company or if you are fired. You are between a rock and a hard place. You either walk away from the options. Or you have to come up with both the money to exercise the options and the money to pay the tax. And if the company tanks after you are gone, then tough cookie. You can only write off the loss $3K per year, one year at a time. On the other hand, if you are a Founder or co-Founder, you get to own shares and not options. Then not only do you not have to worry about exercising, but the clock starts right away for capital gain. And if you sell the company in five years, since these are 1244 stock, only half of the gain is subject to federal tax. The last part of the article is actually the most important. Think about the founders of Youtube. They were employees of Paypal and did not make a lot of money when it was acquired by eBay. But they gained experience, credibility, friendship, connection and just enough money to bootstrap their own idea. It worked out well for them in spite of the inherent pitfalls of owning options.
gleb 18y ago
Well, of course, standard venture model option grant percentages do not make sense in case of a small exit ($50M) which takes 4 years. They are designed for an exit of 5 to 10 times the size. So, if you are setting up an options pool, you should account for target exit size and time. Incidentally, the interests of full salary employees with stock options are much more closely aligned with those of VCs than founders. In Silicon Valley as an experienced engineer working for a startup you should be getting about $150k/year + stock options. Some startups will have good exits. Expected total return per year is about $300k/year long term. But you are forced to save 1/2 of your compensation, and get tax advantages -- both good. And you get to play the become-really-rich-on-stock-options lottery. If you are hiring engineers here the packages should somehow be competitive with that.
- tptacek 18y ago
  At 150k/yr, to make 600k in a liquidity event, you would need to be holding .5% of a company that sold for $115MM --- or about 5.5 times as much as Flickr. In what valley job do you get a full half point of the company for a 150k dev job? How many companies have sold over the past 5 years for more than $100MM?
  - webwright 18y ago
    http://startup.partnerup.com/2008/01/02/2007-acquisitions-web-internet-technology/ http://startup.partnerup.com/2008/01/02/2007-acquisitions-we... More in 2007 than I woulda guessed, but still... I think your points are dead on. 150k seems awful rich for a startup job. Job boards seem to agree: http://www.indeed.com/q-python-l-ca-jobs.html http://www.indeed.com/q-python-l-ca-jobs.html (check the pay box out on the left)
    - gleb 18y ago
      I really meant good experienced engineer. Such a person is worth much more than $150k/year, but you can't get much more cash as an employee in a startup (for good reasons). Also, at that level you are getting at least 10% target bonus, and that's included in the number.
waynep 18y ago
I see his last point here: He’s buying a work environment that is comparatively bullshit-free. Little bureaucracy, few meetings, flexible work schedule/environment, etc. If you’ve ever had an environment like this, you know how addictive it is and how elusive it is in larger companies. ... as the most important.
- gamble 18y ago
  ...plus 10-12 hour workdays.
  - calvin 18y ago
    Time is part of the investment.
    - marvin 18y ago
      Then the article's numbers are off, and he should have halved the projected salary.
      - webwright 18y ago
        That's where the math comes in. I can't think of a single startup, however, that actually pay half the salary of what a person could earn at BigCo... Mostly because most engineers are savvy enough to know what a rotten deal this is (unless the equity position is dramatically bigger).
  - JeremyChase 18y ago
    ...plenty of 'established' companies have developers working 10-12 hour workdays.
    - hello_moto 18y ago
      ...with bonuses, promotion, more holidays, better health benefit (you and your family need this).
kolya3 18y ago
Interesting to note that most people I've met will barter over the number of options or compare competing offers by number of options... but rarely does anyone ask how many shares are outstanding.
- gleb 18y ago
  There are good and bad reasons for this. You really should ask. But there is a common standard for how many shares you should have, so the # shares is normally comparable between different companies. Sometimes you do get this crazy company with 100M shares post round A. That's a bad sign in itself.
  - anamax 18y ago
    Really? What is this "common standard"? I'll agree that there's a range, but the high end is 2-5x the low end, so if you don't know the exact number for different, you can't reasonably compare companies. VCs always ask and they're constantly evaluating investments. Why do you think that the less-practiced should wing it?
- Timothee 18y ago
  I thought the same thing but was told that in case of an IPO, a starting price of around $10-15 a share is usually looked for. According to this article (http://www.inc.com/articles/1999/11/15748.html http://www.inc.com/articles/1999/11/15748.html), "investment banks will target an initial offering price of around $15." If you take this as true, you don't necessarily need to know how many overall shares have been issued. It would all depend on what level of the startup you get in obviously. Anyone can confirm that this is a usable ball-park number?
staunch 18y ago
This is why I would never be an employee with a measly .5% unless: a. I wasn't ready to do my own startup or 2. I _really_ thought the company could be the next Google. I do think this part is a bit wrong: "If you’re getting paid market value, then… Well, there’s no risk– and you shouldn’t be expecting much reward." I don't think that's the right way to look at it. Working for a startup at your market rate is not the equivalent risk to working at an established company at your market rate. The floor can fall out at any point for almost any reason. Also, a really great hacker doesn't have to settle for market rate salary alone. He could be at some other startup that's very early stage or simply values him highly enough to pay a market salary and give him a generous equity allotment.
- prakash 18y ago
  If you remove the Google's of the world, most folks that will make FU money from a startup are the investors, founders, a handful of early employees (maybe), and some senior VP level folks.
- dshah 18y ago
  I disagree on one point: I don't think startups are that much more risky than more "established" companies these days. Established companies seem to fail or downsize reasonably frequently these days. The real question is if/when this happens, is it easier/harder to find the next opportunity if you've been a career "big enterprise" kind of person or have been working for startups?
  - prakash 18y ago
    You are right on the perception of risk, it doesn't matter if it's a startup or a bigco. The difference is you are working 60+ hours at a starup whereas you are working 20 hours of actual work if you are lucky at a bigco.
  - time_management 18y ago
    The 5-year failure rate of new businesses isn't the infamous 80 or 90 percent. It's about 55%. A big company job where there's a 45% chance that it will still be worth coming to work in 5 years would be considered very good.

77 points by dshah 18y ago

Excellent write up! One point I would add: Options do expire, and at least where I work, the expiration is tied to when you leave the company. So, if I quit, I have 60 days to exercise my (vested) options. In plain terms, that means I have 60 days to buy the stock at strike price set in the options agreement. Until I read the agreement, I didn't realize that to make use of the stock options, I would have to spend my own money to buy the stock. I suppose this is obvious to anyone in the know, but for a first-timer like me, it took a little time to wrap my mind around. I just thought stock options were like coupons I could turn in for gold coins or something :)

aston 18y ago
Yeah, you technically need money to buy options, but in most cases you're buying the stock only to immediately sell it again at its current (higher) value. If there's no buyer for your stock you can probably safely let them go, since the market (private as it may be) has determined they're worth nothing.
- tptacek 18y ago
  Not so fast. You also buy stock options when you quit the company, but want to keep the equity you worked 4 years to vest into. Many options plans will require you to buy them within 30-60 days of leaving the company. For obvious reasons, the majority of options purchase scenarios could fall into this bucket, and not the "sure thing" of selling your in-the-money liquid options after an acquisition. Another caveat about this is that there are plenty of horror stories about what happened to people with startup common shares that left their company before acquisition. You are, as you probably know if you're been reading here for awhile, last in line in a liquidity event.
malekov 18y ago
> I just thought stock options were like coupons I could turn in for gold coins or something :) nice
dennykmiu 18y ago
It is actually much worst than that. If you exercise your options while your company is still privately held, then you have no way to sell the shares which means that any gain is only a paper gain and should not be considered a taxable event. This is true until you recalculate your tax return using AMT which you are required to do by law. Currently AMT considers paper gain from options a TAXABLE event!!!! So if you are an employee and you decided to leave the company or if you are fired. You are between a rock and a hard place. You either walk away from the options. Or you have to come up with both the money to exercise the options and the money to pay the tax. And if the company tanks after you are gone, then tough cookie. You can only write off the loss $3K per year, one year at a time. On the other hand, if you are a Founder or co-Founder, you get to own shares and not options. Then not only do you not have to worry about exercising, but the clock starts right away for capital gain. And if you sell the company in five years, since these are 1244 stock, only half of the gain is subject to federal tax. The last part of the article is actually the most important. Think about the founders of Youtube. They were employees of Paypal and did not make a lot of money when it was acquired by eBay. But they gained experience, credibility, friendship, connection and just enough money to bootstrap their own idea. It worked out well for them in spite of the inherent pitfalls of owning options.

gleb 18y ago

Well, of course, standard venture model option grant percentages do not make sense in case of a small exit ($50M) which takes 4 years. They are designed for an exit of 5 to 10 times the size. So, if you are setting up an options pool, you should account for target exit size and time. Incidentally, the interests of full salary employees with stock options are much more closely aligned with those of VCs than founders. In Silicon Valley as an experienced engineer working for a startup you should be getting about $150k/year + stock options. Some startups will have good exits. Expected total return per year is about $300k/year long term. But you are forced to save 1/2 of your compensation, and get tax advantages -- both good. And you get to play the become-really-rich-on-stock-options lottery. If you are hiring engineers here the packages should somehow be competitive with that.

tptacek 18y ago
At 150k/yr, to make 600k in a liquidity event, you would need to be holding .5% of a company that sold for $115MM --- or about 5.5 times as much as Flickr. In what valley job do you get a full half point of the company for a 150k dev job? How many companies have sold over the past 5 years for more than $100MM?
- webwright 18y ago
  http://startup.partnerup.com/2008/01/02/2007-acquisitions-web-internet-technology/ http://startup.partnerup.com/2008/01/02/2007-acquisitions-we... More in 2007 than I woulda guessed, but still... I think your points are dead on. 150k seems awful rich for a startup job. Job boards seem to agree: http://www.indeed.com/q-python-l-ca-jobs.html http://www.indeed.com/q-python-l-ca-jobs.html (check the pay box out on the left)
  - gleb 18y ago
    I really meant good experienced engineer. Such a person is worth much more than $150k/year, but you can't get much more cash as an employee in a startup (for good reasons). Also, at that level you are getting at least 10% target bonus, and that's included in the number.

waynep 18y ago

I see his last point here: He’s buying a work environment that is comparatively bullshit-free. Little bureaucracy, few meetings, flexible work schedule/environment, etc. If you’ve ever had an environment like this, you know how addictive it is and how elusive it is in larger companies. ... as the most important.

gamble 18y ago
...plus 10-12 hour workdays.
- calvin 18y ago
  Time is part of the investment.
  - marvin 18y ago
    Then the article's numbers are off, and he should have halved the projected salary.
    - webwright 18y ago
      That's where the math comes in. I can't think of a single startup, however, that actually pay half the salary of what a person could earn at BigCo... Mostly because most engineers are savvy enough to know what a rotten deal this is (unless the equity position is dramatically bigger).
- JeremyChase 18y ago
  ...plenty of 'established' companies have developers working 10-12 hour workdays.
  - hello_moto 18y ago
    ...with bonuses, promotion, more holidays, better health benefit (you and your family need this).

kolya3 18y ago

Interesting to note that most people I've met will barter over the number of options or compare competing offers by number of options... but rarely does anyone ask how many shares are outstanding.

gleb 18y ago
There are good and bad reasons for this. You really should ask. But there is a common standard for how many shares you should have, so the # shares is normally comparable between different companies. Sometimes you do get this crazy company with 100M shares post round A. That's a bad sign in itself.
- anamax 18y ago
  Really? What is this "common standard"? I'll agree that there's a range, but the high end is 2-5x the low end, so if you don't know the exact number for different, you can't reasonably compare companies. VCs always ask and they're constantly evaluating investments. Why do you think that the less-practiced should wing it?
Timothee 18y ago
I thought the same thing but was told that in case of an IPO, a starting price of around $10-15 a share is usually looked for. According to this article (http://www.inc.com/articles/1999/11/15748.html http://www.inc.com/articles/1999/11/15748.html), "investment banks will target an initial offering price of around $15." If you take this as true, you don't necessarily need to know how many overall shares have been issued. It would all depend on what level of the startup you get in obviously. Anyone can confirm that this is a usable ball-park number?

staunch 18y ago

This is why I would never be an employee with a measly .5% unless: a. I wasn't ready to do my own startup or 2. I _really_ thought the company could be the next Google. I do think this part is a bit wrong: "If you’re getting paid market value, then… Well, there’s no risk– and you shouldn’t be expecting much reward." I don't think that's the right way to look at it. Working for a startup at your market rate is not the equivalent risk to working at an established company at your market rate. The floor can fall out at any point for almost any reason. Also, a really great hacker doesn't have to settle for market rate salary alone. He could be at some other startup that's very early stage or simply values him highly enough to pay a market salary and give him a generous equity allotment.

prakash 18y ago
If you remove the Google's of the world, most folks that will make FU money from a startup are the investors, founders, a handful of early employees (maybe), and some senior VP level folks.
dshah 18y ago
I disagree on one point: I don't think startups are that much more risky than more "established" companies these days. Established companies seem to fail or downsize reasonably frequently these days. The real question is if/when this happens, is it easier/harder to find the next opportunity if you've been a career "big enterprise" kind of person or have been working for startups?
- prakash 18y ago
  You are right on the perception of risk, it doesn't matter if it's a startup or a bigco. The difference is you are working 60+ hours at a starup whereas you are working 20 hours of actual work if you are lucky at a bigco.
- time_management 18y ago
  The 5-year failure rate of new businesses isn't the infamous 80 or 90 percent. It's about 55%. A big company job where there's a 45% chance that it will still be worth coming to work in 5 years would be considered very good.