Startup Employees: Understand Your Offer
So you’ve been looking for startups to join as an early employee. You’ve an offer letter in your inbox. You like the numbers. You call to accept.
Stop. I’ve seen too many people – for better or for worse – rush to accept an offer without much consideration. Don’t make that mistake. While most startups have great founders who are honest, have the right motivations, and properly value what you bring to the table, there are always the ones you want to avoid. But startups always paint a rosy picture, so how would you ever find out?
One key indication is that offer you have in hand. As an early employee, you should understand the larger picture surrounding the offer, before you make your decision.
The amount of cash you get per month. Nothing exciting here.
Options aren’t stocks. They give you the option to purchase stocks at a price determined by the board called the strike price. This is usually low, or below market.
So let’s say you have a bunch of options with 1 cent strike price, and the current share price on the market (or secondary market) is $1.01. When you exercise an option, you pay the company 1 cent to buy the stock, which you then sell for a profit of $1.
Your options have to vest. A vested option is an option that you own, and one that the company can’t take back. This protects the company from employees running away with all the allocated options if he leaves pre-maturely, whatever the reason may be.
Your options vest according to a schedule, typically over 4 years, with a 1 year cliff. This means that 25% of your options won’t vest till you’re there for a year. And after your 1 year anniversary, you’ll vest on a (typically) monthly basis.
Between the lines
There’s more to consider beyond your offer letter. Judging an offer based on a raw numbers is meaningless. You need context.
How much of the company are carved out for employees? How much of the company are you really getting? What do investors really think of the company?
The more data points you get, the more informed your decision becomes.
The option pool
Startups typically have an option pool – a percentage of the company stock that’s reserved for employee stock option plans. Your issued options are taken from this pool. Since this is a fixed pool, the amount you are issued typically depends on your role and the time at which you joined the company.
What percentage of the company, fully diluted, do your options represent?
Companies don’t represent options as a percentage of the company in offer letters because there’s no guarantee that they can maintain this percentage when dilution occurs (through funding rounds, for example).
That said, it’s good to know about the percentage of the company your options represent. Make sure that it’s based on the fully-diluted amount, which accounts for all stocks – exercised or not – that have ever been issued. This is a much better representation of your stake in the company.
There is no reason why the founders wouldn’t give you this percentage, so be sure to ask.
Investors typically get preferred shares, which means that in a liquidity event, there are certain “preferences” attached to it. In some cases, you may see a “1x” preference, which means that in an event of a sale, the investors would get the invested amount back. Similarly, a “2x” preference guarantees them a 2x return on their investment, no matter how low the acquisition amount. In some cases, an unusually high liquidation preference could be viewed as a red flag.
Investors and the Board
It’s good to know if the company has taken smart money or dumb money. Smart money is from investors who can offer strategic help to the company. Dumb money is from investors who offer little help beyond pure financing. Understand the rationale behind the founders’ choice of investors.
The same goes for the board of directors. The board is in charge of the high level decisions of the company. Directors are appointed by the shareholders, and in a startup, it’ll typically consist of the founder and the investors. If there are investors on the board, understand what they bring to the table.
I firmly believe that joining a startup shouldn’t be about the money. And when there’s a great fit between you and the company, these numbers will matter less – due to the larger motivations at play, and the openness and respect that is reflected in the offer.
It’s always our personal responsibility to consider our financial prospects, and weed out the bad eggs. While I’m hardly qualified to give legal or financial advice, I hope this gives you a quick primer of what to consider before accepting an offer at a startup. You should also check out other great resources out there, including the very informative “Engineer’s Guide to Silicon Valley” (hat tip to Kah Seng).
When evaluating an opportunity at a startup, especially the early stage ones, there aren’t many data points available. So find out as much as you can. Talk to people. Understand your offer. Learn about the backgrounds of company and the founders. All this will go a long way in helping you make the right decision.
Catch me on Twitter over here.