>> So what is your equity really worth?...
>> ...
>> The difference between the most recent FMV (409A) valuation and your exercise >> price. ...
>> The difference between the Preferred Price and your exercise price....
The real answer is that it is probably not worth anything unless they have stock liquidity events that only a handful of large startups have (e.g. Stripe.)
If you dont have that, the price is purely theoretical. Further, if you cannot see the cap table and the preference overhang -- and most startups wont let you see it -- then you have no idea what the real price is regardeless of a theoretical 409A value.
Even if you can see the cap table, spending today-dollars and exercising options for the right to sell stock 5 or 10yrs into the future almost never works out -- the cone of uncertainty across 5 or 10yrs is far too great. The better move would probably to be to use that money to purchase long-dated LEAP call options on the Nasdaq Composite
I don't think that's the main takeaway. IMO, the main takeaway is there are, in the best case (exit for >100% of latest 409a), ~three classes of shareholder in a startup: those with preferred shares (investors, occasionally founders if they have a lot of leverage), those with >=1% fully diluted common shares, and everyone else.
In the most common positive case (i.e. sale price is <100% of invested capital), or negative cases, the three collapses into into preferred holders vs common holders.
If you're in the lower class, you should assume your equity is worth zero. No matter what startup you're joining. You're here for the cash comp and to be surrounded by a growing cast of ambitious, upwardly-mobile people.
If you're in the "middle" class and highly value future wealth over present matters, you should act "like a founder" (sacrificing your life to, one day, make 1s or 10s of millions) if the company is on the ups, and you should act "like a mercenary" (leaving to some place where you can resume acting "like a founder") if the company is permanently plateauing or on the downs.
If you're in the "upper" class it's a different game entirely. That's not really the subject of this thread (valuing equity from a typical prospective employee's POV), so I won't go there.
Whether a "good startup" (great founders, great business, great investors) results in "a meaningful outcome for holders of <1% of common shares" involves so much luck and non-determinism that's beyond your influence as a <1% employee that you would be foolish to write it off to anything other than zero. The same is not true for >=1% and founders, of course, so they should value their equity differently.
Edit: the "magic" that many startups try to get away with is convincing people in class X that they're actually in class X+1 (even X+2!) and that, you should therefore act like it!! Be wary.
Not sure if you mean that seriously, or with tongue in cheek. It takes a very healthy dose of luck and market timing to be successful. Even the VCs, the experts, don't know how to pick winners. They expect a 90% failure rate, and this is among the ones they picked!
As an employee you don't have the same profit structure in play -- you can only work at one startup at a time. You cannot spread your bets around and let that one winner make the math work. You have to be 10x better at selecting a startup than the experts, probably 100x better if you expect to beat a big tech salary.
IME picking a good startup is extremely difficult, because even the ones with PMF and growing customers can so easily fail at execution: the human factors are so huge there. You can definitely narrow the field (use common sense: evaluate their business), but long term it’s impossible to know.
Correct, the 409a is only going to show you the maximum possible value.
Realistically, investors get their money back first, so 50% (picking an arbiter number) of that valuation value won’t ever been seen by employees. Then it gets even worse with multipliers and preferences.
It's the preference and its multiplier that gives investors their money back first. These aren't different things, they're one thing, and generally only matter if the company exits for less than the valuation the investors invested at. The exception to this is if any investors have a liquidation preference > 1x (you should avoid companies where this is the case).
Preferences also don't stack with the rest of a liquidity event. E.g. say an investor puts in $100m at a post-money of $1b with a 1x liquidation preference. If the shares go for $900m, the investor gets back their $100m, and that's all. They don't lose money, but they don't make money either. If the shares go at a $1.1b valuation, the investor converts their preferred shares to common shares like everyone else has. The investor doesn't get their money back first and sell more shares on top of that. It's either/or.
> the 409a is only going to show you the maximum possible value
While the points about uncertainty of options are quite accurate, this detail isn’t really true.
For the most part a 409a is the lowest reasonable valuation the company could talk the auditors into accepting. The lower it is the less tax paid and everyone knows that.
>> Then it gets even worse with multipliers and preferences.
Yeah, and most companies wont share the cap table with you, so you do not know the multipliers and preferences. Its like you get $(409a/X) in value, but you dont know what X is and they wont tell you -- but you still have to buy in or lose everything (you typically have to exercise all options upon departure, or lose it!)
Then, once you exercise, you wait for 5yrs to 10yrs for a liquidity event, if the company even survives that long. My annual discount rate would be like 10% or higher.
> The real answer is that it is probably not worth anything unless they have stock liquidity events that only a handful of large startups have (e.g. Stripe.) If you dont have that, the price is purely theoretical.
This is not true in Australia, where they are proposing a new 15% tax on gains attributed to the portion of an individual's retirement account larger than $3 million, including unrealized gains. That means people must put a dollar value on each asset at the end of each income year, including startup shares or venture fund interests.
> spending today-dollars and exercising options for the right to sell stock 5 or 10yrs into the future almost never works out
There are places that will, no recourse, loan you the money to exercise and pay the tax, in exchange for some percentage of the profit, provided it's for a company they like.
Meaning, they lend you the money, but if there's no IPO/liquidity event, you don't owe them any money. 70% (say) of a big number may not be as big as 100% of a big number, but 100% of zero is $0. Which isn't financial advice, just a bit of math.
>> There are places that will, no recourse, loan you the money to exercise and pay the tax, in exchange for some percentage of the profit, provided it's for a company they like.
Yes they do this, but only for select companies. They wont touch most startup equity.
One thing I've learned working for startups is if you're working for a founder who's already had a previous successful startup exit(s), two things are true:
1. the founder already has generational wealth and this current company means practically nothing to them.
2. they've already learned every trick in the book to keep the company's value in their own pocket and out of the hands of their employees.
This seems highly cynical. If the current company means practically nothing to them, why would they be bothering with it at all, especially given that they could be doing almost anything else they wanted, given their generational wealth?
OP is making broad statements, and you might even be right about your guy. But even if your founder is not super wealthy from the first exit, your current startup could go under and if that happens employees will be left with absolutely nothing. Him, on the other hand, will probably have a golden parachute to land with. Either way he will be now be a "serial entrepreneur" and will be able to utilize his VC friends to start the next thing in no time. He's going to be fine.
And there's no telling what he will do if your startup does actually end up being worth something. Transfer the IP to a new company and fire everyone? Introduce new share classes for investors and dilute everyone else to zero? Sell the employees (acquihire) to some horrible BigCorp™ and then retire to Hawaii? No shortage of stunts they could pull once real money is on the table.
Unless you work in SV, I think the advice for the rest of us is: take equity/stocks/options as a lottery ticket. Very unlikely that you’ll cash something, therefore base compensation is king.
It's the same thing in the SV. Unless the company is doing liquidity events the early, but post-founder equity is unlikely to pan out for employees.
And it can motivate employees to stay at the company way beyond what's good for them, as leaving the company means either abandoning your equity or exercising your options and paying real money for a very risky and illiquid asset. My 2c.
The problem becomes they (the company) talks/treats it as money paid and expects a lower salary (or additional passion like being happy to wake up at 4am to deal with an issue randomly) in exchange. They also want people who buy into the lie.
If you work for a moderately large company, it probably won't go to zero (though it could so you may want to hedge your bets). Not sure what SV specifically has to to do with it. I agree in general about focusing on cash on the barrel.
Just something I’ve seen lately at all of the startups I’ve worked at…
The founders, early investors, etc., will cash out way before you do and you will not have the same ability to sell as they did. I’ve seen it tear companies apart. YMMV
"The difference between the most recent FMV (409A) valuation and your exercise price."
This will almost never be the case. This doesn't account for different share classes, liquidation preferences, preferred stock, all of which get exercised before common shares.
A better description would be "the most recent 409A valuation, minus preferred treatment, and your exercise price."
All of that is moot though, as an employee wouldn't have access to the cap table or liquidation stack. The short answer is you'll have no idea how much your equity is worth until you get the wire transfer into your bank account.
Equity as an incentive truly favors the employer. With vesting, equity rarely works out to be better than having a market rate salary, unless the company becomes a household name.
>This will almost never be the case. This doesn't account for different share classes, liquidation preferences, preferred stock, all of which get exercised before common shares.
>Equity as an incentive truly favors the employer. With vesting, equity rarely works out to be better than having a market rate salary, unless the company becomes a household name
I've worked at 4 different startups. Two were acquired and two are still going, with one making a small profit and being a lifestyle business for the founder, and the other having a great product and still growing.
For the two acquisitions, one of which I held 1% equity in, the value of my options was $0, which was very disappointing. In that case, I did get a cash bonus as the VP Engineering and an offer from the acquiring company that was 3X my cash comp, but the stock was worthless.
At this point in my career, I value stock in private companies at exactly $0 and treat it like a nice bonus should it ever amount to anything.
409a valuations explicitly take into account share classes/liquidation preferences. That's kind of the point. If the Preferred last sold for $1.00, the 409a might value the Common at $0.10 per share, which would then typically be the FMV strike price set in the next round of issued options.
If the Common FMV has been steadily increasing from when you received your options, that would typically be a positive sign. Of course, 409a valuations are based on mathematical models. Since Common shares are so illiquid in a private start-up, you don't "really" know what they're worth until a liquidity event.
Actually, it is not. It only seems complicated because it is backed into after calculating the regular tax when you use the IRS tax forms. In other words, first you calculate ordinary tax, then you make plus/minus adjustments for the things that are different under AMT.
If there was a Form 1040-AMT which simply calculated the AMT the same way we calculate regular tax, you would see that it is actually simpler than ordinary tax. (depreciation is simpler, itemized deductions are simpler, personal exemptions for kids go away, the standard deduction is much higher, and so on).
If we did it the other way around - calculate AMT first, then make adjustments to back into ordinary tax, then you'd say ordinary tax is complicated.
Most people don't understand that under the TCJA temporary provisions enacted in 2017 and expiring in 2025, most of the changes just involved moving AMT provisions into the ordinary tax calculation.
I agree AMT itself is not a particularly complicated calculation. But I don't think that was really the point of that quoted statement. The complicated part is figuring out if and when AMT applies to you, and, essentially, for how long it can raise your taxes.
As you said, the tax code requires you to calculate your taxes twice - once using the "normal" rules, and another time using the AMT rules, and you pay whichever is higher. So, depending on your individual circumstances, it's non-trivial to know if AMT will apply to you when making particular money movements during the year. Also, if you have to pay AMT in year one, but then in year two the calculated AMT is below your normal tax calculation, you get a credit for the excess amount (i.e. amount over the normal tax from year 1) up to the delta between the normal tax and the AMT amount. In other words, AMT can often times just cause tax to be paid earlier, but the total amount of money (over years), ends up being the same. Of course, the time value of money comes into play - paying a tax earlier is losing money.
So, point being, there are complicated considerations to take into account.
Many early stage startups are a low oversight environment. This can mean lots of things, beneficial to certain kinds of people: easily push code to prod, touch production databases directly, work weird hours, fix almost any problem you want yourself, know how everything fits together, have more control over your work machine, etc.
Not all startups are grueling to work for. I've been at startups where I barely worked 4 hours a day at times. Results matter more.
Finally, if you just really hate the big tech interview process, you can get into many startups with minimal prep. Not saying it's a financially optimal use of one's time, but it is a thing some people value.
Some people don't like the environment of big companies. There are finite positions at big companies, not everyone can be there. Not everyone is a founder.
We still get paid obscene salaries fucking around with the bonus of a shot to make even more obscene money.
For all the complaining about options there's little acknowledgement of how little startup work contributes to society relative to the money we rake in from people willing to fund it.
What you should understand is that they are a longshot. Like, worse than 10 to 1. I’ve gotten lucky and made a truckload of money on them, and know many people who have done the same. I’ve also had them be an utter waste of money. It’s very much a gamble and it’s unlikely to pay off. This doesn’t make it a scam.
A lottery ticket is legal but expected value is negative. Same with casino games. Sure it's legal and sometimes people win but in my book it's a scam, even if not technically one.
What I particularly resent is the pretence from companies that a lower salary can be compensated by options. Such BS
Sometimes they are not. I think for post startup companies it is somewhat possible to put a value on ESOP then risk adjust for you losing the job, leaving etc. I have been paid out but think bonus cash for a holiday money not life changing. I kept it in post IPO and got more but then anyone could have done that post IPO.
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The real answer is that it is probably not worth anything unless they have stock liquidity events that only a handful of large startups have (e.g. Stripe.)
If you dont have that, the price is purely theoretical. Further, if you cannot see the cap table and the preference overhang -- and most startups wont let you see it -- then you have no idea what the real price is regardeless of a theoretical 409A value.
Even if you can see the cap table, spending today-dollars and exercising options for the right to sell stock 5 or 10yrs into the future almost never works out -- the cone of uncertainty across 5 or 10yrs is far too great. The better move would probably to be to use that money to purchase long-dated LEAP call options on the Nasdaq Composite
The details all matter, but they all matter far less than that fact.
People shouldn't lump all startups together and should have a long think about whether they actually believe in the startup they're joining.
In the most common positive case (i.e. sale price is <100% of invested capital), or negative cases, the three collapses into into preferred holders vs common holders.
If you're in the lower class, you should assume your equity is worth zero. No matter what startup you're joining. You're here for the cash comp and to be surrounded by a growing cast of ambitious, upwardly-mobile people.
If you're in the "middle" class and highly value future wealth over present matters, you should act "like a founder" (sacrificing your life to, one day, make 1s or 10s of millions) if the company is on the ups, and you should act "like a mercenary" (leaving to some place where you can resume acting "like a founder") if the company is permanently plateauing or on the downs.
If you're in the "upper" class it's a different game entirely. That's not really the subject of this thread (valuing equity from a typical prospective employee's POV), so I won't go there.
Whether a "good startup" (great founders, great business, great investors) results in "a meaningful outcome for holders of <1% of common shares" involves so much luck and non-determinism that's beyond your influence as a <1% employee that you would be foolish to write it off to anything other than zero. The same is not true for >=1% and founders, of course, so they should value their equity differently.
Edit: the "magic" that many startups try to get away with is convincing people in class X that they're actually in class X+1 (even X+2!) and that, you should therefore act like it!! Be wary.
As an employee you don't have the same profit structure in play -- you can only work at one startup at a time. You cannot spread your bets around and let that one winner make the math work. You have to be 10x better at selecting a startup than the experts, probably 100x better if you expect to beat a big tech salary.
Realistically, investors get their money back first, so 50% (picking an arbiter number) of that valuation value won’t ever been seen by employees. Then it gets even worse with multipliers and preferences.
Preferences also don't stack with the rest of a liquidity event. E.g. say an investor puts in $100m at a post-money of $1b with a 1x liquidation preference. If the shares go for $900m, the investor gets back their $100m, and that's all. They don't lose money, but they don't make money either. If the shares go at a $1.1b valuation, the investor converts their preferred shares to common shares like everyone else has. The investor doesn't get their money back first and sell more shares on top of that. It's either/or.
While the points about uncertainty of options are quite accurate, this detail isn’t really true.
For the most part a 409a is the lowest reasonable valuation the company could talk the auditors into accepting. The lower it is the less tax paid and everyone knows that.
Yeah, and most companies wont share the cap table with you, so you do not know the multipliers and preferences. Its like you get $(409a/X) in value, but you dont know what X is and they wont tell you -- but you still have to buy in or lose everything (you typically have to exercise all options upon departure, or lose it!)
Then, once you exercise, you wait for 5yrs to 10yrs for a liquidity event, if the company even survives that long. My annual discount rate would be like 10% or higher.
This is not true in Australia, where they are proposing a new 15% tax on gains attributed to the portion of an individual's retirement account larger than $3 million, including unrealized gains. That means people must put a dollar value on each asset at the end of each income year, including startup shares or venture fund interests.
There are places that will, no recourse, loan you the money to exercise and pay the tax, in exchange for some percentage of the profit, provided it's for a company they like. Meaning, they lend you the money, but if there's no IPO/liquidity event, you don't owe them any money. 70% (say) of a big number may not be as big as 100% of a big number, but 100% of zero is $0. Which isn't financial advice, just a bit of math.
Yes they do this, but only for select companies. They wont touch most startup equity.
1. the founder already has generational wealth and this current company means practically nothing to them.
2. they've already learned every trick in the book to keep the company's value in their own pocket and out of the hands of their employees.
Why do dogs chase frisbees?
And there's no telling what he will do if your startup does actually end up being worth something. Transfer the IP to a new company and fire everyone? Introduce new share classes for investors and dilute everyone else to zero? Sell the employees (acquihire) to some horrible BigCorp™ and then retire to Hawaii? No shortage of stunts they could pull once real money is on the table.
And it can motivate employees to stay at the company way beyond what's good for them, as leaving the company means either abandoning your equity or exercising your options and paying real money for a very risky and illiquid asset. My 2c.
The founders, early investors, etc., will cash out way before you do and you will not have the same ability to sell as they did. I’ve seen it tear companies apart. YMMV
"The difference between the most recent FMV (409A) valuation and your exercise price."
This will almost never be the case. This doesn't account for different share classes, liquidation preferences, preferred stock, all of which get exercised before common shares.
A better description would be "the most recent 409A valuation, minus preferred treatment, and your exercise price."
All of that is moot though, as an employee wouldn't have access to the cap table or liquidation stack. The short answer is you'll have no idea how much your equity is worth until you get the wire transfer into your bank account.
Equity as an incentive truly favors the employer. With vesting, equity rarely works out to be better than having a market rate salary, unless the company becomes a household name.
>Equity as an incentive truly favors the employer. With vesting, equity rarely works out to be better than having a market rate salary, unless the company becomes a household name
I've worked at 4 different startups. Two were acquired and two are still going, with one making a small profit and being a lifestyle business for the founder, and the other having a great product and still growing.
For the two acquisitions, one of which I held 1% equity in, the value of my options was $0, which was very disappointing. In that case, I did get a cash bonus as the VP Engineering and an offer from the acquiring company that was 3X my cash comp, but the stock was worthless.
At this point in my career, I value stock in private companies at exactly $0 and treat it like a nice bonus should it ever amount to anything.
If the Common FMV has been steadily increasing from when you received your options, that would typically be a positive sign. Of course, 409a valuations are based on mathematical models. Since Common shares are so illiquid in a private start-up, you don't "really" know what they're worth until a liquidity event.
Ultimately the 409a is for the IRS, not a mark for employees
Actually, it is not. It only seems complicated because it is backed into after calculating the regular tax when you use the IRS tax forms. In other words, first you calculate ordinary tax, then you make plus/minus adjustments for the things that are different under AMT.
If there was a Form 1040-AMT which simply calculated the AMT the same way we calculate regular tax, you would see that it is actually simpler than ordinary tax. (depreciation is simpler, itemized deductions are simpler, personal exemptions for kids go away, the standard deduction is much higher, and so on).
If we did it the other way around - calculate AMT first, then make adjustments to back into ordinary tax, then you'd say ordinary tax is complicated.
Most people don't understand that under the TCJA temporary provisions enacted in 2017 and expiring in 2025, most of the changes just involved moving AMT provisions into the ordinary tax calculation.
As you said, the tax code requires you to calculate your taxes twice - once using the "normal" rules, and another time using the AMT rules, and you pay whichever is higher. So, depending on your individual circumstances, it's non-trivial to know if AMT will apply to you when making particular money movements during the year. Also, if you have to pay AMT in year one, but then in year two the calculated AMT is below your normal tax calculation, you get a credit for the excess amount (i.e. amount over the normal tax from year 1) up to the delta between the normal tax and the AMT amount. In other words, AMT can often times just cause tax to be paid earlier, but the total amount of money (over years), ends up being the same. Of course, the time value of money comes into play - paying a tax earlier is losing money.
So, point being, there are complicated considerations to take into account.
But how startups find early employees then?
Many early stage startups are a low oversight environment. This can mean lots of things, beneficial to certain kinds of people: easily push code to prod, touch production databases directly, work weird hours, fix almost any problem you want yourself, know how everything fits together, have more control over your work machine, etc.
Not all startups are grueling to work for. I've been at startups where I barely worked 4 hours a day at times. Results matter more.
Finally, if you just really hate the big tech interview process, you can get into many startups with minimal prep. Not saying it's a financially optimal use of one's time, but it is a thing some people value.
Dead Comment
For all the complaining about options there's little acknowledgement of how little startup work contributes to society relative to the money we rake in from people willing to fund it.
Startup founder who raises gets to play with obscene money.
If you come across obscene money startup jobs share them. Tons of unemployed developers lurking who would take % of obscene.
Maybe CEOs get that. Most people who get obscene money get it from some kind of investment.
What I particularly resent is the pretence from companies that a lower salary can be compensated by options. Such BS