Wednesday, November 09, 2011

Startup Equity Survey Synopsis: You Are The 99%

The startup equity survey I started several months ago is up to 78 responses (as of March 20, 2012), and with my upgraded SurveyMonkey membership I can now share the results here. If you work in startups you had better read this, as there's a ton to learn about the huge disconnect between the startup equity dream and startup equity reality.

Highlights:

Only 38.5% of respondents know within 2% accuracy the total number of shares outstanding in the startup they work at.

72% don't know what the preference structure is at their startup. You might want to, for two reasons:
1. Whether your startup is Standard or Participating Preferred can have a 30-40% effect on the value of your common shares in a liquidity event;
2. I can virtually guarantee you that if the preference structure at the startup you work at or are interviewing with is gonna f#&k you in the keister upon liquidity, you never asked the right question and your employer consciously avoided disclosing what you'd have wanted to know.

Only 9% legally have any control over what role & responsibilities they'll have post-acquisition. Now do you understand why so few startup employees are truly happy with their role within the acquirer? Reality is management oftentimes doesn't think it through - either in terms of the employees' best interests or, frankly, the best long-term interests of the acquirer - because a) they have no incentive to; and b) you the Common shareholders haven't used your leverage to gain basic control over what happens post-acquisition.

A strong majority (66.7%) of startup workers don't know what the industry average is for equity given to people in similar positions. This wouldn't be an issue for you, the Common, if 50% of you weren't expecting that your startup options will be worth $100K-$1M and 20.6% $1M+. It's a dog-eat-dog startup world, and you 66.7% are wearing Milkbone underwear.

Only 29.5% of you are certain you have any type of trigger clause in your employment agreement with the startup you're at, and even fewer (10.7%) negotiated that language. A trigger clause gives you partial or full vesting acceleration should you be a) fired without cause; b) put into a role inferior to that for which you were hired; or c) upon acquisition. Given its importance, employees' profound lack of knowledge in this area is why a much higher percentage of VCs drive luxury cars while you drive Pinto's.

Dreamers Dream, But Lawyers Wake Them Up
42.3% of respondents expect their startup equity to be worth $100K-$1M after 4 years' vesting, and 25.6% expect $1M+. [Generously] assuming $100-$150K annual salary, people are clearly dreaming that their startup equity will have a big & positive (quite possibly life-changing) impact on income. Yet, only 23.1% have had two or more liquidity events. I realize in retrospect that I should've asked people what, if any, money they made from their equity in those exits, but anecdotally I've heard from several people that by no means did liquidity events always correlate to income events for them.

So what does this all mean? Two things really:

1) A strong majority of non-founding startup employees don't know what they need to about startup equity, and as a result are putting themselves at the mercy of founders and investors for receipt of a chunk of change that they largely expect to change their lives;

2) The glaring lack of knowledge on the part of Common shareholders at startups is a major contributing factor to the huge gap between startup equity income expectations and reality for non-founding startup employees.

I've had 4 startup strikeouts, 2 singles, a double, and an RBI triple on an at-bat that took 8.5 years. That's a .500 batting average; not bad but definitely better than those surveyed. The pain of walking back to the familial dugout after those strikeouts, coupled with the pride of digging out an infield single has taught me a ton about startup equity. If you need help, reach out [chris dot zaharias at gmail dot com] and maybe I can help.



9 Comments:

Blogger myStockOptions.com Editor said...

Thank you for doing this survey. It gets at the range of risks that most employees joining start-up companies do not consider or fully understand. The risk that the company may fail financially is the obvious one, but the risks of dilution or that cash investors (preferred shareholders) will get most of the sale proceeds in an acquisition is not usually not understood.

As for the "triggers," it would be useful if the survey broke them down by type of trigger (can you still do that in survey?), as many stock plans treat unvested grants differently based on situation (e.g., acquisition compared to layoff).

I'm editor of site devoted to equity compensation (www.myStockOptions.com) and we have a Pre-IPO section (see http://bit.ly/gbt3A6 ) that covers some of these risks with suggestions on how to handle them. In the end, it depends on your leverage and what the company is willing to negotiate. What's important is to go into the pre-IPO employment world knowing the range of risks and the true upside.

Bruce Brumberg, Editor
www.myStockOptions.com

8:08 AM

 
Blogger Dan Walter said...

This is great information. I think your % of understanding may actually be higher than reality. My guess is that most people who answered your survey had enough interest and understanding to actually find and be able to respond to it. Imagine if those people with virtually no understanding also responded.

1:12 PM

 
Blogger Achaessa said...

I think this sentence is quite telling - "Half of the respondents expect their startup equity to be worth $100K-$1M after 4 years' vesting." - given that the average time from founding to liquidity event is now up to about 9 years. (This statistic from the NCEO's upcoming Issue Brief on Value and Valuation, due out in December.)

1:25 PM

 
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11:26 AM

 
Blogger HerEvery CentCounts said...

Hi. Thank you for starting this conversation. It's VERY important. I plan to join your in-person event and have been sharing it with every startup employee I know. I'm on my 3rd startup now and I keep getting screwed over on stock options. It's my fault because I don't know the right questions to ask or what to negotiate. I know about total outstanding and %, but that's where my knowledge hits a wall.

Here are two specific topics near and dear to my heart:

1. upon acquisition by a private company (even one about to go public) changes what your shares can be worth. I went through one company where my shares were converted to cash. However, accredited investors had the option to either convert to the same cash price OR convert to shares of the new company. The new company was reportedly being bought by a very large public company or going public itself within just months (and it did) but because it was private at the time of acquisition, I needed $1M in assets to be allowed to make that choice (which is such BS because the rich get richer that way -- though it's supposed to protect me?) I only didn't mind much because on the specific instance I had so few shares and my kind boss decided to give them to me at layoff (I wasn't even going to exercise) but it definitely taught me a lesson for the future. However, I still don't know how to avoid this happening other than finding $1M to put in my bank account (not going to happen for a long time, unless my stock options are ever worth that. Catch 22.)

2. Coming in to a company very early on after this exit (where I ended up forced into $3 per share version the current public price of the then-private now acquiring company ($8.52), I negotiated what I thought was a wise % of options, since that was the only thing I could successfully negotiate in my contract. At my first gig I had a couple of thousand shares resulting in a nice small bonus shortly after I was laid off. But that company had only raised $5M and had about 9 employees so it seemed easy for them to offer something to employees after a small acquisition. The B2B company where I negotiated a large number of options changed that game. It grew really fast and raised a lot of money. Theoretically this is a good thing, except when a company grows too fast and burns through all its money. Regardless, I negotiated 1% of the company to start and took below market rate salary. To be honest, I wasn't clear on total outstanding options at the time, but was told the amount was 1%.

Here's the problem with taking that much of your income in stock when you're not yet a VP (even if your risk coming in super early supposedly was worth this amount of shares and would be later massively diluted in additional funding rounds) ---

The company really benefits most from this arrangement. You work harder because you know that your outcome will largely be effected by how well you can succeed in that first year (and there are so few people on the team that everyone really works hard to build something.) This is not a bad thing for the individual necessarily, but what is bad is that the individual has no control over whether they can last the full four years of vesting. A startup CEO can actually plan to fire their first employee before the 1 year vesting mark or however many years into the 4 year vesting period. So the % really is meaningless. Getting more early is good, if they'll be worth anything, because % wise you get to more before they often fire you. That first 1 year of vesting is key.

Cont...

5:43 AM

 
Blogger HerEvery CentCounts said...

What is even more challenging is understanding the real risk/reward of early exercise (83b elections.) My new company doesn't seem to even allow them. My old company (startup #2) did allow them and offered this as a benefit to early employees. As I took so much of my salary in options, I figured if I didn't early exercise for all that tax savings I would be dumb. Our company was in a hot space and growing fast, we had a number of customers, however, being my first play in B2B, I didn't realize all of the challenges we would face, or the management issues that existed. I was bright eyed and bushy tailed and wanted to believe that we were going to be huge. It was certainly the story being painted by our founders. So I went and wrote a check for $20,000 PLUS interest which I paid to the company to be able to afford the early exercise.

This is completely my fault, but the investment is quite irrational compared to my total investment strategy. Why? It had me investing 5% of my portfolio in ONE super small-cap stock. Not only was I investing 5% of my portfolio in this one stock, but that investment wasn't even something I fully purchased until 4 years and couldn't even touch until the company had an exit (I just locked up all that cash for a long time, losing the ability to diversify and put it in more safe investments or diversify risky investments.)

Regardless, I went ahead and did the 83b. As it was presented, it almost seemed like not exercising meant that I didn't believe in the company or wasn't part of the team. So I did it. And it could have turned out great if the company happened to do very well. Clearly there was a risk for potential reward. It's just still not clear to me what exactly the risk odds are and what outcomes could be.

cont...

5:43 AM

 
Blogger HerEvery CentCounts said...

Taking that much of your early pay in stock options also effects your relationship with executives that later join the company. It really sucks. My boss - who joined after the company had stabilized thanks to the early employee's hard work - constantly mentioned to me that I had a lot of options and clearly was jealous of my options and strike price. This effected our relationship and how he viewed me, because he looked at me as someone who was going to make a lot of money from the company (especially when he was most convinced the company was going to one-day have a billion dollar exit.) Even our new CEO fist pumped me when he found out how many options I had, and it felt insincere as to make me feel like I should continue to work for less than market value. In his mind, he might thane been thinking that the options were going to be worth a lot if he hit his goals, or he might have been thinking that he needs to continue to motivate this employee who is going to be screwed over soon based on what he promised to the board. So any attempt to negotiate a raise was met with commentary on all of that great stock I was sitting on. I did manage to eek in a couple of raises over my tenure, but now that I'm leaving to another startup I realize just how below market I've been paid. Worse, though, is that at this point signs point to the stock being worthless. As I stayed at the company for most of my vesting period, that means I am now potentially going to lose $16,500 of after-tax money that I invested into this company. It still may turn out that I get some of my money back or even make money on this, but I might not know for years. Meanwhile that $16.5k is still locked up and I have no liquidity. I'm not allowed to sell or transfer stock. This seems like a bad deal at this point given the risk. Again, it could have been a good deal.

If one doesn't early exercise, then here's another major way they get f'd that they don't realize -- you stay at your company and then leave after 2 years, you have 90 days to buy the shares or they disappear. And you have to pay tax on the difference between your strike price and current value of the shares. I see two outcomes here:

1) The shares are "worth" a lot more than your strike price, so you have to pay for the entire strike price PLUS all of the tax on the difference between your strike price and current price. What non-exec startup employee can afford this (or this amount of risk?) But after working 2 years, one might feel like they have to buy the stock and especially if it's "worth more" than it was when the employee started. This is a worse effect if the employee hasn't exercised yet and leaves after 4 years, when they are finally allowed to purchase all of their stock that they worked so hard for and own it.

2) The company's stock is actually underwater or hasn't grown from the strike price. The employee then doesn't have to pay extra tax on the difference, but the employee has to decide if it's worth paying more for stock than what it's currently worth. Again, the employee feels like s/he has worked so hard for all this stock that it's a shame to walk and just leave it on the table. Many exercise at this point only to lose the money later.

cont...

5:44 AM

 
Blogger HerEvery CentCounts said...

What isn't clear is what outcomes are at this point and what the tax savings really is in exercising early on at different income brackets vs waiting to exercise later, and what signs an employee should look at to determine when and if to exercise.

Finally, the worst of it is when you leave the company, especially if you joined as an early employee, you are going to lose any visibility or say into the outcome of the organization. While you may own .3%-.5% of the company after dilution, you have to just sit and twiddle your thumbs, sometimes for years, to find out if you are going to see any return on the investment or lose it all. Founders, meanwhile, often get millions of dollars out upon each funding round. The executive team maybe has similar clauses in their contracts? Other employees just watch the VC money being drained (and often spent unwisely or taken out by founders) while their common stock depletes in value.

So I just went to a new startup and again didn't know how to negotiate or protect myself. I think it will get easier at my next position because that's when I'll move into more executive status. Every time I try to ask for any special clauses in the contract (acceleration et al) I get met with "we don't do that for our employees" as a sweeping statement. I'm never clear how negotiable this is. I've never successfully negotiated anything on stock beyond increasing total percentage. This time around I went for more cash and a lower percentage of stock, but I also can't early exercise at the company for better or worse. I don't know if I made a good decision or not, but I'm tired of the anxiety I've had with my boss being jealous of me for my % of shares and strike price as these illiquid shares grew and then shrunk in value. I'm tired of being misled by early-stage founders who tell their employees -- in team meetings -- that the company's share price would one day be worth possibly $30 or more (and looking back realizing how they were clearly flat-out lying to their employees based on their plans for the company's financing.)

cont...

5:44 AM

 
Blogger HerEvery CentCounts said...

Even the best-intentioned CEO can accidentally screw over his employees early on, because it is in their best interest to believe their company's stock will be worth a lot. Yet there are so many variables that it's impossible for any early executive to understand the value of that stock at the time of exit given not being able to guess future markets.

Meanwhile, employees get shocked at exit, if there is an exit, when they don't have the same rights as other startup employees who are accredited investors for their shares to be worth more, or when there are REVERSE STOCK SPLITS (this sounds to be fairly common) right before an exit where $8 per share really is $4 per share. Yes, on paper the employee owns the same amount of the company, however it also seems to be a way of screwing over the employee. I've heard of 5-to-1 reverse stock splits prior to going public (not sure how common this is) so suddenly 100,000 shares are 20,000 shares at, say, $8 per share. Knowing % of company owned is key, obviously, but for younger employees the reverse stock split concept is probably even more shocking.

Oh, and then there are down rounds and other such things that reduce the value of your stock, and I'm not clear exactly what I'm allowed to ask as a "current employee" or "past employee" of a company and what I'm legally allowed to know or be required to be told upon asking.

I'm really looking forward to your talk!

5:45 AM

 

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