It’s been a busy time at the Lazy Man household with the kids back in school. With 20 years of personal finance under my belt and a blog that loses money, my interest in writing has been at an all-time low. I’m still doing the things that I’ve done before, following the financial news, and last week a couple of headlines caught my attention. 1. Oil, Oil, Oil The first was that oil was spiking […]

Imagine joining a startup as employee number 10. Your salary is a bit below what the market pays for your role, but, in exchange, you get equity. How much? 0.25% of the company to be exact. You do the math in your head—if the company sells for $100M in a few years, you’ll make $250,000. Not bad, right? Wrong, and for quite a few reasons. Once you take into account how startup equity typically works, that initial equity grant is worth $97,500, not $250,000. Let’s walk through why this is the case and then answer an even bigger question: is startup equity a bad deal? Why Initial Equity Isn’t Exit Equity Startup equity is confusing because most of what determines its value happens behind the scenes (outside of an employee’s control). This is why, as an employee, your equity at exit is rarely what your initial grant was. This happens for the following reasons: Vesting: Most startup equity vests over four years with a one-year cliff. This means you get nothing if you leave within the first year. But if you make it past year 1, 25% vests immediately and then the remaining 75% vests monthly at 1/48th of the total grant (~2.08% per month). So, if an employee with 0.25% of the company leaves after 2 years, they are only entitled to 0.125% (or half) of their original equity. Dilution: Dilution is a common practice where subsequent financing rounds reduce the total amount of equity owned by everyone in the company. Typical dilution rates are 20% for Series A, 15% for Series B, and around 10% in each round thereafter. So your 0.25% could be 0.15% after a Series A, Series B, and Series C [0.25% * 0.8 * 0.85 * 0.9 = 0.15%]. There are also pool refreshes where new shares are created for future employees, which can further dilute your shares. These can be offset by refresher grants that you receive for staying longer, but this isn’t always the case. Liquidation Preference: Even when a company is sold or acquired, if the amount it exits for is below a certain exit price, then liquidation preferences take hold. For example, imagine a startup raises $10M for 50% of its equity, valuing the company at $20M with a 1x liquidation preference. The liquidation preference means that the venture capitalists (VCs) who gave the company the $10M, get the higher of 50% of the sale price or their $10M upon exit. So, if the company is sold for $15M, the VCs would get their $10M back since 50% of the sale price is less than $10M. This means that the remaining $5M is left for the founder(s) and employees. Liquidation preferences prevent a founder from raising money and then immediately selling the company and pocketing the proceeds. So, even if you own 0.25% of the company, after liquidation preferences, your 0.25% would apply to a smaller pool of funds. Post-Termination Exercise Period (PTEP): Arguably the biggest issue