First employee of startup ? You are probably getting screwed !

Same story again

A friend of mine just told me about his exciting new opportunity:
He met two guys who are opening a new startup. They are known in the community and already had a small exit before. For the past half year they have been working on a startup, got some code and are now just finishing with a 500K$ seed raise.

And, they are looking for their first employee with significant equity !

After some interviews and f2f meet ups, they decided to offer him a job. Of course, they can’t afford to pay market salary just yet but they are willing to give significant equity, a chance to influence the company’s direction and become a core member of their team !

And he was just about to sign up.

Me: “So tell me more, what kind of numbers are we talking about.”
Him: “Good ! Half my normal salary and 1% of the company”

Now this might sound very reasonable and exciting, but perhaps its time for…

A bit of… math !

Taking the optimistic route
– In one year the company does series A and can pay full salary
– They raised 500K at a high 2M (pre-money) valuation, giving away 20%
– His normal 100K/years is cut to 50K/year.

From the looks of it, he is pretty much saving the company / putting in 50K.

What does an investor get for putting in 50K:
- 2% of company shares
- Priority on exit
- Invest small part of his capital

What does employee get for putting in 50K
– %1 company shares (options)
– 4 year vesting plan
– Exercise price
– No priority
– No control or rights of information
– Invest large part of own capital

Strange numbers, and yet people agree to them every day.
Because their 1% will turn into a million.
And as working for half their salary(or less).. hey.. its just for a while.

How low did you compromise ?

EDIT – 14:00:00 UTC
Interesting discussion on HackerNews

Comments

  1. Hmm, although the one thing you are overlooking is that at the VC stages of raising finance, unless you’re a VC putting in $500k, the deal would not be open to you at all. So yes, you come in on less favourable terms than the pure equity investors, but with only $50k to invest there’s simply no way you’d be in at all unless it’s on a deal like this.

    The key is not to worry too much about the deal the other guy is getting and look at your own opportunities. What else could you spend half of your salary (tax free) for a year on that would give you the same potential for return?

    Reply
    • This is just not true. Most $500K seed rounds are built from $50-100K checks from individual investors. Even a lot of VCs write seed round checks on the order of $2-300K. It is extremely rare for a single investor to carry the entire round.

      Reply
        • Only proof that government wants to keep the best investment opportunities away from the little guys.

          “accreditation” is just discrimination.

          Reply
          • While that may be true, it’s still the field you’re playing on. Don’t make your decisions based on a non-existent world.

          • >“accreditation” is just discrimination.

            ===> Network already is starting to route around that using Bitcoin, for example at the GLBSE stock exchange.

    • What makes you say the terms are less favorable? I’d say they’re just different.

      Pure equity investor puts in 50-200k on day one. If they find a cooler company the day after, do they call and ask for their money back? Hopefully not. That probably wouldn’t fly.

      Employee “puts in” 50k in installments of 8k per month spread out over a year. If he or she finds a cooler company, do they quit and join that company? Quite possibly.

      Depending on the vesting terms I would say the employees deal may even be more favorable than the investors.

      Reply
  2. Let’s put the question the other way round: not “How low did you compromise ?” but “how much did you offer to provide for this?”

    Being an employee is something different than being an investor or an founder. While you concentrate on the numbers, I see your flaw already before this:

    “they are willing to give significant equity, a chance to influence the company’s direction and become a core member of their team ! ”

    Let’s assume for a moment that there really was something in the offer specifying the ‘influence’ or the ‘core member part. Like area of work, responsibility, clear target goals, structure around what this means in terms of bonus and payoff, a limitation to how long the salary would stay so low, in what area people are really responsible for what tehy are doing in which area they have impact, the voting process and so on.

    I imagine if the first employee gets screwed (and I am not dismissing that idea) it is on those things, not so much on the payment part.

    An employee is an employee. Not a manager, not an investor, not a founder. There are established roles and mentalities around this and it the weakness of the startup generation we currently see, that they did not go through some years of corporate structure, that would have told them quite a lot.

    Long story short: On paper you are right. But in reality it is about expectations and assumptions. Not ‘how low did you compromise’ but “how much did you not know to make stuff happen so that it is benefitial for you’.

    Reply
    • Since when managers are not employees? I think I’ve just spotted a manager.

      So employees need a “few years on a corporate structure” to adjust to the right “mentality” (i.e. put themselves in their places) so that they can be screwed but still think they got a nice deal? Get out of my planet.

      Reply
  3. Let’s say they double their value within 4 years, so its 5M*1%=50K – that’s exactly what he’s giving up in the first year, but they’ll pay it back over 4 years. So if they really start paying market salary after 1 year, and double their value within 4 years, his options are (almost) equally good. If he really believes they’ll do considerably better than that, then A. He’s too optimistic :) and B. Its not such a bad deal.
    But I generally agree that getting something closer to what the investor is getting is a better compensation for the risk he’s taking.

    Reply
    • The problem is that the employee loses unless the company doubles its value. This has a huge risk associated with it and it is entirely in the founders control. What is it worth to take such a risk? What is it worth to take such a risk and have no power over an exit? Clearly 1:1 is the wrong answer. You should be payed MORE for taking the risk

      Reply
  4. I like how the first commenters are a pair of jackasses trying to justify fucking people over because they have less money.

    Reply
  5. Actually, these numbers actually sound pretty favorable. I have heard .25% to .50% is the typical equity stake for someone in this position, unless he or she makes the company, but in that case, perhaps they should be in a cofounder role. Remember that some of VC or angel’s sweet deal may in fact server as a phantom compensation of sorts for all of the free services he or she provides.

    Reply
    • AFAIK first employees get as much as 3-6% equity. Going for less than that doesn’t make any sense. If the idea was so huge that 1% sounds good, they would be already paying above market and have cash spilling from their stylish office windows.

      Reply
      • Mylo, 3-6% is quite ridiculous unless you are the sole first employee for a significant initial time period, filling an essential role requiring uncommon expertise (which would in practice be closer to a “junior” founder).
        Normally when a start up is ready to employ people on full time basis, they will be looking to hire a few, say 3 – 6. If they gave them all 3 – 6 % that would result in the entire employee equity pool being exhausted.

        Reply
        • Having founded a start-up, raised money, hired, let’s just be clear. Your first employees are pretty much working as hard as the founders. Additionally, the founders may bring nothing but a raw demo that can be put together in very little time and some hustle to show it to/talk to the right people. Their great idea, like the million+ other ideas kicking around, are worthless without execution.

          I’ve been on both side of the equation, and the current standards for equity for early employees are disproportional to the investment those companies want you to make. When you are the first employee, it’s often the case that you’re freeing up one of the founders from doing the job you will be doing. If you take that tact, then that first employee is providing the same value the founder was until the founder hired themselves into another role.

          I’m not saying a first employee is taking the same risk as the founders, but to give them a significantly below-market-rate salary on top of a tiny (1%) bit of equity for putting that much skin in the game early on is a bit insulting.

          Reply
          • Damn straight.
            The kind of employee you want early on is a well skilled determined as hell hard working resourceful one, that doesn’t come cheap, and even if it did, you wouldn’t retain so it would be a failed hire.

  6. I’m in this position (different numbers). Influencing direction of the company? Good luck. The founders have a plan, and they now have 500K worth of investors who believe in that plan. What I’ve found is that I’m working at a job, just like any other. I watch mistakes get made every day, and the founders just think I’m a line item and don’t take my advice.

    I could have just as little influence at a large company, but also be making $30k/year more, have benefits, work 9-5 and have time to do my own stuff after work. But I’m an idiot and keep taking this same deal over and over and over and over……….

    Reply
    • Yes, you are an idiot, find another job that is willing to pay you market rates or become a co-founder yourself. I would never accept a job where I am paid less than market rates for some promised payday in the distant future that may never occur.

      Reply
  7. Anyway you look at it – its a gamble. If you’re accepting equity based on the CHANCE you might make it rich someday down the road, then it’s not worth it to me.

    I was swept up several start-ups during the first bubble and they all crashed and burned. I had to figure out why I was gambling on the chance the place I was working was going to be huge in 3 or 4 years, instead of taking the cash up front at a more stable company. Which proves the authors point. As long as you’re not the first guy through the door, your odds of getting paid better increase as the stability of the company increases.

    Reply
  8. I disagree with the comment “An employee is an employee. Not a manager, not an investor, not a founder. ”

    An employee can be and often is all three at the same time.

    50k of my money is an investment no matter what way you cut it, why should I “buy” shares at a hyper-inflated price – getting ripped off like this would p*ss me off every day I go to work rather than serving to motivate me into being productive…..not that I would ever except the idiot deal being proposed to the fictional employee above.

    Reply
  9. I joined a startup as one of the first 10 employees, received 0.25% of the company vesting over 4 years. At exit, my options were worth almost $400K.

    Best career move I’ve made. Even if the company hadn’t hit it’s exit and I got $0, the work was more rewarding than anything else I’ve done, and my experience there has opened up doors to me that would be closed otherwise.

    Here’s really the only thing that matters: do you believe in the company and vision? If so, what’s your risk? I mean, if you really think it’s going to fail after working there for 3 months, you can bail, right? As an employee, you are assuming *far* less risk than traditional investors, and your upside if things go well can be life-changing.

    Reply
    • You certainly took the 0.25% knowing the company had a high probability of becoming a $160m dollar business, and I bet they already had over a few million in funding. Different situations.

      Reply
  10. Unless I’m missing something – his 1% could be diluted in future rounds to boot. I know the old saying 20% of $1MM is better than 100% of $100K, but seems low. I guess I would be interested in how far along this company is: concept? slideware? beta? Also is there a vesting period for his 1%? What if they want to keep him at $50K for eternity and he has to eat it to keep his vesting schedule of 1%?

    Reply
  11. Any info that warns folks to think carefully before joining a start up is a public service. Never underestimate the greed and hypocrisy that a “boy wonder” CEO and BoD will reveal when big $ is on the line. Typical techies don’t have $ to take start-up employment contract to lawyer before signing. There is nothing (law, recourse) to stop CA start-up employers from screwing their early employees six ways til Sunday.

    One trick I experienced – give founding employees what sounds like generous options (numbers just grabbed from air when company is just a concept). Years of slog later, when the company sells for many millions, hold founding employees to those old options contracts (of numbers that are now worth little) BUT take out BLANK piece of paper and write new (fresh, adjusted to true value) ubergenerous options contracts for chronies who have been brought on board right before the sale. And make founding employees sign off that they agree with this shafting, lest they endanger the deal (and risk getting literally nothing).

    Reply
  12. I just don’t buy the equity concept. I think either you have the money and you pay decent salary, or you don’t. So, the founders should get VC money and pay their employees the market rate.

    Since 99% of startups fail, why would an employee bother to sign up with just equity? That is just vanity it seems to me. Maybe I am old school, but living a happy life with cold hard earned cash, is much better than just money in the form of numbers you may or may not get.

    Reply
    • Under that reasoning, there’s zero reason anyone should ever start or join a startup in lieu of other options, nor should anyone ever invest in anything. Yes, I do believe you are old school – wayyy old school. Back to antiquity, before the notion of stocks and startups ever existed

      Reply
      • There is nothing “old school” about doing risk management. The entails analyzing your age, education, chance of a better paying job, chance of start-up dying, etc, etc, etc. Each individual will have a threshold for the risk they can take and it often involves subjective judgment.

        Only because you might be OK with accepting what seems like a huge risk, doesn’t mean other people don’t accept any risk at all.

        Reply
        • “Maybe I am old school, but living a happy life with cold hard earned cash, is much better than just money in the form of numbers you may or may not get.”

          This is what I’m replying to Giovani. Essentially what he’s just said there is that there is no value in the notion of equity at all – that’s not risk management, that’s zero risk.

          Reply
  13. You make an excellent point.

    The thing is, employees should come in on the exact same terms as any other investor. That includes liquidation preferences, re-up rights, no delay in vesting, etc. (EG: If you’re deferring $60k a year ,you should be getting 1/12th of 60k worth of stock–owned free and clear– every month.)

    VCs are special and should get special terms? BS. VCs are just dumb money trying to screw you over. The only thing a VC has is a large accumulation of money to invest at once.

    Your employees, however, are the ones who really build the company.

    And the idea that two founders should get %80 or whatever to split but the third guy is an “employee” and is in the single digits is also BS. The third employee is 1/3 a founder. The fourth 1/4th, etc. They should get stock like that, maybe not all at once, but vesting along with their efforts in building the company.

    The ONLY reason employees sign up for these raw deals is that they never do the math or they are poor negotiators.

    I can’t tell you how many times I’ve been recruited by HR people who didn’t even know what percentage of the company the options grant represented and didn’t know what “fully diluted basis” meant. I’ve had to talk to CFOs to get that info, and often been told “the details of our investment is private”. Right, ok, well, NEXT!

    Don’t be a sucker.

    Reply
    • I have to call BS on this. Do you think the investor gets to put in 8k every month with no obligation for the next? That’s not how the game is played my friend. The fact is it takes some god damn cohoonas to put up 50k or 200k of your heard earned money at once, and there is infinitely less risk in putting in 8k a month and seeing how it goes.

      Also, I’m sure there are first employees that are 1/3 founders, but that’s the exception not the norm. Just showing up at work doesn’t make you a founder.

      Reply
      • The exception in this case is almost every ad that I see for “we’re hiring our 1st employee” asks for a rock star, someone who’ll have a huge impact on the company, will put lots of hours, etc, etc, etc. It looks to me as the founders really want someone “like them” and not someone that just “shows up for work”. So I’m sure this argument holds true at a lot of big companies but if the founders of a startup are putting those ads and still hiring slackers, well.. they are the get-things-done guys, they should know better.

        Reply
        • “We want a multi-domain expert who is way better at doing what he does than we are at doing what we do, we want him to take a big financial risk, and we want to pay him nickels on the dollar for what we’re going to be making.”

          Reply
  14. If you sacrifice 50k you should get equity worth 50k. Simple. If you are joining at the same time as the investors then you should get the same deal (2%) and if you join later then you may get a higher valuation (1%). How is this even a debate?

    Reply
    • I will caveat that saying – it is all fair, so long as you get the same terms, which you should if you invest/commit at the same time as other investors.

      Reply
      • Yep, but no investor gets those sweet employee terms; getting to put in 8k every month (at the up to 12 months old valuation) with no commitment for the next month. ;)

        Reply
        • No commitment? What about the 4 year vesting plan?

          The company isn’t spending the VC’s 500k in the first month, it doesn’t make any difference.

          Reply
  15. I’m not good with this kind of math (or any, for that matter) but sometimes it seems that founders of start-ups are trying to capitalize on the idea that huge companies like Google and Amazon were once start-ups, now they are valued at the billion dollar range and whoever got first hired is now rich. Perhaps this is so prevelant in Silicon Valley that even the founders believe they are indeed on that path. As others have pointed out, seeing a start-up failing is a sure thing, as predictible as the Sun rising every single day.

    As I’ve said above, each person will have to balance the risk, the chance to do exciting work, etc… I just think the risk is high and sometimes people forget that when they get “Google” and “Amazon” in the head every time they hear the word “start-up”.

    PS.: I was the first employee at a start-up without a good contract (learned afterwards) and when they started to make lots of money, I didn’t see any… so I can relate to founders being greedy when there is big money on the table.

    Reply
  16. Don’t underestimate the tax arbitrage value in this deal. That is what really makes it good.

    In California, taxes (Federal + State + SocialSecurity, etc) on that last bit of marginal income that you are bartering here would have been around 50%. So instead of giving up $50k to get this deal, you effectively only gave up $25K… In the UK and Canada, the tax deal is even worse than that.

    Or put another way, that investor had to allocate $1 million worth of income to end up with $500K to actually invest. (unless he has tax loss credits from too many prior startup investments :)

    And, in California, the tax benefit is even sweeter for a first-in employee since valuation is low enough they can take advantage of Section 83b and have very low taxes on a successful exit. (Assuming the company is savvy enough to setup those sort of tax-advantaged arrangements for you)

    Reply
  17. Just from personal experience, being the first employee, I received 5% share of a company for sticking with the job for 2 years. 1% indeed does feel a bit low, especially if you’re willing to accommodate a lower salary…

    Reply
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  19. I’m sick of everybody thinking that a startup has to make money by raising money.

    There’s tons of startups that are not playing the Angel/VC game, which start as projects on the side to the point that they start making money on their own and then the founders quit their jobs to create a business that can make them tens of millions a year, without raising capital.

    It’s time that we all start looking forward profitable companies, not inflating the values of our companies by getting another round and then exiting, by doing that you create nothing that’s worth fighting for.

    There’s lots of companies out there making more money than all the hyped Ycombinator dummies. It’s not that hard. Just don’t make the X of Y type of company, solve real problems, use the money that you make judiciously to grow and market your products and services, listen to your customers/users, iterate, iterate, and you will make real money without having to sell your ass or screw your employee #1.

    Reply
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  21. A bit of math. I am new to this but I wanted to ask if the math in the problem is right or a typo… 500K at a high 2M (pre-money) valuation, giving away 20%. Isn’t 500k at a 2M valuation = 25%? is this a typo or can you please explain this to me?

    Reply
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  23. I was non-founder employee #1 at a pre-seed startup. They offered me market rate salary plus 3% equity (full shares, not options). Ultimately my shares were diluted in half, but at exit, I walked away with $1.4M. Best choice I ever made.

    Reply
  24. This just means that, unless you are confident that the startup will take off, don’t take this offer if you have a better opportunity lined up.

    Reply
  25. Pingback: First employee of startup? You are probably getting screwed | | BlackSuit LabsBlackSuit Labs

  26. I held out for 8% on my latest startup, but then again I am a seasoned entrepreneur, not just a regular first hire. I actually met with the Founder and investors beforehand and the investor had the nerve to say that if I wanted equity I should pony up money. This blew my mind, how is a massive salary cut (about $80k) not ponying up money? Yes, there is the fact that I have the option to bow out at any time, but I get exactly nothing if no shares have vested. Luckily the Founder saw my value and agreed to my terms. The problem with giving away equity is that too many people aren’t motivated by it. I am very motivated by equity, and the Founder knew this from my past ventures. The truth is that most developers just aren’t that motivated by equity. When I founded a company 7 years ago and raised $500k I gave my first developer 2% and a salary maybe 25% less than what he might command otherwise. But he was right out of school, and this was an incredibly opportunity for him to learn about startups and get some excellent experience on a variety of technologies. The equity didn’t motivate him though, and he eventually left to make more money. That is very often the case (I have several more examples), so I don’t think you can’t be too hard on founders that are stingy with options. If you want the options then you need to command them. If you don’t get what you are worth then it isn’t the right choice.

    Reply
  27. Logic is not the basis of startups. The belief, almost faith in one’s success is. This applies at all levels, from the VC’s to the founders to the employee’s.

    First employee’s join startups to be part of the team, the fun, the excitement. They want to impress their bosses. It feels safer then being a founder, but of course its not. Its an emotional decision plain and simple.

    Reply
  28. I can’t believe how gullible a lot of people are by disagreeing with the gist of the article. These are the kind of employees with future $ balls in their eyes who get fully exploited and don’t even realize it until it is too late. As a first employee you take a big business risk and should be awarded accordingly. 1% is a joke for a company in that stage if you take into account the impact of dilution and the opportunity cost you have.

    Reply
  29. We need a simple model to help us properly slice the pie. It needs to be flexible and fair. By fair I mean it needs to give each founder what they deserve. And by flexible I mean it needs to adapt over time to re-allocate the startup equity so that the distribution stays fair until the fledgling company takes flight. check out Mike Moyer’s book slicing pie it talks about 50/50 share and how to divide it through his grunt calculator.

    Reply
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  31. Question for you guys:
    6 months ago 3 of my friends started a company. 3 months ago I joined the company part time with a plan to go full time after I get paid out on some my largest commission deal which took me 8 months just to close (takes 6 months to get fully paid out on something that closes within a given month)

    My closest friend’s dad put up 100K to start the company with shares to be vested over a 4 year period. Nothing has been written into contract and right now he (dad gave him money) owns 96% with the other two guys owning 2% each. When I joined the company (I was made to believe I would be part of the board, given 2%, and I would be able to exercise my options up to 25% based on founders price (100K). Probably naive but what I was led to believe.
    - Side note for anyone who thinks I’m an idiot for not getting a signed contract before I started you are correct. At the same time its tough to call shots when the other two guys have not said anything and your just trying to find your place in the company. However this is a learning experience..
    - Anyways because my friends dad owns a huge corporation which made 3-400 million in sales last year him and his son will get 51% (was made aware of this yesterday). He obviously brings vendor contacts to the table but the 5 vendors we have we are not getting any deals any there are plenty of other people selling the same products.
    - So since they get 51% and the other two founders made a point that they work full time (me being part time I put in all my nights and weekends) they get 20% each leaving me with 9%.
    - These guys did put in a lot of work but the new site did not get started on until 3 months ago and is not even launched yet (first site they did 6 months ago was a “test” run and flopped).
    - Question 1: For a company that is still brand new (making 10k monthly in sales almost no profit on an ecommerce site except to pay for their lunched) is 9% too low?
    – side note we will be earning salaries but that will be determined by you guessed it my friend the CEO so I cant really count on that yet.
    - If I am going to quit my job and put everything I got into this than I feel like I need a larger percentage. (Another thing that gets me is they act like its worth 100 million already!). Already these guys are saying that if this does make some decent money in 6 months then they will have to leave and find jobs.
    Thoughts on two options..
    Option 1 – If you were me and had say 20k to put in, would you try and become an investor where your money is somewhat protected (4 year vesting schedule) and most likely 100k will not be spent on an ad campaign (still huge risk)? How much percentage should to receive for the 20k (this would have to come from the two 20% owners since the main guy and dad are not giving up control (51%)?
    Option 2 – The two guys are hungry for money and living with parents. Would you use that money to negotiate with them (I wouldnt even get their shares just the option to buy their shares at founder price)? Would you give them the money up front or would you put the options and money in an escrow account that had a timeline attached. Say the company disbands in 6 or 12 months than my money goes back to me and the options are worthless but if it lasts anytime after than I get the options and they get the money. What kind of percentage would you ask from each of them for the 20k?

    - I am new at this so any suggestions and/or opinions would be greatly appreciated. Thanks

    Reply
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