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  1. # What I Wish I'd Known About Equity Before Joining A Unicorn
  2.  
  3. **Disclaimer:** This piece is written anonymously. The names of a few
  4. particular companies are mentioned, but as common examples only.
  5.  
  6. This is a short write-up on things that I wish I'd known and
  7. considered before joining a private company (aka startup, aka unicorn
  8. in some cases). I'm not trying to make the case that you should
  9. _never_ join a private company, but the power imbalance between
  10. founder and employee is extreme, and that potential candidates would
  11. do well to consider alternatives.
  12.  
  13. None of this information is new or novel, but this document aims to
  14. put the basics in one place.
  15.  
  16. ## The Rub
  17.  
  18. ### Lock In
  19.  
  20. * After leaving a company, you generally have 90 days to exercise
  21. your options or they're gone. This seems to have originally
  22. developed around a historical rule from the IRS around the
  23. treatment of ISOs, but the exact reason doesn't really matter
  24. anymore. The only thing that does matter is that if you ever want
  25. to leave your company, all that equity that you spent years
  26. building could evaporate if you don't have the immediate cash
  27. reserves to buy into it.
  28.  
  29. * Worse yet, by exercising options you owe tax immediately on money
  30. that you never made. Your options have a _strike price_ and private
  31. companies generally have a _409A valuation_ to determine their fair
  32. market value. You owe tax on the difference between those two
  33. numbers multiplied by the number of options exercised, even if the
  34. illiquidity of the shares means that you never made a cent, and
  35. have no conceivable way of doing so for the forseeable future.
  36.  
  37. * Even if you have the money to buy your options and pay the taxman,
  38. that cash is now locked in and could see little return on
  39. investment for a long and uncertain amount of time. Consider the
  40. opportunity cost of what you could otherwise have done with that
  41. liquid capital.
  42.  
  43. * Due to tax law, there is a ten year limit on the exercise term of
  44. ISO options from the day they're granted. Even if the shares aren't
  45. liquid by then, you either lose them or exercise them, with
  46. exercising them coming with all the caveats around cost and
  47. taxation listed above.
  48.  
  49. Does ten years sound like a long time? Consider the ages of these
  50. unicorns:
  51.  
  52. * Palantir is now thirteen years old.
  53. * Dropbox will be ten years old this year (2017).
  54. * AirBnB, GitHub, and Uber are all within a year or two of their
  55. ten year birthdays.
  56.  
  57. * Some companies now offer 10-year exercise window (after you quit)
  58. whereby your ISOs are automatically converted to NSOs after 90
  59. days. This is strictly better for the employee than a 90-day
  60. window, but as previously mentioned, ten years still might not be
  61. enough.
  62.  
  63. * Golden handcuffs kick in fast. The longer you stay with a company,
  64. the more equity you build, and a decision to leave becomes that
  65. much harder. This can culminate to the point where early employees
  66. have modest liquid assets but are "paper millionaires", and have to
  67. make the hard decision to throw all that away or stick around until
  68. their founders allow them some return.
  69.  
  70. ### Liquidity Events
  71.  
  72. * No time horizon for any kind of liquidation guaranteed. In fact,
  73. _no liquidation event_ is ever guaranteed, even if the company is
  74. highly successful. One could be at 1 year out, 5 years, 10 years,
  75. or never. We've seen a lot of evidence in this day and age that
  76. companies are staying private for longer (see the list above).
  77.  
  78. * The incentive to IPO between employer and employee are not aligned.
  79. Employees want some kind of liquidation event so that they can
  80. extract some of the value they helped create, but employers know
  81. that allowing employees to extract that value might cost them some
  82. of their best people as they're finally allowed the opportunity to
  83. pursue other projects. One more reason to stay private for longer.
  84.  
  85. * Although the above is one reason that founders don't want to
  86. IPO, it's not the _only_ reason. Many of them do believe
  87. (rightly or wrongly) that there is another 10x/100x worth of
  88. growth left in the company, and that by pulling the trigger too
  89. early on an IPO all of that potential will be lost. For a
  90. normal founder, their company is their life's work, and they're
  91. willing to wait a few more years to see the canvas fully
  92. realized. This is a more noble reason not to liquidate, but
  93. from an employee's perspective, is still problematic.
  94.  
  95. ### Founder/Employee Power Imbalance
  96.  
  97. * Founders (and favored lieutenants) can arrange take money off the
  98. table while raising rounds and thus become independently wealthy
  99. even before they make true "fuck you" money from a large scale
  100. liquidation event. Employees cannot. The situation is totally
  101. asymmetric, and most of us are on the wrong end of that.
  102.  
  103. * Even if you came into a company with good understanding of its cap
  104. table, the ground can shift under your feet. New shares can be
  105. issued at any time to dilute your position. In fact, it's common
  106. for dilution to occur during any round of fundraising.
  107.  
  108. ### Private Markets
  109.  
  110. * Private markets do exist that trade private stock and even help
  111. with the associated tax liabilities. However, it's important to
  112. consider that this sort of assistance will come at a very high
  113. cost, and you'll almost certainly lose a big chunk of your upside.
  114. Also, depending on the company you join, they may have restricted
  115. your ability to trade private shares without special approval from
  116. the board.
  117.  
  118. ### Valuations
  119.  
  120. * Especially in early stage companies, equity is offered on the basis
  121. of a highly theoretical future valuation number. Sam Altman
  122. recommends offering the first ten employees 10% (~1% each), which
  123. could be a big number if the company sells for $10B, but consider
  124. how few companies actually make it to that level.
  125.  
  126. If the company sells for a more modest $250M, between taxes and the
  127. dilution that inevitably will have occurred, your 1% won't net you
  128. as much as you'd intuitively think. It will probably be on the same
  129. order as what you might have made from RSUs at a large public
  130. company, but with far far more risk involved. Don't take my word
  131. for it though; it's pretty simple math to run the numbers for a
  132. spread of sale prices and dilution factors for yourself before
  133. joining, so do so.
  134.  
  135. ### Tender Offers
  136.  
  137. * Some companies acknowledge the effect of drawn out phases of
  138. illiquidity on employees and engage in a tender offer to give
  139. employees some return (google around for some examples). I don't
  140. want to overstate this because receiving a tender offer is strictly
  141. better than the alternative, but keep in mind that one will
  142. probably be structured to minimize the amount of value you can
  143. extract. They're also very likely be infrequent events. Read the
  144. fine print, run the numbers, and consider how much your annual
  145. return _to date_ will actually be (including all the time you've
  146. spent at the company, not just the year of the offer). It's
  147. probably less than what you could've gotten in RSU grants at a
  148. public company.
  149.  
  150. ### Working Environment
  151.  
  152. * This isn't equity related, but it's worth considering that the
  153. environment at a big unicorn isn't going to be measurably different
  154. from a big public company. You're going to have little impact per
  155. employee, the same draconian IT security policies, lots of
  156. meetings, and fixed PTO. In the worst cases, you might even have to
  157. use JIRA.
  158.  
  159. ## I'm Doing It Anyway!
  160.  
  161. So you decided to join a private company anyway. Here's a few
  162. questions that I'd recommend knowing the answer to before accepting
  163. any offer (you'd be amazed at how infrequently this information is
  164. volunteered):
  165.  
  166. * How long is my exercise window if I leave the company?
  167.  
  168. * How many outstanding shares are there? (This will allow you to
  169. calculate your ownership in the company.)
  170.  
  171. * Does the company's leaders want it to be sold or go public? If so,
  172. what is the rough time horizon for such an event? (Don't take "we
  173. don't know" for an answer.)
  174.  
  175. * Have there been any secondary sales for shares by employees or
  176. founders? (Try it route out whether founders are taking money off
  177. the table when they raise money, and whether there has been a
  178. tender offer for employees.)
  179.  
  180. * Assuming no liquidation, are my shares salable on a private market?
  181.  
  182. * Has the company taken on debt or investment with a liquidation
  183. preference of more than 1x? (Investors may have been issued > 1x
  184. liquidation preference, which means they get paid out at that
  185. multiple before anyone else gets anything.)
  186.  
  187. * Will you give me an extended exercise window? (After joining I
  188. realized that most people's window was the standard 90 days, but
  189. not _everyone's_. Unfortunately by then I'd lost my negotiating
  190. leverage to ask for an extended term.)
  191.  
  192. It's really tough to ask these without sounding obsessed with money,
  193. which feels unseemly, but you have to do it anyway. The "you" of
  194. today needs to protect the "you" of tomorrow.
  195.  
  196. ## Summary
  197.  
  198. Working at a startup can be fun, rewarding, interesting, and maybe
  199. even lucrative. The working conditions at Silicon Valley companies
  200. are often the best in the world; it's quite conceivable that you
  201. might want to stay there even if there was never a possibility of a
  202. payoff. But don't forget that as far as equity is concerned, every
  203. card in the deck is stacked against you.
  204.  
  205. The correct amount to value your options at is $0. Think of them more
  206. as a lottery ticket. If they pay off, great, but your employment deal
  207. should be good enough that you'd still join even if they weren't in
  208. your contract.
  209.  
  210. I don't say this just because of the possibility that your startup
  211. could fail, but also because even in the event of success, there are
  212. plenty of scenarios where getting a payout will be difficult. Say for
  213. example that five years in you want to try something new, or want to
  214. start a family and need a job that will pay you well enough to let
  215. you afford a starter home in the Bay Area (not easy). Your startup
  216. Monopoly money will put you in a precarious position.
  217.  
  218. If you're lucky enough to be in high enough demand that you can
  219. consider _either_ a public company with good stock liquidity _or_ a
  220. billion-dollar unicorn, give serious consideration to the former.
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