How stocks in startups work for an early employee?
Simple but entangled math that most employees don’t know
Startups are nothing but a fancy name for a small business except the grind for employees is disproportionately cumbersome. When someone comes up with an idea, they would need smart people to execute. An idea without proper execution is worth nothing. Seldom the startup founders encourage the early employees to treat the company as their “own” and give their “life” to it. In return, the founders offer a dream of becoming rich with the unvested stock options. Most of the early employees have no idea whatsoever how it works and how long-tailed it is.
I was offered 115,000 stock options in a startup, which was spun out of our research lab. The stock options would have been vested in 5 years with a year cliff. That means I would have to work there for five years to get the full stocks vested.
Year 1: 23,000 stock vested
Year 2–5: 1917 stock vested/mo
Secondly, the stock option would have been granted at $0.12 a “common share”, which means I would have to spend $13,800 to buy the stocks. But how I would profit from the stocks? I would have to wait until the company gets public or company allows me to sell my share to private investors (which is rare but happened to Uber and Airbnb employees).
If the company gets public, then the first payout will be towards the investors. For the case of the company that I got an offer from, they had 6 investors, who invested over $12m. The investors have a special type of stock called “preferred share.” Once the company gets public, the preferred stockholders get their money back first. So the first $12m from the public money goes toward the investors. In some cases, some investors ask for more than 1x return for the preferred share.
What if I left the company after three years? I would be able to have three years' worth of stocks vested (69,000 in my case) and I would have to buy it within 30 days of my last day of work to have them granted to me. That would have cost me $8,280. The money would be a gamble at that point because it’s a zero-sum game. If the company doesn’t go public, I lose the whole money. If it gets public, I will make a lot from that for sure. But why would I leave a company which has an excellent chance of getting public? Maybe because it has no chance. That means the three years' worth of stock gain and the option investment is worth $0. Early-stage employees should understand this gamble before they commit their time. Startups suck a lot from personal life and they rarely pay enough cash to compensate that. If the end result is zero stock gain, then it’s nothing but disappointment (not always, experience counts through!).
What if the company die due to funding issue or product issue or anything. It’s purely zero-sum for the employees. Most of the cases employees are treated with an extremely small severance package which is next to nothing. VCs don’t want to spend money on a lost cause and nobody cares about the negative branding of a dead company. So employees get almost nothing as severance and their stock means nothing.