What you need to know before you join a start-up

Silicon Valley and San Francisco are all about startups. If you walk down Bryant street from 2nd to 4th, and look around, every single building you pass by will be filled with startups of different sizes. You can continue walking in any direction for few more blocks, and it will still be the case. Not much changes if you cross Market street -- big part of the financial district is also populated by startups.

Many engineers drop out of college or leave comfortable jobs at Google to join startups as early employees dreaming about huge upsides, fame, and romance of working for a startup.

Back in 2008 I, with my team, got a gold medal at ACM ICPC, which helped me secure a job at Microsoft. I quickly left Microsoft and moved to Silicon Valley to work for a startup. Importantly, from the ICPC days I had lots of connections to other super smart people, many of whom ended up pursuing similar careers.

In 2016 I founded my first company, which went through Y Combinator in Winter 2017, and through a series of adventures and pivots became Near Protocol.

From 10 years of invaluable experience of my old competitive programming friends, to successes and struggles of my YC batchmates, to my own personal experience, I have extensive knowledge of how startups operate and how the romance of startup building often shatters once it meets the reality. In this blog post I will cover some important information that any person that considers joining an early stage startup needs to know.

Disproportional upside

The first employee at a startup often gets around 1% of shares, sometimes slightly more. If you join as employee 5-10, chances are you will be offered less than 0.3%.

Importantly, assuming the company just raised its Series Seed, and has say ~15% option pool, the founders among themselves have on the order of 70-80% of the shares. If there are two founders, then each has more than 30% of the shares, while the first employee, who joins just weeks after them, is offered only 1%.

Both you and the founders are taking equal risk that the company will collapse within the first year of existence, and both you and the founders will probably spend significantly more than 40 hour per week at work in any foreseeable future. If you are taking similar risks, and are working equally hard, why would your share be thirty times smaller than theirs? Some founders argue that they do fundraising, marketing, product discovery and market research besides coding, while the first engineer doesn’t need to do any of that. It is unclear, however, whether hustling is 30x more important than building. Should it be considered more important at all, given you clock the same hours and are equally invested into the idea?

This becomes a problem when the company isn’t doing that well, and gets an offer to get acqui-hired. A $10M acquihire brings $3M to the founders, so they are likely to accept the offer, leaving them significantly richer, and you with $100K that are unlikely to cover what you would have made if you joined Google instead.

Underestimated Dilution

Say you join as the employee #1, and are offered 1% of the shares. You will probably get some refreshes along the way, but those are unlikely to be on the same order of magnitude -- the company just doesn’t have the luxury to give you another 1% in the future. At the same time, each time the company raises money, your share dilutes, since the money are raised on freshly minted shares. How much does it dilute? Actually quite a bit. Investors want a meaningful share in the company, so rounds generally dilute by at least 10-20%. If your company raises three rounds with 20% shares minted during each, your 1% just became 0.57%.

The founders would often argue that this is good for you, since after each round of financing even though your share is smaller, the company is now worth more, so you have a slightly smaller slice of a way bigger pie.

But at the time you were considering the job offer with the 1% shares, the shares were probably pitched in the context of the company having a huge exit and you getting 1% of it, effectively creating a visualization of the huge slice of a huge pie. The dilution is usually severely deemphasized.

So if you consider an offer from a seed stage company, and try to estimate your upside, divide the shares amount offered to you by at least 1.5 right away.

Vested options do not belong to you!

Everybody understands, more or less, how RSUs work when you join Google. If Google gives you 200 shares with a four year vesting, then after the first year you own 50 of those shares. You can now quit the company, and keep the shares. They are yours. Pretty simple.

When people look at startup job offers, they often think the same way. You are offered 1% of the company with 4 year vesting schedule, so after one year you have 0.25%, right? If after two years you don’t like it there anymore, you just quit the company, and keep your 0.5%.

No, you actually don’t. If the startups gave you the shares in the form of an option grant, and you worked for two years, and then quit the company and did nothing, your options, including those that vested, will burn within relatively short period of time, usually 30-90 days.

You actually must purchase your options within that period of time to keep the shares. The purchase itself is not necessarily that painful. Say your grant was 100,000 shares at 10 cents per share. You’d have to pay $10,000 out of pocket to purchase them, but given the potential upside this is not that big of a deal, right? Well, again not quite. The share might have been valued at 10 cents when you joined the company, but, assuming the company was actually making progress, two years in it is probably worth more, say $1 per share. When you purchase your 100,000 shares at 10 cents per share, IRS recognizes that you just had a capital gain of $90,000, since you purchased something worth $100,000 for $10,000, and so suddenly you owe IRS something on the order of $30K in taxes (see this article, particularly the AMT implications if you buy ISOs and hold them). Now, that’s painful. And you can’t sell part of your shares to offset the cost, since the shares are not liquid.

During my years in Silicon Valley I met countless people who either didn’t know they had to purchase their shares, resulting in them losing their stake in the company entirely, or who purchased the shares without understanding the tax implications, then owing IRS dozens, or even hundreds, of thousands of dollars next April.

So what can you do? Well, one option is not to quit the company until it goes public or is acquired. Then your shares are probably liquid, so you can sell them to pay taxes at least. Another alternative is to buy all your shares, including those that haven’t vested, on day one after you join. It is called “early exercising”, and allows you to avoid paying taxes on the price difference of the shares shall you decide to quit the company several years in. Not all the companies offer forward exercising. My personal advice would be: Never join an early stage startup that doesn’t offer early exercising. And (again, just a personal advice) you should only accept an offer if you plan to immediately forward exercise all the offered options, since the remaining shares you’d be only able to keep if you either plan to stay until the company has an exit, or are willing to spend a considerable amount of money on taxes.

Update: some startups increase the time you have to purchase your shares from 90 days to multiple years. A good list of such companies is maintained here.

Overestimated Upside

Assuming you are a good engineer, your alternative to working for a startup is to work for Google, Facebook, Apple or some other big company. In such a company your base salary will be slightly higher, but, more importantly, you’d have liquid shares, and a pretty good bonus. If you are productive, you get good refreshes, and after four years you constantly have multiple grants vesting in parallel, creating a very good inflow of money.

If you join a startup instead as the first employee, and have 1% of the company, the risk you are taking is somewhat reasonable. If after five years the company exits for $100M, which is a rather strong outcome, after accounting for dilution you will get around $600K, which is more than what Google would have paid you on top of the base salary, but it is not an order of magnitude more.

You have a risk that the company will completely collapse, and you’d not even get those $600K, but you also have a chance that the company will exit for few billion dollars, and you’ll get an 8 digit amount of money, so overall it’s a meaningful risk to take. I took it in 2011 with MemSQL, when I joined as the employee #1, and do not regret it.

But if you join as employee #10, and are offered 0.1% of shares, the story is completely different. If the company exits for $100M, you only get $60K, which is a completely meaningless number if you invested few years of your life into the company. So just to break even with going to Google you need the company to exit for close to $1B. Very few companies exit for $1B, and if you are joining a company as the employee #10, the company is at the stage at which the chance of it reaching $1B valuation is super low. And remember, the $1B exit just breaks you even with joining Google. You need the company to exit for $10B+ to have a large upside. How many companies exited for $10B+ in the recent years? Is the company you are joining likely to be one of them?

Why you should join a startup

While your upside might be overestimated, dilution affects your ownership and you will need to pay upfront for your shares, there are strong reasons why you *should* join an early stage company.

Most importantly, you will learn significantly faster than if you worked at a large company. You will be exposed to the latest technologies rather than being locked into internal tools and you will have to iterate significantly faster. Junior people who joined MemSQL and NEAR grew professionally at very high rates and contributed complex code with good architecture after only a few months of being exposed to the crazy speed of building at a startup. You will never have the same growth at Google or Facebook.

You will also be in direct contact with your customers, which is crucial for building a viable product. This allows you to see the direct impact of your work, making it feel more directly meaningful every day.

The general advice is to join a startup if the vision of the startup resonates with you to such an extent that you would be willing to work at a loss for a long period of time to bring that vision to life.

You need, however, to choose the startup wisely because your success will be considerably tied to its success. The team must be very strong and have a lot of experience in the industry the startup is trying to disrupt. The potential market should be large. Ask yourself if you believe that people actually need the product that the company is building, and if you have a slightest doubt, the market might not be there. Without a market the company will never succeed, no matter how good the technology is. If you can’t directly evaluate the health of the product, look for other signals like top tier employees who joined and funding milestones achieved.

Make sure to check out this article by Justin Kan, that partially intersects, but mostly complements this write-up.

How we build our company

Near Protocol is a blockchain company, and many things work differently in blockchain companies. Structure is different, fundraising is different. And since many things are different, we are freer to try things out. This allows us to revisit many aspects of how we compensate our employees. The first five employees of Near Protocol have combined more tokens than the two founders, which is only fair, because they are investing as much time and are taking as much risk as the two of us.

We are also very open with people about their potential upside and the timeline, and never extend an offer to a person if we ourselves are not convinced that it is the best course of action for them career-wise.

Finally, we structured our company in such a way that our tokens never dilute. It makes it harder to fundraise, since investors are used to getting 10-15% ownership (which will later dilute), and not used to think in terms of non-dilutable ownership. But it is our belief that uncontrollable dilution requires both the investors and the employees put a lot of trust into founders, and can create a deceptive feeling that one has higher ownership than they actually do.

More traditional startups cannot implement some of the above changes, but the founders need to significantly improve transparency when hire early employees.

Near Protocol is building an applications platform to power the decentralized internet of the future and break the monopoly of large corporations on users’ data. Follow our progress on Twitter @nearprotocol and join our discord if you want to learn more about the project.

➥   Delina Wellies (delina) started this thread 7 months ago 0 responses.

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