Looking for a detailed framework to value startup job offers? Look no further as Shyam Kamadolli, venture capitalist and entrepreneur, breaks down all of the relevant components and considerations in this post. –John
Evaluating startup job offers is challenging and all the more so for first time job-seekers or those looking to transition into startups from larger corporations.
A few years ago I spoke on this topic at an event where I shared a framework for working through the pros and cons of joining a startup – including the equity compensation levels one might expect in certain roles. I’ve shared those slides below.
To summarize, there is no hard science to this methodology but I have a straightforward recipe that I recommend to friends.
- Establish your cash compensation
- Value the equity with some rigor after you assign a probability to future income.
The three components of cash compensation in your startup job offer
1. Base salary: This is the bare minimum you would gross before taxes but if you want your calculations to be precise, do ask about deductions for health care coverage, and for tax advantaged spending accounts. This calculation leads to your “tax and fixed expenses adjusted” base salary (X).
2. Bonus: Estimate the probability of getting your bonus. Specifically look for the factors that determine whether the bonus will be available. This probability is influenced by performance factors like meeting individual goals, corporate performance, group performance, and in some cases externalities (like raising next round of financing or winning a key customer account). For a more mature startup it is fair to ask what the history has been of paying out bonuses over the past one or two cycles. After you think through these factors, you will have computed a probability adjusted annual bonus (Y)
3. Adjustments for intangible and tangible benefits: Here you should consider add on cash equivalence for commuting costs (if telecommuting), add for savings on child/pet care, and deduct for lack of life/disability/vision/dental insurance coverage (Z).
4. Add X+Y+Z for your total cash compensation (CC). Both Y and Z have probabilities and estimates associated with them but as long as you are consistent across job offers you will be able to compare them fairly.
The trickier part: calculating the equity compensation component of your startup job offer
1. First, collect all the data you can get about your percentage of ownership. Most employers will give you absolute number of shares assigned to you and the number of years in the vesting schedule. The number of shares means very little unless you know the total number of shares issued including common shares issued for convertible / preferred stock, outstanding warrants and all employee options. If you cannot get a specific number you should ask for your fully diluted ownership as a percentage (A).
2. You then need to determine a theoretical exit valuation for the company. Exit calculations keep analysts at PE/VC funds and investment banks busy for endless hours but for your purposes you need to honestly establish for yourself that the company can be acquired by a larger company. You should canvass opinions from the management team, investors (if you have access), other entrepreneurs in the community, and employees at the company.
Adjust for irrational exuberance among vested parties and overblown pessimism among competitors. Weigh opinions of people you respect more than others. The management team will likely position the exit as an IPO but most companies get acquired. Unless you are joining a visibly IPO-track company (12 months to IPO or already filed) a safer assumption is an acquisition.
You should end up with a valuation range (say $50M to 250M) for this supposed acquisition. Assuming the middle of that range to be the representative outcome (B), the cash value of your equity is A*B. Adjust B for strike price of each option if that strike price is substantial.
3. Now assign a probability to that exit and a potential time to exit. If a company has a lot of “traction” and/or buzz it will likely see an exit event sooner than a startup with a lot less excitement surrounding it. A typical assumption of 4 to 5 years to exit can get compressed to two years for a “hot” startup. Develop a weighting system of your own based on your assessment of risk and time to exit. For example, you might weight a pre-IPO hot startup at 90% and a brand new startup with seed funding at just 10%. Lets call this weight C.
4. Last, compute the expected value of your portion of the equity at the time of exit. Based on the prior calculations, you can figure out the expected value of your equity (E) = A * B * C. Divide E by the years of vesting stipulated in your offer to get a rough estimate of your annual equity compensation (EC) (albeit deferred).
Comparing total compensation, TC = CC + EC across your existing job and other offers you may have to determine what works best for you.
This is not a precise method – it cannot be – but it allows you to use some rigor in comparing your options. I urge you to also consider the emotional income/expenditure associated with making such a transition (as highlighted in my slides).