🔎 Myth Busting: Startup Equity Edition
San Francisco native (yes, really). @uw and Lowell High alum. I like to nerd out on fintech, stock options and taxes.
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San Francisco native (yes, really). @uw and Lowell High alum. I like to nerd out on fintech, stock options and taxes.
Hey there,
Vieje back after a short summer break. I took the family to Mexico City for a week, escaping the New York heat to eat tacos, drink mezcal, and chase my 20-month-old around some of the most beautiful neighborhoods I've ever seen. I'm not sure if it's fair to call Mexico City underrated, but I'm always shocked at how few tourists there are compared to other parts of Mexico. If you haven't been, it should be high on your list.
Quick side note: I'll be in San Francisco on August 3rd and heading to Black Hat in Vegas that same week. If you're around either city, let me know. Coffee or a beer is on me!
Anyhow, it's the dog days of summer and news in the tech world is slow. So today I'm writing about something I've been meaning to tackle for a while. After eight years of talking to executives and employees about their equity, I've heard a lot of things. Some of them misguided. Some just flat out wrong. Today, let's bust some of the most common myths and misconceptions about employee equity, starting with perhaps the one I hear most often.
I get why people like to repeat this cliche. You join a startup and you hope that it one day pays out in a big way. Most startups fail and don’t ever get to an exit, so people compare it more to a lottery ticket.
But show me a lottery ticket where you can actually influence the payout by your actions, and maybe I’ll actually play the lottery. Until then, I’ll stay in the world of building companies and investing in them.
The most obvious thing here is that you as an executive or employee of said company have the ability to skew the outcome of the company in your favor by building the business. Your actions in a small startup can create long-lasting value for shareholders in a big way.
In addition, unlike a lottery ticket, the numbers on your equity matter. With a lottery ticket, you sit and hope that your numbers get called by random chance. With equity, the decisions you make along the way such as when and how to exercise, and when to sell, can determine the outcome of your equity as much as the company’s success can. I’ve seen employees at very successful companies walk away with a fraction of what they should have purely based on the decisions made, or not made, along the way.
I think of equity more like a house plant. You can neglect it and hope for the best, or you can tend to it and give yourself the best shot at a great outcome. There’s always an element of luck involved, but most have much more control than they think.
Out of all the myths, this one irks me the most because it's perhaps the worst piece of advice floating around Reddit and X. That “advice” makes its way to company Slack channels and I hear it fairly often.
Like most things in life, your past experiences often shape how you view the world and your actions in the future. That is especially true when it comes to finances. Most people giving the advice online to never exercise your stock options have probably gone through some bad experiences in the past. If someone had equity at 3 companies, and none of them have materialized, that person is probably going to convince themselves that you should never exercise your options.
But that is the core argument for why this is such bad advice. Despite the fact that most startups fail, you can never issue blanket advice like this as each company is different. If that 4th company resulted in low strike price ISO options at Databricks or Anduril, I can tell you that exercising them is likely a good idea and you should at minimum consider it if you believe in the upside of the company still.
The fact is that the math is often in your favor by exercising earlier than an IPO or exit event as you can exercise at a lower price. That’s especially the case for companies that are growing at scale as the level of risk is most likely a lot lower at that stage. The DoorDash IPO is the case study I always come back to. Employees who didn't exercise early missed out on an average of $924,000 in after-tax gains per person. Not because DoorDash failed but because they waited.
The catch is that exercising options is a real investment with real risk. Nobody is saying exercise blindly, but “never exercise early” is just as wrong as saying “always exercise early”. The right answer depends on your situation and beliefs.
This is one that always stings a bit. You put in the work, the company gets to an exit, and you get rewarded. It sounds simple, but that’s not always the truth unfortunately.
A few things can get in the way, first when did you join and what’s the strike price of your options? If your company is worth $1B, but you have to pay to buy your options at $900M, then there’s not much of a spread, at least at the start. When you join the company and at what 409A matters significantly as it determines the spread or gain of the options down the road.
Equally as important is how the company exits. If the company goes public, the post-IPO world is not always a guarantee. The stock can be very volatile and timing could simply be just unlucky even for great companies. Your options could even go underwater, meaning that the strike price is actually higher than the stock market price. The price could always recover, but it’s never guaranteed.
If the exit is through an acquisition, something called liquidation preferences that can kick in. In short, if the acquisition price is lower than what investors previously paid, then those investors get paid back before common stockholders see a dollar. As an employee, you almost always hold common stock, so you are last in line after debt holders and preferred investors. In a clean exit where the acquisition price is significant, then all is well. But if not, then there’s always some math to be done to see what your ultimate pay out per share is.
None of this means that equity isn’t worth it. But an exit announcement does not always guarantee a payday.
If any of these myths hit close to home, then it’s probably a good sign to take a closer look at your equity during the slow period of summer.
That’s it for this newsletter. As always, feel free to let me know what you think or if you disagree with anything above. Until next time!
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