Yes, if you take a $50k/year paycut for $25k/year in equity, you're getting screwed.
But mess with the numbers just slightly - a $4M premoney valuation, and 2% of the company - and suddenly you're getting $100k/year in equity for a $50k/year paycut.
Now of course that equity is risky. It still might not be a good deal, unless you think you have at least a 1 in 2 chance of success.
But the point is: you can obviously get a very good deal as a first employee without taking on the risk of quitting your job with no paycheck. Make sure that it IS a good deal first though!
The first employees of all the startups I know personally have gotten very good deals.
If there's a 50% chance of a positive outcome (which, obviously, is an extraordinarily high chance), aren't you getting a ($100k50%) / ($50kyrs) risk-adjusted payout? If so, you should just take the $100k.
And, this analysis assumes the company doesn't go back to the VC market for capital; when it does (most will), you have to factor in the (strong) risk of dilution. We're also glossing over other risks, like participating preferred stock for investors.
I got a great deal from one startup, watched people get a reasonable ("worked out to the equivalent of years of good-but-not-amazing bonuses") from another, had a positive outcome from one that was still under what I would have gotten from salary, and nothing from 2 more. Equity is a decidedly mixed bag.
If you have the choice (and in this market, developers do), opt for money over equity. If you can mentally partition the "extra" money into "investment" and invest it for a return in something more liquid than startup equity, so much the better.
Unless you think you're a better judge of company valuation than the market, the current risk-adjusted value of the company is approximately the valuation set by the recent round of funding.
The fact of future dilution is irrelevant, since this impacts the investors as much as the employee.
This analysis does ignore liquidation preferences. It also ignores the fact that the options have a non-zero strike price (though probably substantially below the preferred stock with those liquidation preferences). But in the end, startup outcomes tend to be binary: very high or nearly zero. In both of those cases, liquidation preferences and strike prices wash out in the noise.
I agree though: equity is almost the definition of a mixed bag. That's why, as an employee taking substantial compensation in equity, you need to take an investor mindset in choosing where to work.
I don't understand either of your first two sentences.
The 50% risk thing came from you: you suggested calculating based on a 1 in 2 chance of successful outcome. If you're forecasting based on a 1 in 2 chance, you divide by two, right?
Second: as an employee, what do I care whether investors take a haircut? We're computing my outcome, not some notion of fairness.
The point is, if investors are in at $2M, we are assuming $2M is market price. The point of market price is that includes things like "google will compete with us" or "my share will be diluted when the company raises again" as well as "the company might fail".
Now, since you personally are investing in the company (albiet with your labor rather than capital, but it's still an investment since you're paid in equity), you have to decide if it's worth investing in this particular startup. You do that by thinking about whether the startup is going to succeed or fail, since outcomes are pretty much binary.
I disagree, though, that startups have binary outcomes. In fact, one of the big problems in "investing" in startups (cash or labor) is the misalignment of incentives. It's common for the founding team to pursue outcomes that will enrich them but zero out common stock holders, and it's common for investors to push back on exits that would enrich everybody but not satisfy fund goals.
> Now of course that equity is risky. It still might not be a good deal, unless you think you have at least a 1 in 2 chance of success.
Don't startups fail at a rate of 90% or so? All of the sudden that $100k/yeah in equity looks not as great.
Now of course most owners think it won't fail. But then even out of those that are rational, and understand they will probably fail, a large % will still try to convince the first employee that the startup won't fail.
Which is why it's $100k of risk-adjusted equity. Some high percentage will fail[1], but that's already accounted for in the price. In the case the equity is worth a non-zero amount, it will probably be worth much more than $100k.
Trying to decide whether the startup will fail is almost the whole game. In the end that has a much larger impact than your exact equity percentage.
[1] though if you apply a simple filter like "only YC startups" it's way less than 90%
I'm friends with founders of many YC startups (and a number of non-YC startups as well).
If you're a smart founder, you will offer a very good deal to your first N employees. They are by far the most important hires you'll make. Even if you could trick someone into taking too little compensation, you'll regret it in a year when they find out they were snookered.
For the sake of the yc brand if not for anything else, its better to put some numbers out there on what would be a reasonable stake & salary for joining a yc startup as an early employee.
val (stake,salary) = f( valuation,employeenumber)
What's a reasonable f ?
Yeah I understand its a hunch wrapped in a gamble floating in a bubble etc...but quasi-phony numbers are still useful.
But mess with the numbers just slightly - a $4M premoney valuation, and 2% of the company - and suddenly you're getting $100k/year in equity for a $50k/year paycut.
Now of course that equity is risky. It still might not be a good deal, unless you think you have at least a 1 in 2 chance of success.
But the point is: you can obviously get a very good deal as a first employee without taking on the risk of quitting your job with no paycheck. Make sure that it IS a good deal first though!
The first employees of all the startups I know personally have gotten very good deals.