Founders, Initial Employees, and Risk

Founders, Initial Employees, and Risk

A recent discussion online and several real-life conversations have had me considering the risks and rewards of founding startups as compared to being an early employee.

Most of the conversation focuses on the financial risks and rewards of whether or not it is worthwhile to be an early startup employee. The controversial stance is that no, it is not.

An early startup employee has 1-2% of the company, a substantially below-market salary, and relatively little employment stability.

This equity is in sharp contrast to the founders, who typically own 15-50% of the business and who will do very well in an acquisition.

Many startup employees have been frustrated at their perception of the lack of financial rewards from their equity stake vs. the trade-off of the cash compensation.

It's a very fair point. If maximizing your cash with the highest probability of doing so is your goal, then working for an established company that pays at or above the market is the way to go. Consider this scenario for someone for three years of work.

Major company: salary of $150,000 x 3 = $450,000. Assume a $10,000 equity stake (RSU) grant per year, growing at 10% (high growth company), and that's another maybe $35,000 worth of stock. Total rewards: $485,000.

Startup salary: $75,000 first year, $100,000 second year, $125,000 third year. That $300,000 in salary. Add in 2% of a company, diluted twice, the exit value of $10MM. That's only $112,500. (Let's leave aside vesting, preferential investor shares, etc.) Total rewards: $412,500. You're down about 15% in total compensation. Assuming you get that far.

The founder in me says: Well, what if we exit at $100MM. Now we're talking about $1.1MM in equity value and total comp of $1.4MM. You're way ahead.

The problem is: nobody knows that outcome.

The founders clearly believe we're going to make it big. Otherwise, we wouldn't do it at all.

On the flip side, the working environment is very different. Startups are more stressful, more fun, each employee has more responsibility, more impact and more say in the direction

What this comes down to is: Are you seeking consistent financial returns? Or, are you seeking an excellent working environment where you will learn a lot, plus maybe make a lot?

To me, while startups are capitalistic money-making enterprises, it's not just about the money. It's about your willingness to take a risk and what kind of work you want to do.

If you're crunching the numbers and properly adjusting for risk, a startup will probably NEVER work out. If we knew it would be big, the equity would go down to compensate for that. The equity is there to compensate you for the risk and align your interests.

IF you think the equity is too small, you better start your own company!