Employee Stock Options & Funding Rounds
A friend of mine sent a link to a press release about a company that just closed a huge funding round at a huge valuation that expects to go public over the next few years. He wanted my thoughts on other companies that he could join that have had similarly successful funding rounds. His thinking was that he could make a lot of money on the next few financing events, even an IPO.
I think job searchers need to be careful with this kind of thinking. A successful funding round with great investors is a very positive signal. And it's always tempting to jump on the latest rocket ship. But there are a few things potential employees should consider before joining a company following a large funding announcement:
You're not going to get credit for the company's past success. If a company raises a Series B round at a $100M valuation, following a $10M Series A round, the company's valuation has grown by 10x. That's a lot of value creation. But if you join the company after the Series B has closed, you've missed out on all of it. The stock options you receive will be priced at the post Series B valuation. So you're starting from zero. You'll only get credit for the value you create going forward. You have to place a bet on the company's ability to continue to build value on top of what they've already created. A small caveat here: there's often a difference between the valuation investors paid and the company's fair market value, as determined by auditors. So employees that come in after the round might not pay as much as investors paid.
Valuations are super high right now. Because private company valuations are typically marked against the public market, and the public markets are on a 12-year bull run, valuations are arguably inflated at the moment. If the bull market continues, this isn't a problem. But if prices come back down to earth, valuations could come down, and you may find that your options are underwater (meaning they're worth less than the price you'll have to pay for them).
The later you join, the less equity you'll get. Startups reward early employees with lots of equity (potential upside) in return for taking the risk of joining before anything has been built. As time goes on, this risk decreases, and so does the amount of equity the company needs to grant to attract great people. Less risk typically means less equity.
The less senior you are, the less equity you'll get. Generally, the really material stock option grants (.5% to 2% of the value of the company) are reserved for the most senior executives. Employees at lower levels will receive a fraction of that.
Your options have to vest. In most cases, you won't just get an equity grant. You'll have a vesting schedule. Typically over four years with a 1-year cliff. Meaning you won't have the right to buy your options unless you've been at the company for more than a year.
Your vested options aren't liquid. Not only do you have to create value on top of the last funding round, but you also have to find a way to cash out at some point. Generally, this is only done through an acquisition, a secondary offering where an investor buys some amount of employee shares, or an IPO. While IPOs have made a resurgence, it's enormously rare that a startup makes it that far; of the tens of thousands of startups out there, less than 200 companies went public in 2019.
With all of this said, don't get me wrong, funding rounds are an exciting thing. And they're absolutely a signal that the company is onto something. And I’m a huge fan of investing in private companies as early as possible. My point is that potential employees should act like an investor and dig deep on how much value they believe can be created following the big announcement, and what share of that value they'll receive, and the likelihood that that value will be liquid within a reasonable time frame.
This is particularly important for salespeople as they negotiate job offers. There's a tradeoff associated with optimizing for your own success (cash from commission) versus the success of the larger organization (equity). Depending on the circumstances, one can be a lot bigger than the other. The above considerations are important inputs into how to think about the company you might want to join and the compensation plan you want to advocate for as you negotiate an offer.