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Startup Equity 101

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Re: Startup Equity 101

#21

Post by FreakLegion »

SkyPuncher wrote: post #18
TuringNYC wrote: post #12

>> So what is your equity really worth?... >> ... >> The difference between the most recent FMV (409A) valuation and your exercise >> price. ... >> The difference between the Preferred Price and your exercise price.... The real answer is that it is probably not worth anything unless they have stock liquidity events that only a handful of large startups have (e.g. Stripe.) If you dont have that, the price is purely th…

Correct, the 409a is only going to show you the maximum possible value. Realistically, investors get their money back first, so 50% (picking an arbiter number) of that valuation value won’t ever been seen by employees. Then it gets even worse with multipliers and preferences.

It's the preference and its multiplier that gives investors their money back first. These aren't different things, they're one thing, and generally only matter if the company exits for less than the valuation the investors invested at. The exception to this is if any investors have a liquidation preference > 1x (you should avoid companies where this is the case).

Preferences also don't stack with the rest of a liquidity event. E.g. say an investor puts in $100m at a post-money of $1b with a 1x liquidation preference. If the shares go for $900m, the investor gets back their $100m, and that's all. They don't lose money, but they don't make money either. If the shares go at a $1.1b valuation, the investor converts their preferred shares to common shares like everyone else has. The investor doesn't get their money back first and sell more shares on top of that. It's either/or.

Re: Startup Equity 101

#22

Post by CPLX »

SkyPuncher wrote: post #18
TuringNYC wrote: post #12

>> So what is your equity really worth?... >> ... >> The difference between the most recent FMV (409A) valuation and your exercise >> price. ... >> The difference between the Preferred Price and your exercise price.... The real answer is that it is probably not worth anything unless they have stock liquidity events that only a handful of large startups have (e.g. Stripe.) If you dont have that, the price is purely th…

Correct, the 409a is only going to show you the maximum possible value. Realistically, investors get their money back first, so 50% (picking an arbiter number) of that valuation value won’t ever been seen by employees. Then it gets even worse with multipliers and preferences.

> the 409a is only going to show you the maximum possible value

While the points about uncertainty of options are quite accurate, this detail isn’t really true.

For the most part a 409a is the lowest reasonable valuation the company could talk the auditors into accepting. The lower it is the less tax paid and everyone knows that.

Re: Startup Equity 101

#23

Post by [deleted] »

FreakLegion wrote: post #21
SkyPuncher wrote: post #18

Earlier quoted context omitted.

Correct, the 409a is only going to show you the maximum possible value. Realistically, investors get their money back first, so 50% (picking an arbiter number) of that valuation value won’t ever been seen by employees. Then it gets even worse with multipliers and preferences.

It's the preference and its multiplier that gives investors their money back first. These aren't different things, they're one thing, and generally only matter if the company exits for less than the valuation the investors invested at. The exception to this is if any investors have a liquidation preference > 1x (you should avoid companies where this is the case). Preferences also don't stack with the rest of a liquid…

[deleted]

Re: Startup Equity 101

#24

Post by bradlys »

> If you join an early stage company and you have a decent amount of excess capital, early exercise everything and file an 83(b) election. The reasons for doing this: starting the QSBS clock, starting the long term capital gains clock, not needing to worry about your options expiring.

I don't think this is ever worth the risk. If you're even thinking of doing this for QSBS purposes... the amount of tax you'd incur is way too much. Even if you have "excess" capital, you may as well put the $50k+ into a shitcoin and you'd see a much quicker return (or lack thereof). For most people where $50-100k+ in tax is a trivial amount to worry about, why are you joining as an employee? Clearly you've made a lot of money in the past... Just be a founder instead. You're taking on just as much risk.

> If you join an early stage company and you don’t have much capital, don’t do anything just yet. Try to negotiate for an extended post termination exercise window.

For 99%+ of people joining startups as regular employees, this is what you should be doing. If you leave the company before it becomes liquid, exercising the shares can be super risky. We've been waiting on several very well known companies to go public for a long time now. Who knows when they'll go public. At that point, you've spent possibly hundreds of thousands to exercise your shares, hundreds of thousands more in taxes... and they might be worthless and you can maybe deduct $3,000/yr for who knows how long.

> If you can get liquidity at some point, and you think liquidity would improve your life, you probably should.

It is unlikely though.

IMO, until tax law (and especially market conditions) changes - I do not believe in joining any private company unless you are convinced they will IPO within the year. This is assuming you care about compensation significantly.

Re: Startup Equity 101

#25

Post by dmitrygr »

strangelove026 wrote: post #6

At a startup where I've exercised 75% of my options because the company seems to be going to a direction where maybe it's public in a little while (and I've got some other investments which prevent me from being over-invested here). I also want to dump all of the shares as soon as they go public and I'm able (employee sale window-wise) as I anticipate that there'll be a pop followed by a drop. This is all anecdotal g…

> I anticipate that there'll be a pop followed by a drop

You'll miss both. A 6-month lockup is typical. Sorry, do not pass go, do not collect on the "pop"

Re: Startup Equity 101

#26

Post by vrosas »

One thing I've learned working for startups is if you're working for a founder who's already had a previous successful startup exit(s), two things are true:

1. the founder already has generational wealth and this current company means practically nothing to them.

2. they've already learned every trick in the book to keep the company's value in their own pocket and out of the hands of their employees.

Re: Startup Equity 101

#27

Post by t0mas88 »

FreakLegion wrote: post #21
SkyPuncher wrote: post #18

Earlier quoted context omitted.

Correct, the 409a is only going to show you the maximum possible value. Realistically, investors get their money back first, so 50% (picking an arbiter number) of that valuation value won’t ever been seen by employees. Then it gets even worse with multipliers and preferences.

It's the preference and its multiplier that gives investors their money back first. These aren't different things, they're one thing, and generally only matter if the company exits for less than the valuation the investors invested at. The exception to this is if any investors have a liquidation preference > 1x (you should avoid companies where this is the case). Preferences also don't stack with the rest of a liquid…

Whether it's and vs either/or is the difference between a liquidation preference or a participating liquidation preference. And indeed the more than 1x cases are also problematic for common stock holders.

But I do assume the 409A for the fair marker value of the common stock takes these into account? Not a US tax expert :-)

Re: Startup Equity 101

#28

Post by fragmede »

TuringNYC wrote: post #12

>> So what is your equity really worth?... >> ... >> The difference between the most recent FMV (409A) valuation and your exercise >> price. ... >> The difference between the Preferred Price and your exercise price.... The real answer is that it is probably not worth anything unless they have stock liquidity events that only a handful of large startups have (e.g. Stripe.) If you dont have that, the price is purely th…

> spending today-dollars and exercising options for the right to sell stock 5 or 10yrs into the future almost never works out

There are places that will, no recourse, loan you the money to exercise and pay the tax, in exchange for some percentage of the profit, provided it's for a company they like. Meaning, they lend you the money, but if there's no IPO/liquidity event, you don't owe them any money. 70% (say) of a big number may not be as big as 100% of a big number, but 100% of zero is $0. Which isn't financial advice, just a bit of math.

Re: Startup Equity 101

#29

Post by bcyn »

CPLX wrote: post #22
SkyPuncher wrote: post #18

Earlier quoted context omitted.

Correct, the 409a is only going to show you the maximum possible value. Realistically, investors get their money back first, so 50% (picking an arbiter number) of that valuation value won’t ever been seen by employees. Then it gets even worse with multipliers and preferences.

> the 409a is only going to show you the maximum possible value While the points about uncertainty of options are quite accurate, this detail isn’t really true. For the most part a 409a is the lowest reasonable valuation the company could talk the auditors into accepting. The lower it is the less tax paid and everyone knows that.

You're correct about valuation, but the parent post was meant to address "how much liquid dollars should you expect to receive vs. 409a." You are likely to receive less in most cases (read: unless there are wildly successful public liquidity events) due to liquidation preferences.

Re: Startup Equity 101

#30

Post by henry2023 »

ldjkfkdsjnv wrote: post #11
Aurornis wrote: post #5

Earlier quoted context omitted.

There’s more to a successful business than masking an app. A lot of acquisitions are made by companies that could re-build the acquired product themselves. They’re buying the business, brand, and customer base, not the app.

This isnt true, nobody knows what will happen when you can very cheaply replicate software. The sales etc are valuable, but when the cost of producing the product goes to zero, weird things will happen.

Who says the cost of producing software is going to zero?
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