The Reality of Startup Compensation

You may not get rich, but you will learn more than you could imagine.

I think that the risks and rewards of working for a startup are widely misunderstood.

You will often hear that startups are risky, or that 99% of startups fail. But how does this affect the employees that actually work there?

Over the last several years, I worked for two startups that failed. And yet, I would not trade the experience for anything. I have loved building new products, working on small, scrappy teams, and trying to prove ourselves as the underdog. Through the whole process, I made some money, formed new friendships, and built some good tech products (at least I thought so).

But unfortunately, the attractive financial upside of working at a startup was not there.

As a startup employee, we often sacrifice some salary to get equity in the company. The founders entice people to work for slightly less than market rate with the hopes that you can get rich when the company succeeds. However, this promise is often vague, and most people I’ve talked to don’t quite understand how it works. The reality is that equity is not as straightforward as it seems in your offer letter. And startup compensation is much more complicated than it appears at first glance.

Today, I hope to demystify the financial aspects of startups, and share what it’s like to actually work at these companies. Let’s get started.

Startup Fundraising Rounds

Before we dive into the reality of startup compensation, let’s take a brief detour to talk about startup fundraising rounds.

There are so many different phases of “startups” that the word has lost its meaning a bit. Each phase brings its own challenges, complexities, and issues.

In order to grow, you need capital (i.e. raise money). Every time a startup raises a new round of funding, the company culture shifts, the team grows, and they need to find more revenue to justify the money raised. Founders must have a good roadmap and a good plan for what they want to do with the money they are setting out to raise, as the investors hold them accountable every step of the way.

Below is a description of these different startup phases, according to my experience. Not all companies raise consistent rounds, or raise money in exactly this order. And while these numbers provide you with a range, they vary wildly based on the industry, the market, and a number of other factors. These phases should be used as a mental model, not to be confused with the messy reality of running a business.

So without further ado, here’s my rough approximation of startup phases:

Seed Stage:

• Round size: $100K - $5M

• At this stage, the team is small, maybe just a few cofounders or 2-10 early employees. They have an idea, some time on their hands, likely a proof of concept app, and if they’re lucky, some early customers.

• The goal at this stage is to build out the real v1, and find initial traction for the product. This is the stage where it is more important than ever to focus on the customer, understand what problem you are solving, and manage tradeoffs, since time is constantly working against you. Every day you are operating without revenue is one day closer to having no money.

Series A:

• Round size: $5M - $25M

• Once a team raises a Series A, they likely have some traction. They have found product-market fit (of some kind), have some established customers, and the goal is to repeat these early wins and build processes to scale.

• The team may grow to around 15-50 people, each of which with more role definition, starting to specialize into their jobs. The “leadership team” (i.e. founders and early employees who now find themselves with fancy titles like CEO, COO, and CTO) tries to establish a company hierarchy that not only helps the company survive, but also grow. While there may be constant competing priorities, the goal this round is to understand the one direction that will benefit the business the most, and focus all energy towards that goal.

Series B:

• Round size: $10M - $50M+

• The team is bigger, typically 50-200 people, specializing in their respective fields and focusing more on what their department is doing rather than what the company is doing. In a good company, these departmental goals are aligned, but since the company is bigger and has more priorities, it is harder to decide which of the competing priorities wins out. For this reason, it is more difficult to operate and grow a Series B company than any previous phase. Lots of moving parts.

• Being a leader at this phase requires tremendous coordination, because while each department used to be one person, now they’re each staffed with five. The individuals skilled at “doing the actual work” are now managers that have to delegate more than they are comfortable doing. The company must have a clear central vision of what they are and what they are not, otherwise it is easy for the departments to each have their own determinations of what is important.

• At this point, the company has a proven business model, is growing their revenue, and while they may not yet be profitable, they have solid processes in place. If they can buy themselves enough time to figure out the growing pains, perhaps they can reach the point of profitability.

Series C, D, E, & Beyond:

• Round size: Who even knows these days? Can be anywhere from $20M - $1B+

• These rounds are highly dependent on the industry, the company, the market, and a number of other factors. At this point, the company is likely profitable, or has a clear path to profitability. These rounds are often called growth rounds, since the company is using the money they raise to grow and capture as much market share as possible.

• These companies are more corporate, with many layers of management, often preparing for acquisition or IPO (i.e. going from private → public company).

• By these rounds, I would not really classify them as startups anymore. While they may not be Fortune 500 companies, they have processes, systems, and a high degree of specialization. Anything you work on as an employee may not directly impact the company in a large way. Joining a company at this stage will likely not give you the same breadth experience I will describe below, but they will often pay very well to attract the best, most ambitious talent. The company may not make it, but failure at this point means something different than shutting down. They likely have accumulated enough assets to be purchased by someone, and will survive in some form for a while.

Startup Roles, Compensation, and Equity

Why do I tell you about fundraising rounds? Because it’s important to understand that “startups” are not all made the same. The stage of the startup not only drastically affects the company, but also affects your role and your compensation working there.

If you join a Seed stage startup, you won’t really know what your job is. You will be an integral part of developing the team culture. You end up “wearing a lot of hats” and the job description is roughly: “solve problems as they arise”. Your compensation will be relatively low, but you learn more in a month than you would in a year at a big company.

This is the phase of startups that feels like your “job” doesn’t really exist. Sure you may be getting paid, but your faith in the company is based on hope rather than anything tangible or certain. You are willing something into existence, and the act of working each day is a tremendously creative endeavor.

Joining a Series A startup, you will have a more concrete sense of your role and where you fit in the organization. While you still have to be entrepreneurial, the priorities still come from the top, and it’s your role to figure out how to meet the goals defined by leadership. As you work, you will likely run into systems and processes that have been put into place by earlier employees. These systems will end up lasting long past when those early employees leave the company.

Series B and beyond starts to feel more like a corporate role. You are likely a small part of a bigger team, and your goals might be defined in quarterly increments. You know what you have to do, but sometimes it’s hard to relate that work to the company’s growth. I had this experience at an early role at a Series A startup, where I thought my work was meaningful, and yet it’s hard to understand the business impact that it had.

At any of these phases, the roles can be fun, and the lack of structure works very well for some people. But that probably doesn’t answer your most pressing question: how will I get paid?

Equity Payouts: The Mythical Startup Carrot

“We offer a competitive salary,” the founder says, “but more importantly, we want you to share in the upside of the company, and give you equity. What would you say to 10,000 shares of stock options? They will be worth a lot someday.”

I have heard this spiel a number of times throughout my career.

Founders are a rare, charismatic breed with a vision of a world that they want to make exist. They have to constantly convince everyone that it can exist: customers, investors, employees, and even themselves. They are a bit crazy, because you have to be to constantly be building towards a goal. It’s a beautiful endeavor, and a wonderful sales pitch for new employees. They sell purpose, if you want to buy into the vision.

So it’s tempting to believe them when they say that your equity grant may be worth a big sum of money. At 23 years old, I believed them. But three startups later, and not one equity payout yet, I have developed a healthy cynicism of equity.

My new rule of thumb is that equity isn’t worth anything, until it is.

The more option grants I have had on Carta, the more I’ve realized that they are hard to make real. Startups take on average 7 years to get to an exit, and the likelihood that the company actually gets to that point is very low.

A quick aside on liquidation events, or “exits”: a liquidation event is the only way equity becomes worth something. While you may raise money at a high valuation, it doesn’t really matter until the company is sold. The two most common types of exits are acquisitions or IPOs.

IPOs have become increasingly rare, as companies are opting to stay private longer instead of going public. In the 90s and 2000s, most of the value created by a company used to happen post-IPO, while today, it is much more common to create that value as a private company and then get acquired.

Acquisitions can look very different depending on the company. For example, a startup could get acquired by a strategic player, like a tech startup selling to Google, or a startup could merge with another company, like Postmates being rolled into Uber. There are a number of reasons to sell, and it is often dictated by the founder’s goals with the company.

Sometimes a company acquires a startup outright (i.e. a “cash deal”), and other times these are all-stock deals, which means that your startup equity as an employee is simply converted to the stock of the acquiring company. In these cases, you as a startup employee will not be compensated until THAT company is acquired (or they are already public, hooray).

The non-founding employees, while incentivized with potentially hundreds if not thousands of stock options, are very unlikely to get rich when a liquidation event happens.

If you are not one of the first 10 employees at a company, your equity is likely not life-changing unless the company becomes the next Airbnb or Uber. If you believe the founders, and think that you will hit a massive exit, great, put your eggs in that basket.

The more likely reality is that you will be living your day to day life on your salary, and the equity is just a bonus.

A Practical Example to Visualize

Let’s say you’re given 10,000 stock options of a company that you are joining as a Series A employee. This may seem like a lot of shares, but be cautious. Founders have an incentive for you to believe that this is more than it actually is. Selling you the dream of getting rich without actually giving you a lot of the company.

The ludicrously high number of options you get makes people not ask the real question: what percentage of the company is this? How many outstanding shares exist?¹

So let’s say there are 2,500,000 outstanding shares. This is the total number of company shares that exist. Your 10,000 out of 2,500,000 outstanding shares represents 0.4% of the company. Not bad.

To make a million dollars, you’d have to own 2% of a $50M startup. Or 0.1% of a $1B startup.

So it is tempting to believe that if the company sells for a billion, you will make $4M. However, every time a company raises money, they issue new shares, and your equity is likely to get diluted.

Your 10,000 shares may represent 0.4% of the company when you join, but you may only own 0.2% after the Series B, and 0.1% after the Series C. This is not necessarily a bad thing, because it’s a smaller percentage of a theoretically bigger pie. But just know that the math changes every time the company raises a round².

Another complicating factor is that standard equity vesting is four years with a 1 year cliff. Which means that you don’t own any of the company until a full year into your employment, at which point you own 25% of your promised equity in options. Typically, the rest of the equity vests monthly. So after 2 years of working there, you only own 5,000 of your 10,000 promised options.

If you only decide to stay two years (which, according to Carta, is the median tenure for startup employees), you will only own .2% of the company. And your equity will continue to get diluted. But even so, that seems like an okay deal for a few year’s worth of work.

As a benchmark, executives joining a company may earn 1-3% in the later stages, and they are tasked with coming in and making large improvements to process, management, structure, etc. They make sure you go from a Series B to a successful exit. Without them, the company is likely not to make it, which justifies their large percentage³.

Stock Options, not Stock

While there is a lot working against you for equity, one often veiled complication is that you do not actually get stock in the company. You get stock options. You have the right to buy these options at a set price in the future. If you are planning on leaving after 2 years, and have vested 5,000 options in our scenario, you still have to exercise your options, meaning you have to buy them.

This is not talked about often in startup circles, but you actually have to pay the company to own the stock you were given when you joined.

Now, if the company is going through an exit, this is fine. You get the delta between the actual price and your strike price for each option, and the current value of the company is often way higher than it was when you joined and the strike price was set. In less technical terms: you will make money from an exit.

However, that’s for a successful company that is going through an exit. Let’s say instead, you decide to leave after 2 years, before the company makes it to an exit. At the time you leave, you have to exercise your stock options, or else you lose them⁴.

What does this look like? Typically, you would pay the company a few thousand dollars to buy your 5,000 vested shares. And you do this with the hope that the company continues to grow, and the hope that you won’t get diluted, and the hope that an exit happens, years down the road. But in the meantime, you have paid a few grand out of pocket today, on the hopes that the founders take the company to the promised land. But if you’re leaving the company, did you really believe in their vision?

The Bottom Line on Equity

I have not painted a pretty picture of startup finances, because it is very messy. Any time large sums of money are involved, it gets complicated. Everyone wants a bigger share of the pie, and it’s often not the employees that get it.

My point in telling you all of this: if you are relying on your equity in the company to make you rich, you’d probably be better off starting your own startup. The expected value of your stock options joining a startup is very low.

So for all of these reasons, I treat equity like Monopoly money. Worth nothing, until it’s worth something. If the company does well and has an exit, fantastic. Your equity becomes a nice bonus cherry on top of an already successful career sundae.

So why would anyone go work for a startup?

That is a good question, considering all of the bad things I just said about startup compensation.

My answer is that working for a startup will give you more experience than you ever could have imagined. Startups are such a fabulous way to learn and grow, fast. Your role will not be constrained to just being a software engineer, or a product manager, or a marketer. Instead, you will be on a scrappy team that blurs the functional lines of any individual’s role.

You will be given more ownership over tasks than you know what to do with. You will often be lost, not knowing the answer, and nobody on the team does either. Your job is to figure it out.

If you are someone who wants to have tasks neatly laid out for you, the startup world may not be for you. But if you like to figure out novel ways to do things, and research best practices while doing your best at your company, then you should probably join a startup.

You can make such a huge impact on the company, the culture, the process, and the work. Your job is constrained by what you want it to be.

If you go to a larger company, you may be working on projects that are seen by more users, but you are only a tiny piece of that puzzle. At a startup, you are building it from scratch. Whether it’s a new feature in the codebase or a new marketing campaign, you decide what to build next. If the choice is between working on a small button on Google Maps or building towards a new vision, I would choose the new every time.

While pay may not be as competitive as the founders say, you are compensated with invaluable breadth of experience for a few years while you struggle to figure out if what you’re building is worthwhile. You end up being able to tell a pretty good story about it, since you were in the room making the decisions with the founders.

You may forgo some salary, or risk getting laid off. But for me, the risk has been worth it. I would not be where I am in my career without my startup experience.

If you are in it for the riches, you should probably go to a bigger company. When you break down the expected monetary value, it is unlikely working for a startup will compete with the high paying corporate job.

However, if you’re seeking more out of your role, I could not recommend joining a startup more. While the compensation is complicated, and you may never reap the benefits of a huge exit, I think it is well worth the risk.

Who knows, joining a startup could be the most valuable decision you ever make.

Until next week,
Cory

1. I’ve noticed that founders often don’t tell you the number of outstanding shares unless you really pester them to do so.

2. I won’t get into liquidation preferences, preferred stock, or anti-dilution protections, but know that the world of startups and VC is incredibly complicated, most of which to the investor’s favor. They have the capital, so they get to make most of the decisions.

3. I know, 2% doesn’t feel particularly large, but at this stage, we’re talking about 100M - 1B+ exits, so it’s not a bad payday. Assuming you make it.

4. I’ve seen this purchase have to happen within a 90 day window of leaving a company, otherwise you lose your options that were “so valuable” when you joined.