Friday, December 12, 2014

Evaluating a Developer Job Offer Part 6: Equity

Few decisions can have a larger impact on your financial life as a software developer than accepting (or not accepting) a new job. Today we'll consider a controversial topic: equity. A lot of private companies (e.g. startups) try to sell their equity as a form of financial compensation. I use a ridiculous metaphor to explain why you maybe shouldn't give up money for paper. This is part six of an essay on the financial considerations when evaluating a software developer job offer. Just tuning in now? You can jump to the beginning to learn the risks of taking a new job.

Though it may seem daunting, equity is actually really simple. All you have to do is make sure you get as much as you already have at your current company, or more (in supposed dollar value, based on the last investment). Unless the company has filed for IPO or is publicly traded, value the equity at zero. Don’t accept equity for a salary of lower value.

Lots of people will disagree with the value of zero. I plan to write more about this because it is a complex topic. Most equity in private companies is so encumbered that it has little or no real value. In any case, there typically isn’t enough liquidity to accurately value it.
World Trade Center Building
Unless the company is publicly traded, I see stock, stock options, and restricted stock units (RSUs) as an incentive, not compensation. An incentive is something that helps align your interests with the interests of the company.  Debateably, it can also serve as a motivational tool.

Even if the stock is public, that doesn’t mean that it will keep its value over the next couple of years while it vests. When I last worked at AMD, the stock price was around $7.50 per share. Now in October of 2014 it’s about $3.00. The S&P 500 has increased in value almost as much as AMD has lost value over that same time period. Holding a large amount of your compensation in one undiversified equity is a very risky thing.

Compensation is an exchange of value. You trade one thing of value for another thing of value. Equity is different.

The Investment Metaphor for Equity

Imagine that one day you get an unexpected phone call from someone named Pat. You’ve never talked to Pat before, but Pat has an amazing opportunity for you. If you jump in now, you’ll get in before everyone else! Pat wants you to buy stock in a company working on the future of envelope technology. TongueCut Inc. and their safety envelopes are going to be huge! Not only is it impossible to get a lip or tongue injury with their new envelope technology, Pat explains, but they’re working on flavored adhesives and have 14 envelope patents pending. If you want in — and of course you want in — you only have to invest $40,000. So what do you say?

I think most software developers I know would say “no thanks!” But at least some of them would gladly take a $40,000 paycut in exchange for restricted stock units in an unproven startup. The investment in the envelope company might actually be a better deal since presumably Pat isn’t selling restricted shares!

The Fishing Co-Op Metaphor for Equity

Imagine that instead of developing software, you fish for a living. Instead of selling your fish on the market, you join a fishing co-op. The co-op has an interesting deal. You and the other co-op members deliver all your catch to the warehouse every day. The leaders of the co-op then trade or sell all the fish on behalf of the co-op.
Tug on the Mississippi at Dusk
Some days the leaders decide that they should spend the co-op money to buy new fishing gear, pay rent on the warehouse, that the division of shares should be changed, or that they should give some fish away. At the end of the month, the remaining funds of the co-op are split among the members according to the number of shares each has. It might be zero. If the co-op can figure out a way to make the fish more valuable, or if you have a disproportionate number of shares, you might make more money than you would have as a lone fisherman.

Is that compensation? I don’t think so. It’s more of a form of collectivism with totalitarian rule. Also note that the only thing which you can control is how much effort you put into your fishing. The leaders can eat all of the fish, they can give shares of the co-op to lazy friends, they can take a loan against the co-op to buy a Super Bowl commercial.

Now this metaphor isn’t perfect, but hopefully it illustrates just how little value the stock of a private company can have, unless you own enough to have control (e.g. a seat on the board of directors).

My Equity Experience

If you’re trying to figure out how to evaluate an equity offer, maybe my experience can help. Years ago, I gave up more than half my salary for a chance to work at an interesting startup. Replacing that salary was options that gave me ownership in a few percent of that company. Less than a year into the project, I saw issues that I thought would hurt our chances for success. I tried to persuade the CEO to make some changes, like talking to more than one VC for funding and working more to develop interest in the product. He wasn’t very interested in my opinion. After I quit, I heard that the company let the staff go when funds ran out. I still own the stock, which hasn’t earned me a dime and probably can’t be sold.

I think this perfectly illustrates how even holding actual shares of a private stock doesn’t give you any control. I couldn’t change the course of the company even though I could talk to the CEO every day, and I held more than 1% of the stock! And unlike a shareholder of a public company, I don’t receive quarterly reports on the status of the business.

Even equity in more successful startups offers relatively few rewards. Although I have heard of founders being able to cash in some of their equity during funding rounds, it seems like a very rare option for employees.

As a minority shareholder, I have very few rights, and the shares are mostly useless. And that’s why I believe that the value of equity in startups is a myth that usually benefits the biggest owners of a company, not the employees.

Another important task is examining the details of the offer and avoiding common mistakes, which is covered in the next segment

To get your offer down to the bare numbers, I've created a spreadsheet that will guide you through the process of calculating the financial value of a job offer. Fill out your email below to see how different jobs compare. I promise to never sell or share your email.

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1 comment:

Atish Davda said...

Great advice! For anyone evaluating a job offer with a private company interested in further delving into the equity compensation piece, I have pieced together a two-part series of questions you should ask:
Eight Questions to Ask Before Accepting a Startup Job Offer (Part 1)
Eight Questions to Ask Before Accepting a Startup Job Offer (Part 2)

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