Start Up Stories

Working for a Start-Up for Low Pay

Posted in Uncategorized by Devon on May 3, 2009

If you are planning to work for a start-up at below market pay, you ought to think like an investor. The basic idea that I think you want to follow is to value your labor at market rates (e.g. assume your alternative to a start-up is to get a job for $100K), then convert whatever you are taking below that market rate into equity. For example, if your market value is $100K/year but, the start-up can only pay you $50K/year, then you will need $50K in equity compensation for that year because you are, in fact, being asked to invest your labor capital into the business. Generally speaking, the value of a stock option – which is the right, but not obligation, to purchase the company’s stock at an agreed-upon price for an agreed-upon period, in an early-stage start-up company, is about equal to the value of the stock itself (if you want to see the math underlying this principal, send me a note -).

Therefore, in the example above, you will need $50K in cash + $50K in stock or stock options, all of which vests by the end of the first year – to be whole. The value of an option to buy one share, if you assume it is equal to the value of one share of stock – as we have done, is of course – related to the value of the company and the number of shares outstanding. For example, if the total number of shares of all classes of stock in a company, including stock options, is 1,000,000 and the company is worth $1,000,000 – then the value of each share is $1. So, in order to value a stock option, you’ll need to value of the firm and what is called the “fully-diluted equity” of the company – a fancy word for how many shares will make a claim on the value of the company if sold (1,000,000 shares in our example above).

The value of a funded start-up is approximately the value of the firm, after the money was invested, at the last financing round. For example, if a firm is worth $1,000,000 before an investor makes an investment and an investor invests $1,000,000 into the firm, the firm will be worth $2,000,000 after the capital injection and the investor will own ½ the company ($1,000,000 invested out of a $2,000,000 total value). So, you’ll want to ask about the post-money valuation at the last round and the fully-diluted equity in the firm. With these 2 numbers, you can determine the value of a share of stock or an option share. Again, in the example above:

The company is worth $1,000,000 and has 1,000,000 shares outstanding
An investor buys 1,000,000 shares for $1,000,000
The firm now has $1,000,000 more cash in the bank and 1,000,000 more shares outstanding.
The firm is now worth $2,000,000 and has 2,000,000 shares outstanding, all else being equal, a share is still worth $1 ($2,000,000/2,000,000 shares = $1/share)

That said – get a hold of these numbers, establish the value of a share, and make sure that you are compensated for your labor – appropriately, with equity compensation (e.g. $50K worth of stock in the above example per year of work) that’s equivalent to the cash compensation you are effectively investing in the business. If the firm hasn’t been externally financed, it’s valuation is the subject of a future blog…

Are you getting equity for the market value of your labor investment?

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