Incentive Stock Options and Startups

I wound up starting/joining a flamewar on Joel on Software, regarding incentive stock options at a startup.

The original poster, posting under the pseudonym "Joe Tarantino", said (paraphrasing):

I had a job that paid $125k/year including benefits. I quit this job to join a 4 person startup as employee #1. The salary is $75k/year with no benefits. I'm getting 1.5% of the business in options, subject to 4 year vesting with a 1 year cliff. I've been working there for 4 months. I estimate that the business had a valuation of $1M when I started working there.

It's a startup, so I'm working 70+ hours per week. I'm feeling burned out.

I'm thinking of renegotiating for 5% instead of 1.5%. I'm also concerned about dilution as more capital is raised or other employees are hired.

My offer letter said "You get 1.5% in option grants, subject to approval by the board." The board hasn't formally approved my option grant yet, even though I've been working there for 4 months.

Am I getting a screwed?

Short answer: Yes, you're getting screwed.

The details say "I enjoy letting other people take advantage of me. I am looking for rationalizations to avoid noticing the scummy behavior of other people." If you read Joe Tarantino's posts and responses, it's classic "Stockholm Syndrome" or "Stateholm Syndrome". The "abused productive" person looks for rationalizations as to why the parasites aren't evil. The parasites don't even have to try that hard! The "abused productive" person will always make up excuses to avoid noticing evil.

If I'm coming down hard on Joe Tarantino, it's only because my thought process is "OMFG! I really was that stupid once!"

My prediction: Joe will keep working there and get fired just before his 1 year cliff vesting. Alternatively, the company will never be successful and his options will ultimately be worth $0.

You should expect dilution as more employees are hired and VC is raised.

This bit is a huge red flag: "The board hasn't actually gotten around to awarding me my original options yet. " You should have received (without have to ask for it), a formal options grant, details of the option plan, a valuation (price per share), and # of shares outstanding. You could have asked politely once. If they didn't give it, then you know the quality of their ethics and can start looking for a new job.

Your offer letter said "This options grant is conditional upon approval by our board."? In that case, you have nothing.

I've been suckered by the old "We'll formalize the option grant later!" trick more than once. They did all the other legal paperwork for their business, didn't they? They're just stringing you along, knowing you're dumb enough to fall for it. At all the places where I was offered options, I cashed out for a grand total of $0. None of those businesses ever succeeded.

You should view options as a potential bonus. Only take the job if the other terms are worth it on their own. Even if you're a founder, the VC will usually require you to accept vesting of your own shares. This effectively makes the founder the VC's employee.

If you're buying your own health insurance, the cost is double. If you pay $400/month after taxes, that's the same as $800/month before taxes.

Are your options based on the original valuation of $1M, or the current valuation? That's why you needed it in writing!

They already know you're a pathetic loser. They have no reason to offer you a raise. They have no reason to formalize the options grant letter. They'll keep stringing you along.

I've taken several jobs where the terms were "We're offering you a below-market salary *BUT* we'll give you a raise later." I never received a single raise at any of those jobs. It's always "It's coming! Just wait a month or two!"

Let me teach you something useful I learned in school. It's called "basic arithmetic".

You gave up $50k in salary+benefits for this job. Assuming a $1M valuation, your 1.5% in options is worth $15k. The terms are "4 year vesting with 1 year cliff". Your options aren't worth $15k per year. They're worth $3.75k per year.

You would have been better off keeping the extra $50k salary and buying options in Google or Apple or your favorite tech company. You could have bought gold. (Hint: buy gold.)

If you want to get rich quick, you could have taken the $50k salary, gone to Las Vegas, and made a $50k bet on 00 on the Roulette wheel. Then, you would have had a 1 in 38 chance of walking away with $1.8M, which is better than you'll ever get in this job. Plus, you could have done this every year, giving you a 4 in 38 chance.

Suppose you were working 45 hours/week in your old job and are working 70 hours/week in your new job. That's 2250 hours/year in your old job, 3500 hours/year in your new job. Your actual hourly salary was $55/hr in your old job, and it's $21/hr in your new job. You should always calculate your salary on an hourly basis.

You're a good software engineer but you don't know basic arithmetic?

As Joe pointed out, working those extra 25 hours/week is a huge sacrifice. You've lost 100% of your free time.

Is one of the other co-founders a competent programmer? In that case, you have no leverage at all. He probably can keep things moving until a replacement idiot is hired.

You have 4 year vesting with a 1 year cliff. You've been working there 4 months? What prevents them from firing you after 6 more months leaving you with nothing?

There are other ways they could cheat you. They could never formally approve your options grant. The could approve it, but it'd be effective on the grant date and not when you started working there. They could re-incorporate and move all the IP, leaving you with options on a worthless shell. As a minority owner, there are too many ways to get cheated.

At Facebook, a bunch of early employees had unvested options that were *VERY* valuable. They were fired, and replaced with cheaper fools. I'll bet the new employees were also offered options!

That's the problem with options and vesting. You get cheated if the business fails. You can get cheated if the business succeeds, when the temptation is to fire you and replace you with someone cheaper. Even if if the current owners are honest (they aren't), the VC might insist on bringing in his own CEO.

Suppose they are successful and get a $100M valuation 2 years from now. Your 0.5% unvested options are now worth $500k. What prevents them from saying "Let's get rid of Joe and replace him with someone cheaper."?

Unless they cash out, via an IPO or sale to a larger corporation, your equity is worth $0. There's nothing preventing them from hiring their idiot unqualified brother-in-law as CTO, making your investment worthless.

If you're as skilled as you claim you are, then you should start your own business. Take a job that pays a decent wage, and your savings are your seed money. Take a job with a decent workweek, and start your own thing on the side. Ideas are a dime a dozen. It's implementation and execution that counts.

Start looking for a new job. Your bosses probably know you're starting to wise up and they're preparing to replace you.

"Demand a raise!" never works. The correct answer is "Get a new job and write it off as a learning experience." Don't make the "Sunk Costs Fallacy". The 4 months you spent working there are wasted and gone. Do what's in your rational self-interest, based on your current situation. Your tiny slice of equity is practically worthless compared to your fair market salary, if you're telling the truth.

You are an idiot. Your bosses know you're an idiot. They will never respect you. If you demand a raise, they'll just hire a replacement and prepare to fire you.

Are you really that stupid, or are you trolling?

Joe said:

I'm renegotiating, asking for a 5% equity slice. Hooray! They agreed to give me 3%, but they haven't formalized it yet.

A pro-State troll said:

FSK is a pathetic loser who was never successful, and that's why he's coming down hard on Joe. It is wrong for FSK to say "Your friends and coworkers are always looking to steal from you."

I was not saying "In all instances, your bosses and friends are looking to rob you." I am saying "In this specific instance, based on the information provided by Joe Tarantino and the tone of his posts, Joe is definitely getting mind-raped and wallet-raped."

Most of my recent work experiences have been negative. My current coworkers are decent, but that may change.

I'm currently working as a consultant/contractor for a large financial institution for an hourly wage. My headhunter/pimp probably gets $2 for every $1 I get. I accept it, because the salary is still decent. I'm not going to get rich, but my paycheck isn't going to bounce either. I already went through my "Try to get rich via the stock market!" phase, and now I'm just looking to buy gold and silver. I'm planning to start my own business in the next few years, but this is good enough for now. Does that make me a pathetic loser? I have some ideas for stuff to try out that will only take 5-10 hours/week, so this is a decent job to keep while trying that.

Review my "basic arithmetic" calculation above. Joe didn't merely take a $50k pay cut. On an hourly basis, he took a 62% pay cut.

The $50k foregone salary should be treated like an equity investment in the company. Suppose the company had a valuation of $1M when you first started there. (A customer had an option to purchase at a valuation of $1.3M, but declined, so I'll stick with the $1M valuation.)

Joe gave up $50k/yr in annual salary for 1.5% in equity, which is worth $15k. However, it's 4 years vesting, so Joe actually gave up $200k in salary for $15k of equity.

"I'm so smart. I bought $15k in equity for $200k." points out what a pathetic loser Joe is.

For $200k of foregone salary, with a valuation of $1M, the fair equity stake is 20%, making Joe a co-founder. It's too late to ask for that now.

Look at it from Joe's boss' point of view. He originally agreed to work for a 1.5% stake. Now, that pathetic snot-nosed loser is demanding 5%. I'll show him for trying to bully me! I'll find someone else! Besides, 5% still is an insultingly low amount.

However, Joe is earning $75k in base salary, which isn't chump change. However, he can easily get another job for $125k including benefits. He quit such a job to work at the startup. In that case, Joe had a real cost of $50k/year.

This might be a future Netscape. I doubt it. However, you're more likely to be an Eduardo Saverin than a jwz. (Jwz is a famous early programmer at Netscape, who got reasonably rich cashing out his options. Eduardo Saverin was an early Facebook co-founder who got screwed over by Mark Zuckerberg. I'm planning to do a post on Eduardo Saverin.)

A few programmers cashed out for big $$$ during the .com boom. Now, startup founders can get programmers drooling over their pathetic option/equity grants. You still need to evaluate the option grant based on "What is the business worth now? What is my percentage? What would they be able to cash out for if successful? How long will that take? How many shares am I getting, at what valuation, and with what strings attached?" The few successes during the .com boom now give founders the ability to offer share grants to everyone, and have programmers drooling over the offer without seriously evaluating the details.

Answer this question again. What prevents them from firing you after 6 months just before your cliff vesting date? If they successfully raise VC, then they'll be hiring other programmers. If they hire someone else competent, then you *WILL* be replaceable.

At one place I worked, it seemed like they had a policy of "Fire people after 11 months before their cliff vesting date." Two people, one of which was a co-founder, wrote most of the code for the site. They were both fired before they were there a year, leaving them with nothing. Besides, the business was lousy execution of a stupid idea. They did manage to raise $8M(!) in VC due to connections of one of the founders. They aren't in deadpool yet, but they're headed there. Any equity in that startup is really worth $0.

Based on subversion logs, the two people who wrote all the code for the site were no longer there. They probably thought "We're super geniuses!" Their code was *AWFUL*. This isn't "Other people's code always looks awful." It really was awful. They wrote their own code for everything, instead of using standard tools.

Still, I was able to maintain their code. They were not missed.

This was a big red flag. I was being paid a decent base salary, so I stuck around. After a few months, they fired me to make room for one of their idiot friends.

You should not work more than 45 hours per week. You might think your code is awesome. It probably isn't. After 45 hours/week, the cost of fatigue starts to be more than the benefit of working extra hours. If they're a serious business, they should understand if you demand to work reasonable hours. "But it's a startup!" is not a valid excuse for working ridiculous hours. If your boss isn't an idiot, he'll understand if you say "I'll get more done working only 45 hours/week!"

The original question was "Am I being screwed?" The consensus answer seems to be "Yes". My answer is "Yes, and you're enjoying it." This is a classic example of an "abused parasitic" person enjoying getting raped by parasites.

You probably are replaceable and have no leverage. Go find a new job. Start sending out resumes. That costs $0. Your boss started looking to replace you from the moment you said your anus was sore from the pounding.

A pro-State troll said:

Don't burn your bridges!

Stay positive!

No risk, no reward!

What about the parasite burning his bridge with Joe? He tricked Joe into taking a $50k pay cut, and gave him an insultingly low equity stake. Why should Joe be worried about burning his bridge with this scumbag? The scumbag has burned his bridge with Joe. The parasite probably knows other competent programmers eager to take Joe's place.

Why should I always fear burning my bridge with other people? What about other scumbags who burn their bridge with me? If someone is an abusive jerk, then I should be glad that I don't have to deal with them again in the future.

The reality of the State and the Matrix is that there's an abusive jerk in almost any business. I'm stuck in that role unless I start my own business. The magic formula for success is to find a parasite that isn't too abusive, but still performs parasite tasks well.

"Stay positive!" doesn't mean "Don't make a rational analysis of risks and reward." You should not be so optimistic that you overlook negative features of a business arrangement. "Stay positive!" sounds like pro-State trolling.

"Accept abuse in exchange for a vague promise of a later reward!" sounds a lot like Christian pro-State brainwashing.

"No risk, no reward!" doesn't mean "Take risks, without looking at the odds." The problem is "Joe is not being properly compensated for the risk he is taking!" rather than "You should never take risks!" You should take risks, but you also should evaluate the odds. This is an odds-against risk for Joe.

There's a lot of things working against Joe:

1. They never formalized the option agreement, even though he was working there for 4 months. This shows that the owners have scummy ethics.
   
2. There's a cliff vesting clause, which means Joe can be fired in 6 months and he gets nothing.
3. Joe is working 70+ hours/week. If the boss isn't a scumbag, he'll understand if Joe wants to cut back to reasonable hours. At 70+ hours/week, Joe's code probably isn't as great as he thinks it is.
4. 1.5% or even 3% is an insultingly low percentage, given that Joe gave up $50k in salary+benefits to work there.
5. The company might fail, even if Joe's code is awesome.
6. There are all sorts of legal tricks and loopholes that can be used to cheat Joe.
7. Saying "I demand a raise or I quit!" usually doesn't work. If Joe wants fair treatment, he's going to have to switch jobs.
8. As soon as you demand a raise, your boss will start looking to replace you. The time to negotiate was before you started working there, and not now.
   

It's obvious that Joe is going to stay in his abusive job. Staying with parasites is a bad idea. It's a lot of energy wasted for little benefit. Being with someone abusive is very draining, whether it's a business relationship or a personal relationship.

Joe should write this off as a loss. He learned his lesson, and should negotiate properly next time.

There always are other opportunities. It's time for the OP Joe to move on, but he won't.

There's another interesting observation from the thread. Some posters who've been around the block a few times like me realized "Yeah, Joe is getting screwed." Other posters were saying "Joe should be grateful for the tiny slice of equity and the opportunity to make a lot of money." That's parasite reasoning. Suppose you're a parasite and you aspire to be a startup founder. You want there to be clueless fools like Joe eager to work for the fantasy of options and a big payout. Therefore, parasites advise Joe to accept abuse.

It's hard to be sure from his posts, but the OP Joe definitely looks like someone who is being abused by parasites, yet looking for excuses why parasites are really his friends. It's very hard to accept that someone you thought was your friend is cheating you. That's one reason why Bernard Madoff got away with his scam for so long.

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One of the moderators on Joel on Software deleted one of my comments. That is a great example of "how to ruin a forum". I now exercise my "right to leave", and I refuse to post there anymore. Then, the moderators complain "Why doesn't anyone post here anymore?"

One particularly offensive thing about Internet censorship is that the comment is gone with no trace. There's no evidence to the other users that censorship occurred.

With lousy StackOverflow and censorship on "Joel on Software", I see that as a huge waste of time. There was a time when I thought Joel Spolsky was cool. He's clearly jumped the shark.

There are more forums, than I have time to spend tracking all of them. A forum needs users, and if you alienate the best users, then the quality suffers. I haven't posted on mises.org since I had a disagreement with a moderator regarding him deleting my posts.

That is different than blogging. A forum relies on user-generated content. A blog is 1 person's opinions. The vast majority of people who read my blog lurk without commenting. Actually, I have more E-Mails and comments than I have time to respond to all of them.

When I get my own domain, I may put up a forum. If I had a forum, I'd try to be very permissive about what content is allowed. It's a tough thing. The key is a good moderation engine. One person's trolling might be another person's content.