I Made $0 From Equity At 5 Start-Ups

What is start-up equity?

Wall street has their cash bonuses, and tech startups have their stock grants. The billions of dollars in wealth of the tech industry are usually earned through owning company stock. As employees in those early stage start-ups, the lower cash salary, longer hours, and higher risk job is compensated by stock option grants.

Stock option grants give the employee the opportunity to purchase equity in the company at a specific price. Early employees can get purchase prices (ie the exercise or strike price) at very cheap levels until the company grows in worth. When the company grows in value, the equity value (typically diluted) also grows in value. Illustrious examples include Google, Amazon, and Meta as companies that came from nothing to be worth billions. Thus is born the legend that silicon valley riches come from start-up equity.

However, 9 out of 10 start-ups fail is the conventional wisdom, so naturally a lot of start-up equity ends up being worthless. How should employees navigate the mindfield to land on the prize?

A Dollar Not Spent is a Dollar Earned

Although stock options are part of an employee’s compensation package, in reality there are a number of hurdles to jump over in order to own the options:

• A stock option is the option to purchase a stock. It’s not a direct grant. You have to have the money to buy the stock options at the price you were granted them at.
• There’s typically a vesting schedule, such as 1 year cliff and 4 year vest. This means you have to stay with the company for at least a year (ie the cliff). Your options will also not be available for purchase immediately, but will become available based on a schedule that divides the grant over a 4 year timeframe (ie vest).
• There may be taxes upon purchasing the stock options, so be ready to pony up both the cost to purchase and to cover the taxes. During that time, your equity may not be liquid, ie you can buy them, but you can’t sell them.

This comes with some pros and cons. The major con is you still need to earn it by staying with the company and have the money to purchase the options when you can purchase them. The pro is you can walk away from grant as if it was never part of your compensation. The decision to walk away from a grant is the first decision point where we assess how I’ve performed.

To Buy or Not To Buy

Of the five start-ups I’ve been with, not all of the options I was granted turned into owned equity:

• 2 of 5 stock options were granted but not purchased
  • Why did I not purchase the options? In both cases, I did not think it was a good return on investment for a multitude of reasons.
  • The current status? Neither company has had an exit. One of them is defunct.
  • Results assessment:
    • To date, the decision to not purchase the companies was the right decision given the lack of ROI
    • Was forfeiting the equity worth it? Yes, because the cash pay bump for one role and learnings in the other compensated for the equity loss.
• 3 of 5 stock options were granted and purchased
  • Why did I purchase the options? In 1 of 3 cases, the purchase price was extremely low, making the investment a no brainer. In the remaining two, I believed they would likely IPO or have some sort of liquidity event.
  • The current status?
    • 2 companies have had liquidity events
    • 1 company remains private and has not had an exit or liquidity event
  • Result assessment:
    • The company that is private was also the lowest cost to purchase. Similarly, the role came with cash compensation raises which offset any equity loss.
    • 2 of 3 companies where I purchased the equity had liquidity events from an IPO and a share buyback.

A liquidity event is a chance for investors and/or employees to sell their company stock in exchange for cash. The best known example of this is an IPO, but sometimes there are also share buybacks where the company will purchase equity from their employees or investors. Because start-up equity is highly illiquid, employees can wait years before they are able to sell their equity, if the company does well.

Therefore, having a liquidity event would be a hallmark of a successful company where the start-up equity payout makes up for the risk.

Where Did I go wrong, and What Did I Get Right?

From this breakdown, I draw a handful of conclusions with the small sample size:

• 2 of 5 companies had liquidity events, so my win ratio (of picking winners) is actually 40%
• Of the companies I ended up owning the equity in, 2 of 3 companies had liquidity events, making my win ratio 67%, which provides some relief to my bruised ego
• At the companies in which I did not own equity, I advanced my career the most or received significant cash salary increases that effectively doubled my salary from when I first started out in tech. As an overly harsh critic, I also failed to factor in the full picture.

• However, the results clearly show flaws in my decision-making:
  • I over-indexed on roles that would advance my own career and my cash salary in the short-term at the cost of long-term trajectory of the company and my roles there. This confined my experience to particularly early stage start-ups. I prefer early stage companies, but I do wonder if that was a smart choice.
  • I chose the companies based on the people that I liked and would enjoy working with in my domain, and less on the merits of the company’s vision and product. I believed in the company’s leader(s), but I failed to understand that exceptional leaders don’t necessarily translate to a good product. If I had to re-do any aspect of my decision-making, it would be to evaluate more the company and the leadership with respect to product, design, and engineering.

Knowing When to Sell

If two of the companies I worked for had liquidity events, how did I still LOSE money? Am I an idiot? Yes — I am an idiot.

I spent quite a bit of time deciding whether or not I should purchase options, which, as we saw above, played out in my favor. When it came time to sell, I spent no time whatsoever on those decisions. Here’s why: I’m a buy and hold investor.

The Buy and Hold Investment Strategy

The buy and hold investment strategy is a common and often recommended long-term investment strategy for everyday investors to build wealth. The investor would typically purchase stocks, funds, or ETFs on the public exchange or real estate, then hold those investments over a long period of time, years to decades. The investors would hold onto the investments despite ups and downs in the market.

And since we’re talking about investing, we have to throw in a Warren Buffet quote: “If you aren't thinking about owning a stock for ten years, don't even think about owning it for ten minutes.”

For Start-up Equity, Buy then Sell Instead

The IPO Scenario

Start up equity is a poor choice for the buy and hold strategy. An IPO'ed start-up may not be ready to withstand the harsh critique that comes with being a public company. From quarterly earnings, annual audits, and rigorous innovation killing financial controls, an IPO’ed start-up is in its early phases of becoming a mature corporation. The few years following the IPO is a big test for the company. And in many cases investors and employees use the IPO opportunity to cash out as soon as possible, leading to more supply than potentially market demand.

A wise move for a typical employee like myself would have been to sell when the lock-up period expires and cash in on any gains. It’s not an all or nothing game, so I should cash out enough to make some gains and pay myself. Then I can decide whether to keep the remainder for any further potential upside.

The Share Buyback Scenario

A share buyback is the company’s reward to employees. The company helps create a liquidity event so employees can cash out on their options. These events are far and few between, so when the opportunities do arise, it’s typically a smart decision to take it. These events are important to take advantage of, because the sell price is locked at the certain value whereas stock on the public market can fluctuate in price significantly.

How Did I Do, and What Would I Do Differently?

Theory aside, let’s play this out with real numbers from my own experience. I stated that I had purchased my stock options from two companies that subsequently had liquidity events. We’re going to call them company A and B. We’ll be using rough numbers on a price per share basis to make for an easier calculation without deviating too much from the actual events.

Company A: IPO

• Purchased at $3
• Price at the end of lockup $10 (+233%)
• Price sold at $0.50 (-83%)

Company B: Share BuyBack

• Purchased at $2
• Price at buyback $44 (+2100%)
• Current value unknown (0%)

If I had sold Company A stock at the end of the lockup period and Company B shares during the buyback, my gains per share would still be +175% and +1575% respectively (assuming a blended 25% tax rate from long-term federal capital gains, NIIT, and state taxes). This would have outperformed the S&P 500 over the same time frame of investment.

My mistake is not knowing when to sell.

My Advice to My Younger Self

Knowing what I know now, here's what I would tell my younger self about start-up equity:

• Sell your start-ups’ equity when you have the chance
• Don’t be too hard on yourself. Remember everyone makes mistakes, even when those mistakes are six figure mistakes
• Lastly, but most importantly, forget start-up equity, take high cash salaries, and go buy Bitcoin (on Coinbase and not with FTX), Nvidia, and Tesla.

Hindsight is 20-20. This advice is only useful if I also had a time machine -- rendering this advice useless now.

The better approach to making money from start-ups is the more boring methodical approach of:

• Earn good money by making smart career moves in start-ups and tech. Work hard and smart to demonstrate steady career progression and learnings.
• Spend more time educating yourself on stock options and liquidity events. Sell when the chance arises. Plan for taxes accordingly.
• Negotiate harder for both cash and equity, because you have the most leverage at the offer stage to maximize your returns.
• Save as much as possible when you can, because the tide eventually will turn.

It’s much easier to make money from slow, steady progress.

Making money from start-up equity, on the other hand, comes from building a portfolio of companies. Trying to pick individual winners is a bad choice both in private and public markets. Pooling a batch of potential winners is a better strategy, because the potential upside from some will dwarf the losses of others. Therefore, outside of being an investor, I’d recommend to my younger self: figure out from a long-term career planning perspective how to consult for equity.

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Research:

_{1 Tuovila, A. "Tax Loss Carryforwards: How They Work, Types, and Examples." ALICIA TUOVILAALICIA TUOVILA"Tax Loss Carry forwards: How They Work, Types, and Examples." Investopedia.com. March 17, 2024.}

_{2 Wiley, J. "How Incentive Stock Options Are Taxed: The Basics." Wealth Enhancement Group. May 11, 2022.}

_{3 Skoczylas, S. "How stock options are taxed." Carta.com. January 19, 2024.}

_{4 Frank, A. "Incentive stock options and the AMT." JPMorgan.com. December 20, 2023.}

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