As a product-obsessed entrepreneur and investor, I rarely focus on financing mechanics in the start-up world. It tends to be a binary outcome, and people should join a venture for the team and mission more than anything else. However, a string of recent conversations with really talented employees (and prospective employees) at later stage start-ups have stayed in my mind…this post is for them.

Illustration by Oscar Orozco, Behance/99U

A company’s fate is ultimately determined by its people, so talent is everything. But this old adage bumps up against another one: cash is king (or runway is king, for a fast-growing private company). Without runway, talent takes off. 😉 So, it is no surprise that bold moves to extend runway (think late-stage financings at technically large valuations with some tricky liquidation preferences underneath) are done even if they could hurt the company (and its people) in the long run. This is especially true when these financings are ego-driven rather than strategic. The problem is, the employees at these companies don’t understand the implications. They see the valuation, they know the number of shares they own or are being offered, but they do the wrong math.

The “unicorn” phenomenon (the vast number of companies that have raised over $100M at a $1B+ valuation) gets enough media coverage these days. Much has been written about the founders of these companies, their investors, and their rapidly growing valuations. But very little has been written about the employees, the people that do all the work and whose careers rely upon the judgement of their leaders and investors. How can employees — and prospective employees — protect themselves in this environment?

One of my sad predictions for 2017 is a bunch of big headline-worthy acquisitions and IPOs that leave a lot of hard working employees at these companies in a weird spot. They’ll be congratulated by everyone they know for their extraordinary success while scratching their heads wondering why they barely benefited. Of course, the reason is that these employees never understood their compensation in the first place (and they were not privy to the terms of all the financings before and after they were hired).

I have had a few conversations about compensation at so-called “unicorn” companies the past few months. Two of these conversations were with prospective employees — an engineer and a designer — with offers to join later-stage private companies in mid-level producer-manager roles. Another conversation was with the founder of a very early stage startup contemplating an acquisition offer from one of the later-stage delivery/food-related private companies. And the most recent conversation was with a senior HR professional at one of these $1B+ valued companies. All of these conversations reinforced my concern that employees (and founders of acquihire/acquisition targets) don’t understand how the capital structure of later-stage private companies can impact the true value of their compensation and outcome.

The Quick Primer For How “Unicorn” Employees Get Trampled

When CEO’s need more runway, they naturally seek investment at a higher valuation than their last round. When the company’s performance doesn’t warrant the valuation they seek (or when investors have the upper hand), investors can insert special terms to protect their interests, essentially limiting their downside at the expense of past equity holders, many of whom are employees.

Over coffee the other day with the Head of HR at a late-stage start-up, she confirmed for me how few candidates even ask about their stock grants. “And when they do, they ask for more shares, without even knowing the denominator,” she said in amazement. “And when they know the denominator and the hypothetical value of stock at the last round, they almost never ask about liquidation preferences or other barometers for the likely long-term value.” Wow. To bring this home, it’s like negotiating your salary without specifying the currency you’re being paid in.

While the drive to join a company cannot be solely about the money, I also believe that the possibility of reward must accompany risk. If you’re joining an early start-up, these questions are premature and your focus should be on building something of value. But if you’re joining a later stage private company, it’s just being responsible.

Don’t Get Trampled By A Unicorn, Audit Your Comp

So, if you’re an employee working at a “unicorn” company (or are considering joining one), what questions should you have? Here’s a bit of a primer for employees:

Have you raised capital with liquidation preferences, and what are they? A liquidation preference specifies which investors get paid first in the event your company is acquired or goes public. It also determines how much investors get paid before everyone else gets paid. It is standard and necessary to have a “1x non-participating liquidation preference” which means that investors will get the amount they invested out first (before employees). The thing to look out for is a higher liquidation preference, where investors get a multiple of their investment out first, before you or any other shareholder gets a single dollar — regardless of how much equity you own. If your company has raised a lot of money with high liquidation preferences, you could argue that your salary and/or grant should be larger to account for the increased risk of your shares being worthless. Like any investment that is less marketable as a result of an illiquid market, stock that is less likely to be valuable and/or marketable should be discounted.

How many months of runway do you have? The amount of money your company has raised, divided by the amount it “burns” every month (expenses beyond revenue), determines the number of months your company can survive before it either makes more, spends less, or needs to raise more funding. If your company is running out of money, your CEO is more likely to raise money at unattractive terms (like a high liquidation preference). If runway is limited, you’re entitled to ask about the plan.

If you need to raise more money but are unable to do so at standard terms, will you accept less favorable terms or will you raise at a lower valuation? I wouldn’t ask this question straight out, but I’d look for the signs. A big consequence of the press’s celebration of billion-dollar valuations is the desire to be one or stay one, despite unfavorable terms. Founders are essentially compromising the long-term value of shares held by employees in exchange for a larger valuation today. In a more normal world, companies would be able to tolerate ups and downs in valuation with the realization that every company goes through cycles (recall not too long ago when Facebook traded below its IPO price, Netflix plummeted during its transition away from DVDs, etc…). The value of your shares can go up or down, but liquidation preferences stick around. The best CEOs can stomach and lead their teams through some volatility rather than optimize for short-term headlines. In his post last year about the mechanics of these late-stage financings, Bill Gurley (with whom I work as a Venture Partner at Benchmark) makes the point that employees need to understand their CEOs approach, “if your CEO/founder will take a dirty round, and is also anti-IPO, the chance that you will ever see liquidity for your shares anywhere near what you think they are worth is very, very low.”

Has the company taken on debt? Like a liquidation preference, debt must be repaid before the proceeds from being acquired are divided by shareholders. A company with a lot of debt is another red flag that could certainly jeopardize the value of your shares in the event your company is acquired.

Does the company aspire to be a public company? To be clear, a company need not aspire to go public. However, raising hundreds of millions of dollars leaves very few other ways to return value to investors or employees. Nevertheless, there are many CEOs that want to keep their companies private while continuing to raise massive amounts of capital despite unfavorable terms. You deserve to know the intentions of your leaders. Perhaps there is a good reason related to certain milestones your company must reach before going public? Alternatively, it may seem like the allure of less scrutiny is driving decisions (red alert!). The answer you get will help you quantify the likehood of your shares being valuable over time.

If the company’s plan is to stay private for the foreseeable future, have there been secondary sales for employees and/or founders? It’s a controversial question — you may want to fish around vs. appear to be so focused on liquidity, but it is fair for you to know whether employees and founders are selling their shares while the company is still private. If there is no line of sight to becoming a public company, secondary sales are your only chance at liquidity. But there are cultural and signaling implications if some employees are able to sell their shares.

Have the company’s financials been audited? Obviously, the value of your shares in the company is connected to the company’s financials. Early stage start-ups without massive expenses or balance sheets need not endure audited financials. But as companies become larger and/or valuable, checks and balances ensure that mistakes or misrepresentations are not impacting how investors value the business (which ultimately determines how many shares you receive in the company). You’d be shocked to learn how many companies raising money at a billion-dollar valuation are doing so with financials that have never been checked/audited by a third-party. Again, if you’re taking a major risk in your career for a grant of stock with a proposed value, you deserve to know how reliable it is.

Don’t Wait For The Cataclysmic Event, Start Asking Now

Like most bad behavior that brews in any industry, the bad behavior is liable to continue without much attention until a major event blasts it into consciousness.

Imagine waking up one morning to the news that one of the popular “unicorn” companies was just acquired for a billion dollars. “Wow,” you think. Headlines fly around celebrating the outcome. And then suddenly there is a flurry of tweets from employees of the company followed by an expose article revealing the fact that employees actually made very little from the acquisition. How is this possible? The company raised money at increasingly high valuations at unfavorable terms, and there was little left to distribute to common shareholders. Hundreds of employees got nothing more than a hard lesson learned.

I hope it doesn’t take such an event to encourage companies to disclose the mechanics behind their valuation and illustrate the implications for employee shares. But you can start asking now. Your CEOs willingness to answer these questions, the cleanliness and simplicity of his/her answers, and the assurances your CEO provides you are as important as any quoted value for the shares you are given for your investment of time in the company — an investment far more valuable than money.

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PS: Since originally posting this article, I have received a lot of feedback. Entrepreneurs and seed investors appreciate the sunlight on equity comp packages coming from late-stage companies. On the other hand, some late-stage company investors and CEOs are understandably defensive of their best efforts to communicate the possible value of complex equity grants. True, as a company grows, so do the nuances that impact the potential value of equity. However, there are always a finite number of shares and an internal model that can output the value of one common share of equity across many scenarios. Some have suggested ways for companies like eShares, that manage company capital tables, to fill the gap. Another interesting idea to reduce complexity for employees came from Brian Neider at Lead Edge Capital, who suggested a single question for employees to ask management: “Can you please let me know how much money I’d make from my options if the company were to sell or IPO for $100m, 200m, 300m, 400m, etc?” Of course, the answers will inevitably have some disclaimers and dependencies, but the answers will expose the potential impact of terms from late-stage financings.