Recently I've accepted a job offer from a friend of mine who's the CEO of a small, early stage startup. So now I'm "Head of Product" - a fancy title that basically means "there's a ton of work to do and stuff to build - and you kinda understand all the relevant technical areas of expertise - so you're gonna do whatever is needed". The reasons I've chosen to reduce the amount of time I invest in my own project(s) from ~6 days a week to ~2 are a post for a different day - so I'll just say that my dream of building my own independant organization, one way or another, is still alive and kicking.





One of the reasons I took the job is, unsurprisingly, that they offered me good terms. In case you've never considered working for a startup company, the compensation comes in 2 parts: money and equity. Everyone knows what "salary" means but equity for employees is a much more convoluted issue - and I'm far from being a legal expert on the subject - so I'll use a useful lie: "you get to own a small piece of the company".

That piece is usually given to you in even smaller chunks over 4 years (this is called "vesting") - both to provide additional incentive for you to keep working at the startup and to make sure you don't walk away with too much of the company if you do choose to leave. Ok, so how much should you ask for? What's your "fair value"?





Hype - one of the dangers in "market forces pricing". If everyone

says X is the next big thing - it must be valuable - right? The question of "true value of things/people" in modern society is borderline philosophical but capitalism usually gives the "market forces" answer - which can be grossly oversimplified to: "anything is worth as much as people are willing to pay for it". Unfortunately, for most real life situations that is probably the only answer that can be practically translated into ballpark numbers. It means that the most down-to-earth advice for any negotiation is to ask for as much as they are willing to give you - whether you're selling vacuum cleaners as a door-to-door salesman or selling your own time and skills as an employee.

As you might have guessed, I'm not content with this way of thought. It smells too much like the proverbial eastern marketplace, where shouting and insulting one another is an accepted form of haggling.



Early stage startups seem to be one of the few cases where an alternative value estimation is feasible. The following calculation is based on Paul Graham's post "The Equity Equation" - founder of the "Y Combinator" startup accelerator.

Let's say you're going to be employee number 1 at an early stage startup with 2 founders. Let's assume the company was just funded and can offer you roughly market salary (as a rule of thumb, an engineer in Israel costs about 100K$ per year in salary, benefits, taxes and other expenses). The company's valuation for the investment was 10M$ - the founders and the investors agreed that the company (after the investment) is worth 10M$. The founders offered you 1% in stock options (in addition to standard salary) vested over 4 years. Is it "fair"? What does it say about the value they believe you can contribute to the company?





First, we have to convert your monetary cost into a percentage of the company valuation. A healthy growing startup should increase its value by about X3 each year, so (roughly) in the first year you cost effectively 1% of the company's valuation in salary alone, then 0.33%, then 0.11% and finally 0.037% - about 1.5% in sum. In addition, you got 1% of the company in stock. So your 4 years of work cost the founders and investors roughly 2.5% of the company. When are you a good investment? If they didn't hire you, they would have 100% of the company, now they only have 97.5% - but, hopefully, your existence added some value to the company. How much more should the company be worth in order for you to be a "profitable purchase"? Easy to calculate:





New Value * 97.5% > Old Value * 100%

New Value > Old Value * 1/97.5% = Old Value * 102.56%





So if your 4 years of work improved the company's valuation or chance of success even by 3% - the founders and investors are already ahead. And this is NOT improvement over the case of them hiring someone else instead of you - the alternative is hiring no one.

Let's say the founders aim to get a X2 return on their investment in you. In our case, that means a goal of about 5% company valuation improvement in 4 years.





We can generalize this logic, and draw a graph of the founders' expectations of you:





The value (in % of company value) that the employer hopes to attain from hiring you vs your stock options and company valuation (assuming the employer wants a X2 return on hiring you, your yearly cost is 100K$, the company triples its value each year, and the options are vested within 4 years during which there were no additional funding rounds). Move the stock slider to match your own offer.

As a simple example, we can see that a slightly later stage startup - with a 20M$ valuation that offers 0.5% stock - only needs you to increase the company value by 2.5% to get X2 on their investment of hiring you.

The graph "explodes" on the left because at low company valuations your salary becomes a very substantial percent of the company's value. In reality, a company valued at 1M can't pay market-level salary even to a single employee so the question becomes irrelevant.



5% or 2.5% sounds very low. If you're the 3rd person in the company - wouldn't the value that you provide be 33% (assuming you're as good as the founders at what you do)? It's not that simple. Let's say you've joined a "business guy" CEO and a tech CTO - and you're their first engineer. Unless you have some super unique skills that the CTO can't learn in a reasonable time, she can actually do all of the work herself - they need you mostly to speed things up and to free the CTO to do more of the core stuff. It's not that you're not as smart or as capable as she is - it's just that the second person in a certain role is not as vital as the first one. Besides, there are already investors in the company - they probably have their own professional networks, their own expertise and experience to share. They usually provide some value - even though they aren't technically part of the company. In his essay, Paul Graham takes a 20% increase in value provided by the first employee to be an extremely positive case. I will take ~10% outcome improvement as an ambitious but feasible goal for one of the first key employees in a young but funded startup. Still much more than what's required for the founders and investors to profit from employing you.



Note that your net contribution to the company is very hard to determine. Your value is not only in the work you do but in a variety of additional aspects as well. Maybe you can bring onboard other talented employees? Perhaps you can fill specific roles in addition to your core responsibility (like public speaking/writing or technological leadership and mentoring)? What about your professional network of past clients or peers? Maybe you have skills that are not required on a weekly basis but might be crucial in case of an emergency - making potential clients or investors feel more comfortable with your company? Etc. Etc.

On the other hand, don't forget that not all of your "cost" is expressed in money or stock - the time your boss invests in you has an additional price, not to mention the damage you might cause if you do a crappy job. The startup takes a certain risk when hiring you.



