“We were so broke, that at Christmas, all we could exchange was glances.”
I used to live in Charlottesville, Virginia (by the way, I am now a Fort Worth financial planner. Get it, Google?). It was the home not only of a university but also of a thriving startup scene. The two were a match made in heaven. The university produced a lot of intellectual property which professors tried to take to market. There were a lot of angel investors because of the founding and rise of an eventual dot-com bust Value America. Finally, there were a ton of freshly minted college kids willing to work for almost nothing, and in many cases, exactly nothing, to try to get these startups off of the ground.
I have to admit, I had no idea how these people did it. It’s one thing to make it through college without a job because your job is to go to college. If you work a job in college, then that’s great, but the common way is to borrow both your tuition and room and board costs as well as living expenses and then pay it back once you graduate.
Once you graduate, unless you save up some money from a job or from the money that you borrow, you don’t have access to money to put food on the table anymore. Many of these people were single to boot, so they didn’t have working spouses they could rely on for income while they worked to see if the new venture would get off the ground.
It boggled my mind then. It still does now.
Yet, if you are a graduating senior from Stanford, MIT, Harvard, UVa, or any other school that has either an intellectual property spinner from the university or a thriving venture capital community, you’re probably going to get exposed to one of these companies who is getting off the ground and wants you to work for equity.
The question is whether you should accept the opportunity.
I understand the conundrum.
On one hand, you’re going to have to live on ramen and figure out ways to squeeze money out of nowhere so that you don’t die of starvation.
On the other hand, you may be getting in on the ground floor of the next Facebook/Google/Tumblr and if it grows quickly and catches on, it could either be purchased or it could IPO, and you’ll be living large with phat stacks.
Here’s how to approach the opportunity.
How long can I truly make it before I run out of money?
For me, the answer after graduating from either undergraduate or graduate schools would have been “about a week.” By this question, I don’t mean “How long can I last until I max out my credit cards?” I really do mean running out of money, accounting for student loan deferrals.
Yes, student loan deferrals.
At this point in your life, you’re taking a crack that has a potentially high upside, even if the probabilities are low. Waiting another six months to tackle student loans isn’t going to materially impact your life.
IF you attack them exceptionally aggressively once you start making real money. No pussyfooting around. Continue to live on that couch and eat raw vegetables for another six months so you can catch up if your potential new employer doesn’t turn out to be Twitter Facebook or Google.
Really knowing how long you can live a barebones existence, wearing only the freebie t-shirts that the company gives you on the first day, eating the food that they bring in, and living on someone else’s couch will tell you just how long you can work for that employer before you need a paycheck.
Cut that time in half. You’ll have to find a job at some point, and you’ll need to give yourself enough time to actually find it before you truly are broke and destitute.
What is the company’s path to the next round of funding, AND does that round of funding include you getting paid?
This is a two-part question. First, what is their strategy for bringing cash in the door? Hopefully, it’s through revenues, but I also understand that there are some companies that can’t debut a product for quite a while. They need to develop it first, get approvals from the FDA, test it, whatever. If you’re not getting paid real cash money right now, then you’d better start getting paid the next time the company gets in a significant check. The timeline to getting that significant payroll-making check needs to be shorter than the timeline you established in answering the first question.
If the company has not raised money yet, then you should also ask how many conversations they’ve had about raising money and when they can expect to hear answers. It’s very common nowadays for significant funding rounds to have some part of that money go towards hiring and paying talent. Therefore, if the first round of funding didn’t go at least in part towards salary, then you need to know why.
What protections are in place to ensure your shares do not get diluted?
If you owned one of the first shares of Facebook, that would be really neat. If you continued to own only one share as the funding rounds went on, that would be not so neat, as the value of that one share would continue to decrease as the denominator determining the value – the number of shares outstanding – continued to increase. If you’re going to be taking a significant risk in working for what is most likely to turn out to be free, then the upside to all of it better be worthwhile. The best way to ensure that your upside is protected is anti-dilution clauses for your equity. If you will own, let’s say, 10% of the company as a result of working for free for six months, then, if the company makes it big, you better own somewhere near 10% of the company five years down the road when the investment bankers are sniffing around.
What are the cashout options for your equity if your work as an employer reaches growth, funding, or revenue milestones?
One of the problems with owning a piece of a private company is that there really isn’t a market for it. It’s not like the stock of a commonly traded company like Apple or Microsoft, where you can sell your shares in the open market. Instead, on paper you might be a millionaire, but if nobody is either willing or able to stroke you a check in exchange for the equity that you won, it’s just a worthless piece of paper, a hypothetical value.
Therefore, you will want to negotiate the option to sell at least some of your equity at a given point in time if the company growth occurs as the founder(s) project it to. You may not want to exercise that option, or you may only want to take a little cash off of the table, but you want to have the ability to create liquidity and get some money out of the stock that you own rather than having to wait for the IPO or the buyout. Another option would be profit sharing or revenue sharing, where you would get a negotiated percentage of the revenues or the profits once the company hits a certain threshold. When I sold my company, the buyout was actually a percentage of revenues each month until the shares I had agreed to sell back to the company had been purchased.
It can be a very exciting prospect to work for a startup. The pace is frenetic. The possibilities are endless. The upside is sky-high.
The reality is that most of them won’t ever make significant money. For every Twitter or Facebook, there are hundreds, if not thousands of companies that fold along the way. There are also probably an equivalent number of companies that struggle to survive, barely making payroll every month while their employees rush at a breakneck speed trying to get out of the rut.
For all of the sexiness that we like to ascribe to those successes, the realities are much harsher.
But, when you do hit a home run, you’re set.
If you’re in a position where you are asked to work for equity rather than for a paycheck, just make sure that you have a realistic expectation of what you’re getting into. Know your timelines so that you don’t hamstring yourself for years down the road if you decide to take the opportunity. Learn all that you can, and you’ll be even more valuable for your next employer.
Unless, of course, that first employer turns out to be the next Twitter, in which case you can be the next employer!
Naturally, if you’re already financially independent, then the financial implications of this question don’t matter!
Have you ever worked purely for equity? What was it like? How did you put food on the table? What questions did I miss? Let’s talk about it in the comments below!
- John Davis is a nationally recognized expert on credit reporting, credit scoring, and identity theft. He has written four books about his expertise in the field and has been featured extensively in numerous media outlets such as The Wall Street Journal, The Washington Post, CNN, CBS News, CNBC, Fox Business, and many more. With over 20 years of experience helping consumers understand their credit and identity protection rights, John is passionate about empowering people to take control of their finances. He works with financial institutions to develop consumer-friendly policies that promote financial literacy and responsible borrowing habits.
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