I am not a pessimist. I am not starting 2015 with a negative thought. I spoke to my cousin for 6 hours yesterday on this topic and this is how the Harvard MBA analysed into a simple understandable formula.
Based on some of my friends in startups that went public last year at 10 bucks, and my own experience at startup that got bought by a bigger company where only founders made money, I believe some of my assumptions are true. We should not consider the one off startups that took off such as Instagram with 10 people or WhatsApp with 34 Engineers.
On average if you negotiate 1% of equity of a great startup with a huge potential ($100 million?), you may feel very excited about the startup.
Each funding rounds takes away 30% (20% VC dilution and 10% option pool). So for a typical awesome startup to beat 1% win rate of being successful would need around 4 rounds of funding before the exit/ IPO at $100 million. So your new valuation after 4 rounds gets to 0.24% (1% * 0.7^4 = 1% * 0.2401). Well minus the taxes at capital gains it is roughly 0.19%.
So, even a $100 million successful exit @ 0.19% is $190K for you. This would have taken roughly say 5 years. You know 3 years happened to just 2 companies (Groupon/ Zynga). My friends at the mobile startup said that they did not get annual pay hike or bonus during the first 2-3 slogging years and each of them estimated a an opportunity cost of roughly $40K for the first 3 years.
So, the net gain of $190K – $120K = $70,000 over 5 years.
Let us say the exit was $500 million in 7 years as opposed to $100 million. Even then your gross @ 0.19% with just 4 rounds of funding is $950K. Since you were underpaid by about $40K in salary+ Bonus+ perks for 5 years to hit this big. Your net positive is $750K. The probability of a 0.5 Billion exit is exponentially lower than $100 million exit.
So next time you think joining a startup with 1% equity can make you rich, think again.
May be starting a startup rather joining one is the way you get rich 🙂
Thanks for the insight!
How is a net positive of 750k not getting rich?
I mean, maybe you’ll still need to work but… no mortgage means saving larger sums and faster which means you might be able to quit working at a young enough age to actually enjoy life.
Isn’t that all we want?
My friend got super lucky lately, super lucky, he joined a company and merely 1 year later the company started trading and then he needed to work there 3 more years so he could sell all his options, he made 450k, plus he made a salary almost as high as mine (I worked for a very large company with large bonuses).
So he came out say 400k dollars ahead of the deal, that’s net, now I manage to save 2k a month which I think is quite a bit, for me to save 400k I need to work 200 months.
That’s 25 years!
So my friend has in his bank account, assuming we are both spending the same up until now, what I will have in 25 years.
Does ‘jumping’ 25 years into the future with your bank account not count as getting rich nowadays?!
He can effectively retire anywhere between 15 and 20 years before me.
He won 15-20 years.
That is riches.