Formula to evaluate the earnings potential when joining a startup


1

I'm trying to come up with a rough formula to help decide if I should join a startup. I'd like to weigh my current pay vs joining a startup, taking into account opportunity costs and possible final payout, all weighed against the inherent risk of joining a startup. Here's what I'm thinking ATM:

curr(time) = time * CurrentPay

Startup(time) = time * (BaseSalary - OpportunityCost)
Investment(time) = curr(time) - startup(time) (e.g. the amount of pay cut you took)

Payout = (net?)SellPrice * EquityShare

TimeToSell := how long you were at the startup before it sold <= BreakEvenTime = curr - (startup + Payout)

SuccessProbability := odds that a company will be sold for the assumed price
Roi(time) = Equity - investment(time) / investment(time)

MakeMeMove(Investment, Payout, TimeToSell, SuccessProbability) = ???? = do it!/don't do it!

That last part is where I'm stuck... How do I turn Roi/risk into a "make me move" number? Given a statement such as "If the payout is a cool million then I'm willing to take a chance on a company that has a one in ten chance of succeeding.", what formula could I use to evaluate an offer?
Completely arbitrary Example:

Person joins company with 50% chance of selling for $10M in the next two years. Person gives up a job making $100k to make a base salary of $80K plus 1% equity. Given an equivalent amount of work, this person could make an additional $10K/yr in side work had they stayed at their old job. Company beats the odds and successfully sells for $10M after two years...


Curr = $200k

Startup = $140k (salary - opportunity cost)

Investment = $60k (curr - startup

Equity = $100k

Roi = 67% on an investment that had a 50% of returning nothing

Other Questions
  • How much equity share is typical for a: founding engineer (at a software company)? A non founding engineer(e.g. Brought in, say 2 years later). Vague question I know, just looking for some general guidelines...
  • What is the avg time taken to sell a startup? (again, looking for hard and fast guidelines)
  • If the company does sell, is your equity payout based on the sale amount or net profit? Other mitigating factors?
  • How is the payout taxed? Cap gains? Income tax?
  • Are there any tax benefits/liabilities to being an equity holder?

Any advice would be greatly appreciated!

Edited title to highlight the financial focus of the question.

Software Equity Job Offer Tax

asked Apr 14 '12 at 03:26
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Nick P.
6 points
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  • When you finish are you going to next work on a formula to decide whether or not you should marry your girlfriend? How will you weigh the potential advantages of having children over their future costs? – Gary E 8 years ago
  • @gary so you're telling me you never try to weigh the pro's and cons of any significant decision you make in life? Your "should marry your girlfriend/have children" is also a bit of a straw man, since the benefits of family are decidedly more abstract. We're talking time,money,risk here... all things that people measure all the time... But then again, maybe I should just wing it and jump blindly into a big decision based on feelings or something... ;-P – Nick P. 8 years ago
  • @NickP. Well as long as you can judge the probability of failure, costs to your health from working 20 hour days for some period of time, etc you could come up with something tangible. – Karlson 8 years ago
  • You can, and most people do, make up a list of pros and cons before deciding to take a job. But you can't write a formula to make the decision for you. This is a personal choice, based on your personal preferences, and not really applicable to Startups. – Gary E 8 years ago
  • @Gary - One could simply incorporate personal preference into the equation, where the different factors are weighted based on preference (e.g. if I'm a high-risk individual, that may impact certain variables more so than someone with lower risk). at Nick P., I'll post an answer elaborating – Dolan 8 years ago
  • @karlson wise words. that's a big part of why i'm trying to come up with a formula for this... if i can have some sense of the benefit vs status quo, then i can start weighing that against the costs. – Nick P. 8 years ago
  • @dolan exactly. I'm trying to frame this as an investment decision, how much would this investment return, taking into account the level of risk. After all, if you run the numbers and it ends up costing you money, why take the risk? If the numbers look good, then you search your feelings to decide if it's a right fit. – Nick P. 8 years ago

2 Answers


1

There are at least four dimensions that you need to consider whether to join a startup as an employee (or from the flipside, getting other people to join your startup) - those are:

  • Paycut (or opportunity cost) – as opposed to what you can earn if you take a job with a large corporation (like those in the Fortune 1000 list)
  • The company's unfair advantage – as in what interesting factors in the job that the startup offers and more established companies cannot possibly provide.
  • Work/Life balance – often startups are terribly resource-constrained, and you may have to work significantly longer hours due to this.
  • Boss' (or founders') working attitude – It's pretty common for startup founders to be a bit arrogant and you might want to gauge this for the particular startup that you're interviewing with before signing the deal.

If you look closer at the four factors above, only two can be valued with money. Those are paycut and work/life balance (because working hours can easily be translated to dollars). Since the other two can't be easily (and objectively) mapped into dollar values, I suggest you seriously reconsider your approach of making this decision based on financial factors alone.

Note that these factors are only applicable when you join as an employee and not when you also given a large portion of equity that allows you to join as a member of the board.

I've written an article on how to entice experienced employees for your startup, and the materials are also applicable to see whether you want to work for a (particular) startup.

answered Apr 14 '12 at 16:48
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Adib
293 points
  • Thanks for the advice! I'd give you a +1, but i don't have enough rep yet :) Just to be clear, I'm not making a decision based based solely on financial factors, I'm trying to *determine* if the financial factors mitigate all the other negative factors you mentioned. – Nick P. 8 years ago

0

Regarding your equation, it seems you are going in a decent direction. I mentioned in my comment above that you could personalize this equation based on your preferences on things like risk-adversity, amount of savings in bank, etc.

riskAdverse = 0.9

daysSurvivalOffSavings = 90
estimatedDaysToFindNewJob = 30
curEligiblityUnemploymentMonths = 6
etc.

(daysSurvivalOffSavings - daysSurvivalOffSavings)*riskAdverse + ....

Getting lazy on calculations, but hopefully my point of personalizing gets across.
answered Apr 14 '12 at 07:44
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Dolan
101 points

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