Series A startup Equity is worth 4x the preferred price

There's a lot of early-stage employees out there asking, "What's my equity worth?" And a lot of useless responses:

• "It's worth nothing until an exit" (then admit this is a bad deal financially).
• "You figure out what it'll be worth" (not much of a guide).

Instead, let's build an "objective" model -- relying on how the most sophisticated players in the game — the investors — value it.

The naive approach is just multiplying your_shares * preferred_price_per_share. By that math, most startup offers will look like crap compared to a FAANG package. In reality, factoring in all the inherent advantages of early-stage equity backed by top VCs, the equity grant is worth over 4x that naive calculation.

Why? There are three key factors:

1. High Expected Returns (The Asset Class Premium)

Startups are risky and illiquid. To compensate for that, the asset class as a whole must generate high returns. Top VC funds, the ones that set the market price, target ~30% IRRs for their portfolios¹, which is far beyond the public markets. Your own return (the IRR over a portfolio of startup attempts) is a bit lower given the preference stack, but not by much. We'll make it 28% conservatively.

2. The Ability to Quit

While the investor must put in their funds at the one-time capital call, as employee, your decision to invest and continue vesting your typically 4-year equity grant is a continual decision. That is, you can recall your "investment" by quitting, unlike investors.

That is your equity investment is more like a call option. And more volatility means the call option is more valuable. To see why, think of a simplified binary model:

• Heads: The startup 4x's over 18 months. Your vesting equity now makes your total comp eclipse anything you'd get elsewhere. The culture of the valley is such that they'll keep paying you to retain you, as opposed to firing you to save future equity dilution.
• Tails: The startup is going nowhere at this point, if not dead. You just quit and retry this lottery.

3. Much Lower Taxes

With the Qualified Small Business Stock (QSBS) incentive, if you invest (including with your human capital!) in businesses with under $100M in assets, your first $15 million in capital gains are federally tax-free if you hold for 5+ years. That's a 0% rate, compared to FAANG RSUs that are taxed as ordinary income (~40% federal + Medicare) or for non-QSBS equity/ISOs/NQSOs, long-term capital gains (23.8% federal + NIIT). This tax shield can raise your post-tax compensation by 80% or so in California.

¹ This 30% includes cash drag - their IRR of actual invested capital is actually slightly higher - which pushes the employee numbers higher. However, as VCs hold preferred stock with liquidation preferences while employees hold common stock, this effect is slightly more than cancelled out - in my modeling employee IRR is around 28% over a portfolio of repeated startup attempts.

This calculator models your equity's value by combining these three factors. It calculates your risk-neutral upper bound, ignoring any discounting you may apply given your own risk-aversion.

Note: You should use this calculator as a comparison tool between different offers. Just at the headline "Adjusted Total Compensation".

Some presets to get you started:

• Typical Public Tech: Public market returns, typical volatility, RSU tax treatment.
• Unicorn: Late-stage VC returns, higher volatility, RSU tax treatment.
• Series A: Early-stage VC returns, very high volatility, QSBS eligibility.

Play around with it!

The type of equity you receive dramatically affects both the tax treatment and economic terms. Here are the main types:

Restricted Stock Units (RSUs)

• Common at: Public companies, unicorn ($1B+ valuation) startups
• How they work: Company grants you shares that vest over time (typically 4 years)
• Tax treatment: Taxed as ordinary income when shares vest and converted to shares (~40% federal + state)
• Exercise price: $0 - you don't pay to receive the shares
• Risk: Lower risk since you get shares regardless of company performance

Stock Options (ISOs/NQSOs)

• Common at: Early to mid-stage startups
• How they work: They are call options: the right to buy shares at a fixed "strike price" for up to 10 years.
• Tax treatment: Long-term capital gains if held properly (~24% federal + state) net of exercise price, potentially QSBS eligible
• Exercise price: Usually 15-25% of preferred share price when granted
• Risk: Higher risk - options can expire worthless if company doesn't grow

We assume California tax rates and Federal tax rates are calculated using your presets.

To handle the equity returns, factoring in higher expected returns and ability to quit, we produce a very simple model for an upper bound:

• Your common stock goes to $0 over your decision timeline (default: 18 months) with odds p; else multiplied by k (the "success multiplier").
• k represents how much your equity value grows if the startup succeeds (doesn't fail). For example, if k=3.5, your equity becomes worth 3.5x its original value in successful scenarios.
• p and k are constrained by expected returns on valuation and volatility of the stock. Higher volatility and higher expected returns both increase 'k' - riskier startups have higher potential upside when they succeed; higher volatility in turn increases p (riskier startup more likely to fail).
• If the startup fails (or just goes nowhere), you quit and get a new startup job (with 0 lag).
• If the startup succeeds, you continue vesting for the remaining time in your grant (typically 4 years total, so ~2.5 years remaining after an 18-month decision timeline), with your startup stock continuing to increase at the expected return (default 28%).

Deriving k and p from Volatility (σ) and Equity returns (μ)

The two possible arithmetic returns are -100% (or -1) if the value goes to 0, and k-1 if the value goes to k. The expected returns (μ) constraint the relationship between p and k

μ = p * (-1) + (1-p) * (k-1)

Volatility is the standard deviation of returns. We'll use variance (σ²) to make the math cleaner.

Then with these two equations, we can calculate the upside multiplier k and odds of failure p as a function of your provided μ and σ

k = (1+μ) + σ² / (1+μ)
p = σ² / (σ² + (1+μ)²)

Note that in the inputs, you provide annualized μ and σ. To solve p and k, these are linearly scaled by your decision timeline and the equations above are used.

Repeated attempts

Your overall expectation for your 4 year vesting schedule is higher than the expectation on the stock. With probability (1-p), you get the upside multiplier and continued returns at the expected return over your remaining vesting period. With probability p, you lose all your "investment", but try again with a new package that covers the unvested time. Thus, the overall "returns multiplier":