Leaving at the cliff

Leaving at the cliff

Ben Kuhn has an excellent post on valuing startup options - the primary conclusion is that the ability to leave a startup if they’re not doing extremely well increases the value of your options significantly (by 30-100%).
notion image
The above graph from his post demonstrates that, but also shows two other quirks of the standard vesting scheme:
  • After four years, and your initial option grant fully vests, you shouldn’t have any financial incentive to stay at the company, unless you’ve received other stock refreshers or pay raises to be commensurate with market comp.
  • As you approach one year, you have a growing incentive to wait until the cliff, even if the company isn’t doing super well. At the one year mark, the graph has its sharp discontinuity, a point where you should seriously reconsider.

EV Cache busting

Patio11 has a useful thread on the value of startup valuation uncertainty, that ties into Ben Kuhn’s analysis.
Notably: an offer at a company is good given a) your measure of your leverage at it, b) your current estimate of its long-term value.
As you get closer to your 1 year cliff, you have more and more deferred compensation to lose - so you might be willing to stick it out for a B- or C+ company. The reduced EV of the C+ company is offset by the fact that you’re going to get 12 months of equity just next month.
But at the moment of your 1 year cliff you should seriously re-assess the situation: are you still optimistic about the EV of the company? Do you still want to continue purchasing more options at ${OPPORTUNITY COST}? If not, you should leave. Ben Kuhn notes that this would lead to people startup-hopping often, which in practice does happen.

Lotto tickets on the same numbers

Ben Kuhn though focuses on a purely linear model: ie: you’re maximizing the EV of money. He notes this as a caveat:
• Everything here is calculated just with expected values; it assumes you’re completely risk neutral. This is obviously wrong for most people (though maybe not if you plan to donate your extra income).
If you’re not totally risk neutral, this assumption is more and more of an issue the earlier your startup is.
As an early employee at seed or series A startup - you’re not really expecting payouts in high $100k to low $ms range in most worlds. You’re expecting either a) in most cases you go bust and get nothing, b) in some cases you exit and you get significantly rewarded (eg: >$10m).
The converse happens at late stage startups - where it’s unlikely that you get massive payouts, but the worst case is somewhat less than FAANG pay, and the best case is a small multiple of FAANG pay.
This significantly intensifies the motivation to leave for an early startup employee - at your one year cliff, you’ve already got an option on the upside. You’re likely pretty ambivalent between ${BIG NUMBER} and ${BIG NUMBER}/4. Your best bet is to take more shots on target, since the odds are low. If you’re at a later stage startup though, it’s instead more like $1m vs $4m, which is more instrumental for, eg: buying houses in the Bay Area.
As an early startup employee, you’ve already placed a long bet on a set of lotto numbers - do you really want to spend more opportunity cost on the same numbers?

You’re probably not just in it for the money though. A year is good time for you to ramp up, gel with the team and get into a good place to have maximum impact. You’re going to have to start from zero if you leave, but optimizing for impact seems unfortunately not aligned with your financial situation [1]
The financial incentive to stay at an early stage startup drops dramatically after the first year. But perhaps you should still stay?

Appendix: Maybe options are just always bad

One alternate viewpoint is: “This post notices that accruing more options after year 1 is a bad deal, but that’s irrelevant because taking options over cash is always a bad deal”
Dan Luu articulates this case in Startup options vs Cash - where he concludes that startup options are just worse than cash. You can’t out-pick VCs, they have the benefit of diversification, and if you really really want to bet, you should just work at Google and angel invest on the side.
I don’t really have a great response to this claim fwiw. The strongest I can muster is ~= you can out-pick VCs, somewhat diversify by job-hopping, and getting the deal-flow to invest in the best startups makes angel investing prohibitive.

[1] Tender offers & secondary sales seem like they do a good job at improving incentive alignment here - by making it so that you if the company is doing well, you can lower your risk and avoid having to jump ship. But early employee liquidity is still not predominant.