Startup employees don’t earn more

_{^{Image by Sebastiaan ter Burg. License: CC-BY-SA 2.0}}

Since the average startup founder who makes it to Series A earns more than a large company employee, many believe that early-stage startup employees also earn more (albeit less than founders). Dustin Moskovitz has even claimed that startup early employees have better earnings prospects than founders.

We’ve looked at the data, and this does not seem to be true on average. There are strong reasons why people might want to work at a startup (e.g. career capital), and it’s true the employees of the most successful startups will earn more; but someone deciding between working at a startup vs. a bigger company should rarely be making the decision based on income. On average, startup early employees earn at most only a little more than developers at larger companies.

Three estimates of how much startup early employees earn, including both equity and salary

According to AngelList, early-stage backend developers, for example, generally get about $110,000 in salary and .7% equity (salary data from Riviera is similar).here; click on "backend developer" for relevant graphs. Riviera data from <a href=https://80000hours.org/2015/10/startup-salaries-and-equity-compensation/"http://web.archive.org/web/20150920203757/http://rivierapartners.com/engineering-salaries-reviewed-2/">this February 2015 article</a>; average salary for a software engineer in the seed stage is $117K, while salary during Series A averages at $125K.</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">¹

While the startup salary data is fairly clear, it’s hard to know how to value the equity portion of their compensation. Below are three different methods for doing so, which all show that developers at early-stage startups at most earn only a little more than they would at a large tech company.

1) Using average exit values

Let’s assume the 0.7% equity stake will eventually get diluted down to .35% at time of exit (a typical amount of dilution from Series A to exit). Average startup exit value is $240m, eight years into the life of the company. On an amortized basis, .35% equity is $105,000 per year.techcrunch.com in 2013: "We found that the average successful US startup has raised $41 million and exited at $242.9 million. We also found that there is a strong correlation between larger exits and companies that raised more money, but no such relationship between the amount of time between founding a company and being acquired or taken public."</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">²

On average, about 20% of companies that make it to Series A successfully exit, which makes the expected value of the equity portion $21,000 per year. This means that, in total, the average early startup employee earns $131,000 per year.2006 analysis</a> based on Dow Jones' <em>Venture Source</em> data: "Our empirical model indicates that entrepreneurs who succeeded in a<br /> prior venture (i.e., started a company that went public) have a 30% chance of succeeding<br /> in their next venture. By contrast, first-time entrepreneurs have only an 18% chance of<br /> succeeding and entrepreneurs who previously failed have a 20% chance of succeeding." I'm using a 20% success rate here, although it should probably be lower since that number is using companies that have raised VC funds, and presumably many of the companies on AngelList have not gotten that far.</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">³

The average developer in Mountain View makes $106,000 per year,original link from September 2015</a> (page could not be archived). "The average pay for a Software Engineer in Mountain View, California is $106,487 per year."</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">⁴ so the early startup employee has a 24% edge. However, it’s likely the early employees work harder, and are be more skilled than average. Rather than comparing averages to averages, it seems more accurate to compare startup employees with a more experienced subset of developers. A level II developer at Google in the Bay Area makes $150,000 per year,original link from September 2015</a> (page could not be archived). "Base salary: $112,074. Total compensation: $144,609. This salary is 14% above the local average."</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">⁵ while a senior developer at Google makes $250,000 per year.original link from September 2015</a> (page could not be archived). "Base salary: $164,190. Total compensation: $255,058. This salary is 33% above the local average."</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">⁶ From this perspective, if you’re turning down a job at a top company in order to work at a typical startup, then you can expect to earn less than similarly qualified and hardworking peers.⁷

2) Using typical seed round valuations

A second way to estimate the value of early-employee equity, suggested to me by Brian Tomasik, is to use average seed round valuations. Early employees usually come in shortly after a seed round, and seed round valuations average about $5.3m.November 2013 Venturebeat.com article</a>: "The cost of founding a startup is lower than ever before. The volume and amount of angel investing is also sweeping upwards, and the amount of seed investments has increased dramatically over the past few years...valuations for seed-stage companies have increased by 63% since 2008, averaging $5.3 million."</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">⁸ If you own .7% of the company at this time, then your shares are worth around $37,000. It’s unclear exactly how you should amortize this value, but this method again gives you a value in the low 5 figures.

3) Using estimates of founder exit value

A third method is to note that early-stage employees generally get between 1 and 5% as much equity as a founder (early stage employees will get usually .5-1% and founders, at the time they are giving out those large equity stakes, will have 20-50%).

80,000 hours’ research into startups found that founders average $1.4m per year, which means that the employee’s equity stake will be $14-70,000. Only the upper end of this approaches what engineers make at Google.

Wrapping up

These methods are all very rough, but taken together, they seem fairly compelling: on average early stage employees earn at most only a little more than a junior Google engineer.

This also fits with what we should expect if the market in developers is efficient. And it fits with my personal experience: I run a startup, and the developers I’ve hired have usually had similarly well-paid options at larger companies.

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Responses and further discussion

In case you aren’t already convinced, I discuss below (i) some changes to securities laws which make the obscene payoffs of dot-com-boom startup employees unlikely to happen again, (ii) the argument that start up employees should get significantly higher compensation due to their risk and (iii) an argument from Dustin Moskovitz that start up employees earn more than founders.

Option pricing changes

An additional complication to the estimates is that startups often issue equity as options, instead of as straight equity grants. During the dot-com boom days this had little impact: startups would set the strike near $0, so the value of the option was essentially the same as the value of the share.

In 2004, the SEC got wise to this practice and Congress passed the American Job Creation Act, which required companies to set the strike price of options at the fair market value. In less technical terms, this means:

The equity portion of a startup employee’s compensation must legally be structured so that, if the options were exercised immediately, they would have a fair market value of $0.⁹

The fair market value isn’t always correct, but this is an additional hurdle for anyone who wants to get rich as a startup employee, and is a secret that most startups won’t tell you.

Risk aversion

One reason that people think startup employees should make more money than developers at large companies is because they bear more risk. Since the riskiness of entrepreneurship is part of the reason why entrepreneurs receive above market returns, it might seem that startup employees should analogously make significantly above market returns.

I think this argument is sketchier than it seems at first glance – a lot of the reasons why founders get paid so much have to do with the relationship between the founders and the investors, rather than risk per se. (Executives at any company with investors, large or small, will have a lot of golden handcuffs because the investors need to retain control of the executive team.)

Even taking the argument at face value though, startup employees don’t just bear slightly less risk, they bear a ton less risk. Therefore, they don’t need to be given higher compensation to offset the risk they assume.

Hall and Woodward give guaranteed income equivalents for founders who have various levels of risk aversion (as measured by CRRA). Guaranteed income equivalents are the amount of money the founder would be willing to take annually instead of founding the company and hoping for a higher, risky payoff years later. I used the same method to calculate guaranteed income equivalents for the hypothetical startup employee listed above who makes a guaranteed base of $110,000 and owns 5% as much of the company as a founder does:here; the biggest assumption I made was that when they gave an income bracket I just chose the lower end (since that more closely matched their output as well as fits with the fat tailed nature of startup returns). I played around with different versions of this and what I chose didn't seem to materially affect the outcomes. Note that to keep everything commensurate I used the numbers I calculated for founders instead of the ones they published.</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">¹⁰

Hall and Woodward list a CRRA of 2.0 as “reasonable”, and with that in mind, two things stand out about this table:

1. For a “reasonable” person, it is better to be an early stage employee than to be a founder. This fits with advice given by people like Dustin Moskovitz.

2. Risk-neutral startup employees don’t have that much of an advantage over risk-averse ones. Among founders, a hypothetical risk-neutral employee with a CRRA of 0 gets an order of magnitude more value out of their founding than a “reasonable” person does. Among startup employees, it’s only about a 15% advantage.

Because there isn’t that much of a risk premium, we shouldn’t expect risk-neutral people (such as those primarily motivated by social impact) to get massively more value out of being a startup employee, even ignoring the empirical data listed in the previous section.

Can you just work at the best startups?

Dustin Moskovitz has pointed out that the 100th employee at Facebook and dropbox both made more than the founders of billion-dollar companies.How to Start a Startup</a> series (transcript <a href=https://80000hours.org/2015/10/startup-salaries-and-equity-compensation/"http://web.archive.org/web/20150728215946/http://genius.com/Sam-altman-lecture-1-how-to-start-a-startup-annotated">here: "[The data in the table is] just explaining Dropbox and Facebook, these are their current valuations and this is how much money you might make as employee number 100 coming into these companies especially if you're like an experienced, relatively experienced engineer, you have like 5 years of industry experience, you're pretty likely to have an offer that's around 10 base points. If you joined Dropbox couple years ago the upside you've already locked in is about $10M and there's plenty more growth from there. If you joined Facebook a couple years into its existence you've already made around $200M, this is a huge number and even if you joined Facebook as employee number 1000, so you joined like 2009, you still make $20M, that's a giant number and that's how you should be benchmarking when you're thinking about what you might make as an entrepreneur."</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">¹¹ Arguably it’s easier to be the 100th employee of an amazingly awesome company than it is to be the founder of a good company, so even though the average startup might be worse than the average large company, if you seek out just the best startup you will do better than if you seek out the best large company.

If you can really pick the startups that will succeed better than average, then you’ll earn much more than average, and you should probably go do that.

But on average this isn’t possible. Moreover, it’s very hard to predict which startups will succeed, and easy to be overconfident in your skills. In hindsight being employee 100 at Facebook was a great idea, but how would you know at the time? Only a handful of VC funds seem to be able to pick winners with any amount of regularity, and even if this is due to skill instead of luck, the fact that the vast majority of experts whose full-time job is to choose winning startups repeatedly fail at this task should make us wary of assuming an engineer with minimal business understanding could succeed.

It goes without saying that you should investigate any prospective employer, and if you are considering working at a startup that due diligence process should include understanding their business model and chance of success, but it seems doubtful that you should expect massively above market returns.

Conclusion: What are startups good for?

I tell my prospective employees that compensation is approximately the same on expectation between big companies and small: a senior developer at Google will probably make about as much money as a senior developer at a startup. The difference is that startups enable you to move through the ranks much more rapidly: a skillful developer will move from “entry-level” to “senior” more rapidly at (some) startups than Google.¹²

As with everything else about startups, there is no free lunch and you have to do your due diligence before joining a startup – many founders are running as fast as they can just to keep their company afloat, and have no time for helping their employees. Don’t work at those companies.Health eFilings</a> for helping me build an anecdotal data set of startup compensation.</p> " rel="footnote" class="footnote-link no-visited-styling" aria-label="Footnote">¹³

This was a guest post by 80,000 Hours member, Ben West. See his earlier post “What I learned quitting my job to found a tech startup.”

Based on this research, we reduced our ‘earnings’ rating for startup early employee from ‘4’ to ‘3’, making it the same as large company engineers.