What to do if you work at an “overvalued” startup?
Startup employees should understand how their equity compensation functions.
This is particularly important in a downmarket, as we’re seeing now (2023), because many employees have “underwater” (i.e. now worthless) stock options that represent a meaningful portion of their potential net worth.
If you are in this position today—where you work at a company that was overvalued, likely into the billions of dollars, back in 2021 and is coming back to reality today—here is what you need to know:
Disclaimer: The below is not financial or tax advice. Please speak with a professional. We may be able to help at Compound, where we provide everything you need to manage your finances (advice, tracking, investments, taxes, and more).
1. Be calm and intentional:
Remember that startups are a long game and that all great businesses take decades to compound. While you may feel nervous, avoid making rash decisions.
2. Start with data collection:
Gather all of the information you need before making any actual moves. Be sure you understand everything about your equity and the underlying stock (the health of the business). The gathering process likely involves speaking with others. Talk to your manager. Ask them what they think, and they may be able to provide important insight. You can also expect proactive guidance from your leadership team.
This includes getting a complete overview of your equity grants such that you can answer the following questions:
- What type of equity do you own? Stock options (ISOs, NSOs), restricted stock units (RSUs) or some combination?
- What is your strike price? Your strike price is the 409A valuation/share at the time you joined the company.
- What is your vesting schedule? (Typically something like 4 years with a 1 year cliff but this varies by stage of company)
- What is the latest 409A valuation/share? (This is lower than the preferred price generally)
- What is the latest preferred price/share? (This is the investor sticker price for your equity)
- What is your post-termination exercise window? (If you were to leave, what would happen to your equity?)
It also includes getting an understanding of the state of the business:
- How is the business doing? How are the metrics? How is profit looking?
- What is the company’s liquidity plan (if any)? Is it looking to go public in some capacity? At what valuation? What public comps exist on the market today?
- How is the team? Do you believe in them to drive the business forward?
3. Analyze your scenarios:
Armed with the data you’ve collected, you can now begin to analyze the scenarios that make the most sense for your situation. Your analysis should include an assessment of all potential financial outcomes including their short and long term implications. Be sure to highlight risks, such as needing to afford taxes.
It is not that straightforward to figure out if your options are actually valuable (known as in the money) because there are multiple ways to value equity.
For the purposes of this article, we will focus on three ways to value equity:
- Preferred price: A lower preferred price and 409A valuation per share may mean the value of your equity and net worth will be lower than you previously estimated. As a result, it may impact your expectations around ability to achieve your future financial goals (e.g. the size of the house you want to buy on what time horizon or capacity to pay off debt).
- 409A valuation/share: Stock options are taxed upon their bargain element, which is the difference between your strike price and the latest 409A valuation. As a result, a lower 409A valuation may reduce your taxable obligation if you were to exercise your stock options right now (compared to exercising when the 409A is higher).
- Secondary market trading: Anecdotally (not statistically significant data): most companies (in early 2023) are trading down from 50% of their peaks on the secondary market. The secondary market is far from efficient, and remember that startups are built over time, but this may give you an idea as to what you can expect for the value of your equity.
4. Make a decision:
There is no one way to decide what to do with your equity. Here are some heuristics, though, that you should consider:
We suggest you speak with a professional. While it is hard to complain to your friends about a 7 or 8 figure tax bill—this stuff is _tricky_ (not rocket-science, but tricky). Again, the below is _not_ tax or financial advice.
- If you are still excited about your company, now can be a great time to work hard and build something valuable: Chaos is a good time to work with conviction on something you believe in. Hunker down and build something great, and negotiate for additional upside from your leadership team as you prove yourself as critical to the businesses short and long-term success. Down markets may be the absolute best time to differentiate yourself, build skills, learn, and accelerate your career.
- If you are thinking about exercising your stock options now or in the near future: Remember that startups are risky investments, often heavily correlated to your broader net worth. Because there is a lower bargain element, it may be a tax-optimal time to consider exercising your stock options (reminder: options are taxed upon the bargain element which is the difference between your strike price and the latest 409A valuation). Caution: tax lawyers do not rule the world. There are many reasons to _not_ exercise your stock options You should not exercise your stock options if you do not believe the valuation will go higher (than at least your Strike price + covering all the taxes).
- If you need liquidity, times will be tougher than perhaps you originally expected. You should update your financial plan accordingly to make sure you can cover incoming expenses and also adjust your expectations for future wealth. Now is not really the best time to sell your shares on a secondary market (given the lack of demand for most companies, so only do that in a scenario where you have totally given up on the value of the startup).
- If you do not believe in the future of your company, consider trying to find a new job. It may be a more optimal move than trying to strategically buy and/or sell your shares. Now could be a good time to start a new company or find a more stable job. Ultimately, it depends on your risk tolerance and priorities.
Once you have a decision in mind, we suggest you write a memo to yourself (perhaps with the help of a professional) to help you minimize your regret. Why are you making the decision you are making (and remember, not making a decision is also a decision!)? What are the risks? What are you nervous about? Why are you excited? Getting this all into writing can help you really understand your thoughts and motives.
Startup employees are not all doomed—there is more to life than money—but most of them have equity that is now worthless and will likely not be worth anything for many years (until their startup can actually grow into its valuation). We have no way of predicting the future—things may completely turn around tomorrow—but we do know that acting intentionally and creating a plan here can help you better understand where you stand and hopefully obtain some sort of peace of mind as we endure this downturn.