John D. Perrings
Investors are an integral part of the startup ecosystem. They risk their capital on the ideas and reputations of startup founders, and their teams, to help bring a new company to life. The average person would probably consider the amount of money investors risk on any given venture to be significant. However, it is most likely the case that the money invested in a high-risk startup venture is not the money an investor lives on, day-to-day.
For startup employees, however, this is probably not the case.
Startup employees have a unique opportunity. They are the group of people that get to solve the problems that lead to discovering something new and/or better. And then put that out into the world.
But they also take on a unique set of risks. Unlike the investor, the typical startup employee probably does rely on the startup company for income to live on, day-to-day.
Startups are kind of like the Baja 1000. While investors provide the gas, the founders and employees build the 850hp, twin-turbo trophy truck and drive 100mph through the rough desert terrain (racing against 400 other vehicles), looking for the finish line. If the truck runs out of gas, it’s the employees who are stranded out in the desert, not the investors. The investors have 9 other trucks in the race…
Before continuing, let me say that this is not a commentary on the ethics of the investor/founder/employee relationship. There is nothing wrong with investors having capital with which to make speculative investments. Nor is there anything wrong with an employee taking on the risks associated with working for a startup. Startups need money and startups need talented, risk-taking, big-picture employees. The point of this article is simply to point out that there are risks. Risks that can be minimized if aware of them.
Down-markets can create a situation of triple-pain for startup employees:
Having gone through two popped bubbles in Silicon Valley, I know the effects of down economies on employment in the startup world. Employment status is inherently less stable with startup companies.
Your ability to earn an income is your greatest asset.
Question: If you are earning a market pay rate to work at a startup company, but that startup company has a 75% chance of failing and laying you off, are you still earning a market pay rate?
Do banks, investors, or other lenders charge the same amount of interest to high-risk borrowers as they do standard or low-risk borrowers? Go check out one of the peer-to-peer lending platforms, like Prosper.com or Lending Club, and look at the loan rates offered to people with different credit (risk) profiles. You’ll see the answer is “no.” Higher-risk borrowers are charged a higher interest rate to offset risk.
As a startup employee, you are kind of like the “lender,” charging the startup company “interest” (wages) for your labor. Should you charge a 1 yr old startup the same amount of “interest” as you would, say, The Walt Disney Company which has been in business for 95 years?
Most people prioritize their qualified plans (401K, IRA, etc) over their savings. They conflate retirement “savings” with actual savings. Qualified plans are investments not savings.
If there is risk, it is not saving.
When people funnel their savings into their qualified retirement plans, they subject all their savings to risk.
In a down market, not only could you find yourself unemployed, but since your money is locked away in a qualified plan, you could find your retirement account slashed by 20%, 30%, or 40% like what happened in 2008.
Is it really “savings” if you can’t access it when you need it?
In a down economy, many people will be forced to liquidate their qualified plans and, thus, pay taxes and penalties to access cash when they need it. This has long-term negative effects on the growth of your retirement account. You’ll have bought high, sold low, and paid penalties on top of that!
This is why a true emergency savings fund should be prioritized over a qualified plan. If you can’t ride out the downturns in the market, you cannot “invest for the long term.”
As I’ve shown above, employees take on more risk to work at startup companies. Just about anywhere else in the financial world, this risk would be worth something to the person taking it!
We are told that we are compensated for these risks by being awarded employee stock options…
To be continued in Part 2: Employee Stock Options are Not a "Bonus"
My mission is to teach people how to strategically accumulate capital in a way that makes all of their other financial activities perform better, and with less risk.
What are you doing, today, to ensure that you are in a position to take advantage of change, rather than react to it?
- John D. Perrings