Every startup dreams of hitting it big, either by getting acquired or going public. Yet, there’s a downside to getting bought out, especially for employees who may find their upside potential capped and their contributions undervalued.
In the fintech realm, behemoths like Fidelity, BlackRock, JP Morgan, and Bank of America are on the lookout for promising startups. For these giants, shelling out a few hundred million dollars is negligible if they can integrate new tech into their vast networks. For instance, BlackRock’s acquisition of San Francisco-based FutureAdvisor was a significant move. I had a chance to meet Bo Lu, FutureAdvisor’s co-founder, for a tennis match before the acquisition news broke out. The deal, although undisclosed, is rumored by The Financial Times and RIABiz to be around $152 million, marking a substantial return from their Series B funding round in 2014, which valued them at $75 million.
Initially, I was thrilled for the FutureAdvisor team, considering the prevalent startup bubble and their uncertain future. A 2X return in a year is commendable for their venture capitalists, especially against the backdrop of the S&P 500’s performance during the same period. If the co-founders retained a 20% stake, they pocketed around $30 million each.
However, most startup employees aren’t founders; they own minimal shares. From an employee’s perspective, the acquisition scenario might not be so rosy. Consider the employee’s dream of striking it rich, which often ends abruptly with an acquisition. Unlike scenarios where startups like LearnVest got acquired by NorthWestern Mutual for a potential $250 million, FutureAdvisor’s acquisition was straightforward with less contingent on performance hurdles.
Here’s why being part of an early-stage startup can be a gamble:
– The risk of the startup folding within five years is high, over 50%, and the likelihood that your equity will be worth anything is similarly risky.
– With salaries often below market rate, the potential for a 10X return on your equity must be a believable outcome to justify the risk. Otherwise, the opportunity cost might not make it worthwhile.
Let’s compare two hypothetical job offers:
1. A startup offers $100,000 a year with potential equity worth $1 million if things go well, but an 80% chance it’ll be worth nothing.
2. A stable company job pays $150,000 annually with no equity but less risk and guaranteed income.
Most might opt for the first, lured by the potential of a big payout, akin to holding a lottery ticket.
In acquisitions, the reality for employees often is stark. Founders might walk away with millions, but early employees might see their equity diluted or their potential payouts reduced by clauses in their contracts. Even senior employees, who join at a 1.5% equity stake post-Series A funding, might calculate their potential earnings optimistically but find the actual numbers disappointing after taxes and adjusted for below-market salaries.
For those further down the hierarchy, the outlook can be even more discouraging. Consider a mid-level employee with a 0.5% stake. Post-acquisition, their theoretical payout might seem substantial, but after adjusting for lower salaries and taxes, the actual benefit might barely compete with what could have been earned in a more traditional role.
The allure of working for a startup often hinges on the hope of a massive payout. Founders play up this angle, promising revolutionary growth and culture. However, when an acquisition occurs prematurely, that dream can quickly deflate, leaving employees with vested options but not the life-changing sums they might have imagined.
Ultimately, the real test of a successful acquisition from an employee’s perspective is whether it enables them to achieve significant financial milestones, like affording a home in a high-cost area like San Francisco. If the acquisition doesn’t at least provide a solid financial stepping stone, it may fall short of expectations.
From an investor’s standpoint, the end of an investment period due to an acquisition might necessitate finding a new investment home for the capital, which can be a challenge if the acquiring company doesn’t offer similar growth potential.
For those in startups, it’s crucial to stay committed until all your options vest and to continue networking for future opportunities. For anyone considering leaving their job, negotiating a severance instead of quitting could provide a financial cushion and additional benefits, a strategy that’s detailed in resources like severance negotiation guides.
Remember, while joining a startup can be exhilarating and potentially rewarding, it’s essential to approach with a clear understanding of the risks and realistic expectations about the outcomes.
