YC Startup Talks: Startup Equity with Compound (YC S19)

[Music] foreign [Music] Nice to meet you all! My name is Jordan. I'm one of the founders of Compound. Today, I'm very excited to chat with you about my hatred of personal finance.

So, I hate finance more, or as much as most people, perhaps. You know, many years ago when I started the company, I just wanted to build something fun and impactful and kind of work with my friends. Meanwhile, I was being thrown all these acronyms, these fancy words that I didn't understand. My friends convinced me to write this blog post all about equity compensation.

So, I wrote this essay that kind of mapped out what these different acronyms meant. I went from reading engineering code to reading the tax code. I published it on Hacker News on the internet. Lots of people came to me with all these complicated boring adult tasks. They were like, "Help me!" I was like, "Well, certainly there's someone else out there in the world who you could go get help with that's like a real adult professional."

I went and tried to meet those people. They were trying to sell me golfing. They were sending me LinkedIn messages. I was like, "Certainly there's a better way to do this." That's why we built Compound. We're a wealth manager specifically designed for tech people. We work with clients across many of the best companies in the world, and we're super excited to help them manage their money, file their taxes, borrow money, track their assets.

Today, we're talking about perhaps my favorite topic in the world, which is equity compensation. I was super lucky to be able to bring on someone that I really admire who has gone through the ups and downs of different startups. You know, equity has become a big part of their life, which is really, really powerful.

So, I'm very excited to be working with Christina here today. Christina, would you be helpful in maybe giving a quick introduction of yourself, and then we'll dive into the kind of agenda for today?

Sure! So, I joined First Round Capital earlier this year, but the 12 years prior to that, I've basically been working in startup after startup. Most recently, I was at Notion leading our platform and partnerships teams. Before that, I was at Stripe, leading a new business unit. I joined Stripe in 2012 when it was quite small. Then, two small startups before that.

So, broadly, yeah, I have just spent a lot of time in startups and have been very pleased personally with the outcome of my startup equity. I think if people learn a lot more about it, they can be far more educated in terms of the decisions that they make. Totally. And thank you again for spending the time here! Christina, like I said, is someone I've learned a lot from, and I think all of you would be able to as well.

I'm also, you know, you can hear me say this stuff is important, and that will only go so far. But Christina is perhaps living proof that thinking about this stuff can make a really big difference toward your long-term future.

So, my goals for today, to kind of make them as explicit as possible, you know, Christina spent a long time at Stripe. So, I like to say that we are trying to increase the GDP of everyone on this call, right? So, we want to make sure that everyone on this call walks away a bit smarter.

First and foremost, I want to make sure you care about your equity. By being on this call, you're already most of the way there. So thank you for doing that and you should thank yourself because you're doing an adult grown-up thing today by taking control of your finances. The second thing is, I want to make sure that you walk away with kind of an understanding of some of the key terms, you know, some of those acronyms that may scare you, that alphabet soup of different words, that you may not understand regarding joining a company or leaving a company, really everything you have to know kind of in between.

Then the third part is, you know, I want to apply this in the real world and you know, spend some time with Christina, and Max is also on our team, just walking through like, "Okay, if you're in this position, what are the types of things to think about?" And "How do I actually apply it to my life?" If you have questions, feel free to leave them in the chat. I have a note written over here to talk slower, so I'm going to be trying to do that.

But I just love equity and taxes so much that I sometimes talk too fast, so feel free to bother me! It's not bothering; it's helpful feedback. So, we move fairly quickly here, no long intros, I promise.

Number one, get you to care. So, we luckily at Compound have helped people save millions of dollars. The way we've done this is by helping people really navigate the world of acronyms here, and for what it's worth to make sure you fully care, you know, you can save 20 to 40 percent of the value of your equity just by paying attention for the next 15 to 20 minutes, right?

So, it's a very high ROI activity. There's lots of TikToks that you could be watching right now; there are lots of other things that you're doing. But if you just focus on the next 15-20 minutes, I really think we can increase your odds of success in the future. It's almost like Y Combinator for people, perhaps. You know, we can make you more likely to succeed in the future.

So broadly speaking, when you get an offer letter, right, or you're sitting at your company today, there's kind of three components from a compensation perspective. There's cash, there's benefits, and then there's this thing called equity. I mean, equity is one of those things when you're reviewing the contract that you ask yourself, like, "Is this a lottery ticket?" and "What could it be in the future?"

And if you're anything like me, when you see this offer letter and you're like, "I own a thousand options in this company," if you're anything like me, you're like, "Well, what does a thousand options mean?" Right? A thousand options of what? Like, what are they worth? How do I get them? What are the tax implications, etc.?

So what we're going to do over the next about five to ten minutes is cover all the finance tax stuff you have to know, and Max will drop in a link to a blog post we have about this as well. So if you like reading better, if you really like this stuff, you can send me an email—Jordan@compound.com—we can talk about it all the time.

But we'll cover all of these key ingredients so that you can feel fully informed when you're looking at an offer letter or you're looking at your current company. But I have to give one really quick disclaimer, which is that tax lawyers don't rule the world. So there are things you can do and you can become an expert at all of this stuff, and you will in the next five to ten minutes.

But at the end of the day, choosing your personal return on investment for your life is far more impactful than being a tax wizard often. And what I mean by that is choosing where to work, and we'll dive into this with Christina a little bit later, you know, is not just a function of what type of stock option you have, right? You can think a lot about who you're working with, what you're working on, you know, do you enjoy that sort of thing? You know, where you live—like the work, the culture—all of these things are really key ingredients.

And of course, there's this power law dynamic in startups where choosing the right company is also financially very, very valuable beyond all that. So we'll dive into some of the other factors beyond the financial minutia in a second. But I want to make sure that you leave with at least a key understanding of kind of how startup equity works.

So ramble aside, here's what you need to know high-level. When you join a private company, right, and you're offered compensation in that company, the cash is fairly easy to grow and easy to understand. But when you get equity, you have to realize that private companies don't have public valuations. So for private companies, instead, we often use two other types of valuations.

When an investor invests in a company, they get the preferred price, right? That private, that preferred valuation is called 100 million dollars—that's what investors pay for—they invest in your stock. When investors invest in your company, they get also preferred stock, so it has preferential treatment. So, for instance, if the company were to be acquired, they get paid back before the second type of stock, which is called common stock, right?

So investors get preferred stock—that's the first thing you have to know. The second thing you have to know is there's a second type of valuation, and that's called the 409A valuation, or the fair market value. The 409A valuation is a lot less than the preferred valuation. Like when you’re a private company, it can sometimes be like 20-30 percent of the preferred valuation.

I mean, the reason that matters is twofold. One, hopefully, over time, your preferred valuation rises, and sorry, your 409A valuation rises to mirror your preferred valuation. So, when the company goes public, there's just one valuation, right? That's the public stock price. But while you're private, you have two valuations: you have the preferred valuation and you have the 409A evaluation.

Why this matters is because the way stock options work and the way equity works is that you care about the 409A for tax purposes, so that 409A number matters a lot. But that 409A value is how you value shares, and when you join a company, you're often issued stock options. Stock options give you the right to purchase shares, so they're not shares, right? You're not a shareholder when you own stock options—you own the right to purchase shares.

And you unlock the right to purchase shares over time, right? You unlock the right to exercise your options, it's called, when you buy them over time through a process called vesting. You often will get a vesting schedule—call it four years with a one-year cliff, meaning you wait one year before you start unlocking the right to purchase, and then they vest, you know, over time—you continue the right to purchase them, and the price you can pay is called the strike price, right?

So you exercise your—you know—you get the right to purchase them at the strike price, which is a fixed price that remains static, you know, for as long as you're at the company, as long as you're on the options, and you're able to kind of purchase them for the strike price.

Now, the way this all connects is that the strike price, when you join a company, is equal to the 409A at the time of the issuance, right? So that 409A valuation is important because that's how you set your strike price. And the hope, the optimistic view is when you're looking at your company, is that the 409A will continue to rise, right? That share price will continue to rise, and the strike price will remain constant, right?

Well, it will remain constant because it is a fixed price. So the delta between those things is called the bargain element, right? That delta, the spread between the strike price and the latest valuation, is known as the bargain element, and that is a good thing, right? That is the whole mechanic here—you can buy low, in theory, you can sell high in the future.

The problem is that it's only in theory because it's in a liquid private thing. So if you work at a tech company that's private, you can't just sell it, right? It's not liquid—you have to think about the timing of this investment opportunity—that's kind of one variable. The second is that you may owe taxes at the time of exercising before you have any liquidity, right?

So you may buy low, but you can't sell high, and the way the world works today—the government is that you actually owe taxes on the bargain element before you actually sell. So if you have something called a non-qualified stock option, or an NSO, if you have one of those, you will owe taxes on the difference between the strike price, so the strike price, which is the 409A at the time you were issued the option, in the latest 409A valuation on that spread—you owe immediate ordinary income taxes at the time of exercising.

If you have something called an ISO, another type of option, an incentive stock option, you don't owe ordinary income tax, but you owe another acronym—you owe something called the alternative minimum tax, or AMT, which is a totally separate calculation. At Compound, we built calculators to kind of automatically calculate all this stuff for you, but the high level you need to understand is that when you exercise, you may be taxed on the delta between the strike price and the latest 409A valuation.

That bargain element may be taxable. You're also going to be taxed, though, on the time between you acquiring this share and the time you sell it. And the idea here is that if you can make that holding period—it's called greater than one year—you'll most likely qualify for long-term capital gains. But if you make that holding period less than one year, for instance, if you exercise your options and then you immediately sell them, for instance, at an IPO or into a tender offer, one of those events, you'll owe ordinary income tax on the gain, right?

So that delta—that difference—is why you may be incentivized to exercise some of your options earlier. There are a lot of other considerations, so I suggest reading a lot about this, working professional, but very high level, that's how the mechanic works.

So, you're at a company with a fixed strike price, the 409A is kind of growing, and you have a bargain element spread—the option is valuable, so congratulations! But you may owe taxes at the time of exercising, so you have to think about that.

The other thing you have to think about as things kind of scale is this word called dilution. A lot of you know employees are really upset. You know, as a founder of a company sometimes, we raise money and people come to me and they're like, "Oh my goodness, I'm diluted!" And I thought I was doing my job; I thought I was like doing my job going to fundraise to effectively sell equity to our investors so that we could kind of get capital to increase our odds of success.

But as an employee, it may feel sad when you have this kind of percentage ownership of the company, right? You have options or shares, and you know, percentage ownership of the company. And that number might go down over time as the company continues to fundraise.

But we have to often realize that looking at percentage ownership is only one variable. The other thing you can look at is value, or potential value, and kind of being value-aligned with the company is a way to kind of think about your overall return on investment calculation. And that is really the kind of goal of all of this sort of math, which I'm happy to dive into if people want to leave questions.

We can kind of answer a lot of specifics on how that's calculated soon, but what you're really calculating is effectively a return on investment, you know, an ROI. And, you know, beyond money, you could also have an ROI on fun and learning and impact and prestige and network and skills and all these other things.

But money, when you're calculating the ROI, it's just an investment opportunity. I mean, when you're thinking about accepting a startup offer, you know, you want to do this sort of analysis. And your job is actually quite similar to a venture capitalist's job, right? A professional investor's job. Although you have one life, they get to diversify. You have maybe your friends—they have a team of analysts that are underwriting the opportunity and also, they're not going to be waking up all day every day thinking about how to make the stock valuable. They're just giving their money and often kind of walking away slightly.

So that is the kind of job to be done. And Christina, maybe it could be helpful in hindsight to think through this. But I'm curious if we were to go back—not too far—but you were quite early at Stripe. I'm curious, like when you were going through the offer of thinking about am I going to invest my life in working in this company, how did you process it then? And like, what do you wish you could tell yourself in hindsight?

So how did I go through the process ultimately of deciding whether I should take this offer? So, broadly, I would say that with Stripe, the offer had a lower salary component compared to my last startup. So the vast majority of people at Stripe made the same salary, and there wasn't much negotiating allowed as a result of that.

So, I wanted to better understand the equity component, knowing that that was the vast majority of how I was going to be compensated. I knew the basic terminology from my last startup, which I was at prior to Stripe. And basically, what I did was put together a spreadsheet to better understand the Stripe opportunity.

So specifically when I thought about it, I wanted to say, "Hey, let's put together all of the numbers so I can understand here is the compensation from my prior opportunity, and here's the Stripe offer." Right? So first, you start with really basic things. It's like salary, salary plus bonus, and then the equity gross value.

So like, what is the number of shares that are in my offer multiplied by the preferred price of those shares? And so the preferred price is effectively, whoever the last investor was, what price did they pay per share for that company? And that is the equity gross value.

So then, I'm trying to better understand what the exercise cost is, so how much will I be paying for these shares, for these options? And in that case, you would get the exercise cost. So, you know, that's obviously value that you're putting in to the company.

And then I basically calculate the net equity value at the most recent preferred price. So basically, subtract the exercise cost from the gross value, and that is the real value of what I would be getting today at the value of the company valued today in this particular offer.

And then I have a line that's basically like, "What would my comp be over the next four years at my kind of most recent preferred price for Stripe?" And then how would I compare that to the other company?

Right? And I would say at pretty much every company I've ever joined, the new company I'm joining, the offer is pretty much always lower than the previous company. And often, that is just because I've often left slightly larger companies and then gone smaller and smaller and smaller.

And so often those companies don't look as good from an equity perspective. But I do think the thing that that is basically like what percentage of the company I have and that I hope with every company I joined continues to go up.

So, you know, in my spreadsheet, I also include, for example, the 409A price of the share, the fully diluted share count—like how many shares out there exist in the world for this particular company—and then, like, you know, divide the shares by, ultimately, how many shares the company has in total. And that's like the percentage.

So if I were joining as a first ten employee and someone was giving me like 0.01 of the company, I'd say, "Well, it feels a little strange; that's like not what I would expect for how much risk I'm ultimately taking for this particular opportunity."

So, yeah, broadly, those are the things that I looked at from an equity component to understand the offer. I also think there are plenty of things that you can ask to kind of understand the company and like what state the company is in.

But I would just say, like, you know, I think I did all the basic things, which are like Google, like, "You know, how does equity at startups work?" But obviously, Compound has really great materials now that didn't exist then, which I think basically have all of this information.

And I think that I better want it—I basically wanted to understand a number of other questions where the answers didn't necessarily affect my decision to join the company. So, for example, were the equity I was receiving, like, QSBS eligible, which is like nice to have from a tax treatment perspective? But like if the company isn't eligible for that, it's not necessarily going to change my decision on whether or not to join.

So there are plenty of those questions as well. It makes a ton of sense.

So maybe to play it back, you know, I think now you—you know you invest in companies professionally. But perhaps back then, you know, when you were choosing where to work back then, perhaps it sounds like you know you wanted to make sure you understood the offer first and foremost.

And what's sometimes awkward for an employee—and Christina, I imagine you, knowing you, you had the confidence to ask a lot of these questions—but I think, you know, sometimes for a listener, it can feel daunting, right? Like am I burdening the company, you know? They're the hotshot company; they're all over the news.

But like, it's actually your right as an employee to ask these questions because it's your money and like you are about to give your prime time. Like kind of, you know, ask a lot of these questions. Maxine sent over like a list. We also have like a template you can literally copy and paste. You can read it in whatever accent you think is most effective for negotiation!

But that's kind of one index here, you know, one vector. And I just want to—I'm curious, because I think you've been right a lot, and now your job is professionally being right. Like for people who are not professional investors, how do you think about underwriting companies, just in general, about where to work?

Because when you exercise your options, you're investing in a company. When you're joining a company, you're investing in a company. Are there any things you do? Maybe just one or two things that you look for in a company that in particular led you to actually join at the time? Because Stripe back then, you know, wasn't Stripe as we know it now; it wasn't so obvious that it would be such a hit. A lot of people are probably in this position today.

Yeah, I would say with the investor lens and also with the startup employee thinking about, you know, is this opportunity to be valuable for me financially in the long term? I think I'm looking at it from the perspective of probably three different factors: people, market, and lastly product.

And I would say product often, if you're joining very early stage companies, doesn't matter as much, just because it’s very early; the product is not necessarily fully formed. So often, I would say the most data that you have is really on the former two, which is people and market. And so people is absolutely the most important for me, and I have always been extremely people-driven whenever I've ever decided to join a company, and it's generally worked out well for me.

And I think there are a few factors here: one is this like a high-integrity group of people, right? Do I feel like this set of people who are running this company—primarily the founders, first and foremost—are going to have high integrity when they make decisions about the company, whether to take funding, how to spend money, etc.?

Because I want to make sure that we are running a very much above-board company, especially these days when a lot of what you see in the news is people not running companies super well. So firstly that. Second, do I think that these people have the potential to make an outsized impact on a particular base or product area?

And so, you know, for example, when I was looking at the opportunity to join Stripe, they were thinking about building a product that was a developer-focused payments product, which hadn't necessarily been built before. There were a lot of companies that built payment products, certainly, but not necessarily a company that said, "Hey, we're going to look at the developer and build an experience that is critical to them because we think they're the decision-maker in a lot of companies and will continue to be."

And I felt like these were a set of people who actually could build really fantastic developer products and that they were particularly skilled at that and that their lens on this world of payments, which they actually knew nothing about prior to starting Stripe, would be something that, you know, A: they could learn, and B: come at it with an outsider’s perspective.

So I think in terms of people, it was like incredibly smart, incredibly kind, high integrity, and attacking a space that I felt they could be able to attack in a way that would be quite differentiated. And so that kind of gets me a little bit more into market, as well, which is a second factor.

And I think generally you want to join companies that are not building like, you know, small little things that like are kind of nice-to-haves or what we call investing vitamins. You want to build products addressing a real pain point for a particular market that is large.

And generally, you're either looking for a market that is already big—payments was already big, so should I, you know, tick that box—but payments was also growing really fast because more and more payments were coming online rather than offline with cash.

And so I think the great thing about Stripe is that it picked a really fantastic market that was big and growing well and then picked a particular constituent in that market, being developers, who were having an outsized say in what kind of products they could pick for their businesses.

And so those were the factors I think for me that really stood out about Stripe and stood out about Notion and a bunch of other companies that I’ve joined and invested in.

And so I think the most important decision that you can make is like what company to join, and then a lot of the other things, like what is your offer and everything else, those are the details. And you can make a lot of really fantastic optimizations for yourself.

And you know, the time to make them is certainly when you have an offer. It's a very short window to make that decision, but you know, picking the right company is first and foremost.

It makes a ton of sense. You know, I think play it back, a few things that stick out to me. One is I think most people aren't particularly good at underwriting companies, as I said before. It's a hard thing to predict the future, but you've met—you’ve only worked at so many companies, but you've met hundreds, thousands of people in your life.

So if you can underwrite the people right, you can say, "Hey, I'm going to bet on this person to be successful." Like that perhaps is like a much more linear path. The second part of it is, you know, just in listening to Christina and others is, you know, notice how she's using words like incredibly smart or incredibly hard-working.

It's not just enough often to kind of join a company where you feel like, "Oh, we're like a little good." Most startups fail. A good startups fail. Like most great startups actually fail, right?

In order to be an outlier, you really have to believe in being incredible, right? Or absurd adjective—you know, that's great. So I think, you know, when you think about so many things, it's not enough to—you know, for joining a startup right now, there are plenty of other businesses where that's not needed.

But in this context, I think that can often shine through. And then finally, I think what Christina said is super true, and this is one of the reasons about Christina. If you look at her LinkedIn, she's been right often. Most people aren't right often, right?

So picking the right company or, in a lot of cases, just picking the right people to join—that has an outsized impact, right? Now after you do that, though, it is your right, obligation, responsibility, duty to get the most out of it, right?

And that means getting the most out of it on all aspects, including the financial side. Some of the things that sometimes people don't quite grok or before it's too late are just some of the key terms that we've covered very quickly.

But there are some more that I want to make sure that people are kind of aware of when they're first accepting an offer. One of those that I think is really, really powerful is this phrase called early exercising. Early exercising effectively means—and Max is going to walk you through a demo so you get an idea of like the impact of it—but early exercising basically is a clause that allows you as a shareholder or an option holder to purchase all of your options before they vest.

Jordan's talking about early exercising. I can just bring it to life with a couple of simulations that basically show if you're an example, you know, early stage employee. Maybe you join like a series B company. You were granted 200,000 shares, and in this example, it's like one ISO grant, and your strike price is about a dollar.

So what I'll just quickly do is talk through like some of the high-level strategies between exercising later at an exit versus exercising as you vest versus maybe early exercising now.

So if we just click in real quick, in this example, we're waiting to basically exercise until the liquidity event, the IPO, and then we're selling everything. And we're modeling out just basic taxes based on, you know, this profile, and in this case, there's, you know, all of the shares are being sold at short-term capital gains because it's not held for a year.

In the next example though, we're starting to show how the, in this demo, accounts basically exercising a little bit each year—so a third each year. So in 2022, we're exercising a third—but you can see the exercise costs then in 2023 as the 409A starts to jump, right?

The value internally for the employees to exercise their stock options starts to increase as the company raises additional rounds of financing. Now we’re triggering AMT, which is that thing that Jordan talked about earlier in the presentation. So the cost to exercise is the same, but there's additional tax costs.

And then lastly, in this example, right, we're exercising the rest, and then we're selling all of it at the IPO. In this case, you can see that some of the equity is qualifying for long-term capital gains, and some of it's still short-term capital gains, and therefore the net outcome in this example is a little bit better, right? Instead of 2.7 million, you know, it’s 3.4 million in this example.

But the ultimate example of what Jordan's describing is early exercising, and you're basically saying, "Hey, I actually before my equity vest, so when I’m issued my stock, I can buy my equity before it vests over a four-year schedule."

And in this example, you don't have to pay any additional taxes because the 409A equals the strike price—the one dollar strike price equals the 409A—and then you hold on to it—all qualifies for long-term capital gains. And as you can see here, this leads to the largest net outcome because everything's qualifying for long-term capital gains as well as being able to exercise and minimize their tax burden.

So, these are like real life demo examples of various strategies and of someone who's potentially joining like an early-stage startup evaluating this opportunity. And we'll dive into some more, but I'll pass it back to Jordan.

Max, I appreciate you walking through that. Max, and hopefully, my sharing my screen doesn't break our Wi-Fi. But I think it's really clear that like some of these key clauses can make a really, really big difference both when you're joining a company but also when you're potentially leaving your startup.

And Christina, I mentioned that you've joined lots of startups, and you've also left them. You know, at some point, I'm not saying you were an expert at leaving companies, but I'm curious, you know, as you think about your career and taking charge of your career and thinking about, you know, you're at Stripe for many, many years.

And I think nowadays people don't stay at startups for very long; often they kind of bounce around and expect to, you know, get a higher salary every time they bounce around. I'm curious, like how do you take a long-term view towards building