Photographer: Scott Eells/Bloomberg

Big IPO, Tiny Payout for Many Startup Workers

Side deals and volatile shares make stock options a bigger gamble for startup employees.

Jeff Sutton led the corporate IT team at Box for four years, as the online file-sharing company grew from 50 employees to more than 1,000. He joined Box from IBM, making about $95,000 a year—forgoing the higher salary somebody with his decade of experience in systems administration could have made so he could collect stock options, roughly 21,000 in all.

When Box went public at the beginning of 2015, Sutton’s bet seemed to be paying off. On their first day on the New York Stock Exchange, the company’s $14 shares jumped 66 percent, to $23.23. But Sutton, subject to an employee lockup agreement, had to wait 180 days before he could cash out. By then, the stock had fallen more than 20 percent from that high; it’s now trading at about $13, below its initial public offering price. “I thought the stock was going to keep skyrocketing,” Sutton says. “Obviously it didn’t work out that great.”

Let’s be clear: Sutton knows it worked out just fine. He made about $350,000 before taxes on his Box stock, more than enough to buy the world’s smallest violin. It wasn’t, however, the life-changing windfall he’d hoped to secure in exchange for four of his prime Silicon Valley years.

The frustrated expectations of early employees like Sutton have become a common thread in the latest round of technology IPOs. It used to be “the get-rich story happened for people who joined in the early days,” says Saar Gur, general partner at Charles River Ventures. Now they can be among the few left behind. Many executives, early investors, and even later investors are able to cash out before the rank and file, or bargain for guarantees that help ensure a bonanza.

In an era when multibillion-dollar private valuations have almost become the norm in tech, employee stock options may appear more valuable than ever. That, however, presumes a business’s public valuation keeps pace with the often too optimistic internal one. Square, the mobile payment company, maintained a website with an internal stock ticker before its IPO, showing the estimated price steadily rising with each new private investment. Yet when the company went public in November, it priced its shares at $9, well below the expected range. One former employee says the internal ticker sat at $16 when she got her options last year, and her boss told her to expect a post-IPO jump to $50. As of Dec. 16, Square was trading at about $12.

Whatever happens with an IPO, executives tend to hang on to enough equity to guarantee huge payouts when they sell their shares. Most early investors get a chance to sell options on secondary markets before a company’s IPO. Later investors increasingly demand preferential treatment, including agreements that if an IPO underperforms the terms of their investment, they’ll be made whole with an equivalent amount of additional shares. Late-stage investors in both Box and Square had such so-called ratchet agreements in place, further devaluing locked-up employee equity. When those kinds of deals are in place, employees often find their payouts disappointing because they’re so diluted, says Clara Sieg, a partner at Revolution Ventures. Box and Square declined to comment for this story.

Ordinary employees are typically without meaningful financial protections or even a clear sense of what their equity stakes mean, says Chris Zaharias, who’s worked at startups for about 20 years and as a volunteer teaches people about their equity rights. Options grants often don’t come with information on strike prices (discounts on shares), preferential treatment, or even the total number of shares outstanding. “People on average overestimate what they are going to make by about 10X,” he says.

One employee at Jawbone, a maker of fitness-tracking wristbands, says he’s no longer sure of the value of his options given the company’s recent round of layoffs and debt financing. It looks less likely Jawbone will be able to go public at or close to its $3.3 billion private valuation, he says, and it may opt to stay out of public markets entirely, rendering the options worthless. Jawbone declined to comment.

The current crop of overly optimistic workers reminds Brian O’Malley of his younger self. O’Malley, a partner at venture fund Accel Partners, was fresh out of college at software startup Bowstreet when the dot-com bubble burst, taking with it the options the company told him would be worth six figures at IPO. Like many of today’s employees, he says, he was too busy counting his money to consider the risks. “Certain founders think it’s their job to paint a rosy picture for employees,” he says. Luckily he found a mentor who helped him shift to venture capital when Bowstreet crumbled. He says he’s found it better to be as clear as possible with people about their potential earnings to avoid dashed hopes later.

Again, none of this means startup workers are poor, even without accounting for the catered meals, free laundry, lavish parties, and other perks in their playground offices. Average engineers at early-stage startups make $127,000 a year, estimates recruiter Riviera Partners. “It’s a pretty great deal, if you ask me,” says Garrett Remes, an early employee at Zynga. Remes, now a freelance graphic designer, in 2008 walked away from Zynga—and options that eventually would’ve been worth $2 million—to co-found mobile game maker Storm8. Less than a year later, after disagreements with his co-founders, he left that company, too. Nonetheless, he says, the startup lifestyle “was better than I was used to, living in the Midwest.”

Sutton hasn’t given up on the startup world, either. Since Box, he’s managed IT for video advertising company BrightRoll, later bought by Yahoo!, and is now a manager at Instacart, the food delivery startup. But he’s a little more jaded. “It’s almost like winning the lottery for your company to do an IPO and do well,” he says. “It’s definitely not something that happens to everybody.”

The bottom line: When companies fail to meet expectations as they go public, options-holding employees bear much of the brunt.

(Corrects spelling of Chris Zaharias in the seventh paragraph.)
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