Liar's Valuation - Understanding Startup Equity - Article Recap

A recap of Nikunj Kothari's article on why startup valuations are often fictional and what early employees should know about equity offers before joining a startup.

  • Valuations are often fictional: Private startup valuations are frequently inflated and don't reflect market reality—they're set by investors and founders as part of fundraising, not through transparent pricing.
  • Private negotiation, not market: What's written in an offer letter—percentage ownership, strike price, and company valuation—are numbers based on private negotiation, not actual liquidity or market validation.
  • Paper wealth disconnect: Early employees receive equity packages based on 'paper' valuations that may be completely disconnected from real exit value or eventual returns.
  • Incentive structures: Founders and investors have direct incentives to promote higher valuations—it improves perceived success, attracts talent, and can improve deal terms.
  • Exaggerated paper wealth: This environment leads to paper wealth being exaggerated but difficult to realize or cash out when the time comes.
  • Exit realities are messy: Very few startups achieve the multi-billion dollar exits suggested by optimistic equity grant scenarios in offer letters.
  • Multiple dilution paths: Equity can be diluted through additional fundraising rounds, expanded option pools, or special clauses favoring later investors over early employees.
  • Preferred stock matters: Early employees need to understand the mechanics of preferred stock, which often gives investors rights and protections that common stock (what employees get) doesn't have.
  • Liquidation preferences: These clauses determine who gets paid first and how much in an exit—often favoring investors and potentially leaving employees with little or nothing.
  • Due diligence is crucial: Prospective startup hires should ask direct, hard questions about true ownership, investor return preferences, and real-world payout scenarios.
  • Understanding equity math: Employees must build their own understanding of how equity works and not rely solely on founder explanations or rosy projections.
  • Question assumptions: Challenge the assumptions behind valuation numbers before hinging compensation or career plans on them—don't take numbers at face value.
  • Truth vs. marketing: Don't be hypnotized by the vision painted by founders about potential upside—separate marketing from mathematical reality.
  • Know your position: Understand where you stand in the capital structure and what scenarios would need to happen for your equity to have real value.
  • Critical thinking required: Startup talent needs to approach equity offers with skepticism and analytical thinking, not just excitement about potential wealth.
  • Cautionary guide: The article serves as a warning for startup employees to do their homework before accepting equity-heavy compensation packages.

The full article is available here.