I've started my own company in California (which failed), and I'm currently working as the first employee of a game company, so I know a little bit about this stuff. I'll try to tell you what I know, but you should really take it with a grain of salt, because I don't really know all that much about it when it comes down to it.
They are offering a salary that is a 30% paycut from dh's current. He currently grosses 110k plus my 24k, so our income would drop from 134 gross to 104 gross (+ possible freelance work in there).
They say they are making up for it with 50k in common stock options. Now it is my understanding that we need to treat these options as worthless (or maybe more like an unlikely bonus) We make absolutely no money on them unless the company sells or goes public, right? Vesting is standard 4 years 1yr cliff, etc.
These are some things you might want to take into account:
1) How much investment has the company already taken?
The more investment the company has taken, the less 50k in stock options is worth in terms of the percentage of the company that you own (see 2).
More investment means a higher valuation for the company (valuation being the expected worth of the company), but a high valuation isn't necessarily good. As a rule of thumb, investors are typically looking for returns in the range of about 10 times what they invested (but this can vary based on a lot of factors). There will be resistance to selling the company for less than that amount, because the investors aren't looking for small returns. This means its possible for a company to become trapped, unable to sell, because it took too much investment. This would be the worst case for you, since it means those stock options will never amount to anything. You have to gauge how likely it is that you think the company will be able to sell for that amount.
Also, keep in mind that you're getting common stock, not preferred stock. All those big, billionaire investors got preferred stock. That means that in the case of a liquid event (such as selling the company), they get paid first BEFORE you get your percentage of the remainder. To be honest, I'm not exactly clear on the exact mechanics here, so you'll probably want to do your own research. But I'm pretty sure if the company has taken millions in investment and sells for the same, you won't get anything.
2) What percentage ownership does 50k equate to?
Since the company has already taken investment, this will probably be low, like about 1% for a good technical, software engineer type. Maybe an experienced, non-founder CEO might be worth as much as 5%. I don't really know what's expected for an artist, probably less than the engineer. It's really hard to say for sure in any case. The higher the investment taken, the lower this number is likely to be, but that might be justified if the company is expected to sell for a lot.
This is where you have to calculate your expected return. You know you're giving up about 30k per year in income. Expect that you may have to work as many as 5 years before the company sells. It could be a lot less, or it could be a lot more, but I think 5 years is a solid number. The numbers only get better if you sell earlier. So let's say we're looking at giving up about about 150k. Now, take the percentage of the company that you own and multiply that by whatever you expect the company will sell for.
So, for example, let's say you own 1% of the company, and it has 10 million in investment. You can expect that it probably has to sell for at least 50~100 million, or not at all. So let's say that it sells for 50 million. For simplicity, I'm going to assume that's what's left after preferred stock has been paid out. So, if all goes well, you get 1% of 50 million. That's a cool 500k, so its nothing to sneeze at. But keep in mind that you aren't guaranteed to get this, either, if the company never goes anywhere. (Also, don't forget that you'll have to pay taxes on it, so you'll lose, what, a good third of it? But it's the same with the 150k you would have made.)
Obviously, you'll have to figure out your own numbers and figure out for yourself what you think the company might sell for, and so on.
3) It's normal that common stock will dilute if the company takes further investment.
But, while it's certainly possible to get screwed, you typically expect that the company is taking further investment because it thinks it will end up making enough more money in the long run with the investment than without to make up for it. So even though the percentage goes down, it's balanced by the fact that the company is expected to be worth more when it sells.
4) Don't assume that the VCs know what they're doing.
They can't. It's a risk for them every single time.
You'd think that they must be really confident to put millions of dollars into the project, but that's not really how it works. VCs expect that most of their deals will go bad, but the ones that work out will more than pay for all the failures. That's why they expect such high returns (e.g. 10x+). It's kind of sad, but the VC world isn't about picking the best deals. In a lot of ways, its actually far more about appearance. That is, appearing to do something that's at least reasonable and not obviously stupid. Sometimes they invest in things that are more trendy than common sense. That need for social validation is why it's often the hardest to attract the first investor, but once you have a term sheet from one, others will suddenly be a lot more willing to invest, too. At least if it fails, they feel that it wasn't a bad decision because their peers thought it had a chance, too.
Also keep in mind that there are more people out there wanting to invest than there are truly good ideas to invest in.
5) You still have to pay the 50k to get that stock.
These are stock options, meaning that when they vest, you still have to exercise that option to purchase them before you get the actual stock. In practice, while you work at the company, you won't have to exercise, but if you leave the company or if it sells, you'll need the cash on hand if you want the stock.
IMPORTANT: One of the big tax gotchas is not filing a section 83b election form within 30 days of exercising your stock options. Please research this before exercising your options. I don't know the full details, but I think the gist of it is that you only have to pay the tax one time up-front if you file the form, but if you don't, you'll be stuck paying tax every time the stock increases in value, or some such. This can be the difference in 10's of thousands of dollars in tax, depending on your situation.
6) If you're not already living in California, keep in mind that the cost of living is probably higher there, equating a further paycut.
We are worried that the stock will dilute, and it is super important to us that there is some sort of clause about receiving % of profits... even a small %... so if they do well, we do well. How could we ask for this?
I don't really know anything about making this sort of deal. If I were the owner of the company, I might be worried about a deal like this hurting my chances of selling the company when it comes up during due diligence. I have a feeling its unlikely you'll get this.
---
All in all, please don't rely on my advice. I'm not THAT confident in what I've said. Please just use it as a starting place for doing your own research and making your own conclusions.
