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How should you decide which direction to go?

Pragmatic modeling of job opportunities

·Jan 3, 2023·

• Summary
• Scenario 1: Post-IPO Executive vs Pre-IPO Executive
• Scenario 2: Post IPO Exec or Build a Startup
• Conclusions

Summary

As we all start our New Year and for many of those coming to the close of their MBA programs, you will be faced with big decisions. You'll have no shortage of optionality in your future, and many of the compensation models could vary wildly. I've thought a bit about how to model choosing between some of these nonobvious decisions and below you can grab a Google Sheet that may help you in deciding your future.

Scenario 1: Post-IPO Executive vs Pre-IPO Executive

This is a hypothetical situation, but easily transferrable for folks looking to join a pre-IPO startup and who may also be offered a position in a more stable firm similar to a Post-IPO or Publicly Traded company.

Here are the details of these two theoretical offers:

Post IPO Executive

1. Offered Base Pay: $200,000 2. Yearly Performance Bonus or Vested Yearly Bonus:$100,000

3. Profit Sharing 25% of Comp paid in Liquid Securities

Pre IPO Executive

1. Offered Base Pay: $205,000 2. Yearly Performance Bonus or Vested Yearly Bonus:$61,500

3. Yearly RSU Grants: 60,000 Stock Units

It may seem obvious but the huge variability in both of these offers is the liquidity of the security being offered, and the value of it.

Evaluating the options

I modeled this hypothetical situation using a projected pro forma 5-year set of cashflows for both. I then had to do some research on creating an Expected Value (E[v]) calculation for the likelihood that the pre-IPO firm can become a Unicorn justifying an IPO thus providing liquidity to the securities being offered to the Pre-IPO Executive.

According to the article found here by McKinsey, of the 826 $100M ARR companies that existed in the study, 86 of them became Unicorns with a value of over$1B. This seemed as good as any assumption I could make on the likelihood of this pre-IPO business providing liquidity to the equity compensation they are theoretically offering. So that provides an E[v] of Unicorn (IPO) of 10.41%.

The next thing to observe is what price per-share would have to be reached to logically justify choosing the Pre-IPO option over the Post-IPO option. Presuming all soft decisions are equal (ie how happy you think you'd be, excitement about product/project, etc).

To make these two opportunities equal on a 5-year time horizon the IPO stock value would have to be equal to $128.35 per share. So if the firm is quoting you an IPO price of anything less than that, you then have to wait until it grows into that$128.35 share price, otherwise, you chose the lower dollar value option.

There are lots of other considerations on why one should choose a lower total compensation value, maybe there are greater growth opportunities at one firm versus another. Maybe you have friends in one place and know no one in the other.

Here is a link if you'd like to give it a shot for your scenario

Comparison

So comparing the Post IPO Exec:

To the Pre-IPO Exec:

You'd need the stock value to be 128.35 per share to break even on the decision:

If the IPO is projected to be around $16-25 or$20 you'd end up in this situation:

Quite a big difference, so you'd want to gather information to create conviction for yourself that the stock value is likely to rise quickly or you left a lot of money on the table for you and your family.

Scenario 2: Post IPO Exec or Build a Startup

This scenario was quite a bit harder to think through, and a few other modeling steps were done which will be shown in the model as editable assumptions. Let's assume this person is considering the same Post-IPO executive position versus becoming the CEO of their own startup. They'd of course be faced with finding product market fit, identifying customers, selling, hiring, and fundraising. The biggest consideration to compare this is the likelihood of success as an Expected Value and how much you can fundraise to support some basic level of compensation.

CEO of Startup Compensation

1. Base Pay: $75,000 2. Performance Bonus:$0

3. Profit Share / Dividend

In the model provided this CEO is expected to receive 35% of profits which of course will be $0 in the first year. We are creating a very optimistic model where they have a$5M profit in Year 1 increasing 5x every year. It's hard to fathom how to model the exit here, but if you succeed in this scenario and survive to year 5, with these profit numbers you'll very likely have another unmodeled outcome to sell or continue operations of a very profitable business. We are ignoring that scenario for this exercise.

The likelihood of a self-funded or pre-seed startup succeeding as proposed in this model is based on the fact that 99.9% of this stage of startups fail. So the default assumption is 0.1% likelihood of success. Everything you can do prior to making your final decision should be to increase your conviction that you have a higher likelihood of success than 0.1%. Update the sheet to match your projected outcome, but when I use the other assumptions I'd need an E[v] of 1.37% to argue that the startup is an equal choice versus the Post-IPO Executive position.

In these two scenarios, I used a Discounted Cash Flow for each year to compare using a discount rate of 8%.

I'm sure you know but here is the formula (source):

\begin{aligned} DCF &= \frac{ CF_1 }{ ( 1 + r ) ^ 1 } + \frac{ CF_2 }{ ( 1 + r ) ^ 2 } + \frac{ CF_n }{ ( 1 + r ) ^ n } \\ \\ CF_1 &= \text{The cash flow for year one} \\ CF_2 &= \text{The cash flow for year two} \\ CF_n &= \text{The cash flow for additional years} \\ r &= \text{The discount rate} \end{aligned}

Comparison

So for the Post IPO Exec:

Versus the Startup Founder:

You can see that with these assumptions they are equal:

But look how unequal they are after 5 years of struggle and non-success as a founder:

The goal here would be to generate conviction that you have an unreasonable likelihood of not being part of the 0.1% statistic, maybe that you are part of a 5% or 10% likelihood of success. This would drastically improve this model for the Startup.

Conclusions

Of course, there are plenty of other considerations aside from money, however, for many people, this is a very important factor in their risk tolerance. This model can help you think about that dimension of risk, and then you'll have to quantify the value of other non-monetary factors. You could easily assign a yearly value to those in the cash flows for "remote work" or "travel benefits". I chose to leave them out of the model as they are very personal and not incredibly reusable for everyone.

Please bear in mind this is rooted in reality via conversations with classmates and prior colleagues, but by no means reflects an actual exact scenario. The numbers have been adjusted to avoid sharing any specifics of anyone's exact job offer.

If you liked this article and model, then shoot me a comment below! I'd love to hear what folks think.