066: Guide to Building Wealth with Equity Compensation for Private Companies

00:00 - 29:53 | Christopher Nelson: When you work for a private technology company and you have an exit, you have an IPO, you have an acquisition and you do well, you build some wealth coming through that. There's generally speaking two types of people that are going to come forward. The ones that believe that this is one big gambling arena and you're throwing darts and you luckily hit one and they're going to say things like, wow, congratulations, great luck. Or you're going to be approached by a second set of people that you want to then pay attention to and they're going to shake your hand and they're going to say, great investment. Help me understand how you de-risk that. Those are the people that you want to lean into. Those are the people that you want to continue to have conversations with because they understand it's all about thinking like an investor. Welcome to Tech Equity and Money Talk. I'm your host, Christopher Nelson, and today has got to be the most requested episode ever. For those of you who know my story, I worked for, once I decided to think like an investor with my time and talent, I worked for four more private companies, and they were all, three of them were VC backed, one was private equity backed, and three out of four of them went public, went through an IPO. And many people want to know, what was my criteria? How did I choose those companies? So that's what I'm gonna share with you today. I am going to share with you the five criteria that I use, the main criteria. This isn't the only ones, but these are the ones that make sure that I have a clear target that I wanna do deeper due diligence on in front of me. I wanna cover off on that with you today. Before I get into that, I want you to know whether you send an email to ask at techequityandmoneytalk.com or you fill out the contact form or you reply to the newsletter. I listen, I listen and I want to create content that is important for you that you want to know. So many people want to understand this because it is true that when you go to work for technology companies, when they're private, and you go through an IPO, there's an opportunity, not guaranteed, but there's an opportunity to generate significant wealth through the IPO event. I want to ground ourselves out in what we've learned so far. So if you've been listening to this series, last week I spoke with Brian Faroldi. And if you haven't listened to that episode, it was where I sat with him as somebody who evaluates stocks, who was also a technology employee and traded time and talent for equity. How would he evaluate public technology companies to go to work for? He highlighted in that episode as well that working for private technology companies has much more risk. And it's true because in private companies, there is a 90% failure rate. That's the generally understood statistic across the industry that 90% of tech startups fail. That's a one out of 10. And when they don't fail, it means they become a business, but they could also be acquired at cost where nobody really makes any equity. They could go public and lose money in the public market, meaning that their shares again, aren't worth anything or decrease in value, or they could be okay. They could be base hits. And then there's also the home runs. So understand that when you're trading your time and talent for equity, you want to look at your financial goals first and understand what is going to meet your financial goals. I'm saying this is a public service announcement because I think many people are still smitten by the story in the media that talks about going to work for early stage technology companies and being there for many years. And you have a one and done. I've worked for one company. I've made 10 plus million. I'm out a punched out. Well, that is a way to do it, but it is a harder road and it is, it requires a lot more due diligence and understanding of investment to really make that successful. What I try to educate people on in my podcast is that the way that I've seen working for. equity done successfully is people who have gone to work for public established companies continue, they start getting a public company equity that is liquid, is growing in value, and they can trade it frequently and have flexibility when they trade, they start building a financial fortress, they understand what great companies look like, they build skills, and then they start moving to higher risk activities. I immediately think of who I've interviewed on the show, Ritendra Datta. If you go to the first episode that I did with him, in that particular episode, he spoke about the fact that he's been working for smaller and smaller companies. Started at Google, then he went to Meta. Now he's at a pre-IPO company in Databricks. It's a strategy. So I want to make sure and predicate all of this because I made a choice where I was in my career. I was in the middle of my career. My wife and I still did not have any children at that point. So we were, you know, managing our own finances and expenses because both of us were working, made a decision to go for a higher risk opportunity. you have to make that decision for yourself. And so that's important that when you're thinking like an investor, you always focus on risk first. And you'll understand that that's also part of this criteria that I'm laying out today. So the reality is startups fail. And it's important that we look at what are some of the main reasons why startups fail. Lack of product market fit is 34%. So one third of the failures has to do with lack of product market fit. Meaning it's engineering, it's an interesting idea, but there's really no market for it out there. So that's critical for you to understand. 22% fail because of marketing problems. 18% team problems. Those are the three largest issues. So when you understand the issues and the reasons for failure, when you think about your criteria, and this is how investors think, is they always want to remove risk. So if there's a risk of lack of product market fit, that means that you want to look for a company that has great product market fit. If there's marketing issues, you want to look for a company that has an established marketing leader. And if there's team problems, then Where has there been a leader, a company that has created a great culture where people are focused in the right direction? It's important for us to understand these failures because we want to build that into our criteria. So when you think about a criteria for selecting a private company that you want to go to work for, you want to make sure that you have a clear plan, that you have clarity in what you're looking for. And you're also looking for an edge. You're looking for a company that has something special that's different. You're investing your most precious asset, which is time. And so ensuring that you are Approaching this with a level of due diligence is important because the question that you need to ask yourself when you are going to work for private technology companies where the equity is not liquid and you want to get it to that liquidity event. is how much time are you willing to lose? How much time are you willing to work for this company? And the equity may be worth nothing. How much time are you willing to work for this company? You're not sure if the equity is going to be worth anything and you may need to, because there are options, you may need to pay for that equity. Those are important things for you to understand and ask questions. The other thing that you want to ask yourself the question is what size of company makes sense for your skill set? I made a mistake when I went to work for my very first startup company. I had left Accenture and was working for large Fortune 500 companies. I was working in managing very large teams of 50, 100 people, and I went to a very small startup where there was less than 30 of us. That wasn't the greatest fit for my skillset. I didn't have a lot of experience in that arena. That was one of the biggest things that I learned is that my skillset of scaling, of taking companies that have some established process and scaling and owning a specific piece of work is a better fit for my skillset than going to a much smaller company and building out a function. That just is. And so you need to make sure that you're asking yourself that question too, because when you're choosing these companies and you're looking at these roles, it's really important that you understand where you are going to deliver results, where you are going to bring success, because that is what's required to be successful in these private equity companies, because they have a long hill to climb. So without further ado, I want to get into this criteria. So the first thing that I always look at is I want to evaluate the product, the solution that it solves, and the buyer. The product, the solution that it solves, and the buyer. This is important because this is going to be the commercial engine behind whatever you're doing. So if you can understand what is the product and the problem that it solves and where that fits into the marketplace, you can then start understanding how big is what they call the TAM or the total addressable market. So for example, when I was evaluating to go to work for the company Splunk back in 2011, I think I started having some conversations in late 2010. This was the opportunity to look at unstructured data. There was not a lot of companies that were doing unstructured data in real-time analytics and it solved the problem very well. And it also had a lot of different use cases that it could fill. So this is where it had a lot of opportunity, a large total addressable market. The other thing that it had is I could look across and see that this was going to be purchased by the IT department. I had been working as a consultant in IT. I understood IT, the way that IT worked, the way the buying function worked, the way the budgeting process worked. So it was clear to me on how there was a need for this product and who the buyer was. It's important for you to consider this because there's a lot of choices out there. You can have products that are being purchased by the legal department, products that are purchased by the marketing department, right? The marketing department gets a lot of new tools thrown at it. There's always a lot of new marketing tools so that it has a stack that may have a lot of churn where IT departments can have a technology stack and some of that stack can be very sticky. It's hard to change. If you implement a CRM system implemented by a team owned by the business that is supporting hundreds or thousands of sales reps to go replace that, that could cause a big disruption to the business. That's sticky. So understanding your buyer, understanding what is the stickiness of the application, and then understanding what's the problem that it solves is really important. Asking questions like, would you use it? Do you understand the problem that it solves is important. I also want to call out that there's, you know, plenty of B2C companies, business, you know, so there are businesses that sell directly to consumers. So then you have to ask yourself, well, if I'm selling to that, how do I know when the consumer is buying? And then the consumer is going to be buying hundreds of dollars at a time, maybe thousands of dollars versus a enterprise is going to be buying hundreds of thousands of dollars or millions of dollars at a time. So this, when you start thinking about going to work for private companies, analyzing the product and what problem it's going to solve, how sticky it is and who's going to buy it is number one. That's, that's what you need to understand first and foremost, because if you don't have a thesis for that, of how that's all going to work and you can understand clear line of sight to how this business is going to grow, then you're not investing. You're not. This is where then people start throwing dots. Well, I think it's going to work out well. Some of the investing is really creating a thesis. It's applying the scientific method where you're applying a thesis. You want to see how it plays out. And if it's not, as an investor, you can continue to buy more so you can invest more time. You can hold, well, let me see, are we threading some things? I'm not going to do anything. I'm just going to observe for a while. Or you sell, like get out. And this is where criteria number one is the product. And so number two is customer sentiment. I think in this day and age where you can go and see how customers feel about products publicly, it is really straightforward to start understanding how customers think about these products. Now, it could be a scenario where you could be working for a startup company that's pre-customer. That puts more onus on, number one, the product itself and the solution that it's solving. How much clarity do you have that it's going to solve an important problem? How much clarity do you have that there is going to be a buyer for that product? If you don't, that just ratchets up the risk. And that's important for you to understand because investors, we are constantly trying to analyze risk and remove it. It's called mitigation. How do we actually solve this? And if not, that means that we move on. So number two, customer sentiment. How do they feel about the product? How do they feel about the customer service that they're getting? And it's really, do you have raving fans or not? Don't look for mediocrity in this of, Well, I think people are okay. They're lukewarm to the product. Okay. Is that where you really want to invest your time? Or it was evident to me in the companies that I went to work for and their product fit, it was evident to me that all of them had raving fans. They had some fans that absolutely loved what the product did and what it delivered. I can think about GitLab had a phenomenal community of contributors that were contributing to the product, that supported the product, that were working on it at all different levels that you could go and read what their sentiments were about the actual product. Same thing with Yext, same thing with Splunk. There were people that in communities, and this is a tell as well, is when you actually have conferences, when you have communities being built and people are attracted to it. If you are looking at, you know, the product criteria, the buyer criteria, number one, and then you're looking at the customer criteria, all of this right here is going to give you a significant indicator of whether you have a company that's in a growing market that solves a critical problem that customers adore. Because when you have customers activated for you, and I saw this happen multiple times at these, the companies that I worked for is they would then advocate for the product. They then became part of the sales team. You need to try this. They call that the NPS, the net promoter score. And those are some things that in interviews you can ask for. Do you know the net promoter score, the NPS score, the product? How are people reacting to it? That's an important and viable question for you to ask. How do people feel about this product that I am going to trade my time and talent for shares of this company? What are they thinking about it? So product, the fit, and the buyer is number one. Number two is customer sentiment. Number three is the leadership team. Been there, done that experience. When you are getting ready to go through a public event or you're building a company to grow and scale, If you have somebody that has been there and done that already as member or members of the team of the executive suite, so you're thinking about especially the chief executive officer, chief revenue officer, the chief financial officer, chief marketing officer, you know, Whoever has had that public company or scaling company experience is going to be critical in that phase of the game, because it goes back to some of these problems, right? If you have a lack of product market fit, a chief executive officer is going to say, we need to solve that problem. I would argue you wouldn't want to go to work for that company in the first place if that's not clear, but people have solved those problems before. They have turned companies around, got them focused. Marketing problems. If you have a marketing leader, you have a great product, great product market fit, and it just needs to be marketed better. A leader can change that. And definitely when it comes to people problems, because the best teams that I have seen, the ones that have been the most effective are the ones that the chief executive officer and leaders of the organization are all executing the same mission and plan. Nobody is trying to build their own kingdom. Nobody is working against the leadership team. Everybody is rowing the boat in the same direction and they're getting people to move that way too. I think the other thing is to understand, you know, what are these executives' reputations and being able to get a feel for how they execute. That's important for you in understanding if this is going to be a right fit for you in the organization. And it's also important to understand that as companies start getting ready for certain events, sometimes you will have a startup CFO who hasn't had public company experience before. They get rolled off the team and they bring on a CFO who understands that relationship and going forward. So sometimes there are changes in the team that are so important. The other thing, and this is a tip I will give you that I think is so important, is you want to look for a leadership team that's balanced between engineering and business. There are companies out there that are so focused on engineering and the beauty and the delicacy of what is engineering, but they don't understand the customer focus. They don't understand sales, that the CEO is actually the lead sales guy, that they can have some challenges and meet some headwinds. The teams that I've seen the most successful have a phenomenal balance. between engineering and building great products that have a very significant product market fit. They have a static customers and ones that can go sell and put together a very clear business plan that they're continuing to meet or beat every single quarter. That's when these teams really get humming. And so you want to understand as these leaders come together, what's the culture that they create? Because it is so important when you are in these growing and scaling companies that is going to involve a lot of hard work, right? It's at these companies, there was a ton of hard work. You want to understand what's the culture that they're creating. And I can't say enough that who these leaders surround themselves with, who's on the board of directors, you should be able to look in that ecosystem and understand who's had the exit, who's had the success, and how does this all come together. And that rounds out the top three. So you have the product, the buyer, customer sentiment, leadership team. Number four is the financials. Do not sleep on the financials. And I get the fact that this can be a challenge in private companies. However, going to Crunchbase, you can easily understand how much funding they've taken. And beyond Crunchbase, you can actually go to secondary market providers of private companies. So I think of Forge Global and Equity Zen, which are two of the largest ones. A lot of them have write-ups on what they understand the financials to be of the company. And you can also ask questions of this. And the indicators that you're looking for are, and this is something that is the rule of 40 that is looked at when you have a VC company that's looking at a potential investment in a private technology company, they apply what's called the rule of 40. And I think it's a great rule of thumb to say, how's this company doing? And they look at growth rate, so how fast the company's sales is increasing year over year, and then also profitability. And they want the total of these two numbers to add up to 40. So if the growth rate is 30% and the company is making a 10% profit, that adds to 40. That's great. Or if the company is growing at 50% and losing 10% annually, that adds up To what? To 40%. Now, if the company is growing 30% and losing 20%, well, that doesn't add up to 40%. So then that goes outside. But coming up with what your metrics are is really important. And I think the rule of 40, when you think of where VCs are going to put their money, is critical. And this is where, again, when you are thinking like an investor, you have to come up with your own thesis. You have to come up. And I'm going to hit you at the end. I'm going to hit you with my own numbers so that you can get clear on what those are and how I leverage this as well. But you want to be looking at the sales. Are the sales steady and growing? Are they hitting their numbers every quarter? They missed a quarter. Trying to understand why is important. What is their burn rate and distance from profitability? This is something that now you'll see a lot of companies right now in this particular environment where we have high interest rates right now. Profitability and being close to profitability is really important. look at those indicators and understand the financial health of a company. Because this is also in startup companies, right? If they run out of money, these companies will shut down very quickly. So understanding for yourself, what's the burn rate, how this company is managing so that you can make sure that you're part of a growth story and not part of a company that's not going to be there anymore. So the last thing, so to repeat the first four, so there was the product and the buyer, customer sentiment, leadership team, financials. The fifth one is then the quality of the equity. And what does that equity look like? You want to understand how much money they've taken and is the equity diluted or not. I think that works, especially for early stage, if you're going to work for a company in pre-seed or pre-seed or before it gets to an A round of funding. Post, when you start getting to CDE, you are starting to look at what is the quantity of shares that you're going to get. I think dilution becomes a harder metric, but you're also getting smaller pieces of a pie that's growing because usually as companies get to later rounds and funding, they're seeing some success and they're going to grow. But you want to be looking at the type of equity that you're getting. Are you getting ISOs? Do you have to put money out and do you have to invest in this company to actually Own your shares. That is a risk. That's a risk up front is having to buy shares. And you can do cashless exercises, but you have to be at the company. So these are some things to evaluate. Or are you getting RSUs? This is becoming popular in later stage private companies where they do provide RSUs because while it's not as tax efficient and that making it tax efficient has some level of complexity to it, but it's not tax efficient, but people are able to get the shares. Employees can have the shares and they can leave the company with those shares intact. So there's more value to them in the long run and less risk. And then you want to look at is, are the value of these shares going up? What is that valuation based on? Is it based on the market? Is it based on investment and getting clear on that? And then how close are you to liquidity? How close is this to being liquid? Because that's so important. And the litmus test that I always ask myself, you know, when I, you get to the end of these five and you're looking at this, you want to say, well, would I work for this company and also take 300,000 of my own money and put it in there? Let's say 300,000, it's a number because I think of, okay, is that a year of compensation that I would just reinvest in this company? If the answer is no, then you have to really ask yourself, why are you going to work there? Is it for the experience and not for the equity? If you're not willing to invest in it, why not? And I'm not saying that you have to, I'm not trying to say like add… get to an oversized position in this specific company, but I'm trying to go through these mental exercises because as an investor, you want to continually be testing your thesis. And I get the fact that this sounds hard. This may sound a little complicated, but the more repetitions you get, the easier this gets over time. So let me walk you through quickly what was my criteria for a three out of four win rate. So going back to the beginning, so the product and the buyer, I always was looking at B2B companies that were selling into IT, specifically looking at whether IT or did it have a security use case? Was it selling into business applications? Those were things that were important to me. I wanted to make sure that it was growing market and predictable budgets. Those were really, really important to me. Were these markets growing? Were the budget dollars being allocated? Because then, to me, the revenue, my thesis was that revenue became more predictable. I also wanted to make sure that this, you know, had some sort of monthly recurring revenue, quarterly recurring revenue to it as well. So this was, you know, dollars once they made a sale, dollars were constantly coming in. Customers, I wanted customers that were raving fans. I wanted customers that were part of the sales team. We're doing a lot of the sales for it because they love this product so much. having IPO leadership in the sales team was important, whether that was there then, whether that was on the board of the directors. And I would see, as we got closer to the events, I would see different members swapping out and then bringing in key people that would be able to take them through the IPO. I mean, I think of the majority… The three companies that I saw that went public had CFOs that had gone public before. And That was essential. They would also be changing out. Sometimes it would be a chief marketing officer, chief sales officer. They would make these different types of changes so that the company was ready. I wanted there to be a minimum of 50% year over year growth. And I wanted to make sure that that expense ratio, there was just like 10%. It was very close to profitability. That was my minimum criteria. Now, generally speaking, I was working for companies that had higher growth rates than that. But that was my minimum criteria when I was looking at different companies. And then for the stock, I wanted, you know, anything that was 12 to 24 months from an IPO event. Now, part of this was how I structured and created my role, my role for leading business applications team, position myself with an understanding of SOX, Sarbanes-Oxley compliance, so that my phone would ring, opportunities would come my way when companies were looking to go public. because they would then look for resources that would help them through those events. They would look for this type of skilled employee. So that's something that's important for you to understand is that there's techniques and strategies that help you position yourself to be more sought after. So let me give you a few other, I'm going to give you three quick strategies right now to de-risk that these were my non-negotiables. And this was looking at the team, because I know that people who had been successful before in working for private companies, the things that they looked at was, been there, done that. There had to be some key people that had that experience, number one. Number two, understanding the market, the multiples, and dilution. Meaning the valuation of the company, being able to understand why the company was being valued that way, and was it overvalued to the market, undervalued to the market is so important. You have to have your own opinion about this. Because it's easy for companies to get overvalued. We've seen this recently. They get overvalued quickly and then they lose that value. Well, for you as a shareholder, if you don't understand that, you need to because you want to, if you start seeing a lot of things change around that, you may then need to make a decision. Is this the right location for me to continue to trade my time and talent for equity? And the third thing is you want to de-risk. A lot of the things that I was talking about is you want to go into your network. You want to understand people who work for the company, who understand the leaders, who understand the founders, who know the product. You want to do a lot of what's called backdoor interviews, where you're just trying to gather information on the company. You're interested in going to work there and you want to understand these factors. So thank you so much for joining today. I hope that you enjoyed that. I think this is it. It's not rocket science. It's not. The reality is it's relatively straightforward. When you start executing a process like this, the first few times, like anything else, it is going to feel challenging. The more you get repetitions in, the more you understand it, the more that you can make better decisions. And I'm not the only one. If you go to episode three, you can listen to Brian Weiss. He is working for his fourth pre-IPO company right now. And that guy has been three for three, and it was DocuSign, Snowflake, and GitLab. And now he's working for Sixth Sense. indicators that people use as you look at people who have, who've worked for other companies, had success and say, I want to go be on their team. The more you spend time learning about how to think like an investor with your time and talent, the more you're going to understand how this works. And the more you're working for companies and you see what success looks and feels like. you're going to know what that pattern looks like. Because the more, and this happens even today, is because I understand what this pattern of success looks like, I can look at other companies and I can see, okay, they have the DNA. Is that a guarantee? No, but it's an indicator and it allows you to reduce risk. So I could continue to talk about this. I love this subject, but thank you so much for those who requested this. Appreciate you. And we'll see you on the next episode.