Recently an entrepreneur was talking with me about recruiting a new, key team member from a big company. When it came down to compensation, the startup couldn’t afford the same salary, and so the entrepreneur was working on quantifying the value of the equity component. To determine the equity piece, I recommended following the 5x rule where the expected value of the equity is 5x more valuable than the salary given up.
Here’s how it works:
- Potential employee currently makes $100,000
- Job offer at the startup is for $75,000
- Equity has four year vesting
- Over four years, the potential employee is giving up $100,000 in salary, so the equity at the end of four years should be worth $500,000
Intuitively, it makes sense that the potential value of the equity needs to be much greater than the salary reduction since there’s a good chance the equity is worth nothing or something substantially less than 5x. Follow the 5x rule and use it as part of the recruiting process.
What else? What are some other thoughts on the 5x rule for the salary vs equity trade-off?