Many founders and employees don’t realize what the startup downturn means for their equity. In many cases it’s not just worth less–it’s worth 0.

The crash in startup valuations in the last 24 months is difficult to overstate. In the space I know best, ecommerce, average revenue multiples peaked at ~5x. Today, the new normal is 0.5-1x–down 80-90%.

But it’s not just ecommerce. Recently, Bessemer estimated that SaaS multiples are down 75% from peak. Fintech multiples are down from 19x revenue to ~5x now, also down 75%. Multiples for marketplaces businesses like Fiverr or Etsy are down from 10x to 2x, or 80%.

For startup employees with common stock, these declines are especially problematic. Why?

Liquidation preferences.

In VC raises, it’s nearly universal that investors receive at least a 1x liquidation preference on their investment. What does that mean? It means, in a sale or “liquidity event,” investors get at least 1x of their investment back before founders or employees make $1.

Why is that relevant here?

Consider, for example, an ecom business which from 2018-2021 raised $8mm to generate $10mm in annual revenue. Not bad because in 2021 this business would be valued at ~5x revenue, or $50mm. Striking while the market’s hot, the business in 2021 raises a further $12mm at $50mm valuation. It’s now raised $20mm overall.

Let’s optimistically assume the company does well and grows 50% over the next 2 years to $15mm in annual revenue.

Here’s the problem: by 2023 multiples have collapsed and ecom businesses are trading 0.5-1x revenue. So the company is worth somewhere between $7.5-15mm. But because the business has raised $20mm and the investors get their money back first in a sale, that means there would be nothing left over for founders or employees. Because the business is worth less than it has raised, the equity of the founders and employees is worth 0.

To be fair, it’s a bit more complicated. Even if founder/employee equity is worth 0 today, it’s possible that the business grows into its valuation, or that multiples rise again. If that happens, employee equity can again be above water, and that gives the equity some value today. Still, it’s pretty grim to be in this situation.

What are the lessons here?

First, it’s shocking how many founders don’t understand liquidation preference math and what that implies for the value of their equity in downside scenarios. Be informed! Paradoxically, fundraising at higher valuations can dilute you more if you raise too much; if your business raises more than it’s eventually worth, you’re diluted 100%.

Second, founders and startup employees should honestly reckon with the value of their equity. For founders especially, quite often 95%+ of their compensation is in equity form. If your equity is basically worth 0 and you’ve effectively taken a 95% pay cut, it probably makes sense to have a conversation with your employer about your compensation, cash or otherwise.