How does start-up equity end up paying off?
The details of how you can convert your 5% equity share to cash or stocks will be detailed in writing in the legal agreement you have already signed. If you do not have any signed written agreement, there is no 5%. Since 0% of anything is zero, you can expect to get $0 some time within the next few years. Lastly, if the person running the business, tells you that there is 5% equity for you, even though it is not in writing, that is extremely unlikely to be the case. This is because the Seller of the equity has no obligation whatsoever to pay you. In fact, they are obligated by their other agreements with actual shareholders not to dilute their equity without good cause. So, odds are, if your agreement is not in writing, not only will it not be honored, but it probably can't be honored. You will probably never see it.  The startup at some point may start issuing dividends to the shareholders (which would be the owners, including you if you are in fact getting equity), but that day may never come.  If they hire others with this method, you'll likely lose even that 5% as more shares are created.  Think of inflation that happens when government just prints more money.  All notes effectively lose value. I wouldn't invest either, most startups fail. Don't work for free on the vague promise of some future compensation; you want a salary and benefits.  Equity doesn't put food on your table. "Read the book, ""Slicing Pie: Fund Your Company Without Funds"". You can be given 5% over four years and in four years, they hire someone and give him twice as much as you, for working a month and not sacrificing his salary at all.  Over the four years, the idiot who offered you the deal will waste investors money on obvious, stupid things because he doesn't know anything about how to build what he's asking you to build, causing the need for more investment and the dilution of your equity. I'm speaking from personal experience.  Don't even do this. Start your own company if you're working for free, and tell the idiot who offered you 5% you'll offer him 2% for four years of him working for you for free." "Equity could mean stock options. If that's the case if the company makes it big, you'll have the option to buy stocks cheap (which can then be sold at a huge profit) How are you going to buy those without income?  5% equity is laughable. I'd be looking for 30-40% if not better without salary.  Or even better, a salary. To elaborate, 5% is fine, and even normal for an early employee taking a mild pay cut in exchange for a chance at return. That chance of any return on the equity is only about 1/20 (94% of startups fail) There is no reason for an employee to work for no pay. An argument could be made for a cofounder, with direct control and influence in the company to work for equity only, but it would be a /lot/ more (that 30-40%), or an advisory role (5% is reasonable)  I also just noticed you mentioned ""investing"" in the startup with cash. As an angel investor, I'd still expect far more than 5%, and preferred shares at that. More like 16-20%.  Read this for more info on how equity is usually split." "I agree with all the people cautioning against working for free, but I'll also have a go at answering the question: When do I see money related to that 5%? Is it only when they get   bought, or is there some sort of quarterly payout of profits? It's up to the shareholders of the company whether and when it pays dividends. A new startup will typically have a small number of people, perhaps 1-3, who between them control any shareholder vote (the founder(s) and an investor). If they're offering you 5%, chances are they've made sure your vote will not matter, but some companies (an equity partnership springs to mind) might be structured such that control is genuinely distributed. You would want to check what the particular situation is in this company. Assuming the founders/main investors have control, those people (or that person) will decide whether to pay dividends, so you can ask them their plans to realise money from the company. It is very rare for startups to pay any dividends. This is firstly because they're rarely profitable, but even when they are profitable the whole point of a startup is to grow, so there are plenty of things to spend cash on other than payouts to shareholders. Paying anything out to shareholders is the opposite of receiving investment. So unless you're in the very unusual position of a startup that will quickly make so much money that it doesn't need investment, and is planning to pay out to shareholders rather than spend on growth, then no, it will not pay out. One way for a shareholder to exit is to be bought out by other shareholders. For example if they want to get rid of you then they might make you an offer for your 5%. This can be any amount they think you'll take, given the situation at the time. If you don't take it, there may be things they can do in future to reduce its value to you (see below). If you do take it then your 5% would pay you once, when you leave. If the company succeeds, commonly it will be wholly or partly sold (either privately or by IPO). At this point, if it's wholly sold then the soon-to-be-ex-shareholders at the time will receive the proceeds of the sale. If it's partly sold then as with an investment round it's up for negotiation what happens. For example I believe the cash from an IPO of X% of the company could be taken into the company, leaving the shareholders with no immediate direct payout but (100-X)% of shares in their names that they're more-or-less free to sell, or retain and receive future dividends. Alternatively, if the company settles down as a small private business that's no longer in startup mode, it might start paying out without a sale. If the company fails, as most startups do, it will never pay anything. It's very important to remember that it's the shareholders at the time who receive money in proportion to their holding (or as defined by the company articles, if there are different classes of share). Just because you have 5% now doesn't mean you'll have 5% by that time, because any new investment into the company in the mean time will ""dilute"" your shareholding. It works like this: Note that I've assumed for simplicity that the new investment comes in at equal value to the old investment. This isn't necessarily the case, it can be more or less according to the terms of the new investment voted for by the shareholders, so the first line really is ""nominal value"", not necessarily the actual cash the founders put in. Therefore, you should not think of your 5% as 5% of what you imagine a company like yours might eventually exit for. At best, think of it as 5% of what a company like yours might exit for, if it receives no further investment whatsoever. Ah, but won't the founders also have their holdings diluted and lose control of the company, so they wouldn't do that? Well, not necessarily. Look carefully at whether you're being offered the same class of shares as the founders. If not consider whether they can dilute your shares without diluting their own. Look also at whether a new investor could use the founders' executive positions to give them new equity in the same way they gave you old equity, without giving you any new equity. Look at whether the founders will themselves participate in future investment rounds using sacks of cash that they own from other ventures, when you can't afford to keep up. Look at whether new investors will receive a priority class of share that's guaranteed at exit to pay out a certain multiple of the money invested before the older, inferior classes of shares receive anything (VCs like to do this, at least in the UK). Look at any other tricks they can legally pull: even if the founders aren't inclined to be tricky, they may eventually be forced to consider pulling them by a future new investor. And when I say ""look"", I mean get your lawyer to look. If your shareholding survives until exit, then it will pay out at exit. But repeated dilutions and investors with priority classes of shares could mean that your holding doesn't survive to exit even if the company does. Your 5% could turn into a nominal holding that hasn't really ""survived"", that entitles you to 0.5% of any sale value over $100 million. Then if the company sells for $50 million you get $0, while other investors are getting a good return. All of this is why you should not work for equity unless you can afford to work for free. And even then you need to lawyer up, now and during any future investment, so your lawyer can explain to you what your investment actually is, which almost certainly is different from what it looks like at a casual uninformed glance." In the real world, there are only two times you'll see that 5% become worth anything - ie, something you can exchange for cash - 1) if another company buys them; (2) if they go public. If neither of these things happen, you cannot do anything with the stock or stock options that you own.
"You'd have to check the terms of your contract. On most installment loans, I think, they calculate interest monthly, not daily. That is, if you make 3 payments of $96 over the course of the month instead of one payment of $288 at the end of the month (but before the due date), it makes absolutely zero difference to their interest calculation. They just total up your payments for the month. That's how my mortgage works and how some past loans I've had worked. All you'd accomplish is to cost yourself some time, postage if you're mailing payments, and waste the bank's time processing multiple payments. If the loan allows you to make pre-payments -- which I think most loans today do -- then what DOES work is to make an extra payment or an overpayment. If you have a few hundred extra dollars, make an extra payment. This reduces your principle and reduces the amount of interest you pay every month for the remainder of the loan. And if you're paying $1 less in interest, then that extra dollar goes against principle, which further reduces the amount you pay in interest the next month. This snowballs and can save you a lot in the long run. Better still, instead of paying $288 each month, pay, say, $300. Then every month you're nibbling away at the principle faster and faster. For example, I calculate that if you're paying $288 per month, you'll pay the loan off in 72 months and pay a total of $6062 in interest. Pay $300 per month and you'll pay it off in 67 months with a total of $6031 interest. Okay, not a huge deal. Pay $350 per month and you pay it off in 55 months with $5449 interest. (I just did quick calculations with a spreadsheet, not accurate to the penny, but close enough for comparison.) PS This is different from ""revolving credit"", like credit cards, where interest is calculated on the ""average daily balance"". With a credit card, making multiple payments would indeed reduce your interest. But not by much. If you pay $100 every 10 days instead of $300 at the end, then you're saving the interest on 20 days x $100 + 10 days x $100, so 12.5% = 0.03% per day, so 0.03% x ($2000+$1000) = 90 cents. If you're mailing your payments, the postage is 49 cents x 2 extra payments = 98 cents. You're losing 8 cents per month by doing this." "There are a number of reasons I'm in agreement with ""A house that is worth $300,000, or $50,000 of equity in a house and $225,000 in the bank.""  So, the update to the first comment should be ""A paid off house worth $300K, or a house with $150K equity and $275K in the retirement account.""  Edit - On reflection, an interesting question, but I wonder how many actually have this choice. When a family budgets for housing, and uses a 25% target, this number isn't much different for rent vs for the mortgage cost. So how, exactly do the numbers work out for a couple trying to save the next 80% of the home cost? A normal qualifying ration allows a house that costs about 3X one's income. A pay-in-full couple might agree to be conservative and drop to 2X. Are they on an austerity plan, saving 20% of their income in addition to paying the rent? Since the money must be invested conservatively, is it keeping up with house prices? After 10 years, inflation would be pushing the house cost up 30% or so, so is this a 12-15 year plan?  I'm happy to ignore the tax considerations. But I question the math of the whole process. It would seem there's a point where the mortgage (plus expenses) add up to less than the rent. And I'd suggest that's the point to buy the house." We have a lot of debt - at this point I don't even know how much This is your problem. Find out, and while you're at it find out how much income you have and also what your total expenditures are. You seem to be facing up to the problem, but not looking it in the eyes. You just need to take some time, and a little bravery, to get all your financial documentation together and lay it all out so you know what your situation actually is. Its not hard to do this, get a box and put all (old) bills and statements in that you can find, and at the end of a month, pick them out and write down the totals. Then work out your income and all that you've spent that month. This is known as a Statement of Affairs and there are calculators to help you. Then you can work out how much you need to pay off, and how much spare money you have to do this with. You can also start to cut down on all the really unnecessary stuff to increase your spare money that you can use to pay off the debts. Hopefully this won't take too long, and you can easily (if boringly) work the debt off over time. If it really is unsurmountable there are things you can do to help - firstly contacting your creditors and seeing what they can do to either part write off the debt, or freeze it as you pay it off (most creditors understand that if you're desperate enough to talk to them (!) then they may not see any of their debt back and are at least willing to help you pay them back). Generally though, it sounds like you are not in a total mess as you can pay it off. There are people in far worse states than you! But you really do need to be fully aware of your financial situation. Sit down and 'count your money' one lazy Sunday. There are links to help. Try the Motley Fool's guide, and its dealing with debt forum, both of which are very practical (if UK based, the Fool has a US site too, see for yourself if there's the same stuff on it, but this kind of thing tends to be fundamental to people of all nations). The problem I have with gold is that it's only worth what someone will pay you for it.  To a degree that's true with any equity, but with a company there are other capital resources etc that provide a base value for the company, and generally a business model that generates income. Gold just sits there. it doesn't make products, it doesn't perform services, you can't eat it, and the main people making money off of it are the folks charging a not insubstantial commission to sell it to you, or buy it back.  Sure it's used in small quantities for things like plating electrical contacts, dental work, shielding etc. But Industrial uses account for only 10% of consumption.  Mostly it's just hoarded, either in the form of Jewelry (50%) or 'investment' (bullion/coins) 40%.  Its value derives largely from rarity and other than the last few years, there's no track record of steady growth over time like the stock market or real-estate. Just look at what gold prices did between 10 to 30 years ago, I'm not sure it came anywhere near close to keeping pace with inflation during that time.  If you look at the chart, you see a steady price until the US went off the gold standard in 1971, and rules regarding ownership and trading of gold were relaxed.  There was a brief run up for a few years after that as the market 'found its level' as it were, and you really need to look from about 74 forward (which it experienced its first 'test' and demonstration of a 'supporting' price around 400/oz inflation adjusted.  Then the price fluctuated largely between 800 to 400 per ounce (adjusted for inflation) for the next 30 years. (Other than a brief sympathetic 'Silver Tuesday' spike due to the Hunt Brothers manipulation of silver prices in 1980.)  Not sure if there is any causality, but it is interesting to note that the recent 'runup' in price starts in 2000 at almost the same time the last country (the Swiss) went off the 'gold standard' and gold was no longer tied to any currency (or vise versa)   If you bought in '75 as a hedge against inflation, you were DOWN, as much as 50% during much of the next 33 years.  If you managed to buy at a 'low' the couple of times that gold was going down and found support around 400/oz (adjusted) then you were on average up slightly as much as a little over 50% (throwing out silver Tuesday) but then from about '98 through '05 had barely broken even.  I personally view 'investments' in gold at this time as a speculation.  Look at the history below, and ask yourself if buying today would more likely end up as buying in 1972  or 1975? (or gods forbid, 1980)  Would you be taking advantage of a buying opportunity, or piling onto a bubble and end up buying at the high?  Note from Joe - The article Demand and Supply adds to the discussion, and supports Chuck's answer. The most obvious example would be a situation where a Company is growth constrained, but cash flow positive. It may have enough cash flow to service $10 million of debt, but it needs to build a new facility that will cost $20 million. There is the option to raise debt and equity or just raise equity and move quicker to getting that facility up and running.   There are also situations where debt is used to replace equity (i.e. dividend recapitalization or leveraged share redemption). "The other two folks here are right with the math and such, so I'll just throw some intuition out there for you.  The basis for this valuation model is really just tacking the Gordon growth model (which is really just a form of valuing a perpetuity) onto a couple of finite discounted cash flows. So that ending part is the Gordon growth model *at the future point* discounted back to the present.  The Gordon growth model uses a ""next period"" dividend for the very simple reason that it's the next one you'd get if you bought the stock.  Is that explanation clear enough, or were some of these points not adequately explained in your class? I'll help a bit more, if I can." You wouldn't know it's value (Enterprise Value) without knowing its cash balance.  The equation:   EV = Market Cap + Minority Interest + Preferred Stock + Debt - Cash  Enterprise Value is the value of the company to ALL shareholders (creditors, preferred stock holders, common stock holders).  So, taking on debt could either increase or decrease the EV depending on the cash balance of the company.  This will have no effect, directly, on the market cap. It will, however effect the present value of its future cash flows as the WACC will increase due to the new cost of debt (interest payments, higher risk of bankruptcy, less flexibility by management). Yep, but it you didn't answer my question (edit: I know it was phrased as a question, but I do know youre supposed to model changes in cash). When bankers calculate all three approaches, how do they compare them? From what I see, the conclusion of each approach gives us:  * Public Company Approach: Enterprise Value * Transaction Approach: Enterprise Value * Discounted Cash Flow Approach: Enterprise Value + Minimum Level of Operating Cash  Does an investment banker subtract out that minimum level of operating cash at the end of the calculation to get to a value that he can then compare?