Preparing for Startup Life: Financial Planning Tips for Startup Employees

Working for a startup can be a once-in-a-lifetime opportunity offering unparalleled personal and professional development and the potential for a significant payout. Yet startups are inherently risky, with many failing within the first year and few making it to the acquisition or IPO stage.

Thus, if you’re considering a startup opportunity, it’s important to do your due diligence and thoroughly evaluate the potential benefits and drawbacks. Moreover, careful financial planning is necessary to ensure you’re well prepared for the inevitable ups and downs of startup life.

The Benefits of Working for a Startup

Boundaries tend to blur at a small company, especially one in its infancy. Therefore, one of the primary advantages of working for a startup is that it tends to offer accelerated skill development and leadership opportunities you may not find in a traditional corporate role.

In addition, startups often foster an environment of camaraderie and direct impact. Many people enjoy seeing the immediate effects of their efforts, knowing every contribution directly fuels the company’s growth prospects.

Lastly—and perhaps most importantly—working for a startup typically offers the promise of equity. As the company grows, so does the potential value of your shares, which can lead to significant financial gain.

Ultimately, working for a startup that’s successful can fast-track your career, as well as your progress toward financial independence. But before you make the leap, it’s essential to consider the potential risks.

The Potential Drawbacks of Startup Life

Perhaps the biggest risk of working for a startup is that job security can be a genuine concern, as many startups don’t make it past their initial years. In fact, the failure rate for startups is 90%, and 10% fail within the first year, according to the U.S. Bureau of Labor Statistics.

Meanwhile, many startups operate on shoestring budgets in their early years and offer equity to their employees in exchange for a lower salary. Even if there’s potential for significant gains in the future, your pay may not be on par with industry standards in the meantime. Plus, comprehensive perks like health insurance or retirement plans may not always be on the table, especially with younger startups.

Furthermore, your equity may not be worth as much as you think. According to data from AngelList, a venture-backed seed-stage startup has roughly a 2.5% chance of becoming a unicorn today—that is, a company worth $1 billion or more. Depending on your ownership share, which tends to be less than 1% for non-founding startup employees, your after-tax payout may be modest.

Preparing Financially for Startup Life

If you’ve decided to pursue a startup opportunity after considering the potential benefits and risks, you’ll want to take steps to prepare your finances accordingly. By understanding your compensation structure and putting proper safeguards in place, you’ll be in a better position to navigate the financial challenges of working for a startup.

#1: Build an Emergency Fund Before Working for a Startup

An emergency fund is essentially a financial safety net—a stash of money set aside to cover sudden, unexpected expenses. This can help you avoid going into debt or dipping into your retirement savings if you experience a financial setback.

When working for a startup, you may need a cash buffer to cover an unexpected loss of income or sudden expenses like a medical bill or car repair. Most financial professionals advise setting aside at least three to six months of living expenses to cover emergencies. However, depending on your lifestyle and risk tolerance, you may want to save more before diving into the uncertainties of startup life.

#2: Manage Debt & Streamline Your Expenses

Startups, especially in their nascent stages, often operate on limited funds. Your salary may fluctuate or arrive late in some cases, while bonuses or raises may be rare or non-existent.

In preparation for a potential pay cut, it can be helpful to pay down existing debts and minimize your expenses before joining a startup. This can help alleviate the financial and mental burden of making debt payments on time or accumulating more debt by living outside your means.

Furthermore, financial flexibility can be invaluable when working for a startup. Minimizing your fixed monthly expenses can help ensure that even during leaner periods, you can live comfortably without straining your resources.

#3: Consider Your Total Compensation Package

When it comes to working for a startup, salary is just one piece of the puzzle. It’s crucial to understand your equity offerings and benefits (or lack of benefits) to get a clear picture of your potential earnings and out-of-pocket expenses.

First, it’s important to do a full review of your benefits package before accepting a new job offer. If there are gaps, you may be responsible for purchasing your own health insurance and other key benefits, adding to your financial burden.

Additionally, be sure to educate yourself on any equity your employer grants you. Despite its potential value, many employees leave money on the table because they don’t fully understand their equity compensation. For example, employees with stock options failed to exercise nearly half of their in-the-money options that expired in 2022, according to Carta.

To maximize your potential gains, take advantage of any educational resources your employer provides and consider working with SageMint Wealth. We have extensive experience helping clients navigate the intricacies of their equity compensation.

#4: Plan for Taxes When Working for a Startup

If a significant portion of your compensation is in equity, your tax situation can become increasingly complex. Understanding the nuances of each form and the associated tax liabilities is crucial, as mistakes can be costly.

For instance, timing decisions can significantly influence your tax liability when it comes to exercising stock options and selling your shares. You may need to spread these decisions out over several years so that your tax bill isn’t prohibitive.

Meanwhile, if you have Incentive Stock Options (ISOs), there’s a potential risk of triggering the Alternative Minimum Tax (AMT). Navigating the AMT often requires careful planning to avoid an unexpected tax obligation.

The tax implications of equity compensation are varied and complex. It’s a good idea to consult with a financial planner and tax expert to identify proactive tax planning opportunities and strategies to reduce your overall tax burden.

#5: Diversify Your Financial Risks

Working for a startup comes with a unique set of opportunities and risks. Indeed, owning a part of the company, and hence a share in its future success, can be incredibly rewarding.

Yet it can also mean that a significant portion of your financial future is tied to the company’s fate. Therefore, it’s important to balance this risk by investing in other, more steady avenues that can help minimize your financial losses in the event of a company setback.

You can do so by ensuring your outside investments are well diversified across asset classes, geographies, and business sectors. For instance, if you’re working for a startup in the tech industry, you may want to invest more of your outside savings in traditionally stable sectors like healthcare or consumer staples.

SageMint Wealth can help you design a diversified investment portfolio that aligns with your financial goals and risk profile.

SageMint Wealth Can Help You Make an Informed Decision for Your Financial Future

Joining a startup can be one of the most exhilarating decisions of your career. But it’s essential to enter the startup world with both eyes open, as it can significantly change your financial path.

Remember, you don’t need to make this decision alone. SageMint Wealth specializes in the financial planning needs and aspirations of professionals in the tech space. We can help you weigh the opportunities and risks of working for a startup within the context of your overall financial plan and implement strategies to safeguard your finances against potential setbacks.

To learn more about how we help our clients achieve their financial goals and see if we may be the right guide for your financial planning journey, please contact us.