This is one of my favorite posts about valuing start-up options: < http://www.danshapiro.com/blog/2010/11/how-much-are-startup-... >.

But, funny enough, any time I have been in a negotiating position with a start-up, they act deeply offended that I would even ask about liquidity preference, makeup of the board, etc. Many of them refuse to answer these questions. It really flushes out a lot of insecurity and reveals toxic attitudes when founders won't talk frankly about this stuff.

Basically, the start-up world is about providing lifestyle employment that subtly devalues and manipulates skilled workers who don't happen to know enough about employment, or haven't had much life experience with it yet. Sometimes this can be profitable for early stage employees, but most often it is only profitable for outright founders and investors. Holders of regular options rarely make money from them, and when they do it rarely is significant in their lives and usually doesn't compensate them for foregone wage they could have earned in other jobs.

Unfortunately, there is a steady supply of people who value affiliation with a certain tech in-group, and lifestyle aspects of a job, like foosball tables, beer night, dog-friendly offices, etc., more than competitive wage. Usually these people don't realize they aren't being paid or that their options are not worth what they think they are worth, and later they become dissatisfied with the arrangement but have no negotiating power to change it.

Another toxic side effect of this is that some start-ups can have wildly varying pay levels for employees of the same stature in the firm. If two different people are brought in as data scientists, say, but while one of them was completing a Ph.D. the other was working and experienced some of the poor compensation stuff, then when each is hired, one of them will do a better job at negotiating and have a better understanding of what is reasonable. The other may just be happy to have a job after grad school.

Fast forward a few months and both of the data scientsts are each doing a great job and are each adding about the same amount of value to the firm, but one is paid more, and by being paid more is probably also viewed as a higher-status employee and may be closer in line for a promotion or an additional raise. Virtually never will the firm "do the right thing" and adjust the lower-paid person up to a matching salary, because there's no market force compelling them to (due to that employee's asymmetric lack of knowledge about the situation).

Founders and investors often foolishly think of these information asymmetries as arbitrage opportunities, as one might in a financial market. But for extracting productivity from human workers, it usually doesn't work that way, and you're carrying a lot of risk that the whole company will become a toxic place that can't be saved even by vast amounts of "culture" engineering.

Note that rarely is it the founders / investors who are behaving irrationally in these cases (at least not w.r.t. their hiring efforts). It's more often the entry level or bright-eyed engineer who doesn't want to think about unpleasant negotiation or fairness in salary levels, and accepts free lunches in place of 401(k) matching.