This matters more now that the current crop of tech companies have taken so much money.
In the old days, when software companies sold software rather than traditional services enhanced by software, it was common to get to profitability around the B round and then never take any more investment after that. Google took $25-35M and then nothing until IPO, running the company from 2001-2004 off cashflow. Microsoft took nothing except a small mezzanine round (to align incentives with the I-bankers) right before IPO. Github took a $50M Series A on a valuation of $500M; VCs owned 10% of the company, and the 3 founders + employees split the remaining 90% of its $7.5B acquisition. Indeed took a Series A and is profitable. Atlassian took a $60M Series A 8 years after starting the company, when it was already profitable. PlentyOfFish, HotOrNot, Reddit, Wufoo all raised either nothing or just angel money before being acquired.
When you're capital efficient, you get to keep the majority of any sale price.
The current crop of unicorns like Uber, Lyft, WeWork, Postmates, DoorDash, Instacart, AirBnB, and Stripe have all taken massive amounts of capital though, sometimes in the multi billions of dollars. That has to be returned to the investors before the common shares (founders & employees) make anything. If they hit on hard times before a liquidity event, there's a good chance that the common will be wiped out, and investors effectively own the company. Why shouldn't they, when they put up all the money that the company's been burning?
Just to note that it's not useful to group all of these companies together. While they all have massive valuations, and raised lot of funding, they don't have similar businesses at all, or capital efficiencies. The market is also different today than it was with Microsoft or Google. Companies are expected and also need to grow faster (or others will). It took Microsoft 10 years to break $100M in revenue. All companies on your list are about 10 years old but have revenues in several billions.
WeWork's problem was that while they valuation was $47B, they also had $47B committed in long term leases (essentially debt). Uber & Lyft, are in war and their scale hasn't helped the economics as much since neither can get a monopoly on demand or the supply side of the market. Postmates, Doordash, Instacart, all likely operate with large gross volumes but low transaction sizes and low margins which can be challenging.
Airbnb has now more cash the bank than they have ever raised ($3.5B) and it's growing [1]. I suspect Stripe's financials are strong as well.
Free cash flow, and the ability to use or invest it well, eventually lead to a great business. Raising a lot of money doesn't necessarily mean that you are burning a lot of it, and the economics of the business matters.
It's also likely Airbnb will do a direct listing since they don't actually need the cash. Which is also potentially better for employees than traditional IPOs.
Disclaimer: I used to work at Airbnb, but this is all public information or speculation on my part.
No you have it all wrong. Lyft, Uber, WeWork etc are burning money and failing spectacularly because they aren't software companies. They're too tied to traditional markets and their economics don't magically work out because they've tried to throw software into the mix.
We are at the inflection point where they are all about to crash and burn. Good riddance.
This cycle, investors realized that OK, maybe we have to see revenues to believe it's a real business.
But, if you look at things like WeWork, sure, there's revenue, but there's never even been the hope of eventual profit. The business model fundamentally destroys value.
All the companies you're talking about have 1 thing in common: they're considered successes. You're going back in time and cherry picking companies that made it out alive. The early 00s/late 90s were full of companies that took Google levels of money that crashed and burned. There were also tons of companies that took little-to-no outside funding that crashed and burned.
For brevity I omitted all of the dot-com flameouts and also the Web 2.0 startups that never got off the ground, but IMHO they support my larger point.
In the late 90s we had a lot of companies that took a lot of money, and the founders and employees got nothing out of them other than painful experiences. When you look at one of the successful "fat" startups (PayPal), Max Levchin's take ($34M) of the $1.6B acquisition was on the same order as the Wufoo founder's take of their $35M acquisition, or the Viaweb founders take of their $49M acquisition. Even Amazon - probably the most successful "fat" startup in history - languished below its dot-com peak until AWS came out in 2007.
Margins matter. Capital efficiency matters. If you want to actually make money, you should make lots of profits on small amounts of invested capital, not lose lots of money on large amounts of invested capital.
But what if your competitor is willing to lose lots of money on large amounts of invested capital until you are out of business?
Uber and Lyft have it tough in that regard. At the end of the day they've got product market fit in a profitable industry. I mean the very worst case is they become more efficient cab companies, and cab companies have been making money for a very long time.
Their prices are artificially low due to competition, and they are in sort of a prisoner's dilemma. eventually one of them will go broke and the other will raise prices, or something will change about the market (such as driverless cars coming). But if one of them passes up raising and losing money they lose.
Then you have a lousy business model, and you aren't going to make lots of money, and you aren't going to create lots of value, and, as a result, probably won't get a massive payout.
I don't think that's true. Uber's business model is the same as every cab company, but better. It's just a temporary problem (competition forcing them to sell below market value) that they need to overcome.
Their financial struggles are due to them pricing well below what taxi cabs do. But if Uber priced the same as cabs they'd still be an infinitely better service and make lots of money, once Lyft isn't there undercutting.
It reminds me a lot of airlines. They were all hemorrhaging money similarly, even for a decade or two after deregulation, until they consolidated down into a few and raised prices.
Are you arguing that the US airline industry spins profits? I mean, sure, you have some carriers like Southwest which do, but as a friend of mine once put it, the US airline industry exists mainly as an outlet for Boeing to sell airplanes...
That was true for a long time but hasn't been for awhile. They now are mostly profitable. Delta makes almost as much as Southwest and the other majors are still in the billions.
Either way the point still stands: raising too much money transfers the economics and control away from the people involved in day to day operations.
As employees get more educated around stock options I’m certain their risk profile will change and founders will find it harder to rally a tribe around airy promises of a future exit.
I’d have an easier time agreeing with your last point if I didn’t remember thinking the same thing around 2001. Part of why this model works so well for the owners is that there’s always a fresh crop of young people who love the heavily-marketed dream and are willing to devote most of their life to making someone else rich, never realizing how badly outclassed they are by the money guys.
It's also interesting to consider the role SoftBank has played in this shift. Whoever takes SoftBank money will have the deepest pockets and will be able to play hard against competition.
This means you're pretty much forced to either take SoftBank's money, or compete against someone else with SoftBank's money. They don't care much who takes their money, because either way they have the most funded pony in the race.
> Github took a $50M Series A on a valuation of $500M; VCs owned 10% of the company, and the 3 founders + employees split the remaining 90% of its $7.5B acquisition.
They raised another $250M in 2015. Still a lot less funding than they ultimately sold for, but the common pool certainly wasn't 90% of the value at their exit.
> Why shouldn't they, when they put up all the money that the company's been burning?
Because there is another group that's putting up all the work. In startups, that work is generally more intense and risk laden, which is why employees are offered shares as part of compensation. Otherwise, why would they be offering shares? Both groups deserve protection.
The SEC was created so that people couldn't swindle each other in a legal manner. It works to some degree for investors who are, by the definition of these types of investors, rich ($1mm in assets or $200k/income). But it clearly isn't working for the people doing the work.
So our system protects the rich, but not the people who apply a trade. If you think that's ok, fine. But I find it terribly unfair.
Joint stock companies exist as a result of legislation, the separation of capital and management requires courts for mediation. I can't see why someone wouldn't support changing it to be more equitable to all involved, especially if it is done based on merit (where labor and capital are both weighed as equal inputs at the time of distribution of large liquidity events)
So people who work for a start up aren't taking risk?
Employment is more than just the paycheck. It's security. It's a career trajectory. Otherwise, why do consultants get paid more than employees?
You can see it that employees take no risk. That's fine. But then I wonder why start ups tout the stocks they give? And why is it acceptable to tout something that they know has no value?
The SEC has a function. To avoid dishonest actions that would otherwise be legal under standard criminal law from eroding trust in security markets. The employee of the article we are discussing here received 1% for losing out on opportunities of growth in a larger company. Obviously he was worth something to the company, and more than they were willing to pay him in cash. He was betting on the future value of the offerings he was receiving. By being able to trust that, start ups could/would/should obtain labor at discounted rates. This is good for the market. Trust in securities.
You can call him naive. But I will remind you that in the late 19th and early 20th century the stock market was not well capitalized. People presumed they were getting screwed. And anybody who placed trust in the system was called naive. "they shouldn't trust" is an easy argument. It's the old 'it's just the way it is' argument.
It's arguable, but I'd say creating trust within the exchange of securities via systems like the SEC was a great advance in the allocation of resources. It's why we have well capitalized markets. Without trust, friction comes along.
That is why I feel what was described in the article is deeply unfair and given that the entire structure of joint stock companies is a legislative creation, surely it could be changed.
So basically, your view that "the big money goes to the people who risk" seems idiosyncratic and reflexive rather than based on any substantial analysis of the article or the situation.
I'm hardly advocating for any revolutionary ideas. Overall, having read The Wealth of Nations, I'm a big supporter of Adam Smith's ideas. Which is why I can see how the system can be structured differently within the capitalist context.
> So people who work for a start up aren't taking risk?
Not at all like the risk of putting in a big chunk of your own money. When you lose it, it's gone. Too bad, so sad.
Employees have the lowest risk position. They get first claim on the money owed for their paychecks and there are many legal protections for that. The investor is frequently last in line, and gets nothing if the company bankrupts.
> described in the article is deeply unfair
My reading of it was slightly different than yours. If the company hadn't gotten the overhang investment, they would have gone bankrupt and the employee would have lost their job sooner. If the overhang wasn't offered, the investors would not have invested. There was no path for the employee to cash in the stock - unless the value of the company was larger than $100m. But it wasn't.
I have no problem with employment where money is exchanged for time. But that wasn't the case.
The employee got paid for time in the form of money and stock. You are conveniently ignoring this part.
If the stock is worthless, why offer it? The answer to me is obvious, they are being deceitful.
As stated, the SECs' mission is so that people who deal with securities don't engage in deceitful behavior, since deceitful behavior removes trust from market participants which creates friction and increases costs and decreases participation.
The argument that people's rewards, one who put in $50 in cash and another who accepted an offer that resulted in a decreased earnings of say $50 avg should be treated differently is anti-meritocratic. Both risked $50. If the employee wasn't accepting a decreased earnings potential, why offer the stock? You can't have it both ways.
Just as the company would have failed if the investors didn't invest, it would have also failed if the employees left when they saw trouble. Many extensively won't because they have shares. That's why the shares are offered in the first place. To motivate the employee. But it turns out many times those offerings are done in a deceitful manner; the people offering stocks to employees many times know those stocks are extremely unlikely to be worth anything, yet they make a concerted effort to make it appear as if those stocks are worth something.
Investors are protected from deceitful security offerings. Surely you think that's a good thing? Why not apply to all parties?
Literally all I'm arguing for is a more honest (and therefore meritocratic) code in our system when handling the exchange of time for securities, especially in the face of a large liquidity event.
It wasn't worthless when it was offered, the overhang deals did not come until much later, and it did not become worthless until the company sale price was agreed upon. The stock would still have been worth something if the sale price was higher than the overhang.
Getting stock does not mean it can be diluted by further stock issuances. There is no deceit there.
> Literally all I'm arguing for is a more honest (and therefore meritocratic)
Honesty has nothing to do with meritocratic. For example, the person next to you on an airplane surely paid a different price. It's neither dishonest nor meritocratic. It is what both parties agreed upon. Each person has a different level of risk tolerance and desire for money.
Everybody in a startup gets a different deal based on their ability to negotiate, what they want, their risk tolerance, and the desire of the company to get them on board.
If you agree that both put in $50 worth of something, then why does one get something while the other nothing? How is that honest? The employee was investing time for the stock, the investor fiat.
The employee was offered 1% of the company.
Reasonable, everyday people will understand that to be 1% of all money that comes in on a sale after paying legal fees and bond holders.
The rest of the convoluted mess, while legal and negotiated and something I understand, is done in a way that is taking advantage of the information and power asymmetry of the two market participants. Just as stock swindles happened in the late 1800s.
Honest markets do create more meritocratic markets, as market participants can engage without the friction of complete distrust. Courts and systems to create trust are essential. If you don't understand that concept, then we likely won't ever agree, I think it's a pretty basic concept in capitalism and economics. It's like people who don't believe in supply and demand, if you can't agree on something so basic, then all subsequent points will be going off a different basis.
As stated in my earlier reply, look at the stock market and how it was for investors in the 18th century when there were little to no rules protecting investors and therefore there was massive friction from dishonest market participants.
Your argument can be boiled down to 'caveat emptor'. Which is an argument that lacks intellectual cohesiveness when you are simultaneously supporting the legal structure that removed such a situation from the average investor and which has allowed our markets to develop and become fully capitalized as market participation soars when honest behavior is enforced.
It amazes me that someone can honestly argue against providing time investors with the same protection as fiat investors.
No, they weren't. They were offered stock. Stock can always be diluted by future stock issues.
> Reasonable, everyday people will understand that to be 1% of all money that comes in on a sale after paying legal fees and bond holders.
People who accept stock options and don't bother to learn about them have only themselves to blame. The information isn't hard to come by, it's all over the internet.
> It amazes me that someone can honestly argue against providing time investors with the same protection as fiat investors.
They do have the same legal and system protections. They got what they agreed to.
> Courts and systems to create trust are essential.
Yes.
What you're discounting, however, is the role of risk. Risk is always there. The larger the risk, the more potential returns there are. If you try to legally define the risk and legally force two disparate risks to be the same, the result will be all kinds of market distortions.
You argue that the risk of the employee and the investor are the same. They are not, or they would be priced the same. Is it really right to interfere in the negotiations other people are freely making?
I think your argument is at best disingenuous. People leading startups know that people taking stock as a good part of their equity know that the vast majority of startup employees actually don't know how stock equity works in those circumstances. They don't like it when they ask for more cash comp, and it's to the benefit of the company founders that regular employees don't understand. It's also the case that people should educate them.
But like we make laws controlling how real estate loans work to protect people from shysters, we should probably have a lot more required documentation for companies that offer stock in pre-ipo companies.
If this was market based, you'd be right. But if it is legislative based, then this is the definition of circular logic. Given that the structure of preferential stock is legislative based, it is circular reasoning.
I count risk based on what percentage of a person's net worth and potential earnings are tied up in the securities.
That renders a different perspective of risk than just raw numbers which is what you seem to be going off of.
Your argument can be boiled down to 'caveat emptor'. Which is an argument that lacks intellectual cohesiveness when you are simultaneously supporting the legal structure that removed such a situation from the average investor.
> Which is an argument that lacks intellectual cohesiveness when you are simultaneously supporting the legal structure that removed such a situation from the average investor.
Not exactly. The courts are there to enforce the contracts, and protect against fraud. They are not there to protect people from making ignorant decisions and failing to do things like read the contracts they sign. They are not there to remove risk.
Some people say that free markets don't work unless there is perfect information on both sides. This is incorrect. Imperfect information is called risk and is always priced in. The overhang in stocks comes about because investing in the company is perceived as extremely risky.
As a practical matter, it was, since it wasn't liquid and had no security against changes which would eliminate it's theoretical value before it became liquid.
It could have become worth something with the right set of future conditions, but those obviously did not materialize.
It might additionally be getting common stock, under the same terms of other common shareholders, which is to say, behind the preferred shareholders, who are behind the bond holders.
I'm surprised how many people don't get this part.
Person A, investor puts in $100k
Person B, employee gets paid $100k
Company fails.
Person A lost $100k
Person B gained $100k
This is why person A gets the lion's share of the rewards if the company succeed. Person B risked nothing. Person A risked $100k.
The typical retort from Person B is they could have gone to a different company so their risk was to work for this particular company. For example they could have gone to a FAANG company and made a high salary but instead went to some startup at a lower salary on the risk that it would succeed. From one POV that is a risk but it's not your money until it's in your hands. Future money is similar to saying well "if I won the lottery tomorrow". Until you do actually win that money it doesn't really count. You can use that line of reasoning in negotiations (you want me to join your startup but I have an offer from a FANNG company, sweeten the deal if you want me). But after that you didn't actually take a risk relevant to the company. Instead you made a choice to be paid X amount for your labor.
Note: I've never been on the investing side, only the employee side, but for some reason I've never felt ripped off since I knew I was taking no risk.
There is a deep flaw in this logic. Person A and Person B are both investing the same amount, just in different forms.
Person A converted their 100k into 1 year of time.
Person B converted their 1 year of time into 100k of money.
They both put in 100k of something, B put in 100k worth of time, A put in 100k worth of money. If we assume a fair market rate for the conversion, then essentially this is a perfect exchange, and they both traded their different investments for exactly what they were worth. That is, the money invested, got back EXACTLY the amount of time it purchased, and the time invested got back EXACTLY the amount of money it purchased.
Person A and B are trading things of equal value. This means they invested equally, and hence should split the reward equally.
My guess it's you'll claim A got $100k of your time so A is at 0 as well but if we follow that logic in other places we can see how it doesn't work.
A pays $10 for B to make a pie
B pays $10 of time to make a pie
A now resells pie for $20. A does not own B any percentage of profit. That's the business success case just replace "pie" with "business". Similarly A drops pie. B does not owe A a new pie. That's the business fail case. $B got their $10 money for their $10 of time. B's risk has now been paid for. A still has a risk, that they can sell the pie. Replace "drops pie" with "business fails".
Person A has not the time to invest into building the product, so they invest money, 100k's worth of dollars.
Person B has not the money to invest into building the product, so they invest time, 100k's worth of time.
So if we compare dollars in the event of company failure, we have:
Person A is now at -100k
Person B is now at 100k
Person A is now at +1 years
Person B is now at -1 years
Again, this means they both invested equally. What is usually harder to see is the time investment. But Person A gains one year of work they did not have to do on the product (via their investment). Person B loses the year they invest/spend on the product.
Purchasing a product does not imply joint ownership. Consumers do not partly own the profit of the Producer. However, if A and B decided to build a pie product together then yeah, they'd split the profits. Which is what is at stake here in this overall discussion: how should profits fairly get split when two or more parties contribute the resources to build it.
This literally makes no sense, and it wrong even by your own math.
Person A is now at -100k: Agreed
Person B is now at 100k: Agreed
Person A is now at +1 years: If you are valuing 1 year at 100k, then no - they are at zero years. They put in $100K over 1 year, so the two cancel each other out.
Person B is now at -1 years: Again, they have been paid at the rate of $100K for 1 year, so they are at zero years.
Again - I reject this "losing a year" thing. The investor hasn't gained a year at all - you can't lose or gain time. But if you value 1 year at 100K then they have paid for 1 year, but that means they have by-passed other opportunities.
If they invest $100K in 2019 and the company goes bust in 2020 how have they gained a year?
But even ignoring that (!!) your math doesn't work.
Let's say you have 1 year left to live. You have two things you want to do, X and Y, but X and Y take 1 year each to complete. It is the end result you want, but each result takes 1 year achieve, and you only have 1 year left to live. What can you do?
Well, if you have enough money, you can pay for someone else to work on X while you work on Y. In this way, you have been able to get 2 years worth of work done, in only 1 year. In effect, you doubled the number of years you had to spend on getting things done.
Spending money in exchange for someone else's work is a time multiplier on the one who spends the dollars. They get more done in less calendar time, i.e., because they effectively have more effort-time by converting their money to someone else's calendar time.
The entirety of my reasoning in predicated on one simple thing: an investor trades in their money for something of equal value, and the worker trades in their time for something of equal value.
This means, by definition, they are equal partners in the exchange, and hence must split the profits equally. It also means they each gained and lost equally, because they traded evenly.
If you do not agree with the foundational assumption I am making, point out the error in that, as all else necessarily follows.
Also, if the company failed because they failed to deliver that thing you wanted to build does the investor get the time back? No.
But the employee keeps the money.
The entirety of my reasoning in predicated on one simple thing: an investor trades in their money for something of equal value, and the worker trades in their time for something of equal value.
Indeed. The investor buys part of the company, and the worker gets paid for their time.
If you buy shares in Microsoft you get a proportion of the company, not some weird "time" thing.
Are you saying that when a company fails, all employees should return their past salaries paid by that company? Because that’s what splitting the (negative here) reward equally with investors would mean.
No, that doesn't mean that at all. If a company fails, investors don't have to return the time they've invested by putting in extra years of work, so it follows that those who invested time wouldn't return the money they received.
Investor A puts in 100k of dollars, the company fails they've lost 100k worth of dollars.
Worker B puts in 100k of time, the company fails, they've lost 100k worth of years.
The point is, they are both risking equally, when compared in the same units, time or dollars, but not both. The investor is investing 100k worth of time, and the worker is also investing 100k worth of time. If the company fails, they have both lost that invested time.
Investor A puts in 100k of dollars, the company fails they've lost 100k worth of dollars. Worker B puts in 100k of time, the company fails, they've lost 100k worth of years.
This is complete nonsense.
The worker has received $100k for their time and keeps that money. The investor has nothing.
If you try to argue that the workers wage doesn't count for some reason, then you also should argue that the investor's time counts the same as the workers did. Either way the investors is worse off.
The investor is not the least bit worse off. He gains what the worker loses, and the worker gains what the investor loses. The worker gains the 100k, but the investor gains the extra year of work.
That is, the investor, effectively, gets 2x the time they otherwise would have, because they traded some of their money for someone else's time.
Whereas the worker has now lost 1 year, though they did gain 100k for the time they spent.
If you do not believe that the investor is trading their 100k for something of equal value, then please demonstrate this. For it is this equality that underpins my argument.
Saying the investor "has nothing" is naive, since, as with others, you are ignoring what they traded their dollars for.
> Future money is similar to saying well "if I won the lottery tomorrow".
Eh, expected value is a thing. If you lay 3:1 odds on a coin flip and then win, you get real money and are free to feel all happy about it, but you still made a poor decision.
If an employee has an FAANG offer for 300k but goes with a startup for 100k+options they are absolutely taking a risk. The expected value of those options is very real and relevant.
They risked the single thing that absolutely no one, anywhere on the planet, can ever give them back: time.
Yes, they took a lower salary on the risk that it would pay off but they slid in the chips of their days existing on this planet alongside that risk. If no one was willing to take that risk alongside the venture capitalists who only invest easily-replenished money, the VCs would find their investments significantly restricted.
The problem is that the some of the people taking a risk and making investment, often the ones in the worst position, have far less information than others. It is inherently unfair that one "investor" can be worse off than another, especially when stacking up money against time. As the author wrote, this isn't inherently unfair...as long as it's not hidden.
But it's almost always hidden because the "lottery ticket hope" of turning 1% equity into seven figures is spoken of as being a regular amount of risk when, in reality, you'd be better taking that higher salary at a FMANGUNFXZOR company and putting the difference into actual lottery tickets.
(As an addendum, if anyone is about to reply with the words "rational actor" anywhere in it, I'm not moved by that rebuttal. Human beings are not rational all of the time and we are nowhere near as rational as economic textbooks would have you believe. Yet, somehow, that rationality or lack thereof is only called into question whenever the person in the crappier position with less leverage is the one who loses.)
I agree. The idea that time is not risked as an investment is, IMHO, deeply weak minded. Dollars, when used to purchase labor, are essentially acting as concentrated time. It's like a conversion from matter to energy and back. Walking around with lots of dollars is like holding lots of time, more time than you actually have life. So someone with a lot of money has, in effect, a vault of highly dense time they can chip off and trade with someone else, buying, essentially, more life than they could ever have (i.e., paying others to do things they could never in their lives have the time to do).
We humans are such primates, though, that we regard those with far more money as essentially higher class in the social hierarchy, and venerate their actions, and their property, as inherently more valuable than someone with less.
So when investing in a company with money, you are able to participate in that company by buying someone else's time. But, assuming a fair exchange (which is usually not the case for the laborer), then the one who works is trading one year of time for one year of time from the investor, in the form of dollars (assuming a 100k/year salary). However, the investor isn't trading their time in the form of calendar time, but in dollars. The worker is trading their time not in dollars, but in calendar time. The point is, it's an equal exchange. Which, if there are two people, then both would split the reward 50/50 assuming all else is equal.
We get confused as primates because we are comparing dollars and time, not realizing that we need to convert to common units. To know the true fair split, we have to know how much each person invested in the same units, time or dollars, but not both. We have to convert all dollars invested to time, or all time invested to dollars, in order to know the true investment ratios. In the example of Person A and B, both put in 1 year of time, hence a 50/50 split.
If you hired me to build your house for $100k, and you paid me, and then you sold the house, making a profit of $300k, would you give me $150k? Likely not.
I think a better argument is below from 4ntonius8lock, who says that employees were supposed to get (a) $100k AND (b) stock of some value. But employees were not told all the rules under which (b) could be zero.
What is always overlooked is that Person A was also compensated for their dollars. Person A put in 100k and was compensated for those dollars. They didn't trade their 100k for nothing, they traded it for 100k of something of equal value - Person B's time.
Obviously works for hire do not always imply joint ownership. The reason for the discussion is that we are talking about startups built with implied joint ownership. We are trying to infer the equitable joint split for the reward in building something that is implied, often overtly, to be owned by both parties. Both parties in the two person startup are investors.
Most of the things we purchase with money (we spend time to acquire someone else's effort), are sold as someone else's time. If you pay someone to build a house, it's because they were offering that time for sale. This is why software consultants at most startups never get any equity, because their time was already on sale, and was being auctioned off.
They got paid for it in the form of money and stock.
If the stock is worthless, why offer it? The answer to me is obvious, they are being deceitful (the start up and its investors). As stated, the SECs' mission is so that people who deal with securities don't engage in deceitful behavior, since deceitful behavior removes trust which creates friction.
The argument that people's rewards, one who put in $50 in cash and another who and accepted a lower payment/higher risk which resulted in a decreased earnings potential of say $50 should be treated differently is anti-meritocratic. Both are risking $50.
BTW, if the company offered no stock to employees, we wouldn't be having this conversation. But the comments are, or should be, based on the FA of which this is a thread.
I feel sorry for all of us who believe that money is the only thing of value that was traded in the exchange. Which essentially is your same point, I know.
All those who say, "yeah, but they got paid, the investor risked their money" completely see no value in the time that was traded for the money, which, almost by definition, cannot be the case. The money invested was done so in order to be traded for something of equal value - time. But most people do not see this, and consider themselves lucky if the person with the money was "generous" enough to let them have some of the spoils of their joint effort.
Should be noted that Stripe et. al. are paying premium salaries and as they are well funded with customers and income, they're not very risky, or rather, probably the same amount of 'employment risk' as most other private entities.
If they are not pushing everyone to work late hours and long weekends ... then there's little reason to expect that later employees should 'get rich' from a buyout - though they should get something.
Earlier / Senior staff should get something more as well.
Worth noting: Canadian 'News Magnate' Conrad Black went to jail for 'carving out' sales of assets like this as kind of a sales fee. The shareholders not only sued him but he went to jail over it. The tiny but important difference would be the 'buyout carveouts' are backed by shareholders to incent execs to stay on while Black's dealings were ostensibly not (although they probably should have been). And of course Black was a foreigner and this has a material difference in the USA (and many other countries) where non-citizens end up getting treated differently for a variety of reasons.
Not sure if you mean now or a few years ago. Either way, don't believe all the stripe marketing hype.
I was working at a small startup circa 2015, around 100 employees. We looked carefully into payment providers to try to reduce costs. Turns out Stripe was very small, we would be their main customer with a 2 digit percentage of all transactions if we moved our payments through them.
Stripe had (has?) few customers and little volume. Meaning very little revenues, because that's a small percentage fee of all that. It was a fairly risky business and it wouldn't be sustainable without a fair amount of capital upfront and many years.
While it's hard to get confirmed metrics on Stripe given that they're private, it strikes me as unlikely that a 100-person startup would have been Stripe's "main customer" in mid-2015. Analysts estimated their annual revenue to be $450M that year based on a payment volume of $20B, with customers that at that point included Lyft and Slack.
Stripe was in the order of $10B in the previous year and we were above $1B. We were doing well for a small company, can't deny that, but ultimately that's all pocket money when it comes to payments or large companies.
Lyft and Slack were much much smaller back then, also private companies that don't publish any numbers. Not exactly great references at the time.
If you have to learn something from this, it's that Stripe is a long term play, that really needed the capital to sustain and grow the business. The main growth factor by the way is the second-order effect of growing with their customers, and they're very smart to advertise to the HN crowd.
A late reply, but I was just rereading this thread and it reminded me of a few recruiter pitches that seemed to seem it was a positive that a company just had a series E round of funding.
I mean on the one hand, they do have enough of a business case to get that many checks, but on the other, my first thought was that there was no upside at all there most likely.
For employee shareholders of common stock, their stock has the same market value that anyone who's buying for the first time through a broker sees. It's not like they are going to be forced to hand over proceeds of sales on the market back to investors.
When a company goes public, they usually hire an investment banking firm to manage the process. The I-bank does a lot of work to properly value the firm and price the IPO right, but part of their job is also drumming up interest among potential buyers of the stock. Like any securities offering, the IPO is basically an auction where the amount of money you raise, and the terms you raise it at, depends critically on how many people you can get interested in your offering and how excited they are.
One way to incentivize the I-bank to do their very best to get the highest price for the shares, and to keep the price high, is to make them shareholders themselves. Thus, Microsoft did a small (Crunchbase reports it as $1M) financing round with their investment bank right before IPOing, despite not needing the money at all. Any dilution is more than made up for by the better IPO price; basically, the I-bank got to share in their upside by making their upside bigger.
funding where higher risk takers get paid more but "controlling rights" remains with smaller invester(s), so I guess MS didn't want to give up any control by selling shares, other then select few.
As a former founder, I am often surprised by the incredible spend at some startups I've visited. The biggest is headcount - so many fluff jobs.
How many designers does an early stage startup really need? 1, 2, 10, 20, 50? How many SREs do you need when your site is just a handful of AWS instances? How many sales people do you need when your product isn't ready for sale yet?
Each employee fully loaded in the bay area is what like $150-$300K? 20 people like that will chew through your Series A before you know what happened.
Bad (for startups) deals get done when you start running out of runway. Once you're out of runway, you'll sign a 4x liquidation preference at a low valuation because it gets you an infusion of cash now. Now the VCs own you.
Instagram had what, 12 employees when it got bought for 1 billion?
I worked for a small company that fired half the employees (10->5, mostly marketing/sales execs) and absolutely nothing changed. Our revenue actually increased over the next year, not to mention gross sales not paying those salaries. We were originally going to replace them but decided to wait it out for a full year because we realized we didn't need them.
They were all expert busy-workers, who used to try hard when they first joined but got lazy about 2yrs in and started phoning it in. Startups and small businesses have no time for those types of people.
The other massive expense VC-backed companies waste money on are high-paid consultants (and lawyers) from the big business corporatey world.
> Instagram had what, 12 employees when it got bought for 1 billion?
Which was really a pittance.
I acknowledge hindsight is 20/20, but it's interesting to see posts here lamenting that startups hire too many people, when selling for much too little is surely a more grievous financial mistake.
Or to put it another way, if they had 75 engineers when they sold for a billion, the tragedy would still not be that they had too many engineers.
A billion dollars for a 2yr old company in a highly competitive mobile space is a pretty good deal...
They probably saw the risk in FB or Snapchats or w/e competing with them. It was just photos with filters at that point. Not a massive social network like it's become.
Coinbase avoided design forever—using simply twitter bootstrap and uh not much of a logo.
Not every startup can pull this off, but template designs—particularly for web are great and cheap now. Custom UI controls waste money in development and design.
Heidi Roizen, VC, most definitely does not feel Former Millionaire's pain. Yes, liquidation preference overhang is the mechanism. However, the company got sold for $100M. Who sold the company? The founders + the VCs and they got theirs. They could have structured the deal to give the employees something. They didn't.
The advice here is simple. Walk. Former Millionaire owes absolutely nothing to the new company. Staying rewards this screwjob. If the founders + VCs want this Engineering VP to stay then they have to pay the VP to stay.
This could have been handled better if the founders and VCs had left something on the table for the workers. That was a choice they made.
She mentions this in the article - most deals are structured with carve-outs so that specifically those employees you want to stay get multi-million payouts (over multiple years) as long as they stay with the employer. If there was no such carve-out for the VP, it means the acquirer doesn't want them.
The answer is still "walk", but the acquirer is not going to care. The reason to walk is that there's no sense staying in a job where your employer doesn't want you and isn't going to reward you. It's for your own self-respect, not to stick it to the man.
I'm going to plead guilty to giving up after I saw the preference overhang thrust of the article. She in fact gives a good outline of the issues involved. Maybe I had Travis Kalanick and Adam Neumann in the back of my mind.
Still the element of unfairness about is that Certain key employees were incentivized with a “ carve-out “ in order to stay through the transaction and make sure it would happen. Using the example, four years is a long time to be rewarded with squat. However, Roizen also points out that common stock is priced lower than preferred.
Usually someone like an engineering VP or a senior contributor will figure things out well before that and bail. The idea that this was somehow a surprise is difficult to accept.
Not only walk but name and shame the founders for allowing this to happen. No one should want to work for someone who screws their employees like that.
FWIW, I kind of don't believe that this question is real. Questioner clams that he is a VP but also:
> He has no idea how liquidation preferences work
> He was "told" that the company was being acquired (instead of being involved in the sale)
> No one at the company walked him through how his stock was valued, even after the
acquisition. To the point that he thinks he needs to hire a lawyer.
It's a fine question to use as a lead in to explaining how stock options work, and that's a fine thing to write about. But I'd bet money that the author made up the question.
The title is not a meaningful gauge of a person's knowledge or experience. It wouldn't be unheard of for a VP at a company with 50 employees to have similar responsibilities as a manager at a company with 1000 employees. They could also be VP of Engineering/Customer Service/etc. which would typically not be expected to have much, if any, legal or finance knowledge.
It could be. But small companies often give their employees inflated titles, where a "VP" is actually a small team lead with no executive responsibilities.
Titles are usually based on area of responsibility, at a small company you may have a small number people or no people but still have the responsibility... it's just enough for one person to handle. So it's not bad to have a VP of Engineering only manage 4 ppl.... but if everyone things a VP of Engineering is the same at small or large companies that's uninformed of reality. Title inflation helps recruit... so add that on to this as well and it's confusing. Not saying it's right, but that's how it is.
Actually, there is immense title inflation at large companies as well, just depends which company and field. Have you seen the number of VPs in the Finance industry in NYC?
I feel like legal manipulation is very bad for the startup ecosystem. Even here, at the YC forums, people assume their startup equity is worth $0 and advise you to go with a FAANG (or day that they broke even with friends at faangs after their exits). How is a legitimate startup supposed to recruit the best people under these conditions?
> How is a legitimate startup supposed to recruit the best people under these conditions?
Easy. Disclose the preference of the terms you got from investors to your early employees.
This problem is self created. If you don't tell them the terms of your deal, they rightfully assume the terms will screw them, since otherwise why wouldn't you be transparent? Good workers rationally and rightfully go to FAANG instead of a startup if it doesn't feel like the startup is being fair.
Honestly, startups should be more transparent, because they can't compete on money. If they can't even offer trust and upside, they are offering literally nothing over an established public company.
So many people flock to startups because they didn't want to go work for a large soulless corporation (often taking a pay cut in lieu of equity) -- only to discover that startups can also be soulless corporations that focus on greed more than anything else.
Edited to add:
It would be nice if there was an equity dashboard inside each and every startup that basically said, "If the company is sold today at $100M, you get $X." Not only would it serve as motivation, but it would also show every effect every VCO demand on the corporation to your equity.
Ideally it would be a graph over time so you can see if your equity stake is going down or up in value, and you can make an informed decision about leaving. Also many of the VCO shenanigans might stop if people know ahead of time what it means.
Exactly. I once asked a founder if his books were open to viewing by employees and whether I could see the cap table. He looked at me like I had a horn growing out of my forehead, and later I learned he privately complained to the recruiter about how unreasonable and unacceptable requests like that were. There’s this big “youre the tech help and you don’t need to care about banky things like liquidation preference and future dilution” attitude still. Much safer to just go with an established company whose shares can be sold as soon as you get them.
Also:
> How is a legitimate startup supposed to recruit the best people under these conditions?
I’d argue most startups don’t need “the best people”. They need a few hard workers who can wear multiple hats and have a promising skills trajectory. The “social network for dogs” doesn’t need to hire Ken Thompson.
> How is a legitimate startup supposed to recruit the best people under these conditions?
1. As a rule of thumb, you can't.
2. As an exception, you can if they really want to see you succeed (i.e. for your mission).
3. As an exception, you can if they're dissatisfied or bored with their FAANG career and the job represents growth or excitement that they want.
4. As an exception, you can splurge on a few key hires, in terms of salary and/or equity.
5. As an exception, you will find dark horses, people who are currently undervalued by themselves and others.
But as other posters mentioned, the reason I agree with the advice about pricing equity at $0 is because that's rationally the most likely outcome. Honesty about that fact is very much appreciated, but rationally the expected value is actually (approximately) zero.
Some of the bigs do offer that. I know several people who work 3 days a week or 20 hour weeks at FAANG companies. They probably don't offer it entering though but only after a few years.
The entire point of joining a start-up is to 'play the lotto'. You are deferring salary now for a chance at millions later. You would not do it if the expected value was negative[0]. However, it's becoming more and more obvious to even freshmen undergrads that it's all a load of hooey.
Not only are the founders going to need to be super transparent with their finances to get good interviewees, but some other event will need to take place in addition [1]. That makes hiring good employees even more difficult, especially as the company grows.
This behavior by the current unicorns can be overcome, but man will it take a change in the funding ecosystem. Since the current crop already has two unicorns (Uber, Wework) with major funding rounds by a shady group (the Saudis), I really doubt the ecosystem will change for the better of prospective employees.
Like it or not, the wild west phase of tech is over. It is better to join up with the FAANGs at this point for most folks. The expected value of joining a start-up is unlikely to be positive.
[0] Yes, there is a sucker born every minute, but in general, that's the idea.
[1] Events like the prospective employee will require really good healthcare that only this company provides, or the prospective employee really really needs a job for some reason, or the prospective employee lives 5 minutes away, or the prospective employee really is super passionate about the idea, or the prospective employee is a good friend of the founders, etc. Each prospective employee you hire is also unlikely to share any of these events with any other prospective employee, and these events are likely to change over time.
"The entire point of joining a start-up is to 'play the lotto'."
I don't think that's "the entire point" for all of us. I enjoy the challenges of scaling products that already have product market fit; startups are a great place to do such work. I also enjoy small, but not too small, teams; somewhere between 50 and 150 is a nice sweet spot for me. This setup is also found at many startups. Sometimes, markets lack institutional players as well. If I want to work on certain kinds of healthcare, financial technology or cryptocurrencies, startups are also a great place.
There are basically two tiers of startups in my mind, those that compete with FAANGs for talent (Airbnb, for a while Uber, whatever flavor of the month) and usually are comprised of lots of ex FAANGs, and those that are second choices to FAANGs.
Most of the people I know at the first tier also joined mostly for the money. Those in the second tier, it’s because that startup was the best opportunity they had. Or in some small cases, because it gave them experience in something they couldn’t get at other companies (eg a pure ML role).
> How is a legitimate startup supposed to recruit the best people under these conditions?
So, I'm post-exit from a startup I founded. It was >10x on returns, but not a supermassive company. I've also been part of a few other exits now in various capacities. So let me just tell you:
Startup founders get better stock than they give employees. They also often write themselves in super powers or special exit clauses. So for founders, the deal is nearly always better unless things get very bad (and it's usually better to wind down the company rather that push if things look that bad, a tough call).
Most folks have a very distorted view of what startup equity is. People think the equity will be worth a lot. And it could be in very specific cases, like an IPO. In those cases, stock is often great. In acquisitions, it's usually not quite as amazing.
If you do find yourself holding stock in an acquisition as an employee, usually what happens is either your stock is bought from you for a fee, or in rarer cases it's converted into company stock (which is usually the better option if it's a publicly traded company). You can expect some modest five digit sum from even the best outcomes here. But what will probably happen to said engineers or staff is that they'll get "retention bonuses." For engineers, retention bonuses for folks they want to keep on are roughly double-pay wages on a non-incremental payment schedule (e.g., 25% the first year, 25% the second year, 50% the third year) to try and get folks to stay on and embed themselves in the company. This is often a lot more valuable than the stock you're awarded if you can stick it out.
A famous explanation of a big (but not superhuge) acquisition is an old post by then-workaday engineer and founder of a small startup called GitHub named Tom-Preston Werner [0]. In that post he details the nature of his deal with Microsoft and why he didn't take the money.
Considering what he ended up with, it seems like a good deal, but only because he was one of the very few people who managed to pass a company into profitability.
I feel like there's a lot of founder/non-founder equity disparity that doesn't quite make sense. If it ever got to a point where startups genuinely had a hard time recruiting good talent, I would think/hope that one lever available would be to shift the equity balance a bit.
Another might be to just pay engineers in cash closer to their market value. I think (not sure) that people in other fields who work at startups end up having a smaller gap between elsewhere comp and startup comp? Though that also usually comes with even less equity.
All that said, most startups seem to still be able to hire. Maybe people find the experience rewarding enough relative to FAANG to accept the gaps. Maybe people don't quite do the math to understand what the outcomes look like.
Personally, I had left FANNG to go to a startup a few years ago, was recently looking for a new gig, considered going back to FAANG, but decided on another startup that I liked for a lot of reasons, and got myself to a point where I thought the break-even valuation wasn't too crazy. But it's very much not "this will make me rich" and more "this seems like it'll make me happy and I feel like I'm not literally setting money on fire by going there".
By being transparent and giving all the numbers needed for the employee to make a good decision.
For what it's worth, I've always valued options at private companies as zero in making career decisions and looking back I don't think that heuristic ever steered me wrong (even at a company that is now a "unicorn")
from experience: I am very big on transparency and honesty and while that feels good and no one ends up surprised, the problem you run into is that other companies are not particularly honest or transparent.
I would not change what we did (which was basically full disclosure) but it was challenging to deal with.
The legal complexity of all the equity structures possible seems way too daunting anyway.
Passionate young programmers who want to work for a startup don't have the background to understand it, even if the raw information is given when signing up.
Plus, you have no idea what the next round of funding will do to the equity structure...
Isn't it time for regulation to limit this complexity?
There are lots of ways to recruit in these conditions:
One is to deceive or withhold information from potential hires and hope they buy the sales pitch about the company's prospects enough to not care to ask anything.
Another is to be honest and find employees who agree with the sales pitch, even given full information.
Yet another is to just pay a high enough cash salary to attract good-enough candidates.
I’m confused. Are you saying that startups should supposed to lie and tell prospective employees that they’re going to be billionaires? Why do you think you think “the best people” are so naïve?
Never join a startup for riches. You join because you join for professional enrichment. That’s it.
Very early on (pre series A) this isn't so hard. Be completely transparent with your early hires about the cap table, give them a percent or two (even 3-5 for a key hire) to buffer against dilution. Do it in stock, not options, with reverse vest [this is very jurisdiction dependent]. Use the same class as founders.
People in this position can get screwed on exit of course but it's harder (and usually they are the ones you'll want retention terms for anyway).
Doesn't' work at all past the first small handful of core people.
Sound too expensive? Not early enough? Pay something close to market rates and be doing something interesting.
Those companies that have spent years building reputations as nice places to work, with high salaries, and good perks. It's a bit unreasonable to expect everyone to be tempted by some possibility of equity.
I'd tend to assume that if you want highly skilled engineers at a reasonable price, you probably have to know them personally and sell the idea of building the company together to them.
But I think the main difference from today versus, say, the late 90s, is that the top companies will pay so much more for top talent. The old tradeoff used to be that mainstream companies would pay a little more, but if your startup went public you'd by like 10x ahead. Now though, I've seen cases where even if your startup does have a really strong exit, you're only looking to beat a FAANG salary by a modest amount (an amount that may lead to an extra nice vacation or two, but nothing that is going to qualitatively lead to a different standard of living).
Like other pathologies in the startup ecosystem (e.g. acquisitions like FoundationDB getting acquired by Apple and promptly killed, yanking the rug out from under everyone who built a business on it and so making it less likely anyone will trust database startups in the future), this is a tragedy of the commons: it's rational, if extremely scummy, for an individual founder to accept liquidation preferences that fuck over their ICs, but as people keep doing it, it's gradually emptying the talent pool as engineers realize the game is rigged.
I don't have a good answer for this. Humanity in general is terrible at coordination problems like this, even when our survival is on the line, so I'm not sure how a purely capitalist endeavor like startups are supposed to do anything about it.
One thing to remember is that the acquirer has probably done this before while the acquiree is a first-timer. The details are almost certainly going to favor the party with the most experience.
I once worked for a company that was acquired. At the first all-hands meeting after the acquisition closing, the CEO was practically gloating about how cheaply he was able to get us. All because he knew how to structure the deal in a way that wasn't transparent to our company owner.
If there is one way a small shareholder can ensure that they are going to be treated well it is to see to it that they hold the exact same kind of stock as a much larger shareholder. That way a bigger fish will fight for your rights with a lot more power than you ever could do by yourself. There are then still quite a few ways in which you could be screwed but far fewer than without that precaution.
I highly recommend reading Venture Deals by Brad Feld - this book alone lays out perfectly how minuscule are your chances of getting rich, working for a startup.
The areas to lose money are: liquidation preferences, insuficient voting rights, dilution, different stock classes, general benefits to investor's equity compared to staff equity, investor drag-along, 409A valuation, options expiration or company staying private forever.
- common stock is 99.9% worthless, you want preferred stock
- liquidation preference is important, if company doesn't want to tell you, insist on market-rate salary
- if a company tries to switch from an LLC to C-Corp and move you from being a minority owner of LLC (0.1-3%) into a common-stock owner of a C-Corp with the same %, block/sue them; you were working for thieves
It's fine to want preferred stock, but it's pretty rare for employees to ever receive it (unless they put up cash) -- it's reserved for investors to avoid a sandbagging + abscond with the money raised scenario.
Preferred stock (and specifically, liquidity preferences-- the common 1x, nonparticipating term) exists to ensure that if investors put in $10M for 20% of a company, you don't immediately sell the company for $10M and give them $2M back, and split $8M among yourselves. The deal is structured so that the investors have their option of either getting their original money returned or their share of the proportional share of the returns.
I've been in the middle of the opposite. All numbers are synthesized. Founders set up company, initially fund it themselves, take some rounds of investment with preferred, gives up some control. Company runs low on cash, finds new investment from "trustworthy" investors, all preferred. The founders hit 49%, the investors gain control, and make a purchase offer for the precise value of the preferred shares to themselves, which they decide to accept. All common shareholders are instantly out in the cold, with nothing (including the founders, who were utterly screwed).
The first thing they did was fire the founders, of course.
So...foolish founders? Yes. But wait! Foolish investors? YES!!
Because they absolutely screwed every employee, almost all the employees walked the afternoon we were informed.
I've never been prouder of the people I worked with. I think there were four people (tech support/admin) left out of 20 or so. Hard to remember now...so long ago.
For several hours the shitball investors were exceptionally proud of themselves...and then they realized they'd bought a pile of PCs they had no idea how to use. Plus bonus shitty furniture! And goodbye investment, of course.
We all formed a new company within a few weeks. The original founders somehow got money to get us started again...which we did, from absolutely nothing. We rewrote a similar product suite (but better!) in about 9 months, and went to the next big industry show with it.
Shitball investors found out, and promptly sued us (mild shock), claiming without evidence that we must have stolen the code on the way out. Since I was there for every single line of code we wrote the second time around, it was infuriating.
The ball bounces through the courts...they continued to harass us...and all does not necessarily end well.
> I've been in the middle of the opposite. All numbers are synthesized. Founders set up company, initially fund it themselves, take some rounds of investment with preferred, gives up some control. Company runs low on cash, finds new investment from "trustworthy" investors, all preferred. The founders hit 49%, the investors gain control, and make a purchase offer for the precise value of the preferred shares to themselves, which they decide to accept. All common shareholders are instantly out in the cold, with nothing (including the founders, who were utterly screwed).
Usually you structure your board in a way that prevents this-- not to mention that you could likely prevail in litigation if these are the facts because the board has a fiduciary duty to all investors, not just preferred: only if there is no reasonable prospect for common to get something can you accept an offer like this. Not to mention that when a controlling shareholder enters into a transaction with the corporation they have the duty of showing that the transaction is fair for all involved.
This is a really good point that I hadn't considered. Employees are "investing" money in a startup too in the form of opportunity cost, but a founder can't turn around and "sell" the investment when it's just time; when it's actual cash they can.
I wonder if there are stories about this happening in certain contexts that predated liquidity preferences?
Yup, that's the reason I've turned down all startup offers so far and some of them offered 2-3%. They like to hand wave about how much these 50,000 shares are going to cost or how rich I'm surely going to be even after dilution of these 2-3%, but when I tell them point blank that with my current compensation, over the course of 4 years I'm going to lose at least $1M, and ask them what I would get for a $1M investment, they suddenly struggle to find words. The reality is that, once you reach this level of miniature wealth and competence (and that happens quickly), the only next step is to start your own company. Startups don't really see employees as partners.
> They like to hand wave about how much these 50,000 shares are going to cost or how rich I'm surely going to be even after dilution of these 2-3%, but when I tell them point blank that with my current compensation, over the course of 4 years I'm going to lose at least $1M, and ask them what I would get for a $1M investment,
There's a thing you're missing here, and it's option value. You don't commit to the lost money over 4 years all at once, while a cash investor does immediately give up present-valued money. Instead, you commit to spending a year or so there (~$250k-valued), and only if your options look like they're going to be worth a whole lot do you stay beyond that point.
That's a valid point, but if we think about it, what does the founder do with that instant $1M grant? Most likely the founder spreads this $1M over the next few years on employees and other expenses according to his plan, hoping to get the next, bigger, grant. In other words, there is no advantage of having the entire amount upfront (except maybe the lost possibility to invest into short term treasuries with tiny return).
The investor has committed to the entire amount. If something materially bad happens the day after the raise that halves the value of the company, the investor can't flee and the management team can still spend the money if any business prospects at all remain.
You raise an amount that will get you to the next capital raise, and convince other entities that you are sufficiently capitalized (banks, lessors, contract counterparties, prospective employees), and deal with a moderate amount of contingency. You don't want to excessively raise, because it's excessively dilutive when capital is expensive. You also don't want to have to raise again with nothing to show for the spent cash.
Even if we grant your statement "there is no advantage of having the entire amount upfront"-- there would be a benefit to the investor of having option value about whether to continue to invest; option value that an employee has. It's easy to model this and see that option value is quite valuable. (Investors would really like it, so we do see things like efforts at tranched investments or leaving a round open... but entrepreneurs hardly want to have to sell an investor equity at the same price if the investor decides he wants it a year from now).
You bring up a good rebuttle, to which I ask, why not have the preferred shares vest? Then your stake accurately matches the risk you've taken on at any given time.
The time still isn't liquid, though. Yes, if you worked for someone for a year, you've given them $X (where $X is the paycut you took), but the founder can't just turn around and sell that $X to someone else. To the extent that they can, it's (to some extent) because the founder was able to take your time and turn it into something valuable, which is like, what founders/CEOs are supposed to do. At that point these is some sense in which the founder has also "earned" the liquidity.
With a direct cash infusion there's none of that. Any idiot can immediately sell $10M for $10M.
I think time is quite liquid. Let's say I get 500k/year on my current job and someone asks me to join his company for peanuts, but with a good chunk of stock. We could calculate the difference between 500k and peanuts and say that instead of joining that company, I'd pay him this difference every year. That difference would be enough to hire a small team for a small salary, but with stock options. The problem that most founders have is the unspoken refusal to accept that my time is worth this much.
Time isn't liquid. If instead of giving a startup time, you gave them literal cash, then it would make sense that you get preferred (instead of common) stock, to protect against the founder just selling the company immediately for the value of your cash (as was mlyle's point). If you give them your time instead, there's no risk of them immediately selling off "your time", and so it makes sense that you get common stock instead of preferred stock (at least for this one consideration).
The other general point I think you're making though, is that if we look at the value of the time being invested by a startup employee, their ROI is much worse than a literal investor in the company.
This is true, and somewhat unfortunate I think, but I think happens because VCs control larger amounts of capital and thus have more leverage. Both in terms of absolute amounts, but also how quickly they pay it out.
You taking a $400k paycut for 4 years and a VC investing $1.6M are numerically the same, but the VC gives up the $1.6M immediately, whereas you give it up over time, and can at any time decide to stop investing. When you first start, maybe your ROI is worse than a VC's, but three years in, maybe the ROI of the time your investing _then_ will have improved relative to a VC that tried to invest three years in.
Very briefly: for employees to have a good outcome, the company must be a success relative to the funding. I'd love to say that founders are in the same boat as employees, but it's not true. Unethical founders can engineer situations where they alone get millions of dollars and no other employees do. That can be somewhat justifiable (eg taking $1m or something off the table in a round B for a company that eventually fails), or it can be poisonous (Adam from wework getting north of a billion in cash for a company that will probably go bankrupt).
With respect to the article:
$100m exit on $10m funding? Employees should do well. $100m exit on $110m funding? You can't expect a good outcome for the employees in that case. They may get some sort of retention bonus in an acquisition, but that's about it.
Another thing all employees should know is that, as a rule of thumb, you need to triple your valuation between funding rounds. That is not as true late, ie when you have enormous $100m + rounds that are raised in lieu of going public with more of a debt structure than an investment structure.
You should be skeptical of companies that have raised too much money. Eg if a company raises a $100m round B, they are basically saying their metrics have to justify a multibillion dollar valuation.
Anyway, there's a bunch of good links, but (and I'm a company founder), I'd tell you to keep a couple crucial things in mind:
First, don't work for dodgy founders. I understand that's not easy for you to evaluate, but there are ways you can figure out. eg have the founders hired lots of people they're previously worked with? That's a good sign.
Second, if you want a good outcome, the company must be growing. At a startup, you are comped on growth. You should be unafraid to fire founders and execs (by quitting) that are unable to grow the company. That's not to say quit at the first rough patch, but every year when you are deciding if you re-up for another year or not, you should evaluate the metrics over the last year.
Third, understand the runway and the metrics that get you the next round or an exit. Be unafraid to demand to know all the above, and expect positive performance on all those things.
I think the intent to say is that if people they previously worked with are willing to work with them again, that is positive because it shows that previous employees/partners haven't been screwed over.
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Predates KISS's and SAFE's and the round sizes are a bit out of date, but the you-get-nothing scenarios like liquidation preferences and down rounds are still the same.
I have had this conversation with so many people now. If your (private) company has taken VC money, options are toilet paper. Treat them as valueless scraps. Now, maybe you'll get lucky, and make something off of them, but that should be a pleasant surprise, not an expectation. Cash is king. If you're in it for the money, go work at MegaCorp, and take a sizeable, steady paycheck.
“In fact, one of my kids was recently interviewing at a startup and I told her to ask about the preferred overhang — she said the interviewer looked at her like she was asking about his sex life! She didn’t get a call-back.”
I’ll do you one better. This is like asking someone you’re about to have sex with if they have an STD and then having them act indignant and not answer. And you should do the same thing in both cases and run away.
it is understandable that this info is private (after all, you don't want this info leaked to your competitors).
But if you are trying to lure candidates, this info is critical for them to evaluate their offer (esp. if the offer consists of large amounts of stock/options etc). There's no reason this info should be kept secret from them, except when there's foul play on the part of the employer!
If the employer is concerned about the data leaking if the candidate rejects the offer, make them sign an NDA before telling them!
It’s also not the most polite/politic way to ask about it. A neutral way to get the same information is to ask about the cap table and then go from there if needed.
Actually, it wasn't salary negotiation because it was pre-offer. It was during an interview, and the author lamented that "She didn’t get a call-back".
I agree that during salary negotiations it is less important to tiptoe around things. Perhaps it was a bit premature to have even inquired about the cap table in any way during an interview, unless the interviewer had just mentioned how many options would be offered to a selected candidate (which would be oddly specific, pre-offer).
Re your fear and stigmatization of STD's: If you're genuinely worried about STD's then maybe get to know that person and let it be something you glean after loving conversation and an understanding mindset. Demanding to know like it's your right in a transaction is not only unromantic but really demeaning.
The comment on "founders getting offended when asked about the preferred overhang" is a point I think that is getting missed. Yes, there is the whole "caveat emptor" of being an equity employee, but there is clearly a culture of hiding all of the necessary information for making an informed decision.
In a lot of ways, I think the over-emphasis on "startups change the world" has been a contribution to this. There is a greater supply of people who "want to work in a startup" (or rather, think they like the whatever idea they have in their head of what a startup means) than there is demand for early stage employees. So any founders who might have something to hide will have their pick of people to fleece. They can easily pass on anyone who asks the the probing questions about the real value of the company and just wait for a shmuck to come along who doesn't ask.
What can we do to educate the general populace enough to dry up that pool of shmucks? In the long run, the way things are has to be terrible for investors, too. They put their money into founders who aren't being up front with their employees, and probably not getting the best employees because of it.
> Again, let me emphasize, this is not inherently unfair.
I guess our definitions of what is "unfair" are quite different. I think a better term here would be "illegal". It's most certainly not illegal - but I definitely would not consider it fair.
Companies throw options at employees - or potential employees - like candy. They imply, explicitly or not, that when the company gets big and successful, these options are going to be worth tons of money.
Most of us here know they're probably worthless. But executives/entrepreneurs/whoever most definitely suggest otherwise. So it's more like false advertising.
Now is that "fair"? I don't personally think so. I think it's pretty dishonest. I think when sale time comes around, they most certainly realize that these employees think they're finally going to cash in, and they are more than happy to let them think, even though they know otherwise.
Obviously there are exceptions. There are occasions where they actually do end up being worth something. Or where the seniors folks are very clear about how worthless these things actually are. But, in my opinion at least, those are most definitely the exception to the rule. I'm also pretty cynical for the most part, too. So there's that.
When I received my most recent startup offer, I was handed a spreadsheet that outlined the size of my option, and what they would be worth under multiple hypothetical scenarios, including highly-optimistic >400M and >3B valuations.
While it was nice for them to do the math for me, I do think that the scenarios presented were misleading and only represent the case where everything goes exceptionally well.
Now they did caveat that these were based off of assumptions, and that I should consult my own professional advisers etc etc. But, they didn't name any of the factors that could significantly impact returns (liquidation preference, participation, caps, etc.).
I received something similar with my last offer, but it also included the caveat that the shares are currently completely worthless unless we have some sort of exit, which probably wouldn't be happening in the short term.
I think if a venture is unsuccessful employees shouldn't expect to make money from their options. A venture that raises $60MM and sells for $100MM 4 years later is a failure. Making nothing in a case like that seems fair to me. What is perhaps unfair, is if the employee worked for substantially below market wages all of that time, and particularly if they were given a much rosier picture than was accurate. But we shouldn't assume those things are always true.
I think the problem is that it's often difficult to pinpoint the crux of the unfairness, but still feel it all the same. In my opinion, the unfairness is engendered by the realization that time and money are merely different units of the same thing. Which means the investors are getting guarantees on their invested time, but the folks who did all the work are completely unable to recoup any of the time they invested. When we cast the investments in the same units, it clarifies the nature of the inequity.
Investors convert dollars into time (like a conversion from matter to energy), and workers convert time into dollars (energy to matter). Even in physics a seemingly small amount of matter has enormous power with respect to the energy it can unleash. But it can take a lot of energy to form the tiniest lump of matter. Investors are turning their matter, their dollars, into time. A lot of money, in that respect, is essentially lots of time -- more time than you have life, if you have enough of it. So you can do more, by buying someone else's time.
For simplicity, if we ignore non-labor costs (labor is the largest expense in most software startups, e.g.), it would mean that the invested dollars purchased an EQUAL amount of invested time. That is, the investors dollars were converted, with perfect efficiency to time (unless they overpaid the workers, or the workers were underpaid), which means there was conservation of dollars/time. This implies a balance of the two sides of the equation, which means at best (again, for simplicity, only accounting labor costs) the investors could only be guaranteed a share of 50% of the purchase of the company. Or at least that is how it should work, in my opinion.
If the worker is paid for their time, they aren't owed anything for it. If they are taking below market - as I said that may be unfair - then at most their investment is the delta to market compensation.
Also, investors puts in all the money upfront; there is a concept called time value of money that applies here, and what it means is that money paid upfront is worth more than a distribution of the same amount over time. The higher the cost of borrowing (cost of capital), the more valuable that upfront investment is.
If the investor is paid for their dollars, then they aren't owed anything for them either by the same logic. And they most definitely are paid. Investors are compensated for their dollars because they exchange those dollars for time, just as the worker exchanges their time for dollars.
Whether an investor puts money up front or not is irrelevant, as it is only converted to time incrementally as the time is traded for it. Any excess dollars in the bank can, and frequently are, returned to the investor in an exit. Hence they only trade in dollars to match what is invested in time (when only accounting for labor).
It is unfair if a bridge loan is involved. If the preferred stakeholders have the chance they will remove the commons from the equation. In the end both sides take a risk with their shares and it is usually more meaningful to people with little money.
In the example, the common shareholders didn't make a profit because the company didn't make a profit. Ignoring the bridge loan for a moment, after all their expenses, the company just managed to make back what was put in.
The hypothetical bridge loan in this case did earn a profit, but it was a high risk loan. The company was going to be insolvent in 60 days and they hadn't yet found a buyer. The lenders got a multiplier because they risked losing their $10 million loan.
This bridge loan certainly could have been unfair, depending on whether the riskiness was worth the multiplier (for instance, if the company took a loan with 100x multiplier, it would clearly be abusive). If that were the case, the minority shareholders could sue and would win.
I’ve seen a lot a options packages awarded - and most of the time the actual options agreement goes completely unread - it’s baffling - but I think most of time senior managers are too embarrassed to let people know they don’t understand
I have found that in job negotiations, many startup founders are highly reluctant to discuss what the value of their stock option grant is worth, much less what other conditions may impact the payout.
Has anyone else had this experience and what do they advise others to do when faced with the dilemma of turning down an offer due to a lack of transparency into the option grant?
The best way to get information about this is to ask you question and then shut up. You'll get a BS answer first. Just sit there and don't say anything. Most people break down after 30 seconds and give up more information. The longer you keep your mouth shut the more you receive.
It's totally OK to say 'this doesn't seem like such a great deal.' Don't answer questions about what you want - just reply that you don't know enough about their financials to know what they could agree to, only what you can agree to. If it starts going round in circles, think of it as a preview of future experience and decide whether you want to be in that position.
Good advice. However, from a negotiation POV, it’s difficult since there are so many alternative people who only ask how many shares they will get, and think that more shares is better than less, rather than what they are worth. It’s comical. This makes it easy to just pick one of those people and skip the few who know what’s going on. For a founder or VC, this is like free money, since you can promise whatever you want ( 100 zillion shares) and pay them whatever is convenient. Eventually, this will erode the trust needed for Silicon Valley to work.
Simply, the 1% ‘shares’ were actually shares in a company that only begins existing if the company you worked for surpasses some value $X. Example, if the company is sold for $X + $50 million then you have 1% of $50mm. The con with these agreements is that you, the little-person-with-no-leverage, you are not told the X while you are working there. Ask your CFO, they will say in a practiced tone, “We don’t give out that information”.
IMO the best way to tell if the company is a winner, is to see big growth in sales/market size, especially after funding rounds. If the company is on its third funding round with no revenue and no clients then it’s one of these weird VC zombie dogs that manage to get funding because of spectacular bullshit artistry by the CEO (likely with a sales background). In which case your shares are worthless but the pay/gig might be interesting.
There should be a simpler way. All this crap is too complicated.
Even if you manage to somehow do the research and understand it well at some point, unless your working with options grants on a regular basis, you'll probably forget it all before you ever leave the company.
People don't have time to do all this stuff and not get fucked over.
Because of different trigger points, whether different investors are participating or non participating, you needed a spreadsheet to figure out what common gets, for each potential outcome. There is no way to have a conversation with a potential employee about the liquidation stack, it is usually far too complex.
More insideously, the buyer can change the rules. As long as the sellers vote for it, you can do things like wash out common, recap common, give new grants that are incentive grants with a one year cliff.
Option holders don't vote, so you won't even see what they are voting on.
That kind of stuff invites shareholder lawsuits, but it is ill advised to sue because then you are a trouble maker. Otoh, not suing means you are a pushover.
An example of a shareholder wash out was when jobs took over pixar, so i was told by a friend who had shares.
This article is really weird, because the person in Dogpatch says they were granted OPTIONS not stock. So it's possible that this doesn't even touch on liquidation preferences and the strike price was just higher than the sale price.
But if we assume that this was RSUs, or that the strike price was just a fraction of the sale price, I still think the common advice of "consider start-up equity to be worthless" is a little overzealous. Unless the founders accepted some outrageous terms it's probably the case that your options are worth a lot in a company that's doing well. If the company stops growing or takes a down round that's when you should start thinking of your shares as useless.
Why is it that the common shares holders are not properly informed that a certain investment round basically reduced their cash-out to 0? The incentives to invest more time into the company is greatly reduced. The person affected who is asking to Heidi said that they were working very hard, considering that they owned 1% of the shares of the company.
Which is partially why the VP makes several times more at a stable firm vs options/stock/equity that are a lottery ticket, more or less. The VP won't get paid if the company sells but they can by a new car each year.
edit: Oh, well I guess that's not counting the startup's salary. If they were getting paid $200k/yr, that's L6 at Google https://www.levels.fyi/salary/Google/SE/L6/. Less easy, but not as hard as getting to VP.
What information asymmetry? Liquidation preferences are perfectly fair, and not at all a mystery. Especially in the year 2019 when there has been an enormous amount written about them on the internet.
When I was awarded options I was not given any paperwork other than the grant and basic info about it. How is anyone to know what documents have been written without a database of the relevant documents?
It’s bullshit to keep relevant paperwork a secret.
The parasites writing these contracts are counting on people not taking the time to become experts in shady startup contracts. As evidenced by this article, it's working.
It depends on whether your role in the company means that you are part of negotiating the deal. If you are the CEO: then probably yes. If you're an IC engineer: then probably not.
Relatedly, most of these deal terms are pretty standardized. In the vast majority of cases there aren't a lot of negotiations around liquidation preferences, only negotiations around valuations. The exceptions to the rule tend to happen for very large or late stage fundraises.
From a 40,000 foot view, it's odd that employees who are investing their professional effort are relegated to a lower equity tier. I think the person asking the question in the article makes a valid point: why is it fair for human capital to be devalued in this way?
If you start a company and you turn $200 million of investment into an exit of $100 million dollars you haven't done anything valuable. Why would you expect your stock to be worth anything?
Why should investors expect their full investment back when they did a bad job choosing who to invest in?
I don't think it's reasonable to pretend that the current system exists because it's the fairest. Investors exert more negotiating power than employees, and that's the reason they get better terms.
I once stumbled on a rant by a post doc CS student. In addition to an essay why being able to do type erasure is good and why actually doing type erasure is terrible. He had an essay with the observation that while capital has the ability to pull their money and reinvest it elsewhere if they dislike returns and risk, skilled workers are kinda stuck with whatever skill they've invested in. And capital can diversify while a worker usually is stuck with exactly one investment. Given that it seems shitty to give capital better tax preferences than earned income.
If my example (turning $200 million into $100 million) the investors don't get their full investment back. They lose half of it.
But I get your point. And yes, it has something to do with leverage.
But I also assert that the current system is better for common shareholders as well. The idea that we could have a slightly different world in which investors acted exactly as they did today, but bought common shares instead of preferred shares is clearly wrong.
If they're buying common instead of preferred then valuations would drop significantly. Probably by over 50%. This means that either companies would be giving away much larger %s of themselves when fundraising or they would be raising much less capital (which is of course used to pay the salaries of all those common shareholders). Both are probably bad for common stockholders in most cases. Which is why we see very few companies ever do this.
Because the VCs are funding your salary. If the company goes under the investors lose their money. You get to keep the money (salary). So the risk is on them and there should be some protections.
But that salary is discounted based an offer of real ownership of a piece of the company. It's not clear to me why the last 20% of a salary, taken as equity, should have a lower preference in the capital structure than cash invested.
"It's all in the fine print," and the fine print can say anything.
I would say that this is a learning lesson for all who think options will make them rich. If you're at a company make sure you get paid what you're worth in money. Don't count on options as part of your compensation. You are unlikely to get rich because of them. As we have seen over and over again.
This is going to happen more and more often. Companies chased jazzy valuations, they made crazy deals, and now values are starting to drop (and stuff like liquidation preferences come into play).
I know of a company that was sold for $1bn+ and common equity got almost zero. It happens, it is a very silly thing to angry about though (because the valuation was never $1bn+).
This is why, for me, VC money is a last resort and an admission of defeat of sorts. If my business cannot be a business, i.e., an entity that earn's it's keep and makes profit, then maybe it's not meant to be. VC money might prolong it's life, but at that point, they are the real owners of this "entity".
With that, the founders/core group can deploy VC cash injections to stay paid and in charge vs closing shop. Quitting can be really hard for highly driven people or those thinking their idea is going to work even when the numbers say it isn't making money.
There's an incentive mismatch then for them to pursue VC funding and keep going while employees with stock won't notice their probably worthless options becoming definitely worthless options or at best a bonus when all is sold. Like my own performance/holiday bonus at a stable firm, options are nice and possibly count toward total compensation but aren't hard cash and should not be relied upon as an investment or in your budget. Bird in hand and all that.
I decline any offer that puts equity instead of pay. Options, equity etc. is worthless. The only way it's statistically worth anything is if it's your business.
On a side note, I wish Pud would revive fuckedcompany.com (with the last snapshot of the db before it went down). It's still relevant.
I find it "funny" that the whole sharing and startup economy is basically built on top of something that resembles a Ponzi-scheme (not in terms of the actual operation of the scheme, but in the way how unfair the scheme is for different people in different roles). And the fact that the software industry happily embraces this modus operandi is simply mind boggling.
As far as I am concerned this scheme with the stock options (some people call them opportunity or investment) never should be substitute to social contracts, like a monthly pay check.
I find it especially nefarious the fact that people who invest time are penalized over people who invest money. This is especially true when the 4-5 year long time investment of a developer today can be easily worth millions. And a dozen developers' time investment can easily reach tens of millions.
That's a nice answer but the question really needed a lot more information for it to be the right answer. There are quite a few ways in which small shareholders can get screwed, this article illustrates just one of them and quite possibly not the one that bit the questioner.
This is exactly my thought. The author is just guessing. There are 95 comments here, and they are just guessing too.
The real reason of why the employee got zilch would be found by just reading the documentation - the legal agreements awarding the stock options, the purchase and sale agreements, incorporation docs...
If anyone reading this is working at a startup and values their options at zero please get in contact with me (contact info in my profile) and we'll find a way for you to sell me your equity for $1.
Are you really putting your money where your mouth is? Even if I have shares I think are worthless, your offer to buy them is also worthless, so why bother? Actually, your offer is worse than nothing, as I would spend hours dealing with the share purchase agreement without assurance you will follow through and it would send a clear signal to the company that pays me that I believe it's worthless.
2 start ups behind, shares worth 0. both companies took on half a billion (!!!) in funding combined - from VCs, gov etc. Revenue = close to nothing.
I feel that start ups mostly are cash burn machines built to pay cushy salaries to C-level execs and build "impressive" resumes again for the execs. For most other folks, they are a just stepping stone to a "real" world job in a stable corporation.
assume, your shares are worthless, basically a lottery ticket! In both companies i knew that some people put in real money to buy out options, 100s thousands of dollars amounts. Now they are sitting on a bunch of 0s.
As a normal individual contributor not at the C-level or even management level, I just assume the value of any options/shares I receive is zero unless an accountant or the IRS tells me I should believe otherwise. Too many goofy fine-print shenanigans like this to keep track of.
The IRS has a pretty good incentive to value your options/shares as high as the can, their goals and yours are not aligned. Your accountant may be closer to the true value, but even then it may end up significantly lower or higher in practice.
The only thing that accurately values your shares is a sale.
You owe tax on an exercise below market value, whether you can sell or not. This is why you get the official 409a valuation from the CFO before you file your taxes. The 409a is prepared by the company's CFO, accountants, lawyers, and somehow in conjunction with the IRS (or by IRS rules?) and is the valuation that you use to compute whether you owe tax on an exercise or not.
>The only thing that accurately values your shares is a sale.
Accurately? Perhaps. But until that sale happens, you can still be on the hook for more tax.
This doesn't sound like shenanigans. Reading between the lines:
> While it hasn’t ended up becoming the unicorn I was hoping for
it sounds like the company wasn't a success. It could be the preference overhang, or it could be a difficult acquisition.
Fundamentally, if the company isn't a success relative to the funding, employees aren't going to get paid. Employees can get paid quite well on a $100m exit if eg the funding structure was correct for the exit size.
Right, but my guess is people start talking about being a unicorn probably means they did a unicorn-sized funding round. So total raised is comfortably north of $0.1B.
I don't mean shenanigans as a cutesy word for fraud (and to be completely fair, the author touched on how this is something the industry needs to improve at), but I merely mean that the explanation provided to most workers is "you own X number of shares in the company that are currently valued at Y", and anything missing from that summary that makes it untrue is, well, shenanigans to me.
I totally agree that founders/hiring managers should be very clear on how employees are comped. However, in this specific case, I think a >= 1x preference is so utterly standard that employees of a startup need to do 5 minutes of due diligence and understand how their comp works.
For everyone reading this, there are 3 outcomes:
company failure, company success, middling
In the middling outcomes, people need to know the negotiated rules re: who gets what
the problematic circumstance is when the company doesn’t perform and is forced to raise under desperate circumstances. if you can make that distinction then early equity is worth stupid money (and just leave quickly if the company doesn’t perform)
You can't possibly actually values your shares at zero. Test: can I have all of your shares? No? Well then you must value them at _something_. What if I gave you $1? 10? $100?
Just because something is (even incredibly) risky doesn't mean its value is zero.
When people say that options or pre-ipo shares are “worth nothingl, it doesn’t mean that they literally have zero value on the market. They obviously have value, they have the company had a valuation at issue. It means that you shouldn’t assume you’ll see any value from them. Until a liquidity event, you’re not even a paper thousandaire.
Most private equity is worthless in a couple of years. Most companies crash before any liquidity event. Those that don reach an event, have such a preference stack, and so for such a pittance, the options are underwater.
I just don't think it's a very useful mindset. Or at least, it's not a useful way of phrasing that mindset.
You should absolutely understand the very large chance that your equity is worthless. You should absolutely 100% not plan any part of your life around the equity being worth something. You should understand that, even if the equity is ever worth something, it won't be liquid for a very, very long time.
...but all of that is different than it being worth nothing. I feel like the "your equity isn't worth anything" mindset leads to employees allowing startups to give them smaller amounts of equity than they should. It leads to employees not questioning bad practices (like 3x preferred participating shares) as much as they should.
I've had people quote the "equity is worth $0" thing to me in negotiations about equity/reups. In my head: "Oh that's actually great! You can just give me your equity then instead of me having to negotiate a reup with the company."
Said another way: let's say you find out your startup's VCs have participating preferred shares. There's a world where that's fine -- you just now need more equity to get to the same place as you would in a company that had non-participating preferred. But you need to reason about the value of your equity to reach that conclusion. "Equity is worth $0" discourages thinking about that stuff.
It's a mindset about for thinking about your own finances. That's it. It's absolutely the wrong tool for thinking about equity grants.
I've always considered illiquid equity lottery tickets. Yes, playing the lottery is stupid because the expected value is so small. At the same time, I am absolutely buying into the company lottery pool, and want to maximize the number of tickets I get. If it pays off, wonderful. It it doesn't, whatever, because I never counted on the money to begin with.
Like I said, I just think it's a poor name for that mindset. If what you mean is "Count on your equity being worth $0", say that, and not "Value your equity at $0".
Maybe this has to do with the contexts I've heard it in, but my gut is that it too often deters people from thinking more critically about their equity and whether they're being treated fairly. If someone new to startups read just the comment I originally replied to and not any of this follow-up, would they have understood what you're trying to say?
Investor are short-sighted when they steal all the money from startup employees. Equity used to be the one way that startups could compete for talent but the more the word gets out that it's a scam the less that startups are able to compete.
The funny thing that all this might be funded by the big corps who don't really need any startups and competitors around: it's easier to invest 20-30 billions into destroying the reputation of the startup concept, than to continue buying them at 1-15 billions each.
It's stupid that startups don't tell people going in what the overhang is, or that you won't get called back or get weird looks. Everyone is looking out for their bottom line, wtf would a startup expect any less from an employee that's about to spend 60+ hours a week toiling on the product? In any case, this is good info and I'll pass it onto my kids if they ever decide to join or build a startup. Hopefully they decide to be their own founders. I'll supply the garage :) .
Based on my XP, getting details about options is real difficult. HR and hiring managers are used to people who barely understand the vesting schedule, so when you start asking about percentage, strike price, etc etc it's kind of unusual. And yeah, companies tend to not be transparent simply because they play on people's ignorance to make attract them with options while in 99% of cases you will never see a penny from these.
How does owning the 1% stock that doesn't get a pay out when the purchase occurs affect taxes? Do you have to pay taxes on the perceived value of the 1%? Can you consider it a loss?
My former company got acquired for $150 million after raising $87 million. I am not expecting anything. If at all I can expect a tax write off for the shares that I bought
I don't know how old you are, but my guess is that you are young, and you get another shot. Don't be dismayed. Try again.
$100M is an awful lot of money - I'd consider $1M to be a lot. I I understand that you got zilch, and if I were you, I'd be angry too. But you seem to be clever - get over it, and have another go.
/me just another employee. Never been an entrepreneur. Not smart enough.
OK, what I understood from the article is that the guy owned 1% not of the company's acquisition price (as he thought), but 1% from (price - X) where X was unknown and turned out to be greater or equal to the price.
The fact that he didn't realize it until the very end makes the author's advise very correct - "make sure you understand exactly what you own".
This is why I've been saying for years that stock grants/options/RSUs are like playing the lotto, and salary/benefits are more important. Particularly when dealing with privately held firms where you have no ability to sell on the open market.
They're also a tool to keep people in roles they no longer want, because of a promise of a great payoff someday.
This is why you should get a proper salary even if you are working at a "hot startup". Were you expecting a $1m gross payout from owning 1% of a $100m company? That's the kind of gross income you'd get every 2 years of working at Googbookagramazon. Consider opportunity costs carefully.
Check what the owners got, and if they got any payout with the 50% dilution event. If the owners also got nothing, then the investors took it all. But if the owners got say $50 from the deal and you got nothing for your 2% you got screwed.
Is there a benefit in asking to get "paid" in both preferred stock and regular stock to spread the risk out? It seems "preferred" stock is really "preferred but with lots of dangerous caveats" stock.
blah blah options blah preferred blah series A/B/C blah blah
The real reason they got shafted is that they weren't important enough or they didnt follow what is going on. If you have a $1m asset you shouldn't be hoping its OK when there are so many sharks in the building. Yeah it would be nice if you could trust management and VCs but you can't.
"Liquidation Preference" is an agreement between a company and an investor that when the company is acquired or IPOs, the company will pay the investor some specific amount of money BEFORE any other shareholders get paid. If the company negotiated the funding well, the liquidation preference might be 1x (basically saying the company promises to pay back, in full, the investor's original investment if the company is ever sold)
Things get scary when the liquidation preference creeps up to 2x, 3x, or higher. It's possible to raise $5mm with a 3x liquidation preference... which means that the investor will get $15mm payout BEFORE any other shareholders in the event of an exit (which means that, after raising that $5mm, the company can not have an exit less than $15mm without 100% all the proceeds going to the original investors).
Raising $5mm with a 3x liquidation preference, then selling your company for $15mm, is an easy example of how (even founders) can walk away with $0 after a $15mm sale.
What's baffling about it? If someone were to only read the title and not the article and came to the comments section, a summary about the title would be desired. What you're probably baffled about is why do people only read the title and not the article.
I’m not sure... HN is supposed to be real time discussions of articles. summarizing the article not only is not discussion (read it is regurgitation / bastardization) but any argument / discussion had based on the summary will be inaccurate as they are going off of the words of another, who more than likely integrated logical fallacies that did not exist before the comment.
FWIW this happens on reddit too as so many posts have clickbait titles, people are trained to go directly to the comments to find out the non clickbait version.
I often check the comments first to see if there is one as clear and concise as CJ's. Then I don't need to skim a lengthy article for the information I'm interested in - such as the answer to the question in the headline in this case.
Some people rather quickly see the reason than read about the leaves blowing on one crispy fall evening as a dog howled in the distance and the city lights twinkled beneath the moon.
That's the one where they get liquidity prefs up front and then also get to participate with common, right? Worked for a company that had that.
Fortunately we had a violent restructure and an insane cap table got crunched down, cleaned up and all that stuff was made null and void. Definitely a "useful crisis" as we got to an exit later without any liquidity prefs hanging over our head.
Normally the way the preference works is that you "give up" your shares in exchange for being paid back, as if you had initially given the company a loan instead of bought equity.
E.g., you invest $1M, company sells for $15M, and you want to be able to get $2M (2x) of the $15M in exchange for your investment.
With regular preferred shares, you get paid your $2M and then that's it, your initial $1M is paid back.
With participating preferred, you get your $2M, but then act as if you still had the equity that you bought with the $1M (even though you basically already got paid back for it). So you get $2M + whatever your cut of the remaining $13M is.
I invest $100 for 20% of your venture, implicitly valuing the company at $500 . You sell for $200.
- Standard preference: I get $100 or 20% of the company ($40)
- 2x preference: I get $200 or 20% ($40)
- Participating preferred: I get $100 and 20% of the company ($140)
IMO, 1x preference, non-preferred is entirely fair. In the event the company sells for lower than the valuation, the investors get their money back first. The vulnerability it protects against is that I found a company for $0, you invest $100 for 20%, then I immediately turn around and sell for $101. You get $20.25 and I get $79.75.
Participating preferred and >1x preference are unconscionable.
Why moralize? It may be that there's nothing intrinsically unconscionable about it; it could just be a way of expressing the market power the investor and the company had when the funding deal was struck. You could similarly say a harsh down-round is unconscionable (a low valuation can just as easily wipe out returns for employees), but we tend not to think companies taking down-rounds are "unconscionable" so much as they are "distressed".
Founders don't like liquidation preferences for the same reason employees don't --- especially if the company limps to liquidity, which is probably the common case, as opposed to blowing the doors off things, in which case the prefs probably don't matter that much. They're incentivized not to accept high preferences; if they do accept them, isn't that just a sign that the company didn't have much bargaining power? Should the company not take the money under those circumstances, and RIF its team instead?
It seems perfectly valid to "moralize" (that word sure has some baggage, doesn't it?) about those who have power exercising it at the expense of those who don't. In fact, I'd expressly encourage it.
Not saying I'm particularly worried in this case, but overall I don't think that "argument" is a very convincing one if we're actually concerned with "doing the right thing".
In the general case, when it comes to startup financing, isn't the "power" we're referring to is market or bargaining power? Venture firms compete with each other for access to viable startups. If the terms being offered to a startup include >1x or participating preferences, that says something either about the negotiating competence of the startup or about its underlying value.
Is it a moral issue if a startup isn't valuable enough to avoid punitive terms? Who's doing something wrong in that scenario?
Obviously, it's bad if founders conceal that predicament from employees. I agree with the prevailing sentiment that employees should be wary about taking equity compensation.
Isn't pretty much every interaction humans have with each other outside of close friends and family (and even within, to some extent) driven by market forces and/or bargaining power in some way? Some larger examples I can think of off the top of my head are the ballooning costs of healthcare in America today and the trans-Atlantic slave trade.
In the general hierarchy of victims I'm not too worried about exploited startup workers. As you say, it's obviously bad if founders deceive employees, but I'd add that there are degrees of deception and also that there's a whole culture built up around working at startups that seems to suck people in. Who benefits from that? Keep in mind that startup employees are selling themselves in the same market, with even less bargaining power than the founders looking for investment.
If America had a real social safety net and real regulations in place to protect workers, I'd say go nuts. I think market forces can be a great optimizer for efficiency, and we should embrace the core principles of economics because doing anything else is tantamount to sticking our heads in the sand. But we should not forget that people can get hurt, and/or have their full human potential dribbled away down the drain for somebody else's gain. I will keep saying those things are bad until I start saying nothing at all matters.
Liquidation preference of 1x (or lower) is just sensible alignment of investor and founder incentives. The investor wants to make sure that if they buy 20% of the company for $5M, the founders aren't now incented to take advantage of them (in an extreme example: the day after the fundraising, liquidating the company for its assets, taking home $4M themselves and handing the investor back $1M. In a less extreme example, selling the company (in toto) for $10M a year or two later).
Liquidation preference of higher than 1x is a whole different thing. It's, at its most benign, something kind of like a financial instrument a little more like debt than stock, trading a more-guaranteed return for a lower price, or at its most pernicious, basically an attempt to create false impressions of a company's value. If you sell stock with a x3 liquidation preference, that is deeply different, and conveys considerably less investor confidence, than selling the same stock at the same price with x1 liquidation preference, but the press releases get to not mention the preference.
It may be sensible for the founders and investors, but is it sensible for the employees? Many startup employees are paid to a significant extent in stock and do not understand the situation they end up in. They are also powerless and just have to trust that the founders and investors will treat them well.
Rationally, this leads to many of the best people ignoring the startup world
VCs really don't care about "sweat equity" or "discounted salary equity". They believe that if you don't bring actual cash to the table then you aren't risking as much as them (even though they are only putting their clients money, not their personal money in most cases).
That's one reason I didn't have trouble bailing on a startup I helped start. We took in $1.5mm, did some things poorly (such is life but learned good lessons from them) and even with a path forward we would have still required some more investment (since we weren't profitable). Therefore I knew what the current liquidation preference was, I computed what another round's liquidation preference would add, and it became clear we'd have to sell at $30-50m just for me to start getting money.
The likelihood of that happening was small, and the feeling of being un-incentivized from selling at a respectable $20m made me realize the whole game was stupid and rigged. Now I work at a bank making almost 3x of what I made in hard cash (plus better benefits which equals hardware) and that extra money is giving me much better returns in my retirement and stock accounts, and a better quality of life (and less stress).
I was the third employee at a startup. I was young and stupid and thought "20,000 shares" was a lot. I worked my ass off, it was immensely stressful, but we built and launched a product. I later found out it wasn't much of a stake at all- .1% and that's even before any dilution shenanigans and all that. We took a paycut part of the way through, had our 401k contributions slashed and such.
A company in the space (but doing something different) called and made me an offer for twice what I was making. I was the lead developer by that point, had my hands in every significant piece of code, understood how everything fit together and such, and was appalled when I found out that I had such a small piece of the total pie. I demanded more, like 20x more, and they made it sound like I was asking to sleep with their wives. Then they absolutely howled that I was screwing them over by leaving right at launch- they asked me to stay for 3 months, which I said sure- if you match my new salary plus a little more as a retention bonus and to make up for some of the paycut, and again they howled at how could I do this to them...
It was a painful lesson, but I learned something very important- Do not work like you are an owner if you are just an employee! I still to this day (this was 10 years ago now) feel very taken advantage of. I was working tons of late nights and weekends, was a super fanboy of the company, at one point I was going to buy us a company logo made out of Legos to hang on our wall, and now I just cringe at the thought.
There are so many ways to lose in the startup game, just so many, its really not worth playing anymore IMHO unless you are a founder or very early stage employee with material access to the financials and such.
+1 I initially learned this lesson on the other side of, when was part of a startup during college. I was putting in long hours alongside my co-founder, but my staff were doing merely an adequate job.
For a while I was confused and unsure why they weren't also pulling long hours, but I eventually learned the lesson. I was working hard to protect my baby, while my staff were just seeking to gain some experience in a cool niche. I would either have to realign incentives for them to also feel compelled to pull long hours, or I'd have to recalibrate my expectations.
In retrospect, I'm not sure what took me so long to realize this, but I'm glad it happened relatively early on in my life. The first job I took out of college, I made sure to keep my effort in line with my compensation and investment in the company.
I was the third "employee" at an internet startup (maybe the fourth, I forget) after the CEO and the lead tech guy, and I got...$5/hr as a 1099 consultant. That's actually more like $8 in today's money. I just looked it up and it was the same year eBay (AuctionWeb) was founded. Coincidentally my boss asked me to (with hindsight) basically create eBay and I didn't have a clue where to start or the necessary hubris. After that, they figured I wasn't useful as a programmer (I was hired to answer the phones).
Yes, if the employees' future paychecks for the next few months is being funded by that VC check. If the options are (a) VC money - but can only get it with liquidation preference ... or (b) insist on no liquidation preference - and therefore no VC agrees which leads to bankruptcy ... the "sensible for employees" is a moot point because the constraints of limited runway mean the employees care more about steady paychecks rather than owning worthless stock of a bankrupt company. (E.g. Google's first employees' salaries were funded by $25 million VC money from Sequioa and KPCB because Google had near zero revenue. Yes, Sequioa & KPCB had liquidation preference but it was irrelevant to employees since they needed the paychecks.)
On the other hand, if payroll expenses can be funded by revenue and the VC check is optional, maybe not.
That's equity compensation, in my view. It's not like it's different at the FAANGs. If you go to work at Apple, and you work super hard, and the company declines in stock value from $5jillion to $3jillion, nobody is like, "Whaaaat? Why didn't my equity go up in price? I worked really hard, and also $3jillion is still a ton of money!"
Equity compensation is about owning part of the COMPANY. If the company has destroyed value -- if it is now worth less than its bank account, with no company attached, was worth before any revenue -- then your equity is valueless.
Asking for the reward of equity with no risk is weird.
Definitely agree that equity compensation carries risk.
However, I've seen equity pitched as a way to "make up" for the lower cash comp a startup might offer.
This is probably the wrong way to look at equity. The expected value of the equity might make up for lower cash comp, but that's with a large sample size. Employees don't get that benefit at all.
It's definitely up to the employee to understand the risks, but frequently they don't, and employers don't actively educate their employees.
I have no knowledge of the startup world, but based on the article, if both the founder and employees have common shares then their incentives are aligned (i.e. the founder wouldn't want to sell the company unless the price was well above the preference overhang). Of course, deception can pay a role in making this less fair.
The article mentions at least one reason why the incentives often aren't aligned: a carve-out agreement that guarantees specific people (often founders) a cut from the "preferred" part of the pie. As I understood it, this cut is completely unrelated to the amount of shares (common or otherwise) those people own and is a separate agreement saying that they get eg. 10% of the money in the event of a sale.
Carve-outs in general are mentioned in the article. A common type of carve-out: the employee retention pool. The article does not say that founder carve-outs are common. I'm sure they've happened, but you said they happen "often", as a way to get founders to greenlight deals. Do you know how often that happens?
Use a lock-up (like public markets) or have the preferences expire / reduce (like the contracts some banks gave pre-IPO Uber employees). Or be like Softbank and demand a 7% dividend on invested capital. Or if you don’t actually have a constructive relationship with the founders, don’t invest.
The only warrant for preferences is for fueling carry and information arbitrage within the VC circle. There is zero benefit to employees, who thankfully know more today.
Yep. They're locking in their upside to offset for the risk they see in putting in $5 million. 3x preferred is either a weak founder with a good company or more likely an ok founder desperate for funding and therefore pretty high risk for the investor.
Say a company sells 10% of itself to an investor for $10M, with a 2x preference.
If the company sells for $100M, the investor gets $20M off the top. My question: Does the investor still own 10% of the shares, and will they recoup $8M of the remaining $80M?
That's where the difference between participating and non-participating preferences come in. Participating meaning that they also participate in the remaining surplus (so on your example $28M). Non-participating means they choose whichever is better (in your example they wouldn't since $20M is better than 10% of $100M, but if the company sold for $300M they'd choose $30M instead of the $20M).
Shitz, and here I go thinking I knew everything about these sorts of things by attending a 5-day lunch-time course at Capital Factory on Founders Academy Essentials… So much for those cap tables!
That's called participation and it's negotiated as part of the raise.
Non-participating: at liquidation, an investor chooses. They may either be paid back their investment (or more, if they have a multiple), OR they may choose to convert to common and get that percentage. They will, obviously, choose whichever pays them more =P
Participating is then also obvious: investors get their money (or negotiated multiple) out, and then get their ownership percentage of the remainder.
One thing that happens is companies very eager to raise monster rounds agree to shitty terms on all of the above. It's a lever founders and investors can manipulate to raise bigger rounds.
There is preferred stock (full price; i.e. investors) and common stock (incentive plans; i.e. founders/employees).
A liquidation employs one of two methods to distribute payment, depending on which is better for preferred shareholders:
* Method 1. Preferred stock is converted into common stock (usually 1:1). All common stock receives payment.
* Method 2. Preferred stock first receives payment according to liquidation preference which a multiple of the initial purchase value. Then participating preferred stock is converted into common stock (usually 1:1). Finally, all common stock receives the remainder of payment, if any. During preference, carveouts may protect certainly common shareholders.
In good exits, method 1 is used. In bad or mediocre exits method 2 is used.
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Liquidation preference and participation are not required, but are tools to give founders more money per investor share.
Nowadays, you should be able to get a solid valuation for 1x liquidation preference, non-participating, no carveouts.
IMO this is a sensible compromise; if you can't even keep the initial investment value, you really haven't done well anyway.
There are often dividends attached to preferred shares. This is basically interest, and may or may not accrue, and has to be paid out eventually. That's even more money off the top.
It sounds like an easy way to screw holders of common stock out of their money. Don't they have any protection at all? Like at least, does the agreement for "liquidation preference" have to be reasonable (like, they could go to court and challenge it, and the company would have to prove that it was a necessary deal)?
Employees that are paid common stock didn't put any money. They are also paid decent salary. It is like playing a lottery, but only with opportunity cost.
Not sure what needs to be protected here.
> Employees that are paid common stock didn't put any money.
> It is like playing a lottery, but only with opportunity cost.
So, they did put in money. It's "opportunity cost" money as opposed to literal cash, but logically it's still value being invested in the company (the company has $X more in the bank because the employee was willing to take a $X pay cut).
Compared to VCs, engineers are making a lot more of an investment in terms of % of their potential value for a less favorable return.
I think VCs get better terms because A) they control an amount of capital that's rarer and have more leverage, B) they do this professionally and are better at negotiating things. But probably mostly A?
This is why founders and employees should form worked-owned co-ops rather than be slaves to investors. If they absolutely need funding, look for angels, loans, convertible notes or ways to build slowly without giving away control to vampires.
In the old days, when software companies sold software rather than traditional services enhanced by software, it was common to get to profitability around the B round and then never take any more investment after that. Google took $25-35M and then nothing until IPO, running the company from 2001-2004 off cashflow. Microsoft took nothing except a small mezzanine round (to align incentives with the I-bankers) right before IPO. Github took a $50M Series A on a valuation of $500M; VCs owned 10% of the company, and the 3 founders + employees split the remaining 90% of its $7.5B acquisition. Indeed took a Series A and is profitable. Atlassian took a $60M Series A 8 years after starting the company, when it was already profitable. PlentyOfFish, HotOrNot, Reddit, Wufoo all raised either nothing or just angel money before being acquired.
When you're capital efficient, you get to keep the majority of any sale price.
The current crop of unicorns like Uber, Lyft, WeWork, Postmates, DoorDash, Instacart, AirBnB, and Stripe have all taken massive amounts of capital though, sometimes in the multi billions of dollars. That has to be returned to the investors before the common shares (founders & employees) make anything. If they hit on hard times before a liquidity event, there's a good chance that the common will be wiped out, and investors effectively own the company. Why shouldn't they, when they put up all the money that the company's been burning?