
How Wizards of the Coast distributed equity as a startup - gwern
http://www.peteradkison.com/blog-entry-3-wizards-of-the-coast-equity-distributions-part-2/?2
======
alexose
The next generation of startups is going to have to address some employee
equity problems, I think. This notion that early hires are going to share a
small piece of the 10% employee pool needs to stop.

Being employee #1 of a startup can be one of the worst positions a young
developer can ask for. Long hours, high stress, low job security, and for
what? 0.5% of a company that, if it survives, will most likely dilute its
shares?

A startup could really set itself apart by advertising more progressive
structure-- One where shares in the company aren't treated like a lottery
ticket, but an actual piece of value that is worth growing. Too bad VCs don't
see it that way.

~~~
tptacek
Probably not, or that already would have happened. It hasn't.

One problem is that a lot of people look at equity grants as a meritorious
service award. But that's not at all what they are; they're compensation for
risk.

Developers look at risk compensation and say, "well, I undertook a lot of risk
to work long hours for a lower wage". That's true, but the market prices that
kind of risk, and the market cares a lot about substitutes, and the typical
developer taking basis points for their participation is eminently replaceable
by other developers.

On the other hand, the market has no replacement for an entity legally
authorized to trade $1MM for X% of the company, so that risk is priced highly.
Similarly, the market has fewer substitutes for the people who actually start
the company; or rather, those substitutes tend to react to the mispricing by
simply starting their own companies, and thus aren't competing with the
founders for equity.

Pithier:

* there's a _lot_ of ground to be made up in how founders/operators promote startup jobs to developers!

* there's probably some marginal ground to be made up for developer equity compensation

* it probably won't dramatically alter the way startup cap tables look

* developers who genuinely (in a market sense) are poorly served by how startups allocate equity should start their own companies

* developers who can't start companies _probably_ aren't being as screwed as we think they are by small grants --- or, if they are, they're being screwed by being persuaded to work at startups when they should instead work for larger companies that can pay them better wages.

~~~
mentat
> That's true, but the market prices that kind of risk, and the market cares a
> lot about substitutes, and the typical developer taking basis points for
> their participation is eminently replaceable by other developers.

If all you're hiring with your first employees are replaceable people, you're
doing it wrong and will probably fail. Those people not only have to work long
hours, they have to work them well. It's like the APM curve at the beginning
of a RTS. You never make up those time and behind-ness just piles up.

~~~
tptacek
This is one of those things that sounds true but I think probably isn't.
Business isn't an RTS, and most startups aren't really in an APM race.

------
GeneralMayhem
This is a great story, and I'm glad it worked out for them, but it's important
to keep in mind that it's only one data point. This is exactly the sort of
"I'll pay you in equity, and once my great idea makes it big you'll be rich!"
approach that HN usually hates, because 99% of the time said payout never
comes.

~~~
metaphorm
I think its not directly comparable. Wizards of the Coast was never a "my big
idea that will change the world!" type of company. It was a a games publishing
company. They didn't even have one particular game in mind when they started
up. Magic came later. Initially they were doing pretty much any board game and
RPG that wanted to cut a license deal with them. In fact, they still operate
this way to a certain extent, even with Magic as the flagship product.

Because Wizards was never an idea based company I don't think its fair to put
them in the same bucket with the usual suspects who try to exploit naive young
developers by not paying them for hard work.

~~~
tehwebguy
And there was no vesting

~~~
uiri
I'm not sure that that's really true. Investors don't vest because they put in
capital which is immediately available. Similarly, those contributing capital
(either in the form of supplies (e.g. a drafting table) or cash) should get
their shares right away. Those who are accepting equity for labour should vest
because otherwise they may walk away before all of the promised labour
materializes. I think that those who were paid in WOTC stock (in addition to
or in lieu of cash) received their stock in paycheque-sized increments. Which
is fair because the amount of stock they received is a fair trade for the
labour that they put into the company.

~~~
sqrt17
Which begs the question, why would you deliberately build a cliff into the
vesting process? Why not say, 20000$/yr (or whatever arbitrary amount) at
then-current valuation?

As for institutional investment, this would create incentives for the founders
(or other equity holders) to exaggerate the valuation of the company. On a
different note, this kind of vesting would mean more equity for people who
worked for the company while it was growing slowly (and who took on more risks
- that's why you give them equity and not hard cash) before seeing exponential
growth, and no equity growth for people who joined after the company had
reached a stable state.

The next point is, what's whith people who want to disinvest from their
position? This is both the case for investors after a company has reached a
certain size (e.g. Zappos before they were acquired by Amazon), but it will
also be the case when people who get partly paid in equity want out of their
position.

Vesting cliffs unilaterally benefit the current equity holders, because it
creates a skewed incentive structure where you either should leave at the
start or stick it out until the vesting cliff. (And, that's what it was with
Microsoft in the 90s/2000s: many people stayed on exactly for the time it took
for their equity to vest).

------
kauffj
I love the idea of small scale stock offerings, but isn't this illegal? My
understanding was that selling stock like this is a private equity offering
and that private equity offerings are limited to a small number of people
unless the investor is sufficiently rich (the government likes to use the term
"accredited investor").

~~~
zaroth
The most basic provision on a private sale of private stock places no
restrictions on the sale that 'does not involve a public offering'. So in
theory it's only when you start "looking" for investors, when you are
"publicly" selling the shares, then you want a Reg D 506 exemption, and
accredited investors.

However, in practice the Section 4(a)(2) exemption is often not strong enough
protection (since we're talking potentially significant civil and criminal
charges) so companies go for the Reg D safe harbors even when not technically
required. Particularly for unsophisticated / unaccredited investors, the
courts have found that 4(a)(2) is not good enough, even when the sale was
arguably private. See, for example, SEC v. Ralston Purina Co., 346 U.S. 119
(1953). [1]

Following the path of Reg D 506 is actually quite simple, and carries no
downside. But even with Reg D 506 you generally try to avoid unsophisticated
investors, since then you get into scenarios where you are supposed to provide
'access to the kind of information that a registration statement would
disclose' which is very difficult. The crowdfunding regs in theory are
supposed to help alleviate this.

[1] -
[http://scholar.google.com/scholar_case?case=6019539454143305...](http://scholar.google.com/scholar_case?case=6019539454143305122)

[2] - IANAL

~~~
zaroth
Just going to follow up on this to excerpt part of that Supreme Court
decision;

    
    
      Exemption from the registration requirements of the Securities Act
      is the question. The design of the statute is to protect investors
      by promoting full disclosure of information thought necessary to
      informed investment decisions.[10] The natural way to interpret the
      private offering exemption is in light of the statutory
      purpose. Since exempt transactions are those as to which "there is
      no practical need for [the bill's] application," the applicability
      of § 4 (1) should turn on whether the particular class of persons
      affected needs the protection of the Act. An offering to those who
      are shown to be able to fend for themselves is a transaction "not
      involving any public offering."
    

I truly dislike the logic, why can't we stick with the plain meaning of the
text, but they are trying to protect people from swindlers so I can understand
their goal.

The end result is selling shares to the night janitor is almost certainly
_not_ allowed by 4(a)(2) but glad it turned out alright this time.

------
kenrikm
I think the most important takeaway is that he did not try and screw over the
early shareholders, integrity _is_ important. The story about the $280,000
drafting table is relevant, they needed the drafting table it contributed to
the success, If you were to go down that line of thought I wonder how much
each can of Soda bought for early Facebook employees "cost".

~~~
LanceH
There were a lot of drafting tables and tons of other stuff purchased totaling
some unknown amount. But it was that drafting, in that place, with those cards
which made a company.

It's easy to criticize it for being $280k because we don't know the scenario
where they don't have a table. Maybe that scenario is, "fuck it I'm not
working on the floor any more" and the whole company is worth zero.

Then there is the economics of it. Hindsight makes it all easy when you only
question the costs of the winners.

------
MattHeard
> I was successful as a CEO not because of my own brilliance, but because I
> built a team of people far smarter than me who were willing to buffer my
> shortcomings.

This attitude defines a good CEO.

------
javajosh
I always feel dumb asking - but doesn't the total number of shares matter? The
real thing you're buying is a fraction of the pie when someone buys your
company, and it would seem to matter quite a lot whether the pie was cut into
10^3 or 10^6 pieces. Indeed, I wish we could just talk about ownership
percentage instead of shares to remove the ambiguity.

Why is there a reluctance for people to talk about this openly?

~~~
georgeecollins
The number of shares should be figured into the estimated price. If they
figure the company is valued at $100, and a share at $0.50, then they should
be issuing 200 shares.

You should be completely mistrustful of anyone who offers you shares and
doesn't tell you the # of shares outstanding. Alternately, if they tell you
the value of a share, they should tell you the estimated value of the company.

The alternative is presented in Mel Brooks' The Producers.

~~~
ryanburk
> You should be completely mistrustful of anyone who offers you shares and
> doesn't tell you the # of shares outstanding.

this is an amazingly important point that many people I've seen new to the
startup world ignore to their peril. it is too easy to get big eyes when you
hear you are getting 50,000 options not realizing that it is only 0.000001% of
the company since you don't know # of shares outstanding, across all classes
of shares.

~~~
aetherson
It's maddening, too, because nobody ever just tells you the actual shares.
EVERYONE says, "You'll get 50,000 options!" My answer is always, "Okay, and
what percentage of the company is that?" and the answer is always, "Um... I'd
have to go look it up."

Just once, I'd like someone to provide that information for me proactively. It
would instantly increase my estimate of their integrity by 150%.

~~~
STRML
I don't understand how one could _not_ know what percentage of the company
that is. It seems wholly irresponsible not to; both from the perspective of
the potential employee (who may get too little) and from the perspective of
the employer (who may give away too much).

------
nwhitehead
It's funny how everyone seems to have a different view of how equity should
work. I'm reading Felix Dennis "How to Get Rich" (highly recommended, much
better than the title makes it sound). He made his fortune in magazine
publishing which is actually somewhat close to Wizards of the Coast in
business model. His view is exactly opposite; fight as if your life depended
on every share, and pay people bonuses to incentivize performance.

~~~
ianferrel
How does that apply to Wizards? They clearly didn't have any money to pay
bonuses.

------
dtparr
>If I had a deep, intellectual conversation with someone, I’d give them 10
shares. At $0.50 per share, that was only $20 of fictional value, certainly a
fair trade at the time!

Is his multiplication bad, or am I misunderstanding something terribly?

~~~
apetresc
He multiplied by 2 instead of dividing. He meant $5.

~~~
dtparr
Ok, I thought that was the most likely, but didn't want to discount some sort
of option-style benefit.

------
benmathes
"But most of the value in this company came from two things: Richard Garfield
creating Magic: The Gathering, and the employees. Not investors. It’s only
appropriate that the distribution from the sale reflects that."

Hear hear. Investors say that founders and employees are what make startups. I
wish the cap tables reflected that.

~~~
joshu
so how do you propose that change?

~~~
bmajz
This. Having been on both sides of the table (early employee and later a
founder), I still struggle with what the right distribution would and should
be. There are just so many factors to consider (pivots, investors, acquirers,
risk) that it seems unlikely that a simple formula or blanket rule will guide
people right. Probably case-by-case basis and a realization that information
asymmetry + control in early stage companies leads to a slight, but
correctable, favoring of founders/investors' interests.

~~~
benmathes
Yeah, I don't know the right breakdown. I just know that your run-of-the-mill
founding teams (not founders, the teams) are relatively shafted.

------
mproud
Peter says again and again how he did it might not have been the safest way,
that perhaps he was lucky it worked out, that there could have been a better
approach. He does recognize it’s all water under the bridge, that in the end,
he got success. But just keep this in mind — the way they did it is probably
not the best way.

Edit: Read Blog Entry 2, Part 1: [http://www.peteradkison.com/blog-
entry-2-wizards-of-the-coas...](http://www.peteradkison.com/blog-
entry-2-wizards-of-the-coast-equity-distributions-part-1/)

~~~
ryanburk
can you go into why this wasn't "the best" or "safest" way or the
alternatives?

~~~
8_hours_ago
Offering stock instead of money for goods and services to your friends is
risky. If the stock becomes worthless (which is very common for startups),
your friends may not be your friends anymore. Of course, that doesn't mean
much for an investment as small as a $100 drafting table, but losing your life
savings is devastating.

~~~
ryanburk
thanks. totally get the life savings risk - the risk to the investor. I read
it as risk to the company, so didn't know how this would be any riskier than
standard round raises.

------
binarymax
_" We did no mathematical analysis of how the stock should be priced; we
didn’t have the skill to do that"_

Folks may not realize it while doing so, but developing complex gameplay that
is perfectly balanced can be considered a feat of linear algebra. So that
quote made me smile :)

~~~
Beltiras
They actually did a horrible job at making a balanced game as can be seen in
the multiple revisions since.

I loved it and I'm calling it a roaring success in most respects, but balance
is not something I would attribute to the first several incarnations.

~~~
pchristensen
They knew that it was unbalanced and that some cards (Moxen, Ancestral Recall,
etc) were too powerful, but that was on purpose because they expected scarcity
to be a part of the metagame.

If you were playing with your own group of friends who owned a few cards, the
small total number of overpowered cards would be a fun diversion. They didn't
anticipate the huge success and scale the game achieved. With a worldwide
metagame and market for buying/selling cards, scarcity vanished as top players
would pay up to get 4 of whatever card gave them an edge, so revisions had to
be designed in balance, rather than rely on scarcity to create balance.

Source: I read way too much MtG history a few years ago when I was working on
my own card game.

~~~
JoeAltmaier
There's more to it than that. They've re-released edition after edition to
obsolete the previous. Used to be 1 mana got you a 1/0 or 1/1 creature with
nothing else. Now you can get cards with 1 or two features, flying etc.
Anybody using the old ones is a sucker. Its easy to think its all about the
money, you have to buy new cards to keep competitive.

In fact this is why our game club designed their own card game (Orion Empire,
check it out on Kickstarter!) The idea is, new cards will always be different
in some way from old ones, so no card is ever completely eclipsed. So you can
buy new decks to keep it interesting, but your old one is probably still
competitive.

~~~
negativeview
As part of rebalancing they've buffed creatures and nerfed non-creature
spells. It's simply not true that all cards have gotten more powerful, it's
just that early creatures were garbage and early spells were too good.

Nothing we've gotten in the last few sets compare to the original Dual lands,
Channel, the Moxen, Ancestral Recall, Counterspell, or even something as
innocuous as Dark Ritual.

~~~
JoeAltmaier
Well, they're garbage if everything that comes after is inflated. That's my
point.

~~~
negativeview
You said that they release more and more "to obsolete the old." My point is
that was not their goal.

Their goal was always to have spells and creatures roughly balanced. Their
original thinking was that creatures were a repeatable source of damage and
thus should be costed as such.

Turns out they overestimated how much rarity mattered and underestimated the
power level of creatures. As a result, we get pretty mediocre creatures and
ridiculously powerful rare spells.

If every set were trying to outpower the last, then we wouldn't still get
functional reprints of Llanowar Elves or Grizzly Bears, both of which were in
Alpha.

Really, the power creep from year 1 to year 10 or so was a desire to see
creatures played in competitive magic and a desire to see more actual games of
magic (if your opponent wins the coin flip and goes Mountain, Black Lotus,
Channel, Fireball then no actual magic was played).

Since then they've actually been doing a sort of power oscillation. Different
parts get more powerful over time, then go back to weaker again. They mostly
focus on Standard and Limited where the power level of older cards matter
less.

In summary (I've already written too much) there's simple proof that the power
level isn't endlessly increasing: look at Legacy and Modern. Every set that
comes out adds between 0-3 cards that see Modern play and 0-1 cards that see
Legacy play. If power level were just flat going up, that number would be much
much higher.

~~~
JoeAltmaier
Ok, rather than simple inflation they've invented a way to 'pump' the cards,
alternating powerful and weak by category. Even better profits! You don't have
to be the least bit creative to do that; you just wait for the old cards to
get worn out then reprint them in cycles. Great.

~~~
DonHopkins
Is criticizing Magic the Gathering as being evil, vindictive, manipulative and
profit oriented a way you've invented to 'pump' your Kickstarter project?

Why aren't you also criticizing MTG for blatantly promoting Satanism, or does
your card game to that too? ;) [http://church-of-illumination.com/mtg-satanic-
evidence](http://church-of-illumination.com/mtg-satanic-evidence)

~~~
JoeAltmaier
Don't be silly. Its the dozens of disenfranchised young people in our game
club that motivated the game, not the other way around. They were frustrated
and disappointed that every time they built a Magic deck, another edition
would obsolete it. They felt like fools; they gave up on the game. This was a
way to get them interested in gaming again.

------
herbig
"So Do You Wear a Cape" is an excellent history of the founding and success of
Magic: the Gathering and written in a way that you don't have to understand
the game to grasp everything. I highly recommend checking that out.

------
gcb0
i love to put this annecdote on top of facebook's

if the same people were handling WoC, they would have called in the janitor,
made her sell her stock for peanuts before the new stock price set in.
garanteeing that only the suits made any big return of it.

------
random_pr
This is a good related article on the early days of WotC:
[http://www.salon.com/2001/03/23/wizards/](http://www.salon.com/2001/03/23/wizards/)

------
diziet
This sounds like a terrible idea and not 'inspiring' at all.

