
Employee Equity: Dilution - alexandros
http://www.avc.com/a_vc/2010/10/employee-equity-dilution.html
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stevefink
I'm assuming that questions about dilution hit Fred's radar after folks hit
the theaters this weekend to see The Social Network. Although the actual
numbers in the dramatic scene with Eduardo might be slightly exaggerated (I am
not sure what happened in reality and how it got handled) - it's critical as a
startup founder or startup employee to understand how dilution works because
this can and will happen. It's natural. The one thing Fred did not mention is
how some of the more aggressive investors out there will have contracts
written that will limit the amount of dilution that can affect them when
shares are redistributed - that was a new one I ran into with a recent startup
of mine. Ultimately it's all about reading your contracts thoroughly and
having not a good, but a GREAT lawyer who specializes in startups with you
from the beginning.

~~~
morisy
I had the same thoughts, though my co-founder and I had been looking for a
clear explanation of this tricky topics for months before the movie. I'm glad
it came out, pushed by popular culture or not.

As for the factuality of the movie's dilution scene, as best I can tell the
reduction in equity was somewhat less dramatic, but not that much. Instead of
nearly a third of the company, Eduardo owned 7% according to several business
blogs & Wikipedia (but no credible news sources, from which I can't find a
citation about any number). This was reduced to less than a tenth of a
percent, but later settled at about 5% (citation: <http://bit.ly/aDms3t>) for
what amounted to about 6 months of involvement.

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ghshephard
Another Excellent article on this:
[http://baglady.dreamhosters.com/2007/11/16/california-
dreami...](http://baglady.dreamhosters.com/2007/11/16/california-dreamin-
incentive-stock-options-and-the-silicon-valley-workerbee/)

Preferred Share Liquidation Preference is another landmine.

I know at least one (world class valley player) early epinions employee who
walked away with almost nothing - The common shareholders got screwed when
epinions merged with dealtime to form shopping.com - but he had already left
the company for another gig, so there was really zero benefit to taking care
of him.

At Oblix, anybody who was an ex-employee ended up with zero on equity when
they sold to Oracle for $85 Million - preferred shareholders ended up with
everything. Existing employee who made it through the transition landed a
retention bonus, and the founders (some of who were no longer at Oblix) picked
up a "consulting" bonus to make sure the deal went through and they didn't
block it.

A few lessons learned from all these experiences:

o At the end of the Day, you really are at the mercy of the Majority
Shareholders, regardless of what equity you think you may have - unless you
are prepared to go to war in court.

o Always be aware of how much leverage you have with Founders Stock. When a
final sale is going through, you may not have enough voting stock to defeat
the deal, but you may have a large enough block to mount a legal challenge -
it might be easier, and cheaper, and certainly less risky to simply buy you
off. Protect your position.

o Stay close and friendly to the CEO, VCs, and Board Members driving the
financial structure (typically the ones selected by the VCs) They will be the
ones who can re-up you when the dilutive rounds hit the company, or hand out
"retention" bonuses after a sale - and they are the only ones who really have
a clue as to what machinations are taking place.

o Probably most importantly - bring unique value to the table that the company
requires to succeed, and continue to succeed after a sale. I remember walking
out of "The Social Network" wondering how on earth Eduardo manage to walk away
with 7%. The way I watched the movie, Facebook succeeded despite his efforts
to slam it with Ads too early, and his inability to pull in Angels like Thiel.
And how he wasn't sitting right beside Mark night and day, is beyond me. And
seriously, how could he claim to be the "CFO" and not be intimately familiar
with each and every clause of the stock events that were taking place. It was
liked he'd totally checked out and was just showing up now and then to see
what was happening at the company. The movie was very unsympathetic to him.
Now I have go read "The Facebook Effect" and "The accidental Billionaires"just
to see if they portrayed Eduardo in a more sympathetic light.

The movie portrayed Sean Parker as playing a much, much larger role in
Facebook's success than Eduardo - yet they ended up with similar amounts of
equity, which befuddles me.

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oceanician
I'm always suprised at the sums of money involved in salaries and equity in
the states. Seem about 5x the pay of that in the UK. What USD cost of health
insurance would you take off typically? (for a single person)

~~~
mmt
For a small company making an effort to offer benefits comparable to a large
company, such as through a PEO[1], the price tag will run $6k-$10k annually
per employee, inclusive of payroll, compliance, and fixed employment taxes. A
deferred compensation retirement plan (aka 401k) could run another $1k .
Employer-side Social Security is 7.65% of salary.

[1] Professional employment organization, aka "employee leasing"

~~~
tptacek
We offer these benfits and these numbers are in the ballpark without using a
PEO (think "collective bargaining union of small companies").

~~~
mmt
Thanks for the different method of confirmation.

I've found a PEO, itself, tends to cost $100-$500[1] monthly per empployee.
How much (presumably in time, not dollars) does the collective bargaining cost
you?

[1] At 4 employees

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auxbuss
I created an alternative spreadsheet to pg's that is formula-based, which
explains some of the final numbers. (At least that's the intention.) In
particular, where the 3.7% adjustment for the pool refresh comes from.

[https://spreadsheets.google.com/ccc?key=0Ap9s-bcx0E1adGh4cVJ...](https://spreadsheets.google.com/ccc?key=0Ap9s-bcx0E1adGh4cVJEV3o5c3o4ckd4M3NrNXhxRkE&hl=en)

~~~
auxbuss
I updated this spreadsheet so that the coloured fields can be manipulated to
reflect your needs. You need to download it to do this, as if there is a way
to allow this on GoogleDocs, I couldn't find it.

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heliodor
you ideally take investments if you'll be better off afterward than before.
relating to percent share, that means that while you get diluted in percentage
terms, in dollar terms your cut goes up in value, so the percentage doesn't
matter. on the other hand, the percentage determines control, so there's a
balancing act involved.

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mmt
The title strikes me as a bit misleading, since, for all but the earliest
employees, and, of course, founders, dilution's going to be in the noise.

~~~
olegk
I know a del.icio.us employee (one of the first 10) who got completely ripped
off on his equity.

~~~
pchristensen
joshu hangs around here but I doubt he can comment on it. Crunchbase says
delicious was bought for ~$10M. Would an employee #10 ever have more than 1%?
So we're talking max $100K before taking investors or acquirers into account.
I'd be interested to hear more about what his being "completely ripped off"
consisted of. Email me if you don't want to say in public.

