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Options vs. Cash (danluu.com)
679 points by darwhy on June 7, 2017 | hide | past | favorite | 310 comments

"If you look at companies that have made a lot of people rich, like Microsoft, Google, and Facebook, almost none of the employees who became rich had an instrumental role in the company’s success. "

100% false.

The next sentence in the article does a better job at illustrating his point: "Conversely, the vast majority of startup option packages end up being worth little to nothing, but nearly none of the employees whose options end up being worthless were instrumental in causing their options to become worthless."

I interpret the point as being: the monetary outcome of a startup for the employee is a function of their individual contribution (which is what I think the author means by being "instrumental"), plus the contribution of the founders and other employees, plus luck. The magnitude of the individual contribution is small relative to the other factors, so it's difficult to say that a successful startup employee "deserves" a windfall and an unsuccessful one doesn't. The lower the correlation between individual contribution and monetary outcome, the less options should matter for motivating early employees.

This article[0] from almost 10 years ago estimated that the Google IPO resulted in 1,000 people having more than $5 million worth of Google shares.

So I guess it hinges on how you define "instrumental" and "almost none". It's a tautology to say that "instrumental" means "they contributed to the effort", so I would say "instrumental" means "it seems like no one else could have done it" and "almost none" means less than 5%. If you had to take a wild guess about Google, what percentage of that 1,000 would you estimate were instrumental? Furthermore, presumably there are more Google millionaires now, 10 years later. I wonder what percentage of those were also instrumental in Google's success?

[0] http://www.nytimes.com/2007/11/12/technology/12google.html

I am not sure "it seems like no one else could have done it" applies to Nobel Prize type discoveries or Moon Landing like feats of engineering, much less to software companies.

Don't get me wrong, I don't mean to say that many employees at companies like Google are not brilliant or not extremely effective in their work, but "no one else could have done it" is a useless test that relies on mythologizing people. The way I figure out, the people getting rich (as employees) are those that: a) took the risk to get in early enough, b) performed their jobs competently enough to stay long term and to give the company a chance to succeed, c) got lucky enough in that all the imponderable external factors also resulted in that particular company succeeding. That doesn't mean they weren't "instrumental", in the sense of being the people who actually happened to get the work done. But that's different from "irreplaceable".

Yeah this claim I don't understand in an otherwise very good article.

At the startup I worked at, a bunch of people made some money based on equity, and while it wasn't necessarily a perfect correlation between equity and contributions (and how could it be?), roughly speaking, equity and "having instrumental roles in the success" were certainly highly correlated.

I'm not even sure what the idea is here. Are early employees generally considered undeserving of the success of their companies? Who is deserving? The founders? Later employees?

Yup. I came here to write this. You don't know about how those people helped because they're not the public face of the company; but often they started the seed of something that grew into something big (like you!) or solved some critical technical problem blocking scale, or helped land a key deal, or any of a hundred factors that, if they weren't done, would have severely hit the growth of the company, and couldn't have been easily done by someone else walking in off the street with a nice CV - things that required history with the company, its codebase or market or customers etc.

I started off once thinking "yay, X% means I get X% of the company!" and then I found out the shares can be diluted. Then I learned "non-dillutable".

Then I learned about vesting periods, windows for exercising options, and a whole slew of financial terms and devices; each one seemed to come with its own unique "gotcha" that, if you didn't know about, would cost you nearly everything.

Everyone I talk to about these always says "well, don't do that one thing, or if you do that one thing be sure you do it in this way and you're set". The cumulative knowledge you need becomes pretty high pretty quickly though, and the chances of me doing the right legal and financial incantation at the right moment becomes lower.

Nowadays I go with cash. I don't get 'golden handcuffs' that hold me to a job I don't like because it might pay off later. I can calculate the expected value and risks with cash without tons of research. I know my legal recourses if I get screwed out of cash.

Let's not forget the "asset only" acquisition where the company sells it's IP and employees but doesn't sell any shares. Been through one of these and this is what happened, screwing over former employees who had bought options and investors. I think the only people who profited were the bankers.

I've been on the other side of two of these and the explicit alternative in each case was bankruptcy. Also asset transfers are more expensive to the acquirer because you have to explicitly delineate the assets you're buying and what you're not buying. This makes for more lawyer time and pushes the transaction costs up significantly. The real reason to do it is because the team there at the time is more valuable as a group than they would each be on the open market individually. Anyone _not_ there doesn't add that kind of value to the deal.

You may want to argue that IP is also part of these deals and past employees created part of that. This is probably true for some deals, but it has been minimally true for the deals I've seen directly. Sample size of two isn't great, but keep in mind the value of startups is largely believed to be in execution, not ideas. A startup on the verge of bankruptcy probably doesn't have immensely valuable IP because it's 1) not producing present value obviously and 2) isn't obviously worth a lot in the future, otherwise someone would be willing to give you discounted cash today for an ownership percentage of its future value (aka an investment).

Nothing I love more than being bought and sold like cattle.

Out of curiosity, how do you keep the employees from walking after an asset only transfer? The vague promise to them about future riches has already been broken. And you will up changing business practices that ruffle feathers (I'm not sure how you could avoid it. This stuff is rarely written down). Hell, you'll probably assign them to a new project anyway. So how do you keep them from leaving in droves?

Payouts! They get some mix of salary (comparable to existing employees), stock (more generous than existing employees) and a cash payout that's fairly generous if they meet some goals laid out in advance.

And you didn't ask, but if not enough of the team accepts an offer, then it evaporates.

If I am to believe HBO, then sometimes those goals are drinking beers on the rooftop.

Not quite but I know of one high level exec at a company you're familiar with that was given a year after multiple warnings.

Effectively, he had no job but was still on the payroll for a year and maintained his equity. He came in and did virtually nothing for about 6 months and then stopped.

It's a cushy gig but by the time you get it it's a punishment not a reward.

> Out of curiosity, how do you keep the employees from walking after an asset only transfer?

Their compensation at the new company will have a vesting schedule over some period of time, similar to a stock grant.

What you describe is what happens when a company fails. It's not really screwing people over as just a description of failure.

I've seen this happen multiple times. It is by far the most common "acquisition" in my experience.

>"yay, X% means I get X% of the company!" and then I found out the shares can be diluted.

There seems to be a common misunderstanding about dilution.

Dilution is not really the issue. In fact, dilution is a positive sign. It means more investors value the company and want to buy into the ownership.

How do current owners who collectively own 100% of the shares "sell" more shares to future owners?!? By way of dilution. That means everybody gets diluted including the founders, the angels, the VCs, and yes the employees too.

More important than dilution is the shares multiplied by price.

I hear this argument a lot. Mostly from people trying to sell the idea of a highly dilutive funding round.

Sure, further rounds are a sign the company is doing well. The important word being "sign," they don't actually make the company more valuable (what the company does with the money they raise does). If you own a lot of stock, you probably already know if the company is doing well or not. In that respect, the round just puts a number on what you already know.

The math is simple. All things being equal, owning more % of a company == more money. To try to spin dilution in any other way is stretching the truth pretty far, and is rather manipulative IMHO.

Except, all things usually aren't equal. Most people explain dilution like this: you're getting a smaller piece of a bigger pie.

It's zero net gain at the point of dilution. Owning 10% of 10 million or 1% of 100 million is the same money you simply have even less control.

Unfortunately, rational people may have very different risk tolerances. Founders often see it as I have a company and X money to work with. The next round means I have a company and X + Y money to work with. In that context having a 90% chance of 10 million is often better than a 80% chance of 20 million even if the expected value drops the difference between 0 and 10 million is vastly larger than 10 million vs 20 million. But, smaller stakeholders may not agree with this thinking.

Yet you just lost 90% of your money. It's shocking that you can now see the trick being performed on employees.

What a typical employee thought:

- I have 1% of a 10M dollar company. We'll do well and in 2 years I will have 1% of a 100M dollar company.

What will happen in the best case:

- I had 1% of a 10M dollar company. They did well and now he has 1% of a 100M company (dilution in your face!).

He just lost 9M. They were actually never on the table, even thought the hiring department didn't hesitate to pretend they were.

> What will happen in the best case: - I had 1% of a 10M dollar company. They did well and now he has 1% of a 100M company (dilution in your face!).

You've meant to say "They did well and now he has 0.1% of a 100M company" I assume? Otherwise numbers don't add up. If all goes well the value of a smaller percentage after dilution should be higher than before the dilution, for example: 1% of 10M ($100k) -> 0.2% of 100M ($200k).

He didn't lose 9M. In his vision they did well and increased the worth of the company without outside investment. In reality, they didn't do well at all, because 10x dilution when the company grows 10x means the company has not actually created any value, it's just been given cash.

Right, but the only reason you'd take on any dilution as a founder is if you think the extra money will make your shares more valuable in the future.

The issue is that as an employee you don't have that choice. Somebody else makes those decisions for you, you're just along for the ride.

The VC-backed company model isn't set up for employees. The model is so that (a) founders can take risks (b) using money from VCs (c) where if the company does well, the founders and VCs both become richer.

Everything else follows from that. The fact that employees get any shares at all is just a way to get better employees so that the company does well. Only employees of unicorns have any chance of getting wealthy from stock, and you're unlikely to be an early employee of a unicorn.

It's better to view the situation in absolute terms rather than relative terms. Instead of comparing the outcomes of founders/VCs vs employees, compare an employee of a startup to an employee of non-startups. At not-startups, the working environment is very different. Some people enjoy that, some prefer the opposite. Also, getting +$100k (or +$50k, or even just +$10k) is still nice, even if the founders and VCs get 800x more.

The only part I have serious concerns about is the fact that you can end up underwater when it comes time to exercise your options, i.e. your tax bill outweighs whatever profits you'd see. I don't know exactly how this situation arises, but it happened to a friend. It was something like: he could have exercised his shares and gotten several hundred thousand, but he would've needed to pay about $100k in taxes beforehand. Since he didn't have that money, he couldn't exercise the options.

I might be wrong about the specifics, but there are situations similar to that, and it's pretty unnerving knowing that you can jump into a situation where your +$100k somehow turns into -$50k.

> it's pretty unnerving knowing that you can jump into a situation where your +$100k somehow turns into -$50k.

But even your example wasn't that. Your examples was -100k and +300k (or more), but offset by time slightly. That's still a very large net positive, just gated by a period of net negative.

I suspect there are some details that you are missing as to the situation of your friend. I know little about investment vehicles, but I've filed taxes at one point and paid them at a later point many times. For income taxes the rules for this are clear, and the amount you pay in fees and interest is also very clear. For some investment vehicle, I would bet if there's some taxes that need to be paid prior they have automated processes set up to pay them for you and take the amount out of the later payout, for a fee. If not, I can't imagine getting a short term loan for that would be too hard, even if you have to use private money (a real investor, or even just a friend).

Yeah, I'm certain I got some of the details wrong. It sounded like a situation similar to https://news.ycombinator.com/item?id=14464184 where you can owe taxes on money you never saw.

It depends heavily on if there's any prospect of your shares becoming liquid any time in the near future.

or even just +$10k

As someone who has been exactly there, this doesn't compensate for the lower salaries that are de rigeur in startups. Not to mention being an absolute insult compared to the employee's degree of contribution to the resulting event.

"Better than nothing, or being underwater" is pretty thin gruel in practice.

> The VC-backed company model isn't set up for employees. The model is so that (a) founders can take risks (b) using money from VCs (c) where if the company does well, the founders and VCs both become richer.

Does this mean that stock options are not a measure of risk taken by the employee into the company?

You mean the stock options are just like cash? I didn't think so. The employee is invited to take risks but without the protections.

> he could have exercised his shares and gotten several hundred thousand, but he would've needed to pay about $100k in taxes beforehand. Since he didn't have that money, he couldn't exercise the options.

I feel like at least a phone call to a bank would be in order at that point. If it's that simple, surely some sort of mutually agreeable loan could be worked out.

Couldn't you bootstrap it, get £5k on a credit card for the taxes to exercise some of the options, use the profit to pay the taxes on the rest (or a further bootstrap)?

If the shares are not liquid 'cus the company is still private, then no you can't.

But the Revenue consider you to have received value in that "piece of paper" that you can't liquidate? That just seems like perverse tax law - why is it that way?

Surely if they're private shares that can't be sold the extrinsic value is zero, the private share value for tax purposes is no greater than the value of the option?

> Only employees of unicorns have any chance of getting wealthy from stock, and you're unlikely to be an early employee of a unicorn.

Define wealthy.

I have done quite well (not FU, 3-comma money, of course, but solidly 2-comma) from equity as an employee. In my current company, I joined a few months after the Series A (so nowhere near "early"), stayed through the IPO and many years of growth past that.

We were never a unicorn.

Amazon, Facebook, and Google are regularly turning SWEs into millionaires and a substantial part of that is from equity. Microsoft also had a good decade and a half of doing that. Netflix probably does as well. (OK, Facebook was a unicorn; the others probably weren't ever called that, though it may have fit.)

I'm not sure that's particularly relevant to this thread; there are plenty of decisions that materially affect the value of your equity that you have no say in. That's true both in a startup and at a large tech company like Google where a significant part of your comp is in RSUs.

The point in the GP post that I was expanding upon,

> It's zero net gain at the point of dilution.

is focussing on the wrong instant in time.

You should be calculating the effect of the dilution on your exit event, when your equity actually becomes exchangeable for money.

A bit like owning stocks on the stock market then I would guess. Which begs the question of whether to take a higher paying job with no options and invest the difference.

Which should have been clear to you when you joined the company and read and signed the employment and stock options agreements (you did read them, didn't you?). If that isn't to your liking, don't work for a startup.

"It's in the contract!" is a poor excuse for the company acting shitty to you.

You miss the point. I don't think they are acting shitty. They're acting according to what both you and they agreed to in advance. You knew (or should have known) what they were (and were not) going to give you in return for your effort. It's only shitty of them (and illegal) if they don't follow through on that agreement.

And I disagree.

Or to prolong inevitable death.

At the moment that the dilution occurs, you're getting exactly the same size of piece, it's just a smaller proportion of a bigger pie.

But I suppose the idea is that a bigger pie is able to expand larger and faster than it would have been otherwise.

I need you to ELI5 this for me.

Let's say today I own 200 out of 10,000 shares (2%) of a company. Someone comes in and says we want to own 25% of your company and are willing to pay $100M for it. At that point (before any transactions happen) I assume that my company is worth ~$400M, and my shares are worth ~$8M ($400M * 0.02).

So the majority shareholders agree to the deal and dilute stock accordingly. Now there are 13,333 shares. The new buyer get 3,333 (25%) and I still have my 200 (now 1.5%). The company is worth that original $400M value plus the new $100M that was invested, for a total of $500M. My shares are worth ~$7.5M ($500M * 0.015).

Where did my half a million dollars of pie go?

The $400M is a post-money valuation. The investor gave you a current valuation of $300M, and offered to add $100M for a post-money stake of 25%. Thus, 3333 new shares were created and sold to the investor for $100M.

Your slice of pie before the deal is (200/10000) * $300M = 6M

Your slice of pie after the deal is (200/13333) * $400M = 6M

Except that after the deal, your company has $100M more to spend, hopefully on investing in growing the business so that later on, you'll own 1.5% of much more than $400M.

This kind of thing is why management will sometimes try to steer employees away from discussions focused on percentages and toward ones focused on share prices. As an early employee who has been diluted a number of times, I certainly agree that it's more helpful to think in terms of my number of shares (which is unchanging) times a share price (announced at the time of the investment), rather than trying to compute my new percentage of the overall company value.

Got it. This explanation makes sense to me.

The new investor is willing to pay $100M for 25% of the company. That means they think the company will be worth $400M after they invest $100M. That means the current value of the company is ~$300M, not ~$400M.

No. What someone is willing to pay and what something intrinsically is worth is not the same thing. If the stated presumption is that the company was worth $400M before the $100M cash infusion, then it follows that it must be worth $500M after that.

Yes, but the original problem statement was flawed (over constrained and confictingly constrained).

It was "pre-money $400M", "new investment $100M", "new investment gets 25%". Those can't all be held true.

You can change exactly one of them to remove the conflict, so it's either "pre money $300M", "new investment $133.33M", or "new investment gets 20%"

You structured the deal wrong.

If the new people own 25% of the company, then the previous owners own 75%. That means that the new people should get one-third as many shares as previously existed (which you did correctly). But it also means that they should have to put up one-third as much money as the company was worth previously; that is, 133M, rather than the 100M you had them pay.

Your loss is your cut of the 33M loss that your company took by getting underpaid.

Exactly! Thanks for pointing this out because everyone seems to miss it.

At the moment that an investment is made, a company should be worth just as much as it was before, but will have more liquid assets because it's traded equity for cash.

The question for employees and shareholders then becomes: "Do you believe management is capable of using the cash to build additional value, or will they waste it?"

I think this would be the case where language makes a clearer understanding.

"You own 1% of the company" vs "You own 1% of the angel round stock pool."

I think it's clear(er) what the second sentence means.

If you're getting exactly the same size of piece, why name it "per cent"?

you are getting the same amount of pie (your volume of food stays consistent) however the ratio of your piece vs the rest of the pie is what shrinks

>All things being equal, owning more % of a company == more money.

The point is all things are not equal. To restate a sibling comment, dilution means you own a smaller % of a more valuable company.

If it helps, think of "dilution == sell_equity". Dilution is the perspective of the sellers' side (x% - y%). Equity purchased is perspective of the buyer's side (investor's ownership goes from 0% to y%).

>To try to spin dilution in any other way is stretching the truth pretty far, and is rather manipulative IMHO.

Dilution explanation doesn't require "spin" nor mental trickery. It is the natural side effect of how companies sell equity to grow.

E.g. Larry Page's ownership of Google Inc got diluted from 50% in 1998 down to 16% in 2004. That smaller 16% was worth ~$3 billion around the time of the IPO[1]. If Larry insisted on "no dilution", no VC would invest money to help the search engine grow and therefore, he would own 50% of a worthless company.

So all things not being equal:

  50% of $0 = $0
  16% of $20 billion = ~$3 billion.
Obviously $3 billion is more money than $0. Thinking that 50% is better than 16% doesn't make sense for companies that require outside investors to grow. Similar story for Bill Gates' dilution, Jeff Bezos' dilution, etc.

Let's imagine Larry Page had a different conversation with Sequoia Capital to match this misunderstood fixation over "anti dilution"

>1998: Larry owns 50% + Sergei owns 50% = 100%

>1999: Sequoia: "we'd like to buy 10% of Google Inc for $12.5 million"

>Larry responds: "Yes! Great! We need your $12.5 investment but keep in mind that both Sergei and I have anti-dilution clauses so our ownership both stays at 50%."

> Sequoia responds, "So you want me to buy 0% of the company for $12.5 million? Uh, you guys are idiots"

Somebody in that imaginary conversation doesn't understand "dilution" or "equity" or simple math.

[1] http://www.nbcnews.com/id/5033780/ns/business-stocks_and_eco...

Sure, but dilution without representation can be a big risk for a regular employee. You might get a smaller slice of a bigger pie, but it may also represents a smaller real-world valuation if you get diluted too far.

If you have no say over how much you're diluted (like most employees), you could be diluted away to nothing. You have no control. So you must calculate worth accordingly.

Is everyone to get diluted equally. No? Well then, calculate worth accordingly.

In addition, I thought the pie getting bigger was the WHOLE POINT OF HAVING THE SHARES TO BEGIN WITH.

>You might get a smaller slice of a bigger pie, but it may also represents a smaller real-world valuation if you get diluted too far.

Show example math of how someone could get "diluted too far" resulting in less total value (shares x price) after an investment round that prices the company higher than before. If the total value was truly less, it means it was "down round" which is a different beast.

>, you could be diluted away to nothing.

Show how it is mathematically possible to dilute employee's 1% ownership in to 0% without illegal tricks.

When Mark Zuckerberg tried to dilute Eduardo (without also diluting the other owners), he tried to hide the reduced % via a newly created company. He got sued for the financial deception and lost.

It is a lot different if some of the founders/past investors have anti dilution clauses

I'm somewhat new to this topic (and therefore might not understand correctly) but another user, 'oillio', made a response in a different thread [0] which could explain 'getting diluted away to nothing', for example, an investor invests money causing dilution, the company squanders the money or uses it on something that doesn't positively affect the company trajectory. You now own a smaller slice of a pie which is the same size as it was before.

Using his example, if you estimate the value of a company to be 100M and estimate 10 years until IPO, if the investment doesn't raise the value of the company at the time of the IPO in 10 years then the dilution is not good for the employee because the pie is the same size (100M) but his/her shares have been diluted.

Seems like it's pretty difficult to estimate the value of the company in 10 years or the IPO date though which is probably why people just use the amount invested to estimate the value of the company.

[0] https://news.ycombinator.com/item?id=14510483

> Sure, but dilution without representation can be a big risk for a regular employee.

Well, it's a big risk to everyone that doesn't get voting rights, right? Not all investors get voting rights, do they?

In some way, an employee sits between a non-voting investor and a voting investor. They don't get to vote, but they do have some control over the outcome of the company (ranging from small to large, depending on the number of employees and responsibilities of the person in question).

I didn't say anything about anti-dilution. There are complexities, but as you explain, if you take more money, you need to give the investors something.

If you look purely at the accounting, and ignoring voting rights and other complications, you are right. Dilution doesn't change anything.

IMHO this argument is a case of technically accurate, and completely useless.

It doesn't matter what the value of the company is at the moment of the dilutive event. It matters how that event affects the value of the company when the employee liquidates their stock.

The new round could be very good, but not necessarily. There is no guarantee a more well capitalized version of the company will end up growing faster or larger than the current cap table.

When the employee evaluated their original option grant they should have done an analysis of the business, its market, and future growth potential. Lets say the predicted value of the company is $100M in 10 years.

Lets look at two options: Option 1 - The company is continuing on its original trajectory. It is running low on runway and needs a cash injection to continue gaining market share for its quest for profitability. The company still looks like a $100M company, if successful.

The new round may not be good for the employee. When you look forward to the eventual liquidity event, the employee now has a smaller piece of the same sized pie. Maybe the company could still reach its goal by tightening its belt a bit.

Option 2 - The company has identified a new market opportunity. They are raising capital to spin up a new project and capitalize the opportunity. If successful, the company now looks like a $10B company in 10 years.

The new round is potentially good for the employee. On liquidation, they will have a little bit smaller piece of a much bigger pie.

> Lets look at two options: Option 1 - The company is continuing on its original trajectory. It is running low on runway and needs a cash injection to continue gaining market share for its quest for profitability. The company still looks like a $100M company, if successful.

>The new round may not be good for the employee. When you look forward to the eventual liquidity event, the employee now has a smaller piece of the same sized pie. Maybe the company could still reach its goal by tightening its belt a bit.

Sure, but not taking the extra round is also bad for the employee, right? If you don't take the round, and the company now looks like a $50M company, then you have the same piece, of a much smaller pie.

>IMHO this argument is a case of technically accurate, and completely useless.

Actually, your statement of "All things being equal, owning more % of a company == more money." ... is what's misleading.

People are cargo-culting the meme that "dilution is bad" and it has the perverse effect of making them think that awareness of it is "financial sophistication."

Your other statement, "Mostly from people trying to sell the idea of a highly dilutive funding round." ... is also misleading.

It's not the "dilutive" effect that's the core issue. It's whether the company needs the funds. If the company needs the investment, it needs the investment. The dilution is a side effect.

If the new investors want too high of a percentage-of-ownership, then yes, it's "highly dilutive" which is tautology. This may also appear like a dilution problem but it's not. It's a financial literacy problem. The founders are supposed be smart and not sell too much of the company for too little a price! Therefore, I'm not talking about desperate situations of founders getting diluted down to 10% or less which then affects their motivation to run the company. In that case, the company is probably in financial trouble and the other option is to reject the investment which lets employees maintain a non-dilutive ownership of a bankrupt company.

>The new round could be very good, but not necessarily. There is no guarantee [...]

I agree but the backlash against dilution is about expectation of future events whereas your scenario is ex post facto judgement of past outcomes.

For a startup operating in the present moment, do the employees want the company to be able to raise equity financing to help navigate an unknowable future?!? If yes, it means everybody should expect some dilution in exchange for the outside investment.

>Lets look at two options: Option 1 [...] Option 2

Again, for both of your options, the easier and correct focus is shares multiplied by price. In the bad outcome of Option 1, the price went down. In the good outcome of Option 2, the price went up.

Focusing on dilution as some scary boogeyman is backwards since everybody else gets diluted (see Larry Page, Bill Gates, Mark Zuckerberg, etc)

Again, to reiterate the Larry Page example:

- Focus on the $3 billion vs $0. This is shares * price. The price is embedded in the "all other things being equal" part that you dismissed. The price is "not equal"!

- Don't focus on the dilution from 50% vs 16%. You can't play a mental game of "if Larry got 50% of $20 billion, that's $10 billion not $3 billion" because for him to keep 50% (dilution is bad), you have to replay history with him attempting to build Google with zero outside investment. It's more likely he'd have a bankrupt company instead of a $20B company since he can only buy a handful of servers by maxing out his credit-cards, and have no money to hire extra employees. This is the literal application of your "all things being equal". That's flawed ex post facto analysis which doesn't take into account the timeline and reasons people choose to dilute ownership / sell equity to capitalize the company at different stages.

If dilution is bad for the employee, then it is also bad for everyone else. If as you say, "the new round may not be good for the employee", then it also means it's not good for the founders and previous VCs. If the founders are not crooks, the intention for the investment round to help make the company better, not worse.

I still think the main source of outrage about dilution is that people think only the employees get diluted. They don't realize that every owner of the company including founders like Larry Page and VCs like Sequoia will get diluted too. All the sentiments of unfairness flow from that fundamental misunderstanding.

> If the company needs the investment, it needs the investment.

Agreed, but it might not. The fact that it is taking the investment does not mean it is needed, or that it is good for all stakeholders. Investors, founders, and employees all have different goals, motivations, and risk profiles. It is also very possible for the board to make a mistake and take funding that is a net negative for the company as a whole.

My problem is with this argument from your original post:

> In fact, dilution is a positive sign.

These are complex situations. Boiling them down to dilution is good, vs dilution is bad just leads to misunderstanding. Which, in my experience, can be the goal of the person making the argument.

I never said dilution is bad. My original comment was in response to your blanket statement that dilution should be assumed to be good.

I am just saying, "Hold on. It isn't so simple."

In the end, I think we are in violent agreement. People should not get hung up on dilution, it a natural part of the startup lifecycle. It is a factor in the equation, but only a factor. As I alluded to originally, it is much more important what the company is planning on doing with the funds.

Personally, I think the outrage about dilution is due to the fact that many new employees don't take the time to fully understand how it all works when they are hired. The single most important thing employees need to understand about dilution is that, if they join an early startup, it will probably happen at some point. Options for 1% of the company doesn't mean you will own 1% at the end.

Sure, dilution can be a good thing, but that doesn't change the fact that it can also be a gotcha.

> The point is all things are not equal. To restate a sibling comment, dilution means you own a smaller % of a more valuable company.

Right but if you aquired your shares under the assumption that you would own the same percent of a more valuable company, you are still being taken advantage of.

>but if you aquired your shares under the assumption that you would own the same percent of a more valuable company,

The employee shouldn't have that assumption. The correct default assumption is that the employees are diluted just like the founders when new equity is sold.

If the founders mislead the employees into thinking they got 1% -- and it would always stay 1% all the way to IPO, that's an issue with the ethics of the founder and not an issue with dilution. Dilution wasn't the problem. It's the dishonest entrepreneur that's the problem.

Put another way, if a founder told me I would be awarded 1% in stock and it would have anti-dilution protection for all subsequent rounds, I would not think to myself "wow, that's great!". Instead, that would be a signal that the founder is either 1) incompetent with math or 2) a crook.

Right, but if you read the post that you originally started arguing with:

> I started off once thinking "yay, X% means I get X% of the company!" and then I found out the shares can be diluted. Then I learned "non-dillutable".

Then I learned about vesting periods, windows for exercising options, and a whole slew of financial terms and devices; each one seemed to come with its own unique "gotcha" that, if you didn't know about, would cost you nearly everything.

Everyone I talk to about these always says "well, don't do that one thing, or if you do that one thing be sure you do it in this way and you're set". The cumulative knowledge you need becomes pretty high pretty quickly though, and the chances of me doing the right legal and financial incantation at the right moment becomes lower.

Nowadays I go with cash. I don't get 'golden handcuffs' that hold me to a job I don't like because it might pay off later. I can calculate the expected value and risks with cash without tons of research. I know my legal recourses if I get screwed out of cash.

You'll see that it was right all along.

>The cumulative knowledge you need becomes pretty high pretty quickly though,

Yes, I agree that we all go through an early period of ignorance and then we get more financially savvy as we learn more information. We don't know what we don't know.

However, when OP writes, "then I learned "non-dillutable", he/she is misinforming people with expectations that employees can get fixed-percentage ownership that stays at that fixed amount through subsequent investment rounds. The implication is that employees who didn't get such "non-dilutable shares" are getting screwed. This is not the case.[1] The normal situation is for _all_ ownership to dilute. It's not a nefarious trick on the employees.

If people think they are more "financially sophisticated" with knowledge of "no dilution" shares, they are wrong. Instead, if candidates try to negotiate "non-dilutable shares" with a founder as a condition of employment, they will look like clueless idiots. (Reading about mythical "non-dilutable employee shares" on HN made them dumber, not smarter.)

The expected mathematical mechanism for employees to get richer is for the share price to increase instead of the ownership % not to dilute.

[1] "Non-dilutable stock is impractical and unfair, and in some cases impossible.[...]" : https://www.quora.com/I-was-offered-non-dilutable-equity-by-...

Google example is a bad one as most startups fail in practice within few years. Most likely one works in one of those, not at the next business success.

In a typical startup a dilution means that the company run out of initial investments and has no way to get some form of a loan. So selling the ownership is the only way to continue. And if they succeeded with that it would not make the company more valuable. It just meant that owners were good at convincing investors. This is orthogonal to future value of the company.

Totally earnest question, as I'm a fool:

What is the difference between each selling _existing_ shares they own up to the $12.5M valuation and 'diluting' the existing shares?

If the shareholders sell their shares the shareholders keep the money. If the company issues and sells new shares the company keeps the money.

Nothing so long as a small number of people own all the shares, they all agree to sell an equal portion, and the share price allows an equal portion from all owners.

Dilution makes all this simpler.

Also, selling shares would be a taxable transaction for the founders, whereas issuing more shares and selling those is a tax-neutral transaction.

> [T]hey don't actually make the company more valuable (what the company does with the money they raise does).

Yes they do. In two senses. The obvious one is probably not what you meant to refute - the total value of the company post raise is, in the simple case, the value of the company before the raise plus the value of the new cash. The company is more valuable. What I think you meant to say was that your shares don't get more valuable.

That's more true, but they can be. If the raise was a good idea, the company's prospects are improved (and therefore the value of existing shares) by whatever uncertainty existed about its ability to raise that funding.

Isn't it amazing that every day, Apple offers new options, diluting everyone else who owns stock? Crazy anyone would work there, or want any Apple stock given that fact.

If dilution is a non issue then why do professional venture investors demand anti dilution clauses?

Professional investors generally get pro rata rights which allows them to buy more stock in later rounds. They do this because they want the ability to buy more shares in companies that are succeeding.

They don't get magic stock that magically doesn't get diluted.

They used to! Ask anyone who was involved in startups around 200-2002 about the full-ratchet anti-dilution provisions many investors demanded and received. Not fun for anyone else in a down round . . .

Down-rounds were huge back then, regardless weighted average was still the more common way of doing things, even in the early 2000s. Often times, these days, startups are putting pay to play provisions in, so even the weighted average ratchet requires them to keep investing in order to receive their anti-dilution.

Honestly, unless a startup has SERIOUS capital problems, an anti-dilution isn't going to make it's way into a share purchase, so the companies that are still seeing this (and the ones from the early 2000s) weren't in incredible shape to begin with.

Why shouldn't employees also demand, and also be given, the right to buy more shares in subsequent funding rounds?

If I was going to work at a company for X% ownership, I'd sure expect to have the right to invest my own money to preserve my stake in a funding round and avoid dilution. Many employees might not exercise this privilege, since it would require putting (potentially a lot of) cash back into the company, but why aren't they given the choice? I also might expect to receive the same liquidation preference on any shares purchased in cash this way.

I'm not sure I could be comfortable working for a startup without pro rata rights and relatively full knowledge of the cap table and preferences. That's probably why I'm not working at a startup.

1) It would generally be a poor investment choice for an employee to invest their savings in a startup that they were actively working for. Startup employees are already over-invested in their company from a diversification perspective.

2) The majority of startup employees are unlikely to have the cash on hand to make that kind of investment.

Because of #1 and #2 this isn't something that most employees would care about so it's not part of any standard compensation package. It's possible that an employee could negotiate for such a provision though.

The fact that you would want a pro rata right to work at a startup does make you fairly unusual and I agree goes to explain why you have chosen other career options.

Ratchets are a thing, far less common in the valley in the last decade than the decade before, particularly at earlier stages. Founders can put them in as well. Don't forget warrants as part of a deal too.

Price alone will not tell you everything. Let's not forget about different classes of stock: preferred vs common. There are often other rights associated with preferred / investor shares: liquidation preferences, warrants, etc. Rarely can the average employee get these details.

> Dilution is not really the issue. In fact, dilution is a positive sign. It means more investors value the company and want to buy into the ownership.

This doesn't just apply to company shares (a topic which causes people to not think rationally, for some reason).

It applies to a market. Sun's CEO MacNeilly famously said that he liked open systems (in the case of BSD Unix) because "it increases the pie. Our slice gets smaller but all these participants grow the overall pie faster, so our revenues go up."

What fascinated me at the time was how the business press was puzzled by his statement -- they had a more zero sum view of markets in the late 80s/early 90s. Nowadays people understand that the existence of Lyft helps Uber, and vice versa.

And the same is true with people who want to buy your shares.

Dilution is only a positive sign if your stake is increased to compensate. Otherwise it means you're working for less than you agreed to.

> More important than dilution is the shares multiplied by price.

But even with an "up round", where ownership percentage is diluted but your n-shares * price goes up, liquidation preferences can reduce or eliminate your value.*

As the GP said, there's always that "one more thing" that can wipe out your value.

(*citation: personal experience)

> In fact, dilution is a positive sign

Sometimes. But if this were simply a case of ignorance-correction, certain preferred investors would never ask for pro-rata, or everyone would be offered pro-rata.

This seems like it supports the idea of how the knowledge needed to understand options adds up to become impracticaly large for non finance people.

> That means everybody gets diluted including the founders, the angels, the VCs, and yes the employees too.

founders, angels, and early round VCs can simply issue themselves more stock from the pool of unissued shares to counteract dilution.

No they can't. I don't doubt that this has happened before and I'm sure someone can dig up an example or two.

However, what you describe is highly questionable and borderline illegal. It's certainly grounds for a lawsuit by other shareholders (including options holders).

Eh, this is exactly what happened to a friend of mine. The rationale later, was he had been promised X percent, but when the final deal went through, they diluted different pools of company stock to different percentages, and his values went down to 1/10 what he was expecting.

I know I'm missing a lot of info, and its just a second hand example, but it seems in line with grand parent post's idea that for each type of financial tool, there's at least one gotcha you need to be aware of.

>"No they can't."

Can you explain why they can't? I was under the impression that this actually does happen.

Yes, they can. The board has discretion over the allocation of the options pool that will have been set aside as part of each round.

However to issue those to yourself would be like eating your seed stock, since that's the pool that you use for issuing options to new hires, and without that you can't give new employees any equity. For that reason I don't think it's likely.

I think what the grandparent comment is getting at is that you as an employee have little control over the delayed compensation strategy. If you're lucky, you have a honest founder and investors who make sure you're paid for your contribution at deal closing time. If you're not lucky, you have a board/CEO/founder that will take whatever they can get away with (e.g. your value add) and then point to the financial rules/contingencies and say, "Well, we tried to do all we could, but we had to do this to ensure the success of the company. We needed to compensate the administration because it's hard to find such good talent like ourselves. Your still getting something here..." Or some such line. And you end up with some minuscule share at the same time providing critical value to the business.

Just looking through the replies to your comment makes me throw up my hands in confusion and frustration. You say one thing, the next person argues against one point, then someone counter-argues, and so on. It's all a confusing mess. It's like you need a financial rep to be with you at job interviews to understand all this stuff.

Just say no to options, and demand market level salary. I interviewed at an early stage start up in the mid west. The CEO lamented "People here just don't understand stock options" and as the first technical employee I'd be "by far the highest paid person in the company". I said "People do understand stock options, they're a gamble" and declined the offer. I don't want to be the highest paid person at any company.

Only one data point, but my experience at several companies has been that annual follow-on/refresher grants more than make up for dilution from new rounds. A company which only gives you a single grant upon start of employment and then lets it coast for 4 years is doing it wrong.

Do you know of a good resource that could bring a lay IT person up to speed on these kinds of nuanced details? To me it just seems lots of us just dont know about this stuff. I count myself lucky to have a paralegal SO who does it everyday and walks me through it, but most people don't have that.

VC liquid prefs are the real equity killer, according to this article.

Did it even mention participating preferred?

Did you ever engage a lawyer to review your option documentation?

While I agree generally w/ this advice, in my experience, companies try to make that impossible or very difficult for employees. For example, most hiring offers are exploding: I've been given exploding offers over a weekend, over holidays: try getting a lawyer when you're not at home. Further, again in my experience, getting a lawyer is actually significantly challenging to someone who hasn't done it: you need a lawyer in the relevant area of law, and you need to know their price, and these two critical pieces of information seem generally to be the things left off the website.

You can argue that an employee should try to negotiate for adequate time, and maybe they should, but not all will. Those too timid to do so are effectively being taken advantage of; thus I find most companies' positions morally reprehensible.

Working at a startup as an employee with the expectation your gonna get rich is a fools game.

Negotiate for the best deal on options you can get (I.e quantity, terms like early excercise etc) but treat them as a lottery ticket.

A startup is a good way to learn rapidly so focus more on the quality of the people you will be working with, technologies used, what your role will be, vcs backing it etc.

In the long run the network and experience you build from doing this will probably have a greater impact on your networth. Especially if you yourself want to start a startup.

I'm a founder at a high-growth startup in Mountain View. I always tell potential hires, "options are worth nothing until they're worth something. And, they may never be worth anything."

I think that's the opposite of the unrealistic optimism job candidates get. But I think it also helps set the stage for a culture of transparency and honesty very early. Even before that person becomes an employee.

I'm curios to know what HN'ers think of that explanation vs hearing only the optimistic case. Does it make you second guess the company prospects?

It strikes me as an honest statement and if you were pitching me I would give you honesty points :-)

But the problem you are dealing with is the problem in many questions here: these are complex financial instruments and most people don't understand them. Some people will hold false beliefs about these things. Some people will be afraid of the unknowns.

Also the problem is compounded because the word option has different meanings and if you wrongly believe that these employee stock options on private equity are the same thing as listed equity options you're in for a big surprise.

Generally when analyzing a compensation package if you have to do extensive scenario analysis to evaluate the package I think it is worse for most people than a simple package.

Also, the number of scenarios where the founder or investors can make decisions that render the option package worthless is fairly large. This creates a dynamic where if the employee takes an options heavy package they either were foolish / duped, or they are pledging their utmost trust and loyalty in the management team. It's a lot to ask.

Taken literally, this implies comparing offers strictly on cash+benefits, which typically skews things in favor of large companies.

Benefits could mean other things.

Many of us will take less money for remote options or more say in product development.

At my last company I left a few months before they sold. Been wondering if I made a mistake not buying my options. I was finally able to get the final selling price. It was half price per stock than the options were valued at. Looking back I made the right choice even thought it feels like I missed an opportunity.

> Does it make you second guess the company prospects?

Far from it, honest is one of the absolutely critical metrics I use to evaluate any prospective employer. Bravo.

I don't mind someone stating why they believe their start up will have a better chance of success than the average: it is a positive to believe in the product. But don't sell it as a sure thing.

I work in the DevOps/sys admin field, so I'm use to always looking at what could go wrong. I think this is a toss up depending on the persons experience with startups. I've been in mostly small sub 20 person startups for 15 years now so I've seen almost all of it.

You have the people who are new to startups, who think its a ticket to financial freedom in 4 years when they have fully vested and the company sells for 1+ billion. Those people might be scared away.

You have the people who have been through a few startups and have worked at a failed company or a company that the investors took all the money and left the common stock holders with nothing or little to nothing. I'm in this group and that would be a breath of fresh air to hear that. During interviews, if I hear only great things and nothing is wrong then that is a red flag to me.

I agree with the other folks commenting on your reply. I'd view it in a positive light. I'm always suspicious of founders that oversell startup equity.

The younger naive folks who walk away because you were too real will probably remember your candor in a positively Later on once they have some more life experience.

Personally, I would appreciate that level of candor (and that's how I view my options anyway). I've heard far too many pitches from desperate recruiters about how an options package is worth $$$$$$.

Working at a startup as an employee with the expectation your gonna get rich is the game.

Think about the percentage of their investments that VCs expect will pay off. You could work for 15+ years at startups and never be at the successful one.

Startups say that but I think in many cases applicants go to startups because they can't get a job at a bigco that will pay them more. This especially true for new grads who didn't go to a shiny University.

Now this isn't a bad thing as one of the best reasons to go to a startup is to sharpen or learn new skills to become more employable. It's basically what I did till I could swap to a bigco.

> ...applicants go to startups because they can't get a job at a bigco that will pay them more...

I can't speak for others, but I can certainly speak for myself and say that this isn't true. I had my internships at larger companies. Sure, they're not the big 5, but big enough that they're household names. I used them as resume boosters and now _prefer_ startups over large companies.

I was also fortunate enough to grow up without a lot of money, so my lifestyle is fairly affordable and I never had the luxuries that could be difficult to transition to a lifestyle without them. Because of that, and my interest in working on bleeding-edge-and-could-fail tech, I don't mind the risks that startups offer.

I'm confident enough in my skill set that I know I can go after many of those high paying jobs with at least a modicum level of success _somewhere_, but I like the challenges and pace of the startup space instead. I've even rejected offers that offered a larger salary in exchange for a lower salary at a more exciting (and even earlier stage) startup. Does that make me naive/crazy? I don't know, maybe. It's just what excites me more and the tradeoff is worth it for me.

I'd agree with a lot of what you said. The only thing I'd challenge is the implied notion that startups are inherently doing more cutting edge stuff than bigco's.

Right now I'm doing a lot of consulting/contracting at startups. Most of the companies I see on my travels are not really doing anything that falls into the category bleeding-edge-and-could-fail. Most are pretty boring and derivative. Especially compared to some of the stuff I saw worked on at Facebook.

I would argue that a lot of the cutting edge stuff that's being worked on these days is happening at bigco's (Google/Amazon/MSFT/Facebook).

Now their are some big exceptions to this but in general that's what I'm seeing while traveling around SV.

I would say that I prefer working with smaller companies for the sense of camaraderie and the relative lack of politics. That and the ability for my work to have a massive impact.

> Most are pretty boring and derivative

This is also true, sorry for implying that all the work is some sort of bleeding edge.

I disagree. I've been part of multiple startups; Only with the first two did I actually expect to make more money than I would at BigCo. Not because the later startups were worse, but because I was less naive.

The reason that I joined those other startups -- and the reason that I more often work for startups than big companies -- is not about money. It's about pace of career development.

Everything on my resume that is interesting or exciting was done at a startup. Every big jump in skill and in compensation has been a result of that startup mentality. Who's fixing this? Me, I'm the only one here. Who's going to deal with the fallout of my poor architecture? Me, I'm the only one here. Who learned a hard lesson? Me.

I can only speak to the cogs side of the house (I'm devops or whatever they're calling us this week).

> Negotiate for the best deal on options you can get (I.e quantity, terms like early excercise etc) but treat them as a lottery ticket.

Sure, you can ask for a 100% non-dilutable share, but you're not going to get it. In order to negotiate meaningfully, you need to have a valuation of the things you're negotiating on, so you can decide what tradeoffs are good and which are bad.

This is what I don't understand... Why can't developers get non-dilutable shares?

If someone helps you invent something, and they are willing to put their own skin in the game in exchange for an ownership stake, then shouldn't they become wealthy along with you if it is successful?

This whole notion that developers are expendable and disposable and that it is acceptable to give them dilutable stock options is fundamentally immoral and needs to go away.

It's nothing more than greed and exploitation.

When I said "100% non-dilutable share", that was unclear. I meant non-dilutable 100% share. As in, total ownership.

It's entirely possible to negotiate option excercise dates. Asking for 5-10 years to decide if you want to buy is within the realms of possibility for software engineers at early stage startups (pre b round).

Same with early excercise.

Sure. But since this is a negotiation, you probably have to make some choices. Should you press on exercise dates, or on number of shares? If both of these are worth zero in your calculus, you have no means to assess.

I know 100+ people from a dozen companies who've made $1mm+ on equity. None of my friends would write a post like this.

That said, valuing equity is complicated:

- most offers include a healthy mix of cash and equity and benefits. Evaluate the whole package.

- unless you can pre-exercise via 83(b), I generally avoid options. RSUs are fine and many companies are offering them. Clever hack: counter the offer with a demand that the company pay 2% of the cost of exercising for each month you're employed, grossed up for taxes.

- watch out for illiquidity: whales often delay IPO which locks up employees. This compounds the exercise issue. Clever hack: counter the offer with a requirement that the company offer to buy back the equity at the most recent preferred share price, if the company accepts investment at a valuation exceeding $100mm.

Stay positive!

If you are "good" and do well in reviews, a company like Microsoft or Apple (from direct experience), or Facebook/Google/Adobe (I'm assuming, with a little data from people who have gone to these places) will do well by you, to the tune of millions.

Moving upward a little: Several of my ex cow-orkers at MS are now partners, and will be able to retire early and never have to work again, and they're in their late 30s and early 40s. Nice gig if you can get it; it's not always a meritocracy, but getting better.

If you want to make a million dollars from stock over 5 years (in addition to a competitive salary) it's easier to do this at a big company than it is at a startup.

My experience as well. Startups are a lot of fun but not generally as lucrative, from an employees perspective, as bigcos.

Unless you are a sought-after C-level executive, hardly any legitimate companies are going to even consider your "clever hacks."

The first one blows up 409a (requires optionholder to pay fair market value for the shares). As to the second, very, very few investors are going to allow "their" money to be used for a common stock repurchase (at the same per share price) instead of going toward's the company's operations/development/whatever.

Yes, but that's just another asymmetry in the market. Some (many, actually, as far as I can tell) of these "legitimate companies" care very deeply about lower status employees thinking highly of their "clever hacks" regarding equity as part of a compensation package.

$X salary plus y% options at a startup should almost always be viewed as a having a value of $X and no more than that, but these "legitimate companies" want employees to view it as $X + $Million(s) in a future (all but guaranteed!) windfall. There are exceptions, but these are rare.

I wouldn't take issue with these companies trying to pass their crappy "equity compensation" packages off as "legitimate" if there was more openness and honesty about its value and the status of the employees with respect to the company.

The only time anybody should value equity at > $0 is when it's part of a regular grant or purchase of shares with true, market recognized value (e.g. RSU grants, ESP plans in a public company).

> counter the offer with a requirement that the company offer to buy back the equity at the most recent preferred share price, if the company accepts investment at a valuation exceeding $100mm.

As a founder I wouldn't ever agree to that term as written. For starters, your options are common stock whereas investors have preferred. That just means you have to apply a discount though.

More importantly, I've seen first hand the change in team dynamics that happens when some "early" employees get a windfall. Not so much jealousy as this weird sense of complacency which permeates the entire co.

The truth is that at $100mm (heck, even at $1B valuation) the company hasn't "made" it yet. There is still tremendous risk on the table.

I think your idea is interesting, but I might add some step functions. At $100MM the co offers to buy back 1% of your shares, at $500MM up to 5% of your shares, at $1B up to 10% of your shares, and so on.

Realistically what happens is that in large, very late-stage rounds, the company gives employees the chance to sell some of their shares to the new investors at a discount (because of the common vs preferred situation).

> I know 100+ people from a dozen companies

The problem I see with this particular line is how disproportionate it is. If you had said 100+ people from 50+ companies, that might have been more convincing than 100+ people from a select 12 companies.

The problem here is that it's 12 companies, and not every company can be one of those 12. That's like me saying I know 20+ people from 2+ companies that made $1mm+ but those 2+ companies included FB/Twitter/etc.

Are you really going to be able to negotiate terms like that with a company that's at the stage where they are offering RSUs (I.e Airbnb)? I can imagine negotiating terms on options at earlyier stage companies.

Wouldn't you have to be going for a job in senior management to have a shot at doing something like this? Genuinely curious to hear if you have ever successfully done something like this?

Another option that I successfully negotiated for is purchasing shares outright at fair market value using a 51% recourse promissory note due in 10 years at the IRS minimum interest rate.

This avoids the exercise window and acquisition concerns, is pretty tax favorable, and largely aligns your treatment with the founders. It is a bit riskier even if the company agrees to offset the loan with bonuses over time, but at lower valuations I think it is worth considering.

In any case, it's worth it to have a good lawyer look over all your options paperwork to make sure you are getting a fair deal.

What's a " 51% recourse promissory note"?

Instead of paying for the shares with cash now, I agree to pay for them in 10 years, paying interest at the minimum rate the IRS will allow (~2%). The 51% recourse means that the shares themselves are the only collateral for 49% of the loan amount (to limit my risk if the company goes bankrupt and a creditor tries to actually collect on the note).

Interesting. Why not use the shares as 100% collateral?

The IRS will treat it as an option rather than a purchase if the shares are the only collateral, resulting in worse tax treatment.

> I know 100+ people from a dozen companies who've made $1mm+ on equity. None of my friends would write a post like this.

This is addressed in the post:

> Another common objection is something like “I know lots of people who’ve made $1m from startups”. Me too, but I also know lots of people who’ve made much more than that working at public companies. This post is about the relative value of compensation packages, not the absolute value.

How different are startup salaries vs public company salaries? Is that $1m at Public Company the total salary over a certain period, or is it extra salary on top of the potential salary at Startup Company? The quote seems to say it is extra (relative).

If I am supposed to make $1m more at Public Company over -- say -- a 10 year period, then that means my salary at Public Company would have to be $100k more per year than at Startup Company. Is the difference between startup and public really that big?

A senior high performer[0] at a public BigCo can relatively easily make (in total comp) 2x-3x the cash compensation of someone working for a startup.

So if you’re the sort if person who’s likely to work hard at a BigCO long enough for most of your rolling RSU grants to vest, then yes, the comp difference is that big.

[0] note that MANY senior people at BigCos are NOT high performers. So beware of comparing to things like Glassdoor comp figures, which are highly likely to be coming from non-high-performers.

This is true, though I would also add "high performer" does not just refer to your primary job function, but also the secondary job of playing BigCO's internal political games.

small companies have internal politics as well. It's not like working with people disappears. I've worked at both big and small companies, I don't really have a preference but in a big company, you can move around and keep all the good stuff if it gets a little hot under the collar. With a small company lots of times you have to leave to get a new manager or role or move up or just get a change of pace.

The continuity of a big co. can be very helpful from a salary perspective.

Yes. Assume $300k total comp at Facebook/Google/Netflix for a Senior Engineer. Getting $200k at a non unicorn startup is very rare for a Senior Engineer. $180k is more often the cap and $160k is the norm.

And while $300k assumes fairly high performance at a top public company, it's certainly not the upper bound.

TIL. Those numbers are definitively higher than I would expect. Here in Norway the average for someone with a technical or scientific degree and 5-9 years of experience in private sector is 690 000 NOK [1], or about 80 000 USD. The 90th percentile for 10 years experience is 915 000 NOK or 107 000 USD. So for me the idea of making another 100 000 USD more at another company is quite foreign.

[1] https://www.tekna.no/en/salary-and-negotiations/salary-stati...

Those numbers are accurate for the U.S.

Possibly even a little low for the Facebook / Netflix / etc tier.

Throw in stock growth for companies like Google back in the day and FB more recently. FB stock has doubled in ~2 years increasing the liquid value of employee stock compensation by nearly the same amount.

While that's true, I could invest my own funds in Google or Facebook stock and reap similar growth (depending on my access to funds to invest).

Also, some companies will have target compensation bands (I know Yahoo did) where an increase in stock price will actually result in a smaller additional grant each year.

I see that no one points this out: Dan Luu and others in this post are using 'Public Company' to refer to only a small high-growth subset of all public companies, namely Google, FB, Netflix, etc. (and perhaps Apple and Microsoft). Most other public companies: track S&P 500 or you joined at a time when your company's growth slowed down to S&P 500 or if you work at a place like IBM that underperforms S&P 500. In these cases, you aren't necessarily assured millions.

Dan Luu also has a post on this:


Public companies can issue stock grants too. They tend to be much more worthwhile, too, as you can actually sell them once they vest.

The biggest difference may be the tax status of the way those two millions are earned. If you're earning $1m from a public company, you're likely finding yourself in a near-top tax bracket and running into AMT in most years. If you get that same $1m from options, you can be paying taxes like a rich person. If you've handled it right, you can mostly avoid AMT and pay the long-term cap gains rate.

Another difference could depend on the nature of the individual earning that money. If that individual is disciplined and reasonably good at investing their money, taking the corporate job, living frugally and investing everything that's left might make them come out ahead. But if they're like most people, earning more will make them spend more and they'll come out behind the start-up employee who will usually immediately invest most of the windfall (either in a home or the market).

Neither route is obviously better, but it's probably worthwhile to look at the post-tax, post-spending bank balances of both sets of employees to see who comes out ahead since it's not a simple as comparing $1m to $1m.

I'm not sure post-spending is the right thing to look at. One of the many reasons working at a startup is an awkward sell is that it means giving up money during your lowest-earning years in hope of getting more in your higher-earning years. That's the opposite of the smoothing function a rational person would prefer. That extra spending may well have provided a large amount of extra utility.

As far as taxes, a big difference you didn't mention is that startups most frequently exit in a single liquidity event that can't be deferred (i.e. acquisition). Getting that $1MM in one tax year is much worse than spreading it out over even 3-5. At least in my locality, the difference between taxes on a $1mm windfall in one tax year vs. a senior dev salary at a place like Google is ~5%.

> Getting that $1MM in one tax year is much worse than spreading it out over even 3-5

Not if it's long-term capital gains. The year that I banked most of my gains from my company's acquisition (sub-$1m, but just), my tax rate was substantially lower than in previous years. Paying taxes like a rich person has distinct advantages since the game is rigged in their favor.

Doing the math on both sides is incredibly important.

That last idea about how to deal with illiquidity is very interesting. Never seen that suggestion before. Will definitely keep that in mind moving forward (both as an offer taker and an offer maker). Thanks!

Solid proactive suggestions, especially the latter, which I wish I had done at my last company. At my current one, I just elected to pre-exercise.

Oh look, the thing I should have read before joining a startup.

I left [large corporation], who had been paying me very well, to go try out the startup world. I found a cool local company doing something that sounded neat. I looked at the pay (better on a per-paycheck basis) and the options (better than the stock I was getting in the corporate world) and said "this is a great idea! If the startup succeeds, the options will be worth a lot!".

It's a great company with great people and I don't regret that, but the financial implications of the change are starting to sink in. I'm getting a bit more per paycheck, but on the whole I suspect my tax returns over the next few years will add up to less than I was making before, even if the startup succeeds.

> I'm getting a bit more per paycheck, but on the whole I suspect my tax returns over the next few years will add up to less than I was making before, even if the startup succeeds.

That sounds counter-intuitive -- why would that be? Did you have some expense you could claim at [large corporation] that you can no longer claim?

Most of the big post-IPO companies hand out stock on a regular basis as a bonus or a top-up to the actual pay.

The corp in question for me was Amazon. Around 1/3 of my pay (more some years) was in the form of AMZN stock that vested every six months. Stock, not Stock Options. No paying for it, no decisions, just boom, you now own X more stocks and how would you like to pay the income tax on that?

What's worth more? A $200K lump sum in 20 years or $10K every year for the next 10?

The answer depends on how much interest you can earn on the $10K/year. At around ~7% the $10K/year is worth more than the $200K in 20 years.

Your stock grants from Amazon are equivalent to the $10K/year, the options, if you get them, are equivalent to the $200K. The actual weighting is impossible to get precisely but the way you approach it can give you better accuracy than just comparing apples to oranges.

Good news, even if it's horrible, ~2 years is the typical employee tenure so you probably wont be there long. If you are and it's going to be successful you'll be able to renegotiate based on foregone comp at Amazon.

Even assuming a $200k payout after 20 years is a very optimistic startup outcome.

Possibly total comp. Statups are stingy with health insurance, while larger corps are more likely to pick up more of the tab (and occasionally, they'll pay your monthly premiums in full). This can easily add an additional $12k-24k to your total annual comp if you have a family.

Edit: US centric advice

I'm in Canada, so health insurance isn't very expensive (government covers most of it). The biggest thing for me was stock bonuses vs stock option bonuses.

The way I read it, his take-home pay is higher, but either he mis-valued his options as being worth more than his BigCo stock package, or (as is usually the case) the value of the options is virtual until there's a liquidity event ...

His old comp was paycheck + stock vesting (which doesn't appear in paychecks), his new comp is paycheck + (non-exerciseable options) = paycheck

"...compensation package has a higher expected value..."

Expected value is a good measure when you're summing over lots of instances, e.g. if you're a VC fund investing in lots of startups.

As an employee, where you're working for a single startup at a time, robust statistics[1] suggests that the median is a better measure of what you'll expect to make: you have a 50/50 chance of making more/less than the median.

More than half of startups either fail, or don't succeed wildly enough for options to be worth more than the equivalent salary.

(If you work for 5 startups in your career, the best measure might be "sample 5 startups and sum the options payout to produce a value; repeat that many times and take the median of the result." But that's a lot harder to intuit, and is no doubt closer to the median than the expected value.)

[1] https://en.wikipedia.org/wiki/Robust_statistics

Why take the median? For me personally all I need is one year where I make a couple million bucks. What I really care about for my personal financial position is either the sum or mean, because that's what hits my bank account.

Because you'll only work at a handful of startups in your lifetime. You will not make the sum / mean over all startups, only the ones you work at.

Some lotteries that accumulate when there are no winners have weeks with better-than-even odds. By this logic, you should wait until the odds are sufficiently in your favor and then dump your entire savings account into lotto tickets, for an immediate gain.

Of course, even if you can pick up a 20% gain in EV, that small chance you end up a billionaire won't save you from the 99.99..% of cases when you're eating cat food in retirement.

Nobody would ever advise you to take a large percentage of your income and buy options or even stock in a single company in the hopes that that company succeeds enough to make you rich. That's gambling.

Being an employee of the company in question doesn't suddenly make that a good idea. It's an even worse idea since your entire financial future is tied to the company's outcome.

They should pay you more to take that kind of risk.

It is indeed gambling. But it's an opportunity to buy a lottery ticket that has a much higher payout than one you could buy off the shelf. The odds may not be great, but if you happen to hit, the payoff can be very large.

This is an interesting way to flip the perspective, to ask why do startups think offers of options are enticing (as compared to just cash).

But for the potential employee, the advice remains the same; ignore the options when it comes to evaluating a compensation package (and only those who are informed enough to go "weeeeelll..." and have actual reasons for why in a ~particular~ instance they should do differently, should ever consider doing otherwise).

In startups your risk is that 95% of the value of your labor goes into a pool of options whose underlying security (startup stock) never achieves any liquidity event. Also, you do have to factor into your analysis the fact that the tech giants also have options, which are likely not to expire worthless, and also have some upside as well, since they are listed on public exchanges. If startups thought more like Buffett "preferred holding period is forever" they would counterintuitively actually compensate employees with cash more competitively once they achieved positive cash flow (this actually seems to be occurring in a few companies, there are just too few positive cash flow startup examples for quality analysis on this front). More startup employees I know are actually just enjoying their work and salary instead of making a giant sacrifice on a longshot bet in exchange for work they don't think is sustainable. That being said I think what Bezos wrote about amazon's work ethic will always hold true "you can choose to work harder, longer, or smarter but in our case you can't choose 2 out of 3" - paraphrased from memory. Ultimately startups and big companies are trying to design compensation packages that create maximum productivity and the best description I've heard of this is to "take the issue of money off the table". Hard to do that with under market salaries and iffy stock options.

Do you have a link for the comment from Bezos?

It would be good to get some context on what he said.

https://www.amazon.com/p/feature/z6o9g6sysxur57t "It’s not easy to work here (when I interview people I tell them, “You can work long, hard, or smart, but at Amazon.com you can’t choose two out of three”)"

I don't understand this quote. Does he mean that you have to choose ONE of the three? Or that you have to do all three (which means his "or" is misplaced)? Or that Amazon.com chooses for you, rather than you choosing yourself?

He means all 3.

His "or" isn't misplaced, because it's a play on an existing phrase: "better, faster, cheaper - you only get to choose two." Meaning you cannot optimize on all 3 dimensions.

Here he is saying that Amazon expects you to excel at all 3, by providing a contrast to a known idiom that says you cannot.

Maybe I'm being thick, but is he saying you have to choose 3 of 3 or 1 of 3?

I actually thought the same thing reading this quote. But the convention is present three, choose two. His example is an appeal to one's sense of what I can only describe as "drama". The "dramatic" realization being of course that Amazon is different; you have to choose three out of three instead of the conventional choose two out of three. Choosing one out of three is less dramatic and therefore must be eliminated. Not logical I know.

Options are a complex topic, this article gets a lot wrong.

1. The base offer. Many startups pay competitive or close to competitive salaries + equity. 2. The value of the options depends on your ability to pick the right startup and you believe that you can make a difference to the company. I have a friend who picked the right startup 4 times in a row. 3. Stock options are typically priced at 25% of the last round. The reason this is possible via 409a valuations has to do with the differences between common stock and preferred. 4. Issues with investors right impacting the value of your stock options are more problematic with later stage startups. Warning signs are companies that raised a lot of capital but didn't live up to their expectations. Those companies will often be under pressure to accept terms in later stage financing that could destroy founder and stock option pool upside. 5. Venture Deals by Brad Feld is a great read to understand different investment terms. 6. Yes you get more equity if you create your own company. Doing so is extremely risky, stressful and hard though. I'd guess that even with the extra equity, on average, you'll make more money working for one of the big companies. 7. So in a nutshell, starting companies, joining early stage companies. It really depends on your ability to pick the right company and perhaps more importantly your ability to make a difference.

Well that, and a bit of luck :)

I don't think I have ever seen a startup offer a competitive salary/equity package here in the Bay Area for a software engineer. I have found that the best I could do is trade compensation for a good work-life balance since salary is not competitive and stock is so volatile for a startup, whereas at big companies salary often is much more in line with the market and stock has actual liquid value.

Interesting, I typically don't see that here in Boulder.

> Options are a complex topic, this article gets a lot wrong.

...so what did this article get wrong?

> The base offer.

For high level engineers the disparity between what Facebook/Google will pay you and what you'd make at startups can get pretty high. In my personal experience the salaries aren't actually competitive unless you start personally valuing the equity at a significant level. It seems Dan has the same experience.

> The value of the options depends on your ability to pick the right startup

I think his article does a better job of answering the question "how do you value the options provided by the startup assuming X level of success" than you do here. "I have a friend who picked the right startup 4 times in a row" doesn't really help people figure out if they've picked the right startup. "It's possible! People have made money on the stock market!" << This is not reason to play the stock market.

> Stock options are typically priced at 25% of the last round.

I'm assuming you're talking about the section where he calls valuations bogus. Your statement here doesn't invalidate the writing: "First, the valuation is updated relatively infrequently" << this remains true. And the round valuation is still a complex number that's mostly investor speculation and not representative of what your shares will net you -- which is the argument here -- that you might be better off offering cash than some hard to quantify thing.

> So in a nutshell, starting companies, joining early stage companies. It really depends on your ability to pick the right company and perhaps more importantly your ability to make a difference.

Thanks for the inactionable advice.

1. Not even close to true, check Dan's other post here: https://danluu.com/startup-tradeoffs/

2. If you're that good at picking startups, become a VC.

3. Common shares are priced less than preferred because they're worth less than preferred.

4. Startups at every stage give liquidation preferences. Startups under pressure will give more significant preferences, sure, but they're relevant to basically every startup.

What strikes me as odd given the USA's reputation as the home of the self made millionaire that the taxation of employee options is so broken.

Treating options on shares as Income when they are not is just stupid options are a high risk instrument that well be worth nothing as opposed to a higher sallery.

Why is there not a PAC made up of tech industry employees lobbying for reform of Federal and state laws and arguable tech employers should be doing this.

And I should point out that politicaly I am on the left here compared to 95% f the average HN reader.

Options are not taxed until you exercise them. At that point they become an asset that contains "value" but until you exercise the option to purchase stock it is simply only the right but not the obligation to purchase stock at a particular price. When issued options you don't have to exercise them and if you don't you do not pay taxes until you decide to.

Often companies offer the ability to "early exercise" options which means you buy them before they have vested and file with the IRS that you have done this. The reason you might do this is because the strike price of your options will likely be the same as "fair market value" of the stock. This means that when you buy them you do not pay any taxes since the difference is 0.

If you wait and exercise your options then you pay tax on the difference between the "fair market value" and your option strike price. This is taxed as a short term capital gain. However, you now hold the equity and if you sell it 1 year or later you pay a long term capital gain which is generally advantageous. This gain is the price you sell minus the value at the time you purchased.

Often, for people issued options they will exercise and sell immediately when/if the company goes public and they can sell. You keep the difference between what you sold them and what your strike is and you pay taxes on that profit.

The biggest issues are when you want to leave a company but have not bought your options. These are golden handcuffs and it's a decision you need to make if you want to buy them. For a company that is looking good you can often get a loan to buy them. But now you're invested in an illiquid investment of which you can't possibly know the real value. That's a big risk with potentially a large payout.

>Options are not taxed until you exercise them. At that point they become an asset that contains "value"...

The assertion that they then contain value is the contentious point. To the IRS it is defined to have value. To me, it has no more value than the option, because there's no more market for those shares than there is for the options themselves. "Fair market value" is weird when there's no market.

Hence why I said "value" and not value.

If you are arguing that grants of options shouldn't be taxed -- they are not.

If you are arguing that the eventual income from ISO's shouldn't be taxed -- that would be a very odd position, since pretty much every form of income out there in the world is taxed, even illegal income. I can't think of any other income category that is un-taxed under USA tax laws, with the exception of government bonds.

Exercising of options is taxed, which is what I interpreted the OP to be talking about. From the employee's perspective, it seems ridiculous: I'm exercising an option in hopes of future payout, but right now, it's worth literally $0 — I can't convert it to cash — but the government taxes it at >$0 nonetheless.

We are talking about capital gains and not income most companies we are talking about don't pay dividends.

Capital gains are considered "taxable income" by the IRS. I'm fully aware that the profit from ISO's is from cap gains, not dividends.

Source: http://www.taxpolicycenter.org/briefing-book/how-are-capital...

The alternative is that the tax is entirely on exercise of the option.

It IS entirely on the exercise of the option.

Granting and vesting of ISO's are not taxable events. Exercise of ISO's is taxable under the AMT rules, but only if you are above the AMT threshold (admittedly, this is true for a lot of people)

If you're not hitting the AMT threshold, then you only pay tax when you sell the resulting shares.

Wouldn't another alternative be for the tax to be entirely when the underlying stock is sold?

surly on the liquidity event when you exercise the options with out selling you have not received any income or CGT yet.

What tax CGT or Income and in the UK an approved scheme is tax fee in effect - this is to encourage employees share ownership

This is a very interesting discussion for me, as I'm about to incorporate a new AI startup and I'm thinking how to spend my own seed money.

The author's argument in the "Incentive alignment" section doesn't seem strong. "However, as far as I can tell, paying people in options almost totally decouples job performance and compensation." Is there any data to support this or just this author's feelings? Just because the masseuse from Google made millions, it doesn't mean that other people who did well, like their chief legal officer, business operations, and product management executives, who made $160 million, were not instrumental in its success. It just means that not all options were optimally allocated.

Exactly, this ignores where options are awarded for performance.

I'm treating my options like a free lottery ticket with not decent odds. That's it. They don't exist when I plan my finances.

I doubt this is optimal, as options can be evaluated to some extent and risk can be appropriately brought on and managed. But it works for me when trying to do math about my present and future opportunities.

You don't have to over-complicate the analysis. The fact that they give you the options instead of cash is proof the options are worth less than the cash. This is Econ 101: bad currency drives out good as good currency gets horded.

This is too simplistic. There is another reason - options incentivise people in a different way from cash. Say I have an option which is struck at the fair market value of the company on the day I join. When I exercise that option, the value will be the appreciation in the value of the company up to that point (ie the value I have had a role in creating). So options (when the plan is set up well) incentivise employees to maximise the value of the company for shareholders. More broadly you could say that options tend to incentivise long-term value creation ("dividend-seeking") over short-term value extraction ("rent-seeking") behaviours.

Secondly, options incentivise people to stay around (until their options vest). The company also gets to cancel unvested options if a person leaves and even claw back vested but unexercised options in the case of misconduct by the employee. These are all things that are valuable for the company and more difficult to achieve using cash.

Thirdly, there is a big difference to most startups between "value" and "cash". I may well want to pay someone in a cash-equivalent that has equal value to cash (or even greater) because I want to manage my cashflow. After all, I can pay my employees (some of their comp) in options but I have to pay my bills in actual cash, which may be hard to come by until I hit net positive cashflow. In the case of an option, when you exercise and sell, you turn your option into cash, but the cash doesn't come from the company, it comes from whoever buys. This may be more efficient for the company than raising the equivalent cash and paying people directly in cash (because of transaction costs around fundraising).

Well, kind of the whole idea is that maybe they will be worth more than the cash in the future.

When a company gives you options instead of cash, they are making a bet with you that they can make a better return on the cash than you can. They are hoping they can convince you that cash_in_your_hand_now < value_of_shares_in_the_future, but in order for them to even consider making the bet, they have to expect that value_of_shares_in_the_future < cash_in_their_hand_now.

Yes, and things don't go as expected 100% of the time. Again, that's the whole idea here.

Great argument for paying people in lottery tickets!

I mean, yeah. That's what this all is, that's why people refer to options that way. Thing is, people win sometimes.

If you're having to debate in your head "options vs cash", then the answer is definitely cash. Because if the options were worth something, that thought wouldn't even come up. Also, companies where options are of actual value generally do not give you such a choice, they give you plenty of both (provided you are worth it), the objective is to retain you because you are valuable, not to pay you the minimum possible value by presenting tricky choices of "options or cash".

Is there any way to nicely state that you're not interested in equity and prefer cash? I haven't found it. It seems to put off employers who think of equity as an incentive.

And I've met some fantastic companies who have done this, so it's not about bad employers either.

Yes, just explain that you have bills to pay, and while you wish you could participate more in the equity, you're at a point in life where you need cash.

Typically, startups have a mix of employees who are skewed to more cash or more equity.

Would you be interested instead in a well-defined bonus with a bit lower salary? Let's say after each year of work. I am a believer in incentives but I agree that for employees the options are often not the best way to go.

This isn’t my unique thought, I read it somewhere on the internet at some point where it was put much more eloquently, but it makes sense intuitively: The idea is that if you do enough start-ups, one (or if you’re lucky, more) of them will “hit.” I’ve been to a few rodeos at this point in my career. I’ve had one minor hit, and one big hit. It certainly worked better for me than if I’d worked for just cash. YMMV, but I will say not all start-ups are created equal. Sniff out the finances and product viability as much as you can before you join. I like the lottery ticket analogy because it’s true that you’re gambling a bit, I don’t like the analogy because the odds are nowhere even close to the same.

Did you mean to say the odds of striking it rich are nowhere close to a lottery in a favorable or unfavorable light?

Would making secondary market accessible to employees after a cliff - i.e. 2 years - solve this issue of "lottery tickets" we hear all the time?

If we let employees access liquidity events by having the board organizing restricted secondary sales every year, then their options will have a higher probability to have real value?

After all, VCs have lot less risk than employees... We can't diversify our portfolio like they can. They want to invest their money, we want liquidity. Giving us financial flexibility would have only pros IMO and would be a powerful recruiting tool as well.

At my current company, I pushed a lot for employees to get 10yr exercise window extension, which we now have. Now we need to push to get liquidity. I feel like it is our responsibility as employees to keep things moving for a fairer future.

We help adding value to the company, I think it will be fair to be able to sell our options even if the company is still private.

There are also companies like Equity Zen [1] that help giving employees liquidity. I wonder if that is a good alternative too?

Basically if we can unlock the value of options before an exit, options stop being lottery tickets and everyone is happy.

[1] https://equityzen.com

Just week ago there was discussion about options and people shared this tool (https://tldroptions.io/) to calculate amount of money an employee gets based on round and % of the company as options.

Despite the fact that in reality even in best case scenario the sum is rather small -- like 0.01% of a Series A startup with $1B exit will give you like $40K for your 6 year work -- more important issue is different liquidation preferences VCs get for their money.

So, each of many many VCs that invested in a startup by the time of exit exercises own liquidation preferences to scrape every possible dollar -- and in many cases disproportionately more than their fair shares of the startup due to liquidation preferences. As a result there is not so much money left to share among employees after all investors in aggregate get out their money and exercised preferences.

And this is best case scenario. So, a startup needs to have multi-billion exit for employees could make any real money.

If you join a startup immediately following a Series A and you only get 0.01%, you almost certainly got screwed. We were fairly stingy with equity, and an engineer joining then would have gotten around 0.5%, 50x what you're basing your math on. And over a 4 year vesting period, not a 6 year one.

$2mm ($40k x 50) for your 4 years of work is substantially less bad. And employees who stayed with us tended to get new equity grants over time as well.

So yeah, don't take a startup job for tiny amounts of equity. You should get significant equity for joining that early with that much risk.

I've never been a fan of being an employee at an early-stage startup. The options on average have close to zero value, the salaries are lower, and the hours/working conditions are worse [than at generic big company].

So now as a startup founder I'm thinking, why even give my employees options at all? Me and my co-founder are the ones that believe most in the company's upside, so the more shares for us, the better. The plan I've come up with is to 1) try and raise those salaries as best I can to market rates, with the added perks of flexibility, and 2) create a plan for profit sharing in the future.

Profit sharing agreements make more sense to me for a number of reasons. First of all, like equity, its value may never materialize. But secondly, there's actual liquidity and numbers behind it as a possible outcome. Also without the employee stock option pool, I can sell a bit more equity for more cash for better salaries.

What do people think of this idea?

"Me and my co-founder are the ones that believe most in the company's upside."

This compensation scheme will just select for employees that aren't bought into the future of the company.

I dunno. I mean, if that's your plan, why bother with VC funding at all? Why not get a small business loan, and operate that way?

Or here is a better one:

"Sorry we cant actually fulfill the contractural obligations we are (sort of) legally bound to fulfill, and cant pay you like we promised. So will you take a much smaller amount of money and a bunch of worthless stock options instead? By the way our stock options are going to be worth millions in a few months, so this is actually a better deal for you."

Its like some weird pathogen has infected the whole industry with this!

> A company that gives you 1M options with a strike price of $10 might claim that those are “worth” $10M.

I've had a perspective employer make this exact claim to me. I.E. that I could value my options package by multiplying the strike price by the number of options. I had to go back and clarify that, in fact, those options are worth $0 at the current strike price.

It's hard to see this as anything other than gross incompetence or deliberate deception at this point. Options aren't some new thing that only a few people are doing. Besides, if you're giving them out, you had better bother to learn how they work. I'm curious as to how common these claims are because it's pretty egregious.

(and yes, they were options and not RSUs)

i think options do a couple of things: 1) they let employees invest in startups using their time instead of their money, which is handy when you aren't rich and 2) they allow the company to have a legal framework around an IOU: take less salary now, bigger payout later maybe.

thought experiment: knowing everything you know about e.g. stripe right now, would you buy $100k worth of stripe back in ~2012? in 2012 it was a risky proposition to do so, but many people at the time understood why stripe was likely to be big and successful and invested money in it. i'd rather live in the world where there is a mechanism to invest in such a company besides being an accredited investor with access.

many people go wrong when thinking about options in that they don't try to consider the fundamentals of the investment. working at an early-stage startup isn't just a job, it is a way to do risky investments using your time.

all that said, what Dan proposes at the beginning makes a lot of sense: the startup should be willing to give you cash instead of options (provided they have the cash).

Given what you know about Bitcoin now, would you buy $100k worth of bitcoin in 2010? Of course you would.

Except...I didn't tell you that your investment would be held by Mt. Gox. You lost your investment.

There is always risk. Always. 97% of startups fail. They are extremely high risk. The earlier you buy in, the higher the potential payout, but the more likely you are to be backing one that will fail. Even the successful ones, after dilution, may or may not be worth more than the cash over how long it took to IPO/be bought out.

You say you get to make risky investments with time; yes...but that's even worse than money. Money is fungible. Time isn't. You have a set amount in life.

Having a 97% chance you're wasting it (actually, higher, since dilution + etc means even a 'success' may mean you made less than the equivalent cash over how long you worked at the place, the extra hours you put in compared to working on side projects, etc) are some pretty long odds.

> You say you get to make risky investments with time; yes...but that's even worse than money. Money is fungible. Time isn't. You have a set amount in life.

that isn't an argument against startups offering options. that only says that you value your time in such a way that precludes you from investing it in startups.

Sure, and I wasn't arguing against startups offering options. Just against startups valuing them over cash, and expecting employees to do the same.

Really, I'd say the whole thing is a red herring; either way you're working. Your time is being used. So the question is do you want to trade that time for a guaranteed amount of money, or a -possible- amount of money (but, high risk). The only way taking the options makes sense is if the salary is -still- high enough to not get in the way of what you want to do, and you could walk away having netted zero from your options and not feel cheated.

I think that 97% number is misleading.

Sure, maybe 97% fail, but most have already failed before taking on an employee on equity.

A more appropriate number would be the number of startups that fail after that milestone.

For instance, I calculated the numbers for my country, 40% of startups that get accepted into an incubator succeed, 40% fail and close, and 20% stagnate (mine is currently in the 20%).

So, you're buying a 40% ticket, not a 3% ticket. Still losing odds, but not so much so, and if you're an early employee, you can really help tilt the odds (5%? 10%? I don't know).

knowing everything you know about e.g. stripe right now, would you buy $100k worth of stripe back in ~2012?

sure but for every stripe there are 10 startups that either failed or didn't amount to a great payout.

I think the point this post is making that the value of options is statistically not greater than higher salary at a competitor, given the risk an employee takes since he can't diversify his time.

that said if you believe in an idea it is absolutely great to have the option to "go long" on that idea with your time

> sure but for every stripe there are 10 startups that either failed or didn't amount to a great payout.

yep. it's probably more like 100:1 don't go work at the other 99! :)

i agree that the value of options is statistically not greater than the compensation package at GOOGBOOK. that said, you don't get to live 1000 lives in parallel. so, either you have to think very carefully about this one (or ~5) investments you are going to make OR you can go work at a bigger company with higher salary if that isn't for you.

> for every stripe there are 10 startups

"10" is an understatement.

this breaks down quickly because most employment offers at startups don't use option compensation, er, optionally. it is a mandatory substitution for base salary.

"..why shouldn’t the startup go to an investor, sell their options for what they claim their options to be worth, and then pay me in cash?"

Because an option held by an employee has more value because it functions as an incentive.

The incentive effect is therefore entirely dependent on the employee's degree of ignorance! Experience has shown me that "options are worthless" is a pretty good rule of thumb, and I simply ignore everything but the so-called "base" salary when I evaluate a job offer.

I don't want to jump into a debate on a clearly biased post, but I feel that a few things need to be clear: - Many employees prefer options to cash, as it provides the opportunity to make a lot of money. The chances that happens are very low but many people want to take the chance. Just because it's not your preference doesn't mean it's not attractive. - Salaries increase over the life of the company, so if you join a startup today with a lower salary but many options then in a few years you'll have the salary you want AND the options. So the question is whether the difference in salary for those years is worth the opportunity for a big return. - There is a different feeling of working somewhere where you have ownership vs just a paycheck. In the early stages of a company this is important to employees who really believe in the mission. - Most companies do sell shares to investors for cash to pay employees, that is where the money for salaries come from. However, that investment comes with many terms attached, including liquidation preferences, which reduce the returns to employees long term. Giving employees options is the most direct transfer of value if the company does have an exit.

Overall, it's a more complex issue than this post presents. If you don't want equity, don't accept offers that include equity. If you do want equity, then do. Simple.

The lottery is just a way of taxing poor people who don't know math. (c) :)

Exactly. Over time, companies will try (or at least, SHOULD try) to optimize the currency they use to deliver their total reward offering. Whether it is cash, equity, PTO, health/retirement benefits, learning, etc., companies should optimize the use a particular currency if the perceived value of such currency exceeds its economic value.

Great article. The point can be distilled down to information asymmetry - the company wants FROM YOU something that is relatively straightforward and clear (your time) and wants to give TO YOU something that is complex and hard to understand (a complicated financial instrument that may or may not turn out to have value in the future).

As a general rule, you should stay away from such deals. The likelihood is that the company knows more about the instrument than you do, and is using that information to underpay you.

I've been asked today if I'd take equity instead of some cash. My answer was a polite no.

If I could work at the same time for ten startups then I would hedge the risk. Most would fail, one would succeed, it could be worth it. But I can work for only one startup so it's like betting on who would win 2018 NFL. There are better choices than others, still it's down to luck.

Would it be possible for workers to create a diversified pool of startup equity grants? You'd pay in in-kind, and receive a portion of all cash flows from group holdings proportional to what you put in.

There's obvious problems with how to fairly value the in-kind options, and how to avoid making it a market for lemons.

The overall goal is something like if there's 11 co-founders and one makes it big, you wind up with one person with $900M and ten worth $10M, rather than one worth $1B. It's a small enough portion of equity that you're still incentivized to make it big, and a big enough portion of enough equity slices to cut out a lot of the variance.

It just goes to show that just because you think you know how to evaluate stock doesn't mean you do. I have a pretty good understanding of dilution, tax implications, liquidation preferences and so on. But that 5% of equity issued to employees => equity actually acted issued is shocking to me (I would have guessed 35-40%). A friend once told me: unless you're a founder the right estimate of equity is $0 (By which he meant: be comfortable with an offer in every other aspect, then take equity. If you only have a 1/20 chance of getting your equity I'd say that advice is more true than I initially thought.)

> If you look at companies that have made a lot of people rich, like Microsoft, Google, and Facebook, almost none of the employees who became rich had an instrumental role in the company’s success.

Is this true? Dan seems to kind of skim over this point without much proof or thought (which is unlike him!)

I don't have any data on this either, but it seems like a pretty big assumption to take for granted. The implication is that the early employees added little value compared to investors/founders, but in my experience this is the opposite. The team is literally who built the vast majority of the product.

I think he means by count of people, not amount of money made. In other words, MSFT made Bill Gates very rich, plus thousands of others became part of the one percent (multi-millionaires) without making a really amazing contribution.

For one thing, the reason that options/shares aren't traded widely in earlier stage companies is regulatory. If you have too many investors, or something, you have more regulatory overhead to deal with. Small companies don't want to have 5000 investors for this reason. However, I personally know people who have sold their vested options at a significant profit in very early startups (just after an A round).

Options are worth more than cash IF AND ONLY IF you have insights and evidence that the company is going to outperform the current valuation of the company, after being adjusted for risk.

For example, if you see that it is the best team ever assembled. Most startup CEOs says their team is the best ever, but if you interact with the team for a bit and see it is probably true.

For example, if the company needs you really badly, and they are able to give you options based on a valuation that based on current information is a huge underestimate. For example, a drug company that found out yesterday that they got their FDA approval for their new blockbuster drug, and for some reason they need to hire you very badly. This is iffy because they are probably not able to offer any options if they are already far along on being acquired.

Overall, there are certainly startups where the signals would be available to someone thinking of working there such that they would be able to determine if it is likely that options have a promising expected value. I think this is going to be a very low % of startups where that expected value is even remotely close to what you would get at a large company, and very very few where it would be much higher.

Cash is nearly always better for the employee. Startups like options because:

1. They can "pay" people with "free" pieces of paper that effectively cost nothing from a cash standpoint

2. It helps keep staff onboard by slapping golden handcuffs on

3. In the event that these paper options turn into something with actual value that only happens if the founders and investors make a ton of money first, so at that point they don't really care what the options "cost". It's like writing a paycheck that can only be cashed if the founders/investors get rich. A great deal for them, not so great for you.

Net net all these things benefit the founders/investors and not the person receiving the options. In nearly all cases people are getting options as part of core comp because the company can't afford to pay out all that cash. It's important potential employees understand that when agreeing to a base package that is heavily in options vs cold cash. Options should be treated as a bonus that may pay off but very likely won't, not base comp.

Startups also like options because they believe it creates an "ownership mentality" among its employees. I believe this is mostly true.

I think equity compensation is also a selection mechanism. If I'm running an early stage startup, I want everyone to have a stake in the game. Equity compensation attracts employees with that mindset. Conversely, if a potential employee would prefer all cash compensation to equity, that would be a big red flag to me.

One of the struggles of offering equity to employees is finding a mechanism that has no taxable value upon issue, benefits from capital gains, and is legally sound.

One option is to organize as an LLC and offer a profits interest. These can be issued with $0 taxable value and benefit from the upside of the company. They can vest, and once vested they can participate in the gains of the company (including distributed income, not just a sale). I believe these are inherently more fair to the employees because there is no golden handcuff. They don't need to be exercised and once they're vested, you can walk away with them. On the downside, they are a little more cumbersome to set up.

I'd prefer plain old stock without restrictions and a larger proportion of it.

I think we ought to target a controlling interest for the employees (i.e. employees own over 51% of the company) and shareholders vote on the weight of their shares, like they normally do.

In sum, I'd rather see a founder worth $100 Million and 999 employees worth $900k than a $800 Millionaire and 999 employees worth $200k. And I actually think this would have an important impact on the economy by balancing out the income inequality. In other words, not only would we see far more ~$1 Millionaires, but also more $100 Millionaires because now the money is moving faster with all the fresh Millionaires buying goods/services.

The problem with plain old stock is the tax implications. Suppose you join my company when our last round valuation was $10M. Let's also say you negotiated 1% equity. If we granted you 1% equity, you would have a $100,000 tax liability. We just gave you something worth $100,000 so you have to pay taxes on it. You'd be crazy to be willing to pay taxes on risky equity that's theoretically worth $100,000. The company won't pay your taxes for you either. That's a huge waste of money. That's why stock options exist, to give employees the upside and minimize the tax liability.

As somebody who's founded a couple companies, there just aren't enough people with the appetite for risk and drive needed to manage a controlling interest in a company.

And on an economic level, if the net compensation level, including crushing levels of stress and overwork, was so bad between founders and employees, you'd see a lot more founders until the system balanced itself out. And you do not. Most real good engineers just want a fat paycheck and a clear delineation of responsibility. Trust me, a senior valley level salary and not riding that ride is a good gig.

That said, the side of the bread with the butter on it is pretty clear. The reasons for that are less clear until you've done it, but nobody's standing in your way-- you want to be the daddy/get really rich, found a company.

Come now, you believe that more people don't found companies because of the stress? It seems far more likely that most people don't have the capital assets for that to be an option, except three groups... 1. The very young who have very low expenses, the ones who cashed out already, and the ones who started rich.

Untrue. Also untrue that you need funding-- you can replace funding with a brutal workload and a lot of patience. I did it, ask me how, haha.

I mean, don't get me wrong, you are gonna sign up to be broke. For a while. A lot of people have kinda boxed themselves in with a very comfortable middle-to-upper-middle class lifestyle that closes a lot of doors via their household burn rate. That's not the system being out to get you, that's a perfectly valid life choice that you and you alone are responsible for.

Not that there isn't a whole industry revolving around bleeding you white, keeping you chained to the oars by debt until you're no longer useful. Those issues are orthogonal.... I think.

One reason you don't see founders is that, it is so brutal. The odds are stacked against you. Even if I buy lotto tickets with a positive expected return, the variance can make it untennable/unworkable. One would hope the VC comes in and smooths this situation out some, so that more people participate. You're going to have a lot of brilliant people going down dead ends on no fault of their own, why not cushion the blow? Give entrepreneurs, yep give, the money to them to make their product. Let them own >51% of the company. Offer to pay them fully in their own shares or some split between the fund shares and their own company to cushion the blow. If I'm starting a company, I'd take my own shares mostly but I'm not arrogant/foolhardy enough to put my chances of success equal or greater than a whole pool of my peers. I'd bet some of us will be successful, I just don't know who.

To answer another response on this thread about taxes, if it were in fact market value, I'd sell the shares like any other share and pay the taxes owed.

Note: I know there are issues surrounding the number of private owners a company is permitted and other regulations. I'd simply invite a corporate lawyer to take a stab at it. Maybe a large holding corporation that would be public and issue shares to you related to your stake in startup sub corp(s) (akin to paychex, trinet, etc...)

More and more I find myself reasoning about competitive advantage and stuff like that-- whenever I put up with something really unpleasant, I think "Hey, how many of my competitors did I just shake off?"

If everybody got funded, I think the market would just devalue ownership of a company, since, with the barriers to entry knocked down, it wouldn't mean as much. Think about the erosion of the market value on a college education over the years.

There are plenty of people, especially on here, that want to maintain the ever widening gap between the many and the few. You make a great point about how more even distribution would increase the participation in the economy leading to more activity naturally.

Employees should have ownership over the responsibilities of their jobs, anything more is just altruism.

When a company or overly aggressive recruiter tries to sell me options, that aren't worth anything yet, like it's a billion dollar lottery ticket, that's a big Red flag for me. It says something about the culture of the company.

While the math of options value may not always work out, the mindset - that I'm a real part of this thing - is why I got attracted to startups to begin with. Feeling like I own a non-negligible part of it is part of that feeling.

When companies act like that's not the case, whether in terms of compensation or in other ways... it really turns me off. For instance, at one ~10 person startup I worked at, it was common for "Senior Staff" to have closed-door meetings and try to keep us totally in the dark on what was going on, BigCo style.

I need to care about my company, and to feel like my company cares about me. Them letting me have a small slice of it is part of that equation. Acting like they can totally shaft me on cash compensation as a result... well that doesn't work, of course!

Yes, exactly. The start-up I joined did this with a fair vesting schedule. Now I own actual stock in the company without having to pay any cash to take ownership of them. One issue we've found, though, is that early employees have less of a reason to stay on once they become vested. With options, as long as they're employed by the company they don't have to exercise. If they leave, they have only a short period of time before they have to come up with the cash to buy their shares.

One other downside is that an LLC can't go public, so if the company decides to go that route they'll have to reorganize to a C-corp. Of course the lawyers love this because the paperwork required is significant.

> Equity compensation attracts employees with that mindset. Conversely, if a potential employee would prefer all cash compensation to equity, that would be a big red flag to me.

But that says a lot more about you than it does about them. Everyone is different and judging from this thread, many believe equity is bullshit for reasons unrelated to their work ethic or team spiritedness.

Remember that people having a stake in the game (and not current cash) gives incentives for early liquidity. That could be a bad deal for all involved (except the acquirer). If your staff/founders are going broke before the greatest gains in value of the options, they will still have to push for liquidity event before the optimal time.

More than cumbersome to set up, they are extremely cumbersome to amend.

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