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.
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?
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".
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?
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 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).
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?
And you didn't ask, but if not enough of the team accepts an offer, then it evaporates.
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.
Their compensation at the new company will have a vesting schedule over some period of time, similar to a stock grant.
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.
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.
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.
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.
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).
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.
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).
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.
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.
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.
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?
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.)
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.
But I suppose the idea is that a bigger pie is able to expand larger and faster than it would have been otherwise.
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?
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.
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%"
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.
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?"
"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.
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. 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.
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.
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.
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.
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.
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).
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.
>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.
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.
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.
> 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.
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.
> 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".
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.
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. 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.
 "Non-dilutable stock is impractical and unfair, and in some cases impossible.[...]" : https://www.quora.com/I-was-offered-non-dilutable-equity-by-...
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.
What is the difference between each selling _existing_ shares they own up to the $12.5M valuation and 'diluting' the existing shares?
Dilution makes all this simpler.
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.
They don't get magic stock that magically doesn't get diluted.
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.
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.
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.
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.
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)
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.
founders, angels, and early round VCs can simply issue themselves more stock from the pool of unissued shares to counteract dilution.
However, what you describe is highly questionable and borderline illegal. It's certainly grounds for a lawsuit by other shareholders (including options holders).
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.
Can you explain why they can't? I was under the impression that this actually does happen.
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.
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.
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 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?
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.
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.
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.
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.
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.
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.
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.
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.
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.
This is also true, sorry for implying that all the work is some sort of bleeding edge.
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).
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.
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.
Same with early excercise.
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.
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.
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.
$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).
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).
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.
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?
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.
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.
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?
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.
 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.
The continuity of a big co. can be very helpful from a salary perspective.
And while $300k assumes fairly high performance at a top public company, it's certainly not the upper bound.
Possibly even a little low for the Facebook / Netflix / etc tier.
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.
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.
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%.
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.
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.
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?
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?
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.
Edit: US centric advice
His old comp was paycheck + stock vesting (which doesn't appear in paychecks), his new comp is paycheck + (non-exerciseable options) = paycheck
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 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.)
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.
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.
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).
It would be good to get some context on what he said.
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.
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 :)
...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.
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.
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.
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.
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.
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.
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.
What tax CGT or Income and in the UK an approved scheme is tax fee in effect - this is to encourage employees share ownership
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.
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.
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).
And I've met some fantastic companies who have done this, so it's not about bad employers either.
Typically, startups have a mix of employees who are skewed to more cash or more equity.
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  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.
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.
$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.
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?
This compensation scheme will just select for employees that aren't bought into the future of the company.
"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!
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)
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).
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.
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.
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.
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).
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
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.
"10" is an understatement.
Because an option held by an employee has more value because it functions as an incentive.
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.
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.
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.
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.
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.
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.
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.
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 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.
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.
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.
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...)
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.
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.
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!
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.
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.