Is there any reason why stock options can't be non dilutable? If new investors want to come in, they need to buy existing shares, the number of shares can be infinitely divisible to make it easy to always accommodate new investors.
Lets say your company is valued at $100 and all stock is claimed for current employees. Now you want to raise money by selling 50% of your company to investors.
So you create $100 more and now they own 50% (at $200 valuation). This means the investors either over-paid (2x what they were worth!), or you were strongly under-valuing the stocks that existed before.
If you dilute, they get 50% at $50, and the existing stocks are now worth 50% their value. Because you literally sold half the company.
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The first is pretty obviously ridiculous. Nobody would pay 2x the worth, that's the point of deciding on a value. If they paid 2x, it just means you didn't agree on the value.
But if they don't over-pay, it's the same as the second: prior to the sale, your company's value was actually $200 (you were just claiming otherwise), and after the sale your employees only have $100, i.e. half the company's value. Their stocks were still diluted.
Let's imagine that there are two employees who each own half the company, so each has $50 of stock in the $100 company. You wish to raise money.
You can sell 50% of each persons stake, or all of one person's stake, or something else. Without dilution, it would be a founders job to convince the other employees that giving up some of their shares was necessary (assuming the employee equity pool was the only source, but s/employees/other investors for the same result in general), and individual investors or employees could make that choice. Dilution allows certain investors to make that decision on behalf of other investors.
If I wanted to invest in 1% of a company, I want to be in control of that choice, not have someone else modify my investment to be smaller (even if the $-value stays the same, that defeats the point of my investment!)
That "convincing" happened when they agreed to become employees, or as part of receiving their stock options. Or their contract states their shares can't be diluted / what will be done instead. AFAICT those kinds of contracts do exist, but most people can't successfully negotiate for them (outside effectively founding members / top-level execs).
You certainly could make a company where that's the default contract. But your fundraising negotiations will probably be quite a bit harder, as a lot more parties will be at the table.
Ok, so I'm employee #17 and you, the founder, come to me and say "ska, you should really sell 172 of your shares and give the money to the company". Same goes for other investors.
Now your CEO has to horse trade with every investor in the round, and also every existing investor and every employee. Everyone who agrees to the scheme effectively gets diluted, but anyone who refused to go along effectively gets a "free" anti-dilution adjustment. So the incentives are all wonky.
The incentives are precisely the same as they are today. And the argument, by the way, isn't that "you should sell 172 of your shares", its that "you should donate 172 of your shares back to the company, otherwise the value of the rest of your shares may go to $0".
I expect that the major differences you'd see are that you would need some kind of large pool of stock in reserve to save for future investments (or yes, to do buybacks which would give employees/investors early liquidity opportunities with each new round).
This way, at least, you aren't being lied to when they say you'll get X% of the company. My entire point here is that employees don't have enough representation in these kinds of negotiations, and thus almost always end with the shortest stick. So systematic changes, even if those changes make startups harder, are necessary to make them broadly enticing.
The incentives aren't the same because in previous system I can't try and hold out for a personal advantage,in yours I can.
I agree with your basic premise of some of the problems, I just don't see this as a practical way of addressing them. I can imagine explicit buybacks etc., as you suggest, but all those mechanisms will probably the funding side in similar ways to getting rid of liquidation preference.
Keeping a reserve stock for future investment is plausible (may give accounting headaches) but anything you do can't plan for all eventualities; when you are running out of money and all stock is committed you have a problem.
Probably worth pointing out that both stock buybacks and holding reserve stock occur in practice. Especially reserve stock - that seems to be fairly common, as otherwise every new offering of stock to employees means a fresh round of dilution. Which it sorta means regardless (it's less reserve for future investment to use without dilution), but I'd be willing to bet that explicit ~annual dilution along with your bonus is probably less palatable on an emotional level.
(whether or not that equals "founder-only dilution", I dunno. kinda? it's earmarking, it's at least mentally/structurally different)
Buybacks... I haven't personally seen them occur except to take more control back from investors or employees (e.g. to pay off the one(s) that won't agree to dilution), but either way that's the opposite of receiving funds / dilution as it costs the company money.
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I agree entirely that the argument for non-dilutable stocks is "... otherwise the value of the rest of your shares may go to $0". But unless they get voting power proportionate to their stock (like normal) or can be forced to accept buyouts, one person can decide to risk everything for everyone. Or do nothing, and benefit from non-dilution while everyone else gets diluted. Again: it's possible to do this! Founders often have exactly this kind of power! But I don't see that working in most cases for larger groups.
Both points true; I find it hard to imagine reserve stock suitable for all future investment though. Regardless, mostly these schemes end up in a similar place, so how you get there probably doesn’t matter. If employees were the largest voting block it would probably look different...
There is no legal reason why we can't have non-dilutable options. The only reason why it's such common practice is probably vanity (investors want to know they're getting X% when they invest) and the complexity of planning your fundraising schedule at the day of founding. Probably mostly the latter.
If you sell more shares, there is dilution - there is no way around it, it's math.
Each stock is a slice, more stocks, then each slice is smaller.
Now - if the company is growing you get 'diluted' but those stocks are worth more.
But in the examples above where employees are getting 'less/not diluted' it must be at the expense of someone else: founders or older investors who won't like that.
Given that founders, old investors and staff all generally get diluted at the same rate, dilution is actually one of the more fair things that happens in companies at least superficially.
