The 3 points you make forget the little guy: that early employee, whose employee number has 1 digit, who trusted the founders when he accepted the option grant and put 60 hours of work or more each week in the hope of not being screwed when the founders negotiate confidentially with the investors on how the company will move forward.
There's no SEC for privately-held companies, there is basically no oversight and the confidentiality clauses make it almost impossible for this little guy to find out how he's getting screwed and by whom. Learning and talking about it is the only way to fix it, and I'm a bit concerned that you completely overlooked this aspect in your comment.
Very good point - I actually had just edited my point 3 (first sentence) to add this point, posted the edit, and then saw your post. This definitely fits into the equation in an important way as part of the policy discussion. Thanks for highlighting it.
You don't know if any 'little guys' were hurt. If the same amount of money had been taken in through sales of additional stock, at the same pre-money valuation, everyone with vested or unvested options would be more diluted. So treating cash-to-early-shares this way (rather than equity sales) can be a slight benefit to all employees and stockholders.
Meanwhile, investors are diversified and have great counsel, so they can look out for themselves.
The only question for me in a situation like this is if there are people who were vested but unexercised, who would have exercised had they known the unique dividend was coming. It'd certainly be nice for a company to give them the info they'd need to participate knowledgeably.
Secondary transactions don't cause the company to issue more shares. They transfer shares from one party to another, so the total number of shares does not change and existing shareholders take no dilution.
If the only alternative being considered is for founders to sell their existing shares, yes.
But other approaches to limiting founder dilution and rewarding early shareholders could have included new offsetting stock awards to key staff, or selling even more shares to pay bonuses taxed at ordinary income rates. Those could have been more dilutive to smaller shareholders than this dividend approach.
Dividends are legal, tax-favored, and exist to reward actual shareholders-of-record (even though they're rarely used at this growth-needing-capital stage). Closing that alternative wouldn't necessarily benefit the employee-optionholder 'little guy'... but it might benefit the new-money sophisticated investors who would then have more control.
>Dividends are legal, tax-favored, and exist to reward actual shareholders-of-record
there is a special well known definition for a schema when "dividends" are paid using new incoming capital. The dividends you're talking about are supposed to be paid using earnings from the actual business.
When you say "...are supposed to be paid using earnings...", are you referring to a legal requirement? If so, this could be stopped by someone with a legal challenge.
If you just mean traditionally, well, if this is a more efficient way to meet the various goals of all parties to the transaction, I'm with founders/investors/innovation, moreso than tradition.
Also, money is fungible. What if AirBnb has earnings from elsewhere that could pay the dividend, meeting the early shareholders' desire for a interim diversifying return? But, that would then leave less capital for expansion. However, new investors are happy investing money that replaces (and then some) the cost of the dividend to support expansion costs.
There'd then be no essential violation of the way you think things are 'supposed to be': just think of earnings paying dividends, and then new investment adding all required expansion capital. Everybody who's a party to the transaction is happy, in a tax/legally-efficient manner, and no one's rights are trampled.
(As I've mentioned elsewhere, I think the main fairness issue would be if anyone who had the legal right to become dividend-eligible, for example by vested option-exercise, wasn't given that chance. But that's an internal fine detail we don't know about this still-in-progress private company financing.)
>Also, money is fungible. What if AirBnb has earnings from elsewhere that could pay the dividend, meeting the early shareholders' desire for a interim diversifying return? But, that would then leave less capital for expansion. However, new investors are happy investing money that replaces (and then some) the cost of the dividend to support expansion costs.
>There'd then be no essential violation of the way you think things are 'supposed to be': just think of earnings paying dividends, and then new investment adding all required expansion capital.
Even if they had other sources able to completely cover the "dividends", there seems to be the causality link between the investment and the "dividends". In Tom DeLay's case the causality between "donors to RNC" and "RNC to candidates" allowed the jury to recognize shortcut-ed "donors to candidates". It seems to me that it was an obvious bonus (i.e. ordinary income) to founders which for the purposes of lower tax rates (i.e. basically for the reason of greed) was shaped as dividend, and as result they seems to step into the Madoff territory.
>Everybody who's a party to the transaction is happy, in a tax/legally-efficient manner, and no one's rights are trampled.
people were fighting to get a piece of Madoff action.
Founder's can cash out without screwing employees. I had almost no stock as an employee in my first startup, but the founders took care of me post-acquisition.
That kind of thing happens a lot, but you shouldn't count on anything not in writing (and probably not even then, unless it's on a cashier's check).
Google's founders famously helped an early employee (Scott Hassan) who had done a lot of work and didn't have much on-paper equity. He's now running an awesome robotics startup, Willow Garage.
You should probably read this prescient thread a few weeks back. If you go through the comments, the majority of early employees got screwed by the founders. The ones that benefited are the best-of-breed companies like AMZN, GOOG, etc. They took care of their employees.
I'm not talking about the final exit. I'm talking about an award to the founders if they can get the company to a billion dollar valuation. That's all I'm talking about. And not Fu money but something of the order of 1million which would give the entrepreneur a small nest egg for having gotten this far but doesn't really make him financially secure.
And I agree that shafting employees is reprehensible and downright despicable.
At YC startups especially, it is quite common. Founders often take the minimum amount of money necessary to survive. But they will often pay market (especially after Series A) or near-market to their hires, plus equity.
Most intelligently run startup should do the same thing. You should be hiring people who will add more value to the business. Often you should be hiring people who are smarter than you.
It's the same principle which means if Steve Jobs came to me and said he wanted to be involved in my startup, I'd happily hand over 60% of my equity to him. The 40% I'd be left with, whilst proportionally lower than what I had previously, would be worth far more than what it was before.
At the moment I earn my rent + expenses from my business. As and when we close our next round of funding, I'll likely formalise this arrangement (at the moment we're boxing clever with the tax man by paying me in various ways), but I'll definitely pay market + equity for early hires.
We recently got told by our accounting/legal people that founder salaries had to be at least 35k/yr once they started (which we did so we could get payroll/benefits in place for new hires; has to run for 6-8 weeks first, unless you go though a PEO like TriNet, which we didn't want to do) -- otherwise we were going for $2k/mo.
So now I make $3k/mo. It's interesting trying to live within that amount (I have savings, but consciously would like to not dip into them more than I have to) in the Bay Area.
It is a great opportunity to do IRA to Roth conversions and such this year. The crazy thing is I would technically qualify for rent controlled apartments in SF, although my income might be too low to rent them.
I think $50-60k is a much more reasonable founder salary, once we finish Series A. I suspect most Bay Area startups get to that point, or even up to $70-100k, for founders, once they raise >$3mm or so.
Are prospective startup employees really motivated by stock options? There's no shortage of HN posts that actually work out the math and conclude that you won't get rich from employee stock unless the startup succeeds on the scale of Google, Amazon, or Microsoft.
Based on the number of times I've been offered stock options as a benefit of joining a startup, I'd say it's very prominent in startup culture as a motivator and recruitment tool.
If it doesn't hold value (as it seems you're positing), then early employees are getting played in the worst way. They're the ones who are getting screwed.
The context of what most people are saying is that founders are now getting their pound of flesh from VCs/investors (summary of other comments, not this thread.) The tone of those comments is that founders are simply putting steps in place to ensure they don't get screwed.
If this is the case (I don't know how true it is) then the marker for who gets hosed lands squarely on those early employees, and THAT will be a gigantic problem for startups. If early employees begin to distrust founders and investors, it's not just a headwind -- it's pretty much game over. Early employees are quite often the difference between success & failure. Those top-flight team members you need to execute on that idea will use the only leverage they have in that relationship -- they simply won't join the startup.
I hope AirBnB is an anomaly, but I expect this type of scenario to happen more and more. As for founders wanting to put themselves in position to do this -- who could blame them? But, it's not without consequence and their reputation as startup founders will be summarily tested with any future ventures.
The smartest startups will very quickly learn that success will only come when all parts are working together, doing their jobs -- founders, investors, early employees.
There is a rational case for joining a startup as an early employee, especially if the startup is funded. It's likely to be less soul-crushing than working for a big company, you're going to earn a salary (perhaps even a market salary) and you're going to gain experience towards founding your own startup in the future.
Stock options are a less significant part of the equation--they aren't worth anything unless there's an exit, and if there's an exit they still probably aren't worth especially much unless it's an extremely outsized exit, the once-in-a-decade type like Google, Amazon, or Microsoft. They're probably still worthwhile, but it's not prudent for an early employee to expect too much from them.
That's a lovely sentiment, but it's not close to reality when it comes to the presentation made when pitching those early-stage employees to join a startup.
Imagine a founder talking to an engineer about their fantastic idea, explaining how huge the opportunity is, etc. etc. and that the engineer will earn experience and a close-to-market salary. And you'll have options, but they likely won't be worth much unless we become Google, Amazon or Microsoft.
Yeah, I can't imagine that conversation either.
The demand for talent makes this situation appealing only to those who really need the experience. The highest quality talent -- the ones you need for your early-stage startup to succeed -- can do better than this nowadays.
Post-funding, if you offer a market salary, standard benefits, and a startup working environment (which seems to be the norm for YC startups), why wouldn't top talent choose that over, say, working for Google?
> Post-funding, if you offer a market salary, standard benefits, and a startup working environment (which seems to be the norm for YC startups), why wouldn't top talent choose that over, say, working for Google?
If someone was making this statement to me, as a prospective employee at Startup X, a giant red flag would go up. This is a signal that (a) this company isn't aware of what's being offered elsewhere, and (b) this company is projecting what's valuable to me as an employee (no financial gain, but "better working conditions".)
I wish it was that trivial, but this is a quaint notion that simply doesn't work if your goal is to pull in premium talent. It may work once in a while, but long-term -- no way. Maybe that simplicity has worked for you in hiring situations, but in my geography -- you'll end up with mediocre talent.
The bigco environment you mention -- the Amazons, the Googles, the Microsofts -- top flight candidates are using the pool of bigco and startups against each other to gain greater financial rewards. It's leverage, and the top candidates have it and are using it to their advantage.
Play the reindeer games or not, the market is what it is.
If a company sells for $150mm, and you have 1%, and there has been $20-40mm in financing (i.e. certainly not a great outcome for later investors, but ok for early), it's possible your equity will be worth $0 (due to preference), or maybe $200-300k. The odds of the company going from early to this are maybe 20%. Getting 1% isn't all that common either; 0.1% is a lot more likely unless you're pre-A.
$200-300k is nice, but if you figure there's a 20% or less chance of it happening, and you have to wait 4 plus maybe 1-4 more years for it. So, the net present value is about $10k/yr in extra salary.
Now, if you're Google, Facebook, or Microsoft, it's totally different; or if you are early at a company which takes very little financing and has a good ($50-150mm+) early exit.
As an employee, what I'd want from a prospective employer is full visibility into the financials/cap table, and help running through various assumptions about the future. Misleading people about the value of compensation, up or down, isn't reasonable.
As an employer I wouldn't want to be hiring someone who was too stupid to understand the accounting when given the numbers, or too meek to ask for the numbers, either. But an employee would be a lot better if he were motivated by wanting to solve this problem, use this tech, expand skills, be in this industry, or learn to do his own startup, vs. banking on the options lottery.
I'm afraid we're getting off on a tangent on this thread, but your math is correct, and I agree with your probabilities.
> As an employee, what I'd want from a prospective employer is full visibility into the financials/cap table, and help running through various assumptions about the future. Misleading people about the value of compensation, up or down, isn't reasonable.
I think that's the crux of it. Most startups are not this transparent and upfront with potential candidates.
> As an employer I wouldn't want to be hiring someone who was too stupid to understand the accounting when given the numbers, or too meek to ask for the numbers, either.
Very true.
> But an employee would be a lot better if he were motivated by wanting to solve this problem, use this tech, expand skills, be in this industry, or learn to do his own startup, vs. banking on the options lottery.
For the company, absolutely. For the employee? Yes, if certain circumstances hold true. But expecting this to be of equivalent benefit to everyone is uninformed.
> As an employer I wouldn't want to be hiring someone who was too stupid to understand the accounting when given the numbers, or too meek to ask for the numbers, either. But an employee would be a lot better if he were motivated by wanting to solve this problem, use this tech, expand skills, be in this industry, or learn to do his own startup, vs. banking on the options lottery.
Again, great sentiment, but when you fold in everything that's been discussed and you target premium talent, more often than not I'm finding that talent is often going elsewhere.
As a summary, I think the tension around financials between founders and VCs is slowly being pushed off to early-stage employees, and premium talent recognizes it and is expecting more than invaluable startup experience as compensation for making someone else wealthy.
I generally agree with you, but I think most engineers, even really good ones, would rather have extra cash at the current investor valuation, vs. more stock. Assuming your startup can raise 5mm on a 20mm pre, raise 7mm on a 20mm pre with a smaller options pool, and pay people slightly above market vs. slightly below market.
If your startup is a rocket with no problems, either approach works, but if it gets bumpy, having cash extends your runway, and helps you retain key people better than increasing amounts of declining stock.
Plus, having investors put more cash in keeps them motivated to help you longer, sort of like an author's book advance.
There is definitely under appreciated value to being "rich" in your 20s; driving a nice car, living in a nice place that you like, being able to go out to eat... and it really only takes making a marginal extra 10-20k to make a big difference.
Yes, which is making the market rate go up. I'm not talking about accepting below-market rates, I'm just asking what's so much better about accepting a given rate at Google as opposed to a startup.
Options aren't it. They're somewhere between a bonus and a lottery ticket, and if you're smart enough to be "top talent" you're smart enough to figure that out anyway.
> I'm just asking what's so much better about accepting a given rate at Google as opposed to a startup.
Below-market rates? Not sure if that was implied, but that's certainly not the case I'm talking about.
I'm not suggesting that's the case, but you need to ask the candidates who we've identified that are doing so. We've been losing people to AMZN/GOOG (MS less so) who will often have salary offers matched + bonus structures that exceed ours, plus benefits that jump way over anything we can provide. What's so much better about that? You'd have to ask the candidates.
Not sure where the discussion went off, but I'm not suggesting that options are the end-all-be-all for early stage employees. I agree that the chances of them holding any value are low. But this I would say: if they really are this gigantic crap-shoot, why on earth do startups continue to offer them to candidates?
Just to be clear I dont think giving FU money to the founders and nothing to the employees is fair. But something of the order of 500K to 1million for the founder I think is fair. Ie a small nest egg but not nearly enough to be financially secure.
The founder in all ways owes his company to the employees and everyone who has helped him and any big upside MUST be shared.
Just to be clear, I'm not talking about the final exit. I'm talking about an award to the founders if they can get the company to a billion dollar valuation. That's all I'm talking about. And not Fu money but something of the order of 1million which would give the entrepreneur a small nest egg for having gotten this far but doesn't really make him financially secure.
And I agree that shafting employees is reprehensible and downright despicable.
There's no SEC for privately-held companies, there is basically no oversight and the confidentiality clauses make it almost impossible for this little guy to find out how he's getting screwed and by whom. Learning and talking about it is the only way to fix it, and I'm a bit concerned that you completely overlooked this aspect in your comment.