I started off once thinking "yay, X% means I get X% of the company!" and then I found out the shares can be diluted. Then I learned "non-dillutable".
Then I learned about vesting periods, windows for exercising options, and a whole slew of financial terms and devices; each one seemed to come with its own unique "gotcha" that, if you didn't know about, would cost you nearly everything.
Everyone I talk to about these always says "well, don't do that one thing, or if you do that one thing be sure you do it in this way and you're set". The cumulative knowledge you need becomes pretty high pretty quickly though, and the chances of me doing the right legal and financial incantation at the right moment becomes lower.
Nowadays I go with cash. I don't get 'golden handcuffs' that hold me to a job I don't like because it might pay off later. I can calculate the expected value and risks with cash without tons of research. I know my legal recourses if I get screwed out of cash.
Let's not forget the "asset only" acquisition where the company sells it's IP and employees but doesn't sell any shares. Been through one of these and this is what happened, screwing over former employees who had bought options and investors. I think the only people who profited were the bankers.
I've been on the other side of two of these and the explicit alternative in each case was bankruptcy. Also asset transfers are more expensive to the acquirer because you have to explicitly delineate the assets you're buying and what you're not buying. This makes for more lawyer time and pushes the transaction costs up significantly. The real reason to do it is because the team there at the time is more valuable as a group than they would each be on the open market individually. Anyone _not_ there doesn't add that kind of value to the deal.
You may want to argue that IP is also part of these deals and past employees created part of that. This is probably true for some deals, but it has been minimally true for the deals I've seen directly. Sample size of two isn't great, but keep in mind the value of startups is largely believed to be in execution, not ideas. A startup on the verge of bankruptcy probably doesn't have immensely valuable IP because it's 1) not producing present value obviously and 2) isn't obviously worth a lot in the future, otherwise someone would be willing to give you discounted cash today for an ownership percentage of its future value (aka an investment).
Nothing I love more than being bought and sold like cattle.
Out of curiosity, how do you keep the employees from walking after an asset only transfer? The vague promise to them about future riches has already been broken. And you will up changing business practices that ruffle feathers (I'm not sure how you could avoid it. This stuff is rarely written down). Hell, you'll probably assign them to a new project anyway. So how do you keep them from leaving in droves?
Payouts! They get some mix of salary (comparable to existing employees), stock (more generous than existing employees) and a cash payout that's fairly generous if they meet some goals laid out in advance.
And you didn't ask, but if not enough of the team accepts an offer, then it evaporates.
Not quite but I know of one high level exec at a company you're familiar with that was given a year after multiple warnings.
Effectively, he had no job but was still on the payroll for a year and maintained his equity. He came in and did virtually nothing for about 6 months and then stopped.
It's a cushy gig but by the time you get it it's a punishment not a reward.
>"yay, X% means I get X% of the company!" and then I found out the shares can be diluted.
There seems to be a common misunderstanding about dilution.
Dilution is not really the issue. In fact, dilution is a positive sign. It means more investors value the company and want to buy into the ownership.
How do current owners who collectively own 100% of the shares "sell" more shares to future owners?!? By way of dilution. That means everybody gets diluted including the founders, the angels, the VCs, and yes the employees too.
More important than dilution is the shares multiplied by price.
I hear this argument a lot. Mostly from people trying to sell the idea of a highly dilutive funding round.
Sure, further rounds are a sign the company is doing well. The important word being "sign," they don't actually make the company more valuable (what the company does with the money they raise does).
If you own a lot of stock, you probably already know if the company is doing well or not. In that respect, the round just puts a number on what you already know.
The math is simple. All things being equal, owning more % of a company == more money. To try to spin dilution in any other way is stretching the truth pretty far, and is rather manipulative IMHO.
It's zero net gain at the point of dilution. Owning 10% of 10 million or 1% of 100 million is the same money you simply have even less control.
Unfortunately, rational people may have very different risk tolerances. Founders often see it as I have a company and X money to work with. The next round means I have a company and X + Y money to work with. In that context having a 90% chance of 10 million is often better than a 80% chance of 20 million even if the expected value drops the difference between 0 and 10 million is vastly larger than 10 million vs 20 million. But, smaller stakeholders may not agree with this thinking.
> What will happen in the best case:
- I had 1% of a 10M dollar company. They did well and now he has 1% of a 100M company (dilution in your face!).
You've meant to say "They did well and now he has 0.1% of a 100M company" I assume? Otherwise numbers don't add up. If all goes well the value of a smaller percentage after dilution should be higher than before the dilution, for example: 1% of 10M ($100k) -> 0.2% of 100M ($200k).
He didn't lose 9M. In his vision they did well and increased the worth of the company without outside investment. In reality, they didn't do well at all, because 10x dilution when the company grows 10x means the company has not actually created any value, it's just been given cash.
The VC-backed company model isn't set up for employees. The model is so that (a) founders can take risks (b) using money from VCs (c) where if the company does well, the founders and VCs both become richer.
Everything else follows from that. The fact that employees get any shares at all is just a way to get better employees so that the company does well. Only employees of unicorns have any chance of getting wealthy from stock, and you're unlikely to be an early employee of a unicorn.
It's better to view the situation in absolute terms rather than relative terms. Instead of comparing the outcomes of founders/VCs vs employees, compare an employee of a startup to an employee of non-startups. At not-startups, the working environment is very different. Some people enjoy that, some prefer the opposite. Also, getting +$100k (or +$50k, or even just +$10k) is still nice, even if the founders and VCs get 800x more.
The only part I have serious concerns about is the fact that you can end up underwater when it comes time to exercise your options, i.e. your tax bill outweighs whatever profits you'd see. I don't know exactly how this situation arises, but it happened to a friend. It was something like: he could have exercised his shares and gotten several hundred thousand, but he would've needed to pay about $100k in taxes beforehand. Since he didn't have that money, he couldn't exercise the options.
I might be wrong about the specifics, but there are situations similar to that, and it's pretty unnerving knowing that you can jump into a situation where your +$100k somehow turns into -$50k.
> it's pretty unnerving knowing that you can jump into a situation where your +$100k somehow turns into -$50k.
But even your example wasn't that. Your examples was -100k and +300k (or more), but offset by time slightly. That's still a very large net positive, just gated by a period of net negative.
I suspect there are some details that you are missing as to the situation of your friend. I know little about investment vehicles, but I've filed taxes at one point and paid them at a later point many times. For income taxes the rules for this are clear, and the amount you pay in fees and interest is also very clear. For some investment vehicle, I would bet if there's some taxes that need to be paid prior they have automated processes set up to pay them for you and take the amount out of the later payout, for a fee. If not, I can't imagine getting a short term loan for that would be too hard, even if you have to use private money (a real investor, or even just a friend).
Yeah, I'm certain I got some of the details wrong. It sounded like a situation similar to https://news.ycombinator.com/item?id=14464184 where you can owe taxes on money you never saw.
As someone who has been exactly there, this doesn't compensate for the lower salaries that are de rigeur in startups. Not to mention being an absolute insult compared to the employee's degree of contribution to the resulting event.
"Better than nothing, or being underwater" is pretty thin gruel in practice.
> The VC-backed company model isn't set up for employees. The model is so that (a) founders can take risks (b) using money from VCs (c) where if the company does well, the founders and VCs both become richer.
Does this mean that stock options are not a measure of risk taken by the employee into the company?
You mean the stock options are just like cash? I didn't think so. The employee is invited to take risks but without the protections.
> he could have exercised his shares and gotten several hundred thousand, but he would've needed to pay about $100k in taxes beforehand. Since he didn't have that money, he couldn't exercise the options.
I feel like at least a phone call to a bank would be in order at that point. If it's that simple, surely some sort of mutually agreeable loan could be worked out.
Couldn't you bootstrap it, get £5k on a credit card for the taxes to exercise some of the options, use the profit to pay the taxes on the rest (or a further bootstrap)?
But the Revenue consider you to have received value in that "piece of paper" that you can't liquidate? That just seems like perverse tax law - why is it that way?
Surely if they're private shares that can't be sold the extrinsic value is zero, the private share value for tax purposes is no greater than the value of the option?
> Only employees of unicorns have any chance of getting wealthy from stock, and you're unlikely to be an early employee of a unicorn.
Define wealthy.
I have done quite well (not FU, 3-comma money, of course, but solidly 2-comma) from equity as an employee. In my current company, I joined a few months after the Series A (so nowhere near "early"), stayed through the IPO and many years of growth past that.
We were never a unicorn.
Amazon, Facebook, and Google are regularly turning SWEs into millionaires and a substantial part of that is from equity. Microsoft also had a good decade and a half of doing that. Netflix probably does as well. (OK, Facebook was a unicorn; the others probably weren't ever called that, though it may have fit.)
I'm not sure that's particularly relevant to this thread; there are plenty of decisions that materially affect the value of your equity that you have no say in. That's true both in a startup and at a large tech company like Google where a significant part of your comp is in RSUs.
The point in the GP post that I was expanding upon,
> It's zero net gain at the point of dilution.
is focussing on the wrong instant in time.
You should be calculating the effect of the dilution on your exit event, when your equity actually becomes exchangeable for money.
A bit like owning stocks on the stock market then I would guess. Which begs the question of whether to take a higher paying job with no options and invest the difference.
Which should have been clear to you when you joined the company and read and signed the employment and stock options agreements (you did read them, didn't you?). If that isn't to your liking, don't work for a startup.
You miss the point. I don't think they are acting shitty. They're acting according to what both you and they agreed to in advance. You knew (or should have known) what they were (and were not) going to give you in return for your effort. It's only shitty of them (and illegal) if they don't follow through on that agreement.
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).
The $400M is a post-money valuation. The investor gave you a current valuation of $300M, and offered to add $100M for a post-money stake of 25%. Thus, 3333 new shares were created and sold to the investor for $100M.
Your slice of pie before the deal is (200/10000) * $300M = 6M
Your slice of pie after the deal is (200/13333) * $400M = 6M
Except that after the deal, your company has $100M more to spend, hopefully on investing in growing the business so that later on, you'll own 1.5% of much more than $400M.
This kind of thing is why management will sometimes try to steer employees away from discussions focused on percentages and toward ones focused on share prices. As an early employee who has been diluted a number of times, I certainly agree that it's more helpful to think in terms of my number of shares (which is unchanging) times a share price (announced at the time of the investment), rather than trying to compute my new percentage of the overall company value.
The new investor is willing to pay $100M for 25% of the company. That means they think the company will be worth $400M after they invest $100M. That means the current value of the company is ~$300M, not ~$400M.
No. What someone is willing to pay and what something intrinsically is worth is not the same thing. If the stated presumption is that the company was worth $400M before the $100M cash infusion, then it follows that it must be worth $500M after that.
If the new people own 25% of the company, then the previous owners own 75%. That means that the new people should get one-third as many shares as previously existed (which you did correctly). But it also means that they should have to put up one-third as much money as the company was worth previously; that is, 133M, rather than the 100M you had them pay.
Your loss is your cut of the 33M loss that your company took by getting underpaid.
Exactly! Thanks for pointing this out because everyone seems to miss it.
At the moment that an investment is made, a company should be worth just as much as it was before, but will have more liquid assets because it's traded equity for cash.
The question for employees and shareholders then becomes: "Do you believe management is capable of using the cash to build additional value, or will they waste it?"
>All things being equal, owning more % of a company == more money.
The point is all things are not equal. To restate a sibling comment, dilution means you own a smaller % of a more valuable company.
If it helps, think of "dilution == sell_equity". Dilution is the perspective of the sellers' side (x% - y%). Equity purchased is perspective of the buyer's side (investor's ownership goes from 0% to y%).
>To try to spin dilution in any other way is stretching the truth pretty far, and is rather manipulative IMHO.
Dilution explanation doesn't require "spin" nor mental trickery. It is the natural side effect of how companies sell equity to grow.
E.g. Larry Page's ownership of Google Inc got diluted from 50% in 1998 down to 16% in 2004. That smaller 16% was worth ~$3 billion around the time of the IPO[1]. If Larry insisted on "no dilution", no VC would invest money to help the search engine grow and therefore, he would own 50% of a worthless company.
So all things not being equal:
50% of $0 = $0
16% of $20 billion = ~$3 billion.
Obviously $3 billion is more money than $0. Thinking that 50% is better than 16% doesn't make sense for companies that require outside investors to grow. Similar story for Bill Gates' dilution, Jeff Bezos' dilution, etc.
Let's imagine Larry Page had a different conversation with Sequoia Capital to match this misunderstood fixation over "anti dilution"
>1998: Larry owns 50% + Sergei owns 50% = 100%
>1999: Sequoia: "we'd like to buy 10% of Google Inc for $12.5 million"
>Larry responds: "Yes! Great! We need your $12.5 investment but keep in mind that both Sergei and I have anti-dilution clauses so our ownership both stays at 50%."
> Sequoia responds, "So you want me to buy 0% of the company for $12.5 million? Uh, you guys are idiots"
Somebody in that imaginary conversation doesn't understand "dilution" or "equity" or simple math.
Sure, but dilution without representation can be a big risk for a regular employee. You might get a smaller slice of a bigger pie, but it may also represents a smaller real-world valuation if you get diluted too far.
If you have no say over how much you're diluted (like most employees), you could be diluted away to nothing. You have no control. So you must calculate worth accordingly.
Is everyone to get diluted equally. No? Well then, calculate worth accordingly.
In addition, I thought the pie getting bigger was the WHOLE POINT OF HAVING THE SHARES TO BEGIN WITH.
>You might get a smaller slice of a bigger pie, but it may also represents a smaller real-world valuation if you get diluted too far.
Show example math of how someone could get "diluted too far" resulting in less total value (shares x price) after an investment round that prices the company higher than before. If the total value was truly less, it means it was "down round" which is a different beast.
>, you could be diluted away to nothing.
Show how it is mathematically possible to dilute employee's 1% ownership in to 0% without illegal tricks.
When Mark Zuckerberg tried to dilute Eduardo (without also diluting the other owners), he tried to hide the reduced % via a newly created company. He got sued for the financial deception and lost.
I'm somewhat new to this topic (and therefore might not understand correctly) but another user, 'oillio', made a response in a different thread [0] which could explain 'getting diluted away to nothing', for example, an investor invests money causing dilution, the company squanders the money or uses it on something that doesn't positively affect the company trajectory. You now own a smaller slice of a pie which is the same size as it was before.
Using his example, if you estimate the value of a company to be 100M and estimate 10 years until IPO, if the investment doesn't raise the value of the company at the time of the IPO in 10 years then the dilution is not good for the employee because the pie is the same size (100M) but his/her shares have been diluted.
Seems like it's pretty difficult to estimate the value of the company in 10 years or the IPO date though which is probably why people just use the amount invested to estimate the value of the company.
> Sure, but dilution without representation can be a big risk for a regular employee.
Well, it's a big risk to everyone that doesn't get voting rights, right? Not all investors get voting rights, do they?
In some way, an employee sits between a non-voting investor and a voting investor. They don't get to vote, but they do have some control over the outcome of the company (ranging from small to large, depending on the number of employees and responsibilities of the person in question).
I didn't say anything about anti-dilution.
There are complexities, but as you explain, if you take more money, you need to give the investors something.
If you look purely at the accounting, and ignoring voting rights and other complications, you are right. Dilution doesn't change anything.
IMHO this argument is a case of technically accurate, and completely useless.
It doesn't matter what the value of the company is at the moment of the dilutive event. It matters how that event affects the value of the company when the employee liquidates their stock.
The new round could be very good, but not necessarily. There is no guarantee a more well capitalized version of the company will end up growing faster or larger than the current cap table.
When the employee evaluated their original option grant they should have done an analysis of the business, its market, and future growth potential. Lets say the predicted value of the company is $100M in 10 years.
Lets look at two options:
Option 1 - The company is continuing on its original trajectory. It is running low on runway and needs a cash injection to continue gaining market share for its quest for profitability. The company still looks like a $100M company, if successful.
The new round may not be good for the employee. When you look forward to the eventual liquidity event, the employee now has a smaller piece of the same sized pie. Maybe the company could still reach its goal by tightening its belt a bit.
Option 2 - The company has identified a new market opportunity. They are raising capital to spin up a new project and capitalize the opportunity. If successful, the company now looks like a $10B company in 10 years.
The new round is potentially good for the employee. On liquidation, they will have a little bit smaller piece of a much bigger pie.
> Lets look at two options: Option 1 - The company is continuing on its original trajectory. It is running low on runway and needs a cash injection to continue gaining market share for its quest for profitability. The company still looks like a $100M company, if successful.
>The new round may not be good for the employee. When you look forward to the eventual liquidity event, the employee now has a smaller piece of the same sized pie. Maybe the company could still reach its goal by tightening its belt a bit.
Sure, but not taking the extra round is also bad for the employee, right? If you don't take the round, and the company now looks like a $50M company, then you have the same piece, of a much smaller pie.
>IMHO this argument is a case of technically accurate, and completely useless.
Actually, your statement of "All things being equal, owning more % of a company == more money." ... is what's misleading.
People are cargo-culting the meme that "dilution is bad" and it has the perverse effect of making them think that awareness of it is "financial sophistication."
Your other statement, "Mostly from people trying to sell the idea of a highly dilutive funding round." ... is also misleading.
It's not the "dilutive" effect that's the core issue. It's whether the company needs the funds. If the company needs the investment, it needs the investment. The dilution is a side effect.
If the new investors want too high of a percentage-of-ownership, then yes, it's "highly dilutive" which is tautology. This may also appear like a dilution problem but it's not. It's a financial literacy problem.
The founders are supposed be smart and not sell too much of the company for too little a price! Therefore, I'm not talking about desperate situations of founders getting diluted down to 10% or less which then affects their motivation to run the company. In that case, the company is probably in financial trouble and the other option is to reject the investment which lets employees maintain a non-dilutive ownership of a bankrupt company.
>The new round could be very good, but not necessarily. There is no guarantee [...]
I agree but the backlash against dilution is about expectation of future events whereas your scenario is ex post facto judgement of past outcomes.
For a startup operating in the present moment, do the employees want the company to be able to raise equity financing to help navigate an unknowable future?!? If yes, it means everybody should expect some dilution in exchange for the outside investment.
>Lets look at two options: Option 1 [...] Option 2
Again, for both of your options, the easier and correct focus is shares multiplied by price. In the bad outcome of Option 1, the price went down. In the good outcome of Option 2, the price went up.
Focusing on dilution as some scary boogeyman is backwards since everybody else gets diluted (see Larry Page, Bill Gates, Mark Zuckerberg, etc)
Again, to reiterate the Larry Page example:
- Focus on the $3 billion vs $0. This is shares * price. The price is embedded in the "all other things being equal" part that you dismissed. The price is "not equal"!
- Don't focus on the dilution from 50% vs 16%. You can't play a mental game of "if Larry got 50% of $20 billion, that's $10 billion not $3 billion" because for him to keep 50% (dilution is bad), you have to replay history with him attempting to build Google with zero outside investment. It's more likely he'd have a bankrupt company instead of a $20B company since he can only buy a handful of servers by maxing out his credit-cards, and have no money to hire extra employees. This is the literal application of your "all things being equal". That's flawed ex post facto analysis which doesn't take into account the timeline and reasons people choose to dilute ownership / sell equity to capitalize the company at different stages.
If dilution is bad for the employee, then it is also bad for everyone else. If as you say, "the new round may not be good for the employee", then it also means it's not good for the founders and previous VCs. If the founders are not crooks, the intention for the investment round to help make the company better, not worse.
I still think the main source of outrage about dilution is that people think only the employees get diluted. They don't realize that every owner of the company including founders like Larry Page and VCs like Sequoia will get diluted too. All the sentiments of unfairness flow from that fundamental misunderstanding.
> If the company needs the investment, it needs the investment.
Agreed, but it might not. The fact that it is taking the investment does not mean it is needed, or that it is good for all stakeholders. Investors, founders, and employees all have different goals, motivations, and risk profiles. It is also very possible for the board to make a mistake and take funding that is a net negative for the company as a whole.
My problem is with this argument from your original post:
> In fact, dilution is a positive sign.
These are complex situations. Boiling them down to dilution is good, vs dilution is bad just leads to misunderstanding. Which, in my experience, can be the goal of the person making the argument.
I never said dilution is bad. My original comment was in response to your blanket statement that dilution should be assumed to be good.
I am just saying, "Hold on. It isn't so simple."
In the end, I think we are in violent agreement. People should not get hung up on dilution, it a natural part of the startup lifecycle. It is a factor in the equation, but only a factor. As I alluded to originally, it is much more important what the company is planning on doing with the funds.
Personally, I think the outrage about dilution is due to the fact that many new employees don't take the time to fully understand how it all works when they are hired. The single most important thing employees need to understand about dilution is that, if they join an early startup, it will probably happen at some point. Options for 1% of the company doesn't mean you will own 1% at the end.
Sure, dilution can be a good thing, but that doesn't change the fact that it can also be a gotcha.
> The point is all things are not equal. To restate a sibling comment, dilution means you own a smaller % of a more valuable company.
Right but if you aquired your shares under the assumption that you would own the same percent of a more valuable company, you are still being taken advantage of.
>but if you aquired your shares under the assumption that you would own the same percent of a more valuable company,
The employee shouldn't have that assumption. The correct default assumption is that the employees are diluted just like the founders when new equity is sold.
If the founders mislead the employees into thinking they got 1% -- and it would always stay 1% all the way to IPO, that's an issue with the ethics of the founder and not an issue with dilution. Dilution wasn't the problem. It's the dishonest entrepreneur that's the problem.
Put another way, if a founder told me I would be awarded 1% in stock and it would have anti-dilution protection for all subsequent rounds, I would not think to myself "wow, that's great!". Instead, that would be a signal that the founder is either 1) incompetent with math or 2) a crook.
Right, but if you read the post that you originally started arguing with:
> I started off once thinking "yay, X% means I get X% of the company!" and then I found out the shares can be diluted. Then I learned "non-dillutable".
Then I learned about vesting periods, windows for exercising options, and a whole slew of financial terms and devices; each one seemed to come with its own unique "gotcha" that, if you didn't know about, would cost you nearly everything.
Everyone I talk to about these always says "well, don't do that one thing, or if you do that one thing be sure you do it in this way and you're set". The cumulative knowledge you need becomes pretty high pretty quickly though, and the chances of me doing the right legal and financial incantation at the right moment becomes lower.
Nowadays I go with cash. I don't get 'golden handcuffs' that hold me to a job I don't like because it might pay off later. I can calculate the expected value and risks with cash without tons of research. I know my legal recourses if I get screwed out of cash.
>The cumulative knowledge you need becomes pretty high pretty quickly though,
Yes, I agree that we all go through an early period of ignorance and then we get more financially savvy as we learn more information. We don't know what we don't know.
However, when OP writes, "then I learned "non-dillutable", he/she is misinforming people with expectations that employees can get fixed-percentage ownership that stays at that fixed amount through subsequent investment rounds. The implication is that employees who didn't get such "non-dilutable shares" are getting screwed. This is not the case.[1] The normal situation is for _all_ ownership to dilute. It's not a nefarious trick on the employees.
If people think they are more "financially sophisticated" with knowledge of "no dilution" shares, they are wrong. Instead, if candidates try to negotiate "non-dilutable shares" with a founder as a condition of employment, they will look like clueless idiots. (Reading about mythical "non-dilutable employee shares" on HN made them dumber, not smarter.)
The expected mathematical mechanism for employees to get richer is for the share price to increase instead of the ownership % not to dilute.
Google example is a bad one as most startups fail in practice within few years. Most likely one works in one of those, not at the next business success.
In a typical startup a dilution means that the company run out of initial investments and has no way to get some form of a loan. So selling the ownership is the only way to continue. And if they succeeded with that it would not make the company more valuable. It just meant that owners were good at convincing investors. This is orthogonal to future value of the company.
Nothing so long as a small number of people own all the shares, they all agree to sell an equal portion, and the share price allows an equal portion from all owners.
> [T]hey don't actually make the company more valuable (what the company does with the money they raise does).
Yes they do. In two senses. The obvious one is probably not what you meant to refute - the total value of the company post raise is, in the simple case, the value of the company before the raise plus the value of the new cash. The company is more valuable. What I think you meant to say was that your shares don't get more valuable.
That's more true, but they can be. If the raise was a good idea, the company's prospects are improved (and therefore the value of existing shares) by whatever uncertainty existed about its ability to raise that funding.
Isn't it amazing that every day, Apple offers new options, diluting everyone else who owns stock? Crazy anyone would work there, or want any Apple stock given that fact.
Professional investors generally get pro rata rights which allows them to buy more stock in later rounds. They do this because they want the ability to buy more shares in companies that are succeeding.
They don't get magic stock that magically doesn't get diluted.
They used to! Ask anyone who was involved in startups around 200-2002 about the full-ratchet anti-dilution provisions many investors demanded and received. Not fun for anyone else in a down round . . .
Down-rounds were huge back then, regardless weighted average was still the more common way of doing things, even in the early 2000s. Often times, these days, startups are putting pay to play provisions in, so even the weighted average ratchet requires them to keep investing in order to receive their anti-dilution.
Honestly, unless a startup has SERIOUS capital problems, an anti-dilution isn't going to make it's way into a share purchase, so the companies that are still seeing this (and the ones from the early 2000s) weren't in incredible shape to begin with.
Why shouldn't employees also demand, and also be given, the right to buy more shares in subsequent funding rounds?
If I was going to work at a company for X% ownership, I'd sure expect to have the right to invest my own money to preserve my stake in a funding round and avoid dilution. Many employees might not exercise this privilege, since it would require putting (potentially a lot of) cash back into the company, but why aren't they given the choice? I also might expect to receive the same liquidation preference on any shares purchased in cash this way.
I'm not sure I could be comfortable working for a startup without pro rata rights and relatively full knowledge of the cap table and preferences. That's probably why I'm not working at a startup.
1) It would generally be a poor investment choice for an employee to invest their savings in a startup that they were actively working for. Startup employees are already over-invested in their company from a diversification perspective.
2) The majority of startup employees are unlikely to have the cash on hand to make that kind of investment.
Because of #1 and #2 this isn't something that most employees would care about so it's not part of any standard compensation package. It's possible that an employee could negotiate for such a provision though.
The fact that you would want a pro rata right to work at a startup does make you fairly unusual and I agree goes to explain why you have chosen other career options.
Ratchets are a thing, far less common in the valley in the last decade than the decade before, particularly at earlier stages. Founders can put them in as well. Don't forget warrants as part of a deal too.
Price alone will not tell you everything. Let's not forget about different classes of stock: preferred vs common. There are often other rights associated with preferred / investor shares: liquidation preferences, warrants, etc. Rarely can the average employee get these details.
> Dilution is not really the issue. In fact, dilution is a positive sign. It means more investors value the company and want to buy into the ownership.
This doesn't just apply to company shares (a topic which causes people to not think rationally, for some reason).
It applies to a market. Sun's CEO MacNeilly famously said that he liked open systems (in the case of BSD Unix) because "it increases the pie. Our slice gets smaller but all these participants grow the overall pie faster, so our revenues go up."
What fascinated me at the time was how the business press was puzzled by his statement -- they had a more zero sum view of markets in the late 80s/early 90s. Nowadays people understand that the existence of Lyft helps Uber, and vice versa.
And the same is true with people who want to buy your shares.
> More important than dilution is the shares multiplied by price.
But even with an "up round", where ownership percentage is diluted but your n-shares * price goes up, liquidation preferences can reduce or eliminate your value.*
As the GP said, there's always that "one more thing" that can wipe out your value.
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.
No they can't. I don't doubt that this has happened before and I'm sure someone can dig up an example or two.
However, what you describe is highly questionable and borderline illegal. It's certainly grounds for a lawsuit by other shareholders (including options holders).
Eh, this is exactly what happened to a friend of mine. The rationale later, was he had been promised X percent, but when the final deal went through, they diluted different pools of company stock to different percentages, and his values went down to 1/10 what he was expecting.
I know I'm missing a lot of info, and its just a second hand example, but it seems in line with grand parent post's idea that for each type of financial tool, there's at least one gotcha you need to be aware of.
Yes, they can. The board has discretion over the allocation of the options pool that will have been set aside as part of each round.
However to issue those to yourself would be like eating your seed stock, since that's the pool that you use for issuing options to new hires, and without that you can't give new employees any equity. For that reason I don't think it's likely.
I think what the grandparent comment is getting at is that you as an employee have little control over the delayed compensation strategy. If you're lucky, you have a honest founder and investors who make sure you're paid for your contribution at deal closing time. If you're not lucky, you have a board/CEO/founder that will take whatever they can get away with (e.g. your value add) and then point to the financial rules/contingencies and say, "Well, we tried to do all we could, but we had to do this to ensure the success of the company. We needed to compensate the administration because it's hard to find such good talent like ourselves. Your still getting something here..." Or some such line. And you end up with some minuscule share at the same time providing critical value to the business.
Just looking through the replies to your comment makes me throw up my hands in confusion and frustration. You say one thing, the next person argues against one point, then someone counter-argues, and so on. It's all a confusing mess. It's like you need a financial rep to be with you at job interviews to understand all this stuff.
Just say no to options, and demand market level salary. I interviewed at an early stage start up in the mid west. The CEO lamented "People here just don't understand stock options" and as the first technical employee I'd be "by far the highest paid person in the company". I said "People do understand stock options, they're a gamble" and declined the offer. I don't want to be the highest paid person at any company.
Only one data point, but my experience at several companies has been that annual follow-on/refresher grants more than make up for dilution from new rounds. A company which only gives you a single grant upon start of employment and then lets it coast for 4 years is doing it wrong.
Do you know of a good resource that could bring a lay IT person up to speed on these kinds of nuanced details? To me it just seems lots of us just dont know about this stuff. I count myself lucky to have a paralegal SO who does it everyday and walks me through it, but most people don't have that.
While I agree generally w/ this advice, in my experience, companies try to make that impossible or very difficult for employees. For example, most hiring offers are exploding: I've been given exploding offers over a weekend, over holidays: try getting a lawyer when you're not at home. Further, again in my experience, getting a lawyer is actually significantly challenging to someone who hasn't done it: you need a lawyer in the relevant area of law, and you need to know their price, and these two critical pieces of information seem generally to be the things left off the website.
You can argue that an employee should try to negotiate for adequate time, and maybe they should, but not all will. Those too timid to do so are effectively being taken advantage of; thus I find most companies' positions morally reprehensible.
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.