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Comment by bogomipz | Hacker News Reader

>" while still offering downside protection (optionality) to investors."

I'm not familiar with tern "optionality" can you say what that is and how it provides downside risk protection to investors? Thanks.

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Optionality basically just means that there isn't a straightforward linear relationship between the price of something and how much you earn out of it. It's a very general term.

With preferred shares, investors have the option of taking either some percent of the company, or of instead taking a flat payment equal to their original investment (or more). For example, if a venture investor invested $100 into your lemonade stand, they could choose either to get the first $100 when you sold the stand, or to get 20% of the sale price. As long as you sold it under $500, they would take their $100 back, but if you sold it over $500 they would take 20%. If you sold it under $100, they would get all of it. That's the downside protection, since you'd be left with less than 80% of the proceeds even though nominally you own 80% of the business.

The optionality in startup investing has mainly to do with the "limited liability" in Limited Liability Corporation (other types of corporations and partnerships also have limited liability). That is, if you invest a dollar in a corporation, your losses are capped at a dollar. But, your gains are potentially infinite. Another instrument that has that characteristic--limited downside and infinite upside--is an option. The startup equity isn't actually an option, but it is useful to discuss its "optionality" because it does have some similar characteristics.

Thanks for the explanation.

A related question I have then is would RSUs be considered as providing downside risk(but no upside) for employees then as the value is independent of the companies actual performance?

I'm far from an expect, but unless I'm misunderstanding your question, no, that's not it. RSUs negate some of the downside risk for an employee (vs an option), but have similar upside. With an RSU, it has value as long as the company has value, with an option, it has no value unless the sell price is above the strike price.

I probably didn't articulate that as well as I could have. You answered my question though thanks. I actually don't hear about RSUs as much except for some unicorns that seem to be staying private for longer and longer.

Many publicly traded companies issue RSUs over options these days. But yeah, many startups don't.

Yes, I think that RSUs are the most common form of stock grants for publicly traded companies. I think FB might hae been one the first SV companies to use it for employees pre-IPO.

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