You're creating a circular contradiction about the money flow.
A founder has no money.
He gets interest from a VC like Sequoia Capital to invest $10 million. The standard and non negotiable terms of the deal means Sequoia gets "preferential shares" as a condition of writing a check for $10 million.
One of my potential employees (Yizahi) I'm trying to recruit insists on "no preferential shares!". Sequoia then says, "Ok, no $10 million deal then. Bye!"
As a result, both the founders and the employees have no working capital to build a more valuable company.
We can't just shout out "no preferential shares" and "no dilution" without understanding the full ramifications of what that actually means.
We say "no DRM on the Web!" Hollywood says "Okay, no cross-platform movies on the web then, either. Bye!"
If Sequoia is offering $10m at a $40m post money, how do you think that would change if they weren’t getting control and a guarantee they get paid first? Because without preference the founder incentive is a quick low risk liquidation at a price notably lower than $40m as soon as possible, because they’ve got 50% of the equity. This is another way in which financing valuations are an optimistic fiction.
Outsourcing production is hard with lower volume products that require modifications to meet customer needs (eg: they need M6 screws holes instead of 1/4-20 or want it in a particular metal). Contract manufacturers are generally interested in making 10k+ of the same item, not 100.
You're mixing up symptom with cause. The employee is the sucker at the table. (Most founders aren't far behind.)
If the original founders each hold 40%, and some employee holds 1%, after 50% dilution (common after the first couple rounds) the founders are down to 20% and the employee is down to 0.5%. It's possible to bump a star employee up by 0.5% to counter dilution. It is impossible to bump the founders up by 20% to get them back where they started.
The reason founders are OK with this is that they understand that 40% of a $1m company is worth less than 20% of a $10m company.
It seems like almost every startup funding system is predicated on early engineers being decieved about the value of their equity, and when someone tries to point it out on hn the response is "no venture capital firm will fund you if your employees aren't deceived about the value of their equity, idiot!"
That's not quite right - instead, he's implying that vc funds (correctly) think that the chance that this company's shares standing alone will suffice to return a multiple of the fund is low if they are of equal preference to the employees. That's not the same thing as "not very valuable", and the very counterintuitiveness of vc math should tell you that an asset a vc may not want (say, 5% of a company that sells for 75M after 3 years) may in fact be pretty valuable for the median employee.
>It seems like almost every startup funding system is predicated on early engineers being decieved about the value of their equity, and when someone tries to point it out on hn the response is "no venture capital firm will fund you if your employees aren't deceived about the value of their equity, idiot!"
Not at all - look, there are lots of good resources where you can learn more about how your equity works, and good founders will probably point you to them (e.g [0] and [1], although if you need a pointer to this instead of doing the 2-second google search yourself, you're probably not a great startup candidate anyway). Deception need not and should not enter into it. Not to say that there aren't scammy founders, but it's not best practice, and I don't believe Fred Wilson or most other reputable VCs would claim otherwise.
[0] https://blog.dweek.ly/introduction-to-stock-options-startup-... [1] https://foundersgrid.com/employee-equity/ ...
The idea that regular employees are somehow better served by shares that rational investors won't touch takes a lot of justification.
There's some misinformation there. Preferred shares do not have protection from "routine dilution". In fact, dilution is the very mechanism to sell more equity to subsequent investors at a higher price. (E.g. When Accel Partners invested $12 million for 15% equity of Facebook in 2005, they got diluted when Microsoft later invested $240 million to buy 1.6% equity in 2007.)
The "anti-dilution" provision that VCs get is not for "routine dilution". Instead, it's for a really bad event called a "down round"[1] where the next investor pays less than the current investor. We could ask The Universe why employees don't get the same anti-dilution protection but I think it's a moot point... If the company is getting devalued, employees are gonna worry way more about finding a better job somewhere else instead of staying employed on a sinking ship. In other words, a "down round anti-dilution" protection for employees is kind of mathematically pointless.
On the other hand, the type of favorable "anti dilution" for employees that most people are thinking about such as as a 1% grant at hire, and staying at 1% through all subsequent positive "up rounds", and finally at IPO -- is something even VCs don't get. Nobody has that type of dilution protection. Not the founders, nor angels, nor any investors. The closest approximation would be a provision for VCs to pay for more shares to keep their % ownership the same. That's more like "pay to play" rather than "anti dilution". In any case, people don't need that type of dilution protection because what matters is the #_of_shares_ multiplied by _price_.
[1] https://www.feld.com/archives/2005/03/term-sheet-anti-diluti...
I'm about 10 years on from learning this lesson, and I've refused offers since that try to plod the same trail. It's a red flag that doesn't appear until after you've been taken. I would say "scammed," but I do assume companies aren't just out to rip their employees off, they're just going with conventional (received) management wisdom.
But to say that
'you should take a reduced salary because you get this awesome stock grant that vests over four years'
then for four years say
'you should stay at this lower salary as you are diluted because we are giving you stock every year'
followed after four years by
'you got your stock and that's it so keep working at the lower salary and your now diluted worthless stock'
is not the same at all.
What does make sense is to have a risk conversation with these early people, and be willing to give up enough equity to have that make sense to them. So, if your target is to give them 0.5% "at exit", you're going to be giving them, say, 1-2% initially. And do this in the best way, tax-wise, for them in your jurisdiction.
(Most companies will be lucky to be acquired, never mind IPO. Unless you're talking listings on the pink sheets.)