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Comment by jasode | Hacker News Reader

>Well if there is no money [...] No preferential share classes

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.

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Effectively what you are saying is that venture capital funds (correctly) think that that percentage of shares aren't very valuable when they are equal preference to the employees. The employee should use exactly the same evaluation framework: if the VC had nonpreferencial shares they wouldn't be worth the cash equivalent, so don't value your sweat equity that way either. Having the lower class of share should be valued even less.

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!"

>Effectively what you are saying is that venture capital funds (correctly) think that percentage of shares aren't very valuable when they are equal preference to the employees.

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/ ...

I don't believe VC math actually has the property you are saying: the thing about most preferred shares isn't just protection from routine dilution (which makes you more likely to 'win big' if the company becomes a unicorn), they also tend to be much less likely to receive actually zero (better protection from recap), right?

The idea that regular employees are somehow better served by shares that rational investors won't touch takes a lot of justification.

>most preferred shares isn't just protection from routine dilution

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...

It seems like almost every startup funding system is predicated on early engineers being decieved about the value of their equity

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.

Right. People often fail to recognize that without preferential shares startups would just raise at a lot worse valuations.

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.

Another option people fail to consider is not pursuing a term sheet from Sequoia in the first place. Go get money from customers, instead.

Some products require a great deal of initial investment to even roll one unit out. Not everything is an app or a service.

The initial cost for unit 1 can be quite expensive (>500k) if its a non-consumer product.

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.

That's a great option for a founder to consider, but it means you won't have the resources to give compensation that's even competitive on paper.

No, but you can grant shares to employees whenever there is a round so that their share stays the same? Many times shares are being created to sell in the round, why not create shares for the early employees?

Because the goal is to dilute early employees so that their shares are worth less. The literal and specific goal of the modern stage of tech VC is to reduce all other holders of equity to the point where the money, if any is made, is going to the "right people"--the folks who came in with the cash in the first place.

You're mixing up symptom with cause. The employee is the sucker at the table. (Most founders aren't far behind.)

No the goal is not to dilute early employees so their shares are worthless. You’re mixing up symptoms with cause.

This is bass ackwards. The founders get diluted more than anyone else. Every time you issue a new tranche of equity, the existing holders take dilution proportional to the share they currently own.

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.

The founders get diluted more than anyone else. They also start with overwhelmingly more than anyone else. Pity the poor founder with their meager twenty percent--an employee at their pennies of equity is vanishingly unlikely, even at a successful company, to make back the opportunity cost of having their salaries gashed by going to a startup.

Also founders have shares. Employees get options with some crazy three letter types. They HAVE to pay in advance to get even those 0.0001% of shares after dilution. Not only that but they have to conjure that money in what, 3 month term, 1 month? I don't remember exactly.

I wish more people would understand this. It generalizes.

We say "no DRM on the Web!" Hollywood says "Okay, no cross-platform movies on the web then, either. Bye!"

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