Preferred tends to have a choice called a liquidity preference. If investors put in $5M, they might have their choice of getting the first $5M from a sale, or to convert to common and get their share of the company.
This (is one thing that) prevents the founders from taking $5M in capital and then immediately dissolving the company and taking that share. It also helps mitigate investor risk-- they get their investment back before other people get paid.
(Of course, there are many details to liquidity preferences-- participating vs. nonparticipating, ... 2x liquidity preference where investors are guaranteed double their money back, etc. but 1x, nonparticipating is the usual deal and founders hold a lot of common and want to negotiate for reasonable terms here)
An asset sale usually doesn't pay anyone back. If proceeds are not enough to pay the liquidity preference, common gets nothing.
I've been through a few startups as a founder. I have cut similar 1x nonparticipating deals. Unfortunately, my most recent one, no employees got anything because of liquidity preferences-- there was not enough proceeds to pay investors back. (I only received a fraction of my original investment, and other investors similarly got pennies on the dollar).
So you had experience with these exact problems, yet still structured your latest startup so that your employees would end up with nothing?
Literally GP post says that investors got pennies on the dollar back and you’re grousing that employees got nothing for their (worthless) equity? Without disrespect to the effort of founder(s) and employees, the company created negative economic value. That’s the root issue, not that the investors had fair contractual terms that caused them to lose “only the vast majority of their investment” rather than “all of it”.
Maybe starting a business for which the only way to get funding is by screwing over your employees is exactly the problem here?
edit: Actually, the last round of my first company was 1.5x non-participating, so a little worse-- it was the best we could do. Didn't matter because it didn't get triggered.
My first couple companies won. My last company lost. Good luck ever getting capital without that liquidity preference-- it doesn't get done.
My employees got nothing for equity; I lost money overall even when you count my salary. Investors got paid back a portion of what they invested, but lost money too. Everyone lost. Investors and founders were negative, employees were 0 on equity but received their salary/bonus comp.
I would have been a hell of a lot better off personally without the liquidity preference, but is that fair? If the company ends up producing less money than was invested in it, it seems to make sense that the investors should get the money.
Haha that sounds rather brutal when you say it that way :(
But it's still a jarring way to think of the primary activity of five years of my life.
I’m agreeing that employees get screwed more often than not, I’m also saying smaller investors get screwed more often than not.