Founders hold the majority of the stock because they "created" the corporation. When it's time to hire employees, presumably they have some money as well. If a company wants to hire someone, they offer some combination of benefits, equity, and salary that the new employee finds reasonably compelling. Early employees at startups are typically (1) engineers and (2) relatively inexperienced, thus they don't negotiate very large compensation packages.
Employees are making the implicit decision to favor salary and a more certain (not very much more certain) over a disproportionate amount of equity. For every startup that actually hires multiple employees, there are probably 10 more where the equity is worthless.
That's not to say that you can't design more equitable arrangement within the current system. For example, you can allocate an order of magnitude fewer shares than are issued, and each quarter do equity "bonuses" of an amount totaling 1% of the allocated shares so far. In other words, ownership percentage of the company for founders + employees would decay with a half-life of about 17 years. (You'd need protections of investor shares against this dilution to make it acceptable of course.)
You can play with the numbers of course, but the idea is to have long-term ownership reflect an employees honest contribution (determined by relative bonus size vs. the size of the company), and eventually over time even out disproportionate allocations from early on.
Other systems are possible. The fact that founders and investors don't explore them is easily explained: the current system is heavily weighted in their benefit, so why bother?
I'm not arguing that employee equity valuation can't be abusive. It often is. Dishonesty is dishonesty regardless of who shoulders the risks. But if you're a founder and you're transparent and honest, the market does a pretty solid job of allocating upside.
And that's all I'm arguing. It often is abusive, and it shouldn't be. Of course one of the problems is that young coders just out of college looking at the startup scene (typically the only people to make the sacrifices necessary to be first employees, because of a lack of other commitments) don't know that they are getting a raw deal.
So I make posts like this on HN, in the hopes they someone might read it and choose differently.
I agree that because almost all startup candidate employees don't do this, equity can be exploitative.
But by the same token, most engineers don't know how to negotiate salary, and will lose even more money as a result.
The potential employee programmer knows more than the employer about how good his skills actually are and how dedicated he will be which can affect the value of Y.
Come up with "weak", "normal", and "blowout" revenue numbers for 1 year, 2 years, 4 years. You'll probably have to both ask your prospective employer and do a little research, but these aren't sensitive numbers. If the startup you're applying for can't tell you what "the number" is, they're doing it wrong, and you should be wary. You only really need one set of numbers; then discount (say 50%) for "weak", and premium (say 100%) for "blowout".
Now you have a spreadsheet with 3 columns for the years by 3 rows for the scenarios.
Do another grid below that for "deal size" (again by the three years). Instead of "weak", "normal", "blowout", do "2x", "5x", "10x" (crazy successful startups beat 10x, but it's in reality silly to do financial planning based even on a 5x return). Fill the cells in the grid with revenue x2, x5, x10; that's total deal size.
Subtract from each cell the amount the company has taken in funding (prefs might be even worse than that, but just assume 1x).
Now take the % of the company you're getting in equity and work out your take.
Divide each of those "take home" cells by 4, because that's how long you have to work to get all your shares.
If you want to get a little fancier:
If they haven't taken an A round, ding your equity by some % in year 1.
If they haven't taken a B round, ding your equity by some % in year 2.
What about companies that have no or low revenue?
That is what a prospective employee is being asked to do when they take equity in lieu of market salary: invest in company shares.
If a company wouldn't tell me what the prefs were, I'd just assume 2-3x participating.
Employees also typically also get refresher equity grants, eg. my initial options package at Google was worth less than half the total equity I received in my 5 years there. And new stock is issued in fundraising events, so ownership percentage of the company does tend to decay with a half-life of a bit less than 17 years (eg. Bill Gates owned 66% of Microsoft at its founding, had about 26% IIRC in the late 90s, and now owns only about 3-4%).
I think you're completely ignoring the fact that there is a liquid and very competitive market in the founder/labor market. If employees were getting a raw deal at startups, they would quit to become founders, driving down the supply of employees and up the supply of startups until they start getting better equity grants. I've done that; I've been an employee at 2 startups and one big company, and am now founding my second startup. Anecdotally, I know many others who have also bounced between working for startups and founding startups.
I think a more likely explanation is that a massive number of startups die before ever getting their first employee. And so all of those early startup employees who try their hand at being a founder don't actually increase the pool of employing startups very much, and are re-absorbed back into the system as early employees at other startups. If you want a more equitable system, you'd want something where when people quit their jobs, they have a high chance of being able to make it on their own, and there's not a winner-take-all effect where most organizations fail to get traction and the winners absorb those that can't.
But then, that system already exists as well. It's called consulting, and is probably the truest indicator of what an employee's actual market value is.
Some of the more obvious other systems are also legally disfavored. For example American corporate law is really oriented towards equity-based corporations, not workers' cooperatives. This doesn't mean that an alternate legal climate would lead to everyone structuring tech businesses as workers' cooperatives, but the current American legal climate makes it difficult, so fewer are founded than might be the case in a more favorable environment.
And that's the way it works in most of the world. The SV approach of giving early employees shares as an incentive is actually fairly tech-centric. Whoever heard of a restaurant's first waiter getting shares in the business?
However what I'm talking about is something different -- e.g. language in options contracts that cause you lose your shares if you leave the company unless you immediately exercise them, which most people are not in a financial position to do. This has caused many early employees to lose out on windfalls that would have been theirs if they had the same terms as founders (actual vested equity).
Anecdotal there are stories of the early janitor getting stock (or something like that) as if they wouldn't work for just a salary.
The line that I've heard is that it's a way to get people to work for less money than they would get paid if they didn't get equity. [1] But is this really true and how often in actual practice? (Comments?). I mean in a way if it is true you are taking advantage of the naivete of "the janitor" or "admin assistant" who may not even have a clue at all the probability of that equity even being worth anything at all. Because all they know about is what they read of the big wins that everyone talks about and they think they might actually stand a good chance of hitting the jackpot. Why is this right? To me it isn't (even if you believe it yourself as a founder).
Separately with domain name deals there is always a push on the part of sellers that I have noticed to try to get some upside equity when selling what they consider to be a valuable name. In general since the seller isn't taking that much of a haircut on the price anyway it's is usually a bad idea. It's almost pure upside with nominal downside.
[1] Along the lines of your comment "Whoever heard of a restaurant's first waiter" that would be the almost equivalent of the admin assistant or maybe customer service rep. Otoh anyone can easily see a new restaurant offering equity to people who work in the kitchen. Especially the the person in the kitchen (or several) need to be lured away from another job they are at.
An alternative, more progressive position is that all workers should be entitled to some ownership of the fruits of their labour. That is to say, everyone involved in an enterprise, no matter how big or small, is entitled to receive ownership proportional to the impact of their contribution to the success of the endeavor. In this world view there is no division between owners and employees, and unearned rents are minimized.
This is really a philosophical / moral / political debate.
There are some seductive ideas in communism, but making ownership a function of direct contribution sure as hell isn't one of them. The fact that the setup is biased towards owners is the very reason why so many people go and try to start their own business.
Starting your own business and making it successful is extremely hard and risky work. The entire point of putting that hard work in is that at the end of the day, you own the system, and can retire on the fruits of the system you gave birth to.
If ownership decreased to be a proportion of direct contribution, apart from the fact that it'd be very hard to measure that, it would also demotivate most entrepreneurs, myself included, from lifting a finger to start a new business.
There's a marked difference between everyone owns the labor and everyone owns their labor. You don't even have to check the history books. There are plenty of examples of functional, profitable, worker-owned cooperatives in the wild today.
And, in fact, while it might surprise many people on HN, there are many people who are quite satisfied with working for someone else and collecting a paycheck without all the worry and uncertainty that comes with owning a business. (And I'm excluding the people who talk a good game and say they'd like to be their own boss but would never even come close to actually taking the chance or pulling the trigger..)
"If ownership decreased to be a proportion of direct contribution, apart from the fact that it'd be very hard to measure that"
I'd say it would actually be near impossible to measure that actually. And even if you could measure it if it diluted the owners equity to the point where it didn't pay them to operate the business it wouldn't even matter.
I'm reminded a a guy, quite valuable, who worked for me many years ago in another business. After working for 3 months he walked in and asked for some ownership. Although I viewed him as quite valuable I said no, that I'd pay him more but I wasn't going to give him ownership (various reasons for this). Part (and only part) of my logic was that first he wasn't going to pay in for the equity (he just wanted it) and also if the business failed he could just walk away and get a job elsewhere. So he could afford to take risks and chances that I couldn't take.
For a very short period (between businesses) I worked for another company and remember how I couldn't believe how different it was than being the owner. All sorts of things that I had worried about as owner didn't matter anymore as an employee. It was almost like being on a vacation it was that easy.
But you don't have to divide it as "owners" and "employees". The underlying category is the division between those who favor high-risk-uncertain-reward, and those who favor safety-and-salary. I'd argue the varied risk profile is rooted in the psychology of economic participants instead of being born of any classism. The employee that wants to be an owner can be an owner. The owner that wants to be an employee can be an employee.
>An alternative, more progressive position is that all workers should be entitled to some ownership of the fruits of their labour. That is to say, everyone involved in an enterprise, no matter how big or small, is entitled to receive ownership proportional to the impact of their contribution
These types of appeals always leave out the other major factor: owner's capital at risk. We want the workers to get benefits of ownership but never discuss how employees should also bear the same financial risks as the owners. It's an incomplete call to action. The founders/owners are the ones depleting their life savings and maxing out their credit cards to help fund their (sometimes crazy) business idea. If the business goes bust, is there any realistic discussion of employees giving back their salary to help pay off creditors? Of course not. (And rightfully so; the employees took a salary and don't want to deal with any of that -- that's the owner's problem!) The discussion only talks of employees benefiting from additional upside without taking on any additional downside.
If the business was inherited, I can be more aligned with employees sharing more upside. If Joe Dilettante owns business he got from dad, he could run it into the ground without competent employees keeping things profitable. However, since this is Hacker News and the "startup" crowd, we're usually talking about creating businesses from scratch.
> In this world view there is no division between owners and employees,
There already is no division. If an employee wants to be an owner, he can do so. For California, here are the forms:
http://www.sos.ca.gov/business/be/forms.htm
Pointing out those forms is not a snark. I'm emphasizing that there is no "classism" preventing anyone who happens to be an employee now from becoming an owner tomorrow. Submit those forms, and go create wealth. Instead of asking for ownership percentage from other owners, you can simply get the State of California to grant you ownership of your own company. You give ownership to yourself. The avenues of ownership are already available to everyone.
Is this not in the spirit of the Hacker News demographic or am I reading things wrong?
That's quite an understatement of what it takes to quit a job with a salary, build an MVP, structure a company, convince people to work with you, and (if you're hiring pre-revenue) convince investors you'll make them money.
If they take on a below market salary and or additional risk exposure in join a startup they should negotiate a package (be it options or otherwise) that adjusts for that.
Obviously you can argue that employees are in a weak negotiating position; but largely the tech sector in major hubs is skewed in favour of employees with a significant range of employers (run from tech giants to new startups). If a particular company isn't willing to offer a compensation package that satisfies you then there are countless other potential employers.
(and you can obviously start your own company as well)
You've obviously never worked as an early employee at a startup. Pay is never equal or even close to what you'd get at typical big company. Typically that's explained to be because you get equity -- often a pitifully small set of options which if you do the math you'd realize probably wouldn't equal the difference in salary over 4-5 years in anything but the most wildly optimistic scenarios. (The OP's employees' windfall is probably break-even with their opportunity costs.)
>Yes and they get a salary for this like they would at any other company.
> If they take on a below market salary and or additional risk exposure in join a startup they should negotiate a package (be it options or otherwise) that adjusts for that.