Comment by mrkurt | Hacker News Reader

Comment by mrkurt | Hacker News Reader

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I don't think it's either of the above, honestly. "The majority of risk" take is more of a rationalization about why it's ok for founders to get the bulk of the proceeds. "The unequal terms of silicon valley" is the flip side to that. Neither actually explains why this happens, because it's relatively mundane.

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.

The reason why founders hold the majority of the company even years after their role -- important though it remains -- is nothing more than managerial, custodian, or public face, is because of the non-perishable, non-inflationary nature of equity. It is the nature of equity, and the legal system surrounding it, which is the problem.

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?

Why haven't you started a company organized on some alternative set of terms?

I am ;)

So, first, sincerely: good luck to you, and second: doesn't the fact that you can do this indicate that founder terms aren't a conspiracy against employees? If you don't want to accept employee equity, start a company.

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.

> I'm not arguing that employee equity valuation can't be abusive. It often is.

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.

People who want to make careers in the startup sector need to be taught the skill of doing simple financial projections --- how to make 3 revenue forecasts, how to see what multiple of forward revenue results in in what final deal size, and how to work back from total deal size to employee outcome.

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.

Do you think founders have a moral obligation to educate potential employees about financial projections?

To some extent, yes. If you acknowledge someone's market rate is X, and offer them X-k + Y shares, you're obliged to back up why Y is >= k.

Y is also partially determined by the employee. There is uncertainty from both the employer and employee on what the potential upside of Y could be. If an employee (programmer) believes his unique skills will be instrumental in making the company succeed, he won't discount Y as much as another employee (e.g. a chef just cooking the lunch meals for the programmers).

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.

Can you point to any good resources for how to make the relevant financial projections for early employees?

It's not complicated.

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.

Thanks! This will be helpful.

What about companies that have no or low revenue?

Most companies have low revenue in year zero, but if they're not building revenue in year one, they're a lottery ticket, not an investment.

That is what a prospective employee is being asked to do when they take equity in lieu of market salary: invest in company shares.

Even with revenue projections and being able to work back to personal gain, employees often aren't privy to liquidation preferences and the variety of classes of stock that has been handed out. If an employee has 1% of a company and the company sells for $100m, the employee rarely sees $1m.

Is there any good reason at all for an employer not to tell you about preferences? It's a simple question: "do I need to subtract more than 1x the amount of money you've taken from your sale price?"

If a company wouldn't tell me what the prefs were, I'd just assume 2-3x participating.

What you describe is basically vesting and additional stock issuance, and it's common practice for most companies today. The actual numbers are usually 4 year vesting of founder shares, so they get about 6% of their allocated shares per quarter.

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.

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?

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.

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