Open guide to equity compensation

"Fraud" is a strong word, and there's nothing inherently wrong with having multiple share classes. But I really feel that preferred stock as implemented by most early stage startups is an intentional attempt to deceive employees. There's a lot of founders out there telling early engineers they're getting "0.5%" when they know full well that a $1B acquisition down the line is not going to put 5 million dollars in the engineer's pocket.

Playing both sides with this comment

I don't intend to be on the founders' side at all, I'm just not quite sure I'd throw them in jail over it. I'd definitely call it "cooking the books" comfortably.

Can you explain? In most cases, preferences won’t come into play, assuming you raise at a standard 1x preference and sell for more than you have raised. In that case, owning 0.5% should roughly translate into $5M (modulo dilution).

That would be the naive mathematical interpretation and how the system would work if engineers designed it. Lawyers designed it, though, and they probably know some tricks to make that not happen.

There are plenty of valid scenarios where the company sells for a lot, but less than it raised. And 1x preferences are no longer standard post-ZIRP, afaik.

People are often not aware that the value of common is nonlinear, so the value of 0.5% in this case is zero. (For the ML fans out there, the common price per share has one or more ReLU activation layers. :) )

Even with 1x preferences, the company might have raised $2 billion but sells for $1 billion because the investors don't want to get any further losses.

The general rule of thumb is that acquisitions are bad for employees, and IPOs are good, especially if the share price is stable for 6 months.

Intentional misrepresentation is fraud, but I understand pragmatically how the line could become blurred. What I object to is the idea that blurring that line is intentional, even if that is not acknowledged.

Also for acquisitions, often you'll have to work at the acquiring company for some time to get money from your options. Or might get options in the acquiring company instead (which again are worth nothing until some future possible equity event which hopefully translates into cash).

Founders will almost always have common stock too, so they're in the same boat - it's only investors who will have preferred stock. If you don't spend 10 minutes to understand liquidation preferences before accepting a startup offer, that's kind of your problem.

Kinda? The underlying issue is someone you think you can trust not telling you the full details so they can fuck you later.

1. If the company is bootstrapped the founders can have preferred stocks with whatever clauses they want on it

2. Most (all?) companies will not show you their cap tables so it basically boils down to “trust me bro”

Like what? All the examples people have said are where either

1) the company has Nx preferences, for N >1, in which case the company has essentially failed to fundraise or

2) the company sells for less than they raised, which again, is a polite form of failure.

lets no degrade lawyers more than necessary.

Business people hired lawyers to design means and methods to commit _implicit_ fraud and deceptive practices to improve the value of their capital assets.

Those lawyers then go on to sell this product to others.

I'm sure there's some lawyers out there that are going out there shopping this stuff around, but it's Capitalism and Business thats the active agent, not Lawyers.

The underlying issue is trusting someone you should not trust, someone on the other side of the negotiating table who has interests opposite to yours.

The logical conclusion to #2 is valuing the equity compensation at zero, and foregoing it and asking for extra cash.

I’ve yet to work at a startup where liquidation preferences and investor participation is freely given or ever even mentioned. I only know about because I participated in TechStars. So, I guess we can blame employees for not hiring a lawyer to review their sign-on agreement (which, again, doesn’t have that info) or we can hold founders accountable for not sharing all relevant data needed to evaluate an offer. As a prospective candidate It’s one of those things you need to know about to even know to ask about.

I think founders are doing themselves a serious disservice. I loved working at startups but it’s just not worth it in most cases. The trade-off was always take lower salary for a chance at making big money and repeatedly investors and founders perform a rug pull.

Blaming employees for a change in the gentleman’s agreement is certainly one way to look at it. But, it sure feels exploitive, especially for younger folks that haven’t yet been burned by it. If founders keep doing it… well good luck finding anyone willing to work at their startup.

You think engineers never scam?

Yeah but I'm a programmer and don't innately understand that social power dynamics stuff. They're friendly and nice people and offer me drinks and snacks when I meet up with them. What do you mean they don't have my best interests at heart?

Not like lawyers, dentists, car salesmen, etc do!

Have 1x preferences become standard? When I worked in startups early investors often has 2x or 3x liquidation preferences, especially at seed.

I am under the impression that an oversized cap table is pretty much standard. Am I wrong?

Seriously - the whole point of giving your early employees equity is so that you can attract talent without blowing your budget.

It seems like most founders love pretending that there are armies of top-tier engineers rushing to work at their startup in exchange for pay that's well below market and stock that still won't be worth very much even if the company has a wildly successful IPO.

I really wonder why this happens - is it just greed from the founders? The VCs? Do early employees value stock like shit regardless of how transparent the company is?