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Then perhaps the start up should just pay above market rate in salary and not offer any ISOs since those ISOs are so dang valuable but couldn't possibly be give

Then perhaps the start up should just pay above market rate in salary and not offer any ISOs since those ISOs are so dang valuable but couldn't possibly be given the same liquidation preference?

tptacek 7y ago
I mean, I agree. I think employees generally under-value equity, for understandable reasons, and that it's probably more efficient to compensate them in cash. That does mean that when the company sells, the upside goes entirely to management and investors, but I guess you can't have it both ways.
- ivalm 7y ago
  > when the company sells, the upside goes entirely to management and investors But for early startups that's basically an unlikely outcome.
  - tptacek 7y ago
    I agree. Working for early startups is risky. I'm just saying, we're unlikely to mitigate the risk by eliminating preferred shares for investors.
    - ska 7y ago
      What about the converse, giving preference constraints to early/founding employees? Early founders & execs handle this by a combination of a) large initial stake to survive dilution and b) the ability to cut a deal eventually to counteract impact of liquidity preference etc. ... but you can only extend that to so many people. I don't think it's insane to structure things in such a way that you are basically saying if anyone makes money off this, these people do in proportion to their relatively small stake. I suppose the real problems here are that 1) early round investors don't get this protection (but I think they can just accept that) and 2) at some point you get a different class of employee equity which could be hard to judge.
      - tptacek 7y ago
        I don't understand the proposal. I don't see what problem preferred stock for employees solves. I do see what problem preferred stock for investors solves. I do think employees should care about the preferences investors get, and judge their opportunities accordingly.
        ska 7y ago
        Idea is risk management for early stage employees,as a mechanism to make it hard for the company to later write a deal where they are entirely (or nearly) shut out of an event that has at least some decent return for founders and late investors. I was just musing, haven't thought about it deeply. I suspect we agree on the real solution, which is work out your business plan so that you can pay real market rates (and give them a chance to participate in early rounds)
        tptacek 7y ago
        I suspect you're thinking about this in generalities, like "everyone is taking some risk so everyone should have comparable risk protections". But preferred shares for investors address a specific kind of risk, involving management's incentives, one not shared with employees. The rest of the protections VC gets for their shares are simply a result of market power. They have it; employees won't organize and don't.
        ska 7y ago
        More specifically perhaps that very early employees should organize, and push for this. In particular, to counteract management incentives that may otherwise throw them under the bus. Agree it’s not identical to VC case, but similar enough that as a mechanism it could work.
- ska 7y ago
  > I think employees generally under-value equity, Do you mean by this that they attache a low value to the early stage equity they are given, or that they should push for a bigger part of the cap table early? The former I think is really hard to support. After all, it's a common trope (for good reason) that people accept salaries well below market value at a startup on the basis of being convinced to over value the equity they are being offered.
  - tptacek 7y ago
    They attach a low value and do tend to think in terms of their percentage of the cap table, which is irrational. Ultimately, I agree: developers should be paid cash.
    - ska 7y ago
      We agree on the latter, certainly. Overthinking the cap table evolution isn't very useful, but ignoring it entirely is irrational.
      - tptacek 7y ago
        Weighing your relative percentage ownership of the company against anchoring points and folkloric benchmarks is irrational. You need to evaluate the story that gives your shares value, have some clear idea of the numbers the company has to hit to get there, figure out what you'll make according to that story if things go well, risk-weight that, and see if the offer is competitive. Most employees don't do this, even when they're empowered to do so by management. Shares are undervalued by employees; many more of them should just be paid cash.
        ska 7y ago
        Cap table evolution is part of that story. I'm not talking about folkloric benchmarks, I'm talking about understanding who holds what now, what the overall capital needs are going to look like, what that is liable to look like. This is very different at different points in the evolution and and employees should understand that. I don't think we are far apart on this actually, I agree you have to do this sort of evaluation, and that it is fundamentally imperfect. I'm not sure ton how many employees do this or don't, I've know many who do. Many of them fail on the risk-weighting part, and more of them have overvalued their state, ime, than under. If you are really early stage, I also think along with a clear and vetted idea of the numbers the company is going to need to hit is a plan on what to do when that doesn't occur. The more time goes by, the more information you have, the more accurate your EV estimates should be. If they are dropping sharply there is nothing wrong with going back to management and saying this isn't making sense anymore to me, we need to reconsider my comp.

Then perhaps the start up should just pay above market rate in salary and not offer any ISOs since those ISOs are so dang valuable but couldn't possibly be given the same liquidation preference?

tptacek 7y ago

I mean, I agree. I think employees generally under-value equity, for understandable reasons, and that it's probably more efficient to compensate them in cash. That does mean that when the company sells, the upside goes entirely to management and investors, but I guess you can't have it both ways.

ivalm 7y ago
> when the company sells, the upside goes entirely to management and investors But for early startups that's basically an unlikely outcome.
- tptacek 7y ago
  I agree. Working for early startups is risky. I'm just saying, we're unlikely to mitigate the risk by eliminating preferred shares for investors.
  - ska 7y ago
    What about the converse, giving preference constraints to early/founding employees? Early founders & execs handle this by a combination of a) large initial stake to survive dilution and b) the ability to cut a deal eventually to counteract impact of liquidity preference etc. ... but you can only extend that to so many people. I don't think it's insane to structure things in such a way that you are basically saying if anyone makes money off this, these people do in proportion to their relatively small stake. I suppose the real problems here are that 1) early round investors don't get this protection (but I think they can just accept that) and 2) at some point you get a different class of employee equity which could be hard to judge.
    - tptacek 7y ago
      I don't understand the proposal. I don't see what problem preferred stock for employees solves. I do see what problem preferred stock for investors solves. I do think employees should care about the preferences investors get, and judge their opportunities accordingly.
      - ska 7y ago
        Idea is risk management for early stage employees,as a mechanism to make it hard for the company to later write a deal where they are entirely (or nearly) shut out of an event that has at least some decent return for founders and late investors. I was just musing, haven't thought about it deeply. I suspect we agree on the real solution, which is work out your business plan so that you can pay real market rates (and give them a chance to participate in early rounds)
        tptacek 7y ago
        I suspect you're thinking about this in generalities, like "everyone is taking some risk so everyone should have comparable risk protections". But preferred shares for investors address a specific kind of risk, involving management's incentives, one not shared with employees. The rest of the protections VC gets for their shares are simply a result of market power. They have it; employees won't organize and don't.
        ska 7y ago
        More specifically perhaps that very early employees should organize, and push for this. In particular, to counteract management incentives that may otherwise throw them under the bus. Agree it’s not identical to VC case, but similar enough that as a mechanism it could work.
ska 7y ago
> I think employees generally under-value equity, Do you mean by this that they attache a low value to the early stage equity they are given, or that they should push for a bigger part of the cap table early? The former I think is really hard to support. After all, it's a common trope (for good reason) that people accept salaries well below market value at a startup on the basis of being convinced to over value the equity they are being offered.
- tptacek 7y ago
  They attach a low value and do tend to think in terms of their percentage of the cap table, which is irrational. Ultimately, I agree: developers should be paid cash.
  - ska 7y ago
    We agree on the latter, certainly. Overthinking the cap table evolution isn't very useful, but ignoring it entirely is irrational.
    - tptacek 7y ago
      Weighing your relative percentage ownership of the company against anchoring points and folkloric benchmarks is irrational. You need to evaluate the story that gives your shares value, have some clear idea of the numbers the company has to hit to get there, figure out what you'll make according to that story if things go well, risk-weight that, and see if the offer is competitive. Most employees don't do this, even when they're empowered to do so by management. Shares are undervalued by employees; many more of them should just be paid cash.
      - ska 7y ago
        Cap table evolution is part of that story. I'm not talking about folkloric benchmarks, I'm talking about understanding who holds what now, what the overall capital needs are going to look like, what that is liable to look like. This is very different at different points in the evolution and and employees should understand that. I don't think we are far apart on this actually, I agree you have to do this sort of evaluation, and that it is fundamentally imperfect. I'm not sure ton how many employees do this or don't, I've know many who do. Many of them fail on the risk-weighting part, and more of them have overvalued their state, ime, than under. If you are really early stage, I also think along with a clear and vetted idea of the numbers the company is going to need to hit is a plan on what to do when that doesn't occur. The more time goes by, the more information you have, the more accurate your EV estimates should be. If they are dropping sharply there is nothing wrong with going back to management and saying this isn't making sense anymore to me, we need to reconsider my comp.