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You are not accounting for the optionality of the ISO. The ISO is an option to buy a stock, not actual stock. An option on a stock has material value due to th

by jariel 7y ago

You are not accounting for the optionality of the ISO. The ISO is an option to buy a stock, not actual stock. An option on a stock has material value due to the de-risked nature of it. Someone with 'preferred' shares gets their money back first, sure, but someone with an 'option' never even has to put their money in the first place. An 'option' gives you all of the upside with none of the downside. Would you rather put $1M in a company for 10K 'preferred shares', or would you rather be given an option to buy 10K shares at 1 cent each. Without knowing anything else at all, you'd probably choose the later.

bradleyjg 7y ago
> Someone with 'preferred' shares gets their money back first, sure, but someone with an 'option' never even has to put their money in the first place. That’s not true. They are paid for at very high opportunity costs.
- alecbenzer 7y ago
  Yes but the context here is liquid investment, which is what preferred stock are meant to be a defense for (at least according to what I've heard). (The opportunity cost is also paid slowly over years; I think VCs get better terms in part for front-loading all the money.)
ssorallen 7y ago
> An 'option' gives you all of the upside with none of the downside. To see any of that upside you have to exercise the option. If the company has the common 90-day post-termination exercise window, that means if you want to change jobs you need to come up with cash to exercise what’s supposed to be part of your compensation, and if the FMV is much higher than the strike price, hand a bunch of cash to the IRS too. Now you’ve put in your time as an employee and reinvested the salary the company gave you right back into the company, and you’re likely at the back of the line with common shares.
- jariel 7y ago
  Yes, windows on exercising are also part of the value, but you are fundamentally misinterpreting the concept of investing real money and optionality. Your misunderstanding leads you to believe that somehow an option is worth a lot less than a 1x participating stock, and it's not. Again you side-stepped the comparable: As an employee, even with a '90 day exercise window' which would, you chose for compensation (or what would most people chose?) 1) the ability to invest $1M for a bunch of preferred shares; or 2) a bunch of ISO's at a low exercise price? Everyone will take the ISOs due to their riskless nature, now why would they take option 2 if it's so 'inferior'? A 1x participating preferred is a perfectly rational type of financial instrument for VCs, and some type of ISO is actually well aligned for staff. Though things might evolve here and there, there is zero chance that the 1x preferred aspect is going away.
  - zapita 7y ago
    As an employee, instead of exercising, say $30k worth of ISO, I would much rather buy $30k of preferred at fair market value. Even better if I got a discount on fair market value. I would also like the company to pay the 30k upfront as a loan or sign-on bonus, a common practice for executives already.
    - alecbenzer 7y ago
      > I would much rather buy $30k of preferred at fair market value. Sure, but VCs aren't getting shares at FMV either.
      - zapita 7y ago
        My bad, I meant "at the same price as VCs". You are correct that's not what fair market value means.
  - ssorallen 7y ago
    > 1) the ability to invest $1M for a bunch of preferred shares; or > > 2) a bunch of ISO's at a low exercise price? Why is this the choice? how about: 3) a bunch of ISOs of preferred shares at the current FMV Why is a VC putting in $1m riskier than an employee taking a full time job with the company? Why can't an employee who vests shares get the same preference when they reinvest their own money into the company?

by jariel 7y ago

bradleyjg 7y ago

> Someone with 'preferred' shares gets their money back first, sure, but someone with an 'option' never even has to put their money in the first place. That’s not true. They are paid for at very high opportunity costs.

alecbenzer 7y ago
Yes but the context here is liquid investment, which is what preferred stock are meant to be a defense for (at least according to what I've heard). (The opportunity cost is also paid slowly over years; I think VCs get better terms in part for front-loading all the money.)

ssorallen 7y ago

> An 'option' gives you all of the upside with none of the downside. To see any of that upside you have to exercise the option. If the company has the common 90-day post-termination exercise window, that means if you want to change jobs you need to come up with cash to exercise what’s supposed to be part of your compensation, and if the FMV is much higher than the strike price, hand a bunch of cash to the IRS too. Now you’ve put in your time as an employee and reinvested the salary the company gave you right back into the company, and you’re likely at the back of the line with common shares.

jariel 7y ago
Yes, windows on exercising are also part of the value, but you are fundamentally misinterpreting the concept of investing real money and optionality. Your misunderstanding leads you to believe that somehow an option is worth a lot less than a 1x participating stock, and it's not. Again you side-stepped the comparable: As an employee, even with a '90 day exercise window' which would, you chose for compensation (or what would most people chose?) 1) the ability to invest $1M for a bunch of preferred shares; or 2) a bunch of ISO's at a low exercise price? Everyone will take the ISOs due to their riskless nature, now why would they take option 2 if it's so 'inferior'? A 1x participating preferred is a perfectly rational type of financial instrument for VCs, and some type of ISO is actually well aligned for staff. Though things might evolve here and there, there is zero chance that the 1x preferred aspect is going away.
- zapita 7y ago
  As an employee, instead of exercising, say $30k worth of ISO, I would much rather buy $30k of preferred at fair market value. Even better if I got a discount on fair market value. I would also like the company to pay the 30k upfront as a loan or sign-on bonus, a common practice for executives already.
  - alecbenzer 7y ago
    > I would much rather buy $30k of preferred at fair market value. Sure, but VCs aren't getting shares at FMV either.
    - zapita 7y ago
      My bad, I meant "at the same price as VCs". You are correct that's not what fair market value means.
- ssorallen 7y ago
  > 1) the ability to invest $1M for a bunch of preferred shares; or > > 2) a bunch of ISO's at a low exercise price? Why is this the choice? how about: 3) a bunch of ISOs of preferred shares at the current FMV Why is a VC putting in $1m riskier than an employee taking a full time job with the company? Why can't an employee who vests shares get the same preference when they reinvest their own money into the company?