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Sorry for the naive question, how is this not illegal? I would understand if you get 2X after all the capital raised has been cleared, but in this case? You ge

Sorry for the naive question, how is this not illegal? I would understand if you get 2X after all the capital raised has been cleared, but in this case? You get 2x while other people lose their shirts off?

lmm 6y ago
Preferred stock is kind of halfway between a stock and a bond, and selling bonds for less than their face value is pretty normal for high-risk companies.
barry-cotter 6y ago
> Sorry for the naive question, how is this not illegal? Because investors are assumed to be sophisticated adults who can read and do their own research, or hire lawyers to do so on their behalf if they are incapable. Every investor, those who put in money and those who put in labor hours are assumed to have gotten the best deal available to them.
- sukilot 6y ago
  Founders and employees aren't investors.
berberous 6y ago
Freedom of contract. Think about this situation: a company is in dire straights, and will likely go bankrupt and be worthless. The founders and the employees still believe they can turn it around, however. As an investor, you may be unwilling to invest with a 1x liquidation preference, given the high likelihood you lose all your money. So the company and the investor may negotiate a 2x liquidation preference as a way to sweeten the deal and induce the investor to invest in a riskier than usual proposition. Similarly, right after the dotcom bust when many investors lost their shirts, terms became much more investor friendly because the risk was perceived to be higher. At the end of the day, the terms are negotiated between the company and the investors, and it’s a market - if the environment is founder friendly and there’s plenty of capital looking to invest (like today), it’s almost always 1x. If capital is scarce, you take what you can get, otherwise, no capital. The founders are well aware as they negotiate these terms. The rank-and-file employees may not understand the company’s liquidation preference stack, but they can always ask, and if not given or satisfied with answers, ask for more cash comp than equity. It’s again a free market.
- cambalache 6y ago
  I understand the general point, but that surely can justify any practice cloaked in pseudo-legal parlance.It is exactly the same thing that led us to the derivatives disaster.

lmm 6y ago

Preferred stock is kind of halfway between a stock and a bond, and selling bonds for less than their face value is pretty normal for high-risk companies.

barry-cotter 6y ago

> Sorry for the naive question, how is this not illegal? Because investors are assumed to be sophisticated adults who can read and do their own research, or hire lawyers to do so on their behalf if they are incapable. Every investor, those who put in money and those who put in labor hours are assumed to have gotten the best deal available to them.

sukilot 6y ago
Founders and employees aren't investors.

berberous 6y ago

Freedom of contract. Think about this situation: a company is in dire straights, and will likely go bankrupt and be worthless. The founders and the employees still believe they can turn it around, however. As an investor, you may be unwilling to invest with a 1x liquidation preference, given the high likelihood you lose all your money. So the company and the investor may negotiate a 2x liquidation preference as a way to sweeten the deal and induce the investor to invest in a riskier than usual proposition. Similarly, right after the dotcom bust when many investors lost their shirts, terms became much more investor friendly because the risk was perceived to be higher. At the end of the day, the terms are negotiated between the company and the investors, and it’s a market - if the environment is founder friendly and there’s plenty of capital looking to invest (like today), it’s almost always 1x. If capital is scarce, you take what you can get, otherwise, no capital. The founders are well aware as they negotiate these terms. The rank-and-file employees may not understand the company’s liquidation preference stack, but they can always ask, and if not given or satisfied with answers, ask for more cash comp than equity. It’s again a free market.

cambalache 6y ago
I understand the general point, but that surely can justify any practice cloaked in pseudo-legal parlance.It is exactly the same thing that led us to the derivatives disaster.