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This is an oversimplification and, as written, is not quite right. It doesn't matter whether the company is acquired outright or floated on a stock market. If t

by binbag 5y ago

This is an oversimplification and, as written, is not quite right. It doesn't matter whether the company is acquired outright or floated on a stock market. If the company has a well-structured employee options scheme, then either of those events should be classed as an 'exit' event and the employees' options should be automatically exercised and sold, giving them the net gain in cash on that day. As for preference shares, most VCs try to get that. They can be negotiated away by the company management sometimes. If they remain, they come into play in situations where the company isn't successful - where the shares are sold at a lower value than they were bought for. The preference gives the VCs to get their money out first, and leave the scraps for the others. Usually the others includes the founders who are similarly shafted - but then again they evidently didn't build the value of their company very successfully and they signed the deals.

dan-robertson 5y ago
VCs often get shares with (e.g.) 3x liquidation preference meaning that they should leave with max(3x value invested, num_shares x sale_price / total_company_shares), or less if the company didn’t sell for enough money to pay out that tranche and the more senior shares. For VCs, the point is that in a failed company, they get 0. In a medium-success they get up to 3x their investment a bit like buying a bond for 33¢ on the dollar, and in a massive success they get equity-like payout. The problem is that if a company has a lot of shares outstanding with a high liquidation preference then outcomes that look like success to employees or founders may not result in those employees making much money, and the employees generally don’t know the relationship between how much the company is sold for and how much they get paid because it is confidential to the senior executives or investors.
- molsongolden 5y ago
  Often? I agree that liquidation preferences are often overlooked by startup employees but I wouldn't say 3x is common or generally acceptable. The National Venture Capital Association (NVCA) benchmarks[1] show that over 95% of term sheets across all funding rounds include a 1x liquidation preference. [1]https://nvca.org/model-legal-documents/ https://nvca.org/model-legal-documents/ (it's in the Enhanced Model Term Sheet v2.0)
- binbag 5y ago
  In my (UK) experience, a 1x liquidation pref seems requested. 3x seems unpalatable. Maybe things are different in the US west coast. (It's certainly easier to raise money there, so perhaps the terms are harder as a compromise.) You're right that employees with options don't get enough information to understand the value and potential value and mechanisms of their options in private companies. That's what I was driving at (poorly) in a separate comment.
  - askafriend 5y ago
    No, even in the US West Coast, 1x is what's typical. Anything more is non-standard. 3x would mean something is wrong with the company.
- jandrewrogers 5y ago
  A 3x liquidation preference is anomalous. Pretty much every term sheet I see is an eminently reasonable non-participating 1x, which is a de facto standard term these days. If liquidation preferences are consistently higher across startups then it is a sign of an unhealthy investment market.
  - throwawaysea 5y ago
    I think there are two problems here. The first is that what is “standard” is not very well known, so candidates considering startups are operating with little in terms of default assumptions and expectations. Is there any resource that describes what the default even is? The second problem is that companies are never transparent about any of these things. If you ask, you get funny looks or continued evasiveness, and candidates are left with only part of the full picture anyways. From other comments here it seems that even if you run through a checklist of questions, the company’s structure could drastically change in a subsequent funding round of some such event. And if that’s the case, does knowing the current state of affairs matter at all?

by binbag 5y ago

dan-robertson 5y ago

VCs often get shares with (e.g.) 3x liquidation preference meaning that they should leave with max(3x value invested, num_shares x sale_price / total_company_shares), or less if the company didn’t sell for enough money to pay out that tranche and the more senior shares. For VCs, the point is that in a failed company, they get 0. In a medium-success they get up to 3x their investment a bit like buying a bond for 33¢ on the dollar, and in a massive success they get equity-like payout. The problem is that if a company has a lot of shares outstanding with a high liquidation preference then outcomes that look like success to employees or founders may not result in those employees making much money, and the employees generally don’t know the relationship between how much the company is sold for and how much they get paid because it is confidential to the senior executives or investors.

molsongolden 5y ago
Often? I agree that liquidation preferences are often overlooked by startup employees but I wouldn't say 3x is common or generally acceptable. The National Venture Capital Association (NVCA) benchmarks[1] show that over 95% of term sheets across all funding rounds include a 1x liquidation preference. [1]https://nvca.org/model-legal-documents/ https://nvca.org/model-legal-documents/ (it's in the Enhanced Model Term Sheet v2.0)
binbag 5y ago
In my (UK) experience, a 1x liquidation pref seems requested. 3x seems unpalatable. Maybe things are different in the US west coast. (It's certainly easier to raise money there, so perhaps the terms are harder as a compromise.) You're right that employees with options don't get enough information to understand the value and potential value and mechanisms of their options in private companies. That's what I was driving at (poorly) in a separate comment.
- askafriend 5y ago
  No, even in the US West Coast, 1x is what's typical. Anything more is non-standard. 3x would mean something is wrong with the company.
jandrewrogers 5y ago
A 3x liquidation preference is anomalous. Pretty much every term sheet I see is an eminently reasonable non-participating 1x, which is a de facto standard term these days. If liquidation preferences are consistently higher across startups then it is a sign of an unhealthy investment market.
- throwawaysea 5y ago
  I think there are two problems here. The first is that what is “standard” is not very well known, so candidates considering startups are operating with little in terms of default assumptions and expectations. Is there any resource that describes what the default even is? The second problem is that companies are never transparent about any of these things. If you ask, you get funny looks or continued evasiveness, and candidates are left with only part of the full picture anyways. From other comments here it seems that even if you run through a checklist of questions, the company’s structure could drastically change in a subsequent funding round of some such event. And if that’s the case, does knowing the current state of affairs matter at all?