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Three interesting part of the discussion: (1) The opportunity cost to the founder of taking early liquidity: If a founder cashes out 10% of their position for
by corry 2y ago
Three interesting part of the discussion:
(1) The opportunity cost to the founder of taking early liquidity:
If a founder cashes out 10% of their position for $500k @ $25M Series A valuation, that de-risks a lot of their personal life. But when the startup ends up selling for $250M, that $500k of 'early' selling would have been worth $5M (less any dilution between rounds) - hard not to regret the choice in that case even if hedging is going to be the correct choice 99% of the time.
(2) Meaningful vs. not-meaningful amounts:
From my prev example, the founder sells 10% of their position for $500k. Well, if all employees were allowed to sell up to 10% of their positions too, would that even matter to them? If you were an employee and had $200k total value in your options, and you could sell 10%, you're getting $20k. Not really enough to de-risk your life although still might be welcome (and employees would appreciate having the choice).
(3) Sellers need buyers:
In order for there to be a seller of shares, there needs to be a buyer. The founder is effectively choosing his buyer and future business partner by taking investment and choosing to give that buyer more control over the corp by selling him even more shares (his personal shares). The buyer wants to make the founder happy and de-risk their downside so they can be more aggressive or big-picture or whatever, plus is happy to own more of the company assuming it's a hot round.
But what does the buyer want to achieve by purchasing the employees shares? Just to own a little bit more % of the corp? For amounts that might not even matter for the employees and may de-incentivize them?
It's all very complicated and perhaps there are nuances that make every situation unique.
- neilv 2y ago> If a founder cashes out 10% of their position for $500k @ $25M Series A valuation, that de-risks a lot of their personal life. But when the startup ends up selling for $250M, that $500k of 'early' selling would have been worth $5M (less any dilution between rounds) - hard not to regret the choice in that case even if hedging is going to be the correct choice 99% of the time. IMHO, it's very easy not to regret, with those particular numbers. I'd take $500K now plus possibly $45M later -- over $0 now and possibly $50M later. I'd take that deal even if "possibly" were "guaranteed". (Who might regret that is a founder who was otherwise already wealthy.)
- simonebrunozzi 2y agoYou are not taking into account QSBS. [0] When you sell your stocks before 5 years of holding period has passed, you pay significantly higher taxes. So you don't get 500k net, you get 500k gross, or probably 300k net. Which makes the de-risking less compelling. [0]: https://www.investopedia.com/terms/q/qsbs-qualified-small-business-stock.asp https://www.investopedia.com/terms/q/qsbs-qualified-small-bu...
- nine_k 2y agoThis is when you immediately liquidate your stock position, instead of taking a loan using it as a collateral, which would likely cost you 10%-15% in interest, not 30%.
- andrewmutz 2y agoNo, in this example the person sold equity in order to get the 500K. They can't use the equity as collateral for the loan because they dont own it anymore
- nine_k 2y agoYes. They should not have if they were to optimize taxes.
- tyre 2y agoBut then they’re paying interest and very few startups are going to have stock that a someone will lend against. I cannot imagine someone taking Series A stock as collateral for a loan.
- kelnos 2y agoI think it'd be pretty rare for a bank to accept equity in a series A startup as collateral for a loan.
- 2y ago
- ipsento606 2y ago> hard not to regret the choice in that case even if hedging is going to be the correct choice 99% of the time in the scenario you outline the founder sells the remaining 90% of their position for $45MM? I don't think many people would experience any real regret at "only" getting $45.5MM instead of $50MM, due to declining marginal utility of money
- thunkshift1 2y agoAlso bake in the fact in your calculations that 9/10 startups will not see the kind of success you are talking about. And the authors point still stands.. the founder made some money at liquidity event at round A vs … making even more money later if he doesnt sell?
- galaxyLogic 2y agoBird in hand is better than 3 in the bush
- cashsterling 2y agoGreat points... as to #3, investors are often happy to be buyers. They are buying shares anyways that would otherwise have to be created. Allowing founders and employees to sell shares lowers dilution vs. creation of new shares... usually this is not a large effect, but still not bad for current & future investors.
- yuliyp 2y agoI mean it effectively means that the amount of cash going into the business is less than it otherwise would have been. The company wanted $5M of cash. With the owner selling $500k worth of shares it means they had to find $5.5M to be invested. The only reason it happens is that the founder is negotiating both on behalf of the business and a bit for themselves.
- ishan0304__ 2y agoI mean it basically means that the founder is not some dude in early 20s who can crash on a couch and work off coffee shops, they r going thru life as well and they r the one's who drove success so they rightfully expect a piece of that success
- WalterBright 2y agoFor me, it's always regret: 1. If I buy stock, and the stock goes down, I regret buying 2. If I buy a stock, and the stock goes up, I regret not buying more There's no winning :-/
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- flowingfocus 2y agoI find that it sometimes easier to accept this as this is just how life is when I read people with experience write about this. If this is true for you as well: There is a good book review about it on SSC https://www.astralcodexten.com/p/your-book-review-the-laws-of-trading https://www.astralcodexten.com/p/your-book-review-the-laws-o... > Whether or not you make money, you have regrets! If you profited, you could have made more. If you lost money, you shouldn’t have made the trade at all. Like death and taxes, you can’t avoid adverse selection.
- elevatedastalt 2y agoThe simplest strategy is to buy index funds and hold. I never look at the price of any stock every day. I don't plan to sell any index funds either until I retire.
- WalterBright 2y agoBuying the S&P500 etf or index fund is the equivalent of the Blackjack "Dealer Strategy". It's perfect for "fire and forget".
- PheonixPharts 2y ago> hard not to regret the choice If you can't handle "regret" in these cases, then you probably shouldn't be in a position where you're deriving the vast majority of your income/weatlh from investments (which is fundamentally what a CEO does). It's astounding how many ICs can't wrap their heads around the concept that holding onto your RSUs make absolutely no financial sense. With rare exceptions, this doesn't make sense for anyone. And yet, fear for "regret" keeps people holding. But it's not shocking that even in tech many ICs are not good at reasoning financially. But if you want to be a co-founder, and hold a lot of your wealth in investments it's essentially that you learn to reason, plan and accept outcomes accordingly. Otherwise you're more-or-less a professional gambler.
- skybrian 2y agoI believe in diversification and index funds for most people, but this seems overdone. The issue here is that sometimes if you procrastinate about diversifying, it pays off very well. As a Google employee (who joined after IPO), it was by far my best investment and funded my retirement. I guess that's accidental gambling. I did have other investments.
- lurking_swe 2y agoYes that’s accidental gambling. Or what i like to call “at the right place at the right time”. Ask a Yahoo employee how that same plan would have worked out for them. That being said, good for you. :)
- mgfist 2y agoMostly agreed, but as an employee you do have some semblance of material non-public information that gives you a structural edge in assessing the stock. (This probably works better at a 1k-5k company than a Google/FB, but I can't say because I haven't worked at the big faangs). I've benefited financially from having a good sense of how well things are going and holding/selling accordingly (within the confines of the law and blackout periods, of course).
- rybosworld 2y agoNone of this is very good justification for founders being the only employee that have the option to sell part of their stake. > If you were an employee and had $200k total value in your options, and you could sell 10%, you're getting $20k. It obviously depends on your financial situation, but having the option vs not will certainly matter to some employees. Not to mention that the stake could well be worth $0 in the future.
- earnesti 2y agoI don't think it needs any justification, really. The investor decides, whom to sell to and how much. If the founder doesn't want to organize a sale for employees, then he doesn't do that. He would probably have to pitch it and include it in to an already complicated funding round. I totally understand why a typical founder doesn't want to do that. If for you as an employee it is a deal breaker, then you can complain about it, change company or whatever. It is not like the founder owes anything to the employees (unless he has promised that). Everyone in the equation are adults and have to decide themselves, if the position they are in makes sense for them with the terms they have.
- rybosworld 2y ago> I don't think it needs any justification, really From a founder's perspective sure, you can do what's best for you. That's not what this article is about. This article is highlighting that there's a tendency in SV for founders to cash out early, and secretly. And along with that, there's a tendency to paint a narrative that the founders haven't sold a share. It's hard to see that as anything other than deceptive. It's one thing to join a startup that you know may not succeed in the long run. It's another to join a startup that has a founder whose been secretly cashing out along the way. Justification does seem necessary in that second scenario, at least from a morality perspective.
- earnesti 2y agoLying to the employees is scammy and wrong. However regarding that we would need more information what has exactly happened. Not telling or not highlighting something is not the same as lying. Personally I'm not in the SV scene but from Europe, and I don't know much cases of these early cashouts.
- MisterBastahrd 2y ago$500K right now would pay off my home and do a good job of setting me up for retirement in the future. $5M when you already have $45M doesn't move the needle much.
- fragmede 2y agoto put it bluntly asf, you're being poor (and I'm being insensitive). what's $500k going to do for you if you come from a rich family? you already have your rent paid for until you die, and vacations paid for. all you have to do to do is put up with your annoying family, which isn't the worst if you've been through therapy. your mom or dad's abusive? if you've been through enough family therapy, that's not a problem. if you ask you mom or dad, whichever believes in you, they have enough money to fund your dreams (if you care enough to ask) of joining or starting a startup to become an (x) CEO/salesman/builder/marketer/whatever for whatever you want to build, and that includes signing onto some startup that won't pay you a living wage until it fail-exists for $5 million and everyone goes to burning man/Berlin/ibiza on the founders dime (including rent for everyone N months).
- Matticus_Rex 2y agoYes, there are people who won't get the same benefit from hedging like this. But they're a small minority. Not that many people meet your description here.
- dayvid 2y agoWould be interesting to see average founder who can fundraise large amounts and family income. I’d imagine they tend to come from higher income backgrounds, though could be wrong.
- Matticus_Rex 2y agoI'm sure the wealthy are overrepresented, whether or not they got financial help from their families while starting/building the business. But there's a long gap between "being rich makes it more likely to succeed" and "most people who succeed are rich."
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- fragmede 2y agomy goal isn't that someone who is in that position reads this. as you said, they're a small minority. they already know this. but people who aren't in that position might want to know how the world is shaped for other people
- gwbas1c 2y agoI think the most interesting part of the discussion is that the early employees almost always get the worst end of the deal: Going in they have a lower salary than if they work for a more established company. Then, either their shares end up being worthless, or at the final exit, they make less money than if they worked for a more established company the entire time. IE: Being an early employee in a startup is a lose-lose situation. This is something founders need to understand when recruit their early employees: These are often the most critical hires for the business, and therefore it needs a high probability of upside. IMO: A series of retention bonuses, and/or guaranteed bonuses at acquisition / funding events is a good solution. It's how I've sidestepped the equity issue when I was employed during an exit event.
- corry 2y agoI'm curious why you think these employees -- who are getting the worst end of the deal -- are working for startups in the first place? Either they have the skills to be a founder themselves or to work at BigTech... or they are financially ignorant/disinterested enough to not understand how equity in corporations work? Or is the charming and misleading founder who is to blame? My point is that considering the high avg intelligence of the typical startup employee, there must be something else going on. Clearly, people like working at smaller companies that have potential to grow - maybe that's because there's more interesting work, less bureaucracy, smaller teams, more of a sense of a journey, etc. Easy to devalue these things, but what else explains the fact that even when there's more risk and likely poorer financial outcomes these otherwise very intelligent people still choose to work at these companies?
- underdeserver 2y agoOr they want to work at a small startup and have the technical skills, but don't necessarily want to manage people, work insane hours, and meet with customers and potential hires instead of building the product.
- sshconnection 2y agoAn early stage startup is a bad place to avoid working insane hours.
- dmitrygr 2y ago> when the startup ends up selling for $250M s/when/in the statistically and historically very unlikely case that/g
- ericd 2y agoThe strongly diminishing marginal utility of money after $10M for most people makes that first $500k much more impactful than $5M would be after you have $45M.
- underwater 2y agoAnother consideration is that employees are much less conscious of the real value of their stock than founders, and you don’t want to make the (lack of) value of their shares too obvious in the early stages. If you tell them the value of their stock is $200k, and 90% of that is imaginary, then they might start thinking about that job offer with a 500k stock grant at a listed company.
- natosaichek 2y agoThis is basically arguing "It's good to deceive your early employees about the value of their compensation" This is morally repugnant to me, and I hope you're not an executive at a company. If you are, I would not work for you.
- phone8675309 2y ago> If you were an employee and had $200k total value in your options, and you could sell 10%, you're getting $20k. Not really enough to de-risk your life although still might be welcome (and employees would appreciate having the choice). $20k would be a life changing amount of money for me right now
- booleandilemma 2y agoWhat would you do with $20k that would change your life?
- phone8675309 2y agoLet me complete a down payment on a house and stop renting.
- Aerbil313 2y agoPeople often forget how financially limited they were when they were young. There are even college freshmen reading your comment for whom $1k would change their lives. Such as this one who is currently contributing to Textadept on school machines from 2013 on NixOS installed on a USB drive (don't recommend, CPU I/O wait time is frequently >%50) because he spilled coffee on his laptop last semester.
- kelnos 2y agoRegarding your point (1), there's more to it than just the dollar amounts now and later. If we believe the over-leveraged founder story where that founder has mortgaged their home and maxed out their credit cards, being able to sell that equity at series A for $500k could mean the founder is able to pay those debts, and doesn't end up losing their home and being hounded by creditors. (Even if it doesn't get that bad, having that debt over your head is stressful, and running a small startup is already stressful enough.) If we also believe that founders are important to a company's success as it grows from a small startup into something more mature, I'm pretty sure that unfortunate financial (and housing) situation would drastically reduce the chances that the company would make it to that $250M exit later. So taking that $500k may increase the chances that the startup later gets sold for $250M, rather than, say, $50M... or just failing entirely, returning whatever small amount of money is left to investors.