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>However YC gets preferential shares; It's not that YC specifically gets "preferred shares" -- it's that investors in general insist on liquidation preferences
by jasode 2y ago
>However YC gets preferential shares;
It's not that YC specifically gets "preferred shares" -- it's that investors in general insist on liquidation preferences when buying non-liquid shares in unproven private companies.
How would an alternative scenario of investors buying common shares of illiquid stock in a private company actually be realistic? Maybe the startup founders could hypothetically insist on selling only common shares and never preferred shares as a condition of investment?!? But what investors (other than family relatives) would put in money in that case?
Or put another way, let's say we create a brand new VC fund to invest in startups and one of the novel concepts is that the fund only buys common shares to be more "founder friendly". The problem is that hypothetical VC fund will attract no rational limited partners with money because they know that startup founders can just take their invested dollars with no payback protection. Such a VC fund with no investors and no money to invest would be a moot point. The general partner of such a VC fund would be considered a "financial idiot" for buying common shares in startups.
In the end, the "preferred shares" is the market's "risk premium" that investors charge as an offsetting factor for losing 100% of their money. If startup founders can't find a way to convince investors to accept illiquid common stock instead of preferred shares, they need to avoid investors altogether and self-fund via bootstrapping.
- dustingetz 2y agopreferred shares prevent cookie cutter founder fraud. Founder raises $1M at 10 post. Founder decides to sell 6 months later for 2 mil. Investors get 200k back founder gets 1.8 mil. Now run this math for AI unicorns.
- AbstractH24 2y agoThis is a valid concern. But shifting risk entirely to those without preferential shares (typically employees) is also unfair.
- dustingetz 2y agodifferent share classes trade at different prices. Employee NSO/ISO strike price at seed stage (i.e. on a SAFE) are typically priced at a FMV of 10% (!!) of the SAFE's postmoney valuation. Also, your use here of the word "fair" has triggered a personal tick of mine so I must direct you to https://quotefancy.com/quote/3709551/Chris-Voss-The-F-word-Fair-is-an-emotional-term-people-usually-exploit-to-put-the-other https://quotefancy.com/quote/3709551/Chris-Voss-The-F-word-F...
- nradov 2y agoWhy would investors care whether a particular capital structure is "fair" to employees? As long as the company is able to recruit and retain qualified employees, any fairness or lack thereof is entirely irrelevant. But as a potential employee interviewing for a new job, if you're being offered equity compensation then you might want to inquire about share classes and liquidation preferences. It could be a factor in your decision if you have multiple options.
- ultrasaurus 2y agoOr to make it even more obvious: Founder raises $1MM then immediately sells the company for $900k :) Some terms are going to need to exist to prevent that, so the investor shares will always be preferred. Beyond that there are in fact a lot of other terms that are in some deals but not others (2x preference, pro rata, etc..)
- derangedHorse 2y agoHe didn’t claim YC does this where others don’t, his gripe is with the narrative YC pushes and how they seem incongruent to how they currently operate.
- AbstractH24 2y agoWhy is the risk being taken by investors greater than the one being taken by employees and founders? If anything, employees are taking a greater risk because you can replace money far more easily than years of your life.
- epistasis 2y agoOne is risking money, one time, and the money is what could possibly get paid back. If you can find money that doesn't insist on preferred liquidation, good on you. But those with the money tend to have a lot of say on giving it away.
- mlhpdx 2y agoFor what it’s worth, which isn’t much, I see signs this precept is changing because of the huge amounts of investible capital fighting for opportunities as the thaw progresses. It’s not going to be a widespread change, though, most will stick with what they’ve known.
- nradov 2y agoThe level of risk is irrelevant. What matters in access to capital is negotiating power. This isn't a charity. If employees want lower risk then they can go work somewhere else.
- mlhpdx 2y agoLikewise, if investors want to invest (deploy capital) they will adapt. There is more balanced leverage recently.
- pockmarked19 2y ago> The problem is that hypothetical VC fund will attract no rational limited partners with money because they know that startup founders can just take their invested dollars with no payback protection. YC famously claims it is not a VC fund because it invests their own money, they wouldn’t have this problem.
- jasode 2y ago>YC famously claims it is not a VC fund because it invests their own money, Th label "VC fund" can be imprecise because YC itself has changed its structure over the years. The original 2005 YCombinator where Paul Graham & Friends used some of their personal Yahoo wealth from selling ViaWeb ... instead of raising outside money from "limited partners" ... was the period when they were more like "angel investors". Today, YC is more institutionalized and has different funds that raise money from outside investors as limited partners -- very much like traditional VC funds. (https://www.google.com/search?q=YC+new+funds+raise+billions https://www.google.com/search?q=YC+new+funds+raise+billions) But YC still doesn't do all the typical "vc fund" procedures such as take a board seat or negotiate a different % with each startup founder on a case-by-case basis. The VC funds like Sequoia/a16z/etc will require a board seat and negotiate different ownership percentages. So today's YC is a "semi" VC fund depending which aspects are salient to you.