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Walk me through the mathematics of why an Employee at a startup they believe in and have vested equity in would sell that pre-IPO to an investor? Can you provi

Walk me through the mathematics of why an Employee at a startup they believe in and have vested equity in would sell that pre-IPO to an investor? Can you provide a few scenarios? I imagine other HN readers are curious too, especially given our(collective) lack of experience with IPO's....well at least mine.

kevinpet 13y ago
Everyone believes in their company, even the people who work at companies that turn out to be duds. If 90% of your wealth exists only in the theoretical value of your pre-IPO stock, that's not a good balanced portfolio.
- taybin 13y ago
  Everyone?
- patmcc 13y ago
  >>Everyone believes in their company, even the people who work at companies that turn out to be duds. Why would this be true? If desperate, I'm willing to work for any (non-evil) company I believe can pay me what they owe. The product can be absolute garbage that'll never sell, that's not really my problem. It would obviously impact my valuation any stock options, but that's another story. (I'm happy to work at a place I do believe in - although I'm still glad they pay cash and not stock).
rahimnathwani 13y ago
Imagine your net worth consists of 100k cash, and a lottery ticket which, by your reckoning, has 15% chance of being worth 1m, and an 85% chance of being worth zero. Imagine further that you won't know the outcome until 3-5 years from now. Let's forget the time value of money for a moment. The expected value (mean value under all possible future scenarios) is 15% x 1m, i.e. 150k. This is more than half your net worth. Wouldn't you give an investor a discount if he agrees to buy half of the lottery ticket? It would get rid of the 85% chance that you lose over half your net worth through an outcome over which you have only limited influence. Also, you can buy stuff with cash. Today.
- kumarski 13y ago
  I see. That makes sense. Well put. Are you on the team?
  - rahimnathwani 13y ago
    Thanks. No, I'm not on the team.
- gargarplex 13y ago
  Plus, you might not even have enough cash to exercise your options before they expire.
aetherson 13y ago
A couple of other commenters have basically mentioned risk hedging -- that is, the concept that you might think that your company is a good one that has better-than-usual chances to monetize, but recognize that even good companies fail. They're right, and that's one reason. The other reason is liquidity. Sometimes you want money now, not in a few years. Maybe you need to buy a house, or you want to start your own business (and thus not have a salary income for the next two years or more), or you or your spouse are pregnant, or you just decided you have to have a new Model S.
ry0ohki 13y ago
Sometimes a liquidity event is quite a ways off. This is partly why founders of Groupon, early employees of Facebook, etc... sold to secondary markets even when their companies were quite promising. People like money today more than money tomorrow.
czr80 13y ago
So, the textbook answer people will give you is risk diversification - even if you believe in the company, why keep all your eggs in one basket? While there is some truth to this, there is also this: https://en.wikipedia.org/wiki/The_Market_for_Lemons https://en.wikipedia.org/wiki/The_Market_for_Lemons Basically, the risk is that people most likely to want to sell are those with some suspicion that there is a problem, buyers are therefore suspicious and demand a discount, this in turn drives out people with stock in good companies since they don't want to sell at a big discount, and the market collapses...
noname123 13y ago
Maybe as an Employee, you know that your startup is crap and won't go public or will below the IPO price (e.g., GRPN) and you can milk the investors when the impression is better than it seems before IPO. Also typical IPO has a one year lockup period, so it's not like you can cash out the day when a IPO is suppose to skyrocket but have to wait out a whole year while the cooler heads prevail and analyzes your books and 4Q of earnings to analyze your burn rate and revenue.
- johnpmayer 13y ago
  So, insider trading essentially.

kevinpet 13y ago

Everyone believes in their company, even the people who work at companies that turn out to be duds. If 90% of your wealth exists only in the theoretical value of your pre-IPO stock, that's not a good balanced portfolio.

taybin 13y ago
Everyone?
patmcc 13y ago
>>Everyone believes in their company, even the people who work at companies that turn out to be duds. Why would this be true? If desperate, I'm willing to work for any (non-evil) company I believe can pay me what they owe. The product can be absolute garbage that'll never sell, that's not really my problem. It would obviously impact my valuation any stock options, but that's another story. (I'm happy to work at a place I do believe in - although I'm still glad they pay cash and not stock).

rahimnathwani 13y ago

Imagine your net worth consists of 100k cash, and a lottery ticket which, by your reckoning, has 15% chance of being worth 1m, and an 85% chance of being worth zero. Imagine further that you won't know the outcome until 3-5 years from now. Let's forget the time value of money for a moment. The expected value (mean value under all possible future scenarios) is 15% x 1m, i.e. 150k. This is more than half your net worth. Wouldn't you give an investor a discount if he agrees to buy half of the lottery ticket? It would get rid of the 85% chance that you lose over half your net worth through an outcome over which you have only limited influence. Also, you can buy stuff with cash. Today.

kumarski 13y ago
I see. That makes sense. Well put. Are you on the team?
- rahimnathwani 13y ago
  Thanks. No, I'm not on the team.
gargarplex 13y ago
Plus, you might not even have enough cash to exercise your options before they expire.

aetherson 13y ago

A couple of other commenters have basically mentioned risk hedging -- that is, the concept that you might think that your company is a good one that has better-than-usual chances to monetize, but recognize that even good companies fail. They're right, and that's one reason. The other reason is liquidity. Sometimes you want money now, not in a few years. Maybe you need to buy a house, or you want to start your own business (and thus not have a salary income for the next two years or more), or you or your spouse are pregnant, or you just decided you have to have a new Model S.

ry0ohki 13y ago

Sometimes a liquidity event is quite a ways off. This is partly why founders of Groupon, early employees of Facebook, etc... sold to secondary markets even when their companies were quite promising. People like money today more than money tomorrow.

czr80 13y ago

So, the textbook answer people will give you is risk diversification - even if you believe in the company, why keep all your eggs in one basket? While there is some truth to this, there is also this: https://en.wikipedia.org/wiki/The_Market_for_Lemons https://en.wikipedia.org/wiki/The_Market_for_Lemons Basically, the risk is that people most likely to want to sell are those with some suspicion that there is a problem, buyers are therefore suspicious and demand a discount, this in turn drives out people with stock in good companies since they don't want to sell at a big discount, and the market collapses...

noname123 13y ago

Maybe as an Employee, you know that your startup is crap and won't go public or will below the IPO price (e.g., GRPN) and you can milk the investors when the impression is better than it seems before IPO. Also typical IPO has a one year lockup period, so it's not like you can cash out the day when a IPO is suppose to skyrocket but have to wait out a whole year while the cooler heads prevail and analyzes your books and 4Q of earnings to analyze your burn rate and revenue.

johnpmayer 13y ago
So, insider trading essentially.