"Dead equity" could also be used in reference to most of a company's investors.
That is of course, tongue in cheek. Why should employees have their investment of time and energy taken away from them when investors' one-time cash investment earns preference? Another industry double-standard.
It's not really a double standard. A share of stock and an option to buy such share of stock are two distinct products, priced differently.
E.g. MSFT share price today is $64.27, a contract allowing you to buy a share of MSFT on March 17, 2017 for $64 is 83c.
Investors buy their shares in full, cash-on-delivery, so to speak. Would investors like to be able to buy call options in the companies at pre-specified valuations for just 1.5% of the price and complete freedom to exercise (as well as forfeit) those options four years down the road? You betcha.
Not only do they need to pay significantly less to participate, they can spread those bets around and cover roughly 60x more companies, if they choose. Or double or triple down on this one specific company. Or just sell their option down the road in case it's the next FB or Uber without ever needing to put up cash.
Both investors and employees get to buy their shares for cash. Employees though do get the luxury of time, and can not only benefit immensely from stock's rise, but also save their hard-earned money in case of a dud. Investors do not get the latter option. Therefore they seek compensation elsewhere, usually in the liquidation preference department (which is moot anyways if the liquidation value is $0).
I don't think you're really justifying why employees and investors ought to have different terms. To the extend that investors need extra compensation, they can always be compensated with additional shares, regardless of those shares' terms.
I think in an ideal world, investors would normally receive common stock (and more of it), but there are some practical reasons why that isn't the case:
- Selling preferred stock lets a company declare a more lofty valuation.
- If a company sold common stock to investors, they'd have to use the more realistic fundraising valuation when pricing options, rather than a (typically) more conservative 409a price.
- Employees tend to not have access to the cap table, or not understand it, so there's not much disadvantage to giving them less favorable terms.
The basic reason that investor capital has a liquidation preference is that if it didn't, the founders could raise $X million on day N, then since they hold the majority of voting rights, declare bankruptcy on day N+1, and split the majority of the invested capital among each other.
There are ways around this, such as giving the investor a veto on bankruptcies and reorganizations, but the time-honored solution is a 1x liquidation preference where the investor gets their capital back in a bankruptcy.
I'd go with Occam's razor on this - investors always want preferred, the more preferences the merrier, companies always want to sell common, and if they could go sub-common (by stripping the shares of voting rights or dividend participation) they would.
Whoever has the most leverage in the transaction tends to win.
Yeah, but you still have to buy the shares at strike price. So not only are you getting paid below market rate, but you have to spend some of that pay exercise cost and taxes to have proper equity. So it's not so simple.
What did you mean then by "much prefer to have shares over options"? I assumed this implied equal footing with the investors, and shares distributed in exchange for the check. If you have the means and are willing to tolerate the risk, shares are a better deal. If at least one of those components is missing, call options are a better deal.
Because the investors' cash is the thing that enables high growth companies to survive and be, well, high growth (who do you think pays said employees' salaries?). Not saying they don't often make out much better than employees, but no one forces you to accept a term sheet you don't want to, and you should understand the implications of the equity you're getting walking in.
That's possibly the most bullshit argument I've ever heard.
Any founder will tell you employees are more important than investors. It's possible to build a successful company without VC—it's impossible to build one without quality employees.
I don't buy that argument for a second. The employees actual work, causing the startup to be able to actually do something or sell something, is what allows the company to survive.
IMO there's no point in arguing about the relative importance of investors versus employees, because everyone should be in favor of more flexible equity terms.
The 90 day rule creates a lot of risk for employees who lack the capital for early exercise. If employees are rational and well-informed, they'll heavily discount the value of any options with a 90 day expiration. By offering more flexible terms (like Quora's), companies should be able to hire the same candidates while giving away less equity.
Granted, some employees don't ask about the equity terms in their offers, or don't carefully consider the risks. But I think this is improving, and eventually more flexible terms will become standard. I've personally declined a few offers based on the equity terms.
Employees are effectively making an investment in the company in the form of work instead of cash. If a startup chose not to give out stock options, they'd likely have to pay their employees more, and they may have to raise another round to get cash to do so. The dilution from that round would never come back to the original stockholders under any circumstances.
When employees accepted the options in lieu of cash, they were taking a risk in exchange for a potential future reward. The work they put in often makes that success happen, whether or not they're actually working for the company at the time a liquidation event occurs.
I liken the scheme a16z proposes to something like using a loophole to buy back all of your investors' stock at their original valuation, just because you got to profitability. At that point you no longer _need_ their money, so why do investors deserve to reap the rewards?
That is of course, tongue in cheek. Why should employees have their investment of time and energy taken away from them when investors' one-time cash investment earns preference? Another industry double-standard.