This piece gives very helpful advice about the right questions to ask concerning equity when you are about to sign up with a startup as an employee. It also gives credible explanations of most of the equity-related issues at that stage.
In my experience, very few employees who get option grants will ask the right questions to understand what their equity piece really means. That is, they won't even ask about something as basic as how many shares a company has outstanding (much less about size of equity pool, liquidation preference held by the preferred classes, etc.). When they fail to get this information, they really are going into the employment with poor knowledge about what likely will wind up being the most piece of their overall compensation.
Why don't they ask? Sometimes they just don't know how it all works and proceed out of ignorance. More often, however, I think they feel intimidated about pushing a company to disclose what they think is company confidential information, especially when the company is a big-name company that is already VC-funded and the offer otherwise seems tempting.
Because of this, startups will sometimes play games in this area, arbitrarily inflating the size of the company's capitalization structure (e.g., splitting a 10M capitalization structure 3 or 4 for 1 to turn it into a 30M or 40M-share structure). This splitting lets the company make a 100K share offer to a key employee sound like a 200K share offer and hence make it appear better than competing offers from companies working from smaller capitalization structures.
It amazes me how many times employees will simply accept such offers thinking they got better deals than they would have from other companies, when in fact they may have passed up equal or better alternative offers. This is truly a case of flying blind but it happens a lot.
And, as much as it pains me to say this, some companies have a very, very strict policy about _not_ informing their employees or candidates as to what the number of outstanding shares are in the company.
Yes. I feel your rage.
In fact, I've expressed it to the executives of those companies.
But, as long as things look good, the company is getting funding, and an IPO looks like a possible event in the future, most (all?) employees are usually afraid to make waves.
It's like PG often says - there really IS a difference between a founder/early-stage-startup employee, and employees of more established firms. I'm guessing 50% of the HN core would probably call BS and walk away from any company who refused to tell them how many outstanding shares they had, particularly after they were employees of that company.
Uh, honestly, getting diluted at all sounds like utter bullshit. Imagine being told "you will get 100,000 dollars at the end of the year," and then halfway through the year you're told "okay, now it will be 50,000 dollars instead." What's your recourse there? How is it not a ripoff?
Am I misunderstanding a crucial aspect of the system?
Diluting is balanced by desire of the shareholders to keep larger portion of the company and need for the fresh funds.
I.e. seed investors + founders + pre-seed employees (+ISO pool) share all the stock between themselves. Now they are all in the same boat: additional stock is going to be issued for Series A investment and if investment is too large, all of them get diluted too match, if it's not enough, company dies. If you are employee, you can't do much about it, but founders and angels are going to look after their own interest and protect you as well. In this sense the most important number for pre-seed employee is the ratio of his stock to the founders stock.
It's possible to issue additional stock and just grant it to some parties to dilute other party, it's quite hard to do because if diluted party is dissatisfied (and it usually is), it exposes company to litigation.
First, what you're given is a number of shares, not a fixed percentage of the company - if you're given 100,000 options at the start of the year, you still have 100,000 options at the end of the year.
Second, the dilution that occurs through the issuing of shares to investors should make the company more valuable, not less - because the company takes that money and grows with it. Your shares are a smaller percentage of the overall company but end up worth more in absolute dollar terms. (If that's not the case, the company is wasting other people's money - the value of your shares goes down, but this is deserved.)
In other words, if you go from a 1% stake to a 0.1% stake through dilution and then get $20K of a $20M sale, you haven't been ripped off, you just overestimated the company's ability to turn your initial 1% stake into something meaningful.
In my experience, very few employees who get option grants will ask the right questions to understand what their equity piece really means. That is, they won't even ask about something as basic as how many shares a company has outstanding (much less about size of equity pool, liquidation preference held by the preferred classes, etc.). When they fail to get this information, they really are going into the employment with poor knowledge about what likely will wind up being the most piece of their overall compensation.
Why don't they ask? Sometimes they just don't know how it all works and proceed out of ignorance. More often, however, I think they feel intimidated about pushing a company to disclose what they think is company confidential information, especially when the company is a big-name company that is already VC-funded and the offer otherwise seems tempting.
Because of this, startups will sometimes play games in this area, arbitrarily inflating the size of the company's capitalization structure (e.g., splitting a 10M capitalization structure 3 or 4 for 1 to turn it into a 30M or 40M-share structure). This splitting lets the company make a 100K share offer to a key employee sound like a 200K share offer and hence make it appear better than competing offers from companies working from smaller capitalization structures.
It amazes me how many times employees will simply accept such offers thinking they got better deals than they would have from other companies, when in fact they may have passed up equal or better alternative offers. This is truly a case of flying blind but it happens a lot.