Hacker News Reader

Comment by nathan_f77 | Hacker News Reader

I don't really understand why dilution is such a common thing. Why not just issue a fixed number of shares at the beginning and plan for future funding rounds? If I was a founder of a VC-backed startup, I think it would be much more fair to sell my own shares to investors, instead of diluting all of my early employees.

If you offer your first employee 1% of the company, but everyone knows that they're going to end up with ~0.3% after all the dilution, then just give them 0.3% and promise that there will be no dilution.

EDIT: I just got to the end of the article: "Finally, we structured our company in such a way that our tokens never dilute." That sounds like a great idea to me.

View on HN

>I don't really understand why dilution is such a common thing.

It's because the dilution mechanism is the easiest way to sell partial ownership without tax penalties and it also a minimizes the # of transactions among previous owners.

Reducing everybody's ownership by a percentage amount ("dilution") is way more straightforward than having all owners coordinate to sell a fraction of their shares to an investor.

>, I think it would be much more fair to sell my own shares to investors, instead of diluting all of my early employees. [...] , then just give them 0.3% and promise that there will be no dilution.

Let's say an investor wants to invest $1 million. If you sell your shares, it will be a taxable event. You'll pay ~$350k in taxes to the government and keep $650k. On the other hand, if you dilute everybody, that $350k can be used by the company to pay salaries for 2 more programmers for another year.

To simplify all this, what you, as a founder, really want to achieve when looking out for the welfare of employees is to increase their total wealth. Dilution isn't the real issue; instead, it's ultimately increasing their total wealth by making the company more valuable.

(If you want to somewhat approximate the idea that "0.3% that never dilutes", the company could issue extra refresh grants to that employee. But mathematically, that still requires diluting somebody else because all owners still have to add up to 100%.)

>EDIT: I just got to the end of the article: "Finally, we structured our company in such a way that our tokens never dilute." That sounds like a great idea to me.

It's only a great idea of future investors buy into it. If Near's previous tokens "never dilute", then the author doesn't make it clear what the future investors are buying. The investors can't be buying equity since they just said existing tokens don't dilute. So are new investors providing a loan? Or buying bonds? Or buying warrants? Or if they're buying "utility tokens" instead of "ownership tokens", how do their investors make a multiple of their investment back?

> Let's say an investor wants to invest $1 million. If you sell your shares, it will be a taxable event. You'll pay ~$350k in taxes to the government and keep $650k. On the other hand, if you dilute everybody, that $350k can be used by the company to pay salaries for 2 more programmers for another year.

I'm a solo founder who owns 100% of the company, and I forgot how Stripe Atlas set it up for me. My company has a total of 10 million shares, and I purchased 8 million shares at the beginning, and left 2 million shares in the option pool for employees. So if I wanted to raise money, I'd need to issue more shares, instead of selling some of my own (which would be personal income.)

I'm not 100% sure how it works, but I still own those 2 million shares, even if I didn't purchase them. So I don't really know why I purchased 8 million shares, instead of 1 million, or even just 100 shares.

Then if someone wanted to invest $1M, the company could just give them some of the ~unissued~ authorized shares. So I wouldn't need to sell any of my own shares or issue new ones.

Is there any reason why that wouldn't work?

EDIT: Ohhhhhhhh that's exactly how it works already. I got confused between authorized and issued shares. This quora answer helped me understand it: https://qr.ae/TUfj33

Also this Stripe Atlas guide: https://stripe.com/atlas/guides/equity#why-dont-companies-im...

I think it's still a bit annoying that Stripe Atlas only authorized 10 million shares for me, and I already issued 8 million to myself. It sounds like I will have to do some legal work to authorize additional shares for investors in the future.

>I think it's still a bit annoying that Stripe Atlas only authorized 10 million shares for me, and I already issued 8 million to myself. It sounds like I will have to do some legal work to authorize additional shares for investors in the future.

The 'some legal work' in question is trivial if you're the sole owner and stakeholder, so don't be too concerned. :)

Startups don't tend to be fans of tying their own hands in terms of what they can do with stock.

To be fair - investors are also not fans of that. Potential investors will look at how shares and stock options are distributed and determine if it will allow them the flexibility they need in future fundraising/buyout efforts.

To go against this (investor interest and personal flexibility) founders would both have to have strong conviction and KNOW they won't need to rely on pleasing VCs in the future, for the company to survive.

This goes against how startups are currently built.

Yes it is sort of odd that the status quo is to offer a sliding amount of equity (due to dilution).

I'm not immediately sure why a fixed amount of shares, whose value simply increases over time, is not the status quo. The only trouble I can see with this is that shares are non-divisible, so you have to give out at least 1 share, even if it is priced at $10,000.

The shares given to investors often have dilution protection and guarantees as to when the company can sell and what minimum compensation will be given to them if that happens.

They also have protections such as "If the company dies, we will have first claim to any assets of the company"

The reason this is not offered to employees is a combination of fear (if we're being generous) and lack of incentive (the employee often has little leverage and no legal representation to look over contracts).

The end result being - if you have the capital, you have the leverage.

You don't know what future funding rounds there'll be. Maybe you raise a seed investment and then decide to sell the company two years later. Maybe you'll raise 5 more rounds and IPO.

Also, if you sell your own shares the money goes to you, not the company. I guess you could then loan the money to the company, but you'd still be liable for tax.

Going from owning 1% of a 1M company to owning 0.5% of a 2M company isn't unfair. The extra value comes directly from the new shareholders investing their money.

Employees believing their ownership percentage will not change is a problem though, and founders should not suggest that to be the case.

> Going from owning 1% of a 1M company to owning 0.5% of a 2M company isn't unfair. The extra value comes directly from the new shareholders investing their money.

If this we're true, investors wouldn't be adding things like dilution protection to their contracts and special stocks that have further liquidation protections (and potentially voting rights) wouldn't be the norm for non-employees.

Investments are not one-to-one exchanges and employees take up most of the personal risk in the exchange due to lack of any protections as well as lack of a (personal financial) safety net if things go wrong.

Though I agree with you in that whether this is fair or not has nothing to do with what modern companies will do.

The reason that employees do not get these protections and rights is because they lack the leverage to demand them from the people who make those decisions within the company.

> Also, if you sell your own shares the money goes to you, not the company.

I'm a bit confused about the distinction. I'm a solo founder, so I own 100% of my company with no vesting schedule. Although I did set aside a pool of shares for employees. But even if those shares are just sitting there in the company, I still technically own them until I give them to someone else (because I own 100% of the company.)

So that's just what I mean. I guess it becomes a lot more complicated when you have some cofounders and a vesting schedule.

Reply on news.ycombinator.com