And employees deserve to be sandbagged? That seems monumentally unfair...
The first thing they did was fire the founders, of course.
So...foolish founders? Yes. But wait! Foolish investors? YES!!
Because they absolutely screwed every employee, almost all the employees walked the afternoon we were informed.
I've never been prouder of the people I worked with. I think there were four people (tech support/admin) left out of 20 or so. Hard to remember now...so long ago.
For several hours the shitball investors were exceptionally proud of themselves...and then they realized they'd bought a pile of PCs they had no idea how to use. Plus bonus shitty furniture! And goodbye investment, of course.
We all formed a new company within a few weeks. The original founders somehow got money to get us started again...which we did, from absolutely nothing. We rewrote a similar product suite (but better!) in about 9 months, and went to the next big industry show with it.
Shitball investors found out, and promptly sued us (mild shock), claiming without evidence that we must have stolen the code on the way out. Since I was there for every single line of code we wrote the second time around, it was infuriating.
The ball bounces through the courts...they continued to harass us...and all does not necessarily end well.
In any case, don't lose control ;)
Usually you structure your board in a way that prevents this-- not to mention that you could likely prevail in litigation if these are the facts because the board has a fiduciary duty to all investors, not just preferred: only if there is no reasonable prospect for common to get something can you accept an offer like this. Not to mention that when a controlling shareholder enters into a transaction with the corporation they have the duty of showing that the transaction is fair for all involved.
I wonder if there are stories about this happening in certain contexts that predated liquidity preferences?
There's a thing you're missing here, and it's option value. You don't commit to the lost money over 4 years all at once, while a cash investor does immediately give up present-valued money. Instead, you commit to spending a year or so there (~$250k-valued), and only if your options look like they're going to be worth a whole lot do you stay beyond that point.
You raise an amount that will get you to the next capital raise, and convince other entities that you are sufficiently capitalized (banks, lessors, contract counterparties, prospective employees), and deal with a moderate amount of contingency. You don't want to excessively raise, because it's excessively dilutive when capital is expensive. You also don't want to have to raise again with nothing to show for the spent cash.
Even if we grant your statement "there is no advantage of having the entire amount upfront"-- there would be a benefit to the investor of having option value about whether to continue to invest; option value that an employee has. It's easy to model this and see that option value is quite valuable. (Investors would really like it, so we do see things like efforts at tranched investments or leaving a round open... but entrepreneurs hardly want to have to sell an investor equity at the same price if the investor decides he wants it a year from now).
With a direct cash infusion there's none of that. Any idiot can immediately sell $10M for $10M.
Time isn't liquid. If instead of giving a startup time, you gave them literal cash, then it would make sense that you get preferred (instead of common) stock, to protect against the founder just selling the company immediately for the value of your cash (as was mlyle's point). If you give them your time instead, there's no risk of them immediately selling off "your time", and so it makes sense that you get common stock instead of preferred stock (at least for this one consideration).
The other general point I think you're making though, is that if we look at the value of the time being invested by a startup employee, their ROI is much worse than a literal investor in the company.
This is true, and somewhat unfortunate I think, but I think happens because VCs control larger amounts of capital and thus have more leverage. Both in terms of absolute amounts, but also how quickly they pay it out.
You taking a $400k paycut for 4 years and a VC investing $1.6M are numerically the same, but the VC gives up the $1.6M immediately, whereas you give it up over time, and can at any time decide to stop investing. When you first start, maybe your ROI is worse than a VC's, but three years in, maybe the ROI of the time your investing _then_ will have improved relative to a VC that tried to invest three years in.