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Comment by zapita | Hacker News Reader

Except employees do invest money in the business by exercising their options. And that money, dollar for dollar, buys them an inferior product: lower priority in the liquidation stack; less liquidity because of abusive bylaws restricting secondary transactions; less tax benefits since your “gains” are taxed upfront.

The lower the pay, and the higher the relative cost of exercising, the worse it gets. So higher-paid executives are less penalized than entry-level employees who might spend their savings exercising options that will end up worthless.

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"And that money, dollar for dollar, buys them an inferior product: l"

No, employees are usually offered options at market value when they are issued. They are essentially 'free' at the time of their issue. If they 'cost something' at exercising time, then they are 'worth at least' the cost of exercising, and usually more.

An 'option' definitely has value beyond a stock, because you don't have to actually take any risk if you don't want to. You can just 'wait and see' - which has very material economic value.

> No, employees are usually offered options at market value when they are issued.

It absolutely is an inferior product. Preferred Stock comes with a preference, in the absolute best case it's 1:1; owners of Preferred Stock will get 100% of their money back in a sale of the company before Common Stock owners see $0.1. There are sometimes worse deals (for the employees) where Preferred Stock gets back 2:1 or worse.

Common Stock (what employees get as ISOs or NSOs) is absolutely an inferior product.

I believe the grandparents comment was about options not common stock.

You are not accounting for the optionality of the ISO.

The ISO is an option to buy a stock, not actual stock. An option on a stock has material value due to the de-risked nature of it.

Someone with 'preferred' shares gets their money back first, sure, but someone with an 'option' never even has to put their money in the first place. An 'option' gives you all of the upside with none of the downside.

Would you rather put $1M in a company for 10K 'preferred shares', or would you rather be given an option to buy 10K shares at 1 cent each. Without knowing anything else at all, you'd probably choose the later.

> Someone with 'preferred' shares gets their money back first, sure, but someone with an 'option' never even has to put their money in the first place.

That’s not true. They are paid for at very high opportunity costs.

Yes but the context here is liquid investment, which is what preferred stock are meant to be a defense for (at least according to what I've heard).

(The opportunity cost is also paid slowly over years; I think VCs get better terms in part for front-loading all the money.)

> An 'option' gives you all of the upside with none of the downside.

To see any of that upside you have to exercise the option. If the company has the common 90-day post-termination exercise window, that means if you want to change jobs you need to come up with cash to exercise what’s supposed to be part of your compensation, and if the FMV is much higher than the strike price, hand a bunch of cash to the IRS too.

Now you’ve put in your time as an employee and reinvested the salary the company gave you right back into the company, and you’re likely at the back of the line with common shares.

Yes, windows on exercising are also part of the value, but you are fundamentally misinterpreting the concept of investing real money and optionality.

Your misunderstanding leads you to believe that somehow an option is worth a lot less than a 1x participating stock, and it's not.

Again you side-stepped the comparable:

As an employee, even with a '90 day exercise window' which would, you chose for compensation (or what would most people chose?)

1) the ability to invest $1M for a bunch of preferred shares; or

2) a bunch of ISO's at a low exercise price?

Everyone will take the ISOs due to their riskless nature, now why would they take option 2 if it's so 'inferior'?

A 1x participating preferred is a perfectly rational type of financial instrument for VCs, and some type of ISO is actually well aligned for staff. Though things might evolve here and there, there is zero chance that the 1x preferred aspect is going away.

As an employee, instead of exercising, say $30k worth of ISO, I would much rather buy $30k of preferred at fair market value. Even better if I got a discount on fair market value. I would also like the company to pay the 30k upfront as a loan or sign-on bonus, a common practice for executives already.

> I would much rather buy $30k of preferred at fair market value.

Sure, but VCs aren't getting shares at FMV either.

My bad, I meant "at the same price as VCs". You are correct that's not what fair market value means.

> 1) the ability to invest $1M for a bunch of preferred shares; or > > 2) a bunch of ISO's at a low exercise price?

Why is this the choice? how about:

3) a bunch of ISOs of preferred shares at the current FMV

Why is a VC putting in $1m riskier than an employee taking a full time job with the company? Why can't an employee who vests shares get the same preference when they reinvest their own money into the company?

Also: why do startups cover the new hire’s early exercise cost upfront when the new hire is an executive, but not for other employees ?

Because 'Cash in hand' is worth more than the risky nature of what you are able to deliver with your 'time in', esp. after receiving a salary.

That you will never get 'preferred' ISO's is a fundamental fact of the market, which accounts for such risks.

Implying it's 'unfair' is more or less like saying 'your salary is only 1/2 what it should be'. There's definitely an underlying reason your salary is roughly where it is, it's better to understand why it is what it is.

Options can be issued on any kind of stock. I think it makes sense to issue them on preferred stock. However I don't know what is the common way of handling this. In fact, the companies I know don't even have separate classes of stock.

In these discussions it is important to understand that each company might have totally different arrangements when it comes to equity.

> It absolutely is an inferior product.

I don't think they were disputing that? But it's not dollar-for-dollar equivalent -- VCs are paying more (a lot more, I think usually) liquid cash per preferred share than employees are paying liquid cash per option of common stock.

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