Hacker News Reader

Comment by ryguytilidie | Hacker News Reader

I was thinking about this recently and I had a bit of a question. People used to always ask "wow why do founders get so much equity and dish so little out to employees?" and the answer would always be "because the founders takes all the risk". In the last few companies I work for, none were profitable, all had founders making 150k+, and all took at least 1m from our rounds out for themselves. It made me wonder where this supposed risk comes from and why VCs don't seem to mind founders paying themselves so much?

View on HN

You joined at a later stage. Those companies probably represented the top ~20% of outcomes, with a high probability of success for the investors. For every company like the one you describe there are several that didn't raise the round, where the founders took no salary and ran up debts with nothing to show for it. They took the risk and, while they are arguably being rewarded prematurely, it's clear they survived what killed most of their peers.

Sure, all of that makes sense, but I don't see why the CEO of an unprofitable company should be making six figures, pulling out 7 figures and getting a ton of equity. Aren't the employees taking a risk too?

Employees are taking a risk. Employees can negotiate terms when they are hired. Employees can choose not to be employees and start their own companies.

In almost all circumstances, until very, very late in a companies funding cycle, a funded company is designed to be unprofitable.

Investors want to see two thing at that point:

1) A scalable business model. This means that as you add more users the cost of user acquisition goes down, and it is possible to see where the income per user becomes more than the cost per user.

2) Growth in the user base

Combine those two, and the lack of current profits doesn't matter (usually).

If a company is profitable then investors will want to know why that money isn't going into growing the company faster.

I don't see why the CEO of an unprofitable company should be making six figures, pulling out 7 figures and getting a ton of equity

Presumably they are being rewarded for that growth, and making a scalable business model work.

Aren't the employees taking a risk too?

Are they?

If they are being paid market rates, then it is hard to argue they are taking much risk at all.

If they are being paid below market rates then yes, the deserve other forms of compensation.

In some cases, as nl points out, it's because the strong growth and expected future profitability means the investors are happy paying the founders for value they've created.

Other times, it's simply a case of founders transferring investors' money straight into their own pockets.

It's a very, very useful skill as an investor (or employee, for that matter) to be able to distinguish the two.

The whole notion that "employees have a guaranteed paycheck" or "employees are taking no risk" only applies to large, established corporations, or well-funded (in a meaningful, cash-in-hand sense; not the promises-and-notes sense) new companies. Even then it's only marginally applicable and tenuous at best, because office politics and other things beyond the employees' control makes their positions insecure (at best).

At start-ups the concept that employees are taking no risk is just laughable on its face.

The level of risk is significantly different. An employee bears the risk of losing their job. That's a bad thing, but you can go get another one.

The founder has likely foregone salary altogether for some time and run up personal debts while doing so. They've probably tipped a lot (relative to their net worth) of initial capital into the company to get it off the ground. If everything goes wrong, they need to go find a job _and_ deal with the mountain of debt they're now in.

If the company is at a stage where it has paid employees, a significant part of the risk of failure has already passed. There's plenty more risk to come, but you cleared the first few hurdles; and they're big ones.

Source: Founder that did all that stuff.

I don't disagree that the level of risk is different, or even that the level of risk is within, say, an order of magnitude. There's no doubt that some founders risk more (in some cases, much more) than employees. Wouldn't argue otherwise.

However, I would caution you that "racking up debt" isn't something only founders have as a risk. What you've described in your second paragraph is where just about anybody who isn't rich or well connected and has to rack up debt going to college finds himself, at least in the US. I would also caution you that employees frequently cannot merely walk out the door of the failed start up and into a paycheck across the street (as it were). They have to spend time, and their own savings, looking for work, in most places.

Compounding this is that odds are said founder has accumulated something the fresh college graduate or now former-employee hasn't: connections and the ability leverage his 'failure' into lucrative employment or future business opportunities. This helps mitigate the risk significantly.

I would argue that within the Valley your second paragraph actually isn't true. I've found that most people coming out of startups have a very easy time finding a job, unless they choose not to (i.e. they start their own business, etc.). I can't speak to other locales.

There are many places where tech startups exist that aren't the Valley. I've lived in both places. Outside of the Valley I've never had a job search take less than two months (time to offer from start of search); most often it took four to six months. I haven't had to search for a job in the Valley yet, so I'll have to defer to the experience of those who have.

That's why you start the search when you don't need it, yet.

Who's to say you will need it?

If nothing else, an outside alternative improves your negotiation power within the company.

debt?? it's investors' money. where's the debt? there's no debt at all.

You're treating employees as though they had the same tenure requirements as founders did. They just don't. If an employee starts a job at market salary, 18 months later the company dies, so they start another one at market salary, then the same thing happens, so they start another one, and yet again the same exact thing happens, so they start a fourth job, and that's the one they can stay at for several years..... then they've received substantially the same number of paychecks as if they had stayed at the first company for 6 years. It just doesn't matter that they had to change jobs a few times.

If a Founder is working for equity in a company for 18 months and it dies, it's an absolute personal disaster. There's no way to repeat that four times in a row and remain solvent and sane.

This simple example shows the fact that really it doesn't matter whether a company really guarantees an employee a paycheck or not. If it has enough money to pay you for a few months, you're good to start.

I wonder how true that is now.

There are mergers and acquisitions in companies of all sizes, so to some degree no jobs are safe.

Suddenly it makes more sense why people seem to want funding so badly: because then they don't have to be profitable to make money.

> have to be profitable to make money.

Haha, welcome

This is exactly what I was wondering about. Take snapchat for example, how are they getting revenue from funding or off their users somehow?

Are the VCs funding hoping that a company gets picked up by Google, FB, Twitter etc...?

If that were true then they probably wouldn't have turned down Facebook's $3 Billion.

They're gambling on getting an even larger userbase and having Facebook offer $5B

The liquidation preferences matter a lot. The company can sell for a tenth of what the valuation is now, maybe even less, and the investors would still break even. There aren't a lot of new consumer companies with zillions of users to invest in so they might as well, because the downside isn't that bad and the upside is... who knows?

Founders get so much equity because they started the company, and they can offer as little or as much to others as they want.

Non-founding employee equity is driven by market dynamics, where "taking on risk" only explains how they got in the situation of having so much to begin with.

It's fair in the market sense, but it doesn't need to be fair in terms of risk/reward.

Perfectly stated. Employee compensation is a contract freely entered into by the employee. If you think you deserve more, don't take the job.

However, I have sympathy for the fact that founder risk in SV has declined dramatically over the last twenty years, while employee risk has not, but if anything employee stock pools are smaller than they were a decade ago. Yet every founder says "it's impossible to hire good people".

Here are some ways to think about this: The equity is for risk already taken plus the value of the IP- the two years at minimal salary (or none at all) plus opportunity cost of not having a highly paid position (many founders could be execs at larger companies), not being able to save, worrying about payroll, etc. Why else risk your financial future? On top of that, most of the value creation comes in the initial stages (ie. where the work is less commoditized). This implies a larger value capture.

The compensation is market rate for the actual position currently held- eg. a CTO at a scaling startup makes $130K-150K, founder or not. This aligns incentives. A founder no longer working at their company does not/should not make any salary.

Re taking money out of rounds: This is for incentive alignment b/w the founders and investors. Mark Suster discusses this in much more detail than I can, http://www.bothsidesofthetable.com/2009/09/02/should-founder...

These situations are more complicated than they appear at first glance. You really don't know why things are structured the way they are until you get into them.

Because the founders took all the risk, sounds so much better than you showed up late to the party, sorry all the good stuff is gone, we've got some PBRs left though.

Fundamentally though businesses are designed around the risk of employees leaving, therefore you're in a pretty shitty point of leverage.

People will tell you whatever you'll believe in order to pay you less. It's not a VC thing, it's not a CEO thing, it's a people thing.

> why do founders get so much equity and dish so little out to employees?

1. It's their company. They get 100% of the equity until they choose to sell some of it.

2. Founders loose control of the company when they no longer own a majority stake of the equity.

3. They must sell a significant percentage of the equity when they raise money.

VCs do care about how founders spend their money, but it is in the VCs interest for a company to occasionally need to raise more money (see point #3).

lol @ "profitable"

What rock have you been living under? The SV game hasn't been about having a normal profitable business model for the god-knows-how-long.

You gotta get "value" and traffic and buzz and hype! Then maybe Google of whatever will buy you.

It's basically a sort of bubble. And while you operate in a bubble you can make a lot of money!

The only guys in town making money are ad companies, enterprise software companies, and hardware companies

I'm still making up my mind on how to think about these issues. I tend to oscillate between "fraud" and "well, that's what the market will bear".

Everything you've mentioned applies only post a few rounds of mega-million funding.

If you're pre-funding, then you're taking a humble salary - if any salary at all.

So clearly, there's some kind of moral hazard post successful funding. That seems more or less unequivocal and it's somewhat gross but I'm not sure what should be done about it other than vitriolic twitter comments whenever people talk about meritocracies and how inequality isn't a big deal because you too can learn how to code.

The current way of thinking about it is golden handcuffs align vc and founder incentives re: exit timing. Which is why Snapchat turned down $3 billion; the founders were provided with fuck you money and were under no pressure to flip before they've extracted maximum value.

REGARDING RISK AS A WHOLE,

It's not clear to me that founders of VC backed companies - from the founder's perspective, and in this job market - actually incur any exposure to risk above and beyond opportunity cost.

Saying that you quit your job to slum it out for six months building a start up is a pretty good resume polisher, no? Doubly so if you actually investment and treble if you got acquired or otherwise exited.

The way I see it your worst case scenario is suffering reputational penalties by pissing off important investors when/if you a) run out of money or b) try to exit early from your commitment.

This is not to say that VCs should have higher equity portions or that all that hard work and sleeplessness should go unrewarded, but more that equity arrangements are like so because that's what everyone negotiated, and not because of some intrinsic "deservedness".

Many founders work 50-60+ hours a week, they basically do not have a life outside of work. Further, many have worked for a company previously making $80k-$120k+ so $150k+ doesn't seem all that outrageous (to me anyways) because they want to keep their same quality of life.

Also, VC's are okay w/ founders taking money because they don't want them to have financial stress. The focus needs to be on the product.

It has been my experience that some founders can jump directly to a seed or A round without spending all that much time unemployed--or any time unemployed. This means they can draw a salary from day one. In this scenario I don't see a lot of personal risk on the founders' part--and, indeed, if they're able to get this level of funding, they can likely talk their way into a higher level at BigCompany even if the company goes belly up, netting a pay raise even in the failure case.

Maybe risk is an excuse, maybe it's a legitimate justification, but it doesn't matter. Why would you bother founding unless there was possibility of a real payoff, of some kind? With that in mind, it's basically a bribe from investors to someone they judge probably capable to please, please make us rich.

It does not seem appropriate to me for founders of a not-profitable company to take out $1M in cash.

That's because your not a sociopath.

Profitability/revenue are not the only metrics that matter to investors. Remember that in order to take out $1M in cash you have to find investors who are willing to pay you $1M for your shares. To investors, metrics like user growth, retention, and engagement also matter (see: Snapchat).

I'm not making any claims as to whether those investors are being smart or foolish.

Amazon is, to a close approximation, not profitable. Would you say it is unreasonable for its founders to take large paychecks?

Source: See second chart on http://www.mondaynote.com/2012/05/27/decoding-share-prices-a...

That seems like a poor example -- from what I've read (and vaguely remember) their revenue is huge (and they could easily be extremely profitable if they so chose) but they're choosing to keep re-investing all of their revenue into expansion, people, tech, etc..

Even if its a requirement of the VC's so that the cap table works out to what they want? i.e. the VC's want 60% of the company at a specific valuation but they can't do that without the founder selling 5% to them.

If the people who ultimately pay those founders (investors via company board) think it's ok, then it is ok. I'm sure investors aren't willing to freely give out money for no reason.

Reply on news.ycombinator.com