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Comment by alexose | Hacker News Reader

The next generation of startups is going to have to address some employee equity problems, I think. This notion that early hires are going to share a small piece of the 10% employee pool needs to stop.

Being employee #1 of a startup can be one of the worst positions a young developer can ask for. Long hours, high stress, low job security, and for what? 0.5% of a company that, if it survives, will most likely dilute its shares?

A startup could really set itself apart by advertising more progressive structure-- One where shares in the company aren't treated like a lottery ticket, but an actual piece of value that is worth growing. Too bad VCs don't see it that way.

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Probably not, or that already would have happened. It hasn't.

One problem is that a lot of people look at equity grants as a meritorious service award. But that's not at all what they are; they're compensation for risk.

Developers look at risk compensation and say, "well, I undertook a lot of risk to work long hours for a lower wage". That's true, but the market prices that kind of risk, and the market cares a lot about substitutes, and the typical developer taking basis points for their participation is eminently replaceable by other developers.

On the other hand, the market has no replacement for an entity legally authorized to trade $1MM for X% of the company, so that risk is priced highly. Similarly, the market has fewer substitutes for the people who actually start the company; or rather, those substitutes tend to react to the mispricing by simply starting their own companies, and thus aren't competing with the founders for equity.

Pithier:

* there's a lot of ground to be made up in how founders/operators promote startup jobs to developers!

* there's probably some marginal ground to be made up for developer equity compensation

* it probably won't dramatically alter the way startup cap tables look

* developers who genuinely (in a market sense) are poorly served by how startups allocate equity should start their own companies

* developers who can't start companies probably aren't being as screwed as we think they are by small grants --- or, if they are, they're being screwed by being persuaded to work at startups when they should instead work for larger companies that can pay them better wages.

If you model the entrepreneurial/tech ecosystem as a market, you'll find inefficiencies and mispricing of risk everywhere, not just in hiring at early-stage startups.

How else would you model companies and their staffing?

For new startups? A cult (of personality or of the religious persuasion)? A warparty? A pirate crew? All are good options.

> A pirate crew?

I. Every man has a vote in affairs of moment; has equal title to the fresh provisions, or strong liquors, at any time seized, and may use them at pleasure, ...

IX. No man to talk of breaking up their way of living, till each had shared one thousand pounds. If in order to this, any man should lose a limb, or become a cripple in their service, he was to have eight hundred dollars, out of the public stock, and for lesser hurts, proportionately.

X. The Captain and Quartermaster to receive two shares of a prize: the master, boatswain, and gunner, one share and a half, and other officers one and quarter.

Far more equitable than most startups.

Nice! For others, this is from an actual pirate code: http://en.m.wikipedia.org/wiki/Pirate_code

Peter Leeson wrote a paper on the economics of pirates, possibly of interest:

[PDF warning] http://www.peterleeson.com/an-arrgh-chy.pdf

I'm a firm believer that every filmmaking project is a cult, and that directors with cult leader traits are much more effective at getting the project made the way they want it.

There can be obvious downsides to that, of course, but the same thing likely applies to startups.

I don't know if you can force it if you don't have it, but it's probably learn-able.

This is absolutely true.

Do you actually have a model for cults, warparties, or pirate crews? The reason the phrase "model a startup as a market" even makes sense is that reasonably well-accepted and well-defined models do exist for markets.

Certainly. Most of these are arguments for why people would make irrational decisions that break market models.

Cult: A singular leader or small group of leaders convince people who are looking for something to believe in/want to change the world of their worldview. The followers are willing to make non-optimal decisions in order to be a part of something greater/be close to the leader(s).

Warparties: A leader/small group of leaders convinces a group of people who are looking for something to believe in that they're on a holy mission: kill X. The followers are willing to make non-optimal decisions in order to be a part of something greater/be close to the leader(s).

Pirate Crew: A leader/small group of leaders convince a small group of people that they're special - and that they're going to work together to make a ton of cash. This is not necessarily true. The followers are willing to make non-optimal decisions in order to be a part of something greater/be close to the leader(s).

I don't know if a war party or a pirate crew are good options. Startups are attempting to create wealth. War parties and pirate crews aren't engaged in wealth creation, they are involved in wealth destruction. This is an important distinction that often gets lost in comparisons of business and warfare.

I used those terms as flavor more than anything. That said, the core argument of each (we're going to kill X, we're going to make a ton of cash because we're just better and faster) is a typical conceit.

> the typical developer taking basis points for their participation is eminently replaceable by other developers

Is this true for the startup that needs to compete with Google and Facebook on attracting top-level talent?

> * developers ... should start their own companies

> * developers ... should instead work for larger companies that can pay them better wages.

So startups are missing out on these developers, can they afford to continue doing so if other startups start scooping them up?

> Probably not, or that already would have happened. It hasn't.

There was a time when convertible notes hadn't happened, or become main-stream, until they happened.

Agreed. That's the worst possible argument against this happening.

I think HN is getting old. Certainly more conservative in how it views future change.

I'd say "cynical" rather than "conservative." Most people here aren't against change, it's that we've all been burned by these things, time and time again.

> That's true, but the market prices that kind of risk, and the market cares a lot about substitutes, and the typical developer taking basis points for their participation is eminently replaceable by other developers.

If all you're hiring with your first employees are replaceable people, you're doing it wrong and will probably fail. Those people not only have to work long hours, they have to work them well. It's like the APM curve at the beginning of a RTS. You never make up those time and behind-ness just piles up.

With equity in the long run an engineering career looks a lot more like prison or slavery, you are taking all the risk and most often if there's a hiccup you have to live with not getting paid

This is one of those things that sounds true but I think probably isn't. Business isn't an RTS, and most startups aren't really in an APM race.

Completely agreed. I recently applied to YCombinator and one of the questions asks how you plan on sharing equity.

Here was my response:

Everything I have seen, read, watched and smelled has made it clear that it is much better to be over generous with equity than to be stingy.

With that in mind I plan on following the Sam Altman model as follows:

Founder(s): 10%

First 10 employees: 10%

Next 20 employees: 5%

Next 50 employees: 5%

Vesting would happen after 5 years with a 1 year cliff.(I chose 5 instead of the 4 in Altman’s model because of the growing trend of companies taking longer to reach liquidity)

Not only would this model differentiate a startup from competitors to potential hires, like you mentioned, sharing the growth with those who put in the work is the right thing to do.

Besides, what can the gal who owns 10% of Google do that the guy who owns 1% can't?

> Besides, what can the gal who owns 10% of Google do that the guy who owns 1% can't?

Vote herself President of the Board.

> Being employee #1 of a startup can be one of the worst positions a young developer can ask for. Long hours, high stress, low job security, and for what? 0.5% of a company that, if it survives, will most likely dilute its shares?

One thing that's never really brought up in these discussions because it's extremely poorly understood is that startup employees are the only ones given options (in the financial sense) and options are always more valuable than the underlying asset with the degree of premium based on the volatility of the asset.

Think of it this way, as a startup employee, your optimal strategy is to join a company, work for a year and then immediately quit if the company isn't 5x as valuable as when you joined. Over the course of an engineering career, this gives you approximately 20 shots on goal to hit on a hyper growth company. Once you've hit one, you essentially have to do enough work for the next 3 years that you won't get fired and you're vesting stock that's 10x - 1000x more valuable than what you negotiated. Nobody else is allowed to have the option of buying startup stock at 4 year old prices except employees and that's the extreme advantage.

Unfortunately, engineers are not experts at options pricing (nor should they be) so they tend to devalue the equity portion when considering total compensation which leads to the overall dysfunction in the system.

> options are always more valuable than the underlying asset

How about this deal: for any publicly traded stock you're holding, I'll give you an option to buy an equivalent number of shares at current market price.

If the price goes down, your option is worthless but I can still sell the underlying. If the price goes up, I can sell for market price, while you net [market-strike] < market.

I enjoy startups. They can be great learning opportunities, but they're typically a losing bet financially. You have to choose wisely.

The difference is in the starting value. You might pay pounds for the underlying and pennies for the option. But no, 1 long option is never more valuable than 1 share.

>options are always more valuable than the underlying asset with the degree of premium based on the volatility of the asset.

No, you have this backwards. Options are always LESS valuable than the underlying asset. The degree to which they are less valuable is inversely correlated to their volatility. The more volatile they are, the closer in value they are to their underlying asset.

I.e. a January 2015 call for Apple is currently trading at $4.36 per share. That means despite apple shares being worth $103 each, you can buy options for $4.36 each. If you want a longer term you can pay a bit more. A January 2017 call for Apple is $16.65, still more than 5 times cheaper than the actual share.

What employees get are more like options on the options. This secondary option multiplies the value of the option as you have described, but it also presents really awkward conflicts of interest where employees often end up with their shares reduced or being pushed out of the company altogether (see Skype or Zynga). Even still, it's not clear whether this multiplicative value of the option ever makes it worth more than the underlying stock. It could just make it similar.

I was curious if companies ever did fire employees to claw back vesting so I asked on Quora a couple of years ago: http://www.quora.com/Equity-Compensation/Do-immensely-succes... and apparently the answer is, outside of Skype and Zynga, the practice is rare.

It's not just firing them or taking back their options. The incentives change such that the company doesn't really have to put any effort in retaining them anymore. Bonuses/raises/soft perks/etc that the company might normally provide would be less likely. They don't necessarily have to worry about keeping you happy with what you're working on which is not something you normally think about when considering the value of equity.

It's hard to predict exactly what will happen, but the broken incentives are clear. A better model would have them aligned much better.

Yikes this hits close to home for me.

I am employee #1 for a rapidly growing startup, been here nearly two years. It's my first developer position, I'm definitely underpaid (until our A-round apparently), but I have .5%. I feel like pretty soon it'll be apparent whether this is going to ~really~ take off (I honestly feel it will).

Any advice on what steps I should take to prevent getting shafted?

Post your resume on Dice // reach out to recruiters. Get another offer. Wave in front of them as a bargaining tactic.

I'd happily bet you $50 that your next offer will be 25% over your current one. my username at gmail if you'd like to take me up on it.

You say you think it will "really take off" - what's that mean, it's going to be a billion dollar company? Ok then, your 0.5% is going to make you 5 million dollars. That's a net win.

But maybe you mean it's a 50 million dollar company - then, best case (no dilution, you stick it out until they IPO, let's say 5 years working there total) you could walk away with $250,000, or the equivalent of having been paid an extra $40k-$50k per year each year you worked there. That sounds like about break-even financially, with some great experience but shitty lifestyle for several years. Up to you if that was a good deal.

Or maybe you mean it's a 10 million dollar company. Would you be at this job if you had no equity and an extra $10k or would you feel screwed?

Thanks for the perspective - this has been really helpful. I think no matter what happens it will have been an amazing experience that I lucked in to.

> it will have been an amazing experience that I lucked in to.

I'm not really sure why you feel that way. Are you underskilled? You make it sound as though you're underpaid but then call it an amazing experience.

I'm definitely underpaid at the moment but that's the nature of a bootstrapped startup isn't it. They took a chance on me with no degree or job exp. Also money doesn't equal a better experience. I get to work on something really fucking cool and I love the people I work with. I'd probably kill myself at consultancy.

So regardless of whether or not make tons of money on this startup, I'll have 2+ years of job experience for the next job that I didn't have before.

You're rationalizing your state of being underpaid, which is understandable (you want to feel like you're making good choices in your life) but not very rational.

The tell-tale sign is that you compare your current position with a bad job (consultancy).

The thing is: there are plenty of startups that make cool things and have nice people AND pay well AND offer good equity AND have potential to take off in the future.

So if you really think you're underpaid for your skills (as in: you could find another job that is as good as this one and pays better), you should ask for a raise that would match a market rate for your current skills.

If a raise is not possible, you should start looking for a new job (and if you're in SF/Bay Area, there have never been a better time to do that).

Better to love what you do then make more money. Money != Happiness If this guy loves his job and company, and has earned valuable experience, then he is a lucky man! If he happens to make an extra buck or two, so much the better.

Eek.. doesn't

> They took a chance on me with no degree or job exp.

Stand out to you? S/he sounds like a beginner..

I suppose it depends on how you define "lucked in to".

Even building my own company, bootstrapping over these 5 years, I feel like I lucked into where I am. Not because I'm undeserving, but really because I feel lucky to live in an era where I even have that possibility.

If my world is entirely comprised of SV type startups, perhaps I'd feel differently. But I try to keep some perspective. (As in, I lucked into not being a field hand in 4th century Italy, and instead I can use my brain to manipulate electrons through small finger movements, that supposedly create value enough for other people to transfer electrons into a virtual account of "mine" that I can exchange for goods and services.)

I'm sorry if that sounds harsh, it's not intended that way. I really just wanted to point out that people define luck very differently.

If this is your first dev position then you're probably replaceable and won't have much negotiating power in the end.

I've been in this position. .5% of a rocketship is still pretty great. You'll end up with 1.25MM cash if the company exits at a billion (after 2x dilution and 50% taxes if you're in California). Yeah, it sucks to think about how much richer the founders got, whilst you worked just as hard… but it's still important to remember that you were very lucky to be in the right place at the right time, and be along for the ride.

Also, I bet you learnt a fuckton in this position which'll make it easy for you to accelerate your career. For me, seeing the hyper-growth from inside, taking on responsibility as the company grew, handling the shit as it hit the fan… that's priceless experience. Combine that + the 5MM I'll probably make out of it, and it doesn't matter how much better off the founders are, I still got a great outcome.

Sounds like you'll make out ok, but feel it could've worked out better...

After proving your value as an early engineering hire, what about approaching the Founders to re-up the equity on a regular basis? Awesome first quarter 2012? Company revenue up 100x? Profit through the roof? Ok... how about that equity re-up? :-)

Nothing should restrict irreplaceable engineers or engineers who just create tons of $$$ value from getting increased equity post-hire. I'm sure there are some great techniques for this, and this can definitely become a norm in our industry. (My friends on Wall Street have this down to an art form...) As companies grow out, individual engineer performance is usually under-appreciated so there is less leverage.

I'm surprised you didn't walk away with co-founder (10%+) level equity. You built nearly everything... all the hard/nasty bits like supporting multiple api versions across diff platforms and also building/maintaining new features that drove new customer adoption. From an engineering perspective it was pretty awesome to see the value creation, so it's a bummer to hear that after sticking it out you won't get rewarded for that early value creation.

Definitely think it'd be appropriate to show up one day after acquisition and ask for a rather large boat. Or 2. :-)

As a former employee #1 I can attest that even 2-3% of a company at a paltry wage is unsustainable. I know when I start my own business someday it will closer model what was done at WotC - this really resonated with me.

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