Why are we still using old 1990’s cap tables and the same tiny option grants for employees as we did back then? Is that fair? To whom? Is it the right thing to do? I don’t think so.
Back in the 80’s or 90’s, founders had to take actual risk to start a company. You didn’t have today’s glut of capital and investors chasing any two MIT dropouts still looking for an idea. Raising money used to be hard. Everything was expensive, even hard disk space.
Old days: Capital and investors scarce. Easier to hire. Not as many people online — fewer potential customers. Founders took on enormous risk.
Today: Capital abundant. Many new investors, including “angels.” Talent scarce, in particular technical talent. Many more people online — more and larger markets to attack. Founders can start a company for $7 on Digital Ocean with almost no risk. Founders complain constantly they can’t hire engineers.
Let’s look at the 80s. Terms from investors were brutal, if you were lucky enough to even get their attention at all. 3x participating preferred rounds were not uncommon. You would never see that nowadays, because companies have far more leverage. There’s too much capital chasing too few good deals. Startups are often dictating terms to investors, the opposite of what you’d see 25 years ago.
Back in the day, founders would go into debt to buy a hard drive. Some even mortgaged their homes to keep things afloat. Who’s the last founder you met who did that? I haven’t met one in a while.
So if founders aren’t taking the risk today, and professional investors are usually gambling with other people’s money, like your 6th grade teacher’s pension money from CalPERS, who is taking the risk?
Employees take the most risk today. Not the investors or the founders — it’s the employees. Yet they’re still compensated like it’s 1990.The whole founder/employee distinction is often absurd, especially where the early employee starts around the same time as the founders. The titles need to be fixed. And should the compensation be so disparate for those two people?
Early employees take large pay cuts compared to a big tech company salary (not to mention financial firms). They get options that often — usually? — expire worthless.
Ah, the joy of employee options! There are so many issues it’s hard to know what to decry first, but perhaps the most glaring is the window to exercise. If you leave the company you usually have only 90 days to exercise or lose it. That can be very expensive and incredibly risky when you aren’t sure whether the company is going anywhere. It is often a lot of money if the strike price is high.
But let’s say you’re one of the lucky ones. You stay at the company, you’re loyal, and there’s a great liquidity event. Hurray! But you didn’t exercise early (most folks don’t — strike prices are often high, and that’s your real money you’re gambling). Whoops. Guess who gets long-term capital gains tax treatment and who doesn’t? Think employees get screwed again?
Of course, founders and investors get long-term cap gains treatment, assuming they’ve had the stock over a year. I won’t even talk about the retention packages and the golden handcuffs where the employees have little power in any negotiations and might find they need to spend years at the acquirer for whatever the founders and m&a department decide behind closed doors.
Conventional wisdom is that in any given year, about 15–25 companies make it really big. Those are the cases in which options can be really meaningful, but in order for that to be true, you would still have had to join relatively early. Even in a “great” exit, folks who join at the mid-level stage actually end up with surprisingly little.
What do investors think about all this? There’s a strong slant toward the status quo, and most still try to force this outdated 90’s math on today’s startups and employees. Series A investors usually ask for veto rights on option grants to employees. I had to fight on that one firsthand. One told me, “I’ve never given an engineer over a point, and I’m not going to start now.” I lost that hire.
What do founders actually do? Complain, complain, complain. Moan about how hard hiring is. There are no good engineers. “Why won’t engineers leave comfortable jobs at Google to join my startup where they can be over-worked and under-compensated? I know, let’s H1B people since they have no good alternatives.”
Ask most any founder — “What’s your biggest problem?” Nearly always: Hiring. “The person I want won’t leave Google to join my startup that hasn’t shipped anything. It’s only a 40% paycut and the options are worth a lot, I swear.” With logic like that, it’s astonishing that many startups are able to hire at all.
There has to be a better way. We could acknowledge these glaring disparities. We could appropriately reward early employees for the contributions they make. Perhaps even acknowledge, startups are not a zero sum game — if adding a particular engineer to the team increases the company’s value by 10% overnight, granting her additional equity is a no-brainer. And finally, we might even decide to treat those early employees well. I don’t mean “free food in the kitchen” well, I mean compensation commensurate to risk taken. Perhaps, then, hiring might be easier.