Dilution
blog.ycombinator.com
Dilution
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Re: Dilution
#2> Most founders' instincts seem to be to give too much equity to investors and not enough to employees.
Is this wrong? Investors don't receive anything for their capital but equity. Employees receive income, benefits, etc. that have to be factored into the equation.
Re: Dilution
#3> Most founders' instincts seem to be to give too much equity to investors and not enough to employees. Is this wrong? Investors don't receive anything for their capital but equity. Employees receive income, benefits, etc. that have to be factored into the equation.
In the final calculation, employees are the ones who are toiling day-in and day-out for the company's well being – in a real way, the company's future depends on them more than the investors. It can be more valuable to have them invested long-term in the company's success, point for point, than an investor.
Another way to think about it is like this: if an investor told you tomorrow they'd no longer contribute to the company, versus your first engineer, which would be more damaging? The investor's money is already in the bank, whereas the engineer will cost time and money to replace, as well as disrupting the ongoing development.
Re: Dilution
#4> Most founders' instincts seem to be to give too much equity to investors and not enough to employees. Is this wrong? Investors don't receive anything for their capital but equity. Employees receive income, benefits, etc. that have to be factored into the equation.
It's absolutely wrong! Employees are the ones who put in the work to actually build the company.
As you said, investors only put in capital (and sometimes advice and/or intros.) Employees work full-time on the company, oftentimes for below-market rates (what they could reasonably assume to make in salary + benefits at larger companies.)
A company at any size is far, far, far more likely to succeed or fail based on its employees than its investors.
Re: Dilution
#5> Most founders' instincts seem to be to give too much equity to investors and not enough to employees. Is this wrong? Investors don't receive anything for their capital but equity. Employees receive income, benefits, etc. that have to be factored into the equation.
In the final calculation, employees are the ones who are toiling day-in and day-out for the company's well being – in a real way, the company's future depends on them more than the investors. It can be more valuable to have them invested long-term in the company's success, point for point, than an investor. Another way to think about it is like this: if an investor told you tomorrow they'd no longer contribute to the…
"It's more valuable to have them invested long-term in the company's success."
Why? A cash bonus of "If we meet this deadline you will receive $X" is going to increase my productivity much more than "you own 0.01% of an illiquid, unprofitable company". Startup equity is way too abstract for employees to affect their motivation. Peer pressure, mission, pride in work, cash bonuses / raises / promotions are infinitely more impactful.
Re: Dilution
#6Earlier quoted context omitted.
In the final calculation, employees are the ones who are toiling day-in and day-out for the company's well being – in a real way, the company's future depends on them more than the investors. It can be more valuable to have them invested long-term in the company's success, point for point, than an investor. Another way to think about it is like this: if an investor told you tomorrow they'd no longer contribute to the…
"It's more valuable to have them invested long-term in the company's success." Why? A cash bonus of "If we meet this deadline you will receive $X" is going to increase my productivity much more than "you own 0.01% of an illiquid, unprofitable company". Startup equity is way too abstract for employees to affect their motivation. Peer pressure, mission, pride in work, cash bonuses / raises / promotions are infinitely m…
Sure, the argument isn't that equity is the end-all to employee compensation. But early-stage startups often aren't able to to give (significant) cash bonuses, and more importantly, compensating an employee with equity means that 5 years down the line, you're more likely to have someone on the cap table that both contributed to past efforts that made the company successful and also cares about the company's future.
I think in practice this preference makes more sense when you consider that most of the (non capital based) value that early-stage investors can provide applies mostly to early-stage companies.
Re: Dilution
#7> Remember that raising money is not success. Raising huge amounts of money early on is very rarely how companies win (though it is sometimes how companies lose)
I honestly think one of the reasons the company I worked for was successful was our inability to raise money while we were young, which forced a real discipline and creativity for how to do more with less. It also made us skeptical of investors and ensured we didn't base our internal feelings about the company based on what a bunch of incredibly fickle investors thought. This was important both when investors hated us, and perhaps more important when they switched and loved us.
And to the second point, I saw first hand how easy money made one of our competitors so cocky they had no chance of success, and another one got too much money and got distracted spending it all to actually make a core business that made sense.
Money is necessary and important, but having too much of it is also a risk that you need to take seriously.
Re: Dilution
#8> Most founders' instincts seem to be to give too much equity to investors and not enough to employees. Is this wrong? Investors don't receive anything for their capital but equity. Employees receive income, benefits, etc. that have to be factored into the equation.
I think this is saying that founders often underestimate the variance that employees bring to their company's success, and overestimate the variance that an investment round brings.
If you assume that employees are basically fungible and that $100K in salary will buy the same output regardless of who works for you and how motivated they are, then it makes sense to raise $10M rather than $2M, so you can hire 100 person-years of work rather than 20 person-years. VCs become the limiting factor.
If you assume that there are wide varieties in employee output that stem from a.) hiring the right employees b.) into the right roles and c.) compensating them so that they're incentivized to do their best, then it becomes absolutely critical to attract those employees and motivate them. It is unlikely that you will attract these types of employees for a $100K/year salary. It is far more likely that you will attract them with a percent or two of equity that could be worth several million dollars.
In my experience, the latter is a much closer description of reality than the former is.
From the entrepreneur's perspective, what investors or employees "deserve" is irrelevant, what matters is how much of an effect they have on the ability to deliver a good product to a big market. Early employees are in the trenches with you every day; the difference between high effort and low effort from them can make or break the company. Investors give you money and often advice/introductions, but you are one of many investments in their portfolio; they are not going to give you high effort.
Re: Dilution
#9> Most founders' instincts seem to be to give too much equity to investors and not enough to employees. Is this wrong? Investors don't receive anything for their capital but equity. Employees receive income, benefits, etc. that have to be factored into the equation.
It's absolutely wrong! Employees are the ones who put in the work to actually build the company. As you said, investors only put in capital (and sometimes advice and/or intros.) Employees work full-time on the company, oftentimes for below-market rates (what they could reasonably assume to make in salary + benefits at larger companies.) A company at any size is far, far, far more likely to succeed or fail based on it…
>Employees are the ones who put in the work to actually build the company.
Company and work that, in most cases, wouldn't exist without a capital investment.
Re: Dilution
#10In other words, companies are taking investment later and later in their lifespan so founders need to be sure thy have some left many years and many rounds after they started. Capital is dirt cheap and desperate for return - and only getting cheaper.