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Options vs. Cash

danluu.com

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Re: Options vs. Cash

#151

Post by jellicle »

Great article. The point can be distilled down to information asymmetry - the company wants FROM YOU something that is relatively straightforward and clear (your time) and wants to give TO YOU something that is complex and hard to understand (a complicated financial instrument that may or may not turn out to have value in the future).

As a general rule, you should stay away from such deals. The likelihood is that the company knows more about the instrument than you do, and is using that information to underpay you.

Re: Options vs. Cash

#153

Post by shaftway »

mikepurvis wrote: post #70
icedchai wrote: post #58

Earlier quoted context omitted.

Except, all things usually aren't equal. Most people explain dilution like this: you're getting a smaller piece of a bigger pie.

At the moment that the dilution occurs, you're getting exactly the same size of piece, it's just a smaller proportion of a bigger pie. But I suppose the idea is that a bigger pie is able to expand larger and faster than it would have been otherwise.

I need you to ELI5 this for me.

Let's say today I own 200 out of 10,000 shares (2%) of a company. Someone comes in and says we want to own 25% of your company and are willing to pay $100M for it. At that point (before any transactions happen) I assume that my company is worth ~$400M, and my shares are worth ~$8M ($400M * 0.02).

So the majority shareholders agree to the deal and dilute stock accordingly. Now there are 13,333 shares. The new buyer get 3,333 (25%) and I still have my 200 (now 1.5%). The company is worth that original $400M value plus the new $100M that was invested, for a total of $500M. My shares are worth ~$7.5M ($500M * 0.015).

Where did my half a million dollars of pie go?

Re: Options vs. Cash

#154

Post by gnopgnip »

jasode wrote: post #99
joncrocks wrote: post #87

Earlier quoted context omitted.

Sure, but dilution without representation can be a big risk for a regular employee. You might get a smaller slice of a bigger pie, but it may also represents a smaller real-world valuation if you get diluted too far. If you have no say over how much you're diluted (like most employees), you could be diluted away to nothing. You have no control. So you must calculate worth accordingly. Is everyone to get diluted equal…

>You might get a smaller slice of a bigger pie, but it may also represents a smaller real-world valuation if you get diluted too far. Show example math of how someone could get "diluted too far" resulting in less total value (shares x price) after an investment round that prices the company higher than before. If the total value was truly less, it means it was "down round" which is a different beast. >, you could be…

It is a lot different if some of the founders/past investors have anti dilution clauses

Re: Options vs. Cash

#155

Post by [deleted] »

hobbyjogger wrote: post #31
asah wrote: post #19

I know 100+ people from a dozen companies who've made $1mm+ on equity. None of my friends would write a post like this. That said, valuing equity is complicated: - most offers include a healthy mix of cash and equity and benefits. Evaluate the whole package. - unless you can pre-exercise via 83(b), I generally avoid options. RSUs are fine and many companies are offering them. Clever hack: counter the offer with a dem…

Unless you are a sought-after C-level executive, hardly any legitimate companies are going to even consider your "clever hacks." The first one blows up 409a (requires optionholder to pay fair market value for the shares). As to the second, very, very few investors are going to allow "their" money to be used for a common stock repurchase (at the same per share price) instead of going toward's the company's operations/…

[deleted]

Re: Options vs. Cash

#156

Post by georgeecollins »

"..why shouldn’t the startup go to an investor, sell their options for what they claim their options to be worth, and then pay me in cash?"

Because an option held by an employee has more value because it functions as an incentive.

Re: Options vs. Cash

#157

Post by AnimalMuppet »

shaftway wrote: post #153
mikepurvis wrote: post #70

Earlier quoted context omitted.

At the moment that the dilution occurs, you're getting exactly the same size of piece, it's just a smaller proportion of a bigger pie. But I suppose the idea is that a bigger pie is able to expand larger and faster than it would have been otherwise.

I need you to ELI5 this for me. Let's say today I own 200 out of 10,000 shares (2%) of a company. Someone comes in and says we want to own 25% of your company and are willing to pay $100M for it. At that point (before any transactions happen) I assume that my company is worth ~$400M, and my shares are worth ~$8M ($400M * 0.02). So the majority shareholders agree to the deal and dilute stock accordingly. Now there are…

You structured the deal wrong.

If the new people own 25% of the company, then the previous owners own 75%. That means that the new people should get one-third as many shares as previously existed (which you did correctly). But it also means that they should have to put up one-third as much money as the company was worth previously; that is, 133M, rather than the 100M you had them pay.

Your loss is your cut of the 33M loss that your company took by getting underpaid.

Re: Options vs. Cash

#158

Post by mikepurvis »

shaftway wrote: post #153
mikepurvis wrote: post #70

Earlier quoted context omitted.

At the moment that the dilution occurs, you're getting exactly the same size of piece, it's just a smaller proportion of a bigger pie. But I suppose the idea is that a bigger pie is able to expand larger and faster than it would have been otherwise.

I need you to ELI5 this for me. Let's say today I own 200 out of 10,000 shares (2%) of a company. Someone comes in and says we want to own 25% of your company and are willing to pay $100M for it. At that point (before any transactions happen) I assume that my company is worth ~$400M, and my shares are worth ~$8M ($400M * 0.02). So the majority shareholders agree to the deal and dilute stock accordingly. Now there are…

The $400M is a post-money valuation. The investor gave you a current valuation of $300M, and offered to add $100M for a post-money stake of 25%. Thus, 3333 new shares were created and sold to the investor for $100M.

Your slice of pie before the deal is (200/10000) * $300M = 6M

Your slice of pie after the deal is (200/13333) * $400M = 6M

Except that after the deal, your company has $100M more to spend, hopefully on investing in growing the business so that later on, you'll own 1.5% of much more than $400M.

This kind of thing is why management will sometimes try to steer employees away from discussions focused on percentages and toward ones focused on share prices. As an early employee who has been diluted a number of times, I certainly agree that it's more helpful to think in terms of my number of shares (which is unchanging) times a share price (announced at the time of the investment), rather than trying to compute my new percentage of the overall company value.

Re: Options vs. Cash

#159

Post by theptip »

Swizec wrote: post #140
theptip wrote: post #120

Earlier quoted context omitted.

Right, but the only reason you'd take on any dilution as a founder is if you think the extra money will make your shares more valuable in the future.

The issue is that as an employee you don't have that choice. Somebody else makes those decisions for you, you're just along for the ride.

I'm not sure that's particularly relevant to this thread; there are plenty of decisions that materially affect the value of your equity that you have no say in. That's true both in a startup and at a large tech company like Google where a significant part of your comp is in RSUs.

The point in the GP post that I was expanding upon,

> It's zero net gain at the point of dilution.

is focussing on the wrong instant in time.

You should be calculating the effect of the dilution on your exit event, when your equity actually becomes exchangeable for money.

Re: Options vs. Cash

#160

Post by [deleted] »

Swizec wrote: post #140
theptip wrote: post #120

Earlier quoted context omitted.

Right, but the only reason you'd take on any dilution as a founder is if you think the extra money will make your shares more valuable in the future.

The issue is that as an employee you don't have that choice. Somebody else makes those decisions for you, you're just along for the ride.

[deleted]
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