Ask HN: Share dilution

#1

Post by coryl » Sun, Oct 03, 2010, 11:48 PM UTC

Hi fellers,

I'm actually a business graduate but I'm not very familiar with share dilution and corporate structure in terms of screwing someone over. I understand that the basic premise behind share dilution is when the compnay issues new shares; thus lowering the value of previously issued shares.

In The Social Network, Eduardo was apparently screwed over through dilution of his share ownership, but no one else was affected. Why was this? Did he have a separate, special class of common stock different from everyone else? Early angel investors/VCs do things to protect themselves from future dilution; what do they do, and how?

Thanks

Re: Ask HN: Share dilution

#2

Post by rewind » Mon, Oct 04, 2010, 12:25 AM UTC

http://www.litigationandtrial.com/2010/09/articles/litigatio...

Re: Ask HN: Share dilution

#3

Post by devmonk » Mon, Oct 04, 2010, 12:49 AM UTC

I worked at a place where the original investors got royally screwed over time due to dilution. Basically, as was learned in the early 2000's, don't take a job for the options. And as an investor, assume that you might not always have the control and input you start off with when you make that major investment. It is fine to invest your time and energy into a company (and your money if you want to go that route), but know that any company is a gamble, and it is business, not personal. It's fine to be enthusiastic and love your work and your job, in fact that's the goal, but you'll eventually get burned if you think the people you work for really think of you as family, even if they tell that to you (unless they really are family).

Re: Ask HN: Share dilution

#4

Post by adrianwaj » Mon, Oct 04, 2010, 1:13 AM UTC

I'd talk to a lawyer: they'll know the ways you can get screwed over and help protect you.

Re: Ask HN: Share dilution

#5

Post by aamar » Mon, Oct 04, 2010, 2:10 AM UTC

devmonk wrote: post #3

I worked at a place where the original investors got royally screwed over time due to dilution. Basically, as was learned in the early 2000's, don't take a job for the options. And as an investor, assume that you might not always have the control and input you start off with when you make that major investment. It is fine to invest your time and energy into a company (and your money if you want to go that route), but…

Basically, as was learned in the early 2000's, don't take a job for the options.

This is not good advice. Options can be -- and often are -- a great investment, amazing compensation for taking a risk with a job at a startup. Of course it's wrong to think that an option as money in the bank. It's equally wrong to think that they're worth nothing, to not carefully consider them as part of joining a new startup, etc.

Re: Ask HN: Share dilution

#6

Post by devmonk » Mon, Oct 04, 2010, 2:47 AM UTC

aamar wrote: post #5

devmonk wrote: post #3

I worked at a place where the original investors got royally screwed over time due to dilution. Basically, as was learned in the early 2000's, don't take a job for the options. And as an investor, assume that you might not always have the control and input you start off with when you make that major investment. It is fine to invest your time and energy into a company (and your money if you want to go that route), but…

Basically, as was learned in the early 2000's, don't take a job for the options. This is not good advice. Options can be -- and often are -- a great investment, amazing compensation for taking a risk with a job at a startup. Of course it's wrong to think that an option as money in the bank. It's equally wrong to think that they're worth nothing, to not carefully consider them as part of joining a new startup, etc.

You say it is not good advice, but then you say "Of course it's wrong to think that an option as money in the bank." As an employee, would you rather take money in the bank as salary, bonuses, and commission or would you rather risk your hard work on options where there is a very good chance (no matter how hard you work or how much you believe in the company) that the company will never make good on those options, and even if they do, they will have been significantly diluted by investors?

Just because you perhaps made money on options doesn't mean everyone would. I've never talked with a developer that was significantly happy in his/her choice of getting compensated for his/her work in options.

Re: Ask HN: Share dilution

#7

Post by staunch » Mon, Oct 04, 2010, 4:28 AM UTC

devmonk wrote: post #6

aamar wrote: post #5

Earlier quoted context omitted.

Basically, as was learned in the early 2000's, don't take a job for the options. This is not good advice. Options can be -- and often are -- a great investment, amazing compensation for taking a risk with a job at a startup. Of course it's wrong to think that an option as money in the bank. It's equally wrong to think that they're worth nothing, to not carefully consider them as part of joining a new startup, etc.

You say it is not good advice, but then you say "Of course it's wrong to think that an option as money in the bank." As an employee, would you rather take money in the bank as salary, bonuses, and commission or would you rather risk your hard work on options where there is a very good chance (no matter how hard you work or how much you believe in the company) that the company will never make good on those options, an…

You have two options:

1) Work at a non-startup company for more cash upfront with very little to no potential upside.

2) Work at a startup for little cash upfront with large potential upside.

To each his own.

Re: Ask HN: Share dilution

#8

Post by MaxwellKennerly » Mon, Oct 04, 2010, 11:00 AM UTC

rewind wrote: post #2

http://www.litigationandtrial.com/2010/09/articles/litigatio...

Thanks for the link. One very notable part of the Facebook dilution is that Eduardo signed on to a shareholder agreement authorizing it, at least in part. We unfortunately don't have the agreement in question to see how it worked, though it seems that, by way of the agreement, Eduardo was not invested in the new entity as fully as he should have been.

The interesting question is if he ended up with roughly the same share he would have if Facebook had simply taken on the new investors and not tried any "dirty tricks."

IANYL, but I'd say this: if you're at the point where you have more than a basic agreement with co-founders, you want a thorough, diligent lawyer working with you on these issues.

Re: Ask HN: Share dilution

#9

Post by aamar » Mon, Oct 04, 2010, 9:42 PM UTC

devmonk wrote: post #6

aamar wrote: post #5

Earlier quoted context omitted.

Basically, as was learned in the early 2000's, don't take a job for the options. This is not good advice. Options can be -- and often are -- a great investment, amazing compensation for taking a risk with a job at a startup. Of course it's wrong to think that an option as money in the bank. It's equally wrong to think that they're worth nothing, to not carefully consider them as part of joining a new startup, etc.

You say it is not good advice, but then you say "Of course it's wrong to think that an option as money in the bank." As an employee, would you rather take money in the bank as salary, bonuses, and commission or would you rather risk your hard work on options where there is a very good chance (no matter how hard you work or how much you believe in the company) that the company will never make good on those options, an…

A 25% chance to receive $1 is worth something. A 1% chance for $2 is worth something too, as is a 100% chance of $0.01. Everyone here can work out which of these is worth more than others, even though there's a strong chance that any of these bets could "turn out" worthless.

The problem is that options are harder to value: there are many more result scenarios and the math is a little more complicated. As a result, many people opt out of doing the math entirely, and they think either "it's basically worthless" or "it's basically money in the bank."

The latter error is much worse than the former, but here are two consequences of the former: (1) one is less likely to work at a startup which might (in reality) be the best choice, and (2) if one is working at a startup, one's less likely to be nearly as alert to the risks and targets that may make the option worth less or more (at least as a probabilistic matter). The latter is why the options are a win-win for the company and employee.

By the way, I do understand that different people have different tolerances for risk and for different kinds of risk. But even if someone is biased very heavily towards low-risk situations (which is perfectly fine), it's best to do the math, understand the risk/reward profile of the option and then apply that against your own risk tolerance.