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The Equity Equation

paulgraham.com

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Re: The Equity Equation

#111

Post by pg »

euccastro wrote: post #109
pg wrote: post #99

Earlier quoted context omitted.

Suppose your present hope of future utility from your startup varies linearly with the number of shares. (This is not a radical assumption; essentially all startup shareholders feel this, at least for numbers near that of shares they own.) Suppose you trade 6% of your stock in a deal that will increase your average future utility by 6.4%. You've made a straight trade of hope of future utility for future utility. We d…

Not to split hairs, but at different points you said - that for essentially all startup shareholders, the present hope of future utility varies linearly with the number of shares, and - that the utility function for most founders is a step function. Both sound right to me separately, but don't they contradict each other? Maybe most founders just live with this paradox without realising?

No, I don't think they contradict one another. The reason is that the most likely outcome is just to the right of the step.

Most startup founders (initially at least) hope to get a few million, and wouldn't risk that to get a few billion. That's the step. And the most common form of liquidity event is a small-scale acquisition that gives the founders just that level of wealth, since otherwise they won't sell. So in the most common (and most commonly hoped for) good outcome, happiness varies linearly with the number of shares.

Re: The Equity Equation

#112

Post by dpapathanasiou »

cperciva wrote: post #110
pg wrote: post #99

Earlier quoted context omitted.

Suppose your present hope of future utility from your startup varies linearly with the number of shares. (This is not a radical assumption; essentially all startup shareholders feel this, at least for numbers near that of shares they own.) Suppose you trade 6% of your stock in a deal that will increase your average future utility by 6.4%. You've made a straight trade of hope of future utility for future utility. We d…

IF the expected utility varies linearly with the number of shares (and thus the expected amount of money received in the end), you're absolutely right. But does it? For large investment or VC funds, the utility-of-money function associated with any particular investment is almost linear. There's a very good reason for this: As far as Sequoia is concerned, a dollar earned from their Google stock is pretty much equival…

You seem more suited to the VC side of the table, rather than the entrepreneur side.

Re: The Equity Equation

#113

Post by dpapathanasiou »

pg wrote: post #111
euccastro wrote: post #109

Earlier quoted context omitted.

Not to split hairs, but at different points you said - that for essentially all startup shareholders, the present hope of future utility varies linearly with the number of shares, and - that the utility function for most founders is a step function. Both sound right to me separately, but don't they contradict each other? Maybe most founders just live with this paradox without realising?

No, I don't think they contradict one another. The reason is that the most likely outcome is just to the right of the step. Most startup founders (initially at least) hope to get a few million, and wouldn't risk that to get a few billion. That's the step. And the most common form of liquidity event is a small-scale acquisition that gives the founders just that level of wealth, since otherwise they won't sell. So in t…

Since you're talking about step functions and expectation, the final equation should be framed with a binary parameter in mind: x=0 (no liquidity event occurs), x=1 (liquidity occurs).

Re: The Equity Equation

#114

Post by sethlevine »

Paul - This is Seth Levine (quoted in the USA Today article referenced and appropriately called out in your post). Let me set the record straight. While I've seen plenty of articles come to press that has somewhat inaccurate quotes, this was the first time I've been completely misrepresented in an article. I've written a full post on my views here - http://sethlevine.typepad.com/vc_adventure/2007/07/setting-t.... It's particularly frustrating in this case, as I've spent literally hundreds of hours working with TechStars and TechStars companies in Boulder this summer (and am the lead mentor to one very promising project). I actually believe strongly in the model.

I hope you'll consider posting this response up to your main site with a reference to my post clarifying my views.

seth levine

Re: The Equity Equation

#115

Post by cperciva »

dpapathanasiou wrote: post #112
cperciva wrote: post #110

Earlier quoted context omitted.

IF the expected utility varies linearly with the number of shares (and thus the expected amount of money received in the end), you're absolutely right. But does it? For large investment or VC funds, the utility-of-money function associated with any particular investment is almost linear. There's a very good reason for this: As far as Sequoia is concerned, a dollar earned from their Google stock is pretty much equival…

You seem more suited to the VC side of the table, rather than the entrepreneur side.

"Know thy enemy". :-)

Re: The Equity Equation

#116

Post by pg »

sethlevine wrote: post #114

Paul - This is Seth Levine (quoted in the USA Today article referenced and appropriately called out in your post). Let me set the record straight. While I've seen plenty of articles come to press that has somewhat inaccurate quotes, this was the first time I've been completely misrepresented in an article. I've written a full post on my views here - http://sethlevine.typepad.com/vc_adventure/2007/07/setting-t... . It…

Ok, if you were misquoted, I'll take that paragraph out.

Re: The Equity Equation

#117

Post by palish »

staunch wrote: post #105
palish wrote: post #103

Earlier quoted context omitted.

No, really.. It is wise to never publically tell someone they are wrong, unless you're defending someone. You should wait until his friends and colleagues have left his side, then whisper your opinion into his ear. In the Internet world, that means sending him an email. To not do so is bad karma in every sense of the word.. My post above was modded down because I publically pointed out that he was wrong to point out…

You're wrong to tell people they're wrong to publicly tell people they're wrong. Most mature and intelligent people love it when someone is able to offer useful critiques of their work, as long as they're civil about it. For example: http://en.wikipedia.org/wiki/Socratic_method

I don't see in there where you should prefix everything with "What an oversimplification! You're wrong, wrong, wrong!"

Seriously, would you want this guy making a few million? Not only would he be a douche, but he'd be a rich douche. Imagine how he'd treat his waitresses and waiters then. Or his local cops. Or anyone not as smart as he is, which is, apparently, EVERYONE. I'd even call him a detriment to our society, because the child just seems to act like a Paris Hilton with brains. Smart people can be civil, and it's just silly to watch everyone go "Cperciva you're so awesome! You should do X with your life!" and him go "Oh ho ho, didn't you think I already considered that? I turned down a headhunter yesterday, in fact. Now go make me a sandwich."

The dude's a genius, but he could learn a little humility. But he's obviously not going to learn until some event wakes him up to it, so I'm done caring that maybe one more nice person could exist in the world.

Re: The Equity Equation

#118

Post by euccastro »

pg wrote: post #111
euccastro wrote: post #109

Earlier quoted context omitted.

Not to split hairs, but at different points you said - that for essentially all startup shareholders, the present hope of future utility varies linearly with the number of shares, and - that the utility function for most founders is a step function. Both sound right to me separately, but don't they contradict each other? Maybe most founders just live with this paradox without realising?

No, I don't think they contradict one another. The reason is that the most likely outcome is just to the right of the step. Most startup founders (initially at least) hope to get a few million, and wouldn't risk that to get a few billion. That's the step. And the most common form of liquidity event is a small-scale acquisition that gives the founders just that level of wealth, since otherwise they won't sell. So in t…

"The reason is that the most likely outcome is just to the right of the step."

"So in the most common (and most commonly hoped for) good outcome [...]"

Isn't the omission of good in the first paragraph a lapsus, i.e., do you mean most founders think success is the most likely outcome? Or do you mean founders should ignore the possibility of failure for the purposes of making these decisions about stock?

Re: The Equity Equation

#119

Post by palish »

euccastro wrote: post #108
palish wrote: post #94

Earlier quoted context omitted.

If a man is wrong, you don't need to tell him so. Just give it a rest and let others form their own opinions. Seriously, these issues, and a lot of other issues, are covered in "How to Win Friends and Influence People". Read it. If I could figure out a way to get you to feel like you came up with the idea to read it, I would, but I can't, so just read it.

I know you are well intentioned, but if I'm full of it I'd rather someone told me, preferrably in a respectful but blunt way. I'll form my own opinion anyway. I know I took criticism personally and reacted very badly once or twice in the past, so I see your point. But I realised I was being a baby and grew from the experience. No speech on humility can make you humble. At best, it will convince you you should be humb…

You're right, of course.

Re: The Equity Equation

#120

Post by Anonymous314 »

pg wrote: post #70
Anonymous314 wrote: post #58

The article ignores how market prices work - the formula presented lets you know the maximum equity you can give up and still get a positive return by doing so, but incorrectly explains why VCs accept much less - the minimum equity a VC can accept and still expect a positive return on their investment can be far lower than the maximum the startup can afford to give profitably. The VCs are subject to competition with…

Why can VCs afford to give up stock and founders not? Are you talking about liquidation preferences? Startups are just as subject to competition. There's a profit margin on taking investment just as there is on hiring someone, and it expands and contracts depending on how hot the startups is.

I think I was unnecessarily unclear - let's say we're talking about buying eggs. Suppose I'm willing to pay up to $3 for a dozen. That doesn't mean that I should buy them if I find eggs for $2.99 - I should keep shopping around, because grocers can profitably sell eggs for $2 a dozen, so I'm bound to find eggs closer to the $2 mark. I need to take into account what would be reasonable for the other party when deciding if a deal is reasonable, not just the limits of what would be reasonable for me. If I'm stuck, and everyone is selling eggs for $3 a dozen, then it matters whether that's beyond my personal threshold or not. If I only note how close a deal is to my personal threshold, without noting whether the other party would be likely to agree to a more favorable deal, I'm liable to get ripped off, unless I have no leverage for negotiating anyway, and I can only take it or leave it.
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