CoFounder He was about to start a hardware startup that wanted to build a vending machine that looked like it was made by Apple. Until this day, I’ve spent years building software, and his idea around hardware felt so compelling, that I had no doubt and joined him as a CTO and CoFounder. I got 15% of the company.
Rich Man He was a rich man, with a huge house in the best luxury area of the city, with a big exit in the past. He kept saying: “I can’t do this without you..”. Which was very inspiring, and I probably did my best job ever over the the few years. I worked days and nights, my girlfriends left me because we didn’t see each other at all.
Living A Dream Things were going really well, We met Jack Dorsey in SF and presented our machine, partnered up with his company that was doing the payment stands. Lots of the doors were open, We raised money from investors and got into the best b2b accelerator in the world.
Departure While things were going really well, I realized that I could not work here, mainly because I realized I had no passion for hardware and I wanted to be my own boss, while being CTO meant that my boss was the CEO. I spent a year on hiring more people and finding a new guy to replace me as CTO. The replacement went very well, so eventually I left.
I Lost It I moved on with my new startup but a few months later I got an email from the board. They were planning a new funding round as it looked like to me. So first I was happy about that, it meant my shares would be worth more. But it turned out they were planning an internal round, where all investors had to put money in. For all the investors it was relatively little money, but for me, it was more than I could afford. Since I owned 15% and couldn’t participate in the round, my 15% was diluted to 0.15%.
Why? It turns out that in a VC-funded startup, it’s very easy to lose all almost your equity if the startup decides to have an internal round and issue new shares. It may have 100 shares, I own 15 and others own 85. Then it may issue 1000 shares, where each costs 10k. So I’d have to put 150k to stay with my 15%. (the numbers aren’t real, just for an example). So this was the end of the story for me.
The moral: owning Equity in a startup doesn’t protect you at all unless you’re rich.
[An Update/Clarification]
Comment from a Reddit user:
The trick was the pre-money valuation was decided by the “internal round” participants. They basically decided the company was near worthless valuation pre-money. This then meant you owned 15% of nearly nothing.
Reply from me:
YES! This is the only reply that's correct under this thread. This is exactly what happened under the hood. Very few founders know this may happen, and most think their equity is safe, just like I thought. But in this case, both the founders and early investors lost nearly all their shares. (99% of it). Someone might ask: how can they reduce the valuation to such a low number? well, in startups, the board is usually small, just CEO+Chairman, and they can vote for anything they want and it's easy to justify stuff. because they control the story
If you had this right, and felt 150k was too much money to support your position, you could have gone out and borrowed the money from another investor.
To be honest, if at a 1M post money valuation you couldn't justify defending your position, the company was probably, in fact, approximately worthless.
If anything, he might actually consider himself fortunate here that the company successfully conducted its recapitalization and raised fresh equity. Maybe his otherwise-worthless shareholding will ultimately end up in the money, due to the other investors rescuing the company.
There is a near endless list of ways to be defrauded if founders engage in illegal behavior and nobody is willing to legally challeng it. These range from simply tearing up you stock grant to transferring the IP to a parallel entity.
Nothing else. Partners are supposed to leverage the opportunity together, not each other.
It’s why attempts to simplify this and advocate for the actual innovators/creators who are just as much technical people are incredibly important.
Tech people need to retain way more of the equity, period. They create tangible value in building something. The “sales” oriented partners should earn their equity from the pool with delivering distribution or move on.
Avoiding outcomes like these would be a reason I would go through YC if I wanted to chase VC money rather than bootstrap. Having a strong minority investor beside you; one where the VCs do repeat business, and one the VCs care about their reputation, would be very helpful.
> Tech people need to retain way more of the equity
That's just fantasy. Common shares really suck: VC rights trump and VC model has a lot of dilution built into the success case. The median return of a any business is zero. VC money gears the risks higher for a Tech/investor. Good luck!
You left this company in 2016, so by now, you know the outcome. You were there for under 2 years, so you only vested half. Based on my Googling, nothing physical was released and the company barely had a footprint. There's a patent (from when you would have been there), but neither you nor the "big rich man" are on it. It's also based in Oslo, which feels important to note.
I can't put my finger on it, but something feels very off here. I do agree the Reddit comments were quite inept, but at the same time, the conclusion doesn't resonate with me.
I think the real conclusion should be: A lot of startups are somewhere between risky and a straight-up scam, and very few are the next Google. If you're going to join a startup, YOU need to make sure it's the right one. If you don't have money, time is your most valuable asset, and you should be incredibly thoughtful about how you invest it.
It is worth bearing in mind when folks are joining an early stage company (as cofounder or founding engineer) that dilution will occur, and that - especially if you don't stay with the company and continue to be valuable - it may be heavy (though usually not nearly this heavy)
Seems strange from a self described serial founder with 20 projects under their belt.
It seems like they are warning us to not let angel investors trick us into thinking we can hang with them in later rounds of funding that will very likely be necessary. It’s also a warning to put your loved ones first because business isn’t guaranteed. One likely regrets ending relationships after flaking out because one was greedier than one was smart.
The inclusion of generic/non-essential/irrelevant details and exclusion of anything remotely specific/unique/relevant makes this a very bizarre anecdote to consider.
[0] https://www.theverge.com/24067999/ai-bot-chatgpt-chatbot-dun...
Sounds like you're the one who never prompted AI.
I guess this makes sense if they alternative was bankruptcy. If you can't inject money to help at a critical time, then I suppose it makes sense that the business you have a share of is basically worthless, and only the one that has more money is worth something.
Is this just routinely abused to disinherit a shareholder? Does this mean that being a shareholder is just about finding alliances you can use to screw others over, until you eventually get screwed yourself?
I forget the exact details as both the CEO and the board were pulling quite a few nasty moves along the way, but eventually an internal round was used similarly to set a much lower valuation before raising more outside capital. My uncle hadn't left on the best terms, the company was attempting to shove him out and block him from taking part in the internal round to protect his early shares.
Not too surprisingly this ended up in court (or arbitration?), but the moral is the same. When you take early shares there are ways the value can be stripped from you even if the shares aren't. There are good arguments for an internal round to reset a lower valuation, but it can easily be used as an offensive tactic to go after current share holders.
I don't think people often realize what all is really on the table when signing up for a startup. I've worked for a few early startups and will take options or shares, but I view them entirely as a gamble and assume outside investors will chip away at their value before anything is ever cashed in. If I were ever to join as an executive level or founding board member I'd be worried more about sizing up the other members than the business itself. Unfortunately its sometimes more about politics and dirty tactics at that level than it is about what the company is actually producing.
In practice, this tactic does happen but I wouldn't say it's common enough to call it "routine". If the company is succeeding, it's usually better not to screw other shareholders over because the resulting interpersonal conflicts would risk the company's success, and then everybody is worth off. Similarly, if the company is failing but there's any chance of working with the people involved again, it's better not to screw them over because they won't work with you anymore, and word will likely get around that may hamper your ability to work with other people. It's only when the company itself is failing, or there's ambiguity about whether it's succeeding or failing, that there's an incentive to loot the carcass and screw over everyone else so that you get most of the residual value. But in that case, the company was failing anyway, so you wouldn't have ended up with much regardless.
Interestingly the same pattern applies in a lot of situations, because it falls out of the game theoretical incentives and so any situation with the same incentives tends to give the same result. When things are going good, everybody cooperates, and is happy to take a relatively small part of an expanding pie. When things start going badly, everybody fights over who gets the last slice. Makes me worried for the state of humanity over the next 10-15 years.
Side note: If it wasn't a down round, measured from your entry event, your shares gross value still went up.
In general: If the company needs 100k in cash, and all shareholders add cash relative to their share in the company, there is no dilution, cash is added, all is good. If some or all of the current shareholders can't add cash relative to their shares, you need an external investor, that investor has to "get shares from somewhere". If the investor would buy them from the current shareholders directly, there would be no new money in the company, the money would go to the shareholders, that is not what we want here. So new shares are created and only shareholders that do not do a pro rata investment dilute their shares relative to their current share, and maybe a partial pro rata investment, to make up for these new shares, which is fair. Without a down round, valued individually for each entry event of the current shareholders, nobody loses any money here.
I do not understand why you are upset. Am I missing smth?
The point was that here we have a technical founder who spent years of their life working hard to build a product only to have their hard work de-valued in ownership terms by a non-technical founder who would be cleaning toilets were it not for their ability to scam naive engineers into doing The Work for them.
The moral of the story: don't work hard for someone who can de-value your hard work on a whim while laughing all the way to the bank.
I've looked through job listings on workatastartup and I've interviewed with some of those companies. I've also submitted proposals to YC and joined their cofounder search site. So I am mildly familiar with the landscape of VC funding and startups.
On the cofounder search site I had dozens of non-technical co-founders who were trying to scam me out of years of my life by offering me anywhere from 10% to 49% equity as a...get this...COFOUNDER. These people don't want to do the work to develop the skills necessary to make their oftentimes idiotic visions a reality and they almost all want controlling equity stakes, as described in this poor bastard's story.
This is part of the risk you take working at a company at that stage. If that kind of downside risk isn't palatable, then you've learned a very valuable lesson: you probably want to be more selective with the startups you do choose to work with, or simply work at a more established company.
There are a significant amount of startups out there which differ significantly in quality. Given that you as an early stage employee are trading your fair market liquid TC for equity, you are effectively investing in said startup ("sweat equity") -- so you need to ensure you are "investing" with the same level of diligence you would expect any sophisticated angel or seed investor would, especially because you cannot diversify for the period of time you are engaged with said company. If you do not feel equipped or ready to do this kind of diligence, then it is highly likely you won't be confident about your decision to work in early stage startups in general.
Of course, there is no free lunch. More established companies often come with a quality of life at work that is not comparable to early stage startups. But for many, this tradeoff for a better risk adjusted total compensation is worth it.
How can you conclude that? You have only heard one side of the story. The other probably goes something like:
> I hired a CTO who turned out to be incompetent and was unable to build the organization and take advantage of a great opportunity. When we finally convinced him to leave, the company was near failure and we had to raise money at a near zero valuation to keep the lights on. He's getting quite a deal with 0.15% for putting in no money when the rest of us had to risk putting money in to rescue his failure.
And there's no way to tell what's true. Usually in these cases both sides make themselves out to be saints and the other side is the devil, and best to just not believe a word of any of it without evidence.
Doesn’t matter if it’s 20% of the overall issued shares or 0.2%.
If you’re not in a position to buy more shares when they are issued your percentage goes down but, if the new shares are issued at a greater value than what you got your shares for then you have more $Z.
You own 10% of a company that was valued in the last round of funding at 10 million dollars. You have put in significant amount of work since and company has raised a lot more revenue. The fair market value is now at a 100 million dollars, but the existing shareholders put in another 90 million dollars at the same pre-money valuation as last round, diluting every existing share down by 90%. Congrats you now own only 1% of the company and just got robbed of over 8 million dollars. (Fair value of your stock went from 10% of 100 million = 10 million to 1% of 190 million = 1.9 million).
I’ve never really understood the focus on percentages, they aren’t the value.
https://www.reddit.com/r/Entrepreneur/comments/1asosph/i_end...
It is fairly common, and legitimate for a struggling company. There are legal remedies for improper valuation, but YMMV.
These are the magic words. If someone says to you in an offer "stock" and then tries to give it a "value" you say these magic words...
"Can I see the cap table."
If the answer is anything other than "Its in your inbox right now" then you go back and tell them that you want the shares but the value of them is ZERO without the cap table. You then ask for more cash/signing bonus etc.
That, and buying a single share as soon as you possibly can (if your staying or if you think there is an exit in the future)... once your a share holder new rules apply to you, around finance and funding!
Since OP had only 15% it doesn't seem likely that this was a "The Social Network" style trick to actively screw him out of his equity. More likely that it was really an internal round - no new outside investors could be found and the company was out of money. OP had left the company by this time and didn't value their shares enough to participate. Presumably the 15% had been vesting over 4 years, so a company that is out of money, can't raise more and had been at for >4 years, suggests to me that the 15% was really not worth much before the internal round.
Don’t blindly trust leadership or assume they always have your best interests at heart. Stay informed and be willing to challenge decisions that could negatively impact you or your stake in the company.
Presumably if an internal round, the company is dying, so nearly worthless, just IP and team. The new worth is almost entirely the $ going in, and the team that is sticking around to make it work as an incentive. The new $ dilutes the old $, and to get new employees, additional shares are issued, further diluting the old ones.
For such a rebirth, it's not clear - how much should some person who helped recruit a failing team + 1 year of dev be diluted? For people sticking around and the new $, how much should they be incentivized to stay and put in new $, and what % should go to the former 1-year employee doing nothing? That's the pre-money valuation decision.
That may well have been true. If the company was out of reserves/revenue/sales/contracts and about to end without new investment, then it may have had little value, and it makes sense for any new investment to work from the current value of the company.
Can't say if it was fair in this case, but it could have been. It may even have worked out to your benefit. Without the investment you may have ended up with 15% of $0, rather than 0.15% of something.
Or not, but let's say it was. In that case this was fair.
At any point a company takes on investment, it makes sense to do so based on the current value of the company.
Suppose a start-up reaches a point where it's out of money to continue, doesn't have cash flow, and can't find additional investors. At that point the company is nearly dead and may be worth very little. The people remaining may still believe in the company and, if they are able, may be able to keep it going with investment from their own pockets.
"Why didn't I get any money from my startup? - A guide to Liquidation Preferences and Cap Tables"
https://www.reddit.com/r/startups/comments/a8f6xz/why_didnt_...
This post has a lot of numbers and rounds of funding showing the dilution. It is detailed but the math is very easy to follow.
I've worked at 2 startups. Both "failed" but not because of dilution but bad decisions by the executive team. My shares were supposed to be worth $500K to $2M but I ended up losing about $100 because of some tax stuff.
If the company was worth zero before the new round of investment, then surely the investors would not put any money into it?
So, if on the other hand it was worth something, then it's worth what people are willing to pay for it. In this case they valued the company at 1000 shares * 10K, or 10 MM. So OP should receive 15% of that.
An alternate case might be that the new valuation anticipated future profits and so was 100 MM, but since realizing such profits requires further investment that OP cannot make, their share is restricted to 15% of 10 MM, rather than 15% of 100 MM.
But in no case does it make sense to value the company before recapitalization at near-zero.
Always make sure you get your own lawyer whose goal is to maintain your interests to review any paperwork of this nature.
I tell my kids, always try to get equity or ownership rights over anything you do, when you can.
However, these things have gotten so much more complicated in my life time and frankly much more deceptive and hostile to employees who don't have a finance degree. And sometimes it helps to have a finance degree and cash to kick in. (Rich like the OP says.)
As an example: The first salaried job I ever had (19), at a completely boring company (I did their IT) they let you put a % of your paycheck in a thing called an ESOP. I put a little in, forgot about. About ten years later the company was sold and they tracked me down to give me a nice check. One class of stock, no RSUs, if the CEO made money I made money. The last start up I worked at: they had an incredible number of rounds, not all classes of stock were the same, and RSUs. It actually worked out well for me. But I can see how you can use the dream of a big pay out and then pull the rug out in indecipherable ways.
This is a long post about not understand startups and funding and has little to do with VCs.
It feels like you had 15% before the round but the company was probably underwater, and as a common share holder that equity was probably worth nothing.
A 10 year old hardware startup burning cash in this funding environment is going to raise on pretty poor terms if they can raise at all.
99% dilution does seems super high for a down round though, even with ratchets.
And if that pre-money valuation is very wrong you can sue them for fraud. Judges won't take kindly to that sort of maneuver.
I don't think this can be defended against... You just need to make sure that if 50+% of the shareholders ever club together to make any decision, that your interests are on the majority side.
I understand from this sentence that the company was in such an horrible financial situation that even the other people who were on the same situation as you agreed that it was better to raise debt on horrible terms rather than to bankrupt the company.
What was the status of the company before ?
It could have "simply" just been desperate that everybody agrees to be diluted.
The other possibility is that, if you were only 2 shareholders, that the other guy, created an artificial funding round, essentially diluting you (eventually potentially as a Breach of Fiduciary Duty).
The key is to understand what is his position now, if he actually lost or not.
https://www.reddit.com/r/Entrepreneur/comments/1asosph/i_end...
VC's rhyme with feces, and compare for precisely the same reasons!
https://youtube.com/watch?v=-Osi_8_VAow
Except there was no settlement
