The answer is hidden in your question: you own common stock. The investors got preferred stock. As the name implies, their stock has privileges. A common one is liquidation preference. They get their money back first, then the common shareholders get whatever is left.
For an extreme example, say the VC invested $10M for 10% of the company, and then the company doesn't manage to grow, and gets acquired for the same $10M amount. The initial VC gets the $10M back from the acquisition (they make their money back, no profit). Then there is $0 left, and the common shareholders (early employees and often founders) get nothing.
It's a contrived example, and there are many other complexities to such a deal, but you get the idea.
Let's say the company gets acquired for $20M. Is it still possible for the other 90% to make $0? Or is the preference amount exactly equal to the invested amount?
Yes, it is possible to have 1.25 or 1.5x first money out liquidity preference. I'm not sure how common that is though, but I've seem it multiple times.
Also note, you can end up with negative returns since you may have paid taxes on the options.
Typically preference = invested capital, but there are exceptions where it could be more (usually only if investors were investing in a distressed situation)
Common stock is the common case... Unless you are in a strong negotiating position, common stock is what you'll get.
A company can't easily give you preferred shares. Someone has to define what preferred includes: rights to elect someone on the board, right to oversee spending decisions from the CEO, etc... It costs money to structure preferred shares. You also can't piggy-back on a preferred class that already exists, unless the investors that "own" that class are happy to dilute their privileges with you (highly unlikely).
Common stock always exists, by definition, in a corporation. So it's easy to give it to you.
Liquidation preferences mean that some shares have rights that others don't. In a liquidity event (IPO or acquisition), the people holding the "preferred" shares get paid out first, according to the number of shares and the valuation of those shares. If all the cash and other assets from the acquisition are given out to them, then anyone else holding the less-preferred shares get nothing.
Usually, the founders and VC have the preferred shares, while someone writing unit tests at 3am does not.
>He forgot to mention preferred shares given to VC’s with liquidation preferences that likely never disclosed to new engineers.
>Usually, the founders and VC have the preferred shares, while someone writing unit tests at 3am does not.
This. I moved into a VP Eng role at a startup and had options for common stock worth about 0.7% of the company. When we were acquired, those were worth zero, though I was decently compensated by the acquiring company with cash and stock. The money I made was due to my role/position rather than my equity.
Are "liquidation preference" shares just tagged as being worth more than their actual value though? I can't reconcile how they could get paid "according to the number of shares and the valuation of those shares" and have there be nothing left over for the non-preferred stock. If the founders/VCs have any n% of a, say, $10M acquisition, that still has to leave money for everyone else, unless the total number of shares is >100%, someone has a funny idea of a $10M company being worth more than the $10M that was paid for it, or there is something else going on.
My understanding is that you're perfectly correct, however — I'm just trying to demonstrate how I don't really "get" it. I presume there's some other number involved in the "liquidation preference" that is visible to those involved that make it more than a mere n% of company calculation.
Edit: Googling this, it seems like these special investors get to recoup their investment if the company is selling for less than what they valued it at at their time of investment. (And since it seems like this generally applies to VC firms, I gotta say, this is really lame. It was a bad investment, but you know the actual employees took a lot more risk in it, and yet the VCs get a better return — albeit a loss.)
Yes, preferred shares are worth more than shares of common stock. They are valued more highly because of the liquidation preference and other rights. In a great exit, the preferred shares are typically converted to common stock and everyone wins. In a not so great exit, the preferred share rights kick in and the folks with common stock may not get paid.
If you have preferred shares, you often have a "2X liquidation preference"[1] or other multiple. This means that you are guaranteed to get at least two times your initial investment in a liquidation event, even if the value of your shares at the time is less than that amount.
This can (and often does) eat into the common stockholders' (e.g. employees) liquidation amounts.
In my experience (~ 20 years at institutional VC funds), 2x preference (or anything above 1x) is extremely rare. It comes up only when there is a distressed situation, and the investors do not believe that they will receive any money beyond their liquidation preference (i.e. other junior liquidation preferences will consume the rest of the proceeds from the sale of the company).
I saw it around the dot-com days along with a lot of other extremely dubious terms for extremely desperate founders - at least in NYC.
Agreed that more than a 1x liquidation preference these days would generally be surprising, but in a low end scenario or with a few big rounds, all it takes is a 1x to wipe out any upside for founders and employees, but if you're deemed worth it, the acquiring company can offer you a worthwhile incentive to stick around.
I don't even understand what half the words here mean and the alienation of human beings still comes through. We can offer advanced college calculus in public high schools but we can't teach basic finance. I don't think anyone but a handful of workers at my job understands any of this
Something tells me it is less about basic finance or accounting but more about private contracts between the founder team or whoever has control of the company and private investors.
Most of the employees are not given access to those terms. For example, in my last job in start-up , senior only celebrated each investment rounds but never detailed any of its terms. So, I had no idea whatsoever of the actual reward I should expect and that seems to be the norm from what I hear.
If you can program computers you can definitely understand startup finance. It sounds more complex than it really is! Unfortunately, all the jargon confuses people and they wind up getting screwed...
This is why a lot of folks from Good Technology got screwed. Valued at 1.1 billion .. sold for 425 million. Preference stack was skewed to investors + mgmt.
Let's say an original investor bought 50% of the company for 5 million dollars with a 2:1 payout.
This means that on an acquisition the original investor gets a minimum of 2x their original investment. In the case the start up is acquired for anything less than $10 million the original investor gets everything.
The thing is you don't have 1% of vested common stock.
When joining the company, you might be granted a set of options which are described as comparable to 1% of total shares, but the number is almost always effectively lower than that.
If the company does well, future funding rounds will lead to dilution of your ownership.
If the company does poorly, VC's will have liquidation preferences meaning that they get paid back first. This can easily bring your ownership down to 0%.
For an extreme example, say the VC invested $10M for 10% of the company, and then the company doesn't manage to grow, and gets acquired for the same $10M amount. The initial VC gets the $10M back from the acquisition (they make their money back, no profit). Then there is $0 left, and the common shareholders (early employees and often founders) get nothing.
It's a contrived example, and there are many other complexities to such a deal, but you get the idea.