It's fine to want preferred stock, but it's pretty rare for employees to ever receive it (unless they put up cash) -- it's reserved for investors to avoid a sandbagging + abscond with the money raised scenario.
Preferred stock (and specifically, liquidity preferences-- the common 1x, nonparticipating term) exists to ensure that if investors put in $10M for 20% of a company, you don't immediately sell the company for $10M and give them $2M back, and split $8M among yourselves. The deal is structured so that the investors have their option of either getting their original money returned or their share of the proportional share of the returns.
I've been in the middle of the opposite. All numbers are synthesized. Founders set up company, initially fund it themselves, take some rounds of investment with preferred, gives up some control. Company runs low on cash, finds new investment from "trustworthy" investors, all preferred. The founders hit 49%, the investors gain control, and make a purchase offer for the precise value of the preferred shares to themselves, which they decide to accept. All common shareholders are instantly out in the cold, with nothing (including the founders, who were utterly screwed).
The first thing they did was fire the founders, of course.
So...foolish founders? Yes. But wait! Foolish investors? YES!!
Because they absolutely screwed every employee, almost all the employees walked the afternoon we were informed.
I've never been prouder of the people I worked with. I think there were four people (tech support/admin) left out of 20 or so. Hard to remember now...so long ago.
For several hours the shitball investors were exceptionally proud of themselves...and then they realized they'd bought a pile of PCs they had no idea how to use. Plus bonus shitty furniture! And goodbye investment, of course.
We all formed a new company within a few weeks. The original founders somehow got money to get us started again...which we did, from absolutely nothing. We rewrote a similar product suite (but better!) in about 9 months, and went to the next big industry show with it.
Shitball investors found out, and promptly sued us (mild shock), claiming without evidence that we must have stolen the code on the way out. Since I was there for every single line of code we wrote the second time around, it was infuriating.
The ball bounces through the courts...they continued to harass us...and all does not necessarily end well.
> I've been in the middle of the opposite. All numbers are synthesized. Founders set up company, initially fund it themselves, take some rounds of investment with preferred, gives up some control. Company runs low on cash, finds new investment from "trustworthy" investors, all preferred. The founders hit 49%, the investors gain control, and make a purchase offer for the precise value of the preferred shares to themselves, which they decide to accept. All common shareholders are instantly out in the cold, with nothing (including the founders, who were utterly screwed).
Usually you structure your board in a way that prevents this-- not to mention that you could likely prevail in litigation if these are the facts because the board has a fiduciary duty to all investors, not just preferred: only if there is no reasonable prospect for common to get something can you accept an offer like this. Not to mention that when a controlling shareholder enters into a transaction with the corporation they have the duty of showing that the transaction is fair for all involved.
This is a really good point that I hadn't considered. Employees are "investing" money in a startup too in the form of opportunity cost, but a founder can't turn around and "sell" the investment when it's just time; when it's actual cash they can.
I wonder if there are stories about this happening in certain contexts that predated liquidity preferences?
Yup, that's the reason I've turned down all startup offers so far and some of them offered 2-3%. They like to hand wave about how much these 50,000 shares are going to cost or how rich I'm surely going to be even after dilution of these 2-3%, but when I tell them point blank that with my current compensation, over the course of 4 years I'm going to lose at least $1M, and ask them what I would get for a $1M investment, they suddenly struggle to find words. The reality is that, once you reach this level of miniature wealth and competence (and that happens quickly), the only next step is to start your own company. Startups don't really see employees as partners.
> They like to hand wave about how much these 50,000 shares are going to cost or how rich I'm surely going to be even after dilution of these 2-3%, but when I tell them point blank that with my current compensation, over the course of 4 years I'm going to lose at least $1M, and ask them what I would get for a $1M investment,
There's a thing you're missing here, and it's option value. You don't commit to the lost money over 4 years all at once, while a cash investor does immediately give up present-valued money. Instead, you commit to spending a year or so there (~$250k-valued), and only if your options look like they're going to be worth a whole lot do you stay beyond that point.
That's a valid point, but if we think about it, what does the founder do with that instant $1M grant? Most likely the founder spreads this $1M over the next few years on employees and other expenses according to his plan, hoping to get the next, bigger, grant. In other words, there is no advantage of having the entire amount upfront (except maybe the lost possibility to invest into short term treasuries with tiny return).
You bring up a good rebuttle, to which I ask, why not have the preferred shares vest? Then your stake accurately matches the risk you've taken on at any given time.
The time still isn't liquid, though. Yes, if you worked for someone for a year, you've given them $X (where $X is the paycut you took), but the founder can't just turn around and sell that $X to someone else. To the extent that they can, it's (to some extent) because the founder was able to take your time and turn it into something valuable, which is like, what founders/CEOs are supposed to do. At that point these is some sense in which the founder has also "earned" the liquidity.
With a direct cash infusion there's none of that. Any idiot can immediately sell $10M for $10M.
I think time is quite liquid. Let's say I get 500k/year on my current job and someone asks me to join his company for peanuts, but with a good chunk of stock. We could calculate the difference between 500k and peanuts and say that instead of joining that company, I'd pay him this difference every year. That difference would be enough to hire a small team for a small salary, but with stock options. The problem that most founders have is the unspoken refusal to accept that my time is worth this much.