It's not that it's legally permissible, it's that it's within bounds of what all parties agreed to.
If I agree to sell you my car for $5,000 then you show up with the money and give it to me and take the car, I don't get to change my mind later and get mad that you didn't give me more and call you immoral.
For startup employees it's more like they agree to help fix a car you intend to sell in return for payment and a take in the profits of the sale.
A lot of startup exits seem to take the form of you then selling the car to someone for a break even amount, who just happens to also pay you individually an extra $5,000 on the side.
Is it a good deal for you? Yes. Is it a scummy move? Yes.
The reality is that many startup employees may have stacked Stanford STEM degrees yadda yadda yadda, but they can’t do basic math, don’t have a good intuitive grasp of probability, have outlandish expectations, and/or don’t ask clarifying questions about the cap table.
One of my startups sold for about $25-40MM depending on whether you count pre- or post-earnout. The typical engineer got maybe a quarter of a percent of options on common stock. You’d think that would net out to $62.5K but we had a messy cap table. Various investments’ preferred status ate deeply into what remained for common stockholders.
Even if there were no cap table issues, the engineers wouldn’t have been happy, because they hung their hopes and dreams on a multi-hundred-million dollar exit. We experienced 90%+ engineer turnover over the next six months. (We got by just fine.)
Rule of thumb: do not join a startup for the money.
Agreed on not joining a startup for the money. Although it seems like a lot of damage has been done in setting a cultural expectation that joining a startup early will see you become a multi-millionaire, to the benefit of startups everywhere I suppose.
Correct me if I'm wrong here, but isn't another major issue faced by early employees that the math might look good when they join the company, but further rounds dilute their stake so much that it becomes meaningless?
Savvy investors include non-dilutive clauses when they know money needs to be raised, but good luck trying to negotiate this as an employee. It’s also not too bad if the dilution occurs at increasingly higher share valuations and help compound growth (see TSLA).
Yes, though the expression “an up round is an up round” has a lot of truth to it. Dilution is important if you care about control, but as long as the stock is worth more on a per-share basis, you’re doing better.
The problem is when people anchor their calculations about their future lottery winnings to the current float.
I try to tamp down expectations when I’m hiring by trying to sketch out a wide range of plausible scenarios (basically the Drake Equation for startups) but I’m going to go out on a limb and guess that a lot of hiring managers and HR departments set new hires up for disappointment by not throwing cold water on their very optimistic math.
And startups should really be upfront about those cap table details with those employees, especially if there's >1x preference on some of the investment, or other unusual issues.
I don't get to change my mind later and get mad that you didn't give me more and call you immoral.
But on the other hand, if you’d agreed to sell me your car at a price under what you might be able to get elsewhere—maybe because I was financially struggling and you were doing me a friendly favour—you’d probably be pretty miffed if I won the lottery and still demanded you stick to your offer…
If I were miffed, I could rescind the offer or ask for more. Just like the investors could have demanded their money back if they wanted too.
They chose not to, which would seem to indicate they weren't miffed. Nobody forced them to do anything. It's not immoral to ask someone for an accommodation and accept it.
The investors didn't give him the money as a friendly favor to help him it out. It was an investment. Presumably they make a lot of them and understand the risks involved in doing so. If you're going to get hurt feelings whenever one of your investments doesn't pay off, you're not cut out to be an investor.
If I agree to sell you my car for $5,000 then you show up with the money and give it to me and take the car, I don't get to change my mind later and get mad that you didn't give me more and call you immoral.