Today I saw and answered the following question on Quora:
“I’m working at one of the best post-IPO companies in Valley and have an offer from Square with 20% pay cut but stock options which at today’s valuation compensate for the pay cut over 4 years. However, I don’t have any savings and with this pay cut I don’t think I’ll save a lot. So I’m not sure if I’ll be able to exercise my options anyway. What are the alternatives for that?”
This question is a very good example of why private companies, especially in the tech sector where competition over talent is extremely high, should court prospective employees as prospective common shareholders. The shares component is extremely important for such a prospective employee.
Private companies who want to enhance their ability to attract talent need to build a relationship with their current common shareholders and option holder as well as prospective ones. Public companies build relationships within their shareholders and the wider investor community so that people end up buying and/or holding on to their shares, supporting the public stock price. Private companies equally need to build relationships with current and prospective holders of their common stock. They should be answering questions and having a dialogue with their (prospective)shareholders about issues related to the company itself and also the intricacies of private shares.
Here is the answer I provided on Quora:
I think the question you need to answer for yourself is whether equity based compensation from a private company like Square is an attractive proposition compared to that of a public company. I assume that you are also receiving equity based compensation in the public company where you currently work.
The benefit of equity based comp from a public company is that you have access to the same information about the company as every other shareholder or investor on the planet, and you have instant and cheap liquidity at your disposal in the form of the public stock market. You know a lot about the health and direction of the company, and if you don’t like what you are seeing or you simply need cash you can sell your vested shares easily and cheaply.
The drawback of a private company is that you do not have access to much information about the company, and also not as much as some other shareholders. The VCs, who are preferred shareholders, always negotiate for information rights and usually also a seat on the board, which gives them access to information beyond that which is provided to common shareholders.
In general private VC-backed companies provide very little information to their common shareholders as there isn’t much in the way of disclosure requirements that compels them to do so. One such requirements that does exist is that under Rule 701 of the Securities Act, which compels companies to provide information under their employee stock compensation plan, however the execution of this requirement differs widely between companies.
Without getting into the specifics of the success of Square as a company, you should also realize that due to the low or non-existent liquidity of private stock, you are essentially tied to the long term success of the private company and an eventual exit for the preferred shareholders and yourself.
Preferred shareholders not only have access to more information, but they also have the benefit of various financial preference over common shareholders. One such benefit is the ‘liquidation preference’ that VCs commonly negotiate for.
This preference entails that a particular class of shareholders is entitled to receive an amount of money equal to their original investment and any ‘unpaid dividends’ that would have accrued over time, before anyone else is entitled to share in the spoils of an eventual exit. This could create problems for common shareholders such as current and former employees in the event that the ultimate valuation upon exit is disappointing.
Because these are the most innovative and fast growing companies out there where you could individually create much more value than you ever could at a more mature public company. You could be involved in the creation of an entirely new market or the disruption of an old and stodgy one. In the event of a successful exit by the company, the value of your share options is likely to have compounded over the years.
And the above mentioned problems can be easily overcome by companies themselves. While private companies are not subject to much in terms of disclosure requirements, most great CEOs will want to foster a sense of common ownership among employees and provide more information to share- or option-holders then is necessary. Liquidity for private shares can be created, as Facebook or Twitter did in the past by building relationships with secondary buyers who then provided liquidity to common shareholders.
Finally, I’d liked to quote Stephen Cohen, co-founder of Palantir:
“We tend to massively underestimate the compounding returns of intelligence. As humans, we need to solve big problems. If you graduate Stanford at 22 and Google recruits you, you’ll work a 9-to-5. It’s probably more like an 11-to-3 in terms of hard work. They’ll pay well. It’s relaxing. But what they are actually doing is paying you to accept a much lower intellectual growth rate. When you recognize that intelligence is compounding, the cost of that missing long-term compounding is enormous. They’re not giving you the best opportunity of your life. Then a scary thing can happen: You might realize one day that you’ve lost your competitive edge. You won’t be the best anymore. You won’t be able to fall in love with new stuff. Things are cushy where you are. You get complacent and stall. So, run your prospective engineering hires through that narrative. Then show them the alternative: working at your startup.”