The Hot Take
You won't hear this from most investors: but the standard way of dividing up classes of equity is, well, a bit unethical. This isn't click bait & and I'm not here to vilify anyone - I'm here to critique the game not the players.
One argument for favoring capital is that the capital is at risk, and so it deserves more of the upside. This argument falls apart quickly in my opinion, because suggesting that spending years of your life on a startup poses less financial, physical, and mental health risk to you than it does for an investor to park their excess capital isn’t really taking stock of the actual risks at hand.
I think a better argument against my hot take is that the market creates conditions that control the price of equity for a given company and founders ultimately get to chose whether to accept or not, at least early on. Markets are notoriously not good at pricing certain things, but even if they are good at pricing equity it’s not just the price in question. I’m talking about terms, specifically things like liquidation preferences. Granted if you eliminate terms like that, then the price would probably change. I’d still argue that’s a better outcome because at least the company is being priced in a way that equitably values both labor and capital contributors. In the event of an exit labor would be more likely to share in an overall smaller return per investor. Instead, we treat people according to their class: the capital class gets to eat first, then the laborers.
Class vs. Value
I mean we literally create different "classes" of stock where we treat one "class" as "preferred" over another another "class" simply because the preferred "class" has more money. When you start seeing these classes as having more to do with people and their power than their inherent value, it gets ugly. It shows what we value in our society. Why in the world should we prioritize the return of an individual who probably has lifelong stability and money to spare over someone who's dedicating their entire working life to the same cause with no stability or backup? Even for successful entrepreneurs who do have financial security, why is their labor less valuable than the capital when labor logically must precede the money? Who really carries the risk and downside here? It’s the laborer as much as if not more than the capitalist.
Let's be honest, the reason it is this way is not because it's fair or better for everyone, it's because there's a power discrepancy which can either be exploited or corrected. Great investors already do a great job at fairly valuing equity. But the consideration is usually about keeping the team “motivated” to stick with the problem, rarely is it about making sure they get as rich as the investors. Then there are bad investors who tend to be more selfish: these investors negotiate more and more carveouts like liquidation preferences over founders, and they're exploiting the dynamic to do so. Obviously good investors tow the line between what's required of them and what's good for the founders. Only foolish investors actually hurt the founders so much they lose incentive. But that's kind of a selfish place to draw the line, no? Certainly not generous.
But it’s business as usual
Now in our current context, these practices are so normal they’re going to have to continue on for now. Minds won't change overnight and we have commitments to keep. But hopefully if you haven't considered it before, then for the first time you might find it a little classist and you might even be inclined to rethink your next seat at the table. As an VC I would've had to negotiate that stuff on behalf of people way richer than me, and I can't bring myself to do that or to spend 10 years finding the LPs who think like me. One of many reasons I chose to stay an angel in the end. To me this is just another example that shows just because something is normal doesn’t make it ethically acceptable. Regardless, investors still get to buy in at a price they think is fair. That ought to be enough… for now