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Between bad leaver clauses, dilution and liquidation preferences, we're willing to bet most folks out there don't understand their warrants. And who can blame them?
In this episode, we break down the complexities of warrants in compensation packages and answer the question: Are they worth it? Or are they just a scam?
In this episode, we break down the complexities of warrants in compensation packages and answer the question: Are they worth it? Or are they just a scam?
- (00:00) - Introduction
- (02:13) - Understanding Warrants: A Potential Scam?
- (04:22) - Warrants as Compensation: Myths and Realities
- (12:33) - The Complexities of Dilution and Liquidation Preference
- (20:14) - Negotiation Strategies and Secondary Markets
- (24:56) - Conclusion and Final Thoughts
***
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Creators & Guests
What is The Revenue Formula?
This podcast is about scaling tech startups.
Hosted by Toni Hohlbein & Mikkel Plaehn, together they look at the full funnel.
With a combined 20 years of experience in B2B SaaS and 3 exits, they discuss growing pains, challenges and opportunities they’ve faced. Whether you're working in RevOps, sales, operations, finance or marketing - if you care about revenue, you'll care about this podcast.
If there’s one thing they hate, it’s talk. We know, it’s a bit of an oxymoron. But execution and focus is the key - that’s why each episode is designed to give 1-2 very concrete takeaways.
[00:00:00]
Introduction
---
Toni: Hey everyone, this is Toni Holbein, you are listening to the [00:00:03] Revenue Formula with Mikkel and Toni.[00:00:06]
Toni: What we are discussing today is [00:00:09] warrants. What you need to know about them [00:00:12] to avoid being scammed by your [00:00:15] company. Enjoy.
Mikkel: So [00:00:18] this is like, when I [00:00:21] start the intro like that, you're always like, okay, now it comes. [00:00:24] Now comes an amazing intro and it's always like,
Toni: [00:00:27] I never
Mikkel: terrible. It's always terrible.
Toni: that. Don't worry.
Mikkel: But [00:00:30] basically,
Toni: pressure to succeed,
Mikkel: so, [00:00:33] so we're going to Thailand and, [00:00:36] um,
Toni: and your family,
Mikkel: yeah, me
Toni: not you [00:00:39] and
Mikkel: else is coming down.
Mikkel: It's all running [00:00:42] and everyone else is coming down. And, uh, my dad is [00:00:45] like, Oh, can you exchange some [00:00:48] Danish crowns into dollars? So I can [00:00:51] exchange them into Thai baht. In Thailand, I'm like,[00:00:54]
Toni: you
Mikkel: why don't you just exchange it here to [00:00:57] Thai and then
Toni: you're done. I just asked for Thai money. Yeah. Yeah.
Mikkel: [00:01:00] it's
Toni: you go to the counter, it's like, can [00:01:03] I please have, I don't know, a gazillion billion [00:01:06] Thai notes. But
Mikkel: he's like, oh but the [00:01:09] exchange rates are so bad I was like, okay, so you're gonna miss [00:01:12] out on the equivalent of probably 50 euros [00:01:15] is what he's gonna lose out
Toni: you guys buy some traveler checks? No,
Mikkel: [00:01:18] it is, but it's like, and then I was like, so [00:01:21] you want to carry around all that cash to go some [00:01:24] place and have it exchanged locally? Do [00:01:27] you even trust that place?
Mikkel: I certainly wouldn't. It's like, well, ~I, ~[00:01:30] I know a place from before. It's a real, they'll give me a really good [00:01:33] deal. I'm just like,
Toni: yeah.
Mikkel: Oh no, I'm not even [00:01:36] sure I want to withdraw money with my credit card [00:01:39] just out of fear that it's going to get abused like last [00:01:42] time. You know, now didn't I tell you, I think we [00:01:45] had it in an intro even, that my credit card got [00:01:48] abused for like, Lots and lots of cash in, [00:01:51] in France.
Mikkel: Yeah, this is not long ago. And it's not like it was [00:01:54] because I was on holiday and did something, you know, shady with it. It was just like all of a sudden [00:01:57] like boop. And they were like, yep.
Toni: No, but I mean, you need to, I [00:02:00] mean, in general, this has nothing to do with Thailand.
Toni: ~In general, um, if you, if you don't have like this trust that, oh, this is my bank, I can trust this ATM. You, you kind of always have this like, hey, you know, what is this little plastic thing around the, the slot where you put the credit card in? Yeah. ~Is that maybe some, [00:02:03] some third party devices? Are they maybe scanning my credit card right [00:02:06] now?
Toni: Like that, that what always is going, is there maybe a [00:02:09] camera that sees my pin code? It's
Mikkel: yeah.
Toni: [00:02:12] It's, it's,
Mikkel: It's crazy, it's kind of crazy.
Understanding Warrants: A Potential Scam?
---
Mikkel: But, in [00:02:15] any case, uh, what we wanted to talk about [00:02:18] is another classic scam. [00:02:21] Warrants.
Toni: Warrants. [00:02:24] Aye. That was such a Danish reaction.
Mikkel: [00:02:27] Yeah, yeah, yeah. Uh, uh, uh, uh, it's too controversial. [00:02:30] No, we're going to talk a bit about warrants because one of the [00:02:33] problems we at least have discussed is very [00:02:36] few people, at least on the receiving [00:02:39] end,
Toni: of a word, understand
Mikkel: how [00:02:42] they actually work at the end of the day and [00:02:45] how they can or what will need to kind of [00:02:48] align for that to materialize into a payout.
Mikkel: ~Yes. Which is why you're getting it.~
Toni: And you know, [00:02:51] I sometimes refer to it as a lottery ticket. ~Um, ~But you know [00:02:54] what? A lottery ticket is much easier to understand.
Mikkel: Yeah. [00:02:57] And better odds. Yeah.
Toni: Well, I'm not sure about that, but [00:03:00] yes, for sure. Right. ~And, ~and I think ~the, ~the other myth [00:03:03] or scam around warrants is also usually that it's, [00:03:06] yes, it's being sold as a lottery ticket, ~um, ~but [00:03:09] also as a life changing event, potentially.[00:03:12]
Toni: Right. ~Um, ~if this goes the right way, boom, [00:03:15] now you have a Ferrari, ~you know, um, and, and, and, ~You know, that's just not true. ~Um, ~[00:03:18] yes, you have kind of all ~the, you know, ~the odds, but also the [00:03:21] payout, usually even in a great event for the company, doesn't necessarily need to [00:03:24] kind of land like this, ~um, ~which is kind of the conversation I [00:03:27] had recently with a friend of mine, ~uh, ~company exited [00:03:30] for, I don't know, 200, 250, I don't know the exact amount, but it [00:03:33] was something in this range, a million [00:03:36] euros.
Toni: ~Um, ~and, ~uh, ~he was a, ~uh, ~I want to say like a [00:03:39] director of sales. Kind of person. ~Um, ~[00:03:42] and he got a 5, 000, ~uh, ~[00:03:45] from, from, from his
Mikkel: had he been, how long had he been
Toni: [00:03:48] Yeah. So, so a while, um, and you [00:03:51] know, he was like, Toni, am I being scammed? What the fuck is going [00:03:54] on? Kind of this, ~you know, ~this can't be true. ~You know, ~should I be, ~you know, ~[00:03:57] suing them?
Toni: I'm like, no, I think this might be legit [00:04:00] actually. ~Um, ~and because he was so [00:04:03] flabbergasted about this whole thing, we want to just, ~you know, ~break apart [00:04:06] this myth ~of the, um, ~of the sold warrant thing a little bit. And [00:04:09] mind you, ~um, ~I myself have been [00:04:12] extremely lucky with this setup of warrants. ~You know, ~for me, it has not [00:04:15] been a scam and it's been extremely successful.
Toni: So I don't [00:04:18] think it's like all warrants are useless. ~Maybe, Well, maybe the title of the show is going to be called like that. Let's see about that. But, but, uh, you know, ~that's [00:04:21] certainly not ~what I'm, ~what we're trying to say.
Warrants as Compensation: Myths and Realities
---
Toni: I think what we're trying to ~kind of ~do today [00:04:24] is, ~uh, ~number one, ~uh, ~[00:04:27] explain this warrant setup a little bit more.
Toni: And give you a little bit of [00:04:30] the ins and outs of this thing. And then number two, [00:04:33] now that you know a little ~better, ~better what's going on, ~kind of, how, ~how would you [00:04:36] use that? How can you use it for negotiation? ~Kind of, ~how can you, ~you know, ~[00:04:39] use that information to get a better deal, etc. [00:04:42] Right. I think that's what we want to dive in today.
Mikkel: Yeah. I mean, [00:04:45] it is also a very common part of the package you get, and it's being [00:04:48] treated as part of the compensation. And I guess the first question is [00:04:51] really, should you see it as part of your compensation?[00:04:54]
Toni: So, um, well, I [00:04:57] would say, yes, you should see it as part of your [00:05:00] compensation, but there's a couple of caveats here that you just [00:05:03] simply need to be aware of.
Toni: Because this is not money [00:05:06] that lands on your bank account that you can do with whatever, and there's ~like ~[00:05:09] laws protecting you that they can't take the money back and so [00:05:12] forth. Those warrants, they can just [00:05:15] disappear. ~Um, ~for a couple of reasons, ~um, and, ~and ~that is, ~that simply then [00:05:18] by default doesn't really equal [00:05:21] compensation, if you will.
Toni: I think they're part of the [00:05:24] package, ~um, ~but it's really difficult to ~kind of ~say like, ~Hey, ~especially early [00:05:27] stage warrants are compensation, right? [00:05:30] There are some examples when you're a publicly traded [00:05:33] company. where you get restricted, restricted, ~uh, ~[00:05:36] share units or some RSUs. You [00:05:39] know what? That is almost money.
Toni: Like that [00:05:42] stuff is very similar to money. Basically kind of, [00:05:45] there's just a period you need to wait until you get it and then you can [00:05:48] exercise it and so forth. That's the closest to money you will [00:05:51] get. ~Um, ~but this whole warrant stuff that we're talking about today, kind [00:05:54] of why is one an RSU and one a warrant?
Toni: There's some legal [00:05:57] reasons for this. ~Um, ~but really the warrant stuff ~is, um, ~is way more [00:06:00] dicey and tricky. ~Right. ~And number one, why shouldn't you be [00:06:03] considering this ~as, ~as full on compensation? Not [00:06:06] because of the odds, but because of the structure of it. [00:06:09] So let's just say you decide to leave the company.[00:06:12]
Toni: Yeah. ~Um, ~from a company perspective, [00:06:15] you would be then in most language being [00:06:18] labeled a bad leaver, a bad person. [00:06:21] You're leaving. Yeah. You're leaving [00:06:24] on your own volition. And that's [00:06:27] from a company perspective, seen as a bad [00:06:30] person. ~Um, ~because you're kind of giving up, you don't believe in [00:06:33] it anymore. ~You, ~you feel you can, ~you know, ~make more money somewhere else.[00:06:36]
Toni: In those situations, ~very, ~very [00:06:39] often, ~um, ~basically what the company is going to do in the warrant [00:06:42] agreement is that, Oh, you know what? You want to leave, [00:06:45] you lose all your warrants. And, [00:06:48] and not even, not even do I, as a [00:06:51] company, maybe need to buy them back. Because I've [00:06:54] given them to you and I want to buy those rights [00:06:57] back.
Toni: ~Um, ~they don't need to do that. They're just going to take it away from you. [00:07:00] Like, sometimes it's written in a way where [00:07:03] they get invalidated, they're just kind of being shredded, in some [00:07:06] cases the ownership comes back, or whatever it might [00:07:09] be, but that's usually how that works out, right? Um, [00:07:12] and, From a company perspective, [00:07:15] so I've been basically on both ends, one on receiving warrants and [00:07:18] also one on, on creating a warrant structure for employees, right?[00:07:21]
Toni: From a company perspective, you obviously want [00:07:24] to use those warrants to create stickiness with the organization. [00:07:27] Like, Hey, this other offer from [00:07:30] the other company is maybe a bit higher in, you know, [00:07:33] salary, but you would be losing out on those [00:07:36] warrants. So maybe you want to stick around. Loss [00:07:39] aversion, right?
Toni: ~Kind of, ~this is what this whole thing is about. ~Um, ~[00:07:42] but I feel there's a balance to this thing, [00:07:45] right? ~Kind of, ~because as a company also to a degree need to take [00:07:48] responsibility. Let's just say this is for an IC, ~uh, ~or for, ~you know, you know, ~[00:07:51] someone kind of a little bit higher, but not too high up. It's like, well, [00:07:54] maybe also the company didn't do a good job trying to [00:07:57] retain that person, right?
Toni: It's not only that the person is leaving [00:08:00] because. Fuck you. I don't, you know, I don't care about this company [00:08:03] anymore. It could just be like, Hey, I'm sorry. I'm a director [00:08:06] and my boss, the VP is a, is an asshole. [00:08:09] And I just don't want to work here anymore. ~Um, ~so you're kind of [00:08:12] pushing me out by your actions and then you're saying [00:08:15] I'm a bad leaver, kind of, that's not fair, right?
Toni: ~So that, ~[00:08:18] that kind of thinking needs to be part of this. ~Um, ~and that's why I'm saying ~kind of, ~you [00:08:21] can't really see it ~as, um, ~as compensation. Now that was. [00:08:24] The Bad Lever stuff. Now there's the [00:08:27] Good Lever stuff as well. Sorry, this is like, I'll [00:08:30] give you some time to say something in a
Mikkel: second. No, that's fine. I'm just [00:08:33] mentally falling asleep.
Mikkel: That's
Toni: Yeah, I know,
Mikkel: No, no, I'm joking.
Toni: It's like, you [00:08:36] know, Toni the professor here right now. Yeah,
Mikkel: in the Iver [00:08:39] Tower folks.
Toni: tower. [00:08:42] Um, you know what, actually, why don't you tell us about why the Good Lever [00:08:45] clause is kind of screwed.
Mikkel: Why the Good leave clause [00:08:48] is is screwed. So checks
Toni: off his jacket, [00:08:51] starts sweating immediately.
Mikkel: No, no, no, no. So
Toni: [00:08:54] the,
Mikkel: good lever. That's the folks being, [00:08:57] uh, fired. Being fired. Yeah. Um, so they [00:09:00] get to keep part of their warrants [00:09:03] and they got fired. Usually because of underperformance[00:09:06]
Toni: so the, so usually. [00:09:09] If you get fired, um, you [00:09:12] can keep the warrants that you have vested.
Mikkel: [00:09:15] invested. Yeah. However, You
Toni: need to [00:09:18] exercise them, meaning you need to buy them [00:09:21] within like 60 or 90 days.
Toni: Like that's basically [00:09:24] kind of how they're doing this. ~Um, ~and depending on when you join our [00:09:27] organization, That can easily be [00:09:30] 000. You need to basically, [00:09:33] you know, pay them.
Mikkel: Yeah.
Toni: Remember, [00:09:36] after you've gotten fired.
Mikkel: [00:09:39] So your love for that organization is already at a [00:09:42] peak.
Mikkel: No, no,
Toni: But also, you're like, okay, wait a minute, [00:09:45] where am I going to work next?
Toni: Where am I going to get my
Mikkel: I'm going to pay the bills.
Toni: [00:09:48] And then, oh, you know, while you're thinking about [00:09:51] that, Here's a time, you know, clock ticking, ~um, ~and [00:09:54] it's running out in 60 days, and if you haven't paid us, [00:09:57] all this stuff is gone, right? On top of [00:10:00] that, which is pretty wild, and this differs in the different [00:10:03] jurisdictions, I've heard those stories about the US a lot, On [00:10:06] top of that, I can't explain why, right [00:10:09] now, I was able to once.
Toni: ~Um, ~when you [00:10:12] do that, the taxman says, [00:10:15] you made money here now. The [00:10:18] taxman says, you have exercised those [00:10:21] warrants, ~um, ~and you bought them for whatever the strike [00:10:24] price that the price they need to pay was, [00:10:27] but they're currently worth this. So you actually,
Mikkel: [00:10:30] need to pay tax.
Toni: this is capital gains in that point. [00:10:33] So you need to pay in some jurisdictions, not everywhere.
Toni: So [00:10:36] not only I need to kind of put up 50k, ~On top of that, ~you [00:10:39] also need to pay taxes on something that is [00:10:42] probably not going to happen, like realize [00:10:45] for the next five to 10 years.
Mikkel: 10 years.
Mikkel: ~So~
Toni: in [00:10:48] general, such a bad deal and [00:10:51] companies know that, ~um, ~which then leads to even the good [00:10:54] leaver scenario, people give their warrants back.
Toni: They don't exercise them[00:10:57]
Mikkel: them. So no matter how people leave, [00:11:00] no warrants.
Toni: pretty much in almost all cases. [00:11:03] Um, and if that is the [00:11:06] case,
Mikkel: ~uh,~
Toni: I think [00:11:09] either the organization becomes pretty cynical about that
Mikkel: about that [00:11:12] stuff,
Toni: ~um, or ~it's just extremely abundantly [00:11:15] clear that you cannot see this as [00:11:18] compensation.
Mikkel: But you know what? The talent might also become cynical and go [00:11:21] like, Hey, do I want to go work for a Series A company? [00:11:24] They're probably not going to exit for [00:11:27] another many years. Versus if I go for this, ~uh, ~Series [00:11:30] C company, you know? ~Yeah.~
Toni: No, people, people do [00:11:33] that. Like, especially in the C level. ~Um, ~I've [00:11:36] heard this now, you know, talking to a couple of CFOs [00:11:39] that are looking for jobs. Not, not here, ~um, ~[00:11:42] but looking for jobs and was chatting with them and the [00:11:45] way they look at an opportunity is like, Yeah, you know, the churn [00:11:48] is pretty good.
Toni: The CAC Payback is kind of good. They're like [00:11:51] around 40, 50 million. I think this [00:11:54] thing could flip in two years. So that [00:11:57] works out for me.
Mikkel: Yeah, I'll take, I'll take that commission.[00:12:00]
Toni: know, that's, that's kind of how they're thinking about it. ~Um, and, ~and other [00:12:03] people should too, by the way, ~but, ~but generally speaking, I don't think a [00:12:06] lot of people make it part of the consideration, [00:12:09] you know, who's going to exit when.
Toni: I think it's [00:12:12] just when you have this conversation like, hey, you can either [00:12:15] have a little bit more salary or a little bit less warrants. [00:12:18] Um, I think what you need to be equipped with is like, well, [00:12:21] wait a minute. This not really is cash. This is [00:12:24] not really comparative.
Mikkel: I [00:12:27] mean also just to manage the time here. There's two other things that [00:12:30] I, that I wanted to make sure we cover that's also pretty key to [00:12:33] understand.
The Complexities of Dilution and Liquidation Preference
---
Mikkel: And the first one is dilution, [00:12:36] right?
Mikkel: I think if you've, ~uh, ~let's just assume that the listener [00:12:39] doesn't know much about it. Maybe they've seen the social network and [00:12:42] heard something in there about dilution. ~Um, ~can we just position very [00:12:45] simply what is it and why does it exist? ~Uh, ~what are the ramifications on [00:12:48] warrants, if any?
Toni: Yeah. So what happened, ~um, ~in the social [00:12:51] network, basically the Facebook movie, that never happens.
Mikkel: [00:12:54] No, no, no.
Toni: Like they're like, you know, very [00:12:57] super clear, strict kind of things around that. That actually never [00:13:00] happens. ~Um, ~yeah. But what dilution, where dilution [00:13:03] usually happens all the time is, for example, if you have a [00:13:06] new funding round, right?
Toni: Because it's not [00:13:09] that, okay, you have a hundred shares for a hundred percent of the company [00:13:12] and now someone else comes in and takes ten percent of the company [00:13:15] that, you know, ten percent of the shareholders sell the shares. [00:13:18] You know, some shares, that's not how it [00:13:21] works. The way it works is that, you know, instead of a [00:13:24] hundred, you know, shares, now they're like 111 [00:13:27] percent or whatever, whatever the math is here.
Toni: ~Uh, ~you know, [00:13:30] that's how it works. ~Um, ~so what does that mean? Well, [00:13:33] now a hundred percent equals 111, [00:13:36] 111 shares. ~Uh, ~meaning whatever you [00:13:39] had before is now worth a little bit less. [00:13:42] That's how this works. And [00:13:45] this dilution might happen in a couple of different ways. It could [00:13:48] be that they're, ~um, ~either creating or re [00:13:51] upping the ESOP, the employee share option [00:13:54] pool, basically the pool of warrants that [00:13:57] are available in the organization.
Toni: And if they do that, that's [00:14:00] great, but it dilutes everyone else. ~Um, ~and the [00:14:03] same for a new investor, ~uh, ~et cetera. Um, [00:14:06] so if you, let's just say your, um, [00:14:09] first employee.
Mikkel: You're going to get diluted like [00:14:12] crazy.
Toni: Let's just say you're a first employee and you're really proud [00:14:15] and you should be proud to get a full point, like full [00:14:18] one, you know, 1%. ~Um, ~if this becomes a billion [00:14:21] dollar company, ~um, ~it's not that you have 1 percent of a billion, [00:14:24] you will be diluted down to probably, you know, 0.
Toni: [00:14:27] 1 percent or something like this. ~Um, ~depends, [00:14:30] but that needs to be the understanding. And I think [00:14:33] people that are educated in the space are pretty clear on that. Okay. I understand that [00:14:36] because yes, my share of the [00:14:39] pie decreased, but the pie in general [00:14:42] increased. So, yeah. So, you know, even though I have [00:14:45] percentage wise, a smaller share, it's worth more
Mikkel: Can you [00:14:48] ask for non diluted?
Toni: Yeah, you can, but ~you, ~you're [00:14:51] gonna be laughed at.
Mikkel: at. Okay, good. No, I just wanted to clarify because [00:14:54] that's also a term you might have heard, that there are non [00:14:57] dilutive, diluted shares, right? Um, [00:15:00] but I guess that's more on the VC side, usually when they have a bit,[00:15:03]
Toni: No, it's like, ~uh, I, ~I've seen this once ~with a, um, uh, ~with an [00:15:06] advisor, ~uh, ~that he asked for, ~um, ~non diluted [00:15:09] shares.
Toni: ~Uh, ~but I haven't seen it since. Like it's pretty [00:15:12] crazy to kind of
Mikkel: ask for non Diluva shares. ~Yeah. Okay. ~And the other one is [00:15:15] liquidation [00:15:18] preference.
Toni: ~preference. Um, and this is where the gentlemen that I talked about in the intro probably got screwed. ~This is also where founders get screwed, by the way.
Toni: This is not just [00:15:21] a, um, what, what people need to understand [00:15:24] is that, ~um, ~if you give shares to an account [00:15:27] executive, like maybe you have a scheme where that's kind of the case, [00:15:30] those shares. And most [00:15:33] of the cases, ~uh, ~basically have the [00:15:36] same, ~uh, ~share class as the founder shares. So both [00:15:39] of those are considered common shares.
Toni: ~Um, and, um, you know, ~[00:15:42] they're hit by the same dynamics. ~Um, and ~for example, liquidation [00:15:45] preference. is something that is only [00:15:48] given to preferred shares, meaning your [00:15:51] investors put money into the organization. ~Um, ~yes, they have [00:15:54] now 11 shares, if you remember, but [00:15:57] those shares have a couple more rights attached.
Toni: They have like a little bit [00:16:00] of an upside. ~Um, ~and one of those rights is extremely powerful [00:16:03] is liquidation preference, right? And, and [00:16:06] what, you know, potentially happened here [00:16:09] is this company, ~uh, ~You know, I'm [00:16:12] not sure, kind of maybe they raised 50 million, a hundred million or something [00:16:15] like this. ~Um, ~and the investor might've said, I want to [00:16:18] have participating liquidation preference.
Toni: Forget about this word [00:16:21] now, just for, just for the people with, you know, [00:16:24] the, the glasses like Toni, this is participating. [00:16:27] Um, basically kind of they have, uh, you know, participating liquidation [00:16:30] preference or a 2X, uh, 2X [00:16:33] liquidation preference. Basically what this means, [00:16:36] let's just say the company got. Sold for 250 million.[00:16:39]
Toni: There's a hundred million of liquidation preference in the [00:16:42] organization. It could be, depending how this is cut, [00:16:45] that before anyone is being [00:16:48] considered, a hundred to up to two hundred [00:16:51] million of the 250 million goes directly to the [00:16:54] preference shares. Like, goes directly to the investors. [00:16:57] And then 50, [00:17:00] depending on how it's cut, Some of that, not [00:17:03] all, some of that is then distributed to the common [00:17:06] shares, e.
Toni: g. the AE, the sales director, [00:17:09] the founder, and so forth,
Mikkel: So it almost
Toni: looked like a [00:17:12] 250 million exit, really was just a [00:17:15] 50 [00:17:18] million
Mikkel: let's say a big movie where a company [00:17:21] goes bankrupt and owes people a lot of money. Who gets paid [00:17:24] first? The authorities, tax, then who [00:17:27] gets paid second? The bank. And then everyone else, like the [00:17:30] employees, usually in these kind of movies, they are left [00:17:33] holding the bag, right?
Mikkel: And, uh, that's, it's kind of [00:17:36] also what you're saying here. There is a structure, which is to a degree also [00:17:39] fair. Someone puts in money, ~uh, ~an investor, a high amount [00:17:42] of money, there should be a preference for them to get paid [00:17:45] out, right? ~Um, ~but it sounds like this is a case where you have almost [00:17:48] class A and B shares, so.
Toni: it's not like [00:17:51] that, but it's, it's different. So different share classes and they have [00:17:54] different rights.
Toni: Why does liquidation preference [00:17:57] exist? You know, because everyone on LinkedIn is like painting this as this, like, [00:18:00] Ooh, you know, these bad investors. The [00:18:03] reason why this exists is because it's protecting [00:18:06] them on a downside. So let's just say you, ~uh, ~put [00:18:09] 10 million as an investor into a company. And it's [00:18:12] valued at a hundred million for whatever reason.
Toni: Let's just say that's [00:18:15] what it is. You as a founder now, [00:18:18] tomorrow could go and say like, you know what? Let's sell the entire [00:18:21] company for 20 million. Like I [00:18:24] get, you know, my 90 percent from this. ~Um, ~and then the investor that [00:18:27] yesterday put in 10 million gets, ~uh, ~you know, ~two, ~2 [00:18:30] million.
Mikkel: Yeah.
Toni: And this is where liquidation preference [00:18:33] basically comes in.
Toni: It's like, yes, ~you know what, ~sell this thing for 20 [00:18:36] million. But before any of that happens, I get my 10 back, [00:18:39] right? ~Kind of, that's the reason. ~And then an upside scenario, it's [00:18:42] sometimes structured in a way where it's ~basically kind of ~set up ~to, ~to screw you ~as a, ~as a [00:18:45] common shareholder. And, you know, there's some reasons [00:18:48] why founders say yes to that, but that's the reason why that [00:18:51] sales director didn't get, ~you know, ~much, ~right.~
Toni: And this [00:18:54] also leads back to, oh, it's going to be a life changing [00:18:57] ticket. ~Um, one of, ~one of my VP of sales ~in, uh, back on the day ~in a Falcon brand watch, ~um, ~[00:19:00] we were talking about this exit happening [00:19:03] and he was like, Toni, what, I mean, I have those [00:19:06] shares. Can you tell me? What's the [00:19:09] range of this stuff? Is this a new [00:19:12] kettle?
Toni: Is it a new dishwasher? Is it a new kitchen? Is it a [00:19:15] new house? Kind of, what is it? And I looked at it and [00:19:18] it's like, it's, ~you know, ~probably an Ikea kitchen.[00:19:21]
Mikkel: kitchen.
Toni: And he was like, okay, [00:19:24] great. You know, it's like, You know, I was not expecting anything or [00:19:27] much, but like now I know what it is. And this was by [00:19:30] no means in this case, life changing or anything.
Toni: ~Right. Um, and, um, ~I think [00:19:33] this is what people also need to keep in mind. It's like, [00:19:36] yes, the crazy upside, you know, Oh, you know, [00:19:39] I'm a, I'm an early employer of Nvidia and I'm now a, [00:19:42] you know, a hundred million millionaire or something like this. [00:19:45] That happens, you know, once in a lifetime or so, ~um, ~[00:19:48] but mostly what happens, if there's any money at [00:19:51] all from warrants, it's probably going to end up [00:19:54] being only life changing for [00:19:57] founders, ~um, ~and then maybe a little bit life changing for [00:20:00] super early employees.
Toni: For the rest, it's going to be, ~you know, ~a new kitchen, [00:20:03] a new dishwasher, something like that.
Mikkel: There's another thing you [00:20:06] also mentioned which was, ~uh, ~secondaries.
Toni: Yeah. [00:20:09] So, ~um, ~and this is really kind of how you should be [00:20:12] thinking about negotiating some of these pieces. ~So ~
Negotiation Strategies and Secondary Markets
---
Toni: now [00:20:15] that you know, ~um, ~good lever, bad lever, you, you're going [00:20:18] to get screwed. That's why it's not like salary. ~Uh, ~dilution, [00:20:21] just keep this back in your head. That will happen anyway in a good [00:20:24] and bad scenario.
Toni: And then liquidation preference. Those are some of the [00:20:27] reasons why the payout is not going to be as big as you might [00:20:30] think it's going to be. So how can I use this to now [00:20:33] negotiate? ~Um, so. ~First of all, ~um, ~ask for the good lever, bad lever [00:20:36] clauses. ~And, and ~I asked for kind of, you know, just to [00:20:39] understand that, you know, first step, just to understand that, ~um, ~because [00:20:42] that changes a little bit of the dynamic, how you can negotiate this thing.
Toni: [00:20:45] Right. And I'm going to say something else. ~Um, ~I've [00:20:48] used this myself, ~uh, ~successfully, and I'm going to use it [00:20:51] hopefully in the future as well. ~Uh, ~but you can always say like, ah, we can't [00:20:54] change that. That's agreed with the board, blah, blah, blah, blah, blah. [00:20:57] Um, that very much, you know, is changes, [00:21:00] uh, by jurisdiction.
Toni: So there are things that you can [00:21:03] totally change and there are things that you can't. It's really difficult [00:21:06] to figure out what it actually is, but many times there's [00:21:09] more flexibility than the other side will tell [00:21:12] you about,
Mikkel: Yeah.
Toni: So understand kind of this [00:21:15] whole good lever, bad lever thing. Um, and [00:21:18] ultimately, um, as if you, uh, if [00:21:21] you're a C level or something.
Toni: ~Uh, ~make sure [00:21:24] that you try and get, you know, some people call it double [00:21:27] trigger, some people call it accelerated vesting [00:21:30] to get that in there. What that means is [00:21:33] let's just say you have a vesting period of four [00:21:36] years.
Mikkel: ~Um,~
Toni: But the company gets sold after [00:21:39] two years, Accelerate Investing or Double [00:21:42] Trigger basically kind of creates a situation where you now [00:21:45] get compensated for all the shares in your [00:21:48] investing period, which is really what you want, because that really [00:21:51] aligns you with the rest of the C level.
Toni: However, [00:21:54] if you give this to everyone, you basically sell the [00:21:57] company and everyone was like, okay, cool. No incentive anymore. Now give me a new [00:22:00] incentive. ~Now, ~now that I'm a millionaire already. Try and [00:22:03] give me an incentive method, ~you know, try and do that. Um, ~so ~that, ~that's difficult, right? So you want to [00:22:06] be, be careful with this, but if you're a VP or C [00:22:09] level, kind of really, really think about this.
Toni: And then there's the [00:22:12] last one, which is DICI. I've never [00:22:15] pulled this off. I've never thought about it. ~Um, ~but it's really [00:22:18] the topic of secondary. What is [00:22:21] secondary? You might ask. Well, let's just imagine, ~uh, ~[00:22:24] you are closing a, your company's closing a series B, [00:22:27] 50 million, 30 million, whatever it might be, [00:22:30] what usually happens there?
Toni: Is [00:22:33] that the fund says, Oh, well, Mr. [00:22:36] Founder, ~um, ~this is a lot of, you know, it's a big [00:22:39] company now. It's very valuable. Wouldn't it be good for you [00:22:42] to take some chips off the table?
Mikkel: table? Just[00:22:45]
Toni: for your own, so you can relax a little bit. Like, you know, [00:22:48] you need to be worried about this being a billion dollar company, but like [00:22:51] just, just for your mental, mental health, you know?[00:22:54]
Toni: So what happens many times in those rounds is that [00:22:57] founders actually take like one, two, three, up to 5 [00:23:00] million. I've seen more. ~Uh, ~being taken, ~um, ~you know, it's, it's a [00:23:03] 50 million round being announced. What people don't know is [00:23:06] only 40 million went into the company. So people are like, okay, let's [00:23:09] do a 50 million budget, but it's only 40 million going in.[00:23:12]
Toni: The other 10 went to the founders,
Mikkel: the founders. No, it actually [00:23:15] is not, uh, 40, it's 20 because there's also the [00:23:18] marketing money. Yeah. They put in there.
Toni: that's right. So, and this [00:23:21] is a normal thing, I think is also absolutely fair. Um, but [00:23:24] if you're C level, ~um, ~you should be [00:23:27] thinking very hard about the secondary stuff because, ~um, ~[00:23:30] imagine the following, let's just say you have a team of like two, three [00:23:33] founders around you.
Toni: And suddenly all of them have five million [00:23:36] dollars on their bank account. I don't want to, you know, [00:23:39] I don't want to say that fat cat [00:23:42] syndrome is kicking in immediately,
Mikkel: [00:23:45] immediately, but
Toni: the octane level will drop, like for [00:23:48] sure, for sure, right? And you don't want to [00:23:51] be, you know, sitting there as the last C level, [00:23:54] who still has all the chips on the table.
Toni: ~Um, ~and [00:23:57] basically, ~uh, ~you know, even might get screwed [00:24:00] because the founders pumped up the valuation so much [00:24:03] to get kind of, you know, this payday, [00:24:06] knowing that they're probably not going to return this whole
Mikkel: money.
Mikkel: [00:24:09] They're
Toni: probably not going to sell this for a billion, even though that now [00:24:12] needs to be the milestone.
Toni: So if you're a C [00:24:15] level, you should have a conversation with your founders to find an [00:24:18] arrangement now, not when the round is happening. That's too late. [00:24:21] You need to find an arrangement now. It's like, well. [00:24:24] We need to make sure if you take secondary. That [00:24:27] the rest of the team, this very small team, [00:24:30] like Odyssey is going to be, that they also benefit in the same way, because [00:24:33] otherwise we're not aligned.
Toni: Because you're doing ~a, ~a way to [00:24:36] pump this up as much as possible, have a really nice [00:24:39] outcome here, ~um, ~and then everyone else is kind of ~hanging. Uh, ~hanging dry to [00:24:42] try and, ~you know, ~achieve this billion dollar outcome, which you're [00:24:45] only going to be a little bit incentivized for now. Right. ~Um, so ~lots [00:24:48] of stuff to be considered.
Toni: Maybe people need to re listen to this [00:24:51] episode. I'm not sure. Uh, it was a
Mikkel: All you need to do a REV [00:24:54] letter, just structuring this stuff out with, ~um, ~how to use it.
Conclusion and Final Thoughts
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Mikkel: [00:24:57] So I think at least the important note here is, this is not [00:25:00] a compensational element. This is a [00:25:03] lottery ticket, and now hopefully there's a couple of important [00:25:06] pieces you understand better, and that you can talk [00:25:09] with. The team about to understand [00:25:12] the lottery ticket a bit better.
Toni: these things, they [00:25:15] seem minor, but as you start pulling on them [00:25:18] and changing the levers a little bit around, you know, [00:25:21] some of these things might move it a little bit [00:25:24] closer to feeling like compensation, especially early [00:25:27] stage, right?
Toni: If you're able to tweak the [00:25:30] good lever, bad lever stuff. That will make it feel a [00:25:33] lot closer to compensation suddenly, still being [00:25:36] super risky and lottery tickety. ~Um, but ~it's not like, okay, we can take [00:25:39] everything away from you. ~Um, ~which is how most warrants programs are [00:25:42] structured, which ~I just think is just, um, that ~used to work in a world where people were completely [00:25:45] uneducated about this stuff, I think that stopped now.[00:25:48]
Mikkel: That's it.
Toni: Thanks, Mikkel. [00:25:51] Thank you everyone else for listening to me rambling [00:25:54] on this topic. I've been thinking about this obviously deeply.[00:25:57]
Mikkel: So finally we got it out so we can visit
Toni: [00:26:00] No, we were like, oh, Toni, like every week for [00:26:03] like five months. We should talk
Mikkel: ideas, any
Toni: [00:26:06] talk about warrants. And Mikkel's like, yeah, yeah, yeah, yeah, yeah.
Toni: [00:26:09] Great, great idea. Let me put it on my not to do
Mikkel: [00:26:12] Yeah.
Toni: Thank you.
Mikkel: And with [00:26:15] that, thank you so much for
Toni: a good one, everyone. Bye bye.
Mikkel: Please [00:26:18] stay, please stay. Don't leave this show. [00:26:21] Bye.