Norms are in a rapid state of flux on this. I was told by people I consider extraordinarily credible that in the last two years their best companies, whose angel rounds would have resembled Series A a few years back, offered founders salaries roughly approximating market value of eqivalently skilled engineers employed in the area. (i.e. $120k not $40k, in the Bay area.)
I will also report this observation: "You'll think this is crazy. I thought it was crazy. But the last REDACTED deals I did included a partial cash-out for the founders." (I.e. rather than selling 10% of the company for $800k deposited in the corporate account the deal was $600k for the Corp and a $100k check for each founder.)
A thought: Early partial cash-outs could in theory align founders' and investors' targets better. Once a founder gets enough money to get e.g. an okay apartment, he might be more willing to take riskier moves, target really big and avoid acqui-hire offers.
I'm not sure about in the US but in the UK that would be a tax efficient way to do it, as entrepreneurial capital gains are taxed at a much lower level than income.
My understanding is that this was not an achievable option in the solution set e.g. 2 years ago, but 2 years ago the solution set also didn't include "Waltz into a six figure job as a fresh graduate", "Bill mid five figures a month contracting for a funded startup", or "Get this deal offered by somebody on the other side of the street if I don't play ball with you because your startup will fill that round regardless and the only question is how much you extract from us to make it happen."
I'm totally agnostic on whether this is bubblicious or this is just the market finding a more accurate approximation of the true value of the time of anyone capable of launching a product people like, by the way.
1) Have an offering which is extraordinarily difficult to hire for at the moment which...
2) ... accelerates growth of the startup in ...
3) ... a demonstrable manner as evidenced by...
4) ... past successes which are identifiably associated with your name in...
5) ... the minds of people who have authority to cut checks.
That's really the most helpful answer I can give you. "Learn SEO, A/B testing, AdWords, viral acquisition, etc etc." is also as true as the last 47 times I said it but less complete as an answer. There exist few reliable ways to hire for these at the moment and they are, at least potentially, all worth $$$$$$. However, putting out your shingle doesn't get you $x0,000 on your first week.
Does that rule out almost all consumer market startups, because they aren't making anything and don't seem terribly interested in doing so ("We're focusing on growth")?
I don't know what to tell you about how to value labor in companies that don't generate revenue. They all have some metric by which they justify spending hundreds of thousands of dollars a quarter on salaries; presumably, the same metric applies to contract work?
Not "crazy". Crazy is multiple liquidation preferences, participating preferred, founders and early employees in 8-figure exits being unable to buy a house on what they actually get, and the fact that founders have to pay the VC's own legal fees. That shit is fucking nuts. Founders cashing out for less than the market value of the work they produced to get to a seed round? Not crazy.
That's crazy if it happens because VCs conceal the terms of their deal, or offer exploding deals that don't leave time for due diligence.
On the other hand, it's not crazy if the board knowingly accept those terms. If they do, it's because there weren't better terms to be had somewhere else. All of these terms have a dollar value. The more onerous the terms, the lower the implied valuation of the company.
I've never understood how cash outs are crazy. The founders own %100 of the stock before financing. After financing in both cases they own less than %100 of the stock. The company can sell stock and dilute the founders, which often makes economic sense. Or the company can sell stock and dilute the founders while the founders also sell some stock and turn it into cash.
The main argument for founders not being able to sell stock seems to be to keep the founders broke and thus more desperate to take investor terms.
I also think that all money is the same. $100k in sweat equity should be at least as valuable (if not more) than $100k in cash on loan from some teachers pension fund. Thus no liquidation preferences for investors or other special rights. You want my ownership which came from sweat to now suddenly start vesting? Fine, the shares you just bought with cash, start vesting too on the same schedule.
If anyone should have preferences, its those who put in the sweat, not the people who convinced a pension manager to let them invest their money.
Companies that are internet based don't need nearly as much money these days as they did in the past, meanwhile there's a lot of money chasing startups. Its about time that the terms got more equitable.
They're not "crazy", but under normal circumstances with an illiquid investment like a startup, an investor has no incentive to shell out money that's just going to go into the pocket of a founder. Ideally, an investor wants 100% of their investment to go towards increasing the value of the company.
If the company is (for instance) profitable and on a clear trajectory, the incentives are different; maybe the investor in that situation is totally fine paying to take over some of the exposure of the founders. But at an unproven company?
The words "should" and "argument" don't really come into it. Company financing is a market. Don't want to accept liquidation preferences? Fine; wait for the market to get so frothy that desperate investors will fund companies without them, or don't take investments.
Investors are savvy enough to realize that a large part of the value they bring is diversifying risk -- otherwise paying market salaries would be a point of contention. So the words "should" and "argument" really do enter into it. It's a debate over what is reasonable compensation for the equity on offer.
Considering that the market is generally non-frothy for companies without revenue and pretty damn frothy for those with cash and growth, this sort of thing is to be expected: there will always be companies that can't or don't take funding until the founders can insist on stronger terms.
It's almost not a moral issue (I pretty much don't care at all), but it's worth mentioning: both negotiating parties in a VC deal are presumed to be sophisticated, but there's a third party that isn't: the company employees. When founders of companies with many employees take cash-out financing, they are taking liquidity that their employees do not get to access, regardless of their vesting.
Posted mostly because I think Nirvana is dead on. There are lots of bootstrapped founders on HN and no reason for this community to perceive ridiculously onerous terms as social norms. The more people speak up against them, the more fair treatment all founders will get and the more pressure investors will face to get involved at an earlier stage.
Fully agree selective cash-outs can be ethically problematic if there are other stakeholders without the same option. That said, it's probably safe to assume the transfer is happening via a private equity sale rather than having the company issue new stock. And given the evidence this is a first round by a bootstrapped team it seems unlikely there are any outside equity holders. Maybe California is different, but the bootstrapped teams I've known don't tend to give out equity, in part because they only tend to hire when they can afford it, and in part because dealing with legal issues is a luxury before there are revenues.
I will also report this observation: "You'll think this is crazy. I thought it was crazy. But the last REDACTED deals I did included a partial cash-out for the founders." (I.e. rather than selling 10% of the company for $800k deposited in the corporate account the deal was $600k for the Corp and a $100k check for each founder.)