How Elon's Plans for Twitter affect your wallet[Finance Fridays]
Public vs Private Companies, and the nuances of stock compensation
What a crazy week huh,
Originally I had a completely different idea planned for today. But turns out Elon Musk really loves the headlines. So instead, we will cover his saga with Twitter.
Context
For those of you living under a rock, Elon announced his plans to buy Twitter for 43 Billion USD and take it private. But what does it mean to buy a company? And who does the 43 Billion go to? And what does it mean for the company to go private? These are questions that are important to know since a lot of you will end up working for startups/companies, which will offer you equity. However there is a catch to this, and if you don’t understand it, you will severely handicap your earnings.
Equity-Based Fund Raising
As we covered last week, many tech companies prefer to raise funding by selling equity in the companies. Make sure you understand the idea behind equity and shares before proceeding here. It will be crucial.
As we covered in that article, giving out equity comes with the downside of giving up control over the company. The more equity is sold, the more other people have control over your company. And as the common saying goes, “Too many cooks spoil the broth.”
In the case of Twitter, this manifests itself through the increased amount of censorship on the platform. Having more owners/stakeholders operating means that the chance of scaring advertisers away increases. Not to mention, the slightest bad news can lead to large sell-offs, as shown by the Meta. This has led to social media platforms becoming increasingly heavy-handed with their censorship, something that has become a large talking point in today’s world.
So how does Elon plan to protect free speech by buying Twitter? To understand that, it is important to understand another important concept in the stock market. And this is a concept, that is important for a lot of you since it will impact your salary negotiations.
Public vs Private Companies
In this context, I will use Public and Private to refer to Publicly and Privately Listed companies. What’s the difference? The graphic below covers the major points pretty well.
All startups, including the FAANG companies, start as private companies. Once they achieve some success, they transition to public companies via IPOs. This increases the pool of potential buyers from a few accredited investors, to the general populace. Thus going public leads to an increase in the share value of the companies, making investors very rich. The downside, as discussed is a greater sensitivity and a loss in ability to plan for the long term.
Elon’s plan is simple. He buys every share of Twitter. As the sole owner, he can then decide to take Twitter of the public stock listing. He would then have complete control over Twitter’s decisions and can thus reduce the censorship on the platform. This might seem crazy, but some giants like Dell have gone through a similar process.
Now for the bit most of you are waiting for. What does this have to do with you? How does the knowledge of Public and Private Companies help you?
The trick of equity
As I have shared with you in the past, the valuations of a company are tricky. Especially when the company is privately listed. Why?
Startups need people who will commit for the longer term. Employee turnover is expensive, and startups typically can’t afford to stomach this cost. They also don’t have the resources to pay high salaries. Thus, these startups often use Equity as leverage. Let’s take an example. I’m making up numbers to explain the point. Don’t use this as a reference.
Imagine a private company worth 100,000 USD. Instead of an employee 100 USD/month, a company might tell the employee that they will get only 50 USD/month with an equity of 5% in the company. This means that his stocks are worth 5000 USD. He would have had to work 50 months in the 100 USD/month job to make this amount. And as the company grows, his stock portfolio will grow with it. This sounds tempting.
However, here is the kicker, since the company is privately owned, our employee won’t be able to sell his shares easily. He can only cash out when the company goes public, or he finds an accredited investor to buy him out. This might take years, and most startups fail before that. Thus he ends up with worthless shares. This is why startups are considered high risk-high reward.
Many startups will try to entice you to accept a lower salary and take equity instead. And if you financial situation allows it, you can go right ahead. But too many people are not educated about this important topic, and will make a hasty and uninformed decisions. Make sure that is not you. In another post, I will cover stock vesting, and how companies use vested stocks to tie employees into long term contracts.
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Happy Prep. I’ll see you at your dream job.
Beware the Golden Handcuffs,
Devansh <3
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