If you have startup stock options, check your option plan(blog.conspire.com)
blog.conspire.com
If you have startup stock options, check your option plan
http://blog.conspire.com/post/112700131803/if-you-have-startup-stock-options-check-your
167 comments
Founders stock works well for early employees.
Since valuations of pre-series A companies is effectively $0, the cost for employees to buy their shares upfront is minimal (literally a few dollars for a few percent).
But as a company raises capital, it's legally required to have a "409a valuation", which establishes the "fair market value" of the stock. Once this happens, it can cost $x,xxx's of dollars for employees if they're given founders stock (restricted stock) upfront, compared to stock options that have no upfront cost.
One solution to this is to give employees a signing bonus to buy the restricted stock upfront, so it cancels out the amount they owe upfront. Alternatively, you could grant stock options, and sign something that says the company will give them a bonus equal to the exercise price of the options.
Since valuations of pre-series A companies is effectively $0, the cost for employees to buy their shares upfront is minimal (literally a few dollars for a few percent).
But as a company raises capital, it's legally required to have a "409a valuation", which establishes the "fair market value" of the stock. Once this happens, it can cost $x,xxx's of dollars for employees if they're given founders stock (restricted stock) upfront, compared to stock options that have no upfront cost.
One solution to this is to give employees a signing bonus to buy the restricted stock upfront, so it cancels out the amount they owe upfront. Alternatively, you could grant stock options, and sign something that says the company will give them a bonus equal to the exercise price of the options.
100% correct. We hope that we will be able to float those amounts to the employees (as bonus) as we get to later stages of growth, but what I have discussed with our GC looks closer to the conversion bonus when and if that happens.
The boundary cases where there is a contentious firing will have to be taken case by case but then whatever that portion of the taxes are due for the percentage vested we would compensate the bonus as though it was 100% vested based on the agreement.
The boundary cases where there is a contentious firing will have to be taken case by case but then whatever that portion of the taxes are due for the percentage vested we would compensate the bonus as though it was 100% vested based on the agreement.
I was thinking about the exact same model the other day (even to the point of paying new hires a signing bonus to cover the stock purchase + tax liability). The wall I ran into was how long I would be able to continue such a model -- how big of a bonus would I be willing to dole out? 20k? 50k? 100k?
If switching to a stock options at some point, what is the proper time? Post-A/B round? (obviously a nice problem to have if you have to worry about such things)
Would be keen on discussing it further sometime, since we seem to have arrived at the same conclusion independently.
If switching to a stock options at some point, what is the proper time? Post-A/B round? (obviously a nice problem to have if you have to worry about such things)
Would be keen on discussing it further sometime, since we seem to have arrived at the same conclusion independently.
Like you, I don't have a good answer yet.
I think as long as we have the goal of equity = ownership instead of options to own we will figure out how to structure it. Sounds silly but it is fairly innovative/progressive stuff we are trying to do - which is our whole goal anyway to innovate and progress.
I think as long as we have the goal of equity = ownership instead of options to own we will figure out how to structure it. Sounds silly but it is fairly innovative/progressive stuff we are trying to do - which is our whole goal anyway to innovate and progress.
Remember, the part of the bonus used to buy the stock comes right back to the company, it's just one pocket to the other.
The tax piece is out the door (and is mostly a dead-weight loss if the company doesn't make it, one of the rationales behind options.)
The tax piece is out the door (and is mostly a dead-weight loss if the company doesn't make it, one of the rationales behind options.)
Wow I completely overlooked this fact. Thanks!
I wish more companies were so transparent and decent as yours. Why do others prefer not to do it this way, if it's not just sheer greed and obfuscation?
This approach is awesome, but (I am not a lawyer, this is not advice!) one drawback is that the whole concept of an option is that it's optional. If the company succeeds, you exercise your option and spend that money to get a much larger return. If you must buy the option, and the company does not succeed, then you've spent the money and it's gone. You've lost the "option" aspect of an option.
And of course, yes, the company may say "we're spending our money to buy this for you, don't worry" the truth is money is money. Someone (company or you) is buying the option early, thus having less money to spend on other things.
Alternatives could be the company pays you that money, so it's yours to spend as you see fit. Including, someday, buying the option if you want.
Hope that helps!
And of course, yes, the company may say "we're spending our money to buy this for you, don't worry" the truth is money is money. Someone (company or you) is buying the option early, thus having less money to spend on other things.
Alternatives could be the company pays you that money, so it's yours to spend as you see fit. Including, someday, buying the option if you want.
Hope that helps!
In my experience it's neither greed nor obfuscation, but rather along the spectrum of ignorance, cash conservation paranoia, and and/or a misplaced sense of justice.
Ignorance in the case of not knowing it can be done - many "startup" lawyers are operating with a playbook written in 1996.
Cash conservation in the sense of "holy schmoly I'd have to pay $X,XXX upfront in taxes to cover their option purchases???"
And "justice" in the sense of "well I'm taking a personal risk as a founder, so if you're not all in with me then suck it and your options will just go back in the pool when you quit."
Ignorance in the case of not knowing it can be done - many "startup" lawyers are operating with a playbook written in 1996.
Cash conservation in the sense of "holy schmoly I'd have to pay $X,XXX upfront in taxes to cover their option purchases???"
And "justice" in the sense of "well I'm taking a personal risk as a founder, so if you're not all in with me then suck it and your options will just go back in the pool when you quit."
In 99% of cases my guess is they just don't know it is an option because it takes extra work on the company side and is not typically something that a GC or accountant would offer.
I believe this is typically called "reverse vesting", and it isn't incredibly uncommon, but I have only seen it with small (pre-series A) companies.
My (very basic) understanding is that this works fine early on, but once a company reaches a certain size & valuation it becomes hard to continue.
My (very basic) understanding is that this works fine early on, but once a company reaches a certain size & valuation it becomes hard to continue.
> Why do others prefer not to do it this way
Mostly because they don't have experience with option plans, and lawyers tend to recommend what's best for the company (not what's best for the employees).
I granted my early employee founder's stock (same as mine), mainly because I was screwed by stock options in the past. But I had to actively request this from our lawyer (the default is for lawyers to suggest stock options).
Mostly because they don't have experience with option plans, and lawyers tend to recommend what's best for the company (not what's best for the employees).
I granted my early employee founder's stock (same as mine), mainly because I was screwed by stock options in the past. But I had to actively request this from our lawyer (the default is for lawyers to suggest stock options).
So what you're saying is if you give an employee say, 10k shares at $2/share strike price you give them a 20k signing bonus?
Then the idea is that they pay, say, 6k in taxes on the bonus. Then they write you a check for 20k to early exercise the options and file and 83b.
So they're out 6k in taxes but on the other hand they've early exercised so they actually own the stock (subject to 4 years of vesting).
1) What happens if they can't afford the 6k in taxes?
2) What if they don't want to early exercise? Can they just keep the bonus in cash?
3) What if they leave the company in less than 4 years. Do they have to pay the pro-rated portion of the bonus back?
Then the idea is that they pay, say, 6k in taxes on the bonus. Then they write you a check for 20k to early exercise the options and file and 83b.
So they're out 6k in taxes but on the other hand they've early exercised so they actually own the stock (subject to 4 years of vesting).
1) What happens if they can't afford the 6k in taxes?
2) What if they don't want to early exercise? Can they just keep the bonus in cash?
3) What if they leave the company in less than 4 years. Do they have to pay the pro-rated portion of the bonus back?
1) Company could offer more than exercise cost, so it also covers any tax liability. If I'm not mistaken, this is how [Google|Facebook|Apple] RSUs work.
2) Cash bonus would be dependent on employe exercising the grant.. it probably shouldn't be presented as a bonus, so the employee doesn't have to select between the bonus or the stock. If they prefer a cash heavy compensation package, that should probably be discussed in isolation from a stock purchase reimbursement / bonus.
3) This is a tough question. If an employee leaves before 4 years, the company has to buy the restricted stock back from the employee. Perhaps there's a way to legally require the employee to return the buyback check to the company.
2) Cash bonus would be dependent on employe exercising the grant.. it probably shouldn't be presented as a bonus, so the employee doesn't have to select between the bonus or the stock. If they prefer a cash heavy compensation package, that should probably be discussed in isolation from a stock purchase reimbursement / bonus.
3) This is a tough question. If an employee leaves before 4 years, the company has to buy the restricted stock back from the employee. Perhaps there's a way to legally require the employee to return the buyback check to the company.
It used to be common to loan the employee the money to purchase the stock. This avoids both the tax and early termination problems.
Well this is exactly what we are doing! In our case however we are probably going to sequentially forgive the debt, which would look like real income and as long as we space it out the tax burden is slow. All of the transactions are paper anyway so this also keeps our cash flow the same.
What good is equity as compensation if you have to purchase the stock after all?!
What good is equity as compensation if you have to purchase the stock after all?!
A loan of the exercise price + 40% to cover taxes sounds like the best of all worlds to me.
> If I'm not mistaken, this is how [Google|Facebook|Apple] RSUs work.
For FB specifically, they just pre-sell 40% of issued RSUs. The amount then shows up on paystub as income tax withheld.
There's no extra money to be had on top of the RSU grant - for a global company it would be unfair to treat employees at high tax burden locations differently from employees in low tax burden countries.
For FB specifically, they just pre-sell 40% of issued RSUs. The amount then shows up on paystub as income tax withheld.
There's no extra money to be had on top of the RSU grant - for a global company it would be unfair to treat employees at high tax burden locations differently from employees in low tax burden countries.
>Basically the way this works is that we give new employees an up front lump sum in the amount of how much it costs to purchase the shares of the company.
Interesting. Can you provide more detail on this? Do you just pay the lump sum outright as a hiring bonus? Obviously this works at early stages when the stock is like $0.001/share, but what happens after you've raised a few rounds and the current fair value of the stock is in the 6-7 digit range?
Interesting. Can you provide more detail on this? Do you just pay the lump sum outright as a hiring bonus? Obviously this works at early stages when the stock is like $0.001/share, but what happens after you've raised a few rounds and the current fair value of the stock is in the 6-7 digit range?
One way to avoid the whole stock option / RSU mess is to structure your company as a C-corp that is wholly owned by an LLC, and give your employees membership units in the LLC. This is a very unusual setup and it'll take a good lawyer to help you get it right; but the benefits are huge for employees who own stock, because there are zero tax liability and zero purchasing price until the ownership produces a return.
In some states LLC members are not allowed to take salaries. They can only take guaranteed payments, which have other tax implications
Are there any published references on this technique, or a law firm that is well-versed in it?
I don't know of any public resources on the topic, or of any law firms that are particularly adept at this. However, I have seen it done in practice.
I'd recommend talking to a law firm that's well versed in startup corporate law. The big firms Cooley and Orrick come to mind.
I'd recommend talking to a law firm that's well versed in startup corporate law. The big firms Cooley and Orrick come to mind.
Andrew, it would be great if you write a detailed blog post about this. I bet that quite a few startups would love to follow you here.
Do you cover the purchase and tax liability, or just the purchase?
Also, are you not worried about reporting requirements once you reach a certain number of shareholders?
Also, are you not worried about reporting requirements once you reach a certain number of shareholders?
As someone trying to understand the various stock incentive plans, can you explain the difference between this and RSUs with an 83b election?
Does this system effectively make employees do 83b early exercises? or is it more like a custom RSU program?
Yes, an 83b election is required.
Another thing to understand (and this will sound obvious to many of you) is that your options may be worth nothing, even after a multi-million dollar acquisition if there are priority stock holders (the investors) ahead of you in line.
As a young and naive engineer I learned of this fact the day the first startup I worked for was acquired. First I read the big number that was to be paid for the company, was ecstatic, and immediately starting doing "x-million times half a percent" in my head followed by a sinking feeling as I read the clause stating that common stock holders would get $0.
In retrospect it sounds obvious that if the company sells for less than the money the investors put in, your x percent is worth nothing. But it's easy to get carried away thinking you actually own a percent of the company, and that a sale means a pay day for you. Don't let the first word of acquisition get you too excited, the come down sucks.
As a young and naive engineer I learned of this fact the day the first startup I worked for was acquired. First I read the big number that was to be paid for the company, was ecstatic, and immediately starting doing "x-million times half a percent" in my head followed by a sinking feeling as I read the clause stating that common stock holders would get $0.
In retrospect it sounds obvious that if the company sells for less than the money the investors put in, your x percent is worth nothing. But it's easy to get carried away thinking you actually own a percent of the company, and that a sale means a pay day for you. Don't let the first word of acquisition get you too excited, the come down sucks.
The segregation between common and priority stock can be painful. I learned about it the hard way after I left the startup and paid money to exercise the vested options. When the company was acquired, all the common stock was worthless (but the execs with voting power got millions of dollars of bonuses so they didn't care) which meant I had lost the money required to exercise the options.
What annoyed me more than the couple $K I lost from the options was the opportunity cost of not leaving the job earlier. Like all startups, the company paid below average wages (since startups pay a significant proportion of compensation in the form of options) so if I left earlier, I would have gotten a large pay bump from having joined a non-startup that paid a normal salary.
What annoyed me more than the couple $K I lost from the options was the opportunity cost of not leaving the job earlier. Like all startups, the company paid below average wages (since startups pay a significant proportion of compensation in the form of options) so if I left earlier, I would have gotten a large pay bump from having joined a non-startup that paid a normal salary.
Another trick is hidden dividend accrual for preferred stock. The dividends are triggered at liquidity event, so the cap table you thought you were looking at suddenly gets diluted with a bunch of freshly issued stock which is still senior to common.
Pure evil. Which companies have done that?
From reading "Venture Deals" I got the impression it's something a big VC firm tries to negotiate on a fairly regular basis. See, for example, the "Dividends" section of Houzz round http://techcrunch.com/2014/06/02/houzz-on-fire/
TLDR: If you're an average Joe, the people holding the money bags are actively looking to screw you (while waving their philosophical hands and going "these are not the droids you're looking for").
>In retrospect it sounds obvious that if the company sells for less than the money the investors put in, your x percent is worth nothing.
that is what i've been wondering about. If going into startup i take a $50K/year salary hit wouldn't it mean that i'm actually investing $50K/year and thus should get the same quality and price of shares (not options) what the early investors do?
that is what i've been wondering about. If going into startup i take a $50K/year salary hit wouldn't it mean that i'm actually investing $50K/year and thus should get the same quality and price of shares (not options) what the early investors do?
what should happen and what happens legally are two different things. though it's your choice to take that risk, no one is forcing you to work for sub market rates.
How did that happen? The acquirer just purchased a certain class of shares, i.e. preferred stock and didn't care about owning 100% of the company?
It works as follows, there is a line of people who need to get paid,
If the startup took on any debt, at the front of the line is a bank. Their 'note' usually gets paid first. $POOL -= $BANK
When people invested in the Series A, B, C, ... their stock came with a 'liquidation preference' (which can have a few variants, but the two most common are, the investor chooses if they want the liquidation preference or the common value, the investor gets their liquidation preference and the common value. Note that these numbers are in $dollars not in $shares, so if VC A puts in $1M dollars with a 2X liquidation preference they get back $2M dollars. $POOL -= $LIQUIDATION
Sometimes at the same level, or just behind the investors, are convertible note holders, who gave money or equipment in exchange for shares. They often have the choice of getting either their money back, or the shares. $POOL -= $NOTE.
At this point, if there is anything left in the pool it gets distributed to common shares.
A nice rule of thumb is that the most common liquidation preference is 2X (these days anyway) so if the price is < 2X the amount of money raised to date, the common stock will not have any money allocated to it.
And in those situations it makes no difference if your stock 100% vests on acquisition or not, it is still worth 0.
If the startup took on any debt, at the front of the line is a bank. Their 'note' usually gets paid first. $POOL -= $BANK
When people invested in the Series A, B, C, ... their stock came with a 'liquidation preference' (which can have a few variants, but the two most common are, the investor chooses if they want the liquidation preference or the common value, the investor gets their liquidation preference and the common value. Note that these numbers are in $dollars not in $shares, so if VC A puts in $1M dollars with a 2X liquidation preference they get back $2M dollars. $POOL -= $LIQUIDATION
Sometimes at the same level, or just behind the investors, are convertible note holders, who gave money or equipment in exchange for shares. They often have the choice of getting either their money back, or the shares. $POOL -= $NOTE.
At this point, if there is anything left in the pool it gets distributed to common shares.
A nice rule of thumb is that the most common liquidation preference is 2X (these days anyway) so if the price is < 2X the amount of money raised to date, the common stock will not have any money allocated to it.
And in those situations it makes no difference if your stock 100% vests on acquisition or not, it is still worth 0.
The implicit question is—where the acquisition allocates $0 to common, in what sense are the board of directors fulfilling their fiduciary duty to common shareholders in approving the deal?
Well, their fiduciary duty is to all shareholders and common generally holds a minority ownership interest.
It depends heavily on circumstances, but in a less than amazing sale the acquiring company often wants an incentive for employees to stay. So the acquisition offer will ensure that common gets nothing but they'll be covered by an earn-out over the next year(s).
As you can imagine the negotiation gets very tricky because investors do not generally participate in the earn-out.
It depends heavily on circumstances, but in a less than amazing sale the acquiring company often wants an incentive for employees to stay. So the acquisition offer will ensure that common gets nothing but they'll be covered by an earn-out over the next year(s).
As you can imagine the negotiation gets very tricky because investors do not generally participate in the earn-out.
This 2009 case from the Delaware Chancery Court seems on point: In re Trados Incorporation Shareholder Litigation (http://courts.delaware.gov/opinions/download.aspx?ID=193520)
The whole thing is well worth reading for anyone involved with VC funded startups. It involved an acquisition with a management incentive plan and preferences that together left nothing for common.
Among other things the court held that where there is a conflict of interest the board must prefer the interests of common shareholders over those specific to preferred (the interests of preferred over common being contractual). It also found that the board had acted procedurally unfairly and in several places suggested outright dishonesty. For those reasons it applied the harshest standard under Delaware law (entire fairness).
In the end however, it found that the company's value as an ongoing concern though not nothing, was not enough to overcome the large liquidation preference and cumulative dividend. Thus, since prior to the deal common stock was worthless a deal valuing them as worthless was fair within the meaning of Delaware law. Note that the litigation lasted 8 years, and at the end of the linked decision it was an open question whether the defendants were going to have to pay plaintiff's legal fees despite having won. (I couldn't find any information on what was ultimately decided there.)
The whole thing is well worth reading for anyone involved with VC funded startups. It involved an acquisition with a management incentive plan and preferences that together left nothing for common.
Among other things the court held that where there is a conflict of interest the board must prefer the interests of common shareholders over those specific to preferred (the interests of preferred over common being contractual). It also found that the board had acted procedurally unfairly and in several places suggested outright dishonesty. For those reasons it applied the harshest standard under Delaware law (entire fairness).
In the end however, it found that the company's value as an ongoing concern though not nothing, was not enough to overcome the large liquidation preference and cumulative dividend. Thus, since prior to the deal common stock was worthless a deal valuing them as worthless was fair within the meaning of Delaware law. Note that the litigation lasted 8 years, and at the end of the linked decision it was an open question whether the defendants were going to have to pay plaintiff's legal fees despite having won. (I couldn't find any information on what was ultimately decided there.)
You're not understanding the situation. The board isn't choosing where to allocate the money from the acquisition. The money goes to different classes of shareholders based on previously signed contracts.
Yes, but...
The board decides whether or not to take an offer and that offer includes a set of destinations of funds. In particular, the offer may be $Z = $X1 for retention bonuses and $Y1 for purchasing the equity. Or, the offer may be $Z = $X2 for retention and $Y2 for purchasing the equity. The management - who are likely on the board - may want more of the money to go to retention bonuses for senior execs, while the external board members may want more of the money to go to shareholders. And, in many cases, a board member may be involved in negotiating the deal with the acquirer and may push for a particular deal structure.
tl;dr - The board can have significant impact on how the funds get split up, regardless of the previously signed contracts.
The board decides whether or not to take an offer and that offer includes a set of destinations of funds. In particular, the offer may be $Z = $X1 for retention bonuses and $Y1 for purchasing the equity. Or, the offer may be $Z = $X2 for retention and $Y2 for purchasing the equity. The management - who are likely on the board - may want more of the money to go to retention bonuses for senior execs, while the external board members may want more of the money to go to shareholders. And, in many cases, a board member may be involved in negotiating the deal with the acquirer and may push for a particular deal structure.
tl;dr - The board can have significant impact on how the funds get split up, regardless of the previously signed contracts.
If the startup took on any debt, at the front of the line is a bank. Their 'note' usually gets paid first. $POOL -= $BANK
Debt holders do not have priority when the debtor is sold, as the debtor remains in existence. Creditor priority generally matters only where an entity's debt structure is being altered, such as in a bankruptcy, liquidation, or debt restructuring. However, your example is correct if the bank held convertible debt, exercised the option to convert the debt to equity, and the converted equity carried a liquidation preference. (Note that "liquidation" shows up twice in this paragraph but the two usages have very different meanings. "Liquidation" refers to the termination of a corporate business and the distribution of its assets to its creditors and shareholders; "liquidation preference" refers to the maximum return a preferred stockholder may receive when it "liquidates" its holdings in a company as part of an exit event before the common shareholders or subordinated preferred shareholders receive their returns. In the Non-VC world, liquidation preferences are almost always fixed numbers; in the VC-world, liquidation preferences are usually multiples.)
Debt holders do not have priority when the debtor is sold, as the debtor remains in existence. Creditor priority generally matters only where an entity's debt structure is being altered, such as in a bankruptcy, liquidation, or debt restructuring. However, your example is correct if the bank held convertible debt, exercised the option to convert the debt to equity, and the converted equity carried a liquidation preference. (Note that "liquidation" shows up twice in this paragraph but the two usages have very different meanings. "Liquidation" refers to the termination of a corporate business and the distribution of its assets to its creditors and shareholders; "liquidation preference" refers to the maximum return a preferred stockholder may receive when it "liquidates" its holdings in a company as part of an exit event before the common shareholders or subordinated preferred shareholders receive their returns. In the Non-VC world, liquidation preferences are almost always fixed numbers; in the VC-world, liquidation preferences are usually multiples.)
It would be more accurate of me to say that "In my experience, banks require terms in their lending contract
to a startup that results in their notes being paid before anything else."
Clearly there are legal regulations around a company going through bankruptcy and/or restructuring, however when an acquisition is occurring outside the structure of dissolution, which is to say the company is being sold to another entity while it is nominally a going concern, the bank's note may (and my experience does) have specific language to cover that situation and its primacy with respect to where the funds from such a sale might be disbursed :-). The good news is that can also keep a bank from "forcing" a company into default which starts to limit what options they have going forward.
Clearly there are legal regulations around a company going through bankruptcy and/or restructuring, however when an acquisition is occurring outside the structure of dissolution, which is to say the company is being sold to another entity while it is nominally a going concern, the bank's note may (and my experience does) have specific language to cover that situation and its primacy with respect to where the funds from such a sale might be disbursed :-). The good news is that can also keep a bank from "forcing" a company into default which starts to limit what options they have going forward.
I'm genuinely curious, is a 2x multiple really common these days?
All of the recent raises I've been involved in have been Non-Participating Preferred at a 1x multiple. Or at least capped. I was under the impression that was where everyone had sort of settled these days?
I'm basing this almost entirely off personal experience and the cooley report. http://www.cooley.com/files/104854_vf2014q2.pdf
All of the recent raises I've been involved in have been Non-Participating Preferred at a 1x multiple. Or at least capped. I was under the impression that was where everyone had sort of settled these days?
I'm basing this almost entirely off personal experience and the cooley report. http://www.cooley.com/files/104854_vf2014q2.pdf
That has been my experience too.
Tell me if I have this right: given a list of all the investors and note holders and their liquidation preferences, you can calculate a fixed dollar amount that gets subtracted from $POOL before it's divided up among the common shareholders.
In the example above, if you've got $2M in $LIQUIDATION and $NOTE is $1M, that means that common shareholders dreaming about buyout money should simply subtract $3M mentally from any sale price they hear.
That about it?
In the example above, if you've got $2M in $LIQUIDATION and $NOTE is $1M, that means that common shareholders dreaming about buyout money should simply subtract $3M mentally from any sale price they hear.
That about it?
Yes, pretty much. It is always possible to work backwards from the capitalization table and the termsheets from previous funding and other notes, to figure out how much has to be subtracted off before common sees any return.
Basically, the investors (with preferred stock) get paid out first, sometimes at a multiple of their original investment. The amount "left over" goes to the common stock holders. Sometimes that amount is zero, so they get nothing.
I had this happen to me in a previous start up. I wasn't really surprised.
I had this happen to me in a previous start up. I wasn't really surprised.
Suppose the following scenario:
A VC invests $10MM at a $100MM valuation and owns 10% of the company with preferred shares. For simplicity, we'll assume they are the only holders of preferred shares.
An employee is given $500,000 in common stock, equal to 0.5% of the company at the same $100MM valuation.
The company then sells itself to an acquirer for $11MM, substantially below the $100MM valuation. The VC, with preferred shares, gets paid first. So they get their $10MM back. The remaining $1MM would then be divided among common stock holders. The employee above would get $5,000, instead of the $55,000 that 0.5% of $11MM would imply.
In the real world, founders, executives, and VCs often get preferred shares, which ultimately screws regular employees.
A VC invests $10MM at a $100MM valuation and owns 10% of the company with preferred shares. For simplicity, we'll assume they are the only holders of preferred shares.
An employee is given $500,000 in common stock, equal to 0.5% of the company at the same $100MM valuation.
The company then sells itself to an acquirer for $11MM, substantially below the $100MM valuation. The VC, with preferred shares, gets paid first. So they get their $10MM back. The remaining $1MM would then be divided among common stock holders. The employee above would get $5,000, instead of the $55,000 that 0.5% of $11MM would imply.
In the real world, founders, executives, and VCs often get preferred shares, which ultimately screws regular employees.
Correct up until your last sentence. Founders & executives do not often get preferred shares.
It's called a "liquidation preference". http://www.investopedia.com/terms/l/liquidation-preference.a...
The mechanics & technicalities are beyond me, but the consequence is as described above.
The mechanics & technicalities are beyond me, but the consequence is as described above.
I too have been in this situation. It was obvious that we weren't going to be a massive success, but it was still very disappointing to get zero.
Why worry about stock options at all? There is a spectrum of outcomes. On one end the startup flops, or is bought for so little that your share, even if paid out, is close to 0. On the other end you have Google, Facebook, Instagram, etc. Companies where 0.5% is worth quite a bit of money. The problem is that the majority fall in-between, where your stock options will be worth nothing, yet the company will sell for a decent amount of money.
So what you should do is value the stock options at 0. If you have the spare cash, buy them as early as you can, but don't count them for anything. They are a lottery ticket that your company is the next Google and like any lottery ticket they are likely worth nothing. If the startup is offering to pay you half of what you'd make elsewhere, waving stock options at you telling you they'll make you rich, consider if they just handed you a pile of lottery tickets and half a paycheck. If you'd still take it (maybe you really like the people, or want to work in this field), go for it. Otherwise, they are just trying to get your for a far cheaper price than you'd get elsewhere.
So what you should do is value the stock options at 0. If you have the spare cash, buy them as early as you can, but don't count them for anything. They are a lottery ticket that your company is the next Google and like any lottery ticket they are likely worth nothing. If the startup is offering to pay you half of what you'd make elsewhere, waving stock options at you telling you they'll make you rich, consider if they just handed you a pile of lottery tickets and half a paycheck. If you'd still take it (maybe you really like the people, or want to work in this field), go for it. Otherwise, they are just trying to get your for a far cheaper price than you'd get elsewhere.
It's really unfortunate, because there are many engineers like me who would gladly take a pay cut if we were brought in as collaborators and offered real equity deals. Instead we are brought in as serfs to build their 'vision', with no input of our own or recourse if bad management runs our projects into the ground, and offered financial instruments that are obviously rigged against us. No engineer who understands personal finance and seriously values his tech career would be an employee at a startup over an established tech company today.
Founders still behave like VC money is scarce and engineering talent is plenty. I am seeing many of these companies struggle to ship competitive products due to lack of engineering talent, and so I am hoping we see these startups fail and lose to big tech companies that value their engineers, and force the VC funded startup scene to totally re-evaluate their 'standard' offers so that those of us who would prefer smaller teams can join one on fair terms.
Founders still behave like VC money is scarce and engineering talent is plenty. I am seeing many of these companies struggle to ship competitive products due to lack of engineering talent, and so I am hoping we see these startups fail and lose to big tech companies that value their engineers, and force the VC funded startup scene to totally re-evaluate their 'standard' offers so that those of us who would prefer smaller teams can join one on fair terms.
Start your own company.
What do you think fair terms look like for, say, the first 100 people at a tech company where you have 50 engineers, 20 product people, 20 sales people, and 10 business people? All roles will of course have varying levels of seniority and experience.
Preferred shares and invitations to board meetings. If I'm taking a pay cut, I'm an investor and want to be treated like one. If you're so big that you can't offer real equity, you're not a startup, youre an established business, so you should start paying competitive salaries and not use the "We're a startup" excuse to distort the market to your benefit. And competitive means it actually competes, not "competitive".
I don't think you understand the purpose of preferred shares or board meetings.
I assure you I do, and if I didn't you would be able to elaborate.
If investors were buying common stock instead of preferred stock what would happen to valuations?
You don't need to explain to me why the current 'standard' arrangement is designed to please and protect VCs at the expense of engineers. But that's exactly why we have a proliferation of VCs and startups and a 'shortage' of engineers willing to work for them. The classic argument for liquidation preference is because VCs are putting up money, but so is the engineer if he's taking a salary cut, and the only reason you find it ridiculous that I suggest engineers get preferred stock is because you are stuck in an old school mindset where financial professionals are in charge, and they loop in a few chosen engineers (founders) to bamboozle the rest into bad deals, and "work hard because we're a startup and have ping-pong tables". Not surprisingly, you are VP of engineering and trying to hire, so you're invested in the status quo that rewards founders and VCs. I think the echo chamber has made startups so 'cool' that I decided to bet against the herd mentality and get a good deal from a big tech company. I'd love to re-enter the startup industry at some point in the distant future, I just want to challenge the status quo and see an arrangement where engineers are actually partners and true, first-class owners. If this scares away some VC money, good, there are a lot of questionable startups out there already, it would be better for the industry as a whole if some of these startup engineers started collaborating instead of every single one needing to be founder or at least VP of engineering, because the only engineers willing to work for less than that are naive or inexperienced.
This is probably my favorite comment in a while. Most engineers don't understand this stuff, as you know, so it's important to make this broadly known. I don't know of a good way to do that, maybe one of those hot new blog startups like medium.
I'm very curious about the middle part of this spectrum, since I'm currently in it: I'm an early employee with a significant chunk of options (high single-digit %), and the company is profitable and valued at (to my understanding) somewhere well over 10x the total amount of funding we took (I've heard talk of 40-50x). Management is explicitly not looking for an exit: they just want to keep building this company for the long term. My salary started on the low side for my career, but was reasonable, and it has slowly ratcheted up over time to the point where I think it's certainly fair but I could be making more elsewhere. On the whole, it feels like I have a large chunk of (potential) ownership in something very successful.
My question is: how does this actually benefit me in the big picture? I'm approaching the 10 year date when my options agreement is going to EXPIRE, and it's still unclear to me whether I should exercise them, because as far as I can tell, they're just very expensive (when you consider the tax implications) paper. What's the endgame for this success story putting cash in my pocket? Profit-sharing? Other than the usual big-bang exits you read about, I have no clue.
My question is: how does this actually benefit me in the big picture? I'm approaching the 10 year date when my options agreement is going to EXPIRE, and it's still unclear to me whether I should exercise them, because as far as I can tell, they're just very expensive (when you consider the tax implications) paper. What's the endgame for this success story putting cash in my pocket? Profit-sharing? Other than the usual big-bang exits you read about, I have no clue.
Consider (diplomatically!) talking to your boss.
If the company is successful-but-not-spectacularly-successful for a long time, one way to handle such issues is by structuring the flow of money from the company to the founders as dividends - that way, you'll get paid some fraction of what they get paid, indefinitely. Note that there are other ways to structure that particular money flow, though, and there's very little you can do to influence the choice.
For a select few companies, secondary markets exist that trade in illiquid stock. I understand that many equity agreements forbid selling on those markets and/or quickly selling on those markets. However, this only works if the buyers have a reason to believe that the stock will ever be worth anything at all.
You mention valuations, which suggest that some fairly savvy people have decided to exchange money for shares in this company. Do you know how the investors expected to get paid back? It's possible for founders to screw investors, of course, but this may be another thing worth looking into.
If the company is successful-but-not-spectacularly-successful for a long time, one way to handle such issues is by structuring the flow of money from the company to the founders as dividends - that way, you'll get paid some fraction of what they get paid, indefinitely. Note that there are other ways to structure that particular money flow, though, and there's very little you can do to influence the choice.
For a select few companies, secondary markets exist that trade in illiquid stock. I understand that many equity agreements forbid selling on those markets and/or quickly selling on those markets. However, this only works if the buyers have a reason to believe that the stock will ever be worth anything at all.
You mention valuations, which suggest that some fairly savvy people have decided to exchange money for shares in this company. Do you know how the investors expected to get paid back? It's possible for founders to screw investors, of course, but this may be another thing worth looking into.
This is a general big problem, especially with the moribund post-SarBox IPO environment. Before those days, my father made more than a little money arranging cash-outs for founders of such companies, and there's absolutely no assurance you'll ever see a cash out.
But this strikes me as a problem your company ought to care about, especially if your options were part of a compensation package with below market salary, so maybe bring it up with the relevant people? It does them little good to get people like you upset, take a reputational hit, etc.
But this strikes me as a problem your company ought to care about, especially if your options were part of a compensation package with below market salary, so maybe bring it up with the relevant people? It does them little good to get people like you upset, take a reputational hit, etc.
You own more than 5% of the company? With that stake you should be on the board if you exercised the options. There's only 20 5% owners in any company.
Are you invited to board meetings? If not, considering yourself a "potential owner" when you're not invited to the meetings where owners decide things means you are very confused about things. There's a reason why when a company goes public, the quarterly minutes at board meetings become public as well, because you aren't really an owner if you're excluded from even learning about the biggest of decisions.
What you should do depends heavily on whether you have common or preferred shares. If you have the options to buy common shares, which you probably do, they're worthless so don't even bother exercising them, the people who are invited to the board meetings have all sorts of routes they can take so that your options will become meaningless, so to spend the money to exercise and pay the capital gains on them is madness.
My advice is to recognize that you have a sunk cost (look up sunk cost fallacy) and jump ship. Keep applying to companies like Google, Facebook, Amazon, Microsoft, and other larger companies until one makes you an offer, and those companies will give you real compensation packages and stock plans that you will be able to easily turn into American dollars in a year.
What you should do depends heavily on whether you have common or preferred shares. If you have the options to buy common shares, which you probably do, they're worthless so don't even bother exercising them, the people who are invited to the board meetings have all sorts of routes they can take so that your options will become meaningless, so to spend the money to exercise and pay the capital gains on them is madness.
My advice is to recognize that you have a sunk cost (look up sunk cost fallacy) and jump ship. Keep applying to companies like Google, Facebook, Amazon, Microsoft, and other larger companies until one makes you an offer, and those companies will give you real compensation packages and stock plans that you will be able to easily turn into American dollars in a year.
> considering yourself a "potential owner" when you're not invited to the meetings where owners decide things means you are very confused about things
Well gosh, I don't think there's any need to get nasty about it. I may be naive but give me a break. When I refer to ownership I'm obviously simply referring to being a shareholder. No, I am not invited to board meetings, but as far as I know, neither is anybody else who's not exec staff. Is this unusual?
The options are on common shares. Can you elaborate on schemes in which common shares are made to become worthless? I have been explicitly told that there are no liquidation preference multipliers on the preferred shares, and the valuation is well above where that would matter. So what sorts of shenanigans would make my shares worth less? Please be specific if you don't mind. It may be a dumb question, but just telling me I'm dumb isn't really getting the point across.
Regarding going to {GOOG,FB,AMZN,MSFT}, I've actually already been through a couple of those and experienced the "real compensation packages and stock plans" and got a couple pretty respectable windfalls out of them, but I've decided the tradeoffs aren't worth it. Job satisfaction absolutely can't be beat where I am, and that's worth a lot to me. That doesn't mean I don't wonder what my n% is actually worth and how specifically that works.
Well gosh, I don't think there's any need to get nasty about it. I may be naive but give me a break. When I refer to ownership I'm obviously simply referring to being a shareholder. No, I am not invited to board meetings, but as far as I know, neither is anybody else who's not exec staff. Is this unusual?
The options are on common shares. Can you elaborate on schemes in which common shares are made to become worthless? I have been explicitly told that there are no liquidation preference multipliers on the preferred shares, and the valuation is well above where that would matter. So what sorts of shenanigans would make my shares worth less? Please be specific if you don't mind. It may be a dumb question, but just telling me I'm dumb isn't really getting the point across.
Regarding going to {GOOG,FB,AMZN,MSFT}, I've actually already been through a couple of those and experienced the "real compensation packages and stock plans" and got a couple pretty respectable windfalls out of them, but I've decided the tradeoffs aren't worth it. Job satisfaction absolutely can't be beat where I am, and that's worth a lot to me. That doesn't mean I don't wonder what my n% is actually worth and how specifically that works.
If it's a profitable company that you've been at almost 10 years, that you want to stay at, can't you ask them for a raise, and ask them for help with the stock option problem? They probably would want to work with you if you've been there that long.
Raises have of course been requested and granted. My salary isn't really what's at stake here and any raise I could ask for is dwarfed by the potential value of shares sitting on the table that I simply don't know how to get money out of. What are you imagining I'd ask for when you say "help with the stock option problem?" Ask them to buy me out?
Well for example, a very low interest loan secured by the stock from the company to help you buy it out / deal with AMT tax credits being distributed over the years. Or a bonus to help you buy out your long vested stock and the AMT tax difference you will have, etc.
With the bonus, the stock shenanigans that they can perform will be relatively minor as far as additional expenses would go. If they IPO 4 years later and you get a windfall, good. If they liquidate and you get nothing, oh well.
You could also sell the shares to interested people on something like Equidate. Then you don't have to cash in your options until you have an interested buyer. If you get right of first refusal issues, then the company would be buying out your stock directly in that case.
I've never used something like Equidate, so your milage will definitely vary.
With the bonus, the stock shenanigans that they can perform will be relatively minor as far as additional expenses would go. If they IPO 4 years later and you get a windfall, good. If they liquidate and you get nothing, oh well.
You could also sell the shares to interested people on something like Equidate. Then you don't have to cash in your options until you have an interested buyer. If you get right of first refusal issues, then the company would be buying out your stock directly in that case.
I've never used something like Equidate, so your milage will definitely vary.
>>> If you have the options to buy common shares, which you probably do, they're worthless so don't even bother exercising them.
I was in the exact same position as the OP, with expiring options on common shares in a company with no immediate plans to IPO. I (fortunately) didn't take your advice, exercised the options and 3 years later, when we were acquired, I was $500k richer. Of course, everyone's situation is different but I wouldn't take such an absolute position.
I was in the exact same position as the OP, with expiring options on common shares in a company with no immediate plans to IPO. I (fortunately) didn't take your advice, exercised the options and 3 years later, when we were acquired, I was $500k richer. Of course, everyone's situation is different but I wouldn't take such an absolute position.
Why do you think the common shares are worthless, if the company is worth 10x (to use the conservative number) the amount invested in it?
I think my inclination would be to exercise the options, because if I didn't, and they turned out to be worth something, I would just want to shoot myself. But this isn't necessarily a rational argument :-)
I think my inclination would be to exercise the options, because if I didn't, and they turned out to be worth something, I would just want to shoot myself. But this isn't necessarily a rational argument :-)
I think they're worthless because of the nature of liquidation preference. There are a select few elite startups like Dropbox that I would value common options at, but those companies will obviously IPO. Clearly the person who I responded to is at a company that is not going to IPO, exercising options is extremely expensive, and there are well known avenues to making common shares worth $0 and so it's an enormous financial risk. Again, if you're not invited to board meetings, how much do they value you, and how much do they consider you a co-owner and partner? If they don't, and you're in the dark about so much critical information, taking that financial risk is even more of a bad play.
Late-stage rounds that offer employee buyouts are somewhat typical lately.
Also, if you exercise and leave, some places like SecondMarket, Equidate, MicroVentures and a few others provide a chance to offload some of that equity.
In regards to salary, your company should be approaching a maturity point where salaries are defined in bands, by HR (by someone titled "Compensation Analyst" or similarly), not decided on a case-by-case basis.
Also, if you exercise and leave, some places like SecondMarket, Equidate, MicroVentures and a few others provide a chance to offload some of that equity.
In regards to salary, your company should be approaching a maturity point where salaries are defined in bands, by HR (by someone titled "Compensation Analyst" or similarly), not decided on a case-by-case basis.
> buy them as early as you can,
Careful on this one - when you buy, it's a taxable event. The spread between what the IRS thinks the company is worth and what you paid is taxable. You have to pay that NOW.
I've known people that were screwed on this - strike price was around 1, value by IRS was 8 (based on funding rounds). By the time the person could sell the stock, it as worth .013. Fun!
Careful on this one - when you buy, it's a taxable event. The spread between what the IRS thinks the company is worth and what you paid is taxable. You have to pay that NOW.
I've known people that were screwed on this - strike price was around 1, value by IRS was 8 (based on funding rounds). By the time the person could sell the stock, it as worth .013. Fun!
This can go both ways. You can buy in with a strike price of 1.00 while the IRS value of your company is still low, say 2.00. You pay the taxes on the 1.00 difference since the IRS counts that as income, and you become a shareholder.
If your company raises funding in the future and the price goes up to 5.00 it's all profit (aside from capital gains tax when you sell, but chances are you'll pay long term capital gains since you're already a shareholder and these things don't happen overnight). This is better than buying in after the round of funding where you'd pay taxes on the difference of 4.00.
This is why it can be a good idea to exercise your vested shares before a round of funding where the price will go up. It's a trick to minimize your taxes. Not saying there's any less risk in purchasing the shares of a startup however.
If your company raises funding in the future and the price goes up to 5.00 it's all profit (aside from capital gains tax when you sell, but chances are you'll pay long term capital gains since you're already a shareholder and these things don't happen overnight). This is better than buying in after the round of funding where you'd pay taxes on the difference of 4.00.
This is why it can be a good idea to exercise your vested shares before a round of funding where the price will go up. It's a trick to minimize your taxes. Not saying there's any less risk in purchasing the shares of a startup however.
IANAA (I am not an accountant)--
This is not true, or not necessarily. It's calculated for AMT, so if you're already paying AMT, or would be paying AMT with the addition of this income, then yes: You'll be paying that tax now. This is true for many in California with the high state taxes and a relatively high gross income (versus national averages).
However, if the intrinsic value portion of your exercise (i.e. fair market value minus your strike price) as an addition to your AMT worksheet does not indicate you'll owe AMT for the year, then you will NOT see a tax event. This will be true for many non-Californians exercising after their first year, or even after 4 years, depending on the growth of the fair-market-value.
If you are at risk of paying AMT and your intrinsic value is in the low 6-figures (or lower), one solution might be to wait until the beginning of a new tax year, exercise, and quit your job... then take a year off from wages and work for equity (i.e. form your own startup). You'll avoid paying the 26% on that money due at exercise. If you've been paying AMT in the past, you'll even get a tax credit at the end of the year. Obviously, this plan is not without risks, should only be carried-out if you believe in solid growth in the startup for which you own equity and believe in the ability of the new startup you're founding and/or joining. Also, and obviously, you should consult with an actual accountant before considering this crazy idea ;-)
This is not true, or not necessarily. It's calculated for AMT, so if you're already paying AMT, or would be paying AMT with the addition of this income, then yes: You'll be paying that tax now. This is true for many in California with the high state taxes and a relatively high gross income (versus national averages).
However, if the intrinsic value portion of your exercise (i.e. fair market value minus your strike price) as an addition to your AMT worksheet does not indicate you'll owe AMT for the year, then you will NOT see a tax event. This will be true for many non-Californians exercising after their first year, or even after 4 years, depending on the growth of the fair-market-value.
If you are at risk of paying AMT and your intrinsic value is in the low 6-figures (or lower), one solution might be to wait until the beginning of a new tax year, exercise, and quit your job... then take a year off from wages and work for equity (i.e. form your own startup). You'll avoid paying the 26% on that money due at exercise. If you've been paying AMT in the past, you'll even get a tax credit at the end of the year. Obviously, this plan is not without risks, should only be carried-out if you believe in solid growth in the startup for which you own equity and believe in the ability of the new startup you're founding and/or joining. Also, and obviously, you should consult with an actual accountant before considering this crazy idea ;-)
> "Why worry about stock options at all?"
Because they do matter and are still part of the compensation package. There's still a significant difference between a payout that equates to two year's worth of salary vs another that pays out one year's worth.
Because they do matter and are still part of the compensation package. There's still a significant difference between a payout that equates to two year's worth of salary vs another that pays out one year's worth.
It's a lottery ticket. If statistically most startups fail, then statistically most options are worthless.
I think there is a deeper conversation to be had over here -- many outfits in the valley seduce engineers and the talent with this spiel of making money, while as you say the chances of this happening is very rare. In expectation, one would probably make more money working at FB/Google/Apple over a lifetime than at a random startup. Founders would likely prosper, and of course investors will likely recoup their money but most of the time a staff engineer wouldn't make much. I feel that the VCs in the valley are running this racket of seducing and exploiting talent, all the while knowing that most folks wouldn't get much out of the hard work. I suppose one can make a case of Wall Street being more fair in terms of wages distributed as a function of effort (and ensuing results) put in.
> If you have the spare cash, buy them as early as you can
Why would you want to do this? Wouldn't it be better to wait until the company is about to be acquired or IPO so you're not spending money on something of no value?
Why would you want to do this? Wouldn't it be better to wait until the company is about to be acquired or IPO so you're not spending money on something of no value?
Depends on the type of options you have. If you have ISO, yeah. I'd probably wait because there are "games" you can play to not impact your total tax bill for the year (i.e. not trigger AMT).
If they are NQSO, the difference between your option price and market price is a taxable event. So if your option price is $1 and the company IPOs and has a price of $12 when you exercise, you owe taxes on $11 per share (this is a gross oversimplification). Now if you had purchased before the company is acquired/goes public, the price might just be $5 so your overall tax bill is lower. You exercise at a lower price and hope the price goes up.
If they are NQSO, the difference between your option price and market price is a taxable event. So if your option price is $1 and the company IPOs and has a price of $12 when you exercise, you owe taxes on $11 per share (this is a gross oversimplification). Now if you had purchased before the company is acquired/goes public, the price might just be $5 so your overall tax bill is lower. You exercise at a lower price and hope the price goes up.
I am not an accountant, this is not tax advice.
You're usually correct, except for two things (in the US):
1) Holding stock for a year before selling is taxed at the lower long-term capital gains rate (~20% vs ~39.6% at the highest brackets).
2) Exercising an ISO is seen as a taxable income for the purposes of the Alternative Minimum Tax, so exercising late (when the difference between FMV and Strike Price is high) has a higher chance of incurring an AMT burden, whereas exercising early does not incur an AMT burden (because the spread is small) nor a normal tax burden (because this is how ISOs work).
You're usually correct, except for two things (in the US):
1) Holding stock for a year before selling is taxed at the lower long-term capital gains rate (~20% vs ~39.6% at the highest brackets).
2) Exercising an ISO is seen as a taxable income for the purposes of the Alternative Minimum Tax, so exercising late (when the difference between FMV and Strike Price is high) has a higher chance of incurring an AMT burden, whereas exercising early does not incur an AMT burden (because the spread is small) nor a normal tax burden (because this is how ISOs work).
Totally agreed, they're not likely to be worth anything. Maybe they will! But probably not, and getting your hopes up is counterproductive. But then maybe I've just read one too many stories about people's options turning out to be worthless, even when one would expect otherwise.
Then why work at a start-up at all?
The last two companies I've gotten offers from gave me very, very heavy pushback when I tried to figure out what % of equity they were giving me.
They told me they were giving me 5,000 shares (for example). OK... 5,000 of how many? What % of all the shares is 5,000? My understanding is you need this information to know if the equity is worth something or nothing. Yet, they really don't want to give me this information.
For one of these jobs the recruiter I was going through (this is a big recruitment company) literally told me nobody has ever asked these questions about the options they were getting.
Am I doing something wrong? Do I have a misunderstanding of how these things work? Is it unreasonable for me to be told the outstanding shares?
They told me they were giving me 5,000 shares (for example). OK... 5,000 of how many? What % of all the shares is 5,000? My understanding is you need this information to know if the equity is worth something or nothing. Yet, they really don't want to give me this information.
For one of these jobs the recruiter I was going through (this is a big recruitment company) literally told me nobody has ever asked these questions about the options they were getting.
Am I doing something wrong? Do I have a misunderstanding of how these things work? Is it unreasonable for me to be told the outstanding shares?
You are completely reasonable. I've turned down offers because of this exact reason (and it was the only problem with the offer). I tell them that if they won't give me the denominator of the equation, I'll assume it's pretty close to infinity, and value the options aspect of the offer at $0. I think it's shady and manipulative to not provide such details ("but we're giving you 50,000 options!"). What are they trying to hide?
Also, why do these companies think that engineers won't try to find a way to bring math into the equation?
They're assuming that big numbers will make engineers shut up and stop thinking.
You are not doing anything wrong. You do not have a misunderstanding of how these things work.
You should not go work for a company that will not tell you the total number of outstanding shares (so you can calculate your % ownership). It's basically the same thing as saying that they're going to pay you 100,000 a year but not bothering to mention the currency.
You should not go work for a company that will not tell you the total number of outstanding shares (so you can calculate your % ownership). It's basically the same thing as saying that they're going to pay you 100,000 a year but not bothering to mention the currency.
Why isn't the relevant number the valuation per share? (which they have to tell you, because that's information for your tax return, right?)
In other words, if I have an option for N shares that are currently valued at $X, why do I care whether N is 10% or .0001% of the company. The "value" of the grant is the same in either case, no?
In other words, if I have an option for N shares that are currently valued at $X, why do I care whether N is 10% or .0001% of the company. The "value" of the grant is the same in either case, no?
My understanding is that the valuation per share (at least, the valuation that matters for tax purposes) should depend on the 409A evaluation of the company, which determines the current price of shares in the eyes of the IRS. In some cases, especially if e.g. you're pre-revenue or nearly so, this number will be much lower when compared to the valuation per share that you'd see in an acquisition or subsequent funding round, both of which would presumably price in your potential future growth much more aggressively.
The net result is that generally speaking the number given by your 409A would seem low compared to the "true" price of the shares, and make it a weak recruitment tool.
(If this assessment is wrong I'd definitely be interested to hear to learn more)
As an aside -- unscrupulous companies can always quote inflated per-share prices based on extremely optimistic valuations e.g. "we're at least 10x the last round of funding -- your options are worth $500k!" So generally speaking, watch out.
The net result is that generally speaking the number given by your 409A would seem low compared to the "true" price of the shares, and make it a weak recruitment tool.
(If this assessment is wrong I'd definitely be interested to hear to learn more)
As an aside -- unscrupulous companies can always quote inflated per-share prices based on extremely optimistic valuations e.g. "we're at least 10x the last round of funding -- your options are worth $500k!" So generally speaking, watch out.
It's red flag. I asked the same question of one startup and was told that i didn't need to know the answer.
Fast forward 10 years ... The company tried to go public and they had to do a 5760 to 1 REVERSE split to shore up their share price. People who naively thought they had 100k shares ended up w less than 20. Thecompany had to cancel the planned ipo, too.
Fast forward 10 years ... The company tried to go public and they had to do a 5760 to 1 REVERSE split to shore up their share price. People who naively thought they had 100k shares ended up w less than 20. Thecompany had to cancel the planned ipo, too.
I agree with this. An offer I didn't accept wouldn't disclose the numbers, ran out of funds and shut down a year or two after I declined.
And that is why refusing to share information is a bad idea. They lost a (presumably) good hire who might have made a difference to the outcome of their company. They wanted to hire but chose secrecy over a new employee. It didn't work out well.
It's not only reasonable but very crucial for you to ask the total number of outstanding shares. I have made it a point to ask every company this question and have gotten an answer out of them. Also, and this is me, I don't trust a word recruiters say. Not a single word. Ask to talk to the VP (or if possible CEO directly) if the recruiter is being cagey about it.
Usually recruiters are told not to tell people the number. And usually they don't know themselves. So it's probably coming from the top.
> the recruiter I was going through literally told me nobody has ever asked these questions about the options they were getting.
Whenever someone says something like that during a negotiation, you can be sure it's because they don't want to answer the question.
Other good ones:
-"This is totally standard"
-"That form is industry standard"
-"Nobody else has ever had a problem with that"
Whenever someone says something like that during a negotiation, you can be sure it's because they don't want to answer the question.
Other good ones:
-"This is totally standard"
-"That form is industry standard"
-"Nobody else has ever had a problem with that"
Sort of like the common response to questions about non-competes: "Oh, we never enforce that!"
"...then why can't we take it out?"
"...then why can't we take it out?"
It's a totally reasonable question. If you were working for the same person and you signed a contract that obliged the company to do/purchase something and there was un undefined number in there, you'd probably find yourself fired.
"The service level agreement says if something goes wrong we'll get 50% of their staff working on it."
"How many staff do they have?"
"I dunno, but 50% of it sounds like a lot!"
Ask them if they want employees who would sign contracts which lack key bits of information.
"The service level agreement says if something goes wrong we'll get 50% of their staff working on it."
"How many staff do they have?"
"I dunno, but 50% of it sounds like a lot!"
Ask them if they want employees who would sign contracts which lack key bits of information.
I 100% believe that no one else has ever asked that question. Because lot of people have no clue at all.
I've bitched before about losing potential employees to other companies who, they said, were giving "more options," when we were offering them 0.5% of the company.
You should be asking, and if they aren't answering, realize they are offering you cereal boxtops. Whether you choose to value those at $0, or be insulted at walk away, if up to you.
I've bitched before about losing potential employees to other companies who, they said, were giving "more options," when we were offering them 0.5% of the company.
You should be asking, and if they aren't answering, realize they are offering you cereal boxtops. Whether you choose to value those at $0, or be insulted at walk away, if up to you.
You're doing nothing wrong. At the same time, I wouldn't walk just because they aren't being candid. Usually what this tells you - especially for later-stage startups - is that your options have very little expected value (think a few thousand a year in the best case), and you should act accordingly. Sometimes it's not because HR is full of evil monsters - sometimes it's their way of telling you an unpleasant truth that they aren't allowed to say directly.
Assuming if you're truly ready to walk if they don't share, this could even carry over to your negotiation. At this point, it's just business - if this company is willing to give you $XXk more than a competing offer with more candid numbers, then the cash could be worth it to hedge that risk. Depending, of course, on how much you value the upside.
Assuming if you're truly ready to walk if they don't share, this could even carry over to your negotiation. At this point, it's just business - if this company is willing to give you $XXk more than a competing offer with more candid numbers, then the cash could be worth it to hedge that risk. Depending, of course, on how much you value the upside.
I encountered this myself and have a few conclusions:
1) Be open with them and tell them that without a cap table you have to assume the options are worth $0. Use that to push for more salary.
2) The reason for not disclosing that information is often that the company is close to another fundraising event (an IPO for example) and that is very confidential information. It's definitely not a bad thing.
3) A safe assumption (to use yourself, not in negotiations) is that the company will exit at around $10/share. There might be a reverse split or something so take this assumption with a grain of salt.
My experience was not that the company was being malicious. I joined and it worked out fairly well.
1) Be open with them and tell them that without a cap table you have to assume the options are worth $0. Use that to push for more salary.
2) The reason for not disclosing that information is often that the company is close to another fundraising event (an IPO for example) and that is very confidential information. It's definitely not a bad thing.
3) A safe assumption (to use yourself, not in negotiations) is that the company will exit at around $10/share. There might be a reverse split or something so take this assumption with a grain of salt.
My experience was not that the company was being malicious. I joined and it worked out fairly well.
2) You are incorrect here. # of outstanding shares isn't a secret in the events you describe.
3) This is not a safe assumption at all. Just because it worked well for you in one situation does not mean that it will work out in all scenarios.
The reason that companies sometimes don't disclose this information is that when you state ownership as a % it can seem minuscule emotionally. Anything less than 1% just doesn't seem like much even if it actually it.
That being said I don't think this is a good enough reason. Companies should disclose this information and then educate candidates about how to interpret the numbers.
3) This is not a safe assumption at all. Just because it worked well for you in one situation does not mean that it will work out in all scenarios.
The reason that companies sometimes don't disclose this information is that when you state ownership as a % it can seem minuscule emotionally. Anything less than 1% just doesn't seem like much even if it actually it.
That being said I don't think this is a good enough reason. Companies should disclose this information and then educate candidates about how to interpret the numbers.
And what do I do if they use #2? Are you saying it's reasonable for them to not give me that information? Should I assume they're worth $0 in this situation?
What else can you assume, though? You have no information at that point.
No, they did something wrong: not be honest. It sounds like you didn't go there - why work for someone who can't be upfront?
"nobody has ever asked these questions about the options they were getting" -> "company is full of idiots - run (dont't walk) away"
And even that might be deceiving.
First, with the dilution trick (like Facebook did against a founder). Second, the voting vs. non-voting stock.
Also, if you happen to leave the company you likely have to buy the options. If you don't have the cash, you're screwed. If you have the cash, you might end up in unsellable-stock limbo for years. In their case, about a decade and still counting.
First, with the dilution trick (like Facebook did against a founder). Second, the voting vs. non-voting stock.
Also, if you happen to leave the company you likely have to buy the options. If you don't have the cash, you're screwed. If you have the cash, you might end up in unsellable-stock limbo for years. In their case, about a decade and still counting.
Don't work for a company that won't give you all of the details necessary to value their equity.
I'm not surprised that people don't ask about the equity, because people are generally woefully uneducated about it.
Recruiters might be lazy and push back because people really don't ask. But if you press the issue and can't get a straight answer, pick another offer.
I'm not surprised that people don't ask about the equity, because people are generally woefully uneducated about it.
Recruiters might be lazy and push back because people really don't ask. But if you press the issue and can't get a straight answer, pick another offer.
You need to ask for more than just outstanding shares, but about also liquidation preferences and convertable notes as well. Otherwise, you won't get a true understanding of the value of the options.
I just assume it's common stock if I'm not a founder/exec. Is there a lower liquidation preference than that?
I'll have to research what convertible notes are.
I'll have to research what convertible notes are.
They don't want to tell you, because that would essentially reveal their inflated valuation.
If you work at a startup and options stuff is not transparent -- valuation, vesting schedule, terms, etc., you should be quite worried.
Founders often end up in a situation where there is significant dilution and as the hockey stick changes into a slightly different shape they know that nobody's options are worth anything.
Founders with integrity will acknowledge this and make adjustments. Those without integrity pretend it isn't true and create a culture of secrecy around options grants/terms.'
Edit: You should also be able to do the math on what your options are worth fairly easily as funding rounds approach and valuations occur.
Founders often end up in a situation where there is significant dilution and as the hockey stick changes into a slightly different shape they know that nobody's options are worth anything.
Founders with integrity will acknowledge this and make adjustments. Those without integrity pretend it isn't true and create a culture of secrecy around options grants/terms.'
Edit: You should also be able to do the math on what your options are worth fairly easily as funding rounds approach and valuations occur.
Founders often end up in a situation where there is significant dilution and as the hockey stick changes into a slightly different shape they know that nobody's options are worth anything
This is a very common occurrence, and unless you have a seat at the board, you are completely at the company's mercy when events like this happen.
Usually they will make current employees "whole," although the definition of that varies a lot. If you've left, though, you are completely shafted. The board will say "well you are no longer contributing to the company" but the same thing applies to the VC fund that invested last round and didn't this round.
There are an amazing number of hoops that you have to jump through for options in a start-up to pan out, and you have to hit essentially all of them, or else they are worthless.
This is a very common occurrence, and unless you have a seat at the board, you are completely at the company's mercy when events like this happen.
Usually they will make current employees "whole," although the definition of that varies a lot. If you've left, though, you are completely shafted. The board will say "well you are no longer contributing to the company" but the same thing applies to the VC fund that invested last round and didn't this round.
There are an amazing number of hoops that you have to jump through for options in a start-up to pan out, and you have to hit essentially all of them, or else they are worthless.
For those of you that found this interesting and want to learn more about stock options, with advice that is a bit more general, I highly recommend "An introduction to stock options for the tech entrepreneur or startup employee":
http://www.scribd.com/doc/55945011/An-Introduction-to-Stock-...
It gives a detailed background of a lot of key issues related to stock options and some really well reasoned recommendations that are applicable to anybody taking a job involving stock options.
http://www.scribd.com/doc/55945011/An-Introduction-to-Stock-...
It gives a detailed background of a lot of key issues related to stock options and some really well reasoned recommendations that are applicable to anybody taking a job involving stock options.
"But note this doesn’t mean everything will be perfect. If the acquirer decides that you are no longer needed, they could keep your option agreement intact and terminate your employment. You wouldn’t get any further vesting unless you have single-trigger or double-trigger acceleration, and you’d be out of a job. It would be the same as if you’d been fired by your company before the acquisition."
Maybe I'm reading this incorrectly, but if you don't have single-trigger or double-trigger acceleration, the employer has all the leverage they need to renegotiate your (incentive) contract.
Maybe I'm reading this incorrectly, but if you don't have single-trigger or double-trigger acceleration, the employer has all the leverage they need to renegotiate your (incentive) contract.
You're right. That's true the before the acquisition and after. Your employer can say you have to accept a reduced package or get fired.
The difference is the starting point of the negotiation. If the acquirer wants to keep you, the "right" language in the option plan means the starting point is your original comp package. You have to explicitly agree to a reduced package for it to change. If you have the "wrong" language, there is simply no deal in place to start the negotiation.
The difference is the starting point of the negotiation. If the acquirer wants to keep you, the "right" language in the option plan means the starting point is your original comp package. You have to explicitly agree to a reduced package for it to change. If you have the "wrong" language, there is simply no deal in place to start the negotiation.
(without knowing anything about this stuff) it sounds like the difference is that they must fire you if they don't continue your "award" or give it all to you immediately. This takes away the possibility of bluffing on your part / calling your bluff.
You can honestly say, "sorry, not my decision, I can't stay if I don't get all my options (now or on schedule)". That could be a somewhat stronger negotiating position.
You can honestly say, "sorry, not my decision, I can't stay if I don't get all my options (now or on schedule)". That could be a somewhat stronger negotiating position.
Do you know what I call a 1%/4-year vestment "equity" plan? I call that an ESPP (employee stock purchase plan) by another name, with inflated valuations due to startup hype.
Why would anybody agree to that? At least insist the first half percent vest proportionally over the first year with each paycheck.
Why would anybody agree to that? At least insist the first half percent vest proportionally over the first year with each paycheck.
The standard Silicon Valley employee stock option plan is X number of shares vested over 4 years, with the first 25% vesting all at once after 12 months, and the remaining 75% vesting in even installments once per month over the remaining 36 months. This has been the standard for decades.
If you can arrange something more advantageous, by all means do it, but I think you're going to have a hard time negotiating away the cliff. Having the cliff ensures that employee has proved herself before getting a stake in the company, which most investors and founders believe is important.
If you can arrange something more advantageous, by all means do it, but I think you're going to have a hard time negotiating away the cliff. Having the cliff ensures that employee has proved herself before getting a stake in the company, which most investors and founders believe is important.
That may be standard, but it's entirely not in the interests of any employee to play the game. The founders' and investors' beliefs regarding "skin in the game" are missing one key component: the reduced salary one takes at a startup. That reduced salary is skin in the game, as is the acceptance of risk by agreeing be compensated in equity in the first place.
I don't object to 4-year vesting. I don't object to cliffs, either, per se. But I wouldn't consider being treated that way for such a tiny stake as 1%.
I don't object to 4-year vesting. I don't object to cliffs, either, per se. But I wouldn't consider being treated that way for such a tiny stake as 1%.
I think that people talk past each other a lot, and part of it is understanding that 1% is not 1%.
Like, if I'm joining a company that has started to get traction, is well-funded and pays me say 80-90% what Google would pay me, and is likely to either fail or experience a monetization event in the next 3-5 years, and I get 1% of that company, holy shit guys that's amazing. Maybe still overall less compensation than Google would've given me, but more likely to change my life.
If I'm part of the founding team of a company with no product out right now, that's paying me 20-50% of what Google would pay me, and any monetization event is clearly 7+ years off, 1% is a lot less exciting for four different reasons: 1. Obviously I'm giving up more salary. 2. Payout is less likely. 3. Payout even if it happens is farther away. 4. (Crucially) My stake is very likely to be much further diluted before any monetization events.
If you ACTUALLY get 1% of the monetization of any reasonably successful company, you're probably doing pretty damn well. A medium-sized acquisition at $300 million, 1% of that is $3 million. 1% of WhatsApp would've been around $200 million. 1% of Facebook would've made you a billionaire.
Trying to get more than a genuine 1% isn't very important. Trying to figure out what the percentage that they quote you in your job hire process will turn out to be during a monetization is very important.
Like, if I'm joining a company that has started to get traction, is well-funded and pays me say 80-90% what Google would pay me, and is likely to either fail or experience a monetization event in the next 3-5 years, and I get 1% of that company, holy shit guys that's amazing. Maybe still overall less compensation than Google would've given me, but more likely to change my life.
If I'm part of the founding team of a company with no product out right now, that's paying me 20-50% of what Google would pay me, and any monetization event is clearly 7+ years off, 1% is a lot less exciting for four different reasons: 1. Obviously I'm giving up more salary. 2. Payout is less likely. 3. Payout even if it happens is farther away. 4. (Crucially) My stake is very likely to be much further diluted before any monetization events.
If you ACTUALLY get 1% of the monetization of any reasonably successful company, you're probably doing pretty damn well. A medium-sized acquisition at $300 million, 1% of that is $3 million. 1% of WhatsApp would've been around $200 million. 1% of Facebook would've made you a billionaire.
Trying to get more than a genuine 1% isn't very important. Trying to figure out what the percentage that they quote you in your job hire process will turn out to be during a monetization is very important.
This is the best comment in this entire thread. People see 1% and immediately think small when that is not, in fact, the case.
They have almost never thought through the fact that it generally takes a lot of people to build a successful company so that 100% needs to get divided up into a lot of little pieces.
They have almost never thought through the fact that it generally takes a lot of people to build a successful company so that 100% needs to get divided up into a lot of little pieces.
It's pretty tiny when the expectation is that one will be treated like a regular employee with respect to compensation and benefits but expected to behave like a 20% (or more)-equity founder with respect to passion and (especially) effort.
That's not the expectation.
The cliff just creates artificial scarcity from what I've seen. When an employee is let go before 1 year, or quits because it isn't a good fit, I've always seen the company give what they would have vested in anyway (leave at 10 months? Get 10 months worth of vesting). It's really just the right thing to do, since they put work into your company.
No one does this ever.
My experience is very different than yours. I've never heard of anyone leaving before 1 year and not getting anything.
Your strike price stays fixed so any bump in valuation is your gain. Of course, if you're a late employee at a start-up that has just experienced stratospheric growth, the probability of further upside declines, but if you're in that position, you're likely to get RSUs anyways.
Because if someone doesn't work out, you want to get rid of them and have them gone for good, not hanging around your stockholder meeting. A year is enough time for that.
Firing someone just before things vest might trigger ERISA. Don't do that.
Firing someone just before things vest might trigger ERISA. Don't do that.
Is there any generally reasonable 101 on how to do equity/share/stock-option in an early stage start-up? Tried to google for it and never found any general guidance for that.
If you're paying a full salary/benefit for them, the options etc is really just trying to keep them from jumping around? I'm open to all ideas but would like to find some common/typical silicon valley way to do this for startups.
If you're paying a full salary/benefit for them, the options etc is really just trying to keep them from jumping around? I'm open to all ideas but would like to find some common/typical silicon valley way to do this for startups.
I found this very helpful.
http://www.fairmark.com/execcomp/index.htm
http://www.fairmark.com/execcomp/index.htm
I've worked for some of the largest companies in the world as well as been employee number one at multiple startups (one of which was backed by google ventures), so I hope the following advice is good:
If you're going to found a company, go for it. I'd like to do the same myself someday. If you're going to work for a startup, make sure they pay you well. In dollars (or your local currency). I treat stock options as a lottery ticket, not a substitute for income.
Basically working for a startup is much like working for a big company. Neither really offers you long term stability. You have to deal with politics in both. The biggest difference in my opinion is that startups typically have really long hours and some pretty big egos.
If you're going to found a company, go for it. I'd like to do the same myself someday. If you're going to work for a startup, make sure they pay you well. In dollars (or your local currency). I treat stock options as a lottery ticket, not a substitute for income.
Basically working for a startup is much like working for a big company. Neither really offers you long term stability. You have to deal with politics in both. The biggest difference in my opinion is that startups typically have really long hours and some pretty big egos.
I have a related question for folks here.
I joined a startup around 2009 as an early employee, left after a couple years, and bought the vested stock. (The company is based in the US, and I'm not a US citizen, FYI). I've been holding on to these stocks so far. Compoany has rasied a small series A just around the time I joined. The company has raised a few rounds of funding since I left.
It now looks like the company may IPO/ or be privately acquired. I have not been in touch with anyone in the company over the past couple years.
What steps do I take now to ensure I don't get screwed as part of the exit, and/or my stocks diluted to become meaningless? I'm looking for general advice.
I joined a startup around 2009 as an early employee, left after a couple years, and bought the vested stock. (The company is based in the US, and I'm not a US citizen, FYI). I've been holding on to these stocks so far. Compoany has rasied a small series A just around the time I joined. The company has raised a few rounds of funding since I left.
It now looks like the company may IPO/ or be privately acquired. I have not been in touch with anyone in the company over the past couple years.
What steps do I take now to ensure I don't get screwed as part of the exit, and/or my stocks diluted to become meaningless? I'm looking for general advice.
It would be a pretty rare company that is willing to revise their stock option plan in response to a request from a potential employee. They'd have to take the request to their board for approval, then also get a vote of the stockholders, and would have to pay the lawyers to revise the documents. Just an administrative headache regardless of the legitimacy of the request and probably not a great way to start off the relationship with your future employer.
Someone could probably make a nice bit of money on the side helping new engineers in SF review/deal with their stock options. You'd have to know this stuff well, but I don't think that's a big hindrance to anyone.
Think of it as both giving back and pushing back on what can be predatory treatment of employees.
Think of it as both giving back and pushing back on what can be predatory treatment of employees.
Isn't that what lawyers are for? I paid mine a small fee to review my equity agreement before I signed and I made it clear to my potential employer that I couldn't sign until my lawyer signed off on it.
A bunch of Silicon Valley CPAs do this as well as financial advisors/planners. This is a high-class problem to have though, which is also the point where one comes across the need to hire a financial advisor or have a professional CPA do some tax planning.
Options are useless. Their value is entirely based on what the actual shareholders decide. It doesn't matter if stock gets sold to other investors or the company goes public. Options are useless. You want a stake in a business, you need to ask for actual stock. Not options.
Well, you have the right to exercise those options and then they become stock and you have a stake in the company. The nice part of it being an option is it grants you the right to invest in the company at a static price if you choose. And you choose to do this when the company is doing very well.
No. Options can only be exercised if the owner(s) allow it. They can just as easily decide not to exercise them and revalue them at $0. This is generally considered unethical and would dramatically impact retention, but there is no explicit guarantee in options. It is implied and their value is entirely at the discretion of the owner(s).
This is an inadequate overview of options issues for startup employees. The major issues are probably:
1. Acceleration on change of control (the article covers this). 1 year acceleration is fairly common it seems. There should be something here. But fully acceleration of granted options is probably more than you realistically can hope for. After all, you didn't need to work for that year to get the options. There should be some balance here.
2. Rule 83b electoins. Particularly relevant for pre-funding startups and especially for founders. It allows you to pay all the tax on options up front rather than be hit by yearly AMT bills;
3. Clawback agreements. This is a nasty one that was most publicly brought to light with Skype (the second time around). A bunch of executives were fired before the acquisition went through, allegedly for performance reasons. Their options could be bought back at issue price, resulting in a windfall for SilverLake of possibly several hundred million. Want to sue? Well the company was incorporated overseas. Good luck with that.
The moral of the story is watch out for any rights the company has to repurchase your options and at what price.
Repurchases in general aren't necessarily evil. It's good to avoid having a lot of shareholders for early stage companies (due to SEC limits on number of shareholders for non-public companies) but such repurchases need to be fair.
4. You're taxed on options based on their fair market value when they're issued barring a Rule 83b election;
5. Liquidation preferences. VCs generally have some form of preferential treatment on how they're repaid in the event of a buyout. This can take a number of forms.
The most reasonable is that they're simply guaranteed to get their money back. Meaning if they paid $10M for a 40% stake in a company that gets bought for $15M they're going to get their $10M back instead of 40% * $15M = $6M. That's not unreasonable.
But what's not reasonable (IMHO) is "participating preferred" liquidation preferences. What this means in the above scenario is the VC will get $10M of the $15M back and then 40% of the remaining $5M. So the other 60% are divvying up $3M. That's a lot less attractive.
6. Bonuses in lieu of acquisition. You may see a headline that says your company has been bought for $100M and you own 1%. Great! You're now a millionaire! Not so fast...
It may turn out the VC owns 40% participating preferred with $20M funding and the company is actually only being bought for $50M. The other $50M is incentives in the new company paid to the founders and possibly key executives.
So you're only getting 1% of $30M.
7. Dilution. Your 1% may not be 1%. You may have been told something like "there are 1M shares outstanding and we're granting you 10,000 options over 4 years with 1 year cliff". So you own 1% right? Well, maybe you do and maybe you don't.
The company may be reporting outstanding shares rather than outstanding shares plus any obligations it's made. It really needs to report on a fully diluted basis. There may be convertible notes and rights of existing VCs to buy in in future funding rounds, etc.
So anyway there are a lot of potential traps.
1. Acceleration on change of control (the article covers this). 1 year acceleration is fairly common it seems. There should be something here. But fully acceleration of granted options is probably more than you realistically can hope for. After all, you didn't need to work for that year to get the options. There should be some balance here.
2. Rule 83b electoins. Particularly relevant for pre-funding startups and especially for founders. It allows you to pay all the tax on options up front rather than be hit by yearly AMT bills;
3. Clawback agreements. This is a nasty one that was most publicly brought to light with Skype (the second time around). A bunch of executives were fired before the acquisition went through, allegedly for performance reasons. Their options could be bought back at issue price, resulting in a windfall for SilverLake of possibly several hundred million. Want to sue? Well the company was incorporated overseas. Good luck with that.
The moral of the story is watch out for any rights the company has to repurchase your options and at what price.
Repurchases in general aren't necessarily evil. It's good to avoid having a lot of shareholders for early stage companies (due to SEC limits on number of shareholders for non-public companies) but such repurchases need to be fair.
4. You're taxed on options based on their fair market value when they're issued barring a Rule 83b election;
5. Liquidation preferences. VCs generally have some form of preferential treatment on how they're repaid in the event of a buyout. This can take a number of forms.
The most reasonable is that they're simply guaranteed to get their money back. Meaning if they paid $10M for a 40% stake in a company that gets bought for $15M they're going to get their $10M back instead of 40% * $15M = $6M. That's not unreasonable.
But what's not reasonable (IMHO) is "participating preferred" liquidation preferences. What this means in the above scenario is the VC will get $10M of the $15M back and then 40% of the remaining $5M. So the other 60% are divvying up $3M. That's a lot less attractive.
6. Bonuses in lieu of acquisition. You may see a headline that says your company has been bought for $100M and you own 1%. Great! You're now a millionaire! Not so fast...
It may turn out the VC owns 40% participating preferred with $20M funding and the company is actually only being bought for $50M. The other $50M is incentives in the new company paid to the founders and possibly key executives.
So you're only getting 1% of $30M.
7. Dilution. Your 1% may not be 1%. You may have been told something like "there are 1M shares outstanding and we're granting you 10,000 options over 4 years with 1 year cliff". So you own 1% right? Well, maybe you do and maybe you don't.
The company may be reporting outstanding shares rather than outstanding shares plus any obligations it's made. It really needs to report on a fully diluted basis. There may be convertible notes and rights of existing VCs to buy in in future funding rounds, etc.
So anyway there are a lot of potential traps.
I have accepted a startup offer with stock options 2 days back. The CTO told me about the number of outstanding shares in the company and the last 409(A) valuation and the current valuation they are going to raise funding. But except #options, these details are not specified in the offer letter but i have accepted.
Should i consult a lawyer before i join this company? If so, can you guys recommend some lawyer contacts? I have been in bay area for last one year and i don't have much contacts. Help! Thanks
Should i consult a lawyer before i join this company? If so, can you guys recommend some lawyer contacts? I have been in bay area for last one year and i don't have much contacts. Help! Thanks
This is a great resource for legal advise on the case. I also was offered options on a startup that I worked at. I am adding this to my bookmarks :D some cross-reference http://www.businessinsider.com/stock-option-questions-startu...
Generally I prefer to leave the legal stuff for my lawyer and focus on coding, but having a reasonable knowledge on the case is preferred.
Generally I prefer to leave the legal stuff for my lawyer and focus on coding, but having a reasonable knowledge on the case is preferred.
This happened to me. My employer got sold, and only about half of my outstanding ISO's were vested at the time. However, I'd been there a pretty long time, and getting more ISO grants as time went on, so I wasn't too bent out of shape about it.
In my opinion, you should think about instruments such as RSU's and options as accruing to you at the date of vest, not the date of grant. From an accounting standpoint, that's how the company is viewing it, or at least should be.
In my opinion, you should think about instruments such as RSU's and options as accruing to you at the date of vest, not the date of grant. From an accounting standpoint, that's how the company is viewing it, or at least should be.
This stuff is simply too complex. Just like there guides that make open source licenses easier to understand I wish there was the same for startup stock options.
This advice should be directed to entrepreneurs.
As a founder, it's good to know what terms are "standard" and what terms are more pro-employee or more pro-management. Then you can use that information when setting up the option plan with your lawyer, and push back if you feel the lawyer is overzealous in protecting your own interest.
Once the plan is in place, it's unfortunately too late for the employee to seek more favorable terms.
As a founder, it's good to know what terms are "standard" and what terms are more pro-employee or more pro-management. Then you can use that information when setting up the option plan with your lawyer, and push back if you feel the lawyer is overzealous in protecting your own interest.
Once the plan is in place, it's unfortunately too late for the employee to seek more favorable terms.
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mallyvai(1)
This is why I never take equity. It's just a way to dangle a carrot in front of an employee to make them think they will get a big pay day. Many times, the employee doesn't want to quit because this pay day is seemingly right around the corner.
My previous employer gave me stock options on top of my salary. I never really cared about the stock options too much. A few months ago, I found out the owner created a new LLC (and moved the company to this new LLC) essentially making my options worthless overnight.
I would rather get paid my true market value.
My previous employer gave me stock options on top of my salary. I never really cared about the stock options too much. A few months ago, I found out the owner created a new LLC (and moved the company to this new LLC) essentially making my options worthless overnight.
I would rather get paid my true market value.
Also, did you sign an employment contract with the new LLC? If not, then you own the IP you create, not the new LLC, assuming the old entity was dissolved.
Many times, the employee doesn't want to quit because this pay day is seemingly right around the corner.
Seen this way way too many times. I've fell victim to it myself, staying at someplace for too long.
I've never regretted leaving a place too soon.
Seen this way way too many times. I've fell victim to it myself, staying at someplace for too long.
I've never regretted leaving a place too soon.
a good employment contract would cover this scenario...best to make friends with an attorney in the field :)
Where would one go to set about purchasing beer for such a new friend?
Ideally before you accept the offer :)
True, but in the current hiring climate and if you're still at an early stage you should definitely still have leverage.
Yes, if the company is early stage, then nothing should be out of the question.
Basically the way this works is that we give new employees an up front lump sum in the amount of how much it costs to purchase the shares of the company. The employee then purchases those shares from us in line with a vesting agreement. All warrants and conversions are exactly the same as the founders shares.
This means that they pay tax on this purchase as regular income rather than capital gains up front with the money we give them for it. This prevents a heavy tax bill at conversion and allows them to retain their vested shares regardless of if they work for us or not after the first 12 month vesting period.
We calculated that the up front taxes are magnitudes cheaper in the long run because the increased valuation will cover those differences handily and there is no waiting period like there is with capital gains tax.
In the end though our intention was to make a simple way for our employees to actually own the stock we give them as compensation and it not be something that they can lose or be restructured easily. If a VC or acquisition wanted to restructure that away for employees then they would be forced to restructure everyone's, so we are all in.