I highly recommend also reading the book Consider Your Options[0]. It's an easy yet very informative read.
[0] https://www.amazon.com/Consider-Your-Options-Equity-Compensa...
How Startup Options and Ownership Work
21–30 of 100 posts
Re: How Startup Options and Ownership Work
#22Earlier quoted context omitted.
Considering the author's previous article was about how employees do not deserve to keep their equity unless they stay with a company until liquidity, I suspect he would not support granting restricted stock. http://a16z.com/2016/07/26/options-plan/
If they didn't deserve it, then they shouldn't be compensating the employees with equity & should be doing so with cash. Can't have it both ways. (This is more of a response to the link, not your comment in particular)
Well, having it both ways is entirely dependent on market forces. As of right now, it would seem they can in fact have it both ways.
Re: How Startup Options and Ownership Work
#23Earlier quoted context omitted.
I'm not sure I quite get what you mean by "issuing early employees restricted stock awards". Can you elaborate? Is this like an IOU for restricted stock? Isn't that kind of like what stock options are (except for common stock)? And if you just mean giving actual restricted stock (like to investors), then the main problem is you have to pay those taxes right away (the whole point of options). But maybe you mean someth…
If you are granted restricted stock subject to vesting, in the US you owe taxes only when the stock is both released AND vested, meaning the tax bill comes due in stages as the shares vest, not "right away". If you give restricted shares that vest over time and are only released upon a change in control, you can further defer the tax bill due date (though at the expense of the eventual bill being higher on average).
Most restricted stock subject to vesting will require the recipient to file an 83(b) election. This takes the full current value of all shares at the current issue price as income up front. Since the shares are typically worthless at that point, the tax bill is zero.
The alternative is disastrous for a fast growing company. Each month, each year, you are vesting new shares at an exponentially increasing valuation, and now have to pay income tax on that completely illiquid gain with cash you literally don't have.
Re: How Startup Options and Ownership Work
#24Earlier quoted context omitted.
I've been making similar points too, it's actually shocking how founders and VCs are convinced that their way is the absolute correct way Instead of pointing out how stock options are primarily a reaction to accounting and taxation changes over the years , or the conflicts of interest in giving a more objective answer There are plenty of financial products possible that will tread the line of compensating employees f…
Do you have any examples of these products?
yeah, cash money.
if a startup has VC's and lawyers sitting around dreaming up and codifying a complicated and rather arbitrary set of rules to protect their investment from the little people, there's enough cash floating around to pay the employees a fair salary, they just don't want to.
options are fool's gold, plain and simple. you are either a founder, or a venture capitalist, or lawyer, or you should expect a zero or negative value from this silly charade.
if you can't tell which person sitting at the poker table is the sucker...
Re: How Startup Options and Ownership Work
#25The article goes over stock options; but it doesn't address an alternate form of equity; issuing early employees restricted stock awards (instead of options). From the receiver's point of view, Stock Options are a bad deal 99 times out of 100, let's review the cases in which owners of options get screwed: - Company gets acquired, new terms are put into place. - Company gets acquired, company isn't good fit. - Company…
Almost all your points apply exactly equally to restricted stock as it does to options. In both cases you will have a vesting schedule, just in the case of restricted stock it's usually a grant of the shares with no exercise price. In both cases you want to file an 83(b) election so you are taxed based on the FMV of the company when you receive the unvested shares (when the shares are worthless) so that you will only owe capital gains later.
But more importantly, in both cases you end up exactly and equally screwed in terms of you are holding the same class of stock (common) with the same vesting terms (no, single, or double trigger acceleration), all the exact same issues around dilution, liquidity, preferred shares, and unfair buyout terms funneling cash to key executives, etc.
Equity is a massive gamble all around, and there's no magic bullet that I've seen which can defray many of the inherent risks of owning common shares of a private company which has perhaps a 1 in 100 odds of ever seeing a public market or liquidity event that surpasses the total liquidation preferences.
Re: How Startup Options and Ownership Work
#26Earlier quoted context omitted.
If they didn't deserve it, then they shouldn't be compensating the employees with equity & should be doing so with cash. Can't have it both ways. (This is more of a response to the link, not your comment in particular)
Well, having it both ways is entirely dependent on market forces. As of right now, it would seem they can in fact have it both ways.
always depends what employees are willing to do.
Re: How Startup Options and Ownership Work
#27Earlier quoted context omitted.
If you are granted restricted stock subject to vesting, in the US you owe taxes only when the stock is both released AND vested, meaning the tax bill comes due in stages as the shares vest, not "right away". If you give restricted shares that vest over time and are only released upon a change in control, you can further defer the tax bill due date (though at the expense of the eventual bill being higher on average).
Most restricted stock subject to vesting will require the recipient to file an 83(b) election. This takes the full current value of all shares at the current issue price as income up front. Since the shares are typically worthless at that point, the tax bill is zero. The alternative is disastrous for a fast growing company. Each month, each year, you are vesting new shares at an exponentially increasing valuation, an…
> Most restricted stock subject to vesting will require the recipient to file an 83(b) election
No RSU grant "requires" an 83(b) election.
Your second point is why RSU grants with normal vesting and delayed release is desirable.
Re: How Startup Options and Ownership Work
#28This article mentions '“sticker shock” (or reverse!) [up]on leaving their first startup.' Companies can easily ameliorate this, especially for early employees, by permitting early exercise. The 409a valuation rarely changes between financing events so if you get 5000 $.50 options you can pay $2500, file 83(b), and not have to pay any tax until (unless you sell). If you leave before your vesting period is up the compa…
I look at companies like Uber raising billions of dollars (with liquidation preference) and losing billions of dollars in net operating loss each year, and I can only hope for the employee's sake that they have a 409a valuation on the common stock of exactly $1.
In reality they are probably handing out options with a strike price valuating the common shares at billions of dollars and those options are likely worse than worthless.
Re: How Startup Options and Ownership Work
#29The article goes over stock options; but it doesn't address an alternate form of equity; issuing early employees restricted stock awards (instead of options). From the receiver's point of view, Stock Options are a bad deal 99 times out of 100, let's review the cases in which owners of options get screwed: - Company gets acquired, new terms are put into place. - Company gets acquired, company isn't good fit. - Company…
Are there any companies you know that use RSU's or stock grants instead of options? I've been interviewing at some startups and they only seem to offer options with their byzantine rules. Can people negotiate offers from options to RSUs/grants?
RSUs are typical at a certain size -- generally around 500 employees I think these days. There's a forcing function called the Exchange Act, section 12(g) of which says there's a cap on the number of shareholders you can have without reporting financials effectively as if you're a public company. That number was increased from 500 shareholders to 2000 in 2012. The reason for the lower number where RSUs start to be considered than where strictly required has a couple motivations:
1) Generally by 200 employees your stock is starting to be expensive, so exercising is no longer a trivial amount of money. This is especially important if an employee wants to 83(b) exercise (which is pre-buying their shares as soon as they're granted, to move the long term capital gains clock up to a year ahead of where it would otherwise kick in).
2) Getting to 500 employees generally implies some attrition, and of course your investors are also on your cap table, so it's fairly easy to be approaching 2000 shareholders with a smaller number of employees depending on how fast you've grown and how many party rounds you've done.
3) RSUs are trivial for the company to control. Shares that you own can, without special restrictions which are only starting to become standard in the last few years, can be traded on secondary markets even if you can't trade them on a public exchange. RSUs are simply a promise, and while you could write a contract that dictates what you'll do at the time of RSU conversion, that doesn't affect the company because by definition they're already public by then.
Selling your vested options to another party is much harder on the company, since as shareholders this third party has an explicit relationship with the company and, depending on where they are incorporated, rights to examine the company's finances.
Oh, and rereading I just realized I didn't connect the dots from the 12(g) threshold forcing people to use RSUs. RSUs are not considered stock. For tax purposes they are ordinary compensation awarded at the time of conversion, and only then do you count as a shareholder in the company. A company like Uber (could easily have been over 2000 shareholders by now I'm sure) has been using RSUs for probably multiple years now.
Re: How Startup Options and Ownership Work
#30Earlier quoted context omitted.
I've been making similar points too, it's actually shocking how founders and VCs are convinced that their way is the absolute correct way Instead of pointing out how stock options are primarily a reaction to accounting and taxation changes over the years , or the conflicts of interest in giving a more objective answer There are plenty of financial products possible that will tread the line of compensating employees f…
Do you have any examples of these products?
I know of a german financial product, I keep forgetting the name of it, it is a hybrid of a stock and a bond, but it isn't what is typically considered a convertible note.
But basically it is granted at no cost to the employee, offers coupon payments, and matures at a point in time for the full cash value.
In the US, this would be OTC product limiting its utility much like every other kind of financial product that the government is 'protecting us' from. But it wouldn't be impossible to offer to employees.
For startups, the coupon payments would be relatively small, and refresher grants can still be done. If the startup goes bust, it goes bust. Provisions to make it callable can be implemented so in a bigger liquidity event valuing the company higher, employees can still get a lot of liquidity early, and it would likely be senior to common stock.
Anyway, I'll try to get the name of it. It was a lot more counterintuitive than hybrid bond.
edit: genussscheine , or participation certificate. Exempt from securities regulation in germany, but would be OTC in US.