How Startup Options and Ownership Work • Hacker News Board

Re: How Startup Options and Ownership Work

#61

Post by zaroth » Thu, Aug 25, 2016, 7:20 PM UTC

superuser2 wrote: post #55

zaroth wrote: post #23

Earlier quoted context omitted.

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…

>completely illiquid gain Which is why "liquidity event" is one of the conditions for vesting.

I think that's an absolutely crazy way to try to avoid an 83(b) election. I would never want my stock locked up behind a dubious "liquidity event" requirement for vesting.

So you work for a startup for 10 years since inception, it's private all the time, you get annual grants for more and more options, building up options for 5% of the fully diluted shares, but then get disabled and have to stop working. Now you lose all your options because none of them have vested because the company didn't sell yet?

Re: How Startup Options and Ownership Work

#62

Post by superuser2 » Thu, Aug 25, 2016, 7:24 PM UTC

zaroth wrote: post #61

superuser2 wrote: post #55

Earlier quoted context omitted.

>completely illiquid gain Which is why "liquidity event" is one of the conditions for vesting.

I think that's an absolutely crazy way to try to avoid an 83(b) election. I would never want my stock locked up behind a dubious "liquidity event" requirement for vesting . So you work for a startup for 10 years since inception, it's private all the time, you get annual grants for more and more options, building up options for 5% of the fully diluted shares, but then get disabled and have to stop working. Now you los…

It's combined with a stipulation that you are still entitled to the shares whose "time-based condition" has been met, and will be granted them upon any liquidity event even after leaving the company.

Re: How Startup Options and Ownership Work

#63

Post by caseysoftware » Thu, Aug 25, 2016, 7:30 PM UTC

gumby wrote: post #18

This 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 was early at Twilio (#25 or so) and early exercised to take advantage of this one. I ended up with a much smaller tax liability than I would have received if I had waited until I left to the tune of thousands of dollars.

The keys are: a) being there early enough that the strike price is feasible for the cash you have and b) that the company becomes something more valuable later.

If you can do both of those, bravo. But don't count on it.

Re: How Startup Options and Ownership Work

#64

Post by zaroth » Thu, Aug 25, 2016, 7:51 PM UTC

superuser2 wrote: post #62

zaroth wrote: post #61

Earlier quoted context omitted.

I think that's an absolutely crazy way to try to avoid an 83(b) election. I would never want my stock locked up behind a dubious "liquidity event" requirement for vesting . So you work for a startup for 10 years since inception, it's private all the time, you get annual grants for more and more options, building up options for 5% of the fully diluted shares, but then get disabled and have to stop working. Now you los…

It's combined with a stipulation that you are still entitled to the shares whose "time-based condition" has been met, and will be granted them upon any liquidity event even after leaving the company.

Yeah, so Zynga did this... it's complicated and has many pitfalls. For example, their options expired after 7 years. There's also much debate around if the liquidity event can reasonably be construed as a legitimate "performance condition", and whether you have to start accounting for (and paying tax on) the otherwise vested shares once you can reasonable foresee a future liquidity event, not just after said liquidity event actually occurs.

https://www.sec.gov/Archives/edgar/data/1439404/000119312511...

Re: How Startup Options and Ownership Work

#65

Post by prostoalex » Thu, Aug 25, 2016, 8:13 PM UTC

zaroth wrote: post #34

prostoalex wrote: post #31

Earlier quoted context omitted.

> 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 Can you do this, though? 83b election with ISOs makes sense because the tax event is employee writing a check to pre-exercise his shares, so a transaction occurs. For RSUs the transaction seems to occur at the time of the actual grant - there's no money changing hands, no transactio…

Great point! From http://www.investopedia.com/articles/tax/09/restricted-stock... Section 83(b) Election Shareholders of restricted stock are allowed to report the fair market value of their shares as ordinary income on the date that they are granted, instead of when they become vested, if they so desire. This election can greatly reduce the amount of taxes that are paid upon the plan, because the stock price at the…

Thanks for the clarification. Back to the grandparent's discussion, it seems that such election on RSUs is more punitive than on ISOs - an RSU grant to a high-income employee is then taxed as income, potentially as high as 39.6% at federal level (and whatever the state obligations are) versus AMT bill, which tops out at 28%.

Re: How Startup Options and Ownership Work

#66

Post by hkmurakami » Thu, Aug 25, 2016, 8:57 PM UTC

The problem isn't that this information isn't out there. It is -- but you need to (a) recognize that this information is important, and (b) know how and where to find it.

Writing another blog post on a VC blog isn't going to solve the fundamental problem of information awareness and discovery.

It's very much like basic personal finance. The hardest part is becoming aware of the need to educate yourself in the first place. The second hardest part is figuring out what you need to learn. Much of this awareness comes from upbringing and is an element of social capital that we often take for granted.

Establishing a neutral, nonpartisan online resource under a transparent domain name would be a plausible first step.

Re: How Startup Options and Ownership Work

#67

Post by hkmurakami » Thu, Aug 25, 2016, 9:00 PM UTC

calvinbhai wrote: post #13

I am curious to know when is the best time to ask all the questions about the stock options. Before signing the offer letter / getting started or after? Before may be a bad deal for startups, especially the ones that are keeping everything all the equity details under wraps. After is a bad deal for the employee who makes the move, and could be a major bait and switch

Before. At the very least you'e getting a read on their character.

Anything and everything in the contract can be taken away from you when you don't have a controlling stake in the company. The contract language is important, but the trustworthiness of the founding team is even more important. At the end of the day, if they are intent on screwing you over, your contract will be just a piece of paper anyways. By asking for the information up front, you get additional information on the trustworthiness and openness of the management team.

Re: How Startup Options and Ownership Work

#68

Post by sokoloff » Thu, Aug 25, 2016, 9:02 PM UTC

zaroth wrote: post #64

superuser2 wrote: post #62

Earlier quoted context omitted.

It's combined with a stipulation that you are still entitled to the shares whose "time-based condition" has been met, and will be granted them upon any liquidity event even after leaving the company.

Yeah, so Zynga did this... it's complicated and has many pitfalls. For example, their options expired after 7 years. There's also much debate around if the liquidity event can reasonably be construed as a legitimate "performance condition", and whether you have to start accounting for (and paying tax on) the otherwise vested shares once you can reasonable foresee a future liquidity event, not just after said liquidit…

It doesn't have to be solely a performance condition.

I don't think it would be hard to prevail on the facts arguing that a requirement for an IPO (or similar liquidity event) is wholly out of the employee's control and that a substantial risk of that not happening occurs up until the moment that it actually happens. IPOs fall apart/are withdrawn and mergers fail frequently enough that a substantial risk argument could probably be sustained.

Re: How Startup Options and Ownership Work

#69

Post by hkmurakami » Thu, Aug 25, 2016, 9:02 PM UTC

hesdeadjim wrote: post #4

Has anyone ever heard of or seen a way that option holders don't get 100% screwed if a company is acquired for less than the sum of the investors' liquidation preferences?

Retention packages by the acquirer.

Look at the structure and retention deals of acquihires.

Re: How Startup Options and Ownership Work

#70

Post by hobbyjogger » Thu, Aug 25, 2016, 9:03 PM UTC

xenadu02 wrote: post #58

zaroth wrote: post #25

Earlier quoted context omitted.

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…

IIRC 83(b) on options is not available unless the company allows you to pre-exercise the options to turn them into shares prior to vesting. So the vast majority of startup employees don't have the fancy tax-avoiding scheme that founders and investors have.

> So the vast majority of startup employees don't have the fancy tax-avoiding scheme that founders and investors have.

Investors never have vesting on their shares so 83(b) has nothing to do with the preferred stock investors receive. Founders of course do often have vesting and can benefit from filing an 83(b).