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Stock options are complicated

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Re: Stock options are complicated

#101

Post by naedish »

phamilton wrote: post #100
randominternets wrote: post #97

Earlier quoted context omitted.

That sounds suspect to me. The company I work for gives 90 days + 1 month for every 1 month over a year you work there (so work there 2 years and you have 1 year, 90 days to exercise after leaving). Is this arrangement just a loophole?

Do they keep you employed for that month? It's fairly common to extend your termination date for health insurance and visa reasons. If you aren't actually terminated, the 90 days wouldn't have started.

The sentence was slightly hard to parse so you may have missed that you get an extra month for each month you are employed over 1 year. So the stated example of a 2 year tenure gives 1 year and 90 days to purchase the options.

Re: Stock options are complicated

#102

Post by dlubarov »

stanleydrew wrote: post #90
freddyc wrote: post #69

Earlier quoted context omitted.

It's usually in the underlying option plan I believe. I think the challenge with changing the 90 day window is that you run the risk of the option not qualifying as an ISO. If that's the case, it would instead be classified as a non-qualified stock option and the holder would lose the capital gains benefits and be subject to ordinary income tax (IANAL though, so could be way off base).

This is roughly correct. The 90-day exercise window isn't just something made up out of thin air to handcuff employees and keep them from leaving. It's explicitly written into the tax code that an option must be exercised within 90 days of leaving a company if the option is to be treated as an ISO. ISOs are arguably more advantageous than NSOs, which is why this is the default.

A workaround is to convert ISOs to NSOs after 90 days. Quora adopted that policy a while ago and a lot of companies followed suit (Square and Pintrest to name a few). Sam A now recommends that approach - http://blog.samaltman.com/employee-equity

Re: Stock options are complicated

#103

Post by dlubarov »

zenlikethat wrote: post #64
pcmaffey wrote: post #60

Earlier quoted context omitted.

"Dead equity" could also be used in reference to most of a company's investors. That is of course, tongue in cheek. Why should employees have their investment of time and energy taken away from them when investors' one-time cash investment earns preference? Another industry double-standard.

Because the investors' cash is the thing that enables high growth companies to survive and be, well, high growth (who do you think pays said employees' salaries?). Not saying they don't often make out much better than employees, but no one forces you to accept a term sheet you don't want to, and you should understand the implications of the equity you're getting walking in.

IMO there's no point in arguing about the relative importance of investors versus employees, because everyone should be in favor of more flexible equity terms.

The 90 day rule creates a lot of risk for employees who lack the capital for early exercise. If employees are rational and well-informed, they'll heavily discount the value of any options with a 90 day expiration. By offering more flexible terms (like Quora's), companies should be able to hire the same candidates while giving away less equity.

Granted, some employees don't ask about the equity terms in their offers, or don't carefully consider the risks. But I think this is improving, and eventually more flexible terms will become standard. I've personally declined a few offers based on the equity terms.

Re: Stock options are complicated

#104

Post by phamilton »

naedish wrote: post #101
phamilton wrote: post #100

Earlier quoted context omitted.

Do they keep you employed for that month? It's fairly common to extend your termination date for health insurance and visa reasons. If you aren't actually terminated, the 90 days wouldn't have started.

The sentence was slightly hard to parse so you may have missed that you get an extra month for each month you are employed over 1 year. So the stated example of a 2 year tenure gives 1 year and 90 days to purchase the options.

Indeed, I parsed it incorrectly.

Re: Stock options are complicated

#105

Post by prostoalex »

pcmaffey wrote: post #60
zenlikethat wrote: post #42

Earlier quoted context omitted.

A 90-day window might be better for you if you want to stick around at a company for a while and there were other people that came before you, but left. "Dead equity" of startup employees who have left but not exercised means that they can let you do all of the work while they dilute the available equity pool (i.e., take money directly out of your pocket). This a16z article goes into this: http://a16z.com/2016/06/23/…

"Dead equity" could also be used in reference to most of a company's investors. That is of course, tongue in cheek. Why should employees have their investment of time and energy taken away from them when investors' one-time cash investment earns preference? Another industry double-standard.

It's not really a double standard. A share of stock and an option to buy such share of stock are two distinct products, priced differently.

E.g. MSFT share price today is $64.27, a contract allowing you to buy a share of MSFT on March 17, 2017 for $64 is 83c.

Investors buy their shares in full, cash-on-delivery, so to speak. Would investors like to be able to buy call options in the companies at pre-specified valuations for just 1.5% of the price and complete freedom to exercise (as well as forfeit) those options four years down the road? You betcha.

Not only do they need to pay significantly less to participate, they can spread those bets around and cover roughly 60x more companies, if they choose. Or double or triple down on this one specific company. Or just sell their option down the road in case it's the next FB or Uber without ever needing to put up cash.

Both investors and employees get to buy their shares for cash. Employees though do get the luxury of time, and can not only benefit immensely from stock's rise, but also save their hard-earned money in case of a dud. Investors do not get the latter option. Therefore they seek compensation elsewhere, usually in the liquidation preference department (which is moot anyways if the liquidation value is $0).

Re: Stock options are complicated

#106

Post by acjohnson55 »

prostoalex wrote: post #105
pcmaffey wrote: post #60

Earlier quoted context omitted.

"Dead equity" could also be used in reference to most of a company's investors. That is of course, tongue in cheek. Why should employees have their investment of time and energy taken away from them when investors' one-time cash investment earns preference? Another industry double-standard.

It's not really a double standard. A share of stock and an option to buy such share of stock are two distinct products, priced differently. E.g. MSFT share price today is $64.27, a contract allowing you to buy a share of MSFT on March 17, 2017 for $64 is 83c. Investors buy their shares in full, cash-on-delivery, so to speak. Would investors like to be able to buy call options in the companies at pre-specified valuati…

Well then that's doubly ironic, because most startup employees would probably much prefer to have shares over options. I know I would.

Re: Stock options are complicated

#107

Post by acjohnson55 »

dlubarov wrote: post #103
zenlikethat wrote: post #64

Earlier quoted context omitted.

Because the investors' cash is the thing that enables high growth companies to survive and be, well, high growth (who do you think pays said employees' salaries?). Not saying they don't often make out much better than employees, but no one forces you to accept a term sheet you don't want to, and you should understand the implications of the equity you're getting walking in.

IMO there's no point in arguing about the relative importance of investors versus employees, because everyone should be in favor of more flexible equity terms. The 90 day rule creates a lot of risk for employees who lack the capital for early exercise. If employees are rational and well-informed, they'll heavily discount the value of any options with a 90 day expiration. By offering more flexible terms (like Quora's)…

> If employees are rational and well-informed [...]

That's a biiiiiig if. In my experience, this is definitely not the case for the vast majority of startup employees I know.

Re: Stock options are complicated

#108

Post by boulos »

idunno246 wrote: post #20
bogomipz wrote: post #12

This is great write up. Kudos to the author for taking the time. I did have a question about the following sentence: >"If an employer gives you straight-up shares, then the IRS will tax the shares (at ordinary income rates) when they vest." What would be treated as income and taxes here, the strike price x the number of options vesting? Is that correct? For regular worker bees this not very much though right? For ins…

Shares vested x fair market value at vest. So you get 1000 shares when you join, worth $1/share. 250 vest on your first year, and that's when tax is due. But say the company grows and shares are $5/share. 5x250 is 1250 taxed income on the anniversary. Normally at early stages you're talking many thousands of shares though, that can increase rapidly. The fmv is recalculated every year, or on any fundraise events. It n…

But you can frontload all the "income" and taxes upfront. That's what an 83(b) election is: "Hi IRS, I'd like to pay/recognize this taxable event all right now, even before it vests".

So you get 1000 shares x $1/share = $1000 of income, and you pay taxes on it.

Re: Stock options are complicated

#109

Post by acjohnson55 »

zenlikethat wrote: post #66
freddyc wrote: post #63

Earlier quoted context omitted.

> I'd expect that in most high-growth companies the impact of individual contributors quickly gets washed away after they leave I'd argue it's the opposite. Early employees often have an outsized impact on the trajectory of a company and get it to a point where additional hiring is possible. Future generations of workers tend to iterate on the existing (unless there's a significant pivot) and come on board in a more…

> Early employees often have an outsized impact on the trajectory of a company Mmm... I think we'll have to agree to disagree there... Seems to me that the bulk of the work adding value in a company, even if it's "just maintenance", is in the marathon and not the sprint. The initial engineers who contributed to Google Search no doubt contributed value but it's the folks who kept it going strong (and changing for the…

If a company really believes that, they're free to back-load their grants and vesting. The reason they generally don't do this is because "dead equity" isn't a real problem. I'm nearly certain most employee options go unexercised. For one thing, most employees don't vest their full grant before they move on. And those that do often can't afford to buy it anyway.

The one exception might be the handful of employees that joined before the first big round, who might still be able to exercise at a negligible strike price. Again, I don't think it's a real problem in the grand scheme of things.

Re: Stock options are complicated

#110

Post by dlubarov »

prostoalex wrote: post #105
pcmaffey wrote: post #60

Earlier quoted context omitted.

"Dead equity" could also be used in reference to most of a company's investors. That is of course, tongue in cheek. Why should employees have their investment of time and energy taken away from them when investors' one-time cash investment earns preference? Another industry double-standard.

It's not really a double standard. A share of stock and an option to buy such share of stock are two distinct products, priced differently. E.g. MSFT share price today is $64.27, a contract allowing you to buy a share of MSFT on March 17, 2017 for $64 is 83c. Investors buy their shares in full, cash-on-delivery, so to speak. Would investors like to be able to buy call options in the companies at pre-specified valuati…

I don't think you're really justifying why employees and investors ought to have different terms. To the extend that investors need extra compensation, they can always be compensated with additional shares, regardless of those shares' terms.

I think in an ideal world, investors would normally receive common stock (and more of it), but there are some practical reasons why that isn't the case:

- Selling preferred stock lets a company declare a more lofty valuation.

- If a company sold common stock to investors, they'd have to use the more realistic fundraising valuation when pricing options, rather than a (typically) more conservative 409a price.

- Employees tend to not have access to the cap table, or not understand it, so there's not much disadvantage to giving them less favorable terms.

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