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Don’t Tax Options and RSUs Upon Vesting

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Re: Don’t Tax Options and RSUs Upon Vesting

#371

Post by nhumrich »

austenallred wrote: post #18

The importance of this change can’t be understated; this effectively kills compensation at startups in the form of equity, and would make startups completely unable to compete with incumbents. Anyone that has options at a company that grows quickly would be paying tens or hundreds of thousands in taxes to keep their equity, which is still effectively a very risky bet that a company will end up huge. No one would want…

> Anyone that has options at a company that grows quickly would be paying tens or hundreds of thousands in taxes to keep their equity, which is still effectively a very risky bet that a company will end up huge.

No. Most companies give their employees ISOs, which arent affected by this bill. So it would actually be 0 change to the employees. What this affects is the investors or potentially the founders of a startup

Re: Don’t Tax Options and RSUs Upon Vesting

#372

Post by oneshot908 »

corford wrote: post #363
corford wrote: post #178

Earlier quoted context omitted.

On the other hand, even $1M/year doesn't look good compared to what you would have made via options/RSUs if you were employee < 10 at Facebook/Google/Amazon...

Getting a few downvotes for this comment but my point is I think it's too simplistic to frame it as options are junk, it's a rigged lotto for naive young guns yada yada. Sure, the stats aren't great but if you're young, talented, looking for a thrill and aware how the game is stacked, I don't think options/RSUs are bad 100% of the time. Personally, I'd like that road to always exist and make the choice myself rather…

It's not that options are worthless, they're great in fact. It's that the C-suite and the investors usually divvy up the pie amongst themselves and give the rank and file the crumbs that stuck to the pie pan. But let's do the math. The average startup exit is ~$243M, let's call it $250M for say 4 years of work.

https://www.inc.com/issie-lapowsky/average-successful-startu...

Let's say you get paid $150K salary for those 4 years of work at the startup vs $300K at BigCo. To break even, you need to close a $600K deficit, that means you need at least 0.25% just to break even with a guaranteed ROI.

Now let's say you're experienced and you're getting $500K at BigCo, now you need ~0.6% just to break even.

Finally, now you're a domain expert and you're getting $1M at BigCo, now you need ~1.4% just to break even.

In my case, I would need at least 2x the listed equity in each of these scenarios to choose the startup over BigCo. I have never been offered numbers like that. I have had CEOs and CTOs get indignant with me over my math though. Math is hard I guess.

However, if you crave autonomy and freedom, I think the message is clear here: be the C-suite at your own startup, even if you have to bootstrap from a place with a lower cost of living. Lifestyle income is a lot easier than building a $250M+ company IMO.

Re: Don’t Tax Options and RSUs Upon Vesting

#373

Post by chimeracoder »

andreasklinger wrote: post #369
chimeracoder wrote: post #365

Earlier quoted context omitted.

> Yes, but that’s $100k worth of vesting per year based on the value at grant date. Very few situations exceed that in illiquid companies. That's... not rare at all. For a company with a $5 million valuation, you only have to be offered 2% of the company in order to hit that cap. An early employee could easily hit that. And of course, as the company grows, it becomes easier and easier to hit that cap, because it's ba…

So essentially you have a linear limit to the one part that is promised to be potentially exponential?

> So essentially you have a linear limit to the one part that is promised to be potentially exponential?

It's not a linear limit - it's a fixed (constant) cap, but yes.

This doesn't mean you can't receive more than $100,000 in options, but it does mean you'll be taxed on those as NSOs, which is much higher.

Also, note that because of the cliff, you receive your full first year on a single day, which means that your second year's worth of options are much more likely to exceed the ISO cap and auto-convert to NSOs.

Re: Don’t Tax Options and RSUs Upon Vesting

#374

Post by sulam »

chimeracoder wrote: post #365
djrogers wrote: post #245

Earlier quoted context omitted.

Yes, but that’s $100k worth of vesting per year based on the value at grant date . Very few situations exceed that in illiquid companies. [1] http://www.naspp.com/blog/2009/08/iso-100000-limitation.html

> Yes, but that’s $100k worth of vesting per year based on the value at grant date. Very few situations exceed that in illiquid companies. That's... not rare at all. For a company with a $5 million valuation, you only have to be offered 2% of the company in order to hit that cap. An early employee could easily hit that. And of course, as the company grows, it becomes easier and easier to hit that cap, because it's ba…

My experience has been that it’s much easier to hit it later vs earlier. It’s very rare to be offered more than 1% of a company that is already worth $5M. The people who get offers like this are, it turns out, the ones complaining about this tax law most loudly. They are not run of the mill employees.

Later, when a company is close to going public, normal packages will often have less growth in valuation assumed and so it becomes easier to hit the cap as a regular employee. That is not coincidentally the same time companies switch to RSUs.

(Someone made the point elsewhere in this discussion that inflation will render the cap more of an issue as time goes on. They have a real point, I think. Combined with inflated A rounds this may start to be more common than it has been in the last 20 years.)

Re: Don’t Tax Options and RSUs Upon Vesting

#375

Post by sulam »

andreasklinger wrote: post #369
chimeracoder wrote: post #365

Earlier quoted context omitted.

> Yes, but that’s $100k worth of vesting per year based on the value at grant date. Very few situations exceed that in illiquid companies. That's... not rare at all. For a company with a $5 million valuation, you only have to be offered 2% of the company in order to hit that cap. An early employee could easily hit that. And of course, as the company grows, it becomes easier and easier to hit that cap, because it's ba…

So essentially you have a linear limit to the one part that is promised to be potentially exponential?

Just keep in mind it’s the value when you join that matters, not how that value grows over time. If you’re not over the cap in your initial grant, you won’t be surprised later (the one exception being refresh grants — which are rare in early stage companies).

Re: Don’t Tax Options and RSUs Upon Vesting

#376

Post by chimeracoder »

sulam wrote: post #374
chimeracoder wrote: post #365

Earlier quoted context omitted.

> Yes, but that’s $100k worth of vesting per year based on the value at grant date. Very few situations exceed that in illiquid companies. That's... not rare at all. For a company with a $5 million valuation, you only have to be offered 2% of the company in order to hit that cap. An early employee could easily hit that. And of course, as the company grows, it becomes easier and easier to hit that cap, because it's ba…

My experience has been that it’s much easier to hit it later vs earlier. It’s very rare to be offered more than 1% of a company that is already worth $5M. The people who get offers like this are, it turns out, the ones complaining about this tax law most loudly. They are not run of the mill employees. Later, when a company is close to going public, normal packages will often have less growth in valuation assumed and…

> My experience has been that it’s much easier to hit it later vs earlier.

Yes, I said in my original comment that it becomes easier to hit the cap as the company grows. However:

> It’s very rare to be offered more than 1% of a company that is already worth $5M. The people who get offers like this are, it turns out, the ones complaining about this tax law most loudly. They are not run of the mill employees.

This is not true. It's not really that rare for a first hire to get 1% or more[0], and it's also not that rare to have a company that makes that first hire after raising enough money to be valued at $5M. I say this as someone who has been both a founder and an early-stage investor.

But more broadly: most of the people who are complaining about this cap (and complaining the loudest) aren't the early employees. They're the ones who joined later - late enough that they're likely "only" to double or triple the value of their equity by the time an IPO happens (unlike early employees), but still early enough that there's no IPO or acquisition on the horizon[1].

[0] http://avc.com/2010/11/employee-equity-how-much/

[1] Which, given the increasing tendency of large startups to delay IPOs "indefinitely", basically means "any employee of a privately-held company".

Re: Don’t Tax Options and RSUs Upon Vesting

#377

Post by closeparen »

sulam wrote: post #229
hatred wrote: post #218

Earlier quoted context omitted.

Its not that trivial. ISO's have a $100k limit.

Yeah, there's a couple reasons for RSUs to exist and the cap is a big one (the other is shareholder limits). However, the issue is vesting, not the RSU itself. You can delay RSU vesting to happen at a liquidity event and the problems go away. That leads to a bad situation where employees are stuck holding their "earned but not vested" RSUs and can't quit (similar to what already happens to people who can't afford to…

This has been the strategy, but the bill is invalidating it:

>“Similarly, awards with vesting triggers based on exit events such as an initial public offering or change-in-control would be taxable on grant unless they require the recipient to be employed through the liquidity date.“

From Fenwick’s analysis.

Re: Don’t Tax Options and RSUs Upon Vesting

#378

Post by closeparen »

ibejoeb wrote: post #227
ransom1538 wrote: post #69

"The current draft of the Senate Tax Reform Bill would tax stock options and RSUs upon vesting." Ok. I wouldn't panic here. Calm down. How shares are vested is up to the board. So, if this were to pass I would just walk into the CEO's office with a few employees and ask to change how shares vest to: "Upon the vesting schedule AND a written letter from the employee requesting vesting. If the letter isn't submitted the…

It really isn't "made up." Issuing equity compensation triggers all sorts of activity. The notion of vesting is that the individual will come to own shares after the conditions are met sufficient to lift the restrictions. The restrictions often include time in service to company ("after 1 year of service, you will earn 100 shares"), performance toward some specific goal ("prototype passed QA by Q3"), and financial pe…

If the company can’t take them away from you but you’re contractually obligated not to sell for 18+ months, they aren’t really yours.

Re: Don’t Tax Options and RSUs Upon Vesting

#379

Post by Bartweiss »

hkmurakami wrote: post #301
econner wrote: post #297

Earlier quoted context omitted.

The problem though is that if you have ISOs they usually have to be exercised within 90 days of departure from a company. Some companies are extending that deadline to 7 years, but the IRS disqualifies ISOs 90 days after departure so they have to convert to NSOs. So this would prevent companies from providing an option extension.

I thought about this, and if the taxation trigger is "tax upon vesting", and the vesting is done when the options are ISOs, I would think that it is possible that this legislation is worded in a way so that an ISO -> NQO conversion does not trigger a tax event.

Is it clear what tax impact the conversion has? Arguably that's the moment when you "vest NSO options", but then the entire tax blow would drop upon leaving the company, which would be particularly bizarre.

(Is the proposed law even clear about how this would work?)

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