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When a Unicorn Startup Stumbles, Its Employees Get Hurt

nytimes.com

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Re: When a Unicorn Startup Stumbles, Its Employees Get Hurt

#11

Post by davidu »

untog wrote: post #4

The fact that some employees have to pay taxes based on the valuations that VCs dream up terrifies me.

Only those who early exercise, or exercise their stock as it vests. They did this to try and optimize for long-term capital gains.

For most employees who leave their option grants as options, there is nothing to worry about.

When you are given a grant of stock options, you can sometimes ask the company to let you exercise it early, and vest the shares instead of the options. If you do this when the fair market value (FMV) of the underlying stock is the same as when the options are granted, you will not be in a precarious tax situation. However, many people wait a couple years before deciding to exercise their options, and as a result, they need to recognize a paper gain when they exercise later as the FMV is substantially higher. That's what happened here. They exercised later, thinking the stock price would go even higher, and they were wrong, but they had to pay taxes on that higher price.

While it's true they paid a lot of extra taxes, since they never recognized the gains, they can roll that tax credit forward to cover future gains they may get at some other point in the future. I'm not sure how long you can roll these losses forward, but I think it's for a substantial period of time.

Re: When a Unicorn Startup Stumbles, Its Employees Get Hurt

#13

Post by tvladeck »

jameshart wrote: post #9
randomname2 wrote: post #3

This article is written as if it's the startup's fault that tax laws are irrational. Doesn't reflect well on the NYT.

The decision to accept a deal which valued the employees' equity so low compared to the VC owned equity is entirely the company's own. I suppose you could argue that the tax system should be aware that common stock valuation should not be inferred from preferred stock valuation...

The valuation of the company and the waterfall of the payment are two separate things. Presumably this was the highest valuation they could have gotten (no reason not to believe it given that it was a distressed sale). And the tax on the common stock the employees received when they exercised their options was based on the valuation of the common stock - so the tax system did correctly handle that.

Re: When a Unicorn Startup Stumbles, Its Employees Get Hurt

#14

Post by Apes »

rwmj wrote: post #8

Can the overpaid tax be claimed back?

Theoretically, but only over a very long period of many years. If it's a big enough overpay, then it's possible for it to take many decades.

edit: Here's a VERY simplified overview: http://www.wikihow.com/Claim-AMT-Credit

Re: When a Unicorn Startup Stumbles, Its Employees Get Hurt

#15

Post by BlewisJS »

tvladeck wrote: post #10

Regarding the fact that the employees had to pay tax on what turned out to be worthless shares: They could have avoided this by waiting to exercise their options on the eve of the liquidity event. In this case there would have been no risk. But they exercised earlier presumably to start the clock on long term capital gains treatment for the stock they received when they exercised. They took risk they didn't need to t…

You can't presume that they exercised early voluntarily. If you leave the company, you typically have 90 days to exercise options or they are forfeited back to the company. In other cases, they actually just expire after enough time passes, which again forces employees to exercise before a liquidity event.

Re: When a Unicorn Startup Stumbles, Its Employees Get Hurt

#16

Post by BlewisJS »

tvladeck wrote: post #13
jameshart wrote: post #9

Earlier quoted context omitted.

The decision to accept a deal which valued the employees' equity so low compared to the VC owned equity is entirely the company's own. I suppose you could argue that the tax system should be aware that common stock valuation should not be inferred from preferred stock valuation...

The valuation of the company and the waterfall of the payment are two separate things. Presumably this was the highest valuation they could have gotten (no reason not to believe it given that it was a distressed sale). And the tax on the common stock the employees received when they exercised their options was based on the valuation of the common stock - so the tax system did correctly handle that.

The article states that 6 months earlier, the board turned down a potential sale valued at double the eventual sale price.

Re: When a Unicorn Startup Stumbles, Its Employees Get Hurt

#17

Post by jameshart »

tvladeck wrote: post #13
jameshart wrote: post #9

Earlier quoted context omitted.

The decision to accept a deal which valued the employees' equity so low compared to the VC owned equity is entirely the company's own. I suppose you could argue that the tax system should be aware that common stock valuation should not be inferred from preferred stock valuation...

The valuation of the company and the waterfall of the payment are two separate things. Presumably this was the highest valuation they could have gotten (no reason not to believe it given that it was a distressed sale). And the tax on the common stock the employees received when they exercised their options was based on the valuation of the common stock - so the tax system did correctly handle that.

They're not separate. The valuation of a thing is dependent on how much money the owners of that thing are willing to accept for it. The common stock holders' interests were poorly represented in the price negotiation. The decision to structure stock ownership in that way is, again, entirely the company's, not the tax system's.

Sure, employees share some responsibility for accepting compensation that includes stock which can be sold on your behalf without your having any say in the price you're willing to take... but companies choose to offer comp packages which include that kind of stock precisely because it's hard for employees to value, and it's easy for employees to overvalue.

Re: When a Unicorn Startup Stumbles, Its Employees Get Hurt

#18

Post by ScottGillis »

sarciszewski wrote: post #5

> Even worse, they had paid taxes on the stock based on the higher value. That's the most annoying part of the entire article, and why I ask for salary rather than equity. Keep your stock, I'd rather pay my bills.

It's all about risk. Unfortunately, this risk did not pay off.

Re: When a Unicorn Startup Stumbles, Its Employees Get Hurt

#19

Post by tvladeck »

BlewisJS wrote: post #15
tvladeck wrote: post #10

Regarding the fact that the employees had to pay tax on what turned out to be worthless shares: They could have avoided this by waiting to exercise their options on the eve of the liquidity event. In this case there would have been no risk. But they exercised earlier presumably to start the clock on long term capital gains treatment for the stock they received when they exercised. They took risk they didn't need to t…

You can't presume that they exercised early voluntarily. If you leave the company, you typically have 90 days to exercise options or they are forfeited back to the company. In other cases, they actually just expire after enough time passes, which again forces employees to exercise before a liquidity event.

Fair point. I did make that assumption.
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