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We need to rethink employee compensation

aaronkharris.com

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Re: We need to rethink employee compensation

#101

Post by harryh »

x0x0 wrote: post #90
harryh wrote: post #71

Earlier quoted context omitted.

That too. Though that is a much more nuanced issue with a lot of arguments on both sides.

not as nuanced as all that as an employee, if you are lucky/skilled enough to end up at a successful startup, and you aren't very careful with tax issues, you can find yourself stuck: if you leave, you have to exercise, and immediately owe hundreds of thousands of dollars (or more!) on a completely illiquid asset that you can't sell. Which doesn't even take into account the potential for that asset to become less val…

That is certainly one point of view.

And if one person leaves it's not likely to materially affect the business as everyone else keeps it going.

Another point of view is that if all the early employees disappear at the 4 year mark (or whenever they feel they've vested "enough") that could cause very serious problems for the business. There is an element of a prisoner's dilemma here and it's not unreasonable to think about ways to keep people from defecting.

As I said, it's complicated.

Re: We need to rethink employee compensation

#102

Post by dsinsky »

One of the big issues here is that once employees start selling common stock, the strike price of the options can no longer be set at a large discount to the latest valuation as it can when the only transactions are the preferred stock shares that are sold when the company raises money from VCs.

One of the most attractive things about employee stock options is that the strike price is often set at 30-40% of the valuation of the latest financing round. So a company that just raised (preferred) money at a $500m valuation can give their employees options with strike prices around $200m or less. Therefore, the employee can believe that they have a "locked-in" gain day one.*

If employees sold their common shares at anywhere near fair value at the same time the company was raising the round, they would likely sell at a price between $400m-$500m a very slight discount to the preferred shares. Any future option grants given would have to have a strike price reflective of these recent common-stock transactions, and companies would no longer be able to use the low strike prices of options to attract employees.

Obviously, this is just one trade-off among many and in no way means that companies shouldn't allow more sales of employee common stock over time, but its worth understanding the many reasons companies currently are resistant to doing so as much as individual employees would like.

*Obviously, common shares should be priced at a discount to preferred shares but almost everyone I've talked to in the VC/startup community believes that the 60-70% discount applied is extremely generous as it implies that up 60-70% of the value the VCs investment is in downside protection (ie the debt-like element) rather than upside potential (ie the equity-like element), a pretty nonsensical amount for a high-risk, asset-light VC investment.

Re: We need to rethink employee compensation

#103

Post by nkurz »

harryh wrote: post #67
windust wrote: post #61

Earlier quoted context omitted.

Can't stress this enough. If you have Employee Incentive Options is way better to exercise them as soon as they are vested than to wait (if thinking of exercising at all). When you exercise them you pay AMT on what they are worth when exercised (of course the "fair price" is a hidden secret left for the CFO). As time passes, the "fair price" is probably going to keep increasing, but with no liquidity and inability to…

Don't wait until they vest. Do it as soon as they're assigned to you. Avoid the AMT completely.

It should be noted that the choice to allow "early exercise" is made by the company granting the options. While it might be a good tax strategy, you do not (to the best of my knowledge) have any guaranteed right to be allowed to exercise your options until they vest:

http://www.startupcompanylawyer.com/2009/01/11/should-a-comp...

Re: We need to rethink employee compensation

#104

Post by djtriptych »

Jemaclus wrote: post #3

In this market, I tend to think of options as incentives, and not as replacements for salary. Salary gets me in the door and work hard, great people and culture make me want to be there and evangelize, and options incentivize me to work my ass off. (I'd work my ass off without options, but the options really make it easy to say "I will do everything in my power to make this succeed" instead of "I'd rather go spend ti…

* Awaits movement of savvy landlords accepting options as payment

Re: We need to rethink employee compensation

#105

Post by damoncali »

x0x0 wrote: post #90
harryh wrote: post #71

Earlier quoted context omitted.

That too. Though that is a much more nuanced issue with a lot of arguments on both sides.

not as nuanced as all that as an employee, if you are lucky/skilled enough to end up at a successful startup, and you aren't very careful with tax issues, you can find yourself stuck: if you leave, you have to exercise, and immediately owe hundreds of thousands of dollars (or more!) on a completely illiquid asset that you can't sell. Which doesn't even take into account the potential for that asset to become less val…

That's a different issue - that many options agreements require exercising within 30 days of leaving (or so). There's no reason it has to be done that way. There are very good reasons that restricted stock is, well, restricted.

Re: We need to rethink employee compensation

#106

Post by 001sky »

fredkbloggs wrote: post #50
paulpauper wrote: post #31

I don't mean to sound too dismissive, but this article is bunkum. SO I guess by the author's logic, Michael Bloomberg's net worth is zero because Bloomberg LP never went public? The private market is illiquid, but fundamentals will always trump liquidity. If you own equity, that equity - assuming there is no dilution or deterioration in the fundamentals of the underlying business - is wealth. Employee stock options a…

Mr. Bloomberg's privately held equity undoubtedly makes distributions to its shareholders. Stock that does not pay dividends and is unlikely ever to do so is not wealth; it's just a piece of paper. And if you cannot legally sell it to someone else, it's effectively worthless as there is no way to convert it into something of value. The exception is if you have a majority of the voting rights, but that's not what this…

There are many liquidity events that are not in the set of 'IPO' events. But the issue remains that liquidity is a core element of asset value. Many later stage financing events can be structured to provide limited liquidity to founders and early investors; the issue is that this may not help all employees equally. The IPO is useful in this case.

Re: We need to rethink employee compensation

#107

Post by leopoldo »

How crazy would it be to say something along the lines of: "OK, I'll accept your offer but I want to be paid for overtime, and have [some] freedom to work in personal projects/consulting (as long as they don't expose 'trade' secrets from the company)"

It's like saying, I'll take your low pay + stocks but you will also be risking that I start making more money on my own and leave.

Re: We need to rethink employee compensation

#108

Post by tptacek »

branchless wrote: post #64
drivingmenuts wrote: post #5

Earlier quoted context omitted.

I tend to think of options as worthless, until they vest. Which is too far in the future to count on. Pay me money. That's actually useful.

> I tend to think of options as worthless That's why they are trying to pay you with them. For them it's a one-way bet. It's sadly just another case of pushing risk onto the worker and not really passing on much of the upside.

In my experience it's the opposite: the fact that employees generally either (a) regard options as worthless or (b) round allocations down to the nearest 100 basis points is a reason not to use them in compensation: the implied discount employees give them makes equity comp very expensive.

In fact: for this reason, I'd be especially wary of companies trying to buy a few thousand dollars of annual fully loaded cost with large amounts of equity --- it suggests extreme naivete.

Re: We need to rethink employee compensation

#109

Post by danielweber »

I was at a startup company where an employee wanted to sell his stock and had a buyer, and the company said "no, if you want to do your own sale, you will need to hire an auditor in your own dime to determine the value, and we won't let your auditor see the books."

And this company was above average in not pulling dirty tricks.

Re: We need to rethink employee compensation

#110

Post by serge2k »

JoeAltmaier wrote: post #24
toephu2 wrote: post #19

Earlier quoted context omitted.

Even if options vest, they could still be viewed as worthless. E.g., Pre-ipo company, 4 years pass, all your shares vest, however Company might tank in the next 5 years, goes bankrupt, never gets bought out nor goes IPO, your vested shares are worthless.

OR even succeeds, get bought out for 40 million dollars, which all goes to pay investors' convertible debt. Net result: stock worthless.

Or you take a discounted salary in exchange for stock, and after all is done you earn barely more than if you had just went somewhere else for full salary (if you are lucky you get that much).
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