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How Startup Options and Ownership Work

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Re: How Startup Options and Ownership Work

#71

Post by crzwdjk »

patio11 wrote: post #35
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

If you don't know (minimally) the fully diluted count of shares in the company, your option grant is as specific is saying that your salary will be denominated in dollars and you'll be given more detail about it sometime after joining the company, pinky-swear. A company which won't provide enough information to value an option grant contemporaneous with the written offer is being either abusive or stupid. There exist…

Sounds like I was right to pass on the company that promised me "4000 options" and insisted that any details beyond that were strictly confidential and could under no circumstances be disclosed to any non-employees. It seemed especially suspicious in conjunction with the rest of their attempts at hard-sell tactics that just left a bad taste in my mouth.

Re: How Startup Options and Ownership Work

#72

Post by rrdharan »

prostoalex wrote: post #65
zaroth wrote: post #34

Earlier quoted context omitted.

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%.

That's correct.

However, I still much prefer RSUs over options in the case where you're joining a large/later stage company. Say you go to a Slack or Uber today. They won't (I believe they legally can't?) issue you options below their FMV (fair market value). They will give you some arbitrary/negotiable number of RSUs and options however. Then consider the following scenarios:

(1) The company then IPOs or is acquired several years from now, at double the current valuation. In this scenario, assuming you 83(b)'d and early exercised, you get the favorable tax treatment on the gains for the ISOs. But you're still out the exercise price outlay. The RSUs meanwhile are worth what they're worth, and you are taxed on them at the higher rate and that's that.

(2) The IPO or change of control happens too soon (less than 2 years from date of grant or 1 year from date of 83(b)/exercise). Your fancy options spread is still just ordinary income with no advantage over the RSUs.

(2) The company IPOs or is acquired next year, for the same FMV. Your options are worthless, your RSUs are still worth a goodly amount hopefully.

(3) The company IPOs at half the FMV of when you joined. Your options are worthless, your RSUs are worth something.

(4) The company fails/does a down round/whatever. You are probably wiped out regardless.

The only scenario in which the options are more interesting is as noted, very early stage companies where the exercise price is really small, or insane rocketships with an active secondary market providing real liquidity. Or, I guess when the company itself is holding liquidity events regularly (and even then it's only interesting if the FMV continues to grow up rapidly).

Re: How Startup Options and Ownership Work

#73

Post by rrdharan »

zaroth wrote: post #59
scurvy wrote: post #44

Earlier quoted context omitted.

If that's the case, do you require employees to pay for their shares at grant date? Otherwise it's a taxable event (not cap gains but real income) when they vest. Or do you "sell" a portion of the shares back to the company to pay taxes for the employee, then the employee gets 45-50% the number of shares that are vested. This is what Microsoft did when I was there, but they were publicly traded and had a public marke…

If it's restricted stock, either the grant is taxable income, or the stock is paid for at the time of the grant (write a check to the company). Vesting is then defined a reducing percentage of shares the company can buy back over time, and so if the employee leaves or vesting terminates for some reason, the company writes a check to cover the refund. This all works best in the early days when the 409a valuation is ze…

> The solution I would like to see? Illiquid shares in a private startup less than 5 years old and with assets less than $100mm should be valued at a discount to liquidation value, or ideally transferable with no taxable event whatsoever.

I'm curious/confused about how/why RSUs don't satisfy what you want to see here? Is it just because they aren't actually transferrable or sellable given that the company is private?

Re: How Startup Options and Ownership Work

#74

Post by chrdlu »

zaroth wrote: post #60
xenadu02 wrote: post #58

Earlier quoted context omitted.

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.

The only downside of early exercise I can see for the company is accounting for the cash and being ready to buy-back unvested shares as-needed. Since the tax implications are potentially massive for the employee, and we're talking de-minimis work for the employer, early exercise should be a standard term on all ISO contracts. I see this as an educational opportunity for Founders, and if you see a contract without ear…

Early exercise is great for the majority of situations. The 100k limit for ISO options can be a potential downside. If there is a spread between the strike price and the FMV, only the first 100k worth of shares will be considered ISOs and the rest will be treated as NSOs. In the case of no early exercise, you could get 100k of ISOs per year for the 4 years.

Re: How Startup Options and Ownership Work

#75

Post by linkregister »

sulam wrote: post #29
theflork wrote: post #19

Earlier quoted context omitted.

Are there any companies you know that use RSU's or stock grants instead of options? I've been interviewing at some startups and they only seem to offer options with their byzantine rules. Can people negotiate offers from options to RSUs/grants?

RSUs are typical at a certain size -- generally around 500 employees I think these days. There's a forcing function called the Exchange Act, section 12(g) of which says there's a cap on the number of shareholders you can have without reporting financials effectively as if you're a public company. That number was increased from 500 shareholders to 2000 in 2012. The reason for the lower number where RSUs start to be co…

Thanks for this. This is a good analysis of how RSUs are advantageous to both employees and employers.

Re: How Startup Options and Ownership Work

#76

Post by limeyx »

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.

Sadly yes I think that is right

Re: How Startup Options and Ownership Work

#77

Post by nshelly »

> If [an ex-employee] knows (as a result of having been at the company) that the prospects of the business are looking grim or a product launch is significantly delayed, that’s important information a buyer would deserve to know in evaluating whether to buy the stock, and failure to disclose that information creates real legal jeopardy for the seller. This risk exists in a 90-day exercise program as well, but it becomes a lot more acute when you move to 10-year exercise periods.

It seems to me there would be a lower risk under the 10-year exercise window scenario. Under the 90-day window, the ex-employee would be forced to exercise or lose all of their equity and thus liable for a large AMT bill. To mitigate this, that ex-employee, with recent inside knowledge of the company's operations, would look to the secondary market to unload some of those shares and ease the tax burden unless their are strict transfer restrictions in place, increasing the divide between cash-rich and cash-poor employees.

Under a 10-year exercise plan, the ex-employee would be less likely to exercise (better to wait until the company's outcome is more certain) and wouldn't need the cash to buy the shares and cover those AMT taxes.

> ISOs have better tax treatment for employees because the employee does not have to pay taxes at the time of exercise on the difference between the exercise price of the option and the fair market value of the stock

This doesn't seem to count AMT taxes which is the big elephant in the room. In California and most high tax states, employees will have to pay AMT taxes on the difference.

Re: How Startup Options and Ownership Work

#78

Post by HippoViolation »

halifaxbeard wrote: post #14

I remember asking for a cap table at a startup and in not so few words, was told to fuck off. At that point I realized it didn't matter how many options I had, I was going to get screwed should there be an exit, and made my own.

At the last 4 startups I joined, when I asked about number of shares, valuation, etc after getting my options agreement, the owners treated the info like the nuclear launch codes, or that I was asking something deeply personal and I should feel bad about thinking about asking.

Note: I am poor.

Re: How Startup Options and Ownership Work

#79

Post by limeyx »

hkmurakami wrote: post #66

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 p…

I find getting screwed by the taxman a few times while the VPs and investors make out like bandits motivates the research process too ...

Re: How Startup Options and Ownership Work

#80

Post by hkmurakami »

limeyx wrote: post #79
hkmurakami wrote: post #66

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 p…

I find getting screwed by the taxman a few times while the VPs and investors make out like bandits motivates the research process too ...

I'd like to think that we can figure out a way to not have the first timers get screwed either.
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