YC has historically had a big influence on improving financing terms for founders and reducing founder-hostile behavior by investors, by creating competition among investors for YC companies. Should YC maybe consider developing and enforcing a code of conduct addressing these issues, that might similarly improve the situation for start-up employees?
They could maintain a public list of YC companies that abide by the code of conduct in order to encourage good behavior, and to help communicate to potential employees that they would get a “fair” option deal (as early investors, they would clearly have access to the terms of any financing deal).
[EDIT: they could also maybe publish a list of investors who have committed to following the guidelines, and consider excluding VC firms from YC events if they won’t commit to those standards]
Depending on how serious YC was about making a difference here, going against the code of conduct might even be grounds for exclusion from the YC community? My understanding is that YC has always focused on what’s best for the founders, even when they were the outsiders in silicon valley and at their own financial expense. Maybe now that YC is such an important player in the silicon valley ecosystem, they could use that power to maintain the health of that ecosystem in a way that few others could?
Yes, we care a lot about making employee equity more generous and more fair. Part of our YC curriculum now is teaching founders about these issues and encouraging them to follow best practices around being generous and transparent with employees about equity compensation like Sam discussed in his blog post.
I think there is still a lot more we can do, though.
I think part of the problem is that founders/employers/employees don't have a common term set that's known to be a fair deal to all parties. It would only take the addition of a few simple protections to make the equity a fair deal, even without divulging information about the cap table. I'm sure other sets of protections could be devised which provide different tradeoffs. After all, there is no reason that employees couldn't have a dedicated board seat!
- The employee equity participates at the highest prefered equity pool.
- The employee option strike price will always mirror the lowest 409A valuation while the option is open.
- Vested employee options are valid for 100 years while illiquid, and 7 years post liquidity event.
- Modifications to employee equity pools resulting in a decrease in option value as the result of a funding round must be accompanied by a tender offer of 70% of the pre-funding option value.
The above terms wouldn't provide much value if employees didn't understand that the companies equity is better than a competing employers equity.
I'm facing a headache with some options I was granted for a startup back in 2013 for being an advisor. I didn't exercise the options at the time (hindsight is 20-20).
The startup is doing well - it recently raised ~$300m at a ~$3b valuation, but my options expire in Dec 2023 and I'm growing increasingly concerned that they won't have a liquidity event before then.
If I exercise my options before then it will be taxed as income which could leave me owing >$100k in taxes to the IRS - but if the company hasn't yet had a liquidity event then I can't sell the options to pay that.
Seems like a ridiculous situation for early employees/advisors to be placed in.
You can get non-recourse financing to cover exercise costs and taxes. I.e. you can offload the risk of early exercise for a share of the potential upside.
Source: I work at Secfi (https://secfi.com) and our equity and tax advisors are amazing.
This is a common enough situation that there are companies that will loan you the money to help pay for options and deal with tax liability, using the shares as collateral. I haven’t used one myself and am not a lawyer or financial advisor. One for instance:
One strategy is to exercise as many options as you can until you would hit AMT (or an amount above AMT you are ok paying). You can do this each year until your expiration date comes up.
Not quite true - ISOs can incur AMT at time of exercise, which is kind of complicated and doesn't always create a tax burden. In the $100k range, it probably will, but they'd have to do the calculation to find out.
He’s being hit by the AMT due to the value of the options. If you’re hit by the AMT, you’ll owe taxes on the spread between the strike and FMV on exercise, even though you haven’t sold them.
If you have a Roth retirement account (e.g. IRA, 401k), I believe you can exercise what you can cover from those funds and not have to worry about the gains there.
I was lucky enough to cash out of a startup after 7 years and 3 or 4 rounds of funding (I had left by the time I got the payout) as a share buyback for one of the VC investors.
I was diluted from 3.2% to about 1.3% but the value of the company had clearly risen so _at that point_ it was unimportant.
However in my opinion the company's burn rate and lack of growth clearly meant a later exit (likely an acqui-hire IMO) would have seen dilution without an equivalent growth in value, not to mention the ever-increasing VC non-dilution shares accelerating that.
I got majorly screwed on tax because the startup made no efforts to be efficient and were very chaotic in their arrangements for payout so that is definitely another important factor.
Overall by winning the startup share lottery I made roughly $500k for 5 or so years working there and that was as employee #1 so the maths given the pay cut probably don't work out too well (perhaps break even if I'd played the career game well).
However of course I am hugely grateful it happened and I got to see a startup grow from 3 people to more than 10x that and learnt a lot, as well as changing my coding career direction substantially.
I wouldn't recommend joining a startup as a non-founder other than for changing career or starting out. The trade-offs don't really make sense in most cases and you get a lot less say than you think you might (founders understandably want to control what is their baby) - never do it for the money.
I just started working somewhere that does a different equity scheme called “profit interest.” The gist is, they issue you equity whose worth is based on growth in valuation from when you joined. So if you’re granted 1% shares and the company grows from 100m to 200m on liquidity, you’re entitled to 1m. It avoids you having to front money for stock options, and it also avoids the tax burden b/c when issued, the shares are worth zero dollars
It is pretty remarkable if it prevents dilution. Are you sure there's no weasel-wording in your contract that allows arbitrary changes in the future, has funky exercise restrictions, etc.? Their special tax structure makes me suspicious as well (if this is the US). Sadly I think VCs saw all the mini-millionaires being created at FAANGs in the last decade and have pressured many companies into watering down stock compensation, since it's "lost money."
Yes, I was suspicious, too. They offset my suspicions by 1. paying me a generous salary, and 2. giving me time to talk to an accountant about it. The accountant had never heard of it, but looked into it and it was legit. The reason that it's unfamiliar is because it's so danged advantageous to the employees.
There is some room for them to dilute the shares out of existence. Notably I don't have to exercise them, I already "own" them. The vesting schedule is really more of a forfeiture schedule. If I leave after a year, I forfeit 3/4s of them. Otherwise, they're mine into perpetuity, until liquidation.
> So if you’re granted 1% shares and the company grows from 100m to 200m on liquidity, you’re entitled to 1m. It avoids you having to front money for stock options, and it also avoids the tax burden b/c when issued, the shares are worth zero dollars
The 1% options would be one percent of shareholdings at the time the option was offered.
With more shares created/sold later, the dilution means when the options mature, they will be less than 1% of the total company shareholding, or value.
Private company valuations are invented out of whole cloth by the board for lots of reasons, almost none of which are an accurate reflection of the actual growth of the company. Same for profit sharing - profit is an entirely invented number. It doesn't really solve the problem of options being too easy to fiddle and too hard to cash in.
I get the tax advantages of this, though. But I expect if it became common the taxman would want their cut of the nominal growth in value each year, or something. Bastards.
I believe that the tax treatment of your hypothetical Million dollars is different than the treatment of an equivalent Million dollars earned through stock options.
I am not an accountant, so please correct me if I'm wrong.
So when do you get this equity? Is it only at a liquidity event?
Because normally you pay taxes when you get something of value, equity in this case but you can't always sell said equity due to your company being private.
I'm assuming your company is private as a public company doesn't have these issues, they just give you stock, you sell stock, everyone is happy.
Or put another way, how does this setup not give you a tax bill each year, assuming you get your equity each year, that you have to pay with your own cash?
So I'm fairly ignorant about these things, but I'll give it a go.
My company is an LLC. In a sense, I have this equity. This is how the value is defined:
Value = Percent_Of_Shares *(Current_Price_Of_Company - Price_of_Company_At_Time_Of_Issuance)
Note that, on the day these issued to me, the value here is equal to zero, because the current price of company is equal to the price of company at time they are issued. Thus, I have received something which has no value, and thus have no tax burden. Technically I'm now a partner in the LLC.
This has tax implications: when the company is making money, I owe tax money on that. However, they're in growth mode, and losing money, which means I get to carry a tax writeoff. Further, it's written into the company's bylaws that if they make money, they're obligated to give employees a distribution equal to the tax burden that the employee will incur, i.e. when there is a tax burden outside of a liquidation event, they are obligated to give me enough money to cover it. Also, if they sell the company, my shares are vested immediately. I don't know what happens to them covering the taxes if I leave; maybe I become liable for it, and there's a downside there.
The shares are non transferrable, which is lame but apparently quite standard.
There's one thing that some of these articles claim that isn't quite right. Because this arrangement technically makes employees in a partnership, per the IRS this means they have to pay their own side of social security and isn't entitled to e.g. health insurance. It turns out the department of labor has issued conflicting guidance: if I am, for all intents and purposes, employed by a company, then I am to be paid as a W2 employee and am entitled to benefits. My company has chosen to follow the department of labor's guidance.
Yah, I think this is fairly common in the LLC world. You don’t want to get equity in LLc, equity = tax burden. You own 1% equity in a LLC and profit 100 million dollars? Congratulations, you now owe the tax on 1 million in income, even if you saw none of the income and have no way to sell your shares.
What makes options a rough deal is the part of the contract: "We can change anything at anytime for any reason". What kills your options is dilution. You have no control over this AND as time progresses you get more and more diluted with new hires and rounds. You could be the second employee - however, if the founders & VC decide to make 20 million more shares [which they will] - you effectively have toilet paper -- AND you wont be in that meeting.
This isn't new, either - this happened to me a couple times in the late 90's/early 2000's and I've since made a point of not even taking "stock options" into consideration when evaluating job offers. Yet my most downvoted comment on reddit ever was on /r/cscareerquestions when somebody was asking how to weigh stock options when considering job options and I said "not at all" and shared my own experiences.
>Yet my most downvoted comment on reddit ever was on /r/cscareerquestions when somebody was asking how to weigh stock options when considering job options and I said "not at all" and shared my own experiences.
I'm pretty sure I had the exact same experience. I've been a part of three startups. One took nothing more than seed money and has been chugging along for over 15 years. It's a lifestyle business for the owner, so it also hasn't grown at all in over 10 years. The other two startups were both acquired. I was even a VP at one with over 1% equity in the company. Net value of my options was $0 after investors, credit holders, and founders got paid.
Yes, some folks are going to make millions from IPOs, but the opportunity cost is far too high (IMHO). As a VP at the startup, my total compensation with 15 years of experience wasn't a whole lot more (and less, in many cases) than what a new college grad makes nowadays.
Now that I've got a family, college to pay for at some point in the near future, and a retirement to fund, I'll gladly take the sure thing vs. the gamble. I've bid goodbye to startups and have quadrupled my income in doing so.
That's been my experience with the startup/entrepreneur subreddits too - no-one wants to hear anything that contradicts the Startup Dream. I figure there are very few people actually walking the walk in there.
I’ve been surprised by the degree to which people who pride themselves on being analytical badly want to believe that options will make them rich. They’ll talk about the few cases where the finance guys didn’t capture most of the wealth and ignore all of the people who eventually netted a few months salary or less (I’m reminded of the people from meetings with pets.com who were visibly just keeping a chair warm until the IPO made them rich, and ended up calling to ask if we were hiring later that year when the layoffs started).
It’s a cliched observation but it really does remind me of the kids hoping to make it big in pro sports – there are way more who peak at the minor league level at best but the owners make a ton of money by encouraging everyone to think of the exceptions as the rule. Humans are prone to misjudging statistics in general and that’s really bad when one party has the best data and a strong incentive for other people to misjudge it.
That’s strange. My experience with /r/cscareerquestions and other online forums has been excessive cynicism about everything, especially stock options.
The catch is usually when people are asking about RSUs of public companies or other relatively liquid and predictable compensation, in which case equity comp should definitely not be valued at $0.
Reddit tends to be younger people without much life experience. When you're 20 years old and a startup offers you all this equity it does sound really good, but when you're 38 and you realize that equity isn't worth the paper it's printed on, you'd rather get more cash comp
It's a very interesting trend - opinions that got me down-voted into oblivion on HN in 2015 are now super popular. The biggest part of the change seemed to happen when Trump got elected. Anecdotally, it seems like that was the moment when this community lost it's innocence, stopped trusting authority, questioned it's own narratives, and in a sense grew up.
In private companies, always remember: (1) control ≠ equity
(2) equity ≠ profit (3) equity ≠ information.
If this is new to you read Brad Feld's Venture Deals book and do the online course, it's time well invested.
Note this is simply the nature of private equity. Companies go public to drink at the capitalisation trough of public markets, but the cost is regulation and increased transparency. Companies that stay private are rarely bound by significant rules in terms of board or management decisions redefining structure, equity, terms and so forth. There are at least four key firewalls (exercise, issue, share class, transfer) between "options" as issued or promised and meaningful equity value extraction for an employee. Good lawyers can probably name five more, and definitely dream up or deploy tens more at any time without breaking laws.
I learned this in my first board position with VC's on the board (early 2000's). Thankfully I was vital to the company's platform, so had some leverage. But everything was fluid, and able to be changed according to how the VC's needed to present it in terms of a consistently successful investment story.
In the end, I walked away with less than I hoped but more than I think I deserved (for being so naive). But it's been an abject lesson since: nothing in a private company is fixed, it can all be changed according to who pulls the strings. Options and equity are very vulnerable to this. Having equity is no guarantee of power or even a seat at the table (or of future wealth).
> What kills your options is dilution. You have no control over this AND as time progresses you get more and more diluted with new hires and rounds.
People are way too obsessed with dilution because it sounds so scary. "With the stroke of a pen they can create a billion more shares and your percentage goes from 5% to 0.01%"
The reality is that all common shareholders have the same incentive to not dilute the outstanding shares. That almost always includes the founders. Outside of a money raise most of the people involved in the company are aligned in the desire to not dilute each other.
The major source of dilution is new fundraising and while it will effect your percentage of ownership it typically doesn't affect the value of your stake because the dilution is part of post-money valuation. So you might own 1% of a $10m company before the dilution and 0.5% of a $20m company after the dilution but the value of your holding didn't change.
The things people should be worried about are all the shenanigans that happen around participating preferred multiples. Or, the worst, 30-day exercise windows along with the tax treatment of options exercise/AMT. But since those are much more opaque concepts it's way harder to get people riled up about it.
And if you have an unscrupulous CEO there's basically nothing you can do to protect yourself as a worker. But that's way different from the normal dilution you get as part of raising money.
> So you might own 1% of a $10m company before the dilution and 0.5% of a $20m company after the dilution but the value of your holding didn't change.
If that is indeed true, then there's almost no reason not to demand being paid in real cash money rather than stock options. If the company doubles in value and I have the same amount of money, then what's the point of getting options instead of USD?
This like saying, "don't worry, your lotto ticket won't be devalued: We'll make sure that even if those numbers win the jackpot, you'll still get the same $2 and it won't be diluted below that."
Founders usually own a different class of stock though - enough to have a controlling share of the vote no matter how much they’re diluted. This control that they hold ensures they will get paid extra during acquisitions (or sometimes even during fundraising rounds), proportional to the value of the company rather than their share of the stock.
what (if anything) stop the founders from just giving themselves more shares?
they only have the same incentive to not dilute if they are getting the same penalty for diluting, right?
I am not an expert in any of this but it seems they could just agree to issue a ton of shares to all the investors / founders but not to employees in a way where everyone except the employees benefit.
“So you might own 1% of a $10m company before the dilution and 0.5% of a $20m company after the dilution but the value of your holding didn't change.”
Nope. If you are topped up (which means you still have political standing) then you start a new vesting schedule. So all those shares you worked for and vested — you can work for again!! Yay! Until another 4 years you are diluted. Yay! But likely there will be another round while you wait to vest the shares you already had!! Hahahaha!
I bought $1000 of shares at a company when I left. $0.75. Their valuation at the time was like $18.
In retrospect I'm pretty sure all I did was buy myself a tax burden when they fold or pocket change when they exit.
The mistake I made was not realizing the parent comment: that I lack the information to make an informed decision or to be sure they don't just dilute to oblivion. The numbers I did have access to (above) communicated a very misleading story to me.
There was on place I left where the company was doing OK, but there were a lot of red flags on exercising options, so I let them expire. Someone asked why I didn't just exercise some for fun. I didn't want to have to do the taxes. Not pay the taxes, I mean fill out the forms.
That would be true weather you had shares or options... dilution may be worth it, if valuation grows. It’s only bad if there is a down round. But then it’s a black eye for founders and earlier vc also.
I think you need to consider your framing. "It's only bad if there is a down round" - actually, it's good only if they go from giving you options to cashing out without a single bump in the road. The likelihood of all those bad things happening - down rounds, bad exit, no exit, folding completely, etc. those are the most likely thing to happen. And if you're in the company earlier they're way more likely than anything else.
Increasingly, negotiating a job offer at a startup feels like buying a used car. There’s an obvious information asymmetry, and it’s hard to escape the feeling that you’re getting screwed.
The elephant in the room are transfer restrictions. VCs demand their preferred stock trade in the secondary market. At the same time, common stock is locked down. If the common stock is sellable before the company exits, the risk-reward calculus for company equity shifts in employees’ favor.
How does something like this mesh with selling common stock but the company having right of first refusal?
Say I want to sell common stock that I own, to someone who meets the SEC accredited investor definition. It seems that right of first refusal means that the company could buy the stock instead, but it would have to be at the price that I set with the external investor. In that case, don't I as an employee get liquidity either way, since it's being bought at the agreed upon price?
> In that case, don't I as an employee get liquidity either way, since it's being bought at the agreed upon price?
Correct. The problem is a lot of companies go further. They restrict sales completely. In practice, insiders are allowed to purchase at depressed prices in tenders from time to time and then resell at a mark-up in the open markets.
I learned the hard way that options agreements tend to have additional clauses allowing the company to unilaterally restrict sales. The contract might look like it has a straightforward process for employees to sell, with a company first right of refusal (with the company purchasing the stock instead). But there is usually additional fine print that basically gives the board veto power over any transfer of stock.
One question to ask when interviewing at a startup is when was the last time someone sold common shares. You can also turn it around and talk with someone at a platform like EquityZen and ask them "I'm negotiating an offer at X; what has you experience been with them?" Some startups make it very easy for people to sell shares, some don't, and some are so small there's no market for the shares.
I was part of a leadership team at a startup for 4.5 years (went from 10 to 200 employees, series A and B). During that time I accumulated a significant number of stock options which could potentially make me a millionaire.
I left the company because my salary was incredibly low relative other companies in the same area.
I have left and I have no possibility of exercising the options. I technically could but that would mean ~50% of my net worth in a single risky investiment.
If they haven't expired, you should look into the companies that will loan you money to exercise. ESO Fund is one, Employee Capital Partners is another, and I'm sure there are others. There's also the option of trying to sell shares on a platform like EquityZen.
> “For later employees make sure the company offers “refresh” option grants to longer-tenured employees. Better yet, offer restricted stock units (RSUs). Restricted Stock Units are a company’s promise to give you shares of the company’s stock. Unlike a stock option, which always has a strike (purchase) price higher than $0, an RSU is an option with a $0 purchase price. The lower the strike price, the less you have to pay to own a share of company stock. Like stock options, RSU’s vest.”
Aren’t RSUs taxed at the time of grant? Therefore in a refresh grant, the employee would get hit with a large tax bill on the fair market price of the equity, even with an 83(b) election. Most people
probably don’t have that kind of money to lay down up front on something that could still go bust. At least with options, you can always (unless you get fired) stay long enough to see the come through to IPO where options are then a sure thing. Am I missing something here on the quote above?
Not the times I've had them - they were always taxed at time of vesting. There's always an option (or at least I was always offered an option) to sell back some of the stock at the time to cover the tax, even if you weren't exercising the remainder right away. That way there was no out-of-pocket cost to you at the time of vesting (but you did have the option to keep all the RSU's and pay the tax due if you wanted to).
My last employer, Tanium, offered single-trigger RSU's (vesting required time but no liquidity event) - they were taxed as they vested.
We had a couple of choices to pay the taxes: the default was that the employer would buy back some of the stock and use that cash to pay the taxes. Employees would get to keep 70-some percent of the stock. The other option was that employees could write the company a check for the taxes shortly before vesting, and then keep all of the stock.
> Aren’t RSUs taxed at the time of grant? Therefore in a refresh grant, the employee would get hit with a large tax bill on the fair market price of the equity, even with an 83(b) election.
Usually, some portion of the vested RSUs are sold to cover the tax liability, and the rest go into your investment account. The tax rate is the same as regular income.
Readit News
They could maintain a public list of YC companies that abide by the code of conduct in order to encourage good behavior, and to help communicate to potential employees that they would get a “fair” option deal (as early investors, they would clearly have access to the terms of any financing deal).
[EDIT: they could also maybe publish a list of investors who have committed to following the guidelines, and consider excluding VC firms from YC events if they won’t commit to those standards]
Depending on how serious YC was about making a difference here, going against the code of conduct might even be grounds for exclusion from the YC community? My understanding is that YC has always focused on what’s best for the founders, even when they were the outsiders in silicon valley and at their own financial expense. Maybe now that YC is such an important player in the silicon valley ecosystem, they could use that power to maintain the health of that ecosystem in a way that few others could?
That's more of an admonishment, but at least they recognized the problem ...
Yes, we care a lot about making employee equity more generous and more fair. Part of our YC curriculum now is teaching founders about these issues and encouraging them to follow best practices around being generous and transparent with employees about equity compensation like Sam discussed in his blog post.
I think there is still a lot more we can do, though.
- The employee equity participates at the highest prefered equity pool.
- The employee option strike price will always mirror the lowest 409A valuation while the option is open.
- Vested employee options are valid for 100 years while illiquid, and 7 years post liquidity event.
- Modifications to employee equity pools resulting in a decrease in option value as the result of a funding round must be accompanied by a tender offer of 70% of the pre-funding option value.
The above terms wouldn't provide much value if employees didn't understand that the companies equity is better than a competing employers equity.
The startup is doing well - it recently raised ~$300m at a ~$3b valuation, but my options expire in Dec 2023 and I'm growing increasingly concerned that they won't have a liquidity event before then.
If I exercise my options before then it will be taxed as income which could leave me owing >$100k in taxes to the IRS - but if the company hasn't yet had a liquidity event then I can't sell the options to pay that.
Seems like a ridiculous situation for early employees/advisors to be placed in.
Source: I work at Secfi (https://secfi.com) and our equity and tax advisors are amazing.
https://www.esofund.com/blog/exercise-loan
The common stock (what you probably get for your options) is usually valued at significantly less than the valuation from the latest raise.
Sounds like you're dealing in an ISO quantity beyond the limits my mind can comprehend though.
https://www.esofund.com/blog/amt-tax
Regardless, they'll still have to front the $ to exercise and be left with illiquid stock. It's not a good situation.
Might be best to stop using this idiom.
I was diluted from 3.2% to about 1.3% but the value of the company had clearly risen so _at that point_ it was unimportant.
However in my opinion the company's burn rate and lack of growth clearly meant a later exit (likely an acqui-hire IMO) would have seen dilution without an equivalent growth in value, not to mention the ever-increasing VC non-dilution shares accelerating that.
I got majorly screwed on tax because the startup made no efforts to be efficient and were very chaotic in their arrangements for payout so that is definitely another important factor.
Overall by winning the startup share lottery I made roughly $500k for 5 or so years working there and that was as employee #1 so the maths given the pay cut probably don't work out too well (perhaps break even if I'd played the career game well).
However of course I am hugely grateful it happened and I got to see a startup grow from 3 people to more than 10x that and learnt a lot, as well as changing my coding career direction substantially.
I wouldn't recommend joining a startup as a non-founder other than for changing career or starting out. The trade-offs don't really make sense in most cases and you get a lot less say than you think you might (founders understandably want to control what is their baby) - never do it for the money.
note: I posted a more detailed overview of what happened at https://news.ycombinator.com/item?id=25496667
There is some room for them to dilute the shares out of existence. Notably I don't have to exercise them, I already "own" them. The vesting schedule is really more of a forfeiture schedule. If I leave after a year, I forfeit 3/4s of them. Otherwise, they're mine into perpetuity, until liquidation.
Isn't that just like normal stock options?
I think I've seen this called a "virtual option plan".
With more shares created/sold later, the dilution means when the options mature, they will be less than 1% of the total company shareholding, or value.
I get the tax advantages of this, though. But I expect if it became common the taxman would want their cut of the nominal growth in value each year, or something. Bastards.
I am not an accountant, so please correct me if I'm wrong.
So when do you get this equity? Is it only at a liquidity event?
Because normally you pay taxes when you get something of value, equity in this case but you can't always sell said equity due to your company being private.
I'm assuming your company is private as a public company doesn't have these issues, they just give you stock, you sell stock, everyone is happy.
Or put another way, how does this setup not give you a tax bill each year, assuming you get your equity each year, that you have to pay with your own cash?
My company is an LLC. In a sense, I have this equity. This is how the value is defined:
Value = Percent_Of_Shares *(Current_Price_Of_Company - Price_of_Company_At_Time_Of_Issuance)
Note that, on the day these issued to me, the value here is equal to zero, because the current price of company is equal to the price of company at time they are issued. Thus, I have received something which has no value, and thus have no tax burden. Technically I'm now a partner in the LLC.
This has tax implications: when the company is making money, I owe tax money on that. However, they're in growth mode, and losing money, which means I get to carry a tax writeoff. Further, it's written into the company's bylaws that if they make money, they're obligated to give employees a distribution equal to the tax burden that the employee will incur, i.e. when there is a tax burden outside of a liquidation event, they are obligated to give me enough money to cover it. Also, if they sell the company, my shares are vested immediately. I don't know what happens to them covering the taxes if I leave; maybe I become liable for it, and there's a downside there.
The shares are non transferrable, which is lame but apparently quite standard.
There's one thing that some of these articles claim that isn't quite right. Because this arrangement technically makes employees in a partnership, per the IRS this means they have to pay their own side of social security and isn't entitled to e.g. health insurance. It turns out the department of labor has issued conflicting guidance: if I am, for all intents and purposes, employed by a company, then I am to be paid as a W2 employee and am entitled to benefits. My company has chosen to follow the department of labor's guidance.
I'm pretty sure I had the exact same experience. I've been a part of three startups. One took nothing more than seed money and has been chugging along for over 15 years. It's a lifestyle business for the owner, so it also hasn't grown at all in over 10 years. The other two startups were both acquired. I was even a VP at one with over 1% equity in the company. Net value of my options was $0 after investors, credit holders, and founders got paid.
Yes, some folks are going to make millions from IPOs, but the opportunity cost is far too high (IMHO). As a VP at the startup, my total compensation with 15 years of experience wasn't a whole lot more (and less, in many cases) than what a new college grad makes nowadays.
Now that I've got a family, college to pay for at some point in the near future, and a retirement to fund, I'll gladly take the sure thing vs. the gamble. I've bid goodbye to startups and have quadrupled my income in doing so.
It’s a cliched observation but it really does remind me of the kids hoping to make it big in pro sports – there are way more who peak at the minor league level at best but the owners make a ton of money by encouraging everyone to think of the exceptions as the rule. Humans are prone to misjudging statistics in general and that’s really bad when one party has the best data and a strong incentive for other people to misjudge it.
The catch is usually when people are asking about RSUs of public companies or other relatively liquid and predictable compensation, in which case equity comp should definitely not be valued at $0.
In private companies, always remember: (1) control ≠ equity (2) equity ≠ profit (3) equity ≠ information.
If this is new to you read Brad Feld's Venture Deals book and do the online course, it's time well invested.
Note this is simply the nature of private equity. Companies go public to drink at the capitalisation trough of public markets, but the cost is regulation and increased transparency. Companies that stay private are rarely bound by significant rules in terms of board or management decisions redefining structure, equity, terms and so forth. There are at least four key firewalls (exercise, issue, share class, transfer) between "options" as issued or promised and meaningful equity value extraction for an employee. Good lawyers can probably name five more, and definitely dream up or deploy tens more at any time without breaking laws.
In the end, I walked away with less than I hoped but more than I think I deserved (for being so naive). But it's been an abject lesson since: nothing in a private company is fixed, it can all be changed according to who pulls the strings. Options and equity are very vulnerable to this. Having equity is no guarantee of power or even a seat at the table (or of future wealth).
People are way too obsessed with dilution because it sounds so scary. "With the stroke of a pen they can create a billion more shares and your percentage goes from 5% to 0.01%"
The reality is that all common shareholders have the same incentive to not dilute the outstanding shares. That almost always includes the founders. Outside of a money raise most of the people involved in the company are aligned in the desire to not dilute each other.
The major source of dilution is new fundraising and while it will effect your percentage of ownership it typically doesn't affect the value of your stake because the dilution is part of post-money valuation. So you might own 1% of a $10m company before the dilution and 0.5% of a $20m company after the dilution but the value of your holding didn't change.
The things people should be worried about are all the shenanigans that happen around participating preferred multiples. Or, the worst, 30-day exercise windows along with the tax treatment of options exercise/AMT. But since those are much more opaque concepts it's way harder to get people riled up about it.
And if you have an unscrupulous CEO there's basically nothing you can do to protect yourself as a worker. But that's way different from the normal dilution you get as part of raising money.
If that is indeed true, then there's almost no reason not to demand being paid in real cash money rather than stock options. If the company doubles in value and I have the same amount of money, then what's the point of getting options instead of USD?
This like saying, "don't worry, your lotto ticket won't be devalued: We'll make sure that even if those numbers win the jackpot, you'll still get the same $2 and it won't be diluted below that."
they only have the same incentive to not dilute if they are getting the same penalty for diluting, right?
I am not an expert in any of this but it seems they could just agree to issue a ton of shares to all the investors / founders but not to employees in a way where everyone except the employees benefit.
Nope. If you are topped up (which means you still have political standing) then you start a new vesting schedule. So all those shares you worked for and vested — you can work for again!! Yay! Until another 4 years you are diluted. Yay! But likely there will be another round while you wait to vest the shares you already had!! Hahahaha!
In retrospect I'm pretty sure all I did was buy myself a tax burden when they fold or pocket change when they exit.
The mistake I made was not realizing the parent comment: that I lack the information to make an informed decision or to be sure they don't just dilute to oblivion. The numbers I did have access to (above) communicated a very misleading story to me.
(BTW: Congress bailed out dot-com specu-vestors who claimed not to understand the tax event that occurrs when exercising options. https://www.mercurynews.com/2008/11/10/rescue-bill-offers-re... )
Say I want to sell common stock that I own, to someone who meets the SEC accredited investor definition. It seems that right of first refusal means that the company could buy the stock instead, but it would have to be at the price that I set with the external investor. In that case, don't I as an employee get liquidity either way, since it's being bought at the agreed upon price?
Correct. The problem is a lot of companies go further. They restrict sales completely. In practice, insiders are allowed to purchase at depressed prices in tenders from time to time and then resell at a mark-up in the open markets.
I left the company because my salary was incredibly low relative other companies in the same area.
I have left and I have no possibility of exercising the options. I technically could but that would mean ~50% of my net worth in a single risky investiment.
So yeah, I now price stock options at zero.
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Aren’t RSUs taxed at the time of grant? Therefore in a refresh grant, the employee would get hit with a large tax bill on the fair market price of the equity, even with an 83(b) election. Most people probably don’t have that kind of money to lay down up front on something that could still go bust. At least with options, you can always (unless you get fired) stay long enough to see the come through to IPO where options are then a sure thing. Am I missing something here on the quote above?
Not the times I've had them - they were always taxed at time of vesting. There's always an option (or at least I was always offered an option) to sell back some of the stock at the time to cover the tax, even if you weren't exercising the remainder right away. That way there was no out-of-pocket cost to you at the time of vesting (but you did have the option to keep all the RSU's and pay the tax due if you wanted to).
We had a couple of choices to pay the taxes: the default was that the employer would buy back some of the stock and use that cash to pay the taxes. Employees would get to keep 70-some percent of the stock. The other option was that employees could write the company a check for the taxes shortly before vesting, and then keep all of the stock.
Usually, some portion of the vested RSUs are sold to cover the tax liability, and the rest go into your investment account. The tax rate is the same as regular income.
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