I'm really interested in other people's experiences with understanding how their stock options work.
It seems really easy to misunderstand something serious, even if you know quite a lot about equity.
It seems really easy to misunderstand something serious, even if you know quite a lot about equity.
I decided to value the options at $0, and instead think of them like a non-monetary perk: "free lotto ticket Wednesday". I ended up turning down the offer.
Was that experience normal? Did I have a right to know the shares outstanding?
Your BATNA is to walk away from a deal where the counterparty refuses to give you the information needed to make a rational decision.
At least they should be able to tell you the common strike price and ideally the fair market value of preferred shares. This would let you benchmark things fairly well.
What does late stage mean? How many employees? How much funding raised?
I like the experience of working here, but now I totally realize I have lost a significant amount just by not negotiating anything.
2. Would've asked for a better base salary citing all the "ifs" stock options carried with them.
Also at this point in time there is so much shady stuff going on with options that you should always always value options at zero. Frankly if all you are offering is your labor in return for options you don't have the pull to get a particularly good deal. (Example: Friend worked three years at a startup. Friend is smart. Friend got ~$50,000... whoop dee doo dah day)
Only other advice I have is, if you are considering exercising any stock options you need to talk with a tax accountant before you pull the trigger. No exceptions.
Never attribute to malice that which is adequately explained by stupidity.
Getting a seed round doesn't magically confer the founders/C*Os with an comprehensive understanding of how company equity works. Or common sense.
"A witty saying proves nothing." - Voltaire
I mean, imagine if someone followed the same practice for the salary part of compensation: "We will pay you money!" "Eh... how much?" "Some. The actual number is privileged and confidential."
So what is the lesson here? I hear this saying over and over, always with the implication of "Give them a pass". Who cares if they are being crooked, or are too dumb to do division. Either way, the employee loses.
Given my experience of advising early stage startup founders on equity investment, dilution, cap tables, etc., I believe that ignorance is at least as likely as malice in situations where they seem unwilling to disclose all the information the potential employee needs to fully evaluate the potential value of any equity options being offered.
I would never join a startup where the founder wasn't razor sharp and forthcoming on all these details.
This can be seen in recruiting stagee as well, it is usually presented as the take home question. Give them a take home interview problem that takes two days to solve. Those that go for it, will be dedicated and desperate enough to be good workers.
I honestly strongly dislike this quote, because at the end of they day just about every malicious activity could be wrongly attributed to stupidity.
Does that really change anything, if your C-suite is too stupid to understand how companies work?
You can never get this information even as an employee. You ask directly, and nothing. They don't want to give it to you.
Your company could be sold for 100's of millions, paying off the investors at 2x investment, and the common stock holders get nothing.
So yes, options are somewhat of a lottery ticket with ever changing odds. If the company does extraordinarily well, you will do well also. If you truly believe the company has a very good chance at financial success, you should stay irrespective of the number of options. If you are making a significant contribution to that success, a rational company will want to reward you and incent you to stay with more options. If both those things are not true, it is best to seek your fortune elsewhere.
Yes, but the directors of the company are obligated to act in the best interest of shareholders, so hopefully they would do that iff it increases the value of existing shares. (OK, there are many things wrong with this, including the fact that option holders are not shareholders.)
"If the company does extraordinarily well, you will do well also."
Yes, but if the company does very (but not extraordinarily) well, you might end up with nothing.
"If you are making a significant contribution to that success, a rational company will want to reward you and incent you to stay with more options."
But your contribution may not be constant. An early engineer who took a risk (low salary, high chance of being laid off) and built the prototype may not fit in when the company grows, so there may be little rational incentive to treat her fairly.
Also, all shareholders, or the majority?
This is where the GGGP (davidwihl) is both right and wrong—knowledge of the cap table at signing won't guarantee anything, but that combined with a good judgement of character is the best you can do. In the end you can get screwed either way, but if there is any caginess up front then run don't walk away.
Can you give me examples of people in jail for this 'crime'? At worst people saw social network, and it seemed a ok.
My understanding is that options for common shares, such as terms at YC, have not even anti dilution protection. So the # you have is a snap shot, and nothing to do what that % would be when you fully vest.
In many cases, it's because they don't want non-executive employees to be able to know certain financial details, including the valuation of the company. I wish this wasn't the case, but the reasons for it seem logical and in fact fair - it's just that many people assume this is a lot when it probably isn't.
The downside is many people are apt to accept, thinking 10,000 in options is a "lot", and I've made that mistake in the past. In an A round startup, this number could easily be in the several millions of shares outstanding, and likely is. If it's gone through several funding rounds, it's likely even less. 10,000 in a C round is significantly less if they have divided the stock by 10x or more in the previous rounds.
Executives could be pulling in whole percentages of the company, or multiples thereof, and one of the first few members of technical staff could basically be looking at a year's salary or less in payout if the company would sell in 5-8 years.
The percentage of the companys that make it is also a factor. While the article focused on needing to stay at a company, it's fair to consider that the great majority of startups are going to fail or be very small acquisitions (asset deals, acqui-hiring, etc). In these positions, the VCs will get paid first, and there may not be much if anything left.
Another possibility is the company is sold for small prices but the CEO could secure a very very nice deal to join the new company (plus bonuses), which has happened on more than one occasion.
A VC only needs a small fraction of his portfolio to do big exits, so they make lots of bets.
Stock is a huge gamble. I don't recommend "no stock, just cash", but don't ever let someone underpay you on hopes the stock event will happen.
Stock is being used as a retention tool, and that's the design of it, unfortunately.
I'd be much more in favor of equitable profit sharing as a retention tool - suppose a company decides to give away X% of it's profits back to employees forever, and this is done in a way where it isn't the CEO/leaders making all the money. Instead say in a 50 person company, 10% of the profits always go back to the people, and each person gets 1/50th.
This also eliminates sales commission on large deals and makes everyone part of the deal (the whole company) profits - also no quarterly targets, personal bonus tiers, executive bonuses, or anything like that. As the company becomes more efficient, those numbers go up, and it keeps things simple.
Do you know of good examples of this working? I'm interested in how it might work with a typical startup.
I think you would want to calculate a % early in the year, and then award that percentage at the end of the year.
If you wanted to taper that somewhat by employee reviews I guess you could, but it shouldn't be on quota - and ideally you'd just not continue to employ those people you didn't want to be there.
Yes, everybody would lose out if there were no profits. And a lot of startups aren't profitable. But (IMHO) I think that's also where SV investment gets it wrong -- they value growth above profitability sometimes, and this desire for rapid scaling makes or breaks companies, when in the end, I think a greater percentage could be BOTH happy and moderately successful at the same time, rather trying to bust themselves and "go big or go home".
This model is probably a LOT easier to adopt in a bootstrapped company, where there's less likely a board to say no to it -- and yeah, if you're not profitable, you wouldn't do it... and you also would be unlikely to have stock anyway.
The only book I've read on stock options is _Consider Your Options_ by Kaye Thomas, which I thought was good. I do my own taxes, and there was enough detail in that book to let me figure out the tax implications of my options. (Including AMT the one time I had to pay it.)
The actual mechanics when you already have options are straightforward. You either exercise speculatively (pay real cash to turn options into shares, then hold the shares), or exercise risklessly (pay cash to turn options into shares which you sell immediately for more cash than it cost to exercise). Exercising speculatively has risks -- you pay real money for shares that then go down in value, possibly to less than the strike price, possibly leaving you with a tax bill even though you made a loss. Exercising risklessly is safe.
I don't like to speculate with meaningful amounts of money. If in doubt, sell the stock and diversify. Think of the worst case (the company crashes and you lose both your job and the value you thought the stock had). Better to not have all your eggs in one basket and sleep well. I suspect this is not a popular sentiment there, though.
The real question with options is when you're considering multiple job offers. Company A offers $100k and 3000 options. Company B offers $110k and 5000 options. How do you value the options? For a startup, the usual answer is that you can't, because there's no anti-dilution protection. If the founders want to hose you, they can hose you, by diluting your shares or by firing you right before a vesting date. So I value them at zero and take the job I like better, or the job that pays more actual cash.
(RSUs in a healthy public company are a bit different, since they have an actual immediate cash value. I value them at 75% of the current value of the stock. The 25% discount is because of vesting periods.)
They do fun things like giving you a loan with the options as a collateral. You would then default on the loan at the point of IPO.
So theoretically you don't sell them anything.
- $110k + 5k options, with 5M shares outstanding, at a strike price of $1 / share.
- $100k + 3k options, with 1M shares outstanding, at a strike price of $0.01 / share
Both are realistic scenarios for an early-stage startup. The 3k options in the second deal are worth much more than the 5k options in the first deal, on paper. (This is without even brining in valuation in question.)
A call option on a share of Google with a strike price of $50 is worth a heck of a lot more than a call option on "name any startup" with a strike price of a tenth of a penny.
There are, naturally, cash flow implications to this.
As an employee, you just don't know. So value them at zero. Or, if you want to be fancy, epsilon. And take the cash.
It may be safe, but it isn't free. As with most other things, you pay a risk premium -- in this case, in the form of failure to qualify for capital gains tax treatment on the resulting gain, because you didn't exercise in time to hold the underlying stock for more than one year. Depending on the amount, this difference can be quite significant.
You do your own taxes so probably know all this already, but here's a simple example[1] anyway. Let's say you "risklessly" exercise options with a strike price of 100 and a FMV (tax-lawyer speak for fair market value) of 1000. You have immediate gain of 900 -- and because you didn't hold the shares for >1 year, all 900 is Ordinary Income, generally taxed at higher rates than capital gains. (Top federal OI rate is something like 39% last time I checked vs something like 17% for cap gains.) Assuming the OI rate is 39% and the CG rate is 17%, you pay tax of .39 * 900 = 351, for total post-tax cash of 900 - 351 = 549.
What if, instead, you had exercised speculatively, more than 1 year prior? You'd still have taxable gain on 900, but because you'd have held the stock for more than one year (and met some other qualifying factors I won't bother explaining here), your tax bill would be 17% -- meaning that you'd pay .17 * 900 = 153 in taxes, and keep cash of 900-153 = 847.
Not a huge difference when we're talking about gain in the hundreds, but adds up quickly if you're in line for tens or hundreds of thousands or more.
It's really just a question of how you evaluate different kinds of risks, and what you want to pay to hedge them. If you want to balance your tax bite against the risk that your company goes under or otherwise fails to deliver, you may still want to exercise early, but only partially.
[1] I'm eliding a few things and making some assumptions. Not legal advice, talk to a real tax attorney before making decisions, etc.
For you example, say I exercise my option to by 1 at strike price of $100 in 2015. I hold on to it and sell it in 2017 for the FMV of $1000. Do you only pay the capital gains tax of the $900 gain?
Ignore state rules, just at the fed.
However, AMT(alternative minimum tax) doesnt recognize ISO. So in 2015, you have to calculate AMT, which $400 counts towards. This is basically a no-deduction(except a high standard deduction) flat tax, you potentially owe 26-35% on that 400. Even though you didnt sell anything - this is where people get screwed.
So lets say you paid $100 in AMT. In 2017, you still owe capital gains tax on the whole $900, but you calculate AMT and claim the difference, up to $100, as a credit - the difference should be >100. You can actually claim this credit every year until previously paid AMT runs out, but most likely the difference wont be sizable enough until you sell.
Not a tax pro; this is not tax advice; yada yada.
Thanks for responding folks.
You can make ISOs be treated approximately as NQSOs, but otherwise, you're generally getting from an established program and within a company, you don't have to be prepped to negotiate one type vs the other. Over time, the company will no longer be able to issue ISOs and may implement other programs, but they will tend to be "one type fits all" in general.
When the time came to raise our second round, I got intrested in how it would affect my shares and sat down to understand this whole shares thing. And to my dismay it turns out I have to pay for my compensation! I was pretty disappointed, even felt a little bit of resentment that no one took the time to explain things to me. But the reality is that your employer is not obliged to explain how your compensation works -- after all it's all in the contract (except it's written in awful legalese).
2 years later when I quit my job I was broke and barely had enough money to get by until my next paying job. Anyways I hustled to borrow money and exercise my options, all the while I still haven't understood the tax implications (I still don't!). My CPA told me that I can delay paying taxes on this until a liquidation event, and my coworkers who quit at the same time got similar advice. Now and after talking to others who exercised their options, that advice seems out of place and flat out wrong. I'm now trying to figure out what to do next, most likely getting a new CPA or a tax attorney. The whole thing is really stressful and I feel like startups can do better by their employees. At the very least substantially extending the exercise time and making it a standard in SV.
I also made the mistake of not working through the implications until a year or so in. Luckily, I joined early enough that my strike price (and valuation) was still low enough that I could exercise pretty easily.
Disclosure: It appears that my former employer has filed their S-1 in the last couple weeks.
As to stock options they are best treated as lotto tickets. Unless you think the company is very likely to get sold or go public at a high valuation you’re generally better off ignoring them.
PS: https://www.irs.gov/taxtopics/tc427.html
Statutory Stock Options If your employer grants you a statutory stock option, you generally do not include any amount in your gross income when you receive or exercise the option. However, you may be subject to alternative minimum tax in the year you exercise an ISO. For more information, refer to the Form 6251 Instructions (PDF). You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you do not meet special holding period requirements, you will have to treat income from the sale as ordinary income. Add these amounts, which are treated as wages, to the basis of the stock in determining the gain or loss on the stock's disposition. Refer to Publication 525 for specific details on the type of stock option, as well as rules for when income is reported and how income is reported for income tax purposes.
...
Not Readily Determined Fair Market Value - Most nonstatutory options do not have a readily determinable fair market value. For nonstatutory options without a readily determinable fair market value, there is no taxable event when the option is granted but you must include in income the fair market value of the stock received on exercise, less the amount paid, when you exercise the option. You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss. For specific information and reporting requirements, refer to Publication 525.
This is probably something which should be fixed by regulation.