Handcuffed to Uber
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Does keeping early employees "handcuffed" essentially as indentured servants until IPO align with YC's ethics policy?
They do face the gnawing possibility that they could be rich, if only they could sell immediately, or keep the options for later, or or or ... if only!
But they can always just find another reasonably interesting job and get on with a pretty good life. I'm as interested in big success as the next guy, but let's be reasonable - these handcuffs are a lot more like "golden handcuffs" than actual handcuffs (or indentured servitude).
Do you actually support the practice from an ethical standpoint? Employees are recruited to start-ups with equity. That's a core part of their compensation for their work (for which they likely could have received more salary from Google, Amazon, Facebook, etc). Then after they've already done the work, that compensation can be taken from them if they leave the company.
Do you feel this behavior is ethical?
There is only so much "fair" to be had in business. It's not like there aren't 1,000 other "mini ubers" that want to own the market Travis and Co built.
That's literally the logic that was used to justify indentured servitude.
The GP's point is that calling this arrangement "indentured servitude" is more than a little dramatic.
But, debating that term seems to be getting away from the main point--that an employee could have an option on a sizable asset with no way to assert ownership of the asset, despite having fulfilled the vesting requirements set forth in the stock option agreement.
The employees who are saddled with options they can't exercise are adults who agreed to the terms of their employment. They are free to quit Uber and work somewhere else if they want. There are a number of other ways options can become worthless while you're waiting for them to vest. The employees gambled on options and are finding out that there is yet another way to lose that bet.
I can't refute your second paragraph. You're totally correct on every assertion. I just happen to think it stinks, and I happen to think Uber is taking advantage of the situation. There are other companies who recognized this issue and chose to remediate it (to their employee's benefit), rather than exploit it.
So yeah, it's another way to lose the options lottery. I'm glad I know about it now. I'll add it to my list of things to look out for.
Fair carries with it a connotation of plain dealing, that is true; but one can consent to things which are not fair in the sense of "without unjust advantage".
I expect that the vast majority of tech employees with agreements about stock options do not have full transparency about how they work. Thought experiment: ask random (US) employees with stock options "What is an 83(b) election" and "Should you make it, and why/why not," and see how many people have coherent answers.
No, there really is a pretty massive material difference between a startup employee and an indentured servant. It takes extreme naiveté or extreme privilege to confuse these two concepts.
Have you ever used the term "piracy" to describe unauthorized copying rather than attacking and plundering ships on the high seas?
If an employee wants guaranteed compensation, they can negotiate for a cash-only package. If they want stock-based compensation that is not vulnerable to this particular loophole, they can go work for a publicly traded company that hands out RSUs.
The reason we're focusing on the 90-day clock for exercising options (and the attendant bill) is that it's something that happens to a single employee when he or she leaves the company, as opposed to something that affects all the employees all at once. But I'm not sure that changes the aggregate analysis. It feels different, but I'm not sure that it is different. When you an employee joins a start-up, he or she is taking a risk that part of their compensation could end up worthless. The corresponding reward for that risk is the chance for that compensation to be worth beyond their wildest imaginings. If that risk/reward ratio is not to their liking... well, Google is hiring, aren't they?
So have options just become a total con?
(Fun fact: the above sentence is also true about lottery tickets and shares in a Ponzi fund.)
The unethical part is that the startup uses the equity to lure the employee, but fails to adequately warn them about the trickiness coming down the pike when that time comes.
That was not the initially accepted bargain. The bargain was that they take the risk of options becoming worthless or them not staying through the vesting period. Those risks didn't happen, this is the point where they would have earned the right to cash out, but now it turns out that the option isn't actually there.
I've made other people rich multiple times, with my ideas and effort, and gotten dick in return. I definitely would have been better off with a corporate job.
To my shame, I honestly don't understand the accounting behind all this. You'd think I'd learn. But each time I've been screwed a new way. Not knowing how to defend myself, I've mostly opted out. Which also doesn't seem like a good strategy.
He also discusses the need for a change in tax treatment by the IRS. One of the fundamental issues is how options are taxed. Should you exercise an option, you will need to pay taxes on the spread (delta of strike price and current FMV, i.e. latest 409A valuation).
In many cases, the spread is so small or nonexistent, that the tax bill is irrelevant. But, in a few cases it's so large that most people can't possibly raise the capital to cover the tax bill.
I think the fundamental issue is the definition of FMV. When there's no public market, and employees are covenanting away any rights to sell their equity on secondary markets, is there really a fair market? I would say no.
If I exercise an option with no spread, I am paying (at least) as much as it is presently valued.
The key is that you pay taxes on that spread. If you're early enough - I was roughly #25 - and do it early in your tenure, then you only have to come up with the cash to buy the shares and a minor tax bill. If I had waited until I left to execute, the spread would have been 12-15x. I know a few people who stayed 4 years to fully vest and then executed. I don't know detailed numbers but it sounded painful.
If/when Twilio eventually IPOs, then the ROI will be far better than any index fund.
(I don't know anything about the "if/when" as I haven't been inside in over 2 years.)
How do you know there will ever be a spread? If your startup fails, your shares are worthless. Or better yet, your shares are diluted out of most of their value by several subsequent rounds of private equity, which generally you have no control over whatsoever, but which will certainly go to enrich the founders. Resulting in even more direct transfer of wealth of your investment, to the founders and venture capitalists.
I'm having trouble understanding why any startup employee would do this, as opposed to exercising stock options when they actually have value and ideally some liquidity. Yeah you have to pay taxes, but that's because you came out ahead.
I don't see anything other than a massive gamble. You've already staked enough of your future on one speculative start-up as an employee; why would you then put a big chunk of your own money at risk? An index fund has reliable long-term returns.
But you are right, it is yet another risk. At Twilio, the pay was awful but I felt the longer term risk/reward was worth it.
If I was with $startup and the strike price was $texas-sized, I wouldn't do it while the shares were still illiquid because executing would be so much.
IMO the gold standard here is to issue actual founder shares as long as possible (up to and possibly past series a) and then to do options with early exercise and extended validity, and of course complete transparency on all the numbers.
http://blog.detour.com/introducing-progressive-equity/
Early exercise for the vast majority then is something you have to know to ask for in addition to number of shares.
This isn't really true with ISOs (hence the point of them). You may get an AMT gain which is ugly, but you don't owe regular taxes on the spread unlike Non-Quals where you would.
Yes, you're absolutely correct. That's a bad job on my part.
ISOs have a chance of pushing you into AMT land. If you exercise ISOs, and the FMV is different than the exercise price, then you should consult with a CPA to find out if you have a tax liability.
When I was in this situation I had a CPA project my taxes for the current year. It turned out that my taxes under the traditional system were more than under AMT, so I didn't have to worry. But this easily could not be the case if the spread is sufficiently large.
According to Glassdoor this is in the same ballpark as Facebook, Google, Twitter, etc [1].
You are not really making the startup "worse salary but potential equity" trade by working there, when the straight-out-of-college salaries are similar to the averages across all of Google.
[0] https://www.glassdoor.com/Salary/Uber-Software-Engineer-Sala...
[1] https://www.glassdoor.com/Salaries/san-francisco-software-en...
Google, Apple, and Facebook pay more. A lot more just in salary, more like 180-200k before options/RSUs.
Wow that phrase has really lost its meaning lately.
http://fortune.com/2015/03/23/pinterest-employee-taxes/
Disclosure: I work for Pinterest
I left the company.
Laughing at the question is obviously uncalled for, but there are legitimate cause for concern for adopting such policies.
Currently, late stage high growth companies and YC companies are the two segments best positioned to negotiate against VCs for these terms to become "standard".
That said, they are working on it and intend to implement a similar policy if possible. Reputable founders and investors don't want to force people to stay just to keep their options, nor screw people out of compensation they earned.
https://github.com/holman/extended-exercise-windows
Disclaimer: I work at Flexport which has a ten-year window.
Having ISOs matters most when the underlying shares are illiquid, and you can defer the tax obligation until a sale event (provided you don't hit AMT). When you have a 7-10 year exercise window, the company will likely have IPO'ed or have failed. The tax benefit of ISOs are greatly diminished.
I think people downplay how easy it is to hit AMT. A single, no dependents, standard deduction filer making $120k will hit AMT after $26k of on paper gain for ISO exercise. Everything after that will be taxable. Filing jointly, 2 people who each earn $120k can absorb $18k in on paper gains from exercising ISOs. Add in a kid and it drops to $15k.
That's a paltry sum, basically breaking any advantage ISOs provide.
It's a rough situation and something needs to change.
And, they have found a spigot on the economy that can provide for returns for these private equity investors. So why even go public?
To me, this just seems like a well thought out plan to keep employees locked into the company while not allowing them to ever exercise their equity, and keep the return focused on those who have provided capital. The "capital class" if you will.
Carry on worker bee employees; one day you might see those options actually worth something and liquid.
The shares can still be sold, but it's limited to qualified investors. The primary issue is that obviously the same information of a public company isn't available & the SEC doesn't want Joe Smith getting scammed by fly-by-night operations.
It's also worth noting that once there are a certain number of shareholders, Uber has to publicly disclose its finances. That's even if they don't raise capitol & are not traded on the SEC.
Historically this was 500 shareholders, but Facebook got an exception from the SEC. I wouldn't be surprised if Uber did too.
The moral of the story is to forward exercise options if you can. Basically what this means is you pay to exercise on your start date. If you quit or get pink slipped before the standard one year cliff, the company does a buyback. Otherwise, the shares vest as per your vesting schedule. You can potentially avoid a lot of the AMT nastiness this way, and start the clock on long-term gains treatment on day one.
That said, companies really should scrap the 90 day exercise window. Uber et al want to avoid employees selling shares on side markets. If they just allow them to hold onto their options for years, most will sit on them rather than feel rushed to sell. I know they want to retain talent, but they should be doing that via rewards versus punitive measures.
In any case, its worth it to spend a couple hundred bucks on a tax expert to figure out in advance how to handle options so you don't get burned by taxes on fictional gains.
For a later stage company, then math works differently, of course.
It bothers me that the terms are unnecessarily anti-employee. 90 days simply isn't enough time, especially when critical details related to the cap table and liquidation preferences are obfuscated. If they are not prepared to buy shares back at 409a value, they should allow an extended exercise window.
http://www.inman.com/2012/06/08/dont-sweat-quarterly-tax-dea...
But those numbers are still colossal, even when reduced by an order of magnitude or two.
The IRS guidelines say the spread between grant price and fair market valuation. If there's a secondary market, that's your fair market, not 409A (which is a joke anyway).
Also, most companies use the last public valuation as a basis for 409A valuation rather than hiring someone to do it in a separate process. The investors buying shares are the experts here. Of course there are considerations for preferred vs common stock and things like warrants, but they start at the top line number from the last round.
Also there are lots of secondary markets for private companies right now. What makes you think otherwise?
As for 409A valuation, I've never heard of an auditor seriously examining it or questioning its validity. It's mostly the "valuation expert" says, "What value do you want for 409A?" You tell them, they ask to see the books, and then say "OK I can sign off on that."
As for real world proof of Black Scholes being garbage, it doesn't get any better than Long Term Capital Management.
Edit: people buying/selling options are of course performing their own pricing operations. They don't care how the market price is determined, since they believe their model is the best and gives more accurate prices than anyone else.
Edit 2: furthermore, to properly price startup options, you need to account for their 'random-expiration' nature: we have no idea when Uber will IPO. this makes it difficult to use traditional option pricing models which have fixed maturities (you can take integrals over the model's results at each possible maturity). additionally, choosing a discount rate is hard when realizing that most employees are not well-diversified, unlike the investors/funds that the traditional models are written for
While neither are great, binomial is better for American style options than BS.
I guess you could choose an arbitrarily distant expiration date, but my bigger point was that while BS is clearly not going to give perfect results, the results are reasonable enough and transparent enough to justify their use for tax purposes in lieu of actual market prices.
'never' is wrong, depending on your meaning. It's definitely used in many 409A valuations. Typically a 409A will use a couple different approaches to come up with the initial valuation -- it will look at the discounted cash flow, the value of assets and liabilities, and generally will look at 'guideline companies' and their public valuations or cash value upon sale. Once one or more (often times all) of these methods are used for the initial valuation, the value is fed into a Black-Scholes model. That price (after applying discounts for non-marketability) is used as the fair market value for the common stock.
Most companies push the 409A valuations as low as possible precisely because of income tax ramifications on exercise.
If your company says the 409A is $1.50/share but people are selling on secondary markets for $4/share, you must use $4/share when computing your exercise benefit.
If there's no secondary market, it's the last 409A value.
From what I can tell, taxes will be based on the values in Form 3921 (for ISOs and ESPPs), which is delivered by the employer.[0]
Here's a sample 3921.[1] The FMV is delivered in Box 4. My question is where does that value come from? Is it the last 409A valuation, or is it required to use sale data from secondary markets?
I've received several of these forms over the years, and the FMV has always been the value from the last 409A. I have no idea if there was a secondary market for the shares.
I worked at a place that didn't issue 3921's (in the .com go round). I had a hell of a time reaching someone still at the company who could give me that information almost a year later (and after several rounds of devastating layoffs). I really don't know what she based the figure on.
[0] http://www.startuplawblog.com/2011/01/05/companies-remember-...
[1] The line being where your company ceases to be ethical at its core.
The problem isn't just in startups with stock options; another big place it arises is closely held businesses. You receive the family business as an inheritance and suddenly you need to pay - in cash - 40% of the value of the business. Such a large cash hit can and does destroy many companies.
The solution is of course to require the IRS to allow payment in-kind (shares). Then you could exercise your options and hand over ~20% of your shares to the IRS. Or you could inherit the family business and give the IRS 40% of the the company (which suffers no cash flow hit and continues normal operations). This additionally would prevent the IRS from overvaluing in-kind earnings.
I believe the argument here is that if the government wants to claim that these shares have a certain monetary value for tax purposes, then the government should stand behind that value and allow you to pay taxes with those shares at their claimed monetary value.
The end goal would be to prevent small business (or people with stock options) from going under because the government claims a piece of paper is worth $1m, but in reality it can't be sold at all, or couldn't be sold for such a high value. If the government claims "oh but we would lose 20% of the value in selling these shares" then they are essentially admitting that they overvalued them when taxing you.
[1] http://www.renunciationguide.com/expatriation-and-tax-detail... (Tax on deferred compensation and non-grantor trusts)
Does that really not exist?
For developers at unicorns I think services are somewhat better (e.g. secondmarket, elite crowdfunder).
Not true at all. For the last year for which data is available, 2013, only 20 inheritances of a small business were subject to the estate tax. [See http://www.cbpp.org/research/ten-facts-you-should-know-about...]
Additionally, estate taxes are paid by the deceased's estate. In the US, inheritors do not pay federal tax on their inheritance, and only 8 states tax inheritors.
I have no idea why you and gamblor are obsessing over "mom and pop" or "small business" - that wasn't a claim I made at all.
Companies are giving out time-limited stock buying privilege to employees instead of direct ownership. Additionally, some companies can even revoke the privilege through termination of employment agreements.
If employees were treated as full owners, there wouldn't be a problem.
If the IRS didn't require you to realize gains on the spread when exercising, then a lot of these issues would dissolve. That's not to say folks wouldn't find other ways to restrict employee ownership.
I ended up not exercising. Still not sure if it was the right call.
So it's another hit piece on Uber that is completely unfounded.
This will prevent employees from flooding the market post-IPO and devaluing the stock.
EDIT: Nothing quite like watching the public stock price decline while you're in your lockup period.
VCs want protection when valuing a company at $60B+. Employees are, unfortunately, last in line under the current RSU models.
So some employees will work for a negative potentially six figure salary (100% withholding + 5-6 figures owed to the IRS) with no way to pay the IRS until they can sell the stock in the next year?
That can't be right. How does this work?
Typically, a portion of the RSUs are withheld to cover taxes when exercised.
In any case, Uber has to pay the withholding, and i suspect they have no magic way around this.
I think the sibling post answered the question -- RSU's don't vest until the company goes public. So, instead of getting illiquid comp, you just get none until Uber is public.
Typically this is only for short periods for higher-up people but it can affect "normal" engineers too (say you do a tech due diligence for an acquisition etc....)
What consequences?
And at one point Elizabeth Holmes was worth billions, emphasizing that until you the have money in your bank account don't be tallying how much you're "worth".
In theory, those employees were promised to receive x shares of the company that now (partly due to their personal performance) are worth some significant amount.
In fact, that was a lie and they are not actually able to receive that part of their compensation despite having been promised and earned it, vested, etc.
Beware of scams (the legal details cause similar sized of equity options to have extremely different de facto value) and/or treat the offered equity as having near-zero value when comparing compensation offers from different employers.
Maybe there are limitations on how much can be exercised/sold, so that someone with $300mm post-option exercise can't exercise their whole position.
Rights of first refusal are common, but how can Uber prevent a non-employee from selling? I'd love to see the language they use in their options agreements.
My best understanding of a typical "right of first refusal" clause is that it gives the company the right to match any offer by a third-party buyer.
This would add some friction to the transaction, in that the company could have some specified period to consider the offer, leaving the pending transaction with a third-party buyer in limbo (or discourage the third-party from even considering the transaction). But if the company refuses to buy back the stock at the terms of the third-party offer or the period of time for the company to consider the offer expires, then you could go ahead with the sale to the third-party.
Mind you, when I did do a sale on the secondary market, it always took the full thirty days for the company to approve.
I assume that in my wife's case, the company was buying the shares back (privately held firm and we weren't dealing in a secondary market). I guess I'm just surprised Uber doesn't do the same (actually, I'm not, given their C-suite's history of being all-around dicks).
I've never heard of this in the valley, it's standard practice to not allow shares to be traded and provide no option for liquidity until IPO. There can be occasional secondary offerings (Facebook and Square had these) but they are usually a one time deal. Definitely not a concept that Uber invented.
We have capital gains tax which i believe is only taxed on sale of the shares.
https://blog.coinfund.io/explaining-blockchain-to-traditiona...
Rather digital equity and governance systems [1] that are currently being built around blockchain and decentralized projects simply take a much more egalitarian and healthy approach to distributing ownership in the first place. And, hey, if you want to use equity as an incentive for retaining employees, you still can do that using (for instance) a smart contract in a way that is fair and not concentrated as a power in the signature of a single person.
At the end of the day, traditional private equity whether it is an investment or as compensation has a lot of problems, as I'm sure HN readers on here know very well.
[1] Most forward-thinking real world example: http://daohub.org
The issue here is taxation before gains are realized. Are you assuming the government isn't going to tax you, just because it's a smart contract?
(2) Sorry, not following you. I never said or implied anything of the sort. I don't see how that's a central issue to our discussion, but perhaps you can educate me.
Honestly, the best way to decentralize ownership is to lead by example and start a hundred-billion dollar company that distributes ownership. If the next Google has decentralized ownership, that would be a model for other companies to follow. Right now, there is no incentive for any company to do anything nontraditional here.