Does keeping early employees "handcuffed" essentially as indentured servants until IPO align with YC's ethics policy?
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.
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.
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.