Elizabeth Holmes Owes About $25M to Theranos | Hacker News Reader

Elizabeth Holmes Owes About $25M to Theranos

wsj.com

103 pointsus0r41 comments

From the company's POV, this is a cashless exercise. Theranos has loaned $25M to Holmes who paid it to Theranos. This is a common structure. Dunno why the WSJ didn't see that.

From her POV, she doesn't have beneficial ownership. I think that has tax consequences.

http://www.financeandflipflops.com/cash-vs-cashless-exercise...

There is a lot of flexibility there. If they forgive the loan then she owes tax on $25M (as if they had just outright paid her). I am impressed that the board could use her shares as a way of getting the investors not to sue. Seems like owning more of a nominally worthless asset isn't really better than just getting some of your cash back.

They don't have to forgive the loan right? They just take the stock back? Then she would owe nothing and have no tax due.

That might seem like the common sense answer, but is the danger in exercising options and holding them. In this case, the previous poster was correct -- once they forgive the loan, the $25 million becomes taxable income.

The reason it doesn't seem to make sense is that no actual value was gained in the end. However, the IRS (and our tax laws) don't see it that way. Instead, they back at the value that was gained at the time of the transaction. They don't care what happens to the value in later years.

No I mean the stock is collateral regardless of its value. If it was worth more than $25m she would sell it. But it's not so you just give it back.

As stated before, it doesn't work that way. Google the horror stories on those who have excercised options (and held the stock) on a liquidity event who had to pay taxes on gains that existed at the time of the transaction, but later dropped in value. Even though they never saw a gain other than on paper, they get hit with a tax bill they can no longer afford. And the stock is unhelpful because it's current market value is no longer reflective of what it was at the time the IRS recognizes the gain. In your scenario, she could only cover her tax bill with the stock if it were at a equal or higher value as when she excercized them via the loan: https://blog.wealthfront.com/exercise-stock-options-taxes/

That's not a risk if you early exercise at the time of grant where your strike price is equal to 409A price. Then there is no taxable value.

We can agree to disagree. As a two time founder, I had to go through a lot of discusssions with our legal and even my own to grasp the upsides and downsides of what Elizabeth did by trading risk against a lower future tax liability. My take is that you're confusing a normal cashless transaction versus a structured loan as an executive of the company to purchase stock today to hold for a long term horizon. The risks are very real and the liability is very real. I meant this to be a way to share some specialized knowledge I have on the subject to answer why she has an actual liability and why this isn't handed out to just any employee. This isn't coming from book knowledge, but real working knowledge of this arrangement. But at the end of the day, everyone is free to do their own research. :-)

Looks like WSJ wanted a headline and took a cheap shot

This is Theranos we're talking about. There are no cheap shots.

I don't think this (loaning a founder or senior exec money to purchase shares) is that uncommon a situation. When my previous start-up employer was purchased, I read through most of the deal docs, hundreds of pages. One of the things they mentioned is that the company floated several promissory notes to the CEO to allow him to purchase more company stock. It was peculiar enough that I made a note of it, but I never stopped to puzzle out why they did it that way. Possibly to avoid a tax liability at the time of the deal? Or to increase his compensation without actually increasing it on paper?

It's done in order to start the clock early for capital gains. If you excercise shares at the same time you sell them, that transaction is treated as regular income. If you excercise the shares early by purchasing them, then they can be taxed at the lower capital gains rate down the road. There was a response in the thread that asked if this is fair -- to that I would answer that when the purchase is handled as a loan, it is a real liability to the employee (usually the CEO or founder). If the company tanks or the clock ticks too long for a liquidity event, the note has to be paid. So this could be a very risky proposition for an average employee, even it were offered.

If you're a founder, why wouldn't you 83B all of your shares right away when they're worth $.0000001 per share?

83B is for grants of restricted stock, not for stock options.

Understand that but as a founder, why would you give yourself options over stock? It's your company. That makes no sense. You need to pay in capital in some form.

The key is that you need to align incentives for employees, investors, etc by demonstrating a long-term commitment to the company. Lots of more nuanced discussions of this topic exist but here's one I have at hand: http://startupclass.samaltman.com/courses/lec18/

They likely were giving her additional grants later in the life of the company upon reaching certain milestones to make up for her dilution at a strike price that required millions of dollars to exercise. You can get away with founder stock very early on, but at some point, it becomes untenable as the value of the company grows.

Recourse is only the stock though right? So it's not really a loan but more of a gift... I'm surprised Congress, the IRS, or the SEC allows it. Especially as a tax dodge.

No. She is on the hook for the money. It's a huge liability. AFAIK, that's the only way IRS allows this.

I've never heard it phrased as "exercising shares". Do you actually mean exercising options to convert them to shares?

I'm not in the US, so I dont know how that changes things; but when the company I'm working at started it's employee equity scheme it was setup as an interest-free loan to employees to purchase shares. The loan has conditions that the loan can only be repaid through the sale of the shares, with no recourse against my other assets.

Right but is it fair? Should employees not get the same deal?

Fairness, one way or the other, is hard to quantify here. CEO's get compensated a lot more than other employees, in a lot of different ways; you could just as easily argue that isn't fair either. Besides, at the bottom, the CEO is taking on debt that could find him/her bankrupted if the company fails. I don't think it would be responsible to even offer that facility to all employees. It might not even be legal, if the employees are not accredited investors, though I'm not sure about that.

I should add that I don't have any knowledge of who pushed for the deal, and how it was set, but I doubt the CEO strolled in and just asked for the loan. I'm assuming it was part of the compensation package that was proposed or negotiated by the board and their comp consultants.

The CEO won't go bankrupt.. these loans are backed by the stock as collateral. But there should be a law that all such plans and purchase agreements are available to all employees if available to the execs.

Regular rank and file employees should also ask for this provision when negotiating their employment offer. Try to negotiate a deal such that the employer gives you a one-time sign-on bonus which, after taxes, will pay for the early exercise of the offered equity, and get the employer to give you the paperwork for filing 83(b) election.

I had posted about this earlier here: https://news.ycombinator.com/item?id=13426949, which lead to a lively discussion. At least one founder - Steve Newman of Scalyr - came out and said that this is how his startup handles equity compensation (minus the tax cover). More people should ask and get this style of offer.

> The CEO won't go bankrupt.. these loans are backed by the stock as collateral.

I couldn't actually find this out through a google search. What happens if the market rate does not allow the lender to recover the principle? I thought you'd still be liable for the remainder. It's just that they can force a sale if they want to.

This isn't an ordinary debt from a 3rd party; it's a contract with the company - they can put whatever terms and restrictions they like on that contract, including no other recourse for the debt other than proceeds of the sale of that stock, or it's forfeiture.

If the company forgives the debt, doesn't the IRS treat that as income?

Possibly, But there's a difference between a debt being written off (uncollectable) and forgiven. There's also capital gains losses that might offset potential income; the accounting for all of these cashless transactions is complex - that's what the accountants and lawyers are for :P

Allan who also responded is fairly inline with the answer to this -- except one key point: the company can write whatever they want into the contract regarding recourse, but the IRS will only recognize the loan as legit for tax purposes if it has a liability associated with it beyond the stock as collateral. This liability to the key execs will be reflected as a line item on the company balance sheet. And even if the company doesn't aggressively pursue the debt (which they can sue for), you're still on the hook to the IRS for the reason scurvy mentions below.

Are you suggesting it's unfair that different employees get different compensation deals, presumably based on their value to the company?

    > but is it fair?

Is a question for the shareholders and board to ask.

It might be more accurate to think of it as an exploit. There are all sorts of ways company financial structures can be abused - this is just one of them.

It's not really about fair, or founder vs. employee. It's a liquidity thing. The following is an example I totally made up, but it'll sort of give you an idea of how it could work.

Say you found a company, the company is still private, and you outright own shares worth a billion dollars. Selling private shares is a pain in the butt. You can do it, if you find a buyer, but it can be a lot of work.

Now let's say you want to take $25 million off the table. While you can't easily sell your shares, you can borrow against them. Any bank will lend you the money, because you're securing the loan with your billion dollars worth of stock. The risk of your stock collapsing from one billion dollars to zero is fairly low. The stock can drop 97.5% in value and still be enough to cover the loan. If you default on payment, the bank simply seizes your stock.

Now let's say an employee joins the company when the stock is valued at $5/share, and that employee gets 100,000 shares. The stock goes up to $20/share. The employee's stock is worth ($20 - $5) * 100,000, or $1,500,000. The employee wants to borrow against those stock options. Before that can happen, they need to be actual shares. The employee needs to spend $500,000 just to own the stock. If the bank will loan money that is worth up to 10% of the value of stock in a privately held company, you couldn't even take out a loan big enough to buy the all stock in the first place. You could maybe buy a few of the shares, but if the amount you want to borrow is too small, the bank simply won't bother, because it's too much work.

That's not the right example in this case. Here theranos gave the CEO the loan to buy the shares. Do employees get the same deal?

The proposed deal involves Holmes's shares in Theranos? What value do those have now? I assumed the company is total loss at this point.

At the current valuation, I wonder if this is enough to put her into minority shareholder status?

Any paywall free source for this story?

Anything for you http://archive.is/qDQRB

http://archive.is/qDQRB

Possibly they're just trying to get the page views.

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