Startup Equity For Employees
payne.org
payne.org
Summary: don't expect the equity you get from working at a startup (unless you're a VP or an executive) to be worth much. Google-like events where many employees got rich are few and far between. If you do work for an existing company, I suggest looking at salary more than equity as a means of making money. The difference between making 120k vs 80k over 4 years is 160k -- more than you're likely to get from options, and less risky.
"Companies raise money by selling new stock after the board of directors authorizes the sale to investors. Those new shares are created out of thin air by the company, and will dilute all of the current stockholders."
These shares are not created out of "thin air" as the article states. When a corporation is formed, it requests and is granted a certain number of shares by the state in which it is created. These are the authorized shares. At this point, the company may sell shares from their authorized pool of shares. The shares that are sold to raise money are called the issued shares.
This is the point of error. The shares are not created out of thin air, but are rather moved from the authorized shares to the issued shares pool.
Additionally, the company may decide to buyback some of their shares from the people who they sold the shares to. Shares that are repurchased are called treasury stock. The shares that are not repurchased are considered outstanding. Only the issued and outstanding shares have any voice in the company. Authorized and treasury shares can not vote.
To recap, here is a quick diagram:
Authorized
|-Issued
|--Outstanding
|--Treasury
Outstanding is highlighted because that is the only category that has an influence on voting and percentage of ownership. For most young companies, you won't have to worry about the other classes of stock, but for medium+ companies, it's a good thing to understand going into a negotiation for equity compensation.
My point is that the company sells new shares up to the amount authorized, to raise money. In my experience, the authorized number of shares is a minor point; the board/majority shareholders will increase it if it's ever a limiting factor.
Before those shares are sold (issued), they don't really exist -- nobody votes them, they're not compensated if company is acquired, etc. Hence, the simplified "thin air" description.
Also, the board of directors can't exactly increase the number on their own. They have to get permission from the state to do so, since it could have an effect on ownership. If I had a 49% stake in a company, the 51% couldn't authorize and issue themselves more stock to keep me from getting control, but they could dilute my ownership by bringing stock out of treasury or issuing stock from their authorized amount.
A last note, I believe that most companies issue stock compensation directly out of their treasury stock, so if you'll be getting a good deal of ownership, it will probably be from that stock pool. Take that into account to figure out your ownership percentage.
The number of jobs just shrunk by 90%.
Stated differently, I've much more people screwed by the inverse case -- they DON'T exercise, the leave the company, they have 90 days to exercise vested shares or lose the options, the fair market value has crept up, and they end up with a huge AMT tax hit to keep the stock they worked for.
You can't say you know someone who was "fucked" by doing something, and then not tell us what fucked them-- that's teasing!
Assuming after 2 years, you decide you want to exercise the options that are vested, so you pay your company $500 to get your 500 shares.
Company start going down the tube, and folds out, or is selled at fire price. You end up with basically worthless paper on your hands. So, instead of earning money, you lost. Imagine, that instead of $500 that was 5000, 50000. It is a lot of money.
There are also tax implication, depending what kind of taxing schedule you choose. You can find yourself actually paying taxes, for those shares at the time of excercising, yet when you want to sell, they are worthless.
Double ouch. Also, one thing to consider is that when you exercise options, you have buy those shares. If your company is iliquid (not gone ipo), it might take a long time when (if) you are able to sale them (either it goes IPO, or the company is sold). So, you are tying a chunk of your money, in these shares.
So, as always, buyer beware. Do your own math when it comes in cases like this.
I wouldn't consider losing 5k after exercising options (and knowing the obvious risks) as being "fucked," though. Just a bad outcome. And exercising 50k worth of options on a company that has a chance of failing is just stupid.
Except it comes at the same time the company folds, which mean you lose your job and have to pay for the privilege. I agree on a hypothetical 120k salary this isn't a big deal but in many start-ups you're basically at subsistence level.
Assume the company does moderately well, and is sold at a premium.
There is nothing that practicably prevents the company from diluting shares at that point and distributing the new shares among current employees, to the disfavor of everyone who left.
In fact, that seems to happen regularly. Companies get sold, and non-employee non-VC stockholders get nothing because of how the deal is structured.