Ask HN: What can go wrong with stock options? | Hacker News Reader

Ask HN: What can go wrong with stock options?

12 pointsan00nym00s4 comments

(posted anonymously for obvious reasons)

We're looking at stock options as a possible means to compensate people in our start-up, such as very early employees and founders who didn't get enough initial shares.

I'm interested in knowing what the HN community has observed in terms of problems that can happen with stock options, so that those can be covered in the options contracts that we end up creating.

Obviously this would all be checked with a lawyer eventually, but we'd like to avoid involving lawyers in the initial drafting of the conditions and the initial discussions of them.

It'd be great to hear stories of what can go wrong from the point of view of the company executives, from the point of view of the persons receiving the stock options, and from the point of view of more distant shareholders/investors. Any relevant links would of course be very welcome.

Basically, what should we worry about?

PS: Alternatively, if you know of other share transfer mechanisms that would be useful at a stage where just diluting the stock and buying the additional shares outright is too expensive, please do mention those too...a

Strike price being set too high is one thing. The ability to sell those options (rather than having to exercise them) -- this is an issue with the liquidity of stock options. Rights after an individual leaves the company.

For the PS: There could be some financial engineering involved with creating convertible bonds and selling those at a discount to employees. Again, we run into liquidity issues.

Here's something from the wikipedia page on Convertible Bonds:

Hybrid bonds typically are issued as loan capital, but the issuer retains the right to exchange or convert the bonds into convertible preference shares with similar conversion rights and income. The purpose is generally to ensure that the bonds (as loan capital) have the tax offset-ability (against taxable profits) of loan interest, and perhaps pay gross to qualifying investors. At the same time, the ability to change the bonds into cumulative or non-cumulative preference capital should mean that they pose less balance sheet risk. The issuer only achieves the best of both worlds if the hybrid bond is structured so that non-payment of interest does not constitute an event of default.

http://en.wikipedia.org/wiki/Convertible_bond

Convertible bonds would still require paying for the shares, right?

Part of the problem is that the shares are too expensive for the recipients of them to just buy them. Essentially, they should have been allocated as initial founder stock but weren't (due to various reasons that I won't go into).

At the moment, from what I hear, stock options seem to be the best way to allocate shares without needing a large transfer of money from the recipients of the shares to the company (or some other party).

Just to clear up, I am advocating zero-coupon convertibles.

Yes, you'll have to get the corporation to cover the cost of the shares. However, convertibles will give you a tax break since they go onto balance sheets as a liability, and so they effectively give you a ~35% discount.

The flip-side is that recipients will have to pay taxes on the implicit coupon payments. You really need to talk to a corporate accountant to get more details, and whether this is even a legal option for you, but definitely look into it.

EDIT

I misread your question. The payment becomes the responsibility of the issuing corporation, not the individual receiving the stock. That is a more clear answer :)

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