Dear Unicorn, Exit Please
techcrunch.com
techcrunch.com
Second, the bogeyman of "letting some strange interloper see our books" is a myth. Every company's share plan that has share restrictions, also does not confer disclosure rights to common shareholders. That is, you have no right to see the books if you're a common shareholder in these companies. It's not the same with public equities as it is with this new round of startups. It used to be that case that you exercised 1 share of stock upon hitting your cliff. That way you could see the books and see what's really going on. The powers that be (Hello YC) have instructed their companies to remove disclosure rights as a workaround.
The myth that "having lots of shareholders increases costs too much" is also just a myth. Any company with a valuation north of a few mil can afford a finance team (or person) to keep track of registered shareholders. There are services that do this for you. We're talking about companies worth billions of dollars, not the corner bakery worried about the cost of flour because any rise might drive them out of business.
Also, Peter Thiel always told his portfolio companies to allow 83b elections. It's smart for the employee and the employee. I guess it's a changing of the guard from the Founders Fund types to the YC mania today.
Founders and key early hires, who may be receiving restricted stock (not options), are in a different camp because they're receiving stock, not options.
No, it isn't a myth. I used to work for a company which had to re-incorporate for various reasons, and had three shareholders too many; They managed to buy them out before the reincorporation, but it was a big problem (with lots of drama), and if an agreement wasn't reached, the company might have had to fold, and would definitely not have been as profitable, if it couldn't reincorporate.
IIRC, in the US it's 500 shareholders; We were subject to laws in several countries, the minimum of which had 40 shareholders trigger these problems. Regardless, it is not a myth -- having lots of shareholders has weird and unexpected costs.
You might have been forced to fold for reasons, but having 500 shareholders wasn't one of them. Going out on a limb here, but it sounds like there were lots of other serious problems and cap table length was a minor one.
They couldn't have more than 40 shareholders, and they quite clearly were affected by this.
Also, the JOBS act is from April 2012. Almost every ESOP, ISO etc. plans in effect today were prepared and enacted before the JOBS act.
The problem is that 83(b) elections just aren't applicable unless (i) you own stock, not options, and (ii) that stock is subject to vesting.
Longer explanation: When you buy something, if you are paying less than the fair market value for that thing, then the spread is taxable income to you. Typically this spread is calculated at the time of the sale, so if you're buying shares at $0.0001 per share and they are currently worth $0.0001 per share, you'd think there would be no problem. But the IRS says that if shares are subject to vesting then the spread is actually calculated at the time that the shares vest. So a common case would be that you buy shares now for $0.0001/share, next year you hit your cliff and a bunch of shares vest, and at that point the price has gone up to say $0.001/share, and you would then owe taxes on the difference between $0.0001 and $0.001 per share. The 83(b) election gets you out of this trouble by letting you say at the very beginning that you want to be taxed on all shares up front, so the spread is calculated on day one, and is 0, and there's no tax liability.
So if you own shares and they are subject to vesting, either by a purchase of restricted stock or an option exercise, then yeah, make an 83(b) election and you can do that with or without the company's permission. But if you just own an option that you haven't yet exercised then an 83(b) election just doesn't apply and it's not something the company chooses to allow or not allow.
It's just you have to return the unvested stock when you leave?
As an employee though, you can always vote with your feet. When considering a job at a startup, you should go over the stock option plan and ask hard questions. Remember... the founders (generally) don't have stock options. So sometimes founders at small startups don't even know the implications of the stock option plan they've created, and might be open to changing it if it means the difference between hiring you and not hiring you.
And for the larger companies that have thought about it, you can always pick the ones with more employee friendly plans. The higher the initial value of the company when joining, the harder it is to exercise options if you can't sell the stock immediately (because you have both a high exercise price and taxes on gains). So this can be a non-trivial difference between compensation offers at bigger companies.
However, the private market liquidity is always controlled by the company, and that can create artificial boundaries on timing and volume, which can be trouble if an employee wants to leave on their own schedule.
Also remember that if your $5mm company becomes a $1b unicorn after 4 years, and you got %0.5 at the start, then through dilution your %0.5 stake can become a %0.05 stake. Which means you get $500k / 4 years = $125k/yr in stock. But you cannot sell that stock, so it would of been better to go work at apple. It's very rare that a startup will pay better for an employee better than the big cos.
Yes, as I noted above I do agree that volume constraints are an issue and are pretty annoying. Even in the examples where you get to hold options for 7 years, you wouldn't get the ability to sell at the "peak" (if you think there is one) unless the company was public.
There are many things you have to take into account when valuing stock options, and from a purely compensation basis I agree that Apple/Google/Facebook are going to be tough to beat.
http://www.scribd.com/doc/55945011/An-Introduction-to-Stock-...
The "summary" section had a good list of questions, and if you read the document you'll have all the background necessary to understand their importance.
There was a good thread or subthread on this recently - can't find it.
The company has a large bag of tricks to dilute your options, if desired.
I had this discussion in depth with a Valley CEO a few years back. The best indicator you get as a candidate is that the CEO has rewarded employees in past exits.
Now focusing on the numbers could theoretically prove you're getting a bad deal, but it can never prove you're getting a good deal.
(I'm guessing the "hard questions" start with total shares/options outstanding, valuation, and liquidation preferences).
I was very lucky - when I left I was able to just barely cover exercising everything by liquidating my non-retirement investments and savings, then sell enough on the secondary market (which took many nerve wracking months) to cover the AMT bill, pay myself back and set aside enough to pay the tax bills for selling shares.
Very much "Silicon Valley Problems", and I don't expect much, if any, sympathy - especially since I had a good outcome. I'd just like to see the AMT rules changed to make it easier on employees who don't have the luxury of liquidity.
Cash is cheap for a few large banks and other organizations rolling in money. Not for the middle class / upper middle class employee.
Capital losses are only allowed to offset your normal taxes by a small amount in the USA.
Also companies drag their feet in getting you the proper documents that you might be missing. It can take months and those 2-3 months later, ESO isn't interested anymore. It's happened to me.
A seed stage startup? Sure. But if Uber made you an offer tomorrow, would it really be prudent to value the equity at $0?
It's not very true for unicorns. Stock in the unicorns is going to be worth something -- it's just frustrating to try to realize that value right now.
Employees join for a number of reasons but stock compensation is one of them. This compensation has always been risky and hard to value but it is now becoming risky, hard to value and even if the company succeeds the compensation won't be realized for a very long time.
Going public has significant downsides and substantial on-going costs (for example, reporting), but it is one of the few ways value can be taken out of a company by shareholders. I wish there were another way.
If the party line is: "hey, we are going to be a billion dollar company!" and then one employee says "hey, I want to sell at this $100M valuation", even if the $100M is a solid upside from the employees strike price the next natural question for the founder is: "hey, why would you sell at this valuation if we all know we are going to unicorn?"
Lots of people are reasonable and could understand many good reasons to sell at that point, but in high-growth culture those are not always appreciated. Sure, employee can/should suck it up, but it still makes it more challenging.
Generally, I think this is why company's should more regularly organize secondaries, it removes this dynamic to a certain extent.
Because I want to buy a house with a fire pole.
That's the market that should determine the value of the shares obviously. The last price fetched on that market. Whether its liquidity is high or low, it's still a viable market, even if it's not the public stock market.
If they are RSU's , I am assuming they can't be sold at all in the private markets ?
Can anyone with prior experience elablorate on these ?
Buyers are generally hesitant because they want to get financial info and other private data to make an analytic investment decision. Given that VC-style investment are more normalized now and they aren't as based on fundamentals, investors are definitely more willing to invest without private financials BUT really large asset managers (who spend 99% of their funds on public stocks with their expansive disclosures) will not tolerate this, limiting the market. Besides, they are getting common stock, which sucks compared to the other investors who get preferred stock.
Companies don't usually want this to happen because they don't want a shareholder (who has voting and other legal rights) that they don't know or trust, and who is not aligned with them in the way that employees and VC are (supposed to be..ha).
The solution growing in popularity tries to deal with all of these by having a company organize a secondary offering, like what pinterest does (palantir does it too, twilio recently did, so do a bunch of companies). Usually this means the company knows the buyer (sometimes an existing investor) and basically gives them the info they would give a VC, except the investors buys employee shares rather than new stock - sometimes this will be asked for an investor when they are doing a preferred stock deal, and the investor will agree as an additional "company favorable" term. Important to note here too, that USUALLY the biggest sellers in these deals are the founders, so while it's a very nice thing for them to do for their employees, there's some healthy self-interest there as well =)
To solve this, it seems like a more likely path is longer exercise windows, more liquidity in the markets for stock and/or options. If we're talking about "unicorns" like AirBnB, Uber and such, I imagine there is a demand so if a way for buyers and sellers to come together existed, it could work.
There are some advantages companies would be forgoing, but it's not like going public just to let employees cash out.
Huh? The exercise price for options is established when employees are granted stock options, which almost always occurs at the beginning of employment. Employees can calculate the total cost of exercise based on the information contained in the Notice of Stock Option Grant. You can and should ask for this information before you join a company.
If you are granted 100,000 options with an exercise price of $0.20, you know that the total cost of exercise (assuming full vesting) will be $20,000. The company's valuation could increase fifty-fold and it wouldn't affect the cost of exercise.
Companies with skyrocketing valuations can be precarious for employees who join late, but here too employees can calculate everything up front and they should take into concern liquidity risk when evaluating what their options are really worth.
Very few articles on ISOs and AMT highlight the minimum tax credit that is applied when the amount paid under AMT exceeds what would otherwise have been paid.
What if you exercise a little every year, triggering AMT each year? No credit for you and the credit is reduced the older it gets. Like you said, each situation is different, but most people are going to pay a boatload in taxes on this and not be able to claim it as a credit later on.
Of course IF you are lucky enough to have $20K sitting around, enough faith in your company the day you get your options AND your company lets you early exercise, then you can avoid this. Unfortunately, for most folks those conditions are not all met =(
And even after that you're holding a non-liquid asset which could be diluted to nothing or the company could simply fail and you can't dump the stock.
I'd argue that it's in the employees' best interest to realistically value the equity portion of their compensation package.
This is another case in the world where having money helps you make money. I think most people rationally understand that it often takes money to make money, but the startup scene is usually portrayed differently.
The only escape from this problem is an 83(b) election, which I've heard many companies say they don't allow (IANAL and am not sure what the circumstances are here). It's also the case that with an 83(b) election you are putting real money, potentially a significant amount of real money, into the company's bank account with no expectation of when that investment will become liquid. So this also has risks, but at least the AMT is on the spread, which is $0 in this case.
AMT credit is worthless unless your salary income is around $300k+.
AMT should not apply until you actually liquidate capital gains, but good luck getting that kind of thing passed or addressed.
The IRS now expects you to pay tax on your $980,000 in income. However, your stock is not liquid, so you can't sell it. This is why you can need "millions" to acquire your options.
1. Exercise your options, pay potentially huge taxes on it, and be left holding stock that is practically worthless because you can't sell it
OR
2. Give up your options and move on with your life
I know what I'd do.
(Hint: this is where part of the SV age discrimination comes from)
* When the company has an IPO, you only pay the Long Term Capital Gains tax rate (20%), instead of the standard income tax rate (39.6%).
* Once your stock options have vested, you have the freedom to leave at any time without worrying about taxes or losing your options.
So you can risk tens of thousands now to potentially save hundreds of thousands later, in addition to giving you some freedom.
It's very risky. The company might fail. The company might be successful, yet never have a liquidity event (acquisition or IPO). But you only join a startup if you believe it has a good chance at success. You're risking a huge amount of time and effort, so you may as well risk a bit of cash too.
And even just thinking about the stock price, $20,000 can be a lot of money to spend on something you can't sell.
The overhead, requirements and legalities are there for a reason. If you've raised $10b, you can afford the overhead dollar amount; but can you afford the visibility?
It's very hard for a tech company to thrive in that kind of environment - capital expenditures required to develop new products or enter new markets will often not be profitable for several years, and getting the public market to understand that is impossible.
I mean, is there some kind of truth that it's harder for public companies to do ultra-long-range moonshot stuff? Maybe. But the idea that this is what's keeping Uber or AirBnB or Palantir from going public is ridiculous.
When private funding is available, IPO is not needed by definition. And since comp structures are set up with the expectation of IPO or exit, it's employees who are affected.
If you are negotiating an offer with a private company, you should attempt to price the risk of having to forfeit your stock comp. This risk has increased recently (that's what this story is about) but most people still under-negotiate it in their offers.
The biggest factor, in my opinion of course, is that some large private investors realized that they could capture most of the upside in an IPO before the IPO actually happened. The first real example of this is DST and Facebook. This has obvious advantages for the private investor -- they get access to a source of high quality risk for their portfolio. It also has obvious advantages for the company -- they get access to capital without having to manage to Wall St's expectations (and that's no minor thing).
Facebook was sort of the proto-unicorn, and it spawned imitators. Those imitators were not just startups, it also spawned imitators on the investment side. Suddenly a source of relatively easy money -- the initial IPO allocation in "sure thing" companies -- weren't available to the usual suspects, and those funds have naturally followed the leaders into the D, E, and F rounds of the new breed of unicorns. These deals are even accessible to relative small fry now -- private bankers will routinely shop around access to these funding rounds to people with assets "only" in the 10's of millions. Sometimes they're shopping a theoretical deal that they want to present to the company in question, and sometimes they're shopping AirBnB.
At any rate, many of the gains you used to be able to get in companies like Amazon or Google are now going to people able to get access to these pre-IPO deals. Financing private companies is very different now than it was 5 years ago.
Unicorns and Valuations are like Schrödinger's cat... until you open the box they are neither dead or alive, not worth 10Billion or Zer0
I'm sure it would be in a company's best interest to chain their people to desks too. We don't allow that, for obvious reasons.
Seriously, fuck this "unicorn" shit and fuck that whole culture of juvenilty that comes out of the polar vortex of immaturity called Silly Con Valley.
Speaking of unicorns, if you want something to hate for the next few minutes, watch this video: https://www.youtube.com/watch?v=bMJIBxtDUHc .
Cry me a river, basically. If this is a serious issue that needs to be addressed, it's at most inside baseball not worth the rest of us worrying about.
Seriously, how many employees are there in the world of companies that could take "please exit" as serious advice? A few hundred, tops? And these are hardly impoverished folks to begin with, they could get solid six figure jobs at established tech companies in most cases. So why are we crying for them?
Stock-Option-Holding and often financially restricted from exercising.