15 ms·

Employee Equity

• porterhaney 12y ago
  Adding to Sam's post I'd like to see employees made aware about tools like 83(b) elections to decrease their tax liability.
  • x0x0 12y ago
    do you (or anyone else) know what happens if you do an 83b election then leave the company before 4 years? Also, this doesn't really help post A, particularly if you're getting pretty senior and have a bunch of experience. At my last place, I would have had a $50k bill to do an 83b. I could write that check but goddamn is that a lot of cash to part with. edit: thank you @rosser
    • rosser 12y ago
      Typically, the company will buy back unvested shares at the strike price if you've forward exercised them.
    • the_watcher 12y ago
      Ask to forward exercise when joining. From what I understand, there isn't a negative impact on the employer, you are just being granted RSU's that they have an option to buy back for $0 before your cliff, and then convert to ISO's at your cliff. You can file that 83b election immediately, which will substantially drop your tax burden.
      • x0x0 12y ago
        right right, but I have to (1) come up with $50k in cash (in my example), and (2) if the job isn't working out, I want the fraction of my initial payment back upon leaving and it isn't clear this happens...
        • Matt_Mickiewicz 12y ago
          Early exercise makes the most sense for seed stage companies where the exercise price is still low... at companies where you have to spend $50K or more to exercise, I've seen loans being handed out by the company to its executives to make it possible for them to take advantage of it.
          • lhnguyen09 12y ago
            Any insight into why a company wouldn't allow forward exercising? The legal/finance team at my company refused to do it, though I wasn't given an explanation why.
            • hundt 12y ago
              * It's extra hassle/paperwork. * Employees have less incentive to stay because they won't run into the AMT "handcuff" situation (where if they leave they have to exercise their options or lose them, and they can't afford to pay the taxes to exercise the options). * More employees will actually exercise their options before liquidity, which means more minority shareholders.
      • Matt_Mickiewicz 12y ago
        Yep, we offered this to all of our employees at Hired after our seed round, but before our $15m Series-A. The majority took the early exercise option once they understood it. It's a massive lift for our team (based on tax savings) when an eventual liquidity event occurs, with no downside for the company other than additional paperwork and some legal costs.
  • rosser 12y ago
    I actually had to explain 83(b) elections to HR at my current job. I don't think it's just employees that need to be made aware of them...
  • 100k 12y ago
    I have tried to figure this out: is there any point to doing forward exercise and 83(b) election with ISO options, which is what most employees get?
• runT1ME 12y ago
  >Perhaps the best way to think about it is to try to come up with a total compensation package with the same expected value (using the company valuation of the last round, or a best-efforts guess if it’s been a long time since the round) as the employee would get at a big company like Google Am I missing something or is this saying people should be offered an 'expected' equal compensation package to what they would get at Google? What would the incentive be? Google is a company with quite a bit of projected longevity, career progression, and very good perks. Why would I choose a startup with inherently greater risk for only the same reward?
  • the_watcher 12y ago
    I think he is saying to use the "expected value" calculation that guys like Michael O. Church and the others who warn of the dangers of overvaluing options. Generally, this applies a heavy discount to the potential value of the options to account for the increased risk. So the compensation package should be salary + EV(options) ~= big company. That leaves substantial upside in the case of a success (and if you are joining a company and taking any options at all instead of salary, you should be betting on this anyway). Google may not be the best company to pin to, since they offer pretty generous stock grants from what I understand.
    • x0x0 12y ago
      The problem with ev calculations is variance (as Michael O, et al, will no doubt forcibly assert.) Employees in the bay area housing market are probably better off taking a lower ev with a corresponding much much lower variance.
      • the_watcher 12y ago
        That's probably all true. My only point was I don't think Sam was saying to make the compensation package that equals what you'd get at Google based on the most optimistic outcomes, but on a true, expected outcome using some broader averages (which leaves room for upside).
    • 12y ago
• lpolovets 12y ago
  This is a great post, and I agree with almost everything Sam wrote. I think problems #1 and #4 are unfair (you might get less than you deserve, or less than you thought you were getting), but problems #2 and #3 are extremely unfair (you can't take what you've earned with you if you leave the company, or you have to pay taxes on something that has no liquid value and might not have any value in the long run). I'd love to get Sam's (or anyone else's) thoughts on the 10%/20%/30%/40% 4-year vesting schedule that was mentioned. I don't like this schedule for two reasons: 1) It creates larger discrepancies in what employees earn over time relative to each other. If employee #1 joins today and gets a 2% grant, and employee #20 joins in 2 years and gets a 0.2% grant, then in year 3 of the company, employee #1 will vest 30x as much as employee #20, instead of 10x with the current 25%/25%/25%/25% scheme. 2) This scheme seems to replace and/or ruin refresher grants. Currently, if you do a good job, you get refresher grants every year or two. With the 10/20/30/40 system, you're already getting higher and higher compensation over time, regardless of performance, and the bump from refresher grants while you are vesting your original grant becomes minor. Furthermore, the drop from what you vest in year 4 to what you'd vest from just refresher grants in year 5 becomes much more dramatic and much more likely to push someone to look for other work. What do others think?
  • gfodor 12y ago
    The back-weighted scheme is also problematic because sets up a perverse incentive to consider letting people go at the end of their second year unless they are all-stars, since the company ends up keeping 70% of that equity and gets 2 years of hard work out of the person. With an even weighted scheme there is no time-dependent tradeoff like this to be made, the employee continually earns shares at a fixed rate and as long as they are contributing managers never have a hard "decision point" to make with regards to their shares.
  • x0x0 12y ago
    The problem with back weighted grants (and amazon is famous for this) is that the companies that do it are the ones who ride developers raw and are doing it to attempt to stanch horrific employee turnover. Well, I guess I'm generalizing from the example of amazon, but really, is that the company you want to keep? My take on it as a startup employee is (1) no, (2) hell no, and (3) your company sucks and you are doing this to attempt to lock me in. Also, hell no.
• x0x0 12y ago
  The best solution I have heard is from Adam D’Angelo at Quora. The idea is to grant options that are exercisable for 10 years from the grant date, which should cover nearly all cases That is an awesome idea, and really classy on Adam's part.
  • codezero 12y ago
    It's a great idea, and Adam is classy for a number of reasons, but having just left Quora, I only have 90 days to exercise my options, so it's not something Quora is doing right now, which is what the article seems to imply.
    • jayp 12y ago
      I think you should hit up Adam and see if he can provide you with a 9-year 9-month extension. If not, you should let Sam know so he can provide an update clarification on the article. There is also a precedent for such type of clarification updates in YC family. YC founding partner, Jessica Livingston, provided a clarification with respects to Sabeer Bhatia of Hotmail vs. DFJ ventures based on the statements Bhatia made in an interview with her for the book "Founders at Work".
  • JonFish85 12y ago
    From a company's point of view, wouldn't that really suck, having all of these outstanding shares in limbo? I'd imagine at least part of the 90-day thing is just so that the company knows the status of those shares. For an employee, the company is holding those out as a carrot for you: someday those shares might pay off, if you work hard. For a former employee, he/she gets 90 days to decide whether to pony up the cash for the company (who gets money in exchange for the shares), or they get the stock back to give to other employees. Having to keep track of "large" (unsure of how to quantify that) percentages of the company that might be purchased at a later date seems like a liability that the company wouldn't want to have to track, especially as a startup with other things to focus on. They're useless to the company, the only upside is for the employee.
    • 12y ago
• andrewfong 12y ago
  I've been thinking of putting together something simple to analyze employee option paperwork and add some plain English annotations to help employees understand exactly what they're signing. Based on my experience, there's something like 5 or so templates that cover 90% of the startups in the valley, so shouldn't be too hard. Is there any interest in something like this?
  • the_watcher 12y ago
    This would be fantastically useful. Please, do this. I looked, hard, for this in the last month. If you need it, I'll talk to my employer about creating a template with dummy information based on my package.
  • filmgirlcw 12y ago
    Please do this! It's not just valley startups that are confused by this -- other cities are too. And as you say, there are usually 5 templates that cover the vast majority of cases.
  • conorgil145 12y ago
    I agree that a resource like this would be incredibly valuable for startups and employees outside of the valley too. Even though they may not have the same details, the annotations may help explain general concepts and terms which are important. I had a comment on another thread recently proposing something in a similar vein to help employees understand what their stock options mean/are worth: https://news.ycombinator.com/item?id=7584320 https://news.ycombinator.com/item?id=7584320
  • betadreamer 12y ago
    Yes!! This will be very helpful
  • dylanlacom 12y ago
    I agree, this would be awesome.
  • jacobheller 12y ago
    We at Casetext are interested in this space as well. Our annotations technology will undergo some major improvements in the near future, but even the way they are today may be sufficient to meet your needs. Hit me up (jake at casetext.com) if you want to work together to make this a reality. Here's an example of what docs look like on Casetext now: https://casetext.com/contract/simple-agreement-for-future-equity https://casetext.com/contract/simple-agreement-for-future-eq...
• aferreira 12y ago
  Regarding the question of knowing what percentage of total equity your stock grant represents, most companies that are not incredibly early stage will simply not tell you. Pushing the subject further will make you look like you're nosing around where you shouldn't, often leading to the offer being dropped (this has happened to me). Not to say it wasn't a not-so-great company to start with, but a dropped offer is a dropped offer.
  • minaguib 12y ago
    That really makes no sense. "Here are options to buy 10,000 shares" "Umm. Thanks. Is that a lot ? Is it peanuts ?" Without knowing the second number you might as well not be having that discussion.
    • aetherson 12y ago
      Yeah, it's crazy. But it's super-common. I always ask how many shares are outstanding, and nobody ever has the information at hand. It's like they said, "We're going to give you 10,000 units of some currency. But we won't tell you whether it's a Zimbabwe dollar (current value: $0.002) or a Euro (current value: $1.38)."
  • joeframbach 12y ago
    I kept pushing, and wasn't told. I ended up leaving not long after. I should have left on the spot.
  • lauradhamilton 12y ago
    A reputable employer will tell you what percent of the company the stock represents. Simply knowing how many shares you were granted without knowing how many total were issued tells you nothing about what your shares are worth. If a company wants to issue you shares as compensation but won't tell you how many total are outstanding, run.
  • fishtoaster 12y ago
    I was lucky that my first job was upfront about what I was getting (%, # options, and outstanding shares). I like to think that I have enough confidence at this point that I would refuse a company that wouldn't tell me what me equity is worth.
• mikeleeorg 12y ago
  Very interesting. I like this train of thought. I have a lot of developer friends that would rather (and are) pursuing their own entrepreneurial ideas than join an existing company. While I wholeheartedly support that, the flip side is fewer startup-savvy developers available to join other startups. There are a lot of reasons why they are pursuing their own ventures. A common one is: "It's not worth it to be an employee of a startup. You need to be a founder. (Or maybe employee #1-5.)" You may disagree with that belief, but it's certainly a belief many hold. Sam's suggestions may take this reason off the table.
  • tensafefrogs 12y ago
    > "It's not worth it to be an employee of a startup. You need to be a founder." Yup. If you can get a job at a tech company that offers high compensation, you will likely make more there (and gain lots of great experience) than you will at a startup. Look at the value over 4 years: - Startup salary (~$100k-ish) vs. Tech co (~$140k-ish+) - Startup equity could be worth $1,000,000 if you get 1% and the company sells for 100 million (obviously there can be other factors here, but lets just use that number) - Large co. Stock grant could be 150k-200k+(or more!) over 4 years, and you'll likely get refresher grants on top of that each year. And the stock price will likely go up over those 4 years. So after year 4 you are making quite a bit off of your vesting stocks. There's also a pretty good chance the startup will fail, which would net you nothing but a sub-market salary for the last few years, so it will be harder for you to negotiate a higher salary at your next gig. Or if you are acqui-hired, you'll get some small hiring bonus and then have to wait 4 more years for your new stock to vest. To me, the only time joining a startup and taking below-market compensation is if you are just starting out and want to gain some experience you might not get at a more established company, or perhaps your skills aren't up to par so you can't get past the interviews[1]. Or maybe you just like the "startup culture", and that's cool, but why not start your own thing instead? [1] Note that if your startup gets acqui-hired, you'll probably have to interview anyway, which could result in not getting an offer!
• birken 12y ago
  The problem with the 10%/20%/30%/40% thing is that if the company shoots way up in value, an employee could theoretically be fired after two years and not capture much of the value they helped to create. It also doesn't necessarily need to be malicious [1], sometimes companies change and a person's skills aren't as valuable anymore. If I were a prospective employee I would never take a deal like this, because it is really difficult to have that much trust in a company and founders that you likely don't know that much about. I can't say the standard 4-year vest with a 1-year cliff is the most optimal situation, but from an employee perspective it is way better than 10/20/30/40. 1: Though it could be, I know there was a story about something happened at Zygna like this
  • johnrob 12y ago
    Great point. In dollar terms within the respective vesting years, 10%/20%/30%/40% might look something like 5k/100k/200k/500k, which is extremely back loaded (and could help explain the Zynga 'scandal').
  • brudgers 12y ago
    The scenario is little different from any other where someone lacks a controlling interest. Controlling interests can sell the company to another company they control at a price that suits their interests. They can issue shares to dilute equity and use the shares to acquire a company which they also control. Any legal action agaist such practices can be defended on the company's dime. In other words, if scumbags control the company, scumbags control the company. Fortunately, most people aren't scumbags.
    • michaelochurch 12y ago
      In other words, if scumbags control the company, scumbags control the company. Fortunately, most people aren't scumbags. Most people aren't, perhaps. Most people who have the connections to be VC-funded startup founders are scumbags.
      • 603techguy 12y ago
• diziet 12y ago
  It's quite difficult to compete with Google and their revenue/cash hordes when it comes to salary / total comp. Especially if you price the options at the last round's price and discount them some more. Imagine a well to do company of 2 founders (in SF/Bay Area) and a team of 3-4 others that raised a seed at 10m cap. They want to grow their team headcount to 15 and are busy hiring, running servers, etc. They can offer a 100k salary (more than enough to live on) to a sort of senior engineer or PM and want to compete with Google on total comp. Let's say they need to make up the other 100k difference in comp & salary with options. Over 4 years, you're looking at a 4% equity chunk to one employee, the 6th person joining the company. Not that I think numbers in line with this aren't realistic (I do agree with Sam that more generous equity grants are better), but for most companies that make a 15% option chunk for employees it's difficult to rationalize a number like that. Edit: Also, that puts the equity comp of that 6th employee (or 10th, because in most cases you will have a similar equity bracket for those people) at about 1/8th of the founders, not the 1/200th that Sam mentioned. I wonder how many people have made offers to employees with a similar comp plan.
  • revelation 12y ago
    The 100k number isn't engraved in stone, to stay the same for 10 years. If there is a talent shortage and big houses raise salaries to pull it in, VC will have to follow up.
  • acgourley 12y ago
    It would be more realistic if it accounted for the expected growth of the company valuation. It's unrealistic that the company should be valued at 10m for the next 4 years - it's going to grow or zero. Also their salary is likely to bump. Just doing some quick numbers it might be realistic to give the same "EV" as google by granting 2.3% with no raise or 1.5% with a salary that approaches market over 4 years. I think that's very reasonable for the kind of person who is turning down a 200k/yr job to work for you.
    • paulbaumgart 12y ago
      The valuation is the expected value. And since we're talking about investors who get preferred shares, the actual valuation for determining the value of the common shares (which employees get) is lower than that, still.
• PabloOsinaga 12y ago
  I totally dig these ideas - is there any consensus docs floating around we can use for our employees? and/or is anybody implementing these ideas today? ( perhaps we can borrow their docs ). Thx
• rdl 12y ago
  I don't think the 4/1 aspect of vesting is a particularly big problem. If you are enjoying your job at 4 years, the job has probably changed substantially, and you can renegotiate for a refresher grant. I don't see any problem with restricted stock pre series A, when equity is the biggest consideration for employees. As long as financing is notes, the common hasn't yet been priced, so you can just use a very low value. Willingness to issue refresher grants is easy for CEO and board to change. I don't think you need to be as open as buffer, but being open with percentage ownership and financials seems obvious. RSUs with a performance modifier already cover most of this for larger companies. Something like that for startups probably wouldn't work since so much of the risk is company-wide vs. individual.
  • prostoalex 12y ago
    Most people don't know how to renegotiate, and by the time they need to do it, they've negotiated their compensation at some other place and are giving a 2-week notice. Founders/management need to be proactive about this. Good school of thought on this is Andy Rachleff of Benchmark / Wealthfront https://blog.wealthfront.com/the-right-way-to-grant-equity-to-your-employees/ https://blog.wealthfront.com/the-right-way-to-grant-equity-t...
    • rdl 12y ago
      It would be cool if people got a "career manager" who helped them with this kind of stuff on an ongoing basis (at least within a given job, if not across companies for the duration of a career). If you trust the founders, they can probably help you up to ~50 person companies like this, but there is an inherent conflict of interest.
• johnrob 12y ago
  The easiest would be if the IRS would agree to not tax illiquid private stock until it gets sold, and then tax the gain from the basis as long-term capital gains and the original value as ordinary income. I think employees would be more than happy to treat all of this as ordinary income, if that would make it more appealing to the IRS.
  • prostoalex 12y ago
    Why? Worst-case AMT rate is 28%, worst case income tax rate is 39.6%. If you have a choice and means, you want to pay AMT.
    • johnrob 12y ago
      It's a quid-pro-quo. Right now, if a company gives you private stock you have to treat it as income and pay taxes for it. It's not real income yet, since you can't sell it, but you pay taxes. Later on (hopefully), the stock turns into real money and you pay the (lower) long term capital gains rate. What I was proposing was: Hey IRS, if you let me skip the taxes early on, I'll pay a higher rate down the road. I will gladly sacrifice long term upside for short term risk in this particular case (since the odds are already so heavily skewed in the other direction).
      • prostoalex 12y ago
        > Right now, if a company gives you private stock you have to treat it as income and pay taxes for it. It's not real income yet, since you can't sell it, but you pay taxes. I think RSUs do exactly that. They're taxed at conversion time which typically coincides with a liquidity event. At issue time they're not treated as income precisely due to restricted nature of it.
        • johnrob 12y ago
          After some googling, I agree with you. RSU's are much better than options. So... The solution to the problem of better compensating employees could simply be giving RSU's in place of options.
• awicklander 12y ago
  There's another option that people never seem to talk about. Treat people well, give them a good working environment, and give them a fair salary based on the fact that they don't have any equity. Most engineers I know with stock options and a discounted salary would have been much better with a higher annual salary and no stock options at all.
  • zacharycohn 12y ago
    Sometimes there is not money to do that.
    • gohrt 12y ago
      If the idea can't get angel funding or a bank loan, then perhaps the idea isn't good enough to build.
      • zacharycohn 12y ago
        Or the founder prefers to bootstrap it?
  • prostoalex 12y ago
    This is attractive for someone out of college, but if you're trying to attract someone senior with a YouTube/Google/LinkedIn/Facebook/Twitter exit in their resume (and sometimes multiple of those, not that uncommon in the Valley), your fair salary is likely to be less than the total package they can get elsewhere.
    • Iftheshoefits 12y ago
      In that case odds are the startup doesn't have sufficient funds to pay for the talent it (thinks it) needs. I'd argue that this means the startup is: a) mistaken about its needs; b) poorly run; or c) a bad idea (e.g. the price the target market is willing to pay is insufficient to support even the optimally efficient startup's costs to provide service).
• filmgirlcw 12y ago
  This is a fantastic article. Sam is dead-on that the current situation isn't fair and often offers employees little to no information about how the options work. The 90 days to exercise thing is a real bummer -- for lots of reasons. As Sam says, not every employee is in a position to relinquish that kind of money for the options and taxes. I would say that if you are looking to go someplace else, depending on the size of the company and the situation, it's not out-of-line to try to value the options you won't get to exercise (or even the exercise price) into your new salary. Most companies aren't going to be willing to give you what you need to vest-out upfront, but it is a good way to negotiate either a one-time bonus or higher salary.
• sskates 12y ago
  I'll be forwarding this to our lawyer when we implement the legal paperwork on our stock option plan. We already do 1) and 4) as much as we can. If anyone here has any ideas of how else we can be more friendly to employees with regard to equity I'm all ears.
  • mahyarm 12y ago
    #2 is the biggest one of them all. But it will be really hard to convince start ups to do this, since it has a big golden handcuffs component to it if the start up gets some decent momentum. #2 will also simplify tax planning considerably.
• zosegal 12y ago
  I think the Wealthfront Equity Plan is pretty interesting: http://firstround.com/article/The-Right-Way-to-Grant-Equity-to-Your-Employees http://firstround.com/article/The-Right-Way-to-Grant-Equity-...
• ChuckMcM 12y ago
  I am a fan of giving options every year with a performance multiplier. That way the high performers are rewarded with more options and your available options are more accurately divided amongst the employees who have made the most impact. When you are not yet cash flow positive as a startup you can give 'bonuses' in options rather than in cash. I don't know if we could figure out a portion that employees could contribute to additional investment rounds if they wanted to take some money off the table.
  • enjo 12y ago
    How do you define performance? It's a fantastically difficult thing to define. In my experience every attempt at this (at least for engineers) ends up in a situation where people are putting their effort into maximizing metrics as opposed to furthering business goals. We completely decouple performance reviews from compensation. Full stop.
    • prostoalex 12y ago
      What? Why? Don't the overachievers then become bitter knowing that the guy next desk to them is making more by working less, just because he was better at negotiating at some point?
      • enjo 12y ago
        We solve that through careful hiring, and not being afraid to part ways with folks who can't get the job done satisfactorily. Interestingly we decouple the two precisely because of what you're describing. When you start singling out specific people, other folks who are also doing very good work pretty quickly become disinterested in their job. That's bad. Even worse, measuring ACTUAL value to the company is really really difficult (I'd suggest that it is impossible). So now you are in real danger of driving your most valuable people, the ones your system failed to recognize, out the door. That's bad news.
        • prostoalex 12y ago
          Do you then have a flat compensation that's known to everybody in the company?
• spo81rty 12y ago
  This is where having a startup outside of the valley is nice. Nobody where we are (KC) really even expects stock options. We just pay a good competitive salary and don't have to compete with someone like Google paying 2x as much. We have given some people stock incentives but because we pay well and competitively it isn't the primary compensation. The costs of running a startup are so much lower here.
  • larrys 12y ago
    I'm curious why the people who are not in the valley don't go to the valley. Is it because they: a) aren't motivated to b) don't know what the potential is there may not even know what is going on. May not even know about YC or VC's etc. c) don't think there is potential there (think it's all over hyped and focuses on a few people who win). d) have family obligations which prevent them from moving to the valley e) Other reasons? Thoughts?
    • lightsidelabs 12y ago
      Some cities are really nice places to live with unique resources of their own. In Pittsburgh, for instance, there are fewer interesting software jobs but a beautiful city with a lot of exciting non-technical things going on, a healthy ecosystem around Carnegie Mellon, and very nice 1-BR apartments in the best, most central and walkable parts of town for $800/month. Not everything needs to circulate around the moonshot opportunities of the VC ecosystem.
    • runako 12y ago
      Reasons I've heard: - Cost of living relative to expected salary is too low. - Can work for big public companies that pay well in lower-cost areas. - Weather preferences. - Family lives thousands of miles away from SF. - Over 30, still interested in doing technical work. - Want to own a home, not a millionaire. - Interested in starting a business, low-cost matters if not going for VC. - Found interesting & challenging technical work elsewhere. Etc. This is kind of like asking why people didn't all move to NYC in the 2000s, or Texas during the oil boom, etc.
    • sscalia 12y ago
• aetherson 12y ago
  I don't understand why options are taxed at exercise. You aren't getting money out of the transaction. If you have an option to buy a share at $1 (when the share is valued at $10), and later you sell at $50, why isn't the tax treatment just that you have a $49 capital gain? Why do we instead do a $1 -> $10, and then a $10 -> $50 tax thing?
  • robrenaud 12y ago
    The stock is an asset that has value. This view makes a lot more sense when the stock is liquid and you can go and get rid of it right after you exercise your option. I agree that this totally sucks if there is no easy/public market for the stock.
    • aetherson 12y ago
      The option was an asset that had value as well. We do not generally charge capital gains on assets with values until they actually get turned into money. If a stock that you bought traditionally appreciates, or your house does, you don't pay cap gains on it unless you sell the asset in question. I appreciate that in this case you're turning an asset into a slightly different asset, and that's not like just ordinary appreciation, but I don't know why it really matters. A rule of "capital gains gets charged when you turn an asset into cash" makes sense.
  • hundt 12y ago
    This is indeed what happens if the option itself (and not just the underlying security) is actively traded. [1] However in that case, when you receive the option, you have taxable income equal to the current FMV of the option (determined by looking at the market). To do the analogous thing with startup options would (a) result in employees getting taxed even earlier and (b) require using Black-Scholes or something to estimate the value of the option, resulting in "income" that is even more divorced from reality than the current status quo. [1] http://www.irs.gov/publications/p525/ar02.html#en_US_2013_publink1000229198 http://www.irs.gov/publications/p525/ar02.html#en_US_2013_pu...
  • darkarmani 12y ago
• deleted 12y ago
  [deleted]
• applecore 12y ago
  > Founders certainly deserve a huge premium for starting the earliest, but probably not 100 or 200x what employee number 5 gets. When the founders started the company, their equity was pretty much worthless. When employee #5 is hired and gets 0.50% of the company, her equity presumably has some dollar value. Employee #5 gets a better deal than the founders, even though the founders have 100x more equity. The only thing that matters is the dollar value of the equity at the time it's awarded.
  • robobenjie 12y ago
    The dollar value at the time it is awarded matters zero. As an employee the only time a dollar value matters is when I can cash out. The problem is that you have to predict the percentage contribution of an employee from now until liquidation before they do any work. (This is why we vest options, so that if they don't contribute they don't get anything.)
  • mikeklaas 12y ago
    The employee typically gets options, not equity. They are valued at the current market value of the company and cost that amount to acquire. So the value upon grant is 0[1]. [1] modulo accounting tricks
    • thecage411 12y ago
      It depends on what you mean by value; if you mean the price someone is willing to pay for them this is clearly not correct -- otherwise every out-of-the-money option would sell for 0.
  • x0x0 12y ago
    and that dollar value is exactly $0.00 -- you can't give in-the-money-options without severe tax consequences [1] http://www.mbbp.com/resources/business/stock_option_pricing.html http://www.mbbp.com/resources/business/stock_option_pricing....
• ironhide 12y ago
  You either own the company or you're nothing.
  • ironhide 12y ago
    Down voted for telling the truth. That's the moment when you know you called it right.
    • DanBC 12y ago
      You are currently at minus 7 karma. You might want to re-evaluate your understanding of how karma on HN works. It is rare for people making factually correct statements to be that heavily downvoted.
• jbkp 12y ago
  You know, it's funny, I read things like this from time to time: "so if I have 0.5% of company and it gets acquired tomorrow for $100 million dollars, will I get $500,000?" and I remember that I am in this exact scenario, and have no idea what the answer is. I've been an employee at a startup for 2 years now. I joined when I was young, naive, and broke — I don't even remember if I read the paperwork before signing it. Does anyone have any advice for how to go about learning more about employee options? I realize I sound dumb, but better late than never. Some questions I've always had but have been too afraid to ask: - How does one exercise their options? - What taxes are there and when do you have to pay those? - In the above scenario, what factors are involved in me actually getting that $500k? - What questions aren't I thinking of because I don't know enough about any of this? For example, I've never asked about my options since signing the paperwork: was there something I would have had to do already that I haven't, and will likely screw me in the future? P.S. Throwaway for anonymity (because I am embarrassed to have to ask!).
  • runako 12y ago
    1) Go talk to HR for the documents relating to your specific situation. This is not something that will be threatening to HR. 2) Take the documents to an attorney for advice on how to proceed.
  • x0x0 12y ago
    I've exercised before. Typically, you email hr and say, "I want to exercise"; they send you some paperwork which you fill out; you write the company a check. DO NOT DO THIS BEFORE UNDERSTANDING TAX CONSEQUENCES. You will typically pay tax on the spread between strike (your price per option) and the fair market value (fmv) which is set by the board and often updated quarterly. This can also be a backdoor way of a board tightening those golden handcuffs; if you where early enough the taxes may well exceed the strike price. You should also be able to get the fmv by asking. Keep in mind these shares you're buying may well be completely illiquid and the irs wants their taxes right now anyway. A numerical example: 20k shares with a strike of $0.11; fmv of $0.39. Then I write the company a check for 2e4 x 0.11 = $2200 dollars and report income to the irs of 2e4 x (0.39-0.11) = $5600 (for amt). A nuance is if the company is succeeding, it can be worth it to buy options when they vest; it starts the clock ticking on long term capital gains and can roughly half your tax bill if and when you can actually sell the share. Which reminds me: you will pay taxes twice: once when you exercise the option to turn into a share, and again when you sell the share. If you are lucky enough to go public the company will often get a firm that handles all this for you and just gives you a check net of all taxes. A good accountant will cost $500-ish (or less) to go over your situation in detail. It's worth the money. If you already pay ab accountant, not someone at hr block or similar people who just know how to fill out paperwork, they may go over your situation for much less money. Also, you must understand amt; that can bite hard. If you don't understand amt, see that accountant.
• 7Figures2Commas 12y ago
  There are a lot of things in this post that deserve to be addressed, like the fact that the 90 day exercise period for ISOs after termination is based on IRS rules, not arbitrary company policy. But what really needs to be addressed is the fact that employee startup equity rarely produces the kind of reward that one would expect it to given the outsize attention that is paid to it. Sam writes: > As an extremely rough stab at actual numbers, I think a company ought to be giving at least 10% in total to the first 10 employees, 5% to the next 20, and 5% to the next 50. In practice, the optimal numbers may be much higher. It's worth testing these numbers against real-world data. For this, I'll use CB Insights' 2013 Global Tech Exits Report[1], which shows that: 1. 1,825 private tech companies exited in 2013. 2. Only 19 of them exited at a $1 billion-plus valuation. 3. 45% of exits were under $50 million, and 72% of exits were under $200 million. If you assume that the first 10 employees receive 10% of a company's equity, and that each employee in that group receives 1%, a $200 million exit produces up to $2 million before taxes for each of the early employees. A $50 million exit produces $500,000. If you're making $125,000/year as a senior engineer, $500,000 gross after 4 years is the equivalent of what you earned in salary over the past 4 years. That's a nice bonus, but not life-changing wealth. $2 million is nicer, but if you plan to stay in the Bay Area, you might spend half or more of that on a modest house or condo. Once you factor in the cost of exercising your options, taxes, dilution, liquidation preferences, lack of acceleration and the fact that a good portion of employees leave before fully vesting, you can see that even in a scenario where 10% of the company is given to the first 10 employees, employees aren't likely to see the type of compelling returns that Silicon Valley dreams are made of. Facebook and Twitter-like exits, where thousands of employees become paper millionaires overnight and the earliest gain tens or hundreds of millions of dollars, are the exception, not the rule. What's worth considering further is the fact that 66% of the companies that exited in 2013 had raised no institutional capital according to CB Insights. So, as a prospective employee, in joining a venture-backed company (or a company coming out of a prominent accelerator), you may be putting yourself at a disadvantage even before you take into account the fact that employee equity is most vulnerable to dilution and liquidation preferences at these companies. Final note: CB Insights' 2012 Global Tech Exits Report[2] shows similar trends to the 2013 report. In fact, in 2012, over half of exits were under $50 million and 76% of the companies that had an exit had not raised institutional capital. [1] https://www.cbinsights.com/blog/global-tech-exits-report-2013 https://www.cbinsights.com/blog/global-tech-exits-report-201... [2] https://www.cbinsights.com/blog/tech-mergers-acquisitions-deals-2012-report https://www.cbinsights.com/blog/tech-mergers-acquisitions-de...
• mrmch 12y ago
  Would it be within the YC wheel house to provide standard employee equity agreements (just like the YC note)?
• practicalpants 12y ago
  This is probably not the right vehicle to ask 'Am I being treated fairly?', but I think I will anyways. The startup is pre Series A, I'm the first non founding/non executive level engineer, I'm technically a contractor but treated pretty much exactly like an employee (I know that's a whole separate thing), I'm not the most experienced engineer, i.e. last year at my prior job I was an intermediate level but this year I would be considered senior at most organizations, I get a decent hourly rate, it's 95% remote, and my equity percentage is... .25% with four years of vesting. I could be wrong, but I've come to the conclusion that after dilution and taxes, any thing short of a billion dollar exit isn't going to be compensatory for my efforts. I don't know how correct my conclusion is, and whether I should try negotiating for more.
  • calcsam 12y ago
    You're right, with the caveat that you did accept the offer :)
  • dk8996 12y ago
    A few points; .25% seems low but; a) How close is you hourly rate to what you would get normally? b) Are you learning tech that will set you up to make big money? c) Are you gaining insight about the industry that will set you up to be a co-founder?
    • practicalpants 12y ago
      Interesting points, thanks for your comment. a) It's actually about $15-20 an hour less going off of my last job. I do consider it extra compensation that they are remote friendly, because I got to do some world traveling while working and they were fine with it. But now I'm back home in the Bay (...but also considering traveling again to make it worth my while). b) Nope, just web stuff I'm already used to doing. The CTO at least is talented so I have learned from him. c) Potentially. So far no specialized insights into opportunities for new players in the space. Those insights may or may not come.
      • sbisker 12y ago
• jstrate 12y ago
  I've worked at two startups, including one YC. Both were acquired by larger tech companies. I was employee #3 at one and rebuilt most of a broken codebase in the other. I got nothing out of either WRT options. I agree with the author on point 4 but I don't think more options are the answer, I should have just asked for a higher salary I would have been better off. Startup-bucks are even worse than a lottery ticket, because of tax complications and money required to cover strike price. Now I work at a large tech company in SV and wont be involved in another startup unless I'm a founder.
  • Iftheshoefits 12y ago
    You've identified one of the reasons I hesitate to put myself in the "startup labor market" for any startup that isn't well-funded. Even well-funded startups give me pause. I'm not interested in putting in founder-like work for entry-level employee-like compensation plus a lottery ticket. Unless the equity is meaningful and imbues the recipient with an actual, real voice in the direction of the company it's just a way to sidestep offering real compensation.
    • karmelapple 12y ago
      I'm curious: what is "founder-like work" to you? Is it 50–80 hour work weeks? Or does it mean 40 hours but making the initial, architectural decisions of a new piece of software? Serious question.
      • radicalbyte 12y ago
        My wife owns a Pharmacy* and works 50-60 hours a week, so I guess that "founder-like" work involves a similar time investment. * The medical sort, and here in Holland the Pharmacists require the same education as a medical doctor but specializing in pharmaceuticals not diagnosis.
      • Iftheshoefits 12y ago
        Either. In the first case, it's unreasonable to put in more than a couple of hours of overtime here and there for even market rate wages at any company, whether it's a startup or not. "Uncompensated (comp time doesn't count) overtime" is a euphemism for "exploitation." In the second, the employee is effectively creating at least one of the revenue generating engines of the business. He deserves to reap the rewards of his labor. That means more than below-market wages plus "startup bucks"/lottery tickets. The entire issue, as I see it, can be distilled to this: founders want employees who are taking significant risk, who will work for and treat the business like the founders themselves would, but who considers below-market wages plus "startup bucks" as great compensation, even when it is historically not.
• mathattack 12y ago
  I've seen companies strategically fire people to get out of option awards. Or grant very generous options, only to plan on firing the folks later. Very shady business. I've become a bigger believer in cash. Unless you TRULY believe the vision.
• skrebbel 12y ago
  Completely off topic, but I'm this post made me realise that Sam Altman went from programmer to enterpreneur to financial guy. This post has very little ado with what he once started doing. He's a partner (and president) of an investment fund now, a pretty odd career move once you take the pink Silicon Valley glasses off. This entire post is about finance. Not about business, not about products, not about customers, just finance. Personally, I understand just about half of the entire post. To be clear, I don't think this is a bad thing. I envy Altman for understanding this (and for running YC at an age younger than mine, but that's another thing). But that's not my point. What I wonder about, is whether this is inevitable for successful enterpreneurs. Is the path programmer->enterpreneur->finance the obvious one? Sam's path might've been odd, given that his startup wasn't the next Facebook, but you see the same in startups that are the next Facebook, such as Facebook. Zuckerberg used to be a PHP hacker and now he's this NASDAQ CEO. I'm not sure about Drew Houston but all I read about Dropbox recently were acquisitions. Does growing business make you a finance guy, or do you need to be somewhat of a finance guy to grow a business? I'm really curious which is the chicken and which is the egg here.
  • benmathes 12y ago
    Finance allows diversification in ways that operating (programming, marketing, etc.) doesn't. One usually needs to either (a) make money operating or (b) gain experience marking to either (a) invest your own money or (b) invest the money of others. (at least in private markets)
  • robot 12y ago
    Being a founder means looking after your employees and that's what this post is about. Entrepreneurship is not solely about building and creating things. You have to lead, manage, and look after the company and its most valuable asset, the employees. Employees need to be compensated properly, and the devil is always in the details, so he is diving into financial details on how to achieve that. Financials are not the point of this post, it is the consequence of proper employee compensation.
  • UweSchmidt 12y ago
    I was half-expecting him to advocate a "less equity for employees" stance since, superficially, don't investors already compete with founders for percentages? Of course it makes sense on a higher level, e.g. when wanting startups to be desirable workplaces, or wishing for their own ecosystem to be a fair place etc. So, maybe not your average "financial guy"...
• zck 12y ago
  There's another effect of the ten-year exercise window. Remember how Facebook was "forced" to go public because so many people owned stock? (http://www.businessinsider.com/why-the-sec-will-force-facebook-to-go-public-2011-1 http://www.businessinsider.com/why-the-sec-will-force-facebo...). Well, if there's a ten-year exercise window, some of the people will hold their options and not exercise them. My -- albeit limited -- understanding of the situation is that those people are not counted as stockholders. They have options, not stock. So the ten-year exercise window is also good for the startup, because it delays the time until the startup has to publicly disclose its financials.
• derekrazo 12y ago
  You could run your start up as a co-op.
• bankim 12y ago
  Kudos for a post focusing on startup employees and not founders!
• logfromblammo 12y ago
  I can only speak for my own experience, but everyone I have ever known has always been screwed by options. As such, I automatically assign a value of $0 to any options attached to an employment offer. You can pretend that yours are worth more thanks to your unique structuring as much as you like, but thanks to everyone else in the industry, you will still have to convince your employee that you are not just spewing delusion at him. While I can't prove it, I believe I was once fired just to prevent my options from vesting. As an employee, you're really better off with zero options and a higher salary 99.9% of the time. But that means the owners have to sell more of their equity to make payroll. If you want to be a nice guy and keep the early employees eligible for big payouts, take your share of the buyout/IPO and give them bonuses out of that. No one trusts the option plans any more.
• DavidWanjiru 12y ago
  The thing I try to think about in the context of me being the owner of a successful business, and not necessarily in software, is profit sharing, as opposed to equity sharing. Profit is a degenerate case of equity, in the sense that a large (albeit not whole) part of why you want to own equity is to own a share of the profit. At any rate, at the level of employee options, you want own enough equity to play the decision making role that holding equity enables you to. Beyond that, the value a market assigns to equity you own is (should be!) ultimately dependent on the profit that will accrue to that equity. At the same time, profit sharing is a lot less messy and much more rewarding to employees than equity. Sure, you're not getting a share of this asset that you've helped build, but from what I'm hearing, the story is the same with options. And profit should be easier to "give away" than equity from the founders' perspective, I think. I realize that sharing profit is complicated when businesses are in the red, but on the whole, I suspect there might be better value in the idea for all involved. Not that I have any idea about how exactly to go about sharing this profit, assuming it exists, I don't. I just happen to think it might be a more satisfactory path to take, assuming the fork on the road reads "Equity Sharing" this way, "Profit Sharing" that way.
  • msoad 12y ago
    How many of YC startups are profitable in their first five year?
• d2ncal 12y ago
  Great article. One thing that he forgets to mention is to let employees "Pre Exercise" the options. For a very young startup (even for Series A), the shares are still worth pennies per share, and letting employees pre-exercise the shares not only saves them from AMT but also lets the long term capital gains kick-in sooner. Only a few startups that I've seen do this, and its really effective specially for employees.
• sscalia 12y ago
  Great article. It should read "How not to get fucked at a startup" This coming from someone who got bent over a barrel.
• philovivero 12y ago
  I worked as one of the very early founders of Digg. I bought my options. Obviously they're worth nothing, yet I owe the IRS about $120k. This threatens to destroy all my savings, retirement, and credit for 10 years. ISOs are not only worthless 95% of the time, they're also actively EXTREMELY DANGEROUS 50% of the time if they're not simply worthless. My suggestion: get a salary, and buy just-IPO'd stocks from companies you believe in. If you find yourself ready to buy some ISOs, I further recommend you IMMEDIATELY sell them, as in have the buyer sitting there with you as you purchase the ISOs, and do the trade instantly thereafter. Take the short term capital gains hit. Do not hold onto them no matter what any CPA or tax attorney tells you unless they can talk at length about ISO+AMT Tax Trap and assure you you cannot possibly have that happen to you.
  • otterley 12y ago
    Don't you get to credit AMT charged against worthless ISOs in later tax years?
  • thrownaway2424 12y ago
    Why did you exercise them?
• leccine 12y ago
  I have calculated my hourly rate including the money I would get after the IPO with 40USD share price and it came out around 100 USD. This is extremely sad given that I am senior engineer, imagine what somebody in a lower paid position gets. I think generally speaking, it is not worth it to work for 12 hours a day for a startup and get 10K shares over 5 years. If you actually work 8 hours and in your spare time doing a side project you might end up way better. You could get the ideas from the 4hour work week book.
• deleted 12y ago
  [deleted]
• lectrick 12y ago
  Maybe startups should abandon the stock market process entirely and issue a new cryptocurrency instead. The founders can pre-mine whatever percentage they wish and then pay employees in part in that currency, which would be traded on an exchange the same way stocks currently are.
• bambam12897 12y ago
  I wonder what the author thinks of ESOPs and cooperatives.
• dalef 12y ago
  Great article, but I am still not really understand some of the part of the whole picture. Can someone help here? I am now working in a series A company, taking 0.13% of the company, 13,000 shares (options). At the other side, Pinterest offers me 30,000 RSUs which I turned down because I thought Pinterest was already a late stage company. But after I did these researches (including this post), I am wondering if I made a right decision? my 13,000 shares will always be 13,000 shares, no matter how much dilution we have in future, right? so does it mean even if my company grew to the size of Pinterest in future, I still only have that 13,000 shares instead of 30,000 I could get from Pinterest easily with less risk? Or all late stage startup companies have split their stocks otherwise I don't see how joining a early startup for 13,000 would be any better
  • korzun 12y ago
    Number of shares you have does not mean much, if they close another round your shares will be diluted.
• emocakes 12y ago
  I worked at a startup, was employee number 4, and the 2nd lead developer after the CTO, I got offered a pathetic 0.025% over 4 years. Options like that are disheartening and really don't make you want to stick around for 4 years getting paid dirt to eventually be able to claim your $20k worth of options. I left and now am getting paid close to triple my old salary with options getting close to 10% in a business model that is far more profitable than the previous. I think lots of people just starting out in the startup scene get taken advantage of and taken for a ride.
• jpasmore 12y ago
  Tax laws make this more complex than it needs to be. It would be ideal to eliminate options altogether and compensate employees with stock. Take the market value of a job minus the amount the employee is actually paid (the startup discount) and pay the discount in stock -- common shares (VC's will be in preferred). All employees should get 2% of salary as a starting point in shares. Allow employee's to buy additional shares by forgoing comp or simply investing. Peg share price and timing of share grants to Rounds or any investment (Notes). Perhaps have repurchase rights only if terminated for cause. Doesn't matter if someone comes in for 8 months but adds value during that period, so vesting concept is eliminated. Would need IRS to change grant from ordinary income to capital gain type of treatment where taxes are paid when some actual liquidity/transaction occurs.
• DanielRibeiro 12y ago
  Great post by Sam. For employees, I'd also refer to Alex MacCaw's An Engineer’s guide to Stock Options[1]. Alex used to work at Stripe, and at the end of his article he shares some intersting bits of stock tax alternative not covered by Sam: If you can’t afford to exercise your right to buy your vested shares (or don’t want to take the risk) then there’s no need to despair – there are still alternatives. There are a few funds and a number of angel investors who will front you all the cash to purchase the shares and cover all of your tax liabilities And he goes further: If you’re interested in learning more about financing your stock options then send me an email[2] and I’ll make some introductions. I’ve set up an informal mailing list, and have a group of angel investors subscribed who do these kinds of deals all the time. [1] http://blog.alexmaccaw.com/an-engineers-guide-to-stock-options http://blog.alexmaccaw.com/an-engineers-guide-to-stock-optio... [2] the link is to alex at alexmaccaw.com
• semerda 12y ago
  Mary Russell & Chris Zaharias are trying to do that here http://stockoptioncounsel.com/ http://stockoptioncounsel.com/ with a bill of rights endorsement by educating folks on stock options and their rights. There are all sort of clauses and tax implications around given options that confuse people. Most end up believing the % they got will make them a millionaire. This is a great opportunity for Freakonomics to dig into the state of stock options in startups. When I was in my 20s I was more gullible by all the talk of stock options and becoming a millionaire from them. However I never stopped investing in property and after 10 years I am happy I continued investing into tangible assets that I was in control of. Stock options is a lottery at best. And as you get older, and learn the value of money and your time, you see the opportunity costs clearer. As a side note, I've been through an IPO and fed all the brain wash leading up to it. Reality is always far from the dream. Many people don't like to talk about their failures only successes hence you hardly ever hear about this. Now saying all that, there are the minority that strike it rich either by being an early employee of a startup that goes big (small % of something large) or are a founder of a successful startup when the stars align. Employee compensation in startups will need to change as more folks start to realize the opportunity costs. My word of advise, invest in yourself and stuff "you are in control of".
• STRML 12y ago
  I'm starting to see companies tossing around the idea of "Phantom Stock Options"; that is, shares kept purely on paper that are never issued to the employee. Upon a liquidity event, the employee can exercise the shares and be paid their value as regular income. This has some tradeoffs, some of them positive, some of them negative, but I am far from an expert I would love some input from somebody who knows more. It does appear to be vastly simpler for all parties, and completely eliminates any possibility of a tax trap. However it seems to guarantee that you will be paying income tax on the sale, which can be quite sizable. And the specifics of what happens after you leave, voluntarily or otherwise, is incredibly important considering that you are never granted any actual stock.
  • patio11 12y ago
    It is highly likely that the IRS would treat any instrument described as "Like a stock option, except minus the tax treatment for stock options" as "a stock option." The magic words to ask your accountant about are "substance over form doctrine." One of many consequences: an informal agreement, backed by paper or otherwise, to give you compensation in event of an acquisition, where that agreement survives your departure from the firm, is taxable at ordinary income rates on at its fair-market value. This income is realized in advance of the eventual acquisition/sale. That's why startupers care so much about their 83(b) elections, because otherwise that landmine bankrupts people.
• fragsworth 12y ago
  > startups try to have very small option pools after their A rounds, because the dilution only comes from the founders and not the investors in most A-round term sheets. Why is this the case? If you try to align the interests of the investors with the interests of the founders, you'd find that this would put you at odds with your investors. A company's total value might be quite a bit higher by having the ability to offer large amounts of employee options (just as an example, the ability to easily hire media personalities with a big followings without breaking your bank), which is good for both the founders and the investors. I understand the investors are trying to protect themselves from the founders deciding to give a ton of shares to their friends (and then potentially back to the founders, in other ways), but I wonder if there is a better solution to this.
• mikepurvis 12y ago
  I'm curious about this bit: "It causes considerable problems for companies when employees sell their stock or options, or pledge them against a loan, or design any other transaction where they agree to potentially let someone else have their shares or proceeds from their shares in the future in exchange for money today." What are the problems with these schemes? I'm presently employee #1 at a startup, and 99.9% of my present net worth is tied up in illiquid paper there—the rest is a 10 year old station wagon and some Ikea furniture. I'd really like to be able to pledge my options for a loan to buy a house, so I'm curious to know the issues which may arise from such an arrangement.
• sparkzilla 12y ago
  As a founder I looked into paying vendors/employees with options, but have found they are too brittle. Because option deals are created at the start of employment they require a lot of faith on the part of the founder, who does not know the employee's abilities or temperament. Options do not track well with performance and cannot be adjusted easily. I also do not want to be in the position of considering terminating an employee because they have more options than what I think they are worth, and employees should not have that fear either. Instead I am working on giving vendors and employees a convertible note that is based on their performance month-by-month. Let's say an employee or vendor is taking $5000/month less than they should be because it's a startup. The company credits them $5000 to their note each month (this can be more if there's a risk premium), and adds any performance bonuses as well as they come up. This lets management clearly track performance against the shares they are giving, and lets the employee know that if they work more they can get more. As time goes on the value of the note increases and the employee can converts their note to shares at the current valuation (or a discounted valuation). This seems a lot more flexible to me than options, and is less stressful for the founder and the employee. Am I missing something?
• gibybo 12y ago
  Vesting options at a startup are really like second-order options. If they were granted to you immediately they would just be ordinary options: you have the option to buy the stock at the strike price. However, since they must vest over a period of time in which you are sacrificing a higher salary, you are also given the option of whether to continue vesting those options (by staying at the company) or not (leaving the company). The second-order option is what makes them valuable. Most startups either grow aggressively during those 4 years or they die. If they fail early, you don't have to sacrifice much salary for the now worthless options. If they are doing well, the options are now worth much more yet you are still only sacrificing the same amount of salary for them. The problem is that the value of this presents a direct conflict between the company and employee. When the value of the unvested options grow, the company can reduce the unvested amount (or fire them if they don't agree)[1] because it will be disproportionate to the value the employee is providing. Note that they don't actually have to go after the unvested shares to recapture this value. They can go after any other form of compensation they are providing since it will still be more than the employee can get elsewhere. Essentially, this means the employee's upside potential is severely limited. Since the value of a share in a startup is based almost entirely on a massively higher future value, this tremendously reduces the value of typical startup vesting options. If I worked for a startup I'd want straight equity. Find the value of the common stock and pay 10-30% of my salary in common stock. The amount of shares will float as the value of the company does, but this is required in order to keep incentives aligned. I'll pay the tax out of my salary (at ordinary income rates). If the company succeeds, almost the entire value derived from the equity will still be taxed at capital gains rates. [1] See Zynga, Skype, and probably many others we never hear about.
• deleted 12y ago
  [deleted]
• danbmil99 12y ago
  Has anyone had experience with "early exercise" of (non-ISO) options? As I understand it, this strategy lets you treat them for tax purposes as if you bought the underlying stock, meaning no tax liability at vesting or exercise, and capital gains are all you pay at final sale. The downside is you have to pony up for the full strike price of all the shares at hiring. Works great if the company valuation is still nominal (ie before a 'valuation event' such as series A, though there may be cap note seed investment already) One could imagine a company offering a hiring bonus that covers the cost of early exercise (padded for expected tax loss). Maybe the real problem is this shit is complicated. Then again, we're programmers, right? Don't we do complicated by nature?
  • hundt 12y ago
    You can early exercise non-ISO options if your stock agreement allows it (also ISO but it's a little more complicated). If you also file an 83(b) election then you are indeed treated for tax purposes as if all the shares vested immediately, so if you exercise before the value of the shares exceeds your strike price then you pay no taxes until you sell the shares (or there's an acquisition or something). http://www.mystockoptions.com/faq/index.cfm/catID/B7469ACD-2DD6-4A51-85D787C8D8285FC7/objectID/D943A1F3-30A9-11D4-B9080008C79F9E62 http://www.mystockoptions.com/faq/index.cfm/catID/B7469ACD-2... As you say, the big issue with this is paying the exercise price. There's not really any way around that. If you're going to pay your employees extra money to cover the exercise price then you might as well just give them shares instead of options. Another option is to loan the money to employees. I don't know how common that is with startups.
  • ridgeguy 12y ago
    I have experience with early grant of non-ISO shares, which may be different from what you're asking about. I was granted shares (on a vesting schedule) at the time of formation of the company. I paid tax up front on the entire potential share grant when the shares were valued at $0.000001/share, which was a reasonable valuation at the time (very high risk, no tech proof, no demonstrated market, etc.). Although I have a significant # of shares and a significant % of equity in the company, the tax I paid was quite affordable. See 83(b) election. If it pans out and I sell my equity, I will pay long-term capital gains on the difference between the valuation at the time of my 83(b) election and the sale price. If it doesn't pan out, I'm not exposed to AMT or other tax weirdnesses that other posters have noted. I found this mechanism useful.
• joewallin 12y ago
  Congress should change the law so that the transfer of stock to workers is not taxed. I am not sure why pro-worker legislation like this wouldn't be supported.
• brudgers 12y ago
  Altman's post suggests that the context needs changing. I suspect it needs changing to keep up with some of the very changes YC has wrought - changes to VC and the creation of startups and the options available to the sorts of employees startup founders need. The issue is that the new startup culture has diversified power and our concept of 'business founder' is out of date. A software company founder is not the analog of a white shoe law firm partner. A personal realtionship with Jeff Bezos isn't why people buy toasters from Amazon or host their SAS on AWS, because it's not some Rolodex full of 30 year of golf course relationships and keeping the jobs of bureaucrats secure that make it rain. "On the internet nobody knows you're a dog.* [1] Or cares that you're a founder. While I agree with Altman that something needs to change in the direction of making employee's richer ,I think he probably doesn't go far enough. The problem isn't so much tax code as capital structure and the rigidity of company structure that results. A key hire is a key hire because it changes the company. Ideally, a company would change it's structure to reflect that change. Ideally, a company's capital and corporate structures would be agile as in development. Key employees are just as exposed to the 'you can be a founder' meme as everyone else, and they're in a better position to pursue it than most. A founder shouldn't expect talent to hang around making them rich. In terms of game theory, I think of it as a founder's dilemma. Altman's piece suggests YC might be seeing it too. In the current context, a founders's 30% of a $40,000,000 exit is better than even a 1% employe share of a $1,000,000,000 one - much better perhaps than the numbers would suggest because 30% gets a seat at the table, and that old Mark Cuban idea of looking around the table? Well if you're not at the table, the worst case is you're just dead money picking up the tab for someone's boat payment. [1] http://www.paulgraham.com/hiring.html http://www.paulgraham.com/hiring.html
  • tptacek 12y ago
    If this was true, YC would see a trend of companies failing not because they failed to find a product/market fit, but because they had a fit and failed to execute when a key engineering employee left. And yet YC is forever telling people to focus on "building something people want", above all else. Jessica Livingston just gave an interview listing the things that caused startups to fail; it was a short list, and included "founder breakup" and "failing to build something people want", but not "key engineer leaves". This squares with ~15 years of experience, mostly in startups, a significant chunk of it in the valley. Recruiting is important, team building is important. But the value of any one "key" developer is lower than your comment makes it out to be. Loss of a key engineer is, for most companies, even in highly technical spaces, easily survivable. Orthogonally, I'd also suggest you think of a Venn diagram. Draw a circle for "highly effective and appropriately specialized engineer". Now figure out where the circle is for "wants to found a company", and the circle for "intrinsically capable of founding a company", and the circle for "has life circumstances compatible with founding a company". I get to talk to a lot of developers --- I hire them, at what I believe is a reasonably fast clip, and I work at a consultancy to software development shops --- and I think this notion that everyone wants to found a startup is the product of a lot of HN echo. Most developers do not in fact want to start companies. Starting a company is stressful and, believe it or not, even if you can wangle your way into being a founder many times in a row, it isn't the most reliable path to retiring wealthy.
• jboggan 12y ago
  I'm going to be in a position soon to start hiring people and I've been thinking long and hard about this. I do think that engineers tend to get the short end of the stick when it comes to options, even when the nominal percentages sound good. I can think of friends who were early engineers at "successful" companies that took an awful long time to see any real money, let alone the vast majority who get nothing. I'm seriously considering a profit sharing / options system where options are only vested in quarters that are unprofitable and profit sharing occurs otherwise. I know that this wouldn't be different at all for many start-ups that have little chance of profitability early on, but for those that do it could be a very interesting way to align interest and not screw the employees.
• mschaecher 12y ago
  Back-weighting seems backwards to me, especially for early employees. They receive less options for the risky, earlier stage and more options for once things are stable and proven. Most startups won't even make 4 years, and therefore early employees who take that risk can end up with almost nothing if a sale or IPO occurs in, say, 18 months after starting employment.
• HowardMei 12y ago
  As far as I know, Huawei was the only real employee-coshared company on the planet issuing dividends attached 'virtual' stocks to their employees where virtual means stock ownership validity tied to the employment. Engineers working in Huawei bought shares priced at net asset value with salary or bank loans and gain dividends at a yearly ROI around 17%~75%. This unique 'communist' capital structure was created due to lack of venture capital and outside financing. It's also an experiment before China fully adopting western style corporation law. Huawei has a complicated capital structure of founder (1.42%) + employee union (98.58%) which scared many big investors away and hindered it from IPO. Recently, Huawei adjusted the virtual stock policy to freeze its capital structure because the structure complexity incurred a lot of accusations from the US government and harmed its growth in several major markets. Alibaba also failed to request change of Hongkong IPO rules to apply employee-partnership to protect its senior employees. Therefore, employee equity isn't merely about internal profit sharing or fairness at all. Investors or traditional capital markets don't like the 'communist' flavored capital structure. Employee option is the only viable solution before some one totally disrupt the current capital market.
• pyrrhotech 12y ago
  the real villain here are the VCs and to some extend YC for promoting them. VCs are the ones who perpetuate the myth of "work 80 hours a week for a startup at 50% market rate and you'll be rich in 4 years". In reality, they take all the preferred stock so that even if the company sells out for double or more what it was worth when you join, you end up with nothing. I've worked at a startup that sold for 4x what it was worth when I joined, and I still ended up with nothing. A couple guys who had been there longer ended up with a few thousand dollars. What a scam! Work at a large, established organization and earn your fair market rate at a 40 hour work week, and start your own company on the side if you want to get rich folks. I'd never work for any startup again unless I was the founder.
• ivan_ah 12y ago
  I wish there existed exit strategies other than IPO and being bought. At the rate at which tech-giants are buying tech-startups, we'll end up with very few, very large tech conglomerates. I'm not sure how efficiently things run in these giant companies. More managers = more trouble and less autonomy for the lower levels of the pyramid. Central management and the pyramid are almost like communism, and we know how well that turned out... Why can't a mid-sized profitable company pay out dividends to stock-holders? Say growth mode for the first 5 years to reach profitability, then start cutting cheques to founders, early employees, and first-round investors. I know losing cash will probably hurt the company momentarily, and stunt the growth of the business, but then you start a second round with a new pool of employee stock and new investors come it to do another 5 years. Basically, he/she who wants to, can smooth-exit after 5, 10, or 15 years, while keeping the same company envelope, mission, and mid-sized company culture throughout the company's life. I guess this would work only for //very// profitable companies that end up with lots of cash in the bank, but if you haven't build a profitable company after 10 years what's the point?