4 ms·

Common Stock Ownership Spreads Among Startup Investors

40 points by dpflan 11y ago

dpflan 11y ago
If anyone from the community has any experience with this (either as an investor, a founder taking investing, or an employee taking options), I think it'd be great to share how you dealt with it (if you legally can discuss it).
analog31 11y ago
Granted I'm neither a startup employee nor an investor in such things. But it seems to me that if investors can trade in common stock, the greatest benefit will be to establish a real value, rather than a fictitious value, for common shares.
- dpflan 11y ago
  I would suspect that the common stock and preferred stock are priced according to their value (voting rights, preference at payout, etc). I think that ownership of common stock by other investors with the desire to ensure that common stock gets fairly represented (i.e. gets its money's worth) in a liquidity event is the biggest benefit here because it may balance the desires on both sides of the fence.
CIPHERSTONE 11y ago
Having read recently about "Good welling to blackberry for a fraction of what it was valued at and how screwed the employees were that had common stock, I'd be leery of any kind of common stock. But that's just me. http://www.nytimes.com/2015/12/27/technology/when-a-unicorn-start-up-stumbles-its-employees-get-hurt.html http://www.nytimes.com/2015/12/27/technology/when-a-unicorn-...
- dpflan 11y ago
  It does showcase the preferential treatment and the motives of investors who have preferred stock. When they need to ensure a return they seem to have the leverage to do so. In this example though we see the battle emerging between large common stock owners against preferred stock owners. From that article on Good: "In October, Brian Bogosian, a former Good C.E.O. and a significant shareholder, along with two institutions that own common shares, said the board was not looking after the interests of common stockholders and sued in Delaware Chancery Court. They are seeking unspecified damages and fees." The double-edge sword (taxes and cost to take ownership in a company that will probably only payout from a long, expensive lawsuit, brought on mostly by wealthier owners of common stock...) is when employees exercise their options to obtain shares to then have ownership to contest payouts that obviously favor preferred stock.
deleted 11y ago
[deleted]
- deleted 11y ago
  [deleted]
  - skj 11y ago
    Seems a bit off topic.
dasil003 11y ago
My dream is to start a company with sufficient traction and revenue that I can demand investors take common stock if they want to invest. Such a situation would be a huge recruiting advantage, and combined with a generous and transparent employee equity plan would enable a much stronger team than traditional arrangements allow for. The only problem is getting that level of traction is far from easy.
- pc86 11y ago
  I think if you had that level of traction and revenue, more often than not you wouldn't need any investment at all.
  - w1ntermute 11y ago
    Exactly, you could just use debt financing instead of giving up equity.
- adventured 11y ago
  You don't need traction to get that. There are a few big investors that are willing to buy common stock. I have one owning part of my company today. I had zero traction, just an early functional product. I would never allow an investor into my company under any other terms: they eat the same dog food I or anyone else does. You don't need their money, there is a lot of money flowing around out there, so set the terms how you see fit and find the investor to match it.
  - matrix 11y ago
    Mind expanding on how one might find such an investor? I agree that the ideal scenario would be for investors to take the same risk (and reward) as other shareholders, but I have no idea how to find investors receptive to that idea.
klochner 11y ago
In the US, one benefit of two-tier structure is that employees can early exercise options at a very low stock price to get preferential tax treatment (taxed at long-term rate rather that ordinary income). With all common it's likely too much money to exercise before a liquidity event, so early employees end up losing an extra 15% of their payout in taxes.
- nycthrowaway 11y ago
  Apologies if I misunderstood your comment, but are you implying the price per share can be different for common and preferred stock, and therefore the spread used to calculate AMT for employees can be negligible even post investment? I assume you're referring to the "AMT" alternative minimum tax, which is calculated based on the spread between exercise price and current valuation according to most recent 409(a) filing. My impression was that this valuation, calculated post-series A/B/C, reflects the most recent per-share price paid by investors. Since investors typically receive preferred stock, the per-share price in the 409(a) filing will reflect the price investors paid for preferred stock. In most cases, common stock will not have a real "per share" price until a liquidity event. So how is the price-per-share valuation calculated for common stock? I was under the impression that the spread used to calculate AMT is the difference between the most recent preferred stock price per share, and the exercise price of the options, regardless of whether they bought common or preferred stock.
  - klochner 11y ago
    I was talking about income tax at time of exit. If you pre-exercise and file an 83b, you realize profit as long-term capital gains rather than ordinary income. It's hard to pre-exercise if doing so costs you $100k+ in exercise costs (you have to pay the option price). Options on common stock will be set at the price of common, which can be 10x if there are no preferred shares. Read here regarding common/preferred valuations: https://www.quora.com/What-were-typical-ratios-between-409a-and-preferred-stock-valuations-for-early-stage-web-startups-in-2010 https://www.quora.com/What-were-typical-ratios-between-409a-...
deegles 11y ago
I've been thinking about a model where a startup/early-stage company would give NO shares on hiring, but instead slightly more salary and a generous (15% discount?) stock purchase program. That people feel less obligated to negotiate and employees get more flexible vesting (month-to-month). I have no idea how that would work with pre-IPO companies, tax implications, etc but it feels more fair to me. On a similar note, I wish there were better ways to prevent dilution among early-stage employees. They ostensibly generated the value that investors are buying, so why must they lose out on every funding round? Of course, employees could negotiate for more options on every round but not everyone will do so.
- laxatives 11y ago
  Getting a chunk of stock options with huge upside seems palatable vs guaranteed shares at a large tech company. Offering me a 15% discount seems insignificant. The moment you go public, everyone is going to buy all the shares available. How do you decide how many each person can buy? If I buy before an exit event, I am taking on even more risk than the option because now I am paying all of the taxes. This offers no benefits, but increased tax risk and I'm paying more to buy shares in the first place.
thinkingkong 11y ago
This is very different. These are all investors buying commons in a series D or later timeframe which isnt terribly uncommon. Some companies at this stage will have previous investors or other shareholders cash out at some discounted rate prior to issuing any new equity. Highly doubt this would happen for any but a few unicorn style companies. The first few rounds of financing are where youll see the worst dillution.

40 points by dpflan 11y ago

If anyone from the community has any experience with this (either as an investor, a founder taking investing, or an employee taking options), I think it'd be great to share how you dealt with it (if you legally can discuss it).

analog31 11y ago

Granted I'm neither a startup employee nor an investor in such things. But it seems to me that if investors can trade in common stock, the greatest benefit will be to establish a real value, rather than a fictitious value, for common shares.

dpflan 11y ago
I would suspect that the common stock and preferred stock are priced according to their value (voting rights, preference at payout, etc). I think that ownership of common stock by other investors with the desire to ensure that common stock gets fairly represented (i.e. gets its money's worth) in a liquidity event is the biggest benefit here because it may balance the desires on both sides of the fence.

CIPHERSTONE 11y ago

Having read recently about "Good welling to blackberry for a fraction of what it was valued at and how screwed the employees were that had common stock, I'd be leery of any kind of common stock. But that's just me. http://www.nytimes.com/2015/12/27/technology/when-a-unicorn-start-up-stumbles-its-employees-get-hurt.html http://www.nytimes.com/2015/12/27/technology/when-a-unicorn-...

dpflan 11y ago
It does showcase the preferential treatment and the motives of investors who have preferred stock. When they need to ensure a return they seem to have the leverage to do so. In this example though we see the battle emerging between large common stock owners against preferred stock owners. From that article on Good: "In October, Brian Bogosian, a former Good C.E.O. and a significant shareholder, along with two institutions that own common shares, said the board was not looking after the interests of common stockholders and sued in Delaware Chancery Court. They are seeking unspecified damages and fees." The double-edge sword (taxes and cost to take ownership in a company that will probably only payout from a long, expensive lawsuit, brought on mostly by wealthier owners of common stock...) is when employees exercise their options to obtain shares to then have ownership to contest payouts that obviously favor preferred stock.

deleted 11y ago

[deleted]

deleted 11y ago
[deleted]
- skj 11y ago
  Seems a bit off topic.

dasil003 11y ago

My dream is to start a company with sufficient traction and revenue that I can demand investors take common stock if they want to invest. Such a situation would be a huge recruiting advantage, and combined with a generous and transparent employee equity plan would enable a much stronger team than traditional arrangements allow for. The only problem is getting that level of traction is far from easy.

pc86 11y ago
I think if you had that level of traction and revenue, more often than not you wouldn't need any investment at all.
- w1ntermute 11y ago
  Exactly, you could just use debt financing instead of giving up equity.
adventured 11y ago
You don't need traction to get that. There are a few big investors that are willing to buy common stock. I have one owning part of my company today. I had zero traction, just an early functional product. I would never allow an investor into my company under any other terms: they eat the same dog food I or anyone else does. You don't need their money, there is a lot of money flowing around out there, so set the terms how you see fit and find the investor to match it.
- matrix 11y ago
  Mind expanding on how one might find such an investor? I agree that the ideal scenario would be for investors to take the same risk (and reward) as other shareholders, but I have no idea how to find investors receptive to that idea.

klochner 11y ago

In the US, one benefit of two-tier structure is that employees can early exercise options at a very low stock price to get preferential tax treatment (taxed at long-term rate rather that ordinary income). With all common it's likely too much money to exercise before a liquidity event, so early employees end up losing an extra 15% of their payout in taxes.

nycthrowaway 11y ago
Apologies if I misunderstood your comment, but are you implying the price per share can be different for common and preferred stock, and therefore the spread used to calculate AMT for employees can be negligible even post investment? I assume you're referring to the "AMT" alternative minimum tax, which is calculated based on the spread between exercise price and current valuation according to most recent 409(a) filing. My impression was that this valuation, calculated post-series A/B/C, reflects the most recent per-share price paid by investors. Since investors typically receive preferred stock, the per-share price in the 409(a) filing will reflect the price investors paid for preferred stock. In most cases, common stock will not have a real "per share" price until a liquidity event. So how is the price-per-share valuation calculated for common stock? I was under the impression that the spread used to calculate AMT is the difference between the most recent preferred stock price per share, and the exercise price of the options, regardless of whether they bought common or preferred stock.
- klochner 11y ago
  I was talking about income tax at time of exit. If you pre-exercise and file an 83b, you realize profit as long-term capital gains rather than ordinary income. It's hard to pre-exercise if doing so costs you $100k+ in exercise costs (you have to pay the option price). Options on common stock will be set at the price of common, which can be 10x if there are no preferred shares. Read here regarding common/preferred valuations: https://www.quora.com/What-were-typical-ratios-between-409a-and-preferred-stock-valuations-for-early-stage-web-startups-in-2010 https://www.quora.com/What-were-typical-ratios-between-409a-...

deegles 11y ago

I've been thinking about a model where a startup/early-stage company would give NO shares on hiring, but instead slightly more salary and a generous (15% discount?) stock purchase program. That people feel less obligated to negotiate and employees get more flexible vesting (month-to-month). I have no idea how that would work with pre-IPO companies, tax implications, etc but it feels more fair to me. On a similar note, I wish there were better ways to prevent dilution among early-stage employees. They ostensibly generated the value that investors are buying, so why must they lose out on every funding round? Of course, employees could negotiate for more options on every round but not everyone will do so.

laxatives 11y ago
Getting a chunk of stock options with huge upside seems palatable vs guaranteed shares at a large tech company. Offering me a 15% discount seems insignificant. The moment you go public, everyone is going to buy all the shares available. How do you decide how many each person can buy? If I buy before an exit event, I am taking on even more risk than the option because now I am paying all of the taxes. This offers no benefits, but increased tax risk and I'm paying more to buy shares in the first place.

thinkingkong 11y ago

This is very different. These are all investors buying commons in a series D or later timeframe which isnt terribly uncommon. Some companies at this stage will have previous investors or other shareholders cash out at some discounted rate prior to issuing any new equity. Highly doubt this would happen for any but a few unicorn style companies. The first few rounds of financing are where youll see the worst dillution.