19 ms·

Who pays when startup employees keep their equity?

255 points by tanoku 10y ago

ktothemc 10y ago
Wouldn't RSUs open employees to a different and more punitive tax regime (income tax) than options (which would fall under capital gains if you exercised early enough)?
- superuser2 10y ago
  I believe if you hold your RSU-granted stock for 1 year, you can pay capital gains tax on it instead. I'm not a CPA.
  - phamilton 10y ago
    You would only pay capital gains on the gains from that stock. At RSU vest you would owe taxes on the market value of those RSUs.
  - URSpider94 10y ago
    But, you have to pay income tax on the value of the shares at the time when they vest, i.e. become non-restricted. You have zero control over that vesting schedule, and thus the tax bill, and you likely wouldn't have a liquid market for the shares before an IPO. Any gain post-vest can indeed be long-term cap gains, if you hold the shares > 1 year.
- phamilton 10y ago
  RSUs are simpler and can be planned for. For example, a company could grant RSUs with a mandatory buy back vesting schedule (basically 83b election) upon hire and include the taxes as part of the comp package. Examples: Junior Engineer Sally joins Company A and is offered 0.25% of the company in RSUs. Company A recent raised at a 20M post money with a preferred share price of $1 and a FMV of $0.20. She owes tax on $10k of RSU gains. Company A either: 1) Buys back $4000 of stock in order to cover taxes 2) Provides a $4000 signing bonus to cover taxes. Senior Engineer Bill joins Company B and is offered 0.05% in RSUS. Company B recently raised at a $500M valuation with a preferred share price of $10 and FMV of $3. He owes tax on $75k of RSU gains. Company B either 1) Buys back $30k of stock or 2) provides a $30k signing bonus.
jedberg 10y ago
This is where having a lobbying group would be helpful -- this really needs to be fixed through policy. We need to get the tax law changed so that RSUs are taxed on liquidity instead of vesting. Then you'll still avoid the corruption the tax is supposed to protect against (paying an executives millions in what was previously untaxed compensation through RSUs in the 80s) but still allowing them to be given as startup equity compensation.
- iandanforth 10y ago
  Can you go into a bit more detail on what counts as liquidity? Can I sell on a secondary market? Can a bank let me guarantee a loan based on my current units? Can non-liquid units be transferred to my next of kin tax free?
  - jedberg 10y ago
    These are all details that would have to be worked out, but the gist of it would be that you shouldn't be taxed on it until you're able to sell it. But I'll give it a shot: > Can I sell on a secondary market? Sure, and then you get taxed on the money you made, where your basis is $0. > Can a bank let me guarantee a loan based on my current units? That's tricky because it would be a way for people to work around the law. What if we made you pay tax if you took out a loan with the stock as collateral? > Can non-liquid units be transferred to my next of kin tax free? Seems like it would be reasonable to allow that. The value would still be $0, but when it became liquid, your next of kin would have to pay taxes on the value with a basis of $0, which would make it not a good workaround for estate tax since you would save money if you transferred it under the $5M lifetime limit.
- wyman 10y ago
  Absolutely agree. ISOs should also be taxed on liquidity as well, instead of an AMT on exercise. There was a group, ReformAMT.org, opened in the wake of the 2000 tech crash, where many employees ended up owing massive amounts of AMT on now-devalued stock. However, it seems that the employers' and investors' interests are against the employees' here - the investors want what few employee shares are lost to be returned so they are diluted less, employers want holden handcuffs to reduce mobility, and only the much-weaker at lobbying employees want more freedom/mobility.
buttershakes 10y ago
This is very interesting. Options are really an unappealing mechanism to incentivize employees. I feel like they prey on people who really don't know any better, and don't understand the tax implications or the possibilities around future dilution. As a rule of thumb I discount face value of options by as much as 70%, that generally doesn't go over very well with people trying to convince you to accept them in lieu of cash. The single trigger RSU is a very hard sell though, as we can see from this example it hurts both Investor and Founder equity stakes, unless people start balking at options (which they should) it won't fly.
- jusben1369 10y ago
  Quick question. Do you work for a startup now with options? Or, have you in the past? I'm trying to work out if people who object to options would ever join startups. Or, if they're appetite for risk is too small to be a potential candidate.
  - beachstartup 10y ago
    i would only ever join a startup as a co-founder. i would never own less % than anyone else, i.e. at least one other founder should have the same equity as i do. that's my personal heuristic, ymmv. if i'm going to work for someone else it's going to be the most stable situation possible, i.e. an established company with market or better salary and benefits and a reasonable workload.
  - buttershakes 10y ago
    I have started multiple startups, and joined others at various times. I've also professionally traded options. I have a huge appetite for risk, but the risk/reward isn't there for most early employees who are getting paid less cash in exchange for options. You just can't take them at face value. I would say many early stage employees aren't taking appreciably less risk than the founders themselves, but at a fraction of the upside.
    - chris11 10y ago
chollida1 10y ago
There was a PE firm that came around about 4-5 years ago trying to raise money on this very premise. Their thesis was that - startups would remain private longer. - employee's lost their options when they leave - longer periods to go public means more employees return options to the pool which means employee option pools can be smaller - longer private periods leads to more rounds raised which benefits investors over employees as the former can participate on each round to keep from being diluted - exits would come eventually and the investors would always have superior terms, I believe that they were working under the assumption that investors would never have mandatory black out periods after IPO so they could essentially participate in the opening day IPO pop. This is one of the coolest and most maddening things about finance. Every time you think you've come to a big realization, usually you find out that someone else came to the same conclusion many years ago and has been making money "arbing" it out ever since.
- hobbyjogger 10y ago
  Seems like a pretty good investment thesis (especially if they were truly ahead of the curve here). Except I doubt the last bullet is accurate. I'd be very surprised to find that even 10% of tech IPOs have significant preferred investors not subject to a lock-up. Underwriters really, really don't like holders (even small ones, but especially big ones) being able to sell right off the bat. And if the market is flooded with VC investors dumping shares just after the offering, then there may well be no "pop" to participate in.
- hkmurakami 10y ago
  Maybe I'm missing something, but that doesn't really sound like a "thesis" but rather just an identifying mispriced securities ("arb opportunity" also works). I agree with the latter that the late stage market for startup growth capital likely did not price this advantage in, and that the PE fund had an edge. But even at that stage there are winners and losers, and I would think that a thesis would still need to resemble the kind that Series B investors must concoct, and be able to sift out the winners from the losers. In any case I appreciate you sharing this info. It's enlightening.
- mahyarm 10y ago
gringofyx 10y ago
Either way it's a losing game, consider a company like Google - how would they attract new employees on either scheme given that the company has been around for 15+ years? The only people who win are those who get in early, or invest big. Any IPO ultimately results in people earning money who don't "work" for that money - that means the actual workers lose out everytime.
- DominikR 10y ago
  > Any IPO ultimately results in people earning money who don't "work" for that money - that means the actual workers lose out everytime. It is wrong to believe that people would invest large amounts of money randomly without spending significant amounts of their time to make sure the investment will create them some returns. Also they have the risk to actually loose 100% of their investment, which some guy employed at Google with a 6 figure income doesn't have. Of course they'll need more profit to cover for the risk. Think about it this way: If there were no investors there wouldn't be a Google or Facebook as we know it today as these companies didn't make a dime for the first 5 or 6 years of their existence. You can be critical of these two companies (I am) but there are thousands of other companies in the IT sector that just wouldn't exists if they had to make profit right from the start and grow organically.
  - gringofyx 10y ago
    Your argument is surely moot because it assumes that startup employees take on no risk. Not to mention conflating IPO with startup options/shares. There are many companies out there that have never, nor will, take investment or IPO yet are still successful. There's also an argument to say that any company that isn't profitable from day one shouldn't exist in the first place. Your argument also suggests that founders must go "cap in hand" to investors to beg for startup capital. In all scenarios I do not see a positive outcome for the employee, and it seems only more and more difficult to attract new talent
    - landryraccoon 10y ago
      I dunno man, if you don't like the offers at Google where do you think you'll do better? They pay pretty well...
spullara 10y ago
I can imagine that there would be other consequences to the change. For example, I could see anyone on the edge around their 1 year vesting cliff would be fired to avoid parting with their equity. It would probably also push down the amount of equity offered because of the increase in value. Further, some companies are already doing this, vesting could be back loaded with the majority vesting in the later years.
- hodgesrm 10y ago
  Firing people to avoid paying them can get you into serious legal trouble. Good discussion on https://news.ycombinator.com/item?id=3962292 https://news.ycombinator.com/item?id=3962292.
- delphinius81 10y ago
  There are companies that already let people go before their 1 year cliff (or do other types of restructuring that results in the vesting period to reset). However, I think it would be appropriate to give fewer options as a consequence of this change, since the options would be a more realistic part of the compensation package when you have a longer-period of time to determine if you want to exercise them. I could definitely see the 1 year cliff going away too, else you'd have people collecting 25% of their options at various places and moving on to other companies each year. Eventually one of those companies will do well and your "work" investment will pay off. You can do shotgun investing with your employee options. But a lot of this misses the point that your company's growth is entirely reliant on a productive employee base. If you back load vesting or start firing people right before their cliff, or do any other practices such as this, why would anyone choose to work for you?
codeonfire 10y ago
Is the presumption that founders and investors are not trying to screw employees? I genuinely can't tell from the article. I thought it's just common knowledge that they will try to screw employees at every chance. With options it was different strike prices for management/ founders vs employees. With RSU's it is weird vesting schedules and forcing forfeiture situations.
- iaw 10y ago
  This comment isn't very productive. Some high-level valley participants are definitely bad actors but the bulk of them are just normal people in positions of power.
  - deleted 10y ago
    [deleted]
  - codeonfire 10y ago
    Normal people that like money. If this article is about how equity compensation can be improved, then that is a fairly messed up world view and kind of insulting. Employee equity compensation is always designed to explode or have no value. Workers are sick of the schemes. Just pay cash. Companies don't want to and never will improve equity compensation. A better solution would be a law that requires a cash value of granted options or RSU's to be reported to workers which would require a look at sale-ability, strike price, volality, expected employee turnover, etc.
    - ericd 10y ago
      Actually there's a big movement to making options exercisable well after employees leave. So, no. Startups don't have enough cash to compete in terms of pure salary with the leverage that the Googles of the world have. And stock can turn out very well for employees, I've seen it happen at a fairly good rate. You just need to make sure you're getting what you're worth, risk adjusted.
      - 10y ago
wtvanhest 10y ago
Equity is one area where I would encourage YC to get more involved. We need someone to step in and lobby the government for tax treatment of options that reflects their economic reality to early stage employees. We also need to encourage companies to use a 'standard' stock option agreement which is well known by everyone so that equity offers can be compared across companies. If you take equity from an early stage company that has also raised a ton of money with a liquidation preference, what are your chances of getting paid out, even on a big exit? That question is basically impossible for most people out here to answer.
- cubano 10y ago
  It wouldn't be very hard to collect existing data points and come up with a rough approximation, would it? I would think enough data now exists to allow such an analysis to have some idea of those numbers.
  - wtvanhest 10y ago
    I doubt it. The past 5 years have been somewhat unique in that companies were given lots of cash with liquidation preferences and 'fake' valuations. A good example are T Rowe Price's 'unicorns': http://www.marketwatch.com/story/uber-airbnb-and-other-unicorns-have-valuations-cut-at-t-rowe-price-2016-04-15 http://www.marketwatch.com/story/uber-airbnb-and-other-unico... If UBER IPOs for any less than $12.5Bn, what will the early employees get? Probably not much compared with the value they helped create. Right now, that looks impossible, but who knows what will happen? My point is that there is not a historic president for what has happened in the private markets and I would do anything I could to cash out of equity if I held it in a unicorn and I was liquid. I would love to see YC step up and encourage founders to issue employee friendly stock options.
    - wtvanhest 10y ago
      *precedent not president
trhway 10y ago
reminded how 10 years ago upper class was trying to initiate grass roots and steer protests against options expensing. They failed and as a result we have RSU pretty much everywhere instead of options. The startups are the last bastion, and i think with the modern "who needs an IPO with such great C round (and related caching out for chosen ones)" approach, people will start to get the picture and the RSU will come there too.
- mason55 10y ago
  The problem with startup RSUs is that you are taxed when the RSUs vest. If there is no liquidity (which is the case for most startups) then you're paying taxes on RSUs which you can't sell and may never be worth anything.
  - rrdharan 10y ago
    This is not always the case. The grant may be structured such that you don't actually have the shares in your possession even after vesting, you just have a claim on them that will be honored at IPO or change of control. This though means you can't dump them on SharePost/SecondMarket etc. even after they vest.
efoto 10y ago
There was a HN discussion ten days ago [1], where several people including myself were suggesting 83b rule RSUs as a possible solution. Nice to see this method quantified. https://news.ycombinator.com/item?id=11963551 https://news.ycombinator.com/item?id=11963551
timcederman 10y ago
There is a downside to RSUs. Say you work for a private company with a high valuation, e.g. AirBnB at $25B, and you are granted 0.01% equity over 4 years. That means you are vesting $2.5m of RSUs over 4 years, and these RSUs are taxable at that amount. Typically for folks earning over $150k/year in base salary, particularly if married, even half as much will put you into AMT territory, and you will end up paying a significant chunk of cash each year in taxes (even if RSUs are withheld for taxes, because the withholding cannot account for things like AMT). Options with extremely long exercise windows helps obviate this tax burden and allows the employee to decide when/if to improve their tax position by exercising ahead of a liquidity event.
- home_boi 10y ago
  Does the government take private RSU's as payment for taxes? It seems unfair to tax people for equity that even the government itself doesn't value.
  - jonny_eh 10y ago
    But if I pay you bitcoin for goods/services, you still need to pay tax on that, in USD.
  - JonFish85 10y ago
    Of course not, the IRS takes cash. It's far simpler that way, and probably will remain that way for quite awhile.
    - pc86 10y ago
      And it probably should - the IRS is in the business of collecting money from citizens and corporations. It should not be in the business of managing investments and RSUs in thousands of private entities.
  - timcederman 10y ago
    Yes, typically there is withholding to help cover the taxes, but for four year grants in the range of $1m+, the default withholding doesn't fully cover the taxes.
shon 10y ago
It's interesting to see the popular response to this thread being one where people think employees are better off with salary over options. This seems crazy to me as I have watched many close friends cash out options from companies including Google, Yelp, Apple and Pandora and buy houses (some with cash), start companies, become investors and/or take long sabbaticals with the proceeds from their options. With salary there is a clear upper bound and the tax on W2 income is simply the worst. I would say that at least in the Bay Area, options are a good bet and much better bet based on what I've seen. Startups are always a gamble for everyone involved. But outside of the financial industry, where 6 and 7 figure cash bonuses are common, I think options are superior to other forms of compensation if you're trying to optimize for gaining a "life changing amount of money" in less than say 10 years. High salary could only compare if you are very good at minimizing tax and maximizing the money making potential of your salary though investments (requiring additional work). But if you're going to have to invest anyway, why not work for a company you believe in and have a chance at influencing the company's success as well as your own?
- EpicEng 10y ago
  >including Google, Yelp, Apple and Pandora So, companies that exist in that tiny portion which are actually hugely profitable? Most companies aren't, and most options are worth little to nothing at the end of the day. After a decade in start ups and now supporting a family, I'll always take salary over options.
- marssaxman 10y ago
  My experience has been that you never get enough influence over the company's success to make a significant difference, and the options don't pay off frequently enough to rely on. For my own part, I've been at this for over 20 years and I've never come close to making any significant amount of money from options. They have lost all incentive power. Pay me cash money now, and I'll invest it however I please.
- thisone 10y ago
  you've had no close friends who've lost their options, or had their options become worthless when companies fail? You're one lucky person to know!
rdl 10y ago
Is a single trigger RSU somehow different in trigger than single trigger options? I've always been told that single trigger, at least for the majority of engineering, means your company won't be purchased. Single trigger makes sense for legal, accounting, etc who are likely gone in an acquisition. Double trigger makes sense overall.
- phamilton 10y ago
  If the premise is that employees can move the needle on the stock price through their contributions, then double trigger doesn't make sense either. I recently went through an acquisition where all of our stock was converted into the acquiring company's stock. It was maddening to see our team continue to perform well but see the price of our equity tank along with the rest of the company.
calcsam 10y ago
The barrier to entry of this stock option tweak: it requires an informed populace, ie, us. If you are a founder with reasonable engineer cred and announce differentiated stock option terms, ie, Adam D' Angelo at Quora, there's a reasonable chance that engineers considering joining your company will be encouraged by your effort on this. If you're someone else, and your company offers this, many experienced engineers, not unreasonably, will value their equity packages at zero regardless of what you do. Many others, such as new grads, will not know enough about stock options to understand the distinction you're drawing. If you do decide to offer RSUs for the reasons the authors cited, you may want to follow the example of Henry Ward at eShares and put together some good presentation materials to explain the benefits of this course. Otherwise, you're making an expensive choice for little benefit.
- a_small_island 10y ago
  >"If you are a founder with reasonable engineer cred" Can you expand on this? Are you of the mind that engineers should only trust other engineers?
kazinator 10y ago
Who pays for this? Is the following answer somehow too obvious to be true? When you eventually sell the equity, the stock exchange will hook you up with counterparties who buy the stock. Those counterparties are who pays you.
arrty88 10y ago
i really think Profit Interest Units are the best form of equity for both employees and employers https://www.nceo.org/articles/equity-incentives-limited-liability-company-llc https://www.nceo.org/articles/equity-incentives-limited-liab...
cloudjacker 10y ago
Its not "options" vs "RSUs" There are a wide range of financial products used around the world that would better fix the tech sectors compensation incentives and nobody is talking about them. Think different didn't mean argue about false dichotomies. It is a total charade for the venture firms to propel the notion that they are doing employees a favor by even offering stock. "How gracious of us to dilute our investment at all!" Dilute the preferred shares with 8% dividend and liquidity preferences! Offer convertible bonds or other hybrid products! You can incentivize people in 101 ways, and you guys are debating about two of them under the assumption that the crowd is right
nfriedly 10y ago
The last startup I worked at went through a merger. In the process, they created a new company and gave all employees stock in the new company, on the same vesting schedule as the options had been on in the previous companies. They organized things and provided help to ensure that all US employees were able to make a Section 83(b) election for our stock in the new company as soon as it was created. (This means we paid taxes early based on the current value (zero) instead of potentially paying much larger taxes in the future.)
55555 10y ago
I have really never understood the confusion over why this doesn't get implemented. It has always seemed clear to me that there's not enough demand for change, and investors and founders want things to stay the way they are. It's a really, really good deal for them.
powera 10y ago
The assumption that every employee leaves after 3 years and keeps none of their equity is absurd. I don't see any value in that example at all.
- te 10y ago
  > 3 year employee tenure > 100% loss of potential equity when employees leave the company ... ... > You can also see that only the employees hired in year 8, 9, 10 > (the final 855) have any shares at the end of year 10. Quite bizarre! Yes, quite the mystery indeed.
dman 10y ago
I wish companies adopt the same "what have you done for me lately" mindset to investors as they do to employees.
payne92 10y ago
While the dialog around various equity-based incentive compensation mechanisms is good, this article is off base in SO many ways: >>With an often high strike price, Only an issue at the later stages of companies (note: this writeup argues RSUs "from the beginning"). >>a large tax burden on execution due to AMT, Only if you are exercising later in the company stage, when the fair market value has (usually) gone up. If you are bullish on the company, it's generally best to exercise as you vest, for this very reason. Also, exercising as you vest gets the timer going for (a) cap gains treatment (much better tax rates), AND, a possible Qualified Small Business Stock tax exclusion (5yr holding, significant tax break). >>and a 90 day execution window after leaving the company many share options are left unexecuted. This is MUCH less of an issue if you are exercising as you go along (see above). If you you have just left a large unicorn private company, there are often secondary buyers for the stock. You could exercise and sell some stock to them to cover your exercise cost. Regarding RSUs, you HAVE TO PAY TAX AS YOU VEST. For a private company, you're just replacing one potential problem (AMT with option exercises) with a very specific actual problem (steady tax liability as without liquidity). RSUs are a very useful compensation tool, but you can't declare them unilaterally better. ALL equity compensation forms require some "user sophistication", including options and RSUs. If you don't understand how to optimize your situation, get advice from someone who does!
danieltillett 10y ago
I have always thought that companies should work out the salary of a new employee in all cash then once the parties are happy allow the employee to trade in whatever percentage they liked for equity. If you value the equity at zero why should the company give it to you and if you value it very highly why should they give you cash?
- 21echoes 10y ago
  Because startups are, effectively by definition, equity rich and cash poor. Trading $100k/yr in ISOs for $100k/yr in cash across 10 employees increases your cash burn by $1M/year, which is make-or-break for a lot of startups.
  - danieltillett 10y ago
    But this doesn’t work if the employees doesn’t value the ISOs. If I want to hire you to come and work at my startup and you will only come if I pay you $200K then I either have to give you $200K cash or cash and some number of ISOs that you value at 200K as a package. If you don’t value the ISOs and I offer you 100K cash and ISOs that I consider are worth 100K then I have just offered you 100K. My value does not equal your value and me pretending is does not make it real. The nice thing about cashing out equity like this is it signals your true valuation of the company, both to yourself and the company. Just giving options on top of cash tells nothing.
    - 21echoes 10y ago
      Of course, no one is saying that companies and employees have to value ISOs the same, but no one is saying employees who value ISOs at zero should be working at a startup either
bitwize 10y ago
Taking equity instead of cash is like asking the company to denominate your salary in Bison Dollars. Worth a lot IF the plan for world domination goes off without a hitch but until then...
kriro 10y ago
I like the basic idea and it's nicely presented however conceptually I'd favor a model where the employee gains come primarily from the losses of later stage investors and not early stage investors (and founders). """Within the investor class the earlier investors lose more. Year one investors go from 3.2% to 2.3% about a 25% loss, pretty much the same as founders. Year ten investors go from 9.0% to 8.7% about a 3.5% hit.""" So basically I'd like to work from sort of the reverse of this but I assume it's not very likely due to the investment horizons etc. Basically I suppose late stage investments should be a good chunk more expensive.
abalone 10y ago
This is clearly a shot at Kupor's infamous A16Z post where he claims employees who stay suffer a LOT more dilution (80%) when employees who leave keep 100%.[1] But this poster's model puts it at just 5%. There's clearly wildly different assumptions at play here. Can someone smarter than me spell them out? One that jumps out is the assumption here that no employee stays past 3 years. Isn't that a pretty high attrition rate for a pre-IPO startup? [1] http://a16z.com/2016/06/23/options-timing/ http://a16z.com/2016/06/23/options-timing/
abalone 10y ago
Hold up. This post proposes using "single trigger RSUs" instead of options, claiming that taxes are deferrable to a liquidity event. But according to this[1], FICA taxes are still due on vesting. So RSUs would still have immediate tax consequences, potentially very expensive for unicorns. Are there actually any startups offering RSUs? [1] https://www.acc.com/chapters/wisc/upload/The-Rise-of-Restricted-Stock-Units-1.pdf https://www.acc.com/chapters/wisc/upload/The-Rise-of-Restric...

255 points by tanoku 10y ago

Wouldn't RSUs open employees to a different and more punitive tax regime (income tax) than options (which would fall under capital gains if you exercised early enough)?

superuser2 10y ago
I believe if you hold your RSU-granted stock for 1 year, you can pay capital gains tax on it instead. I'm not a CPA.
- phamilton 10y ago
  You would only pay capital gains on the gains from that stock. At RSU vest you would owe taxes on the market value of those RSUs.
- URSpider94 10y ago
  But, you have to pay income tax on the value of the shares at the time when they vest, i.e. become non-restricted. You have zero control over that vesting schedule, and thus the tax bill, and you likely wouldn't have a liquid market for the shares before an IPO. Any gain post-vest can indeed be long-term cap gains, if you hold the shares > 1 year.
phamilton 10y ago
RSUs are simpler and can be planned for. For example, a company could grant RSUs with a mandatory buy back vesting schedule (basically 83b election) upon hire and include the taxes as part of the comp package. Examples: Junior Engineer Sally joins Company A and is offered 0.25% of the company in RSUs. Company A recent raised at a 20M post money with a preferred share price of $1 and a FMV of $0.20. She owes tax on $10k of RSU gains. Company A either: 1) Buys back $4000 of stock in order to cover taxes 2) Provides a $4000 signing bonus to cover taxes. Senior Engineer Bill joins Company B and is offered 0.05% in RSUS. Company B recently raised at a $500M valuation with a preferred share price of $10 and FMV of $3. He owes tax on $75k of RSU gains. Company B either 1) Buys back $30k of stock or 2) provides a $30k signing bonus.

jedberg 10y ago

This is where having a lobbying group would be helpful -- this really needs to be fixed through policy. We need to get the tax law changed so that RSUs are taxed on liquidity instead of vesting. Then you'll still avoid the corruption the tax is supposed to protect against (paying an executives millions in what was previously untaxed compensation through RSUs in the 80s) but still allowing them to be given as startup equity compensation.

iandanforth 10y ago
Can you go into a bit more detail on what counts as liquidity? Can I sell on a secondary market? Can a bank let me guarantee a loan based on my current units? Can non-liquid units be transferred to my next of kin tax free?
- jedberg 10y ago
  These are all details that would have to be worked out, but the gist of it would be that you shouldn't be taxed on it until you're able to sell it. But I'll give it a shot: > Can I sell on a secondary market? Sure, and then you get taxed on the money you made, where your basis is $0. > Can a bank let me guarantee a loan based on my current units? That's tricky because it would be a way for people to work around the law. What if we made you pay tax if you took out a loan with the stock as collateral? > Can non-liquid units be transferred to my next of kin tax free? Seems like it would be reasonable to allow that. The value would still be $0, but when it became liquid, your next of kin would have to pay taxes on the value with a basis of $0, which would make it not a good workaround for estate tax since you would save money if you transferred it under the $5M lifetime limit.
wyman 10y ago
Absolutely agree. ISOs should also be taxed on liquidity as well, instead of an AMT on exercise. There was a group, ReformAMT.org, opened in the wake of the 2000 tech crash, where many employees ended up owing massive amounts of AMT on now-devalued stock. However, it seems that the employers' and investors' interests are against the employees' here - the investors want what few employee shares are lost to be returned so they are diluted less, employers want holden handcuffs to reduce mobility, and only the much-weaker at lobbying employees want more freedom/mobility.

buttershakes 10y ago

This is very interesting. Options are really an unappealing mechanism to incentivize employees. I feel like they prey on people who really don't know any better, and don't understand the tax implications or the possibilities around future dilution. As a rule of thumb I discount face value of options by as much as 70%, that generally doesn't go over very well with people trying to convince you to accept them in lieu of cash. The single trigger RSU is a very hard sell though, as we can see from this example it hurts both Investor and Founder equity stakes, unless people start balking at options (which they should) it won't fly.

jusben1369 10y ago
Quick question. Do you work for a startup now with options? Or, have you in the past? I'm trying to work out if people who object to options would ever join startups. Or, if they're appetite for risk is too small to be a potential candidate.
- beachstartup 10y ago
  i would only ever join a startup as a co-founder. i would never own less % than anyone else, i.e. at least one other founder should have the same equity as i do. that's my personal heuristic, ymmv. if i'm going to work for someone else it's going to be the most stable situation possible, i.e. an established company with market or better salary and benefits and a reasonable workload.
- buttershakes 10y ago
  I have started multiple startups, and joined others at various times. I've also professionally traded options. I have a huge appetite for risk, but the risk/reward isn't there for most early employees who are getting paid less cash in exchange for options. You just can't take them at face value. I would say many early stage employees aren't taking appreciably less risk than the founders themselves, but at a fraction of the upside.
  - chris11 10y ago

chollida1 10y ago

There was a PE firm that came around about 4-5 years ago trying to raise money on this very premise. Their thesis was that - startups would remain private longer. - employee's lost their options when they leave - longer periods to go public means more employees return options to the pool which means employee option pools can be smaller - longer private periods leads to more rounds raised which benefits investors over employees as the former can participate on each round to keep from being diluted - exits would come eventually and the investors would always have superior terms, I believe that they were working under the assumption that investors would never have mandatory black out periods after IPO so they could essentially participate in the opening day IPO pop. This is one of the coolest and most maddening things about finance. Every time you think you've come to a big realization, usually you find out that someone else came to the same conclusion many years ago and has been making money "arbing" it out ever since.

hobbyjogger 10y ago
Seems like a pretty good investment thesis (especially if they were truly ahead of the curve here). Except I doubt the last bullet is accurate. I'd be very surprised to find that even 10% of tech IPOs have significant preferred investors not subject to a lock-up. Underwriters really, really don't like holders (even small ones, but especially big ones) being able to sell right off the bat. And if the market is flooded with VC investors dumping shares just after the offering, then there may well be no "pop" to participate in.
hkmurakami 10y ago
Maybe I'm missing something, but that doesn't really sound like a "thesis" but rather just an identifying mispriced securities ("arb opportunity" also works). I agree with the latter that the late stage market for startup growth capital likely did not price this advantage in, and that the PE fund had an edge. But even at that stage there are winners and losers, and I would think that a thesis would still need to resemble the kind that Series B investors must concoct, and be able to sift out the winners from the losers. In any case I appreciate you sharing this info. It's enlightening.
mahyarm 10y ago

gringofyx 10y ago

Either way it's a losing game, consider a company like Google - how would they attract new employees on either scheme given that the company has been around for 15+ years? The only people who win are those who get in early, or invest big. Any IPO ultimately results in people earning money who don't "work" for that money - that means the actual workers lose out everytime.

DominikR 10y ago
> Any IPO ultimately results in people earning money who don't "work" for that money - that means the actual workers lose out everytime. It is wrong to believe that people would invest large amounts of money randomly without spending significant amounts of their time to make sure the investment will create them some returns. Also they have the risk to actually loose 100% of their investment, which some guy employed at Google with a 6 figure income doesn't have. Of course they'll need more profit to cover for the risk. Think about it this way: If there were no investors there wouldn't be a Google or Facebook as we know it today as these companies didn't make a dime for the first 5 or 6 years of their existence. You can be critical of these two companies (I am) but there are thousands of other companies in the IT sector that just wouldn't exists if they had to make profit right from the start and grow organically.
- gringofyx 10y ago
  Your argument is surely moot because it assumes that startup employees take on no risk. Not to mention conflating IPO with startup options/shares. There are many companies out there that have never, nor will, take investment or IPO yet are still successful. There's also an argument to say that any company that isn't profitable from day one shouldn't exist in the first place. Your argument also suggests that founders must go "cap in hand" to investors to beg for startup capital. In all scenarios I do not see a positive outcome for the employee, and it seems only more and more difficult to attract new talent
  - landryraccoon 10y ago
    I dunno man, if you don't like the offers at Google where do you think you'll do better? They pay pretty well...

spullara 10y ago

I can imagine that there would be other consequences to the change. For example, I could see anyone on the edge around their 1 year vesting cliff would be fired to avoid parting with their equity. It would probably also push down the amount of equity offered because of the increase in value. Further, some companies are already doing this, vesting could be back loaded with the majority vesting in the later years.

hodgesrm 10y ago
Firing people to avoid paying them can get you into serious legal trouble. Good discussion on https://news.ycombinator.com/item?id=3962292 https://news.ycombinator.com/item?id=3962292.
delphinius81 10y ago
There are companies that already let people go before their 1 year cliff (or do other types of restructuring that results in the vesting period to reset). However, I think it would be appropriate to give fewer options as a consequence of this change, since the options would be a more realistic part of the compensation package when you have a longer-period of time to determine if you want to exercise them. I could definitely see the 1 year cliff going away too, else you'd have people collecting 25% of their options at various places and moving on to other companies each year. Eventually one of those companies will do well and your "work" investment will pay off. You can do shotgun investing with your employee options. But a lot of this misses the point that your company's growth is entirely reliant on a productive employee base. If you back load vesting or start firing people right before their cliff, or do any other practices such as this, why would anyone choose to work for you?

codeonfire 10y ago

Is the presumption that founders and investors are not trying to screw employees? I genuinely can't tell from the article. I thought it's just common knowledge that they will try to screw employees at every chance. With options it was different strike prices for management/ founders vs employees. With RSU's it is weird vesting schedules and forcing forfeiture situations.

iaw 10y ago
This comment isn't very productive. Some high-level valley participants are definitely bad actors but the bulk of them are just normal people in positions of power.
- deleted 10y ago
  [deleted]
- codeonfire 10y ago
  Normal people that like money. If this article is about how equity compensation can be improved, then that is a fairly messed up world view and kind of insulting. Employee equity compensation is always designed to explode or have no value. Workers are sick of the schemes. Just pay cash. Companies don't want to and never will improve equity compensation. A better solution would be a law that requires a cash value of granted options or RSU's to be reported to workers which would require a look at sale-ability, strike price, volality, expected employee turnover, etc.
  - ericd 10y ago
    Actually there's a big movement to making options exercisable well after employees leave. So, no. Startups don't have enough cash to compete in terms of pure salary with the leverage that the Googles of the world have. And stock can turn out very well for employees, I've seen it happen at a fairly good rate. You just need to make sure you're getting what you're worth, risk adjusted.
    - 10y ago

wtvanhest 10y ago

Equity is one area where I would encourage YC to get more involved. We need someone to step in and lobby the government for tax treatment of options that reflects their economic reality to early stage employees. We also need to encourage companies to use a 'standard' stock option agreement which is well known by everyone so that equity offers can be compared across companies. If you take equity from an early stage company that has also raised a ton of money with a liquidation preference, what are your chances of getting paid out, even on a big exit? That question is basically impossible for most people out here to answer.

cubano 10y ago
It wouldn't be very hard to collect existing data points and come up with a rough approximation, would it? I would think enough data now exists to allow such an analysis to have some idea of those numbers.
- wtvanhest 10y ago
  I doubt it. The past 5 years have been somewhat unique in that companies were given lots of cash with liquidation preferences and 'fake' valuations. A good example are T Rowe Price's 'unicorns': http://www.marketwatch.com/story/uber-airbnb-and-other-unicorns-have-valuations-cut-at-t-rowe-price-2016-04-15 http://www.marketwatch.com/story/uber-airbnb-and-other-unico... If UBER IPOs for any less than $12.5Bn, what will the early employees get? Probably not much compared with the value they helped create. Right now, that looks impossible, but who knows what will happen? My point is that there is not a historic president for what has happened in the private markets and I would do anything I could to cash out of equity if I held it in a unicorn and I was liquid. I would love to see YC step up and encourage founders to issue employee friendly stock options.
  - wtvanhest 10y ago
    *precedent not president

trhway 10y ago

reminded how 10 years ago upper class was trying to initiate grass roots and steer protests against options expensing. They failed and as a result we have RSU pretty much everywhere instead of options. The startups are the last bastion, and i think with the modern "who needs an IPO with such great C round (and related caching out for chosen ones)" approach, people will start to get the picture and the RSU will come there too.

mason55 10y ago
The problem with startup RSUs is that you are taxed when the RSUs vest. If there is no liquidity (which is the case for most startups) then you're paying taxes on RSUs which you can't sell and may never be worth anything.
- rrdharan 10y ago
  This is not always the case. The grant may be structured such that you don't actually have the shares in your possession even after vesting, you just have a claim on them that will be honored at IPO or change of control. This though means you can't dump them on SharePost/SecondMarket etc. even after they vest.

efoto 10y ago

There was a HN discussion ten days ago [1], where several people including myself were suggesting 83b rule RSUs as a possible solution. Nice to see this method quantified. https://news.ycombinator.com/item?id=11963551 https://news.ycombinator.com/item?id=11963551

timcederman 10y ago

There is a downside to RSUs. Say you work for a private company with a high valuation, e.g. AirBnB at $25B, and you are granted 0.01% equity over 4 years. That means you are vesting $2.5m of RSUs over 4 years, and these RSUs are taxable at that amount. Typically for folks earning over $150k/year in base salary, particularly if married, even half as much will put you into AMT territory, and you will end up paying a significant chunk of cash each year in taxes (even if RSUs are withheld for taxes, because the withholding cannot account for things like AMT). Options with extremely long exercise windows helps obviate this tax burden and allows the employee to decide when/if to improve their tax position by exercising ahead of a liquidity event.

home_boi 10y ago
Does the government take private RSU's as payment for taxes? It seems unfair to tax people for equity that even the government itself doesn't value.
- jonny_eh 10y ago
  But if I pay you bitcoin for goods/services, you still need to pay tax on that, in USD.
- JonFish85 10y ago
  Of course not, the IRS takes cash. It's far simpler that way, and probably will remain that way for quite awhile.
  - pc86 10y ago
    And it probably should - the IRS is in the business of collecting money from citizens and corporations. It should not be in the business of managing investments and RSUs in thousands of private entities.
- timcederman 10y ago
  Yes, typically there is withholding to help cover the taxes, but for four year grants in the range of $1m+, the default withholding doesn't fully cover the taxes.

shon 10y ago

It's interesting to see the popular response to this thread being one where people think employees are better off with salary over options. This seems crazy to me as I have watched many close friends cash out options from companies including Google, Yelp, Apple and Pandora and buy houses (some with cash), start companies, become investors and/or take long sabbaticals with the proceeds from their options. With salary there is a clear upper bound and the tax on W2 income is simply the worst. I would say that at least in the Bay Area, options are a good bet and much better bet based on what I've seen. Startups are always a gamble for everyone involved. But outside of the financial industry, where 6 and 7 figure cash bonuses are common, I think options are superior to other forms of compensation if you're trying to optimize for gaining a "life changing amount of money" in less than say 10 years. High salary could only compare if you are very good at minimizing tax and maximizing the money making potential of your salary though investments (requiring additional work). But if you're going to have to invest anyway, why not work for a company you believe in and have a chance at influencing the company's success as well as your own?

EpicEng 10y ago
>including Google, Yelp, Apple and Pandora So, companies that exist in that tiny portion which are actually hugely profitable? Most companies aren't, and most options are worth little to nothing at the end of the day. After a decade in start ups and now supporting a family, I'll always take salary over options.
marssaxman 10y ago
My experience has been that you never get enough influence over the company's success to make a significant difference, and the options don't pay off frequently enough to rely on. For my own part, I've been at this for over 20 years and I've never come close to making any significant amount of money from options. They have lost all incentive power. Pay me cash money now, and I'll invest it however I please.
thisone 10y ago
you've had no close friends who've lost their options, or had their options become worthless when companies fail? You're one lucky person to know!

rdl 10y ago

Is a single trigger RSU somehow different in trigger than single trigger options? I've always been told that single trigger, at least for the majority of engineering, means your company won't be purchased. Single trigger makes sense for legal, accounting, etc who are likely gone in an acquisition. Double trigger makes sense overall.

phamilton 10y ago
If the premise is that employees can move the needle on the stock price through their contributions, then double trigger doesn't make sense either. I recently went through an acquisition where all of our stock was converted into the acquiring company's stock. It was maddening to see our team continue to perform well but see the price of our equity tank along with the rest of the company.

calcsam 10y ago

The barrier to entry of this stock option tweak: it requires an informed populace, ie, us. If you are a founder with reasonable engineer cred and announce differentiated stock option terms, ie, Adam D' Angelo at Quora, there's a reasonable chance that engineers considering joining your company will be encouraged by your effort on this. If you're someone else, and your company offers this, many experienced engineers, not unreasonably, will value their equity packages at zero regardless of what you do. Many others, such as new grads, will not know enough about stock options to understand the distinction you're drawing. If you do decide to offer RSUs for the reasons the authors cited, you may want to follow the example of Henry Ward at eShares and put together some good presentation materials to explain the benefits of this course. Otherwise, you're making an expensive choice for little benefit.

a_small_island 10y ago
>"If you are a founder with reasonable engineer cred" Can you expand on this? Are you of the mind that engineers should only trust other engineers?

kazinator 10y ago

Who pays for this? Is the following answer somehow too obvious to be true? When you eventually sell the equity, the stock exchange will hook you up with counterparties who buy the stock. Those counterparties are who pays you.

arrty88 10y ago

i really think Profit Interest Units are the best form of equity for both employees and employers https://www.nceo.org/articles/equity-incentives-limited-liability-company-llc https://www.nceo.org/articles/equity-incentives-limited-liab...

cloudjacker 10y ago

Its not "options" vs "RSUs" There are a wide range of financial products used around the world that would better fix the tech sectors compensation incentives and nobody is talking about them. Think different didn't mean argue about false dichotomies. It is a total charade for the venture firms to propel the notion that they are doing employees a favor by even offering stock. "How gracious of us to dilute our investment at all!" Dilute the preferred shares with 8% dividend and liquidity preferences! Offer convertible bonds or other hybrid products! You can incentivize people in 101 ways, and you guys are debating about two of them under the assumption that the crowd is right

nfriedly 10y ago

The last startup I worked at went through a merger. In the process, they created a new company and gave all employees stock in the new company, on the same vesting schedule as the options had been on in the previous companies. They organized things and provided help to ensure that all US employees were able to make a Section 83(b) election for our stock in the new company as soon as it was created. (This means we paid taxes early based on the current value (zero) instead of potentially paying much larger taxes in the future.)

55555 10y ago

I have really never understood the confusion over why this doesn't get implemented. It has always seemed clear to me that there's not enough demand for change, and investors and founders want things to stay the way they are. It's a really, really good deal for them.

powera 10y ago

The assumption that every employee leaves after 3 years and keeps none of their equity is absurd. I don't see any value in that example at all.

te 10y ago
> 3 year employee tenure > 100% loss of potential equity when employees leave the company ... ... > You can also see that only the employees hired in year 8, 9, 10 > (the final 855) have any shares at the end of year 10. Quite bizarre! Yes, quite the mystery indeed.

dman 10y ago

I wish companies adopt the same "what have you done for me lately" mindset to investors as they do to employees.

payne92 10y ago

While the dialog around various equity-based incentive compensation mechanisms is good, this article is off base in SO many ways: >>With an often high strike price, Only an issue at the later stages of companies (note: this writeup argues RSUs "from the beginning"). >>a large tax burden on execution due to AMT, Only if you are exercising later in the company stage, when the fair market value has (usually) gone up. If you are bullish on the company, it's generally best to exercise as you vest, for this very reason. Also, exercising as you vest gets the timer going for (a) cap gains treatment (much better tax rates), AND, a possible Qualified Small Business Stock tax exclusion (5yr holding, significant tax break). >>and a 90 day execution window after leaving the company many share options are left unexecuted. This is MUCH less of an issue if you are exercising as you go along (see above). If you you have just left a large unicorn private company, there are often secondary buyers for the stock. You could exercise and sell some stock to them to cover your exercise cost. Regarding RSUs, you HAVE TO PAY TAX AS YOU VEST. For a private company, you're just replacing one potential problem (AMT with option exercises) with a very specific actual problem (steady tax liability as without liquidity). RSUs are a very useful compensation tool, but you can't declare them unilaterally better. ALL equity compensation forms require some "user sophistication", including options and RSUs. If you don't understand how to optimize your situation, get advice from someone who does!

danieltillett 10y ago

I have always thought that companies should work out the salary of a new employee in all cash then once the parties are happy allow the employee to trade in whatever percentage they liked for equity. If you value the equity at zero why should the company give it to you and if you value it very highly why should they give you cash?

21echoes 10y ago
Because startups are, effectively by definition, equity rich and cash poor. Trading $100k/yr in ISOs for $100k/yr in cash across 10 employees increases your cash burn by $1M/year, which is make-or-break for a lot of startups.
- danieltillett 10y ago
  But this doesn’t work if the employees doesn’t value the ISOs. If I want to hire you to come and work at my startup and you will only come if I pay you $200K then I either have to give you $200K cash or cash and some number of ISOs that you value at 200K as a package. If you don’t value the ISOs and I offer you 100K cash and ISOs that I consider are worth 100K then I have just offered you 100K. My value does not equal your value and me pretending is does not make it real. The nice thing about cashing out equity like this is it signals your true valuation of the company, both to yourself and the company. Just giving options on top of cash tells nothing.
  - 21echoes 10y ago
    Of course, no one is saying that companies and employees have to value ISOs the same, but no one is saying employees who value ISOs at zero should be working at a startup either

bitwize 10y ago

Taking equity instead of cash is like asking the company to denominate your salary in Bison Dollars. Worth a lot IF the plan for world domination goes off without a hitch but until then...

kriro 10y ago

I like the basic idea and it's nicely presented however conceptually I'd favor a model where the employee gains come primarily from the losses of later stage investors and not early stage investors (and founders). """Within the investor class the earlier investors lose more. Year one investors go from 3.2% to 2.3% about a 25% loss, pretty much the same as founders. Year ten investors go from 9.0% to 8.7% about a 3.5% hit.""" So basically I'd like to work from sort of the reverse of this but I assume it's not very likely due to the investment horizons etc. Basically I suppose late stage investments should be a good chunk more expensive.

abalone 10y ago

This is clearly a shot at Kupor's infamous A16Z post where he claims employees who stay suffer a LOT more dilution (80%) when employees who leave keep 100%.[1] But this poster's model puts it at just 5%. There's clearly wildly different assumptions at play here. Can someone smarter than me spell them out? One that jumps out is the assumption here that no employee stays past 3 years. Isn't that a pretty high attrition rate for a pre-IPO startup? [1] http://a16z.com/2016/06/23/options-timing/ http://a16z.com/2016/06/23/options-timing/

abalone 10y ago

Hold up. This post proposes using "single trigger RSUs" instead of options, claiming that taxes are deferrable to a liquidity event. But according to this[1], FICA taxes are still due on vesting. So RSUs would still have immediate tax consequences, potentially very expensive for unicorns. Are there actually any startups offering RSUs? [1] https://www.acc.com/chapters/wisc/upload/The-Rise-of-Restricted-Stock-Units-1.pdf https://www.acc.com/chapters/wisc/upload/The-Rise-of-Restric...