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I'm not sure I quite get what you mean by "issuing early employees restricted stock awards". Can you elaborate? Is this like an IOU for restricted stock? Isn't

I'm not sure I quite get what you mean by "issuing early employees restricted stock awards". Can you elaborate? Is this like an IOU for restricted stock? Isn't that kind of like what stock options are (except for common stock)? And if you just mean giving actual restricted stock (like to investors), then the main problem is you have to pay those taxes right away (the whole point of options). But maybe you mean something else.

sokoloff 10y ago
If you are granted restricted stock subject to vesting, in the US you owe taxes only when the stock is both released AND vested, meaning the tax bill comes due in stages as the shares vest, not "right away". If you give restricted shares that vest over time and are only released upon a change in control, you can further defer the tax bill due date (though at the expense of the eventual bill being higher on average).
- zaroth 10y ago
  Most restricted stock subject to vesting will require the recipient to file an 83(b) election. This takes the full current value of all shares at the current issue price as income up front. Since the shares are typically worthless at that point, the tax bill is zero. The alternative is disastrous for a fast growing company. Each month, each year, you are vesting new shares at an exponentially increasing valuation, and now have to pay income tax on that completely illiquid gain with cash you literally don't have.
  - sokoloff 10y ago
    > Most restricted stock subject to vesting will require the recipient to file an 83(b) election No RSU grant "requires" an 83(b) election. Your second point is why RSU grants with normal vesting and delayed release is desirable.
    - zaroth 10y ago
      I've personally written restricted stock grants which require 83(b) elections to be filed. My understanding is that is boilerplate in the Restricted Stock Purchase Agreement. Please note, Restricted Stock !== RSU, and RSUs are not eligible for 83(b) because they are just a promise of future shares, no stock is actually issued until the conditions are met. (see above)
      - scurvy 10y ago
        If that's the case, do you require employees to pay for their shares at grant date? Otherwise it's a taxable event (not cap gains but real income) when they vest. Or do you "sell" a portion of the shares back to the company to pay taxes for the employee, then the employee gets 45-50% the number of shares that are vested. This is what Microsoft did when I was there, but they were publicly traded and had a public market to "sell" into (though it went straight to company stock buyback plan). Private companies don't have that luxury and would have to pay real money to the IRS to foot employees' tax bills at various vesting dates.
        zaroth 10y ago
        If it's restricted stock, either the grant is taxable income, or the stock is paid for at the time of the grant (write a check to the company). Vesting is then defined a reducing percentage of shares the company can buy back over time, and so if the employee leaves or vesting terminates for some reason, the company writes a check to cover the refund. This all works best in the early days when the 409a valuation is zero. Once you have a high valuation, getting real amounts of equity into employee hands that has a good chance of actually being valuable in the future is extremely difficult, because with each share you give to an employee you are giving essentially 40-50% of that to Fed + State, plus another 30% of any future gain. Since this is all based on fantasy valuations of an illiquid asset, it is playing with fire in the worst way. The only other option is options with high exercise prices based on highly speculative earnings forecasts, for shares which are 2nd or 3rd in line behind all the preferred stockholders. This might work out for late hires at Google and Facebook, but almost never anywhere else. I mean think about it -- "Here are some common shares of my company; I just raised $50m at a $500m valuation, we are burning $5 - $10m in cash every quarter. We are are going to be absolutely massively huge and a billion dollar unicorn in no time. There are currently $100m of preferences ahead of you, and we will certainly need to raise huge amounts of more cash in the years ahead to achieve our vision. You will have no input into how the company is run, no effective voting power, and no seat at the table during an acquisition. Our 409a valuation is just $100m!" As an employee, getting an option to pay for that is supposed to be an incentive?! The solution I would like to see? Illiquid shares in a private startup less than 5 years old and with assets less than $100mm should be valued at a discount to liquidation value, or ideally transferable with no taxable event whatsoever. If those shares are encumbered or sold, then the holder pays short or long-term capital gain rates on the full amount of the sale. No 409a, no exercise price, no 83(b). There's absolutely no reason to try to pre-tax a portion of the value of the shares up-front when they are illiquid and impossible to value. This proposal is basically tax-neutral. If you want, you could extend the short-term capital gains rate to 2 or even 3 years instead of 1 for this type of transaction, to avoid someone taking highly valuable shares of a later-stage company, and getting the full amount taxed as capital gains just 12 months later. To put this in perspective, with QSBS / Section 1202 (qualified small business stock) the first 10x or $10m of gains on original issue shares is 100% Federal capital gains free after a 5-year holding period. This was made permanent in 2015. Some states also eliminate or reduce the state capital gains as well -- although not California for a few years now :-( So politicians are making startup investing very attractive for anyone who can get Founder/Restricted or Preferred shares, but they have left the employees' options completely in the dark ages. It's time to fight for some reforms here...
  - superuser2 10y ago
    >completely illiquid gain Which is why "liquidity event" is one of the conditions for vesting.
    - zaroth 10y ago
      I think that's an absolutely crazy way to try to avoid an 83(b) election. I would never want my stock locked up behind a dubious "liquidity event" requirement for vesting. So you work for a startup for 10 years since inception, it's private all the time, you get annual grants for more and more options, building up options for 5% of the fully diluted shares, but then get disabled and have to stop working. Now you lose all your options because none of them have vested because the company didn't sell yet?
      - superuser2 10y ago
        It's combined with a stipulation that you are still entitled to the shares whose "time-based condition" has been met, and will be granted them upon any liquidity event even after leaving the company.
        zaroth 10y ago
        Yeah, so Zynga did this... it's complicated and has many pitfalls. For example, their options expired after 7 years. There's also much debate around if the liquidity event can reasonably be construed as a legitimate "performance condition", and whether you have to start accounting for (and paying tax on) the otherwise vested shares once you can reasonable foresee a future liquidity event, not just after said liquidity event actually occurs. https://www.sec.gov/Archives/edgar/data/1439404/000119312511326687/filename1.htm https://www.sec.gov/Archives/edgar/data/1439404/000119312511...
        sokoloff 10y ago
        It doesn't have to be solely a performance condition. I don't think it would be hard to prevail on the facts arguing that a requirement for an IPO (or similar liquidity event) is wholly out of the employee's control and that a substantial risk of that not happening occurs up until the moment that it actually happens. IPOs fall apart/are withdrawn and mergers fail frequently enough that a substantial risk argument could probably be sustained.
SmellTheGlove 10y ago
Sort of. With restricted stock, the stock is not transferable from the company to you until certain conditions are met. The grant has been made, but the shares aren't yours until they vest (conditions met). I believe (I'm not a tax lawyer) that you pay taxes on the fair market value of the stock as of the vesting date, but you can elect to pay those taxes on the date of the grant instead, based on the value of those shares on that date (with the risk being that if the shares never vest, you don't get your tax money back). Then there are RSUs - restricted stock units. This is more like an IOU in that the company promises now to grant you a block of restricted stock at some point in the future. It's to manage taxation, and again, that's less my area. A good explanation is here: http://avc.com/2010/11/employee-equity-restricted-stock-and-rsus/ http://avc.com/2010/11/employee-equity-restricted-stock-and-...

sokoloff 10y ago

If you are granted restricted stock subject to vesting, in the US you owe taxes only when the stock is both released AND vested, meaning the tax bill comes due in stages as the shares vest, not "right away". If you give restricted shares that vest over time and are only released upon a change in control, you can further defer the tax bill due date (though at the expense of the eventual bill being higher on average).

zaroth 10y ago
Most restricted stock subject to vesting will require the recipient to file an 83(b) election. This takes the full current value of all shares at the current issue price as income up front. Since the shares are typically worthless at that point, the tax bill is zero. The alternative is disastrous for a fast growing company. Each month, each year, you are vesting new shares at an exponentially increasing valuation, and now have to pay income tax on that completely illiquid gain with cash you literally don't have.
- sokoloff 10y ago
  > Most restricted stock subject to vesting will require the recipient to file an 83(b) election No RSU grant "requires" an 83(b) election. Your second point is why RSU grants with normal vesting and delayed release is desirable.
  - zaroth 10y ago
    I've personally written restricted stock grants which require 83(b) elections to be filed. My understanding is that is boilerplate in the Restricted Stock Purchase Agreement. Please note, Restricted Stock !== RSU, and RSUs are not eligible for 83(b) because they are just a promise of future shares, no stock is actually issued until the conditions are met. (see above)
    - scurvy 10y ago
      If that's the case, do you require employees to pay for their shares at grant date? Otherwise it's a taxable event (not cap gains but real income) when they vest. Or do you "sell" a portion of the shares back to the company to pay taxes for the employee, then the employee gets 45-50% the number of shares that are vested. This is what Microsoft did when I was there, but they were publicly traded and had a public market to "sell" into (though it went straight to company stock buyback plan). Private companies don't have that luxury and would have to pay real money to the IRS to foot employees' tax bills at various vesting dates.
      - zaroth 10y ago
        If it's restricted stock, either the grant is taxable income, or the stock is paid for at the time of the grant (write a check to the company). Vesting is then defined a reducing percentage of shares the company can buy back over time, and so if the employee leaves or vesting terminates for some reason, the company writes a check to cover the refund. This all works best in the early days when the 409a valuation is zero. Once you have a high valuation, getting real amounts of equity into employee hands that has a good chance of actually being valuable in the future is extremely difficult, because with each share you give to an employee you are giving essentially 40-50% of that to Fed + State, plus another 30% of any future gain. Since this is all based on fantasy valuations of an illiquid asset, it is playing with fire in the worst way. The only other option is options with high exercise prices based on highly speculative earnings forecasts, for shares which are 2nd or 3rd in line behind all the preferred stockholders. This might work out for late hires at Google and Facebook, but almost never anywhere else. I mean think about it -- "Here are some common shares of my company; I just raised $50m at a $500m valuation, we are burning $5 - $10m in cash every quarter. We are are going to be absolutely massively huge and a billion dollar unicorn in no time. There are currently $100m of preferences ahead of you, and we will certainly need to raise huge amounts of more cash in the years ahead to achieve our vision. You will have no input into how the company is run, no effective voting power, and no seat at the table during an acquisition. Our 409a valuation is just $100m!" As an employee, getting an option to pay for that is supposed to be an incentive?! The solution I would like to see? Illiquid shares in a private startup less than 5 years old and with assets less than $100mm should be valued at a discount to liquidation value, or ideally transferable with no taxable event whatsoever. If those shares are encumbered or sold, then the holder pays short or long-term capital gain rates on the full amount of the sale. No 409a, no exercise price, no 83(b). There's absolutely no reason to try to pre-tax a portion of the value of the shares up-front when they are illiquid and impossible to value. This proposal is basically tax-neutral. If you want, you could extend the short-term capital gains rate to 2 or even 3 years instead of 1 for this type of transaction, to avoid someone taking highly valuable shares of a later-stage company, and getting the full amount taxed as capital gains just 12 months later. To put this in perspective, with QSBS / Section 1202 (qualified small business stock) the first 10x or $10m of gains on original issue shares is 100% Federal capital gains free after a 5-year holding period. This was made permanent in 2015. Some states also eliminate or reduce the state capital gains as well -- although not California for a few years now :-( So politicians are making startup investing very attractive for anyone who can get Founder/Restricted or Preferred shares, but they have left the employees' options completely in the dark ages. It's time to fight for some reforms here...
- superuser2 10y ago
  >completely illiquid gain Which is why "liquidity event" is one of the conditions for vesting.
  - zaroth 10y ago
    I think that's an absolutely crazy way to try to avoid an 83(b) election. I would never want my stock locked up behind a dubious "liquidity event" requirement for vesting. So you work for a startup for 10 years since inception, it's private all the time, you get annual grants for more and more options, building up options for 5% of the fully diluted shares, but then get disabled and have to stop working. Now you lose all your options because none of them have vested because the company didn't sell yet?
    - superuser2 10y ago
      It's combined with a stipulation that you are still entitled to the shares whose "time-based condition" has been met, and will be granted them upon any liquidity event even after leaving the company.
      - zaroth 10y ago
        Yeah, so Zynga did this... it's complicated and has many pitfalls. For example, their options expired after 7 years. There's also much debate around if the liquidity event can reasonably be construed as a legitimate "performance condition", and whether you have to start accounting for (and paying tax on) the otherwise vested shares once you can reasonable foresee a future liquidity event, not just after said liquidity event actually occurs. https://www.sec.gov/Archives/edgar/data/1439404/000119312511326687/filename1.htm https://www.sec.gov/Archives/edgar/data/1439404/000119312511...
        sokoloff 10y ago
        It doesn't have to be solely a performance condition. I don't think it would be hard to prevail on the facts arguing that a requirement for an IPO (or similar liquidity event) is wholly out of the employee's control and that a substantial risk of that not happening occurs up until the moment that it actually happens. IPOs fall apart/are withdrawn and mergers fail frequently enough that a substantial risk argument could probably be sustained.

SmellTheGlove 10y ago

Sort of. With restricted stock, the stock is not transferable from the company to you until certain conditions are met. The grant has been made, but the shares aren't yours until they vest (conditions met). I believe (I'm not a tax lawyer) that you pay taxes on the fair market value of the stock as of the vesting date, but you can elect to pay those taxes on the date of the grant instead, based on the value of those shares on that date (with the risk being that if the shares never vest, you don't get your tax money back). Then there are RSUs - restricted stock units. This is more like an IOU in that the company promises now to grant you a block of restricted stock at some point in the future. It's to manage taxation, and again, that's less my area. A good explanation is here: http://avc.com/2010/11/employee-equity-restricted-stock-and-rsus/ http://avc.com/2010/11/employee-equity-restricted-stock-and-...