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In my experience most people at startups who leave end up not exercising their options due to the cost of exercising them coupled with the fact that they may be

by xt00 10y ago

In my experience most people at startups who leave end up not exercising their options due to the cost of exercising them coupled with the fact that they may be underpaid due to the assumption that their options may end up quite valuable. So basically they pay somebody 90k/year then give them ~20k/year in options. Then they quit after 2 years and have 90 days to buy like 50k worth of stock at the strike price they were promised. So they end up paying 50k to buy some common shares (not preferred). An investor who paid 50k to invest in the company most likely got preferred shares, so the young guy who paid 50k who probably can barely afford that is now taking way more risk for a much smaller percentage of the company. If the company goes under the preferred shareholders have a chance to get their money back during a firesale of assets or IP or whatever, but the common shares are screwed. So I tell virtually everybody unless there is a well established secondary market to sell your shares of your particular company, then don't take the options. I honestly think the 90 day exercise is totally ludicrous in the startup world. I think that should be a major negotiation point with anybody who is joining a startup. They should just insist on it no matter what.

draw_down 10y ago
At this point, anybody offering those terms is well-aware it's not in the employee's best interest. And they don't give a shit. I agree, 90 days is totally ridiculous.
- zenlikethat 10y ago
  A 90-day window might be better for you if you want to stick around at a company for a while and there were other people that came before you, but left. "Dead equity" of startup employees who have left but not exercised means that they can let you do all of the work while they dilute the available equity pool (i.e., take money directly out of your pocket). This a16z article goes into this: http://a16z.com/2016/06/23/options-timing/ http://a16z.com/2016/06/23/options-timing/ (Though I'm not saying I agree 100% with their naturally biased position) An extended exercise window is not an end-all-be-all solution. Other solutions that don't have the dead equity problem include: 1. Actually pay startup employees reasonable salaries and don't pretend their equity is 100% certain to lead to great riches since it is a risk 2. IRS / Congress could fix tax treatment in this situation, since it is not serving the purpose it was intended to (avoid rich people dodging taxes) 3. Startups actually IPO / get liquid faster instead of contributing to our existing private equity bubble where liquidity events are delayed indefinitely, rendering equity useless. More liquid cash flying around is generally better for everyone as long as it's not a dotcom-era bubble. Employees have just as much of a responsibility to learn this stuff as their employers do to act generally ethically. They're your employer, not your parents.
  - ThrustVectoring 10y ago
    "Dead Equity" has some advantages as well. You align the long-term incentives of the company with those of employees who are moving on earlier. If you know that you'll never have to deal with a scaling issue, why would you spend the effort dealing with it? Getting employees invested in long-term outcomes helps with principle-agent problems like this, which can help company performance more than the cost of "Dead Equity".
    - zenlikethat 10y ago
      I see your point but don't really agree with your argument -- in my experience engineers who consciously know what a good or a bad engineering decision for the future is will make the good decisions regardless -- it's the terrible engineers who don't know any better you need to worry about. In either case, given an extended exercise window both are sitting around collecting value indefinitely after leaving. They don't need to contribute anything to the next "generation" of work but they still collect the rewards. I'd expect that in most high-growth companies the impact of individual contributors quickly gets washed away after they leave.
      - ThrustVectoring 10y ago
        If you think that former early employees don't contribute to future "generations" of work, then the ethical thing to do is to offer better cash compensations and less equity. It's not really ethical to offer equity compensation that looks like it could be valuable but has significant hidden barriers to actually being used.
        zenlikethat 10y ago
        > the ethical thing to do is to offer better cash compensations and less equity That's one of my main points: Employees have the power to refuse employers that offer equity in lieu of fair salary. But my experience has been that people keep falling for the equity carrot again and again, and as long as they keep falling for it, employers will keep doing it.
danpalmer 10y ago
> I honestly think the 90 day exercise is totally ludicrous in the startup world. I think that should be a major negotiation point with anybody who is joining a startup. They should just insist on it no matter what. Unfortunately, while the number of options, salary, holiday, etc are relatively easy for a company to change, I think changing the contracts around exercising for a single employee is a change large and complicated enough that companies are unlikely to do it.
- xt00 10y ago
  Yea I'll have to find some term sheets laying around, but I can't remember seeing the 90 day exercise being explicitly written into most term sheets. I only have seen it written into people's offer letters. Does anybody know where that language would be written actually otherwise? Some sort of bylaws or something -- seems like that could be relatively easily changed to read something like "exercise period of employee stock options is 90 days after termination of employment unless otherwise stated in employee offer letter and should not be greater than 10 years."
  - freddyc 10y ago
    It's usually in the underlying option plan I believe. I think the challenge with changing the 90 day window is that you run the risk of the option not qualifying as an ISO. If that's the case, it would instead be classified as a non-qualified stock option and the holder would lose the capital gains benefits and be subject to ordinary income tax (IANAL though, so could be way off base).
    - stanleydrew 10y ago
      This is roughly correct. The 90-day exercise window isn't just something made up out of thin air to handcuff employees and keep them from leaving. It's explicitly written into the tax code that an option must be exercised within 90 days of leaving a company if the option is to be treated as an ISO. ISOs are arguably more advantageous than NSOs, which is why this is the default.
pinot 10y ago
Not to mention $90k person is likely leaving because they have low faith in the company in the first place.
- zenlikethat 10y ago
  Just playing devil's advocate here: So they are leaving because they have low faith in the company, but still expect to be able to collect rewards on other peoples' work years later if the company happens to succeed? If they didn't have a high degree of confidence in the company, the safe bet would always be to not exercise.
  - st3v3r 10y ago
    "Other people's work" that builds on their work, too.
  - aanm1988 10y ago
    They already put in the time. That's the whole point of vesting.
  - morgante 10y ago
    This mentality is dangerous and pernicious. We have vesting schedules for a reason. They'd be reaping the rewards of their past work, not other people's future work.
- programmarchy 10y ago
  To add a counter-anecdote, I left a startup while still having a good amount of faith in the company. Left after finishing work on a couple of their products because I wanted a lifestyle change and had an opportunity to strike out on my own venture. The product was great, but engineering culture was a death march, partially due to the seasonal industry (hardware/toys) and partially due to management. Oddly enough, a bunch of other engineers also left shortly after -- after all the hard work was done. Company is profitable now due to increased sales, but also cutting salary costs. Strike price was still low when I left, so I bought my options.
deleted 10y ago
[deleted]
CalChris 10y ago
Wise advice but if the distinction between preferred+common is a real difference, then don't take the stock. Hella don't take the stock.
- zenlikethat 10y ago
  Curious about this, what "distinction" are you referring to here exactly? My understand is that the whole point of preferred vs. common shares is that there's a distinction: preferred shares get, well, preference in a liquidity event. This ensures investors recoup their losses if things go awry.
  - jschwartzi 10y ago
    The problem is that the whole point of options is as consideration for the employee's time investment.
  - CalChris 10y ago
    We are talking about the exact same distinction and the exact same scenario only from different POVs. To be clear, I'm not at all saying that investors who put up real money for startups shouldn't get preferred stock as compared with employees' common. What I am saying is that if+when an employee leaves a startup and has say 90 days to buy any accrued options then that employee should utterly pass if they think the company looks at all dicey. If it looks dicey then the distinction between preferred and common is very real and hella pass. Most startups fail and this employee is leaving that company for some reason. Now if the employee is early and the options are cheap and there's little taxes then maybe it's a lottery ticket. The details are always more complex. I'm just looking at it from an employee's POV. You're probably looking at it from a VC's POV. Would you voluntarily sign a pay to play agreement late in the game? No. You'd stare cold and hard at the facts on the table. You sure wouldn't throw good money after bad. You should expect the same from a rational employee.
    - elastic_church 10y ago
      employees don't currently have the transparency to make this objective decision. founders and board members are very opaque about this information, the prevalence and the covenants of preferred shares. the state of delaware has created greater transparency requirements for securities holders of private companies. fortuantely it is still trendy for companies to incorporate in that state despite the 55+ distinct jurisdictions under the federal umbrella. unfortunately, employees have found themselves in legal battles with their own companies for attempting to leverage these regulations.
jpm_sd 10y ago
In my experience (have worked at 3 start-ups), if you quit, you probably don't expect the options to ever be worth anything!
- hkmurakami 10y ago
  Eh, worked at one where there was a departmental exodus while the company was expected to IPO within the year (and it did). Plenty of people left due to political reasons or after full vest, exercised their options, and made out well. Anecdotes.
abalone 10y ago
> Then they quit after 2 years and have 90 days to buy like 50k worth of stock at the strike price they were promised. This is missing the key point of the article which is that there are also taxes to pay, not just the strike price. What you're saying is valid -- even the strike price can be a lot for someone to afford on their way out without any liquidity. But it is very important to understand that it's much worse than that at "successful" startups that have increased in value substantially over those 2 years. You also have to pay AMT (28%) on much of that gain in value, which could end up costing even more than the strike price itself. Hopefully more startups will offer extended exercise windows of several years. Some are. See: https://github.com/holman/extended-exercise-windows https://github.com/holman/extended-exercise-windows
gumby 10y ago
Just one point: > An investor who paid 50k to invest in the company most likely got preferred shares, so the young guy who paid 50k who probably can barely afford that is now taking way more risk for a much smaller percentage of the company. The common shares cost less than preferred shares as they lack the preferences. So when the employee leaves, her 50K will buy a larger percentage of the company than your hypothetical investor. She may of course still be taking a larger risk as she probably has a smaller asset base than the investor and his customers (err, LPs).

by xt00 10y ago

draw_down 10y ago

At this point, anybody offering those terms is well-aware it's not in the employee's best interest. And they don't give a shit. I agree, 90 days is totally ridiculous.

zenlikethat 10y ago
A 90-day window might be better for you if you want to stick around at a company for a while and there were other people that came before you, but left. "Dead equity" of startup employees who have left but not exercised means that they can let you do all of the work while they dilute the available equity pool (i.e., take money directly out of your pocket). This a16z article goes into this: http://a16z.com/2016/06/23/options-timing/ http://a16z.com/2016/06/23/options-timing/ (Though I'm not saying I agree 100% with their naturally biased position) An extended exercise window is not an end-all-be-all solution. Other solutions that don't have the dead equity problem include: 1. Actually pay startup employees reasonable salaries and don't pretend their equity is 100% certain to lead to great riches since it is a risk 2. IRS / Congress could fix tax treatment in this situation, since it is not serving the purpose it was intended to (avoid rich people dodging taxes) 3. Startups actually IPO / get liquid faster instead of contributing to our existing private equity bubble where liquidity events are delayed indefinitely, rendering equity useless. More liquid cash flying around is generally better for everyone as long as it's not a dotcom-era bubble. Employees have just as much of a responsibility to learn this stuff as their employers do to act generally ethically. They're your employer, not your parents.
- ThrustVectoring 10y ago
  "Dead Equity" has some advantages as well. You align the long-term incentives of the company with those of employees who are moving on earlier. If you know that you'll never have to deal with a scaling issue, why would you spend the effort dealing with it? Getting employees invested in long-term outcomes helps with principle-agent problems like this, which can help company performance more than the cost of "Dead Equity".
  - zenlikethat 10y ago
    I see your point but don't really agree with your argument -- in my experience engineers who consciously know what a good or a bad engineering decision for the future is will make the good decisions regardless -- it's the terrible engineers who don't know any better you need to worry about. In either case, given an extended exercise window both are sitting around collecting value indefinitely after leaving. They don't need to contribute anything to the next "generation" of work but they still collect the rewards. I'd expect that in most high-growth companies the impact of individual contributors quickly gets washed away after they leave.
    - ThrustVectoring 10y ago
      If you think that former early employees don't contribute to future "generations" of work, then the ethical thing to do is to offer better cash compensations and less equity. It's not really ethical to offer equity compensation that looks like it could be valuable but has significant hidden barriers to actually being used.
      - zenlikethat 10y ago
        > the ethical thing to do is to offer better cash compensations and less equity That's one of my main points: Employees have the power to refuse employers that offer equity in lieu of fair salary. But my experience has been that people keep falling for the equity carrot again and again, and as long as they keep falling for it, employers will keep doing it.

danpalmer 10y ago

> I honestly think the 90 day exercise is totally ludicrous in the startup world. I think that should be a major negotiation point with anybody who is joining a startup. They should just insist on it no matter what. Unfortunately, while the number of options, salary, holiday, etc are relatively easy for a company to change, I think changing the contracts around exercising for a single employee is a change large and complicated enough that companies are unlikely to do it.

xt00 10y ago
Yea I'll have to find some term sheets laying around, but I can't remember seeing the 90 day exercise being explicitly written into most term sheets. I only have seen it written into people's offer letters. Does anybody know where that language would be written actually otherwise? Some sort of bylaws or something -- seems like that could be relatively easily changed to read something like "exercise period of employee stock options is 90 days after termination of employment unless otherwise stated in employee offer letter and should not be greater than 10 years."
- freddyc 10y ago
  It's usually in the underlying option plan I believe. I think the challenge with changing the 90 day window is that you run the risk of the option not qualifying as an ISO. If that's the case, it would instead be classified as a non-qualified stock option and the holder would lose the capital gains benefits and be subject to ordinary income tax (IANAL though, so could be way off base).
  - stanleydrew 10y ago
    This is roughly correct. The 90-day exercise window isn't just something made up out of thin air to handcuff employees and keep them from leaving. It's explicitly written into the tax code that an option must be exercised within 90 days of leaving a company if the option is to be treated as an ISO. ISOs are arguably more advantageous than NSOs, which is why this is the default.

pinot 10y ago

Not to mention $90k person is likely leaving because they have low faith in the company in the first place.

zenlikethat 10y ago
Just playing devil's advocate here: So they are leaving because they have low faith in the company, but still expect to be able to collect rewards on other peoples' work years later if the company happens to succeed? If they didn't have a high degree of confidence in the company, the safe bet would always be to not exercise.
- st3v3r 10y ago
  "Other people's work" that builds on their work, too.
- aanm1988 10y ago
  They already put in the time. That's the whole point of vesting.
- morgante 10y ago
  This mentality is dangerous and pernicious. We have vesting schedules for a reason. They'd be reaping the rewards of their past work, not other people's future work.
programmarchy 10y ago
To add a counter-anecdote, I left a startup while still having a good amount of faith in the company. Left after finishing work on a couple of their products because I wanted a lifestyle change and had an opportunity to strike out on my own venture. The product was great, but engineering culture was a death march, partially due to the seasonal industry (hardware/toys) and partially due to management. Oddly enough, a bunch of other engineers also left shortly after -- after all the hard work was done. Company is profitable now due to increased sales, but also cutting salary costs. Strike price was still low when I left, so I bought my options.

deleted 10y ago

[deleted]

CalChris 10y ago

Wise advice but if the distinction between preferred+common is a real difference, then don't take the stock. Hella don't take the stock.

zenlikethat 10y ago
Curious about this, what "distinction" are you referring to here exactly? My understand is that the whole point of preferred vs. common shares is that there's a distinction: preferred shares get, well, preference in a liquidity event. This ensures investors recoup their losses if things go awry.
- jschwartzi 10y ago
  The problem is that the whole point of options is as consideration for the employee's time investment.
- CalChris 10y ago
  We are talking about the exact same distinction and the exact same scenario only from different POVs. To be clear, I'm not at all saying that investors who put up real money for startups shouldn't get preferred stock as compared with employees' common. What I am saying is that if+when an employee leaves a startup and has say 90 days to buy any accrued options then that employee should utterly pass if they think the company looks at all dicey. If it looks dicey then the distinction between preferred and common is very real and hella pass. Most startups fail and this employee is leaving that company for some reason. Now if the employee is early and the options are cheap and there's little taxes then maybe it's a lottery ticket. The details are always more complex. I'm just looking at it from an employee's POV. You're probably looking at it from a VC's POV. Would you voluntarily sign a pay to play agreement late in the game? No. You'd stare cold and hard at the facts on the table. You sure wouldn't throw good money after bad. You should expect the same from a rational employee.
  - elastic_church 10y ago
    employees don't currently have the transparency to make this objective decision. founders and board members are very opaque about this information, the prevalence and the covenants of preferred shares. the state of delaware has created greater transparency requirements for securities holders of private companies. fortuantely it is still trendy for companies to incorporate in that state despite the 55+ distinct jurisdictions under the federal umbrella. unfortunately, employees have found themselves in legal battles with their own companies for attempting to leverage these regulations.

jpm_sd 10y ago

In my experience (have worked at 3 start-ups), if you quit, you probably don't expect the options to ever be worth anything!

hkmurakami 10y ago
Eh, worked at one where there was a departmental exodus while the company was expected to IPO within the year (and it did). Plenty of people left due to political reasons or after full vest, exercised their options, and made out well. Anecdotes.

abalone 10y ago

> Then they quit after 2 years and have 90 days to buy like 50k worth of stock at the strike price they were promised. This is missing the key point of the article which is that there are also taxes to pay, not just the strike price. What you're saying is valid -- even the strike price can be a lot for someone to afford on their way out without any liquidity. But it is very important to understand that it's much worse than that at "successful" startups that have increased in value substantially over those 2 years. You also have to pay AMT (28%) on much of that gain in value, which could end up costing even more than the strike price itself. Hopefully more startups will offer extended exercise windows of several years. Some are. See: https://github.com/holman/extended-exercise-windows https://github.com/holman/extended-exercise-windows

gumby 10y ago

Just one point: > An investor who paid 50k to invest in the company most likely got preferred shares, so the young guy who paid 50k who probably can barely afford that is now taking way more risk for a much smaller percentage of the company. The common shares cost less than preferred shares as they lack the preferences. So when the employee leaves, her 50K will buy a larger percentage of the company than your hypothetical investor. She may of course still be taking a larger risk as she probably has a smaller asset base than the investor and his customers (err, LPs).