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I don't think this (loaning a founder or senior exec money to purchase shares) is that uncommon a situation. When my previous start-up employer was purchased, I

I don't think this (loaning a founder or senior exec money to purchase shares) is that uncommon a situation. When my previous start-up employer was purchased, I read through most of the deal docs, hundreds of pages. One of the things they mentioned is that the company floated several promissory notes to the CEO to allow him to purchase more company stock. It was peculiar enough that I made a note of it, but I never stopped to puzzle out why they did it that way. Possibly to avoid a tax liability at the time of the deal? Or to increase his compensation without actually increasing it on paper?

sjg007 10y ago
Right but is it fair? Should employees not get the same deal?
- URSpider94 10y ago
  Fairness, one way or the other, is hard to quantify here. CEO's get compensated a lot more than other employees, in a lot of different ways; you could just as easily argue that isn't fair either. Besides, at the bottom, the CEO is taking on debt that could find him/her bankrupted if the company fails. I don't think it would be responsible to even offer that facility to all employees. It might not even be legal, if the employees are not accredited investors, though I'm not sure about that. I should add that I don't have any knowledge of who pushed for the deal, and how it was set, but I doubt the CEO strolled in and just asked for the loan. I'm assuming it was part of the compensation package that was proposed or negotiated by the board and their comp consultants.
  - sjg007 10y ago
    The CEO won't go bankrupt.. these loans are backed by the stock as collateral. But there should be a law that all such plans and purchase agreements are available to all employees if available to the execs.
    - deleted 10y ago
      [deleted]
    - mikekchar 10y ago
      > The CEO won't go bankrupt.. these loans are backed by the stock as collateral. I couldn't actually find this out through a google search. What happens if the market rate does not allow the lender to recover the principle? I thought you'd still be liable for the remainder. It's just that they can force a sale if they want to.
      - allannienhuis 10y ago
        This isn't an ordinary debt from a 3rd party; it's a contract with the company - they can put whatever terms and restrictions they like on that contract, including no other recourse for the debt other than proceeds of the sale of that stock, or it's forfeiture.
        scurvy 10y ago
        If the company forgives the debt, doesn't the IRS treat that as income?
        allannienhuis 10y ago
        Possibly, But there's a difference between a debt being written off (uncollectable) and forgiven. There's also capital gains losses that might offset potential income; the accounting for all of these cashless transactions is complex - that's what the accountants and lawyers are for :P
      - brianfitz 10y ago
        Allan who also responded is fairly inline with the answer to this -- except one key point: the company can write whatever they want into the contract regarding recourse, but the IRS will only recognize the loan as legit for tax purposes if it has a liability associated with it beyond the stock as collateral. This liability to the key execs will be reflected as a line item on the company balance sheet. And even if the company doesn't aggressively pursue the debt (which they can sue for), you're still on the hook to the IRS for the reason scurvy mentions below.
- bww 10y ago
  Are you suggesting it's unfair that different employees get different compensation deals, presumably based on their value to the company?
- peteretep 10y ago
  > but is it fair? Is a question for the shareholders and board to ask.
- amorphid 10y ago
  It's not really about fair, or founder vs. employee. It's a liquidity thing. The following is an example I totally made up, but it'll sort of give you an idea of how it could work. Say you found a company, the company is still private, and you outright own shares worth a billion dollars. Selling private shares is a pain in the butt. You can do it, if you find a buyer, but it can be a lot of work. Now let's say you want to take $25 million off the table. While you can't easily sell your shares, you can borrow against them. Any bank will lend you the money, because you're securing the loan with your billion dollars worth of stock. The risk of your stock collapsing from one billion dollars to zero is fairly low. The stock can drop 97.5% in value and still be enough to cover the loan. If you default on payment, the bank simply seizes your stock. Now let's say an employee joins the company when the stock is valued at $5/share, and that employee gets 100,000 shares. The stock goes up to $20/share. The employee's stock is worth ($20 - $5) * 100,000, or $1,500,000. The employee wants to borrow against those stock options. Before that can happen, they need to be actual shares. The employee needs to spend $500,000 just to own the stock. If the bank will loan money that is worth up to 10% of the value of stock in a privately held company, you couldn't even take out a loan big enough to buy the all stock in the first place. You could maybe buy a few of the shares, but if the amount you want to borrow is too small, the bank simply won't bother, because it's too much work.
  - sjg007 10y ago
    That's not the right example in this case. Here theranos gave the CEO the loan to buy the shares. Do employees get the same deal?
- neffy 10y ago
  It might be more accurate to think of it as an exploit. There are all sorts of ways company financial structures can be abused - this is just one of them.
brianfitz 10y ago
It's done in order to start the clock early for capital gains. If you excercise shares at the same time you sell them, that transaction is treated as regular income. If you excercise the shares early by purchasing them, then they can be taxed at the lower capital gains rate down the road. There was a response in the thread that asked if this is fair -- to that I would answer that when the purchase is handled as a loan, it is a real liability to the employee (usually the CEO or founder). If the company tanks or the clock ticks too long for a liquidity event, the note has to be paid. So this could be a very risky proposition for an average employee, even it were offered.
- scurvy 10y ago
  If you're a founder, why wouldn't you 83B all of your shares right away when they're worth $.0000001 per share?
  - siberianbear 10y ago
    83B is for grants of restricted stock, not for stock options.
    - scurvy 10y ago
      Understand that but as a founder, why would you give yourself options over stock? It's your company. That makes no sense. You need to pay in capital in some form.
      - dkfmn 10y ago
        The key is that you need to align incentives for employees, investors, etc by demonstrating a long-term commitment to the company. Lots of more nuanced discussions of this topic exist but here's one I have at hand: http://startupclass.samaltman.com/courses/lec18/ http://startupclass.samaltman.com/courses/lec18/
      - brianfitz 10y ago
        They likely were giving her additional grants later in the life of the company upon reaching certain milestones to make up for her dilution at a strike price that required millions of dollars to exercise. You can get away with founder stock very early on, but at some point, it becomes untenable as the value of the company grows.
mattchamb 10y ago
I'm not in the US, so I dont know how that changes things; but when the company I'm working at started it's employee equity scheme it was setup as an interest-free loan to employees to purchase shares. The loan has conditions that the loan can only be repaid through the sale of the shares, with no recourse against my other assets.

sjg007 10y ago

Right but is it fair? Should employees not get the same deal?

URSpider94 10y ago
Fairness, one way or the other, is hard to quantify here. CEO's get compensated a lot more than other employees, in a lot of different ways; you could just as easily argue that isn't fair either. Besides, at the bottom, the CEO is taking on debt that could find him/her bankrupted if the company fails. I don't think it would be responsible to even offer that facility to all employees. It might not even be legal, if the employees are not accredited investors, though I'm not sure about that. I should add that I don't have any knowledge of who pushed for the deal, and how it was set, but I doubt the CEO strolled in and just asked for the loan. I'm assuming it was part of the compensation package that was proposed or negotiated by the board and their comp consultants.
- sjg007 10y ago
  The CEO won't go bankrupt.. these loans are backed by the stock as collateral. But there should be a law that all such plans and purchase agreements are available to all employees if available to the execs.
  - deleted 10y ago
    [deleted]
  - mikekchar 10y ago
    > The CEO won't go bankrupt.. these loans are backed by the stock as collateral. I couldn't actually find this out through a google search. What happens if the market rate does not allow the lender to recover the principle? I thought you'd still be liable for the remainder. It's just that they can force a sale if they want to.
    - allannienhuis 10y ago
      This isn't an ordinary debt from a 3rd party; it's a contract with the company - they can put whatever terms and restrictions they like on that contract, including no other recourse for the debt other than proceeds of the sale of that stock, or it's forfeiture.
      - scurvy 10y ago
        If the company forgives the debt, doesn't the IRS treat that as income?
        allannienhuis 10y ago
        Possibly, But there's a difference between a debt being written off (uncollectable) and forgiven. There's also capital gains losses that might offset potential income; the accounting for all of these cashless transactions is complex - that's what the accountants and lawyers are for :P
    - brianfitz 10y ago
      Allan who also responded is fairly inline with the answer to this -- except one key point: the company can write whatever they want into the contract regarding recourse, but the IRS will only recognize the loan as legit for tax purposes if it has a liability associated with it beyond the stock as collateral. This liability to the key execs will be reflected as a line item on the company balance sheet. And even if the company doesn't aggressively pursue the debt (which they can sue for), you're still on the hook to the IRS for the reason scurvy mentions below.
bww 10y ago
Are you suggesting it's unfair that different employees get different compensation deals, presumably based on their value to the company?
peteretep 10y ago
> but is it fair? Is a question for the shareholders and board to ask.
amorphid 10y ago
It's not really about fair, or founder vs. employee. It's a liquidity thing. The following is an example I totally made up, but it'll sort of give you an idea of how it could work. Say you found a company, the company is still private, and you outright own shares worth a billion dollars. Selling private shares is a pain in the butt. You can do it, if you find a buyer, but it can be a lot of work. Now let's say you want to take $25 million off the table. While you can't easily sell your shares, you can borrow against them. Any bank will lend you the money, because you're securing the loan with your billion dollars worth of stock. The risk of your stock collapsing from one billion dollars to zero is fairly low. The stock can drop 97.5% in value and still be enough to cover the loan. If you default on payment, the bank simply seizes your stock. Now let's say an employee joins the company when the stock is valued at $5/share, and that employee gets 100,000 shares. The stock goes up to $20/share. The employee's stock is worth ($20 - $5) * 100,000, or $1,500,000. The employee wants to borrow against those stock options. Before that can happen, they need to be actual shares. The employee needs to spend $500,000 just to own the stock. If the bank will loan money that is worth up to 10% of the value of stock in a privately held company, you couldn't even take out a loan big enough to buy the all stock in the first place. You could maybe buy a few of the shares, but if the amount you want to borrow is too small, the bank simply won't bother, because it's too much work.
- sjg007 10y ago
  That's not the right example in this case. Here theranos gave the CEO the loan to buy the shares. Do employees get the same deal?
neffy 10y ago
It might be more accurate to think of it as an exploit. There are all sorts of ways company financial structures can be abused - this is just one of them.

brianfitz 10y ago

It's done in order to start the clock early for capital gains. If you excercise shares at the same time you sell them, that transaction is treated as regular income. If you excercise the shares early by purchasing them, then they can be taxed at the lower capital gains rate down the road. There was a response in the thread that asked if this is fair -- to that I would answer that when the purchase is handled as a loan, it is a real liability to the employee (usually the CEO or founder). If the company tanks or the clock ticks too long for a liquidity event, the note has to be paid. So this could be a very risky proposition for an average employee, even it were offered.

scurvy 10y ago
If you're a founder, why wouldn't you 83B all of your shares right away when they're worth $.0000001 per share?
- siberianbear 10y ago
  83B is for grants of restricted stock, not for stock options.
  - scurvy 10y ago
    Understand that but as a founder, why would you give yourself options over stock? It's your company. That makes no sense. You need to pay in capital in some form.
    - dkfmn 10y ago
      The key is that you need to align incentives for employees, investors, etc by demonstrating a long-term commitment to the company. Lots of more nuanced discussions of this topic exist but here's one I have at hand: http://startupclass.samaltman.com/courses/lec18/ http://startupclass.samaltman.com/courses/lec18/
    - brianfitz 10y ago
      They likely were giving her additional grants later in the life of the company upon reaching certain milestones to make up for her dilution at a strike price that required millions of dollars to exercise. You can get away with founder stock very early on, but at some point, it becomes untenable as the value of the company grows.

mattchamb 10y ago

I'm not in the US, so I dont know how that changes things; but when the company I'm working at started it's employee equity scheme it was setup as an interest-free loan to employees to purchase shares. The loan has conditions that the loan can only be repaid through the sale of the shares, with no recourse against my other assets.