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Startup Stock Options – Why a Good Deal Has Gone Bad

678 points by furkansahin 8y ago

l2c1928 8y ago
It's bad for most people, but when it's good it's really good. I was lucky to join a now unicorn as one of the first few dozen employees a few years ago. I forward exercised with a few thousand out of pocket (section 83b) an equity grant now worth around $1.5m. Because I forward exercised my options at a low valuation I didn't have to worry about paying taxes if I exercised at a later time when the company's valuation grew. It also meant that my gains became long-term capital gains, and thus taxed lower, as soon as possible after I vested each month.
- seibelj 8y ago
  I too would like to win the lottery.
  - l2c1928 8y ago
    My point is that there are ways to manage risk as an employee, such as early exercising assuming you are joining an early stage startup where the cost is low enough. I would've been screwed if I didn't early exercise.
  - CalChris 8y ago
    If you think of the Valley (or wherever you are) as a lottery then your chances of winning are about the same as those of a lottery. If you think of yourself as your personal VC then your odds approach those of a VC which while not great and moreover not diversified, they are much much better than a lottery.
    - donaldknuth123 8y ago
      This analogy fails almost immediately. Real VCs distribute their bets across dozens of companies. You personally are placing one massive bet on one single company so your odds are far worse than a VC.
    - maxxxxx 8y ago
      How do you diversify as an employee/engineer? work for 10 startups at the same time?
      - CalChris 8y ago
        You can't. That is what distinguishes you from a VC. Actually, you can. Serially. Plenty of people work for a startup through its early stage. A year here, a year there. That's diversification.
        maxxxxx 8y ago
        But how do you determine when it's time to jump ship? A year seems awfully short to make that determination.
        CalChris 8y ago
        If your object is diversification of your investment then one year isn't too short. However, typically your option vests monthly after the cliff. So you don't have to stay for two years unless you want to.
      - opportune 8y ago
        Bounce around until you find somewhere that has a rocketship trajectory? If you can work at 10 startups over a 20 year career, your odds aren't terrible
- creaghpatr 8y ago
  Good point, although do long term cap gains apply to private company stock being held over years until the liquidity event?
  - l2c1928 8y ago
    I paid long term capital gains after selling a portion of my private stock via a tender offer last year.
  - bgentry 8y ago
    You get switched to long term capital gains 1 year after exercise or two years after the grant start date, whichever is later.
    - theIV 8y ago
      I don't believe the "or" part of this statement is right. I think you still need to hold for 1 year after exercise AND two years after the grant for long term to kick in. Not sure what the best source on this is, but a quick DDGing: https://www.fool.com/knowledge-center/tax-rate-on-exercising-stock-options.aspx https://www.fool.com/knowledge-center/tax-rate-on-exercising...
      - bgentry 8y ago
        I think we're saying the same thing. If I early exercise my options on day 1, then I still have to wait until the 2 years after the grant date (2 years of employment) to get long term capital gains treatment. If I wait 4 years, then exercise, then I have already satisfied the 2 years post-grant requirement, but I still have to wait a year after the exercise to get long term capital gains treatment. The key part was my last clause: "whichever is later".
- lostcolony 8y ago
  Yes, just like buying a lottery ticket is bad for most people, but when it's good it's really good. Stock options are never a reason to join a company. They are potentially an added bonus. But they should never be valued in that initial "should I work here?" Not when first taking the job, and not when considering whether you should leave or not (barring an imminent IPO that would delay your leaving by a bearable month or two)
- aliston 8y ago
  If you go into a casino, put 1000 on green at the roulette table and win, did you get a good deal? The fact that some people win at startup roulette doesn't mean that it's a good financial decision to join a startup, especially considering that you can make the same sort of money without the risk elsewhere.
  - chadash 8y ago
    Parent started with "It's bad for most people, but when it's good it's really good.". So yes, roulette is similarly bad for those who don't win and good for the few who do.
    - deleted 8y ago
      [deleted]
    - aliston 8y ago
      Article is titled "why a good deal has gone bad." My point is that winning does not make it a good deal. To expand on it further, even if you are lucky to have joined a unicorn, you still didn't get a good deal in comparison to virtually everyone else involved in the company. The founders are likely billionaires and you made off with a low 7 figure outcome while taking on only marginally less risk. That's not a good deal by any reasonable definition.
      - jerguismi 8y ago
        > To expand on it further, even if you are lucky to have joined a unicorn, you still didn't get a good deal in comparison to virtually everyone else involved in the company. The founders are likely billionaires and you made off with a low 7 figure outcome while taking on only marginally less risk. That's not a good deal by any reasonable definition. I wouldn't see the risk of being an employee and founder as similar. Typically often founders are for time periods without salary etc. Early employee should just consider it as a job with more risk of the company going down under (that risk also exists in more established company). You can request more salary for the job or some additional perks (such as options). I think for the employee the risks of joining to startup are quite easy to manage compared to a founder.
- mlthoughts2018 8y ago
  Your story still leaves a lot of room for skepticism. For one, 1.5MM is not actually a very good deal for an engineer in your situation, and likely the company gave you very unfavorable terms. Electing 83b is a fairly irrelevant detail in your story as it only affects taxes, not the outcome of the company. Your shares are likely going to get hugely diluted exactly because of growth investing like in the article. Investors and founders will essentially trade away your share of the company in new rounds, while they get huge payouts for it, your shares may grow a small amount, again realized over some long time horizon. Let’s take an extreme example and say your shares double in value (not likely) through the remaining funding rounds, and eventually in another ~7 years you can actually sell them in some liquidity event. So that’s $3 MM (gross) over 10 years. That works out to be $300,000 / yr in equity compensation. Certainly very high. But not any kind of crazy number. Definitely there are rank and file engineers in FAANG companies, Wall Street, and other industries getting annual RSUs or bonuses well beyond that without having to wait 10 years to realize it or have the risk that it folds or you get laid off and lose a bunch of future value, and have a high base salary, good benefits, and good work/life balance the whole time. Given that even a crazy outcome like $3 MM annualized over 10 years isn’t significantly better than other reasonable total comp opportunities, this overall paints a really bad picture for start-ups. Your case, which is nearly about the best lottery ticket someone could get, is only slightly better than a competitive position at many public companies, finance shops, etc. Meanwhile, almost all start-up outcomes would be far worse.
  - l2c1928 8y ago
    There's a myth that you can't realize gains if a company doesn't IPO...I've already sold some shares in a tender offer. There is an active secondary market for shares if I chose to sell more. Not sure what your point is about $3MM over 10 years. Why would you divide it over anything other than the number of years you actually worked at the company? You've assumed I was a senior engineering hire. I was in a junior non-technical role a year out of college.
    - mlthoughts2018 8y ago
      Early selling for employees is exceedingly rare and also often on bad terms, this was mentioned in the OP article. Again, it’s lucky that you were able to, but is such a wildly unlikely outcome that functionally everyone else has to ignore that aspect of your story. To boot, being able to sell in a secondary market transaction only after about 3 years is even more ridiculously rare (to the point that it makes me question if your whole story is even true, or just some trolling). The few companies I’ve heard of allowing that type of thing (late pre-IPO Spotify, Squarespace), only allowed it after early employees like yourself would have waited 7-10 years before getting any payout. > “Not sure what your point is about $3MM over 10 years.” Please re-read my comment to help understand. > “You've assumed I was a senior engineering hire. I was in a junior non-technical role a year out of college.” Where did I make an assumption about junior vs senior level? As for your claim you were given this grant for a non-technical role 1 year out of college, I think it’s more likely you’re just lying to troll this comment thread. Just in a Bayesian sense, the conditional probability that you’re lying is higher than that this is a true story. It’s not impossible that this could have happened for a non-tech hire with no experience, but that mere possibility also is irrelevant compared with the far greater probability that this is just made up.
- luckystartup 8y ago
  I have a very similar story: Was on the first 10 employees at a now unicorn, forward exercised with a few thousand dollars, and my shares are also now worth around $1.5m. But unfortunately the company blocked all attempts at selling any shares on secondary markets. Something you might not be aware of: If you joined the company before they had $50M in assets, your stock would also qualify as QSBS [1], which means you don't have to pay any tax on gains of up to $10 million. [1] https://www.andersentax.com/services/for-private-clients/business-owners-and-entrepreneurs/qsbs https://www.andersentax.com/services/for-private-clients/bus...
- SkyBelow 8y ago
  >but when it's good it's really good. I don't think this is true. There are cases where people have broken equal or made slightly more than working at a corporation would have. It can be really good, but it can also be just okayish or not that great. This is based off my reading of the phrase, which means that good options have to be really good. The "it is really good" that is actually written verses "it can be really good" that is closer to the truth (imo).
- khazhou 8y ago
  My problem with it is that there are many scenarios that are fantastic for the founders, but only one (unicorn) that is fantastic for non-founders. You can put in the same long hours, pour your soul into it, take the same risk for years, but if there's an exit event, you'll only be feeding off crumbs while the founders feast on the rewards.
seibelj 8y ago
Valid reasons to work for a startup: - You are a cofounder. - You have little experience and you are using this to break into the industry, and get experience on many different technologies ("wear many hats"). - They are working on a very specific problem or using a specific technology that you strongly desire to work on and it's difficult to do it anywhere else. - You want to work a certain way (remote, on the beach, whatever) and they are willing to go this route. Invalid reasons for working at a startup: - Getting rich off stock options. - Making a lot of money in salary. - Work / life balance. - Stability.
- ohaideredevs 8y ago
  Not exactly a unique experience, but my .05 - I started of at a startup with a "lol just do it" attitude to whatever the problem was. Worked 12 hours a day a lot, was stressed out all the time, didn't have a life, got calls at odd hours to deploy...but, if I didn't have that experience, I wouldn't have grown nearly as fast. Got to see all aspects of the products and the consequences of the decisions we made early on. Learned more in a year than in the last 3 at corp/consulting jobs. Then again, maybe it was noob gainz and I made at least a third less than I would have at a corp job. Not sure if going back to a startup would be nearly as beneficial in terms of "levelling up." Seems like the game now is to grind whiteboard before I get too old for Google. A friend grew from junior developer to director of IT at that startup, so there's that aspect as well, though I have also seen a number of startups hire leadership outside.
  - toomuchtodo 8y ago
    > Worked 12 hours a day a lot, was stressed out all the time, didn't have a life, got calls at odd hours to deploy...but, if I didn't have that experience, I wouldn't have grown nearly as fast. Congrats on using the opportunity to grow in an abusive role. It should not be normalized is the point.
    - brootstrap 8y ago
      On the opposite side of this argument. I was there. I was shit in college but managed a degree and self taught programming. I was hustling hard to graduate and convince someone to hire me as a programmer even though I had no degree. I was 23 at the time. If you are in this scenario, just you, no wife kids etc. What is wrong with working really hard on a problem? I loved the startup and it fit my perfect niche. I would grind 12 hours days, but also had lots of freedom. Remote work, unlimited days off etc. Sure at sometimes you get burnt out but you are a sponge soaking up everything you can. now i'm 28 with wife and kids, no overtime for me. I still work extremely hard and lazer focused, but i show up at 7:30-8am and leave at 4 everyday :p
mlthoughts2018 8y ago
It’s not just that the structure of option grants has worsened (also, expiration practices still are pretty bad for employees), but also that the valuation of the option grants is often way too low. If, as in the article, a start-up is effectively offering a low salary + a lottery ticket and expecting candidates to see it as at least equally as valuable as a high total comp figure from a competitor, then the lottery ticket has to be priced very highly, to drag up the expected value after accounting for all the high likelihood outcomes that have poor payoffs. Add to this the fact that, despite false promises, you won’t get more freedom, career opportunities, cutting edge work, etc., at most start-ups than you would at even average-case public companies, and it’s a bleak picture. No aspects of the work experience will create additional forms of “payoff” that help offset the low salary and poor lottery ticket equity, and in many cases the work environment will be toxic, full of immature behavior, unprofessional, etc., and candidates should really be requiring higher compensation than at a big company, to deal with the start-up dysfunction. When the option valuation (even assuming a hilariously unlikely high value exit or IPO) is eventually diluted and spread out across ~10 years that you have to delay getting that money you earned (or even lose it all because of a layoff + poor expiration policy), and at best it turns out to be the annualized equivalent of a pretty modest bonus, it’s just deeply not worth it. You will not have gotten anything else out of it (specialized experience, leadership or business skills, networking, oddball perks) that offsets the income you could have been earning almost anywhere else.
- commandlinefan 8y ago
  I was awarded RSU's at my last company (a perpetual startup) - not millions, but maybe tens of thousands of dollars. I had a signed contract that guaranteed them. But then the company merged/consolidated/de-consolidated/re-merged and shuffled around so that when they finally got rid of all of us, they said that those stock options were worth nothing, too bad, so sad. And what am I going to do, spend $100K on a lawyer to maybe recover a quarter of that ten years from now? And they know we won't, that's why they get away with what they get away with.
  - CalChris 8y ago
    I don't know but you may have been the victim of 'liquidation preference' (and participation). Your perpetual startup never went public. Each of the investors, seed, A, ... has a preference in case of a liquidity event (exit) over earlier investors and a participation (multiple) as well. Your RSU was just at the bottom of the heap and there was nothing left. The founders would have had something equivalent to your RSUs but ... they were doing the negotiation. For example, IIRC, Anthony Levandowski cut his employees out when he sold 510 to Google. (So it shouldn't have surprised anyone at Google when he later screwed them as well.) https://www.invigorlaw.com/key-term-sheet-provisions-liquidation-preference/ https://www.invigorlaw.com/key-term-sheet-provisions-liquida... Edit: the article even says it: Today, if you’re an employee you’re now are at the bottom of the stock preference pile. In this case, I'd only work for a startup if my preference seniority was equal to that of the founders. And the article says that too: If you’re one of the early senior hires, there’s no downside of asking for the same Restricted Stock Agreements (RSAs) as the founders.
save_ferris 8y ago
Why don't startups offer actual equity grants instead of options? It seemed strange to me when I was starting out in my career that I needed to take a lower salary and options to exercise upon my exit, which wound up costing me thousands of dollars from that lower salary. Two years later, one founder forced out his two other cofounders, started a new company in the exact same space, and poached his best employees, essentially jettisoning the cap table in the process. The small frys who exercised their options were totally screwed. That was a real lesson for me on how crazy this stuff can be.
- l2c1928 8y ago
  Late stage private startups almost always grant RSUs. If they didn't it would be way too risky for most people to join because the cost to exercise would be very high.
- howard941 8y ago
  > Why don't startups offer actual equity grants instead of options? Great tax advantages. For ex one startup I worked for did it the other way resulting in recognizable tax income and everyone got hit with a tax bill. Fortunately when it was brought to leadership's attention they were enlightened enough to offset the tax bill with cash but don't expect that, ever.
- andrew311 8y ago
  Share grants would be seen as income by the IRS and most states and taxed at their Fair Market Value. Options on the other hand usually qualify as Incentive Stock Options that aren’t taxed at grant time and “when exercised, it isn't necessary to pay ordinary income tax. Instead, the options are taxed at a capital gains rate.” [1] Options are better up front because there is no outlay for the employee. They are a hassle down the road. However, if you exercise during a liquidation event your tax liability is probably covered. Stock is a pain upfront unless granted before the first round of funding or any real revenue when the stock value is very little. They are easier down the road, though. Just my two cents. HackerNews, please correct any errors in logic or how this stuff works. 1. https://www.investopedia.com/terms/i/iso.asp https://www.investopedia.com/terms/i/iso.asp
btilly 8y ago
To his suggestions, I have another. Offer internal Dutch auctions on a regular basis to provide an opportunity for investors/the company/etc to buy stock from employees at a reasonable price. This makes the value of the company, from the point of view of the employee, not "funny money" but something very tangible. With an opportunity to cash out long before it is public.
- kurthr 8y ago
  I'd be very careful with that... there are all sorts of internal/external events that can influence the perceived value of the company and information about them is not evenly distributed. Creating an environment where individuals in some groups can profit from this disparity (or even misinformation) is asking for ugly office politics.
  - btilly 8y ago
    All possible solutions come with downsides. It is still an option to consider.
  - jimbokun 8y ago
    Interesting, "insider insider" trading then, where some insiders are more inside than others.
- conanbatt 8y ago
  The easiest solution is that startup employees should be able to sell their shares in the open market, as they please. Then all the problems go away.
  - btilly 8y ago
    That requires that you have IPOed. And that comes with its own set of complications. Though there are secondary markets arising for this sort of thing.
    - conanbatt 8y ago
thesausageking 8y ago
He glosses over an important point: it's now typical for founders to take money off the table as part of financing rounds, sometimes as early as the A round. Founders will request it as part of a funding round and, there's so much competition to invest in the top startups, that VCs go along with it. Decades ago, this wasn't the case. Founders waited for the IPO like employees. If you're an engineer sitting on $5m of vested stock in a decacorn, it makes financial sense to sell some of it. Today, companies make that really hard to do. If employees could easily sell their stock while the startup is still private, this would solve a lot of the problems.
- nrmitchi 8y ago
  It was mentioned about half-way through the article. > And finally, in many high valued startups where there are hungry investors, the founders get to sell parts of their vested shares at each round of funding. (At times this opportunity is offered to all employees in a “secondary” offering.) A “secondary” usually (though not always) happens when the startup has achieved significant revenue or traction and is seen as a “leader” in their market space, on the way to an IPO or a major sale.
- goobynight 8y ago
  No way they'll make it easier to sell. That's not solving a problem for the business. They need to keep the carrot dangling.
- dalbasal 8y ago
  If early liquidity wasn't an option for founders, this massive pre-ipo/private-ipo market wouldn't exist. Without early liquidity, a pre-ipo zuck/kalanick/etc. would be a paper billionaire with $0 in the bank and >$1bn "invested" in a risky tech startup. That's not financially or mentally sound, even by their risk lovin standards. If investors demanded every penny go towards growing the business, those CEOs would just IPO earlier to get liquidity. It's a necessary alignment of interests, if investors' interest is delaying the IPO. Employee options holders can't just decide to take a company public, so their interests can stay misaligned.
  - 8y ago
jpmattia 8y ago
I think an important point was missed: Steve writes: > The first big idea is that unlike in the 20th century when there were two phases of funding startups–Seed capital and Venture capital–today there is a new, third phase. It’s called Growth capital. It used to be that The Public would provide the "Growth capital" via an IPO; Now the public is providing, I suppose, post-Growth capital via the IPO. In an current era where the market believes P/E ratios of 24 make sense [1], that has so far been viable. If more historically normal valuations return to public companies, or if the latest crop of unicorns fail to provide great returns for the IPO investors, I strongly suspect this new division of funding phases will come to an end. [1] https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-earnings-chart https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-ea...
markbnj 8y ago
> As Venture Capital emerged as an industry in the mid 1970’s, investors in venture-funded startups began to give stock options to all their employees. I don't understand this part of the post. When do "investors" grant stock options? When I did a startup back in the 90's the founders owned all the equity the day after the company was incorporated and a stockholder agreement signed specifying what each of us owned. We then sold equity to angel and venture investors by carving out a piece of the common in the former case, and issuing new preferred shares in the latter. Later the company granted ISOs to employees by an act of management, ratified by the board which did of course include investors. But at no time would I have said that the investors "shared their ownership" with employees. All current owners were diluted by the issuance of new shares or rights to new shares, but it was never a flat-out decision by the investors to share what they owned. It was a management decision.
- breischl 8y ago
  I imagine that was just a shorthand or maybe he misspoke. It would be a management decision, but they would most likely need to clear it with the investors. Frequently the funding deal between investors and management will even carve out a chunk of equity for incentives.
dman 8y ago
Thank you for writing this! This discussion is long overdue.
gumby 8y ago
A super trivial and tangental point but Fairchild was funded to make discrete semiconductors -- specifically transistors. In those days they were all assembled by hand! The chip (IC) was invented a year or so later.
geggam 8y ago
From my experience most startup stock are common so they dont get paid until the preferred get settled up. You can have 20k shares of stock and walk away with nothing even in an a successful IPO
bitL 8y ago
It's sad that VC/founder's greed and throwing early employees under the bus became the norm :-( I guess that's a sign of maturity of our field and an indication for bright people to move on to take risks directly, offer their services to companies as legal persons and ignore startups as employers.
olliej 8y ago
This is exactly the point I have been making: the equity grant structure for startup employees is not (or no longer?) compensates risk for employees
iblaine 8y ago
IPOs are increasingly turning into an exercise of the Greater Fool Theory [1]. I'm not sure if it's investors or employees who are the bigger fool. Investors can fall back on ratchets [2]. Lyft may sue a bank for helping pre-IPO investors short sell [3]. What does seem to be clear is the widening gap between smart money (investors) and dumb money (employees). [1] https://en.wikipedia.org/wiki/Greater_fool_theory https://en.wikipedia.org/wiki/Greater_fool_theory [2] https://www.investopedia.com/terms/f/fullratchet.asp https://www.investopedia.com/terms/f/fullratchet.asp [3] https://www.cnbc.com/2019/04/06/lyft-is-threatening-litigation-against-morgan-stanley-accusing-the-firm-of-supporting-short-selling.html https://www.cnbc.com/2019/04/06/lyft-is-threatening-litigati...
dgudkov 8y ago
>VC’s typically have pro-rata rights to keep their percentage of ownership intact, but employees don’t Either all shares must be diluted, or none. When someone's shares are diluted but someone's not, it's a scam. The concept of privileged shareholders is just wrong. The whole system looks overly complicated and corrupted.
- 6gvONxR4sf7o 8y ago
  I believe pro-rata rights are rights to invest in further rounds. They can keep their percent ownership only if they contribute more money. This is like employees on vesting schedules, who can continue to get more options by continuing to work. Startup shares are a shitty deal, but this doesn't strike me as one of the reasons.
  - jm20 8y ago
    Correct, you don't just "gift" them more equity, you have to pay more (usually a much higher per-share price) to keep that equity.
- breischl 8y ago
  Oh, and he didn't even touch on things like liquidation preference and participation. Basically says that even though they own X% of the company, they get paid out like it was 4*X. Or maybe they get $YY out before anybody else gets paid. This means that the percentage of the company your shares equate to is only a small part of the picture. You also need to know what deals were cut with every investor now _or in the future_ to know what your shares will be worth.
m0zg 8y ago
It never was a "good deal", it was always a lottery. And one that you're set up to lose if you're not a co-founder.
rmrm 8y ago
having worked at a lot of startups with various outcomes, I've come to firmaly believe the net preset value of your options is actually correct. If you take all the shares I've ever had options given on, and multiplied them by the strike price, it isn't far off from the ultimate amount of money they've been worth. The variance is high between each one, but taken together.. If you get a 100,000 shares at 0.10 each...they are likely over multiple trials going to be worth around 10K. Act accordingly.
- deleted 8y ago
  [deleted]
shay_ker 8y ago
> Better yet, offer restricted stock units (RSUs). Restricted Stock Units are a company’s promise to give you shares of the company’s stock Do startups commonly offer RSUs? I suppose my follow-up is whether it's easy to do, using Carta or something similar.
dalbasal 8y ago
The weird thing is that this state of affairs (a) doesn't save investors very much dilution. Meanwhile, (b) options do a much poorer job of motivating/recruiting employees, (c) an even worse job of aligning interests and (d) the risk/downsides aren't reduced at all. If stock "values" start to drop, it can really make a company feel like a sinking ship. That's the risk of equity sharing. They can make bad times worse. This happens no matter how distant/unlikely a liquidity event is. The solution has been mentioned all over this thread: make them liquid somehow. Alternatively, stop doing options and do something else instead. Aren't startups supposed to be breaking conventions and being creative? I agree this Steve B's implication, the average stock option scheme is a vestigial artefact. Unless you're in a position (and of a mind) to negotiate terms, it's a checkbox.
matchagaucho 8y ago
Sure companies are worth more in 10-12 years. But when VCs are managing 7 year funds, their LPs may require returns sooner. I'm surprised this article didn't mention Investors ability to simply hold shares post-IPO. Leave it to the LP pension managers to decide how much upside they want to risk.
JohnFen 8y ago
I've never really considered stock options to be a good deal, really. There's a reason they're widely referred to as "wallpaper". Options are a bit like lottery tickets. All other things being equal, it's marginally better to have them than not, but their existence has never affected my decisions about where to work.
kabdib 8y ago
I made a bunch of money from ISOs at large, established companies. I made zero (well, negative, really) from startup stock options, even before things got really shifty in the 2000s. One startup that I left, that is now a billion dollar company, simply decided to "extinguish" the shares I bought a few years after I resigned. I was probably cheated, but it's not worth the effort to go after them and they know it. Treat startup options as wastepaper. You might get lucky, but it's really, really unlikely.
- deanmoriarty 8y ago
  I would be really curious if someone could shed some light on how a healthy company could simply decide to "extinguish" exercised shares. Like how exactly would they go about doing that, and do you have examples I can read up describing where and how this happened? I would understand if that happened when the company is in trouble (e.g. valuation dropping below the last preferred valuation, so preferences kick in, or as a result of the company having to honor very high liquidation preferences), but otherwise? The only couple very shady cases I know about where Facebook with the Brazilian cofounder (with a complicated legal process where they reincorporated the company into a new one or something like that) and Skype with the employees (who naively signed a clawback clause in their agreement stating that the company could repurchase shares in the future at the original grant value even if their price skyrocketed, or something similar). In all the other cases I know about where employees got screwed, it was because the company saw its valuation plummet and the investors preferences kicked in, in one way or another, so "extinguishing" common shares in that case is "expected" and more similar to a public company declaring bankruptcy and seeing the shareholders being wiped out while the bond holders can generally recoup something, since they have "preferred" terms inherent in the nature of the bonds.
  - mrnobody_67 8y ago
    See Zynga, cancelling options prior to IPO: https://news.ycombinator.com/item?id=3220819 https://news.ycombinator.com/item?id=3220819
    - 8y ago
brownkonas 8y ago
I think another correction to the diminishing value of stock options and longer IPO horizon is that insane hours are less common now, even at the peril of the success of the median startup. It's also a result of the tight tech labor market and the wealth divide between new startup comp and FAANG comp. Why should I would disproportionate hours if there's another job with a more certain outcome that does not require this. Curious if others have seen a drop in hours expected from your average startup (separate discussion if longer hours is a key ingredient and overall a good thing).
- paulddraper 8y ago
  I think startup demographics are changing slightly. Fewer early 20 bachelors.
- president 8y ago
  If anything, I have only seen an increase in work hours in my peer circle. Which startups are cutting hours?
jiveturkey 8y ago
this is a contorted, misguided, wrong argument. as evidenced by the lack of a proposed solution. i could refute his arguments point-by-point but i'll just highlight a few. 1. in a couple of places, he notes that "employees" put in as much hard work as "founders" but don't receive equivalent compensation. this is an absurd comparison. the amount of hard work is irrelevant, it's the value you bring to the table. part of that value is via hard work, and part is via the unique (or not) skill set. the unskilled janitor or maintenance man might put in hard work, but is an easily replaceable skill. if in fact you think you are bringing as much value as the founders, but aren't getting rewarded, the solution is very, very, very simple: become a founder. 2. So while the VCs gain the upside from keeping a startup private, employees get the downside. What? Given the very well known, no excuses for not knowing this, fact that the large majority of startups fail, VCs take 100% of the risk, by virtue of laying out 100% of the capital. The employees get a salary during this time (no "downside"), and any upside is free money to them. Now this isn't a perfect rebuttal, but steve's argument is also lacking in nuance so i'll leave it there. 3. VCs have moved the liquidity goal posts _but_ haven't moved the vesting goal posts. Is he suggesting the vesting schedule needs to be longer?? To match liquidity??? this is nonsensical. the overriding problem, he suggests, is this new "growth capital" phase. i don't agree this has made the stock option deal "bad". yes, it changes the nature of it, but not to as negative a degree as he implies. if he wants companies to IPO earlier, well what happens is that your 1 basis point of options will be worth 10x less than if you stick it out. it's like people complaining about dilution: dilution isn't a problem ... your net cash value increases with each round. it's not really feasible to have the hoi polloi be able to liquidate options at each round.
thebyrd 8y ago
I've made money on my ISOs at every startup I was an early employee of. The secondary markets are fairly liquid if you know how to navigate them. None of the companies were in the Bay Area either.
jordanwlong 8y ago
Check out the Employee Stock Option Fund (www.esofund.com), we help employees fund the cost of exercise and any taxes. Our funding is on a non-recourse basis so we can help alleviate any risk (especially given the long time to exit that is mentioned here).
dustingetz 8y ago
If options are busted how should a startup compensate and align employees?
MobileVet 8y ago
I was part of a very well know incubator and a very early employee at a flagship company. Founder blew tons of cash and dilutions but that is part of it and I didn’t mind. What was ethically shady was shortly after I left with 4yrs vested they decided to restructure the entire company so they could attract investment. They took all the debt from the original company and put that in a shell company that then owned a portion of the new company. Guess where early employees’ stock went? The debt vehicle. I actually did make some money on the eventual exit, but probably 1 or 2 orders of magnitude off of what it would have been if my stock was in NewCo. Consider the tech we built was a major driver of the acquisition, it was frustrating. People are greedy, no matter how nice they are to your face.
- seattle_spring 8y ago
  A company I used to work for is in the process of doing this right now. Makes me feel really stupid spending ~10k exercising the shares.
  - entangledqubit 8y ago
    While you're probably bound by some restricted shareholder agreement, you may get a lot of mileage by just asking a lawyer to ask some questions on your behalf. If this restructuring is going on in the context of some larger time sensitive deal, they may throw something your way to not screw up the timeline. Of course, this all depends on your tolerance for pain.
    - maxxxxx 8y ago
      I have heard that too. By raising an issue you may delay some deals so they may choose to pay you off just to get rid of you. But obviously there are no guarantees and hiring a lawyer may cost money.
    - MobileVet 8y ago
      Yea, I pinged the acting CEO... but I really should have had a lawyer make the inquiry to the founder & lead investor.
fisherjeff 8y ago
IMO, startup options should be treated like lottery tickets: some people might win big, but the EV is ~0. Negotiate compensation accordingly.
habosa 8y ago
There are so many absolutely horrifying stories in this thread about startups deliberately restructuring to take money away from rank and file employees. Of all the reasons I've been told not to take startup stock, this one is new to me. What can be done about this? At the very least can we name and shame?
gwbas1c 8y ago
I joined a company where my offer letter had two salary options: A higher salary with less stock, or a lower salary with higher stock. (It wasn't a very large difference.) About a year later, we were sold, and the payout from the stock did not justify the salary difference. In order to justify the difference, the payout needed to be about 20x. When I confronted the CEO she just changed the subject, and didn't understand why I stopped keeping it a secret that I was looking for another job.
- atomical 8y ago
  Why do you fault her for selling?
  - gwbas1c 8y ago
    I don't! If the company wasn't sold I was going to find another job. The bigger problem was that she was setting general compensation far below what was competitive. The new parent company fired her, and gave us all big raises and retention bonuses.
- lumost 8y ago
  The problem in these situations is that your were offered "stock" as in a portion of the equity of the company, and given a complex financial instrument with undefined terms and indeterminate payout. You felt screwed when you discovered you'd been given something worth 1/20th of the dollar value. Startups have effectively given away their biggest talent attraction, why bother working for a high risk startup for "options" when you can work for a steady growing FANG with liquidity and real "equity"? From a talent acquisition perspective it doesn't make sense.
- anonytrary 8y ago
  To clarify, were you expecting a 20x payout on your stock, or was the payout was 20x less than what you were expecting? Either way, sounds like you got bamboozled when you signed the offer letter. I'd almost always take a higher salary at a startup. The vast majority of startups aren't anywhere near Facebook or Google.
deleted 8y ago
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aiisahik 8y ago
The article is right but misses the biggest problem with options: the need to spend money you may never get back in order to have a chance to be paid anything. There are two ways this happens: - You leave the company after 4 years and have 30-90 days to exercise. The exercise will cost you $20,000. The company is nowhere near an exit. Do you do it? - When you exercise you are either immediately hit with a tax bill for NSOs or you get screwed on AMT with ISOs. You suddenly owe money to the IRS simply because the company received a very high 409A valuation just before you left. A liquidity event is nowhere in sight. You've taken a huge gamble by joining a fledgling company that pays little with a low probability of success. You toil for years an overcome tremendous odds to just keep the company alive. But now when you leave the IRS and the company itself wants you to take a final gamble with your hard earned cash. I used to be an attorney who drafted option agreements. Now I've been at two startups as early employees. The reason why this never comes up is because employees do not know what they are getting themselves into. The options are worth very little BY DESIGN. Unless you are among the first 5 hires, you will have no leverage to negotiate a better deal.
- nojvek 8y ago
  A number of startups screw over their employees with options. 90 days is a terribly short exercise window. Kinda like a scam in a way. But not all startups are like that. Where I work (Mixpanel), that window is 5 years. Which I feel is a much generous and fair offer. With stock options, I pay no tax. If the company liquidates, then I convert the options to real stock (yeah i’ll have to pay money to do that). If things go better, I hold that stock for one year and when I sell, I pay capital gains tax at a much lower rate on the gains. But. Big BUT, there’s a lot of assumptions. Things may not go well, may it doesn’t get valued as much, may be it takes longer than 5 years. Lots of may be’s. That’s part of the startup gamble. We are hiring btw if anyone is interested in analytics space. DM me.
  - chauzer 8y ago
    But you have NSOs though, not ISOs right? From what I understand, ISOs are required by law to have a 90 day exercise window, so companies that offer more than 90 days after leaving a company are having ISOs converted to NSOs. When you exercise the NSOs, you still will have a tax bill.
deleted 8y ago
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pmarreck 8y ago
I feel like you almost need a business degree as a work-seeking technologist to understand all the financial structures and future implications at play, here
naveen99 8y ago
Other employees can liquidate shares in the secondary market too, fairly easily.

678 points by furkansahin 8y ago

l2c1928 8y ago

It's bad for most people, but when it's good it's really good. I was lucky to join a now unicorn as one of the first few dozen employees a few years ago. I forward exercised with a few thousand out of pocket (section 83b) an equity grant now worth around $1.5m. Because I forward exercised my options at a low valuation I didn't have to worry about paying taxes if I exercised at a later time when the company's valuation grew. It also meant that my gains became long-term capital gains, and thus taxed lower, as soon as possible after I vested each month.

seibelj 8y ago
I too would like to win the lottery.
- l2c1928 8y ago
  My point is that there are ways to manage risk as an employee, such as early exercising assuming you are joining an early stage startup where the cost is low enough. I would've been screwed if I didn't early exercise.
- CalChris 8y ago
  If you think of the Valley (or wherever you are) as a lottery then your chances of winning are about the same as those of a lottery. If you think of yourself as your personal VC then your odds approach those of a VC which while not great and moreover not diversified, they are much much better than a lottery.
  - donaldknuth123 8y ago
    This analogy fails almost immediately. Real VCs distribute their bets across dozens of companies. You personally are placing one massive bet on one single company so your odds are far worse than a VC.
  - maxxxxx 8y ago
    How do you diversify as an employee/engineer? work for 10 startups at the same time?
    - CalChris 8y ago
      You can't. That is what distinguishes you from a VC. Actually, you can. Serially. Plenty of people work for a startup through its early stage. A year here, a year there. That's diversification.
      - maxxxxx 8y ago
        But how do you determine when it's time to jump ship? A year seems awfully short to make that determination.
        CalChris 8y ago
        If your object is diversification of your investment then one year isn't too short. However, typically your option vests monthly after the cliff. So you don't have to stay for two years unless you want to.
    - opportune 8y ago
      Bounce around until you find somewhere that has a rocketship trajectory? If you can work at 10 startups over a 20 year career, your odds aren't terrible
creaghpatr 8y ago
Good point, although do long term cap gains apply to private company stock being held over years until the liquidity event?
- l2c1928 8y ago
  I paid long term capital gains after selling a portion of my private stock via a tender offer last year.
- bgentry 8y ago
  You get switched to long term capital gains 1 year after exercise or two years after the grant start date, whichever is later.
  - theIV 8y ago
    I don't believe the "or" part of this statement is right. I think you still need to hold for 1 year after exercise AND two years after the grant for long term to kick in. Not sure what the best source on this is, but a quick DDGing: https://www.fool.com/knowledge-center/tax-rate-on-exercising-stock-options.aspx https://www.fool.com/knowledge-center/tax-rate-on-exercising...
    - bgentry 8y ago
      I think we're saying the same thing. If I early exercise my options on day 1, then I still have to wait until the 2 years after the grant date (2 years of employment) to get long term capital gains treatment. If I wait 4 years, then exercise, then I have already satisfied the 2 years post-grant requirement, but I still have to wait a year after the exercise to get long term capital gains treatment. The key part was my last clause: "whichever is later".
lostcolony 8y ago
Yes, just like buying a lottery ticket is bad for most people, but when it's good it's really good. Stock options are never a reason to join a company. They are potentially an added bonus. But they should never be valued in that initial "should I work here?" Not when first taking the job, and not when considering whether you should leave or not (barring an imminent IPO that would delay your leaving by a bearable month or two)
aliston 8y ago
If you go into a casino, put 1000 on green at the roulette table and win, did you get a good deal? The fact that some people win at startup roulette doesn't mean that it's a good financial decision to join a startup, especially considering that you can make the same sort of money without the risk elsewhere.
- chadash 8y ago
  Parent started with "It's bad for most people, but when it's good it's really good.". So yes, roulette is similarly bad for those who don't win and good for the few who do.
  - deleted 8y ago
    [deleted]
  - aliston 8y ago
    Article is titled "why a good deal has gone bad." My point is that winning does not make it a good deal. To expand on it further, even if you are lucky to have joined a unicorn, you still didn't get a good deal in comparison to virtually everyone else involved in the company. The founders are likely billionaires and you made off with a low 7 figure outcome while taking on only marginally less risk. That's not a good deal by any reasonable definition.
    - jerguismi 8y ago
      > To expand on it further, even if you are lucky to have joined a unicorn, you still didn't get a good deal in comparison to virtually everyone else involved in the company. The founders are likely billionaires and you made off with a low 7 figure outcome while taking on only marginally less risk. That's not a good deal by any reasonable definition. I wouldn't see the risk of being an employee and founder as similar. Typically often founders are for time periods without salary etc. Early employee should just consider it as a job with more risk of the company going down under (that risk also exists in more established company). You can request more salary for the job or some additional perks (such as options). I think for the employee the risks of joining to startup are quite easy to manage compared to a founder.
mlthoughts2018 8y ago
Your story still leaves a lot of room for skepticism. For one, 1.5MM is not actually a very good deal for an engineer in your situation, and likely the company gave you very unfavorable terms. Electing 83b is a fairly irrelevant detail in your story as it only affects taxes, not the outcome of the company. Your shares are likely going to get hugely diluted exactly because of growth investing like in the article. Investors and founders will essentially trade away your share of the company in new rounds, while they get huge payouts for it, your shares may grow a small amount, again realized over some long time horizon. Let’s take an extreme example and say your shares double in value (not likely) through the remaining funding rounds, and eventually in another ~7 years you can actually sell them in some liquidity event. So that’s $3 MM (gross) over 10 years. That works out to be $300,000 / yr in equity compensation. Certainly very high. But not any kind of crazy number. Definitely there are rank and file engineers in FAANG companies, Wall Street, and other industries getting annual RSUs or bonuses well beyond that without having to wait 10 years to realize it or have the risk that it folds or you get laid off and lose a bunch of future value, and have a high base salary, good benefits, and good work/life balance the whole time. Given that even a crazy outcome like $3 MM annualized over 10 years isn’t significantly better than other reasonable total comp opportunities, this overall paints a really bad picture for start-ups. Your case, which is nearly about the best lottery ticket someone could get, is only slightly better than a competitive position at many public companies, finance shops, etc. Meanwhile, almost all start-up outcomes would be far worse.
- l2c1928 8y ago
  There's a myth that you can't realize gains if a company doesn't IPO...I've already sold some shares in a tender offer. There is an active secondary market for shares if I chose to sell more. Not sure what your point is about $3MM over 10 years. Why would you divide it over anything other than the number of years you actually worked at the company? You've assumed I was a senior engineering hire. I was in a junior non-technical role a year out of college.
  - mlthoughts2018 8y ago
    Early selling for employees is exceedingly rare and also often on bad terms, this was mentioned in the OP article. Again, it’s lucky that you were able to, but is such a wildly unlikely outcome that functionally everyone else has to ignore that aspect of your story. To boot, being able to sell in a secondary market transaction only after about 3 years is even more ridiculously rare (to the point that it makes me question if your whole story is even true, or just some trolling). The few companies I’ve heard of allowing that type of thing (late pre-IPO Spotify, Squarespace), only allowed it after early employees like yourself would have waited 7-10 years before getting any payout. > “Not sure what your point is about $3MM over 10 years.” Please re-read my comment to help understand. > “You've assumed I was a senior engineering hire. I was in a junior non-technical role a year out of college.” Where did I make an assumption about junior vs senior level? As for your claim you were given this grant for a non-technical role 1 year out of college, I think it’s more likely you’re just lying to troll this comment thread. Just in a Bayesian sense, the conditional probability that you’re lying is higher than that this is a true story. It’s not impossible that this could have happened for a non-tech hire with no experience, but that mere possibility also is irrelevant compared with the far greater probability that this is just made up.
luckystartup 8y ago
I have a very similar story: Was on the first 10 employees at a now unicorn, forward exercised with a few thousand dollars, and my shares are also now worth around $1.5m. But unfortunately the company blocked all attempts at selling any shares on secondary markets. Something you might not be aware of: If you joined the company before they had $50M in assets, your stock would also qualify as QSBS [1], which means you don't have to pay any tax on gains of up to $10 million. [1] https://www.andersentax.com/services/for-private-clients/business-owners-and-entrepreneurs/qsbs https://www.andersentax.com/services/for-private-clients/bus...
SkyBelow 8y ago
>but when it's good it's really good. I don't think this is true. There are cases where people have broken equal or made slightly more than working at a corporation would have. It can be really good, but it can also be just okayish or not that great. This is based off my reading of the phrase, which means that good options have to be really good. The "it is really good" that is actually written verses "it can be really good" that is closer to the truth (imo).
khazhou 8y ago
My problem with it is that there are many scenarios that are fantastic for the founders, but only one (unicorn) that is fantastic for non-founders. You can put in the same long hours, pour your soul into it, take the same risk for years, but if there's an exit event, you'll only be feeding off crumbs while the founders feast on the rewards.

seibelj 8y ago

Valid reasons to work for a startup: - You are a cofounder. - You have little experience and you are using this to break into the industry, and get experience on many different technologies ("wear many hats"). - They are working on a very specific problem or using a specific technology that you strongly desire to work on and it's difficult to do it anywhere else. - You want to work a certain way (remote, on the beach, whatever) and they are willing to go this route. Invalid reasons for working at a startup: - Getting rich off stock options. - Making a lot of money in salary. - Work / life balance. - Stability.

ohaideredevs 8y ago
Not exactly a unique experience, but my .05 - I started of at a startup with a "lol just do it" attitude to whatever the problem was. Worked 12 hours a day a lot, was stressed out all the time, didn't have a life, got calls at odd hours to deploy...but, if I didn't have that experience, I wouldn't have grown nearly as fast. Got to see all aspects of the products and the consequences of the decisions we made early on. Learned more in a year than in the last 3 at corp/consulting jobs. Then again, maybe it was noob gainz and I made at least a third less than I would have at a corp job. Not sure if going back to a startup would be nearly as beneficial in terms of "levelling up." Seems like the game now is to grind whiteboard before I get too old for Google. A friend grew from junior developer to director of IT at that startup, so there's that aspect as well, though I have also seen a number of startups hire leadership outside.
- toomuchtodo 8y ago
  > Worked 12 hours a day a lot, was stressed out all the time, didn't have a life, got calls at odd hours to deploy...but, if I didn't have that experience, I wouldn't have grown nearly as fast. Congrats on using the opportunity to grow in an abusive role. It should not be normalized is the point.
  - brootstrap 8y ago
    On the opposite side of this argument. I was there. I was shit in college but managed a degree and self taught programming. I was hustling hard to graduate and convince someone to hire me as a programmer even though I had no degree. I was 23 at the time. If you are in this scenario, just you, no wife kids etc. What is wrong with working really hard on a problem? I loved the startup and it fit my perfect niche. I would grind 12 hours days, but also had lots of freedom. Remote work, unlimited days off etc. Sure at sometimes you get burnt out but you are a sponge soaking up everything you can. now i'm 28 with wife and kids, no overtime for me. I still work extremely hard and lazer focused, but i show up at 7:30-8am and leave at 4 everyday :p

mlthoughts2018 8y ago

It’s not just that the structure of option grants has worsened (also, expiration practices still are pretty bad for employees), but also that the valuation of the option grants is often way too low. If, as in the article, a start-up is effectively offering a low salary + a lottery ticket and expecting candidates to see it as at least equally as valuable as a high total comp figure from a competitor, then the lottery ticket has to be priced very highly, to drag up the expected value after accounting for all the high likelihood outcomes that have poor payoffs. Add to this the fact that, despite false promises, you won’t get more freedom, career opportunities, cutting edge work, etc., at most start-ups than you would at even average-case public companies, and it’s a bleak picture. No aspects of the work experience will create additional forms of “payoff” that help offset the low salary and poor lottery ticket equity, and in many cases the work environment will be toxic, full of immature behavior, unprofessional, etc., and candidates should really be requiring higher compensation than at a big company, to deal with the start-up dysfunction. When the option valuation (even assuming a hilariously unlikely high value exit or IPO) is eventually diluted and spread out across ~10 years that you have to delay getting that money you earned (or even lose it all because of a layoff + poor expiration policy), and at best it turns out to be the annualized equivalent of a pretty modest bonus, it’s just deeply not worth it. You will not have gotten anything else out of it (specialized experience, leadership or business skills, networking, oddball perks) that offsets the income you could have been earning almost anywhere else.

commandlinefan 8y ago
I was awarded RSU's at my last company (a perpetual startup) - not millions, but maybe tens of thousands of dollars. I had a signed contract that guaranteed them. But then the company merged/consolidated/de-consolidated/re-merged and shuffled around so that when they finally got rid of all of us, they said that those stock options were worth nothing, too bad, so sad. And what am I going to do, spend $100K on a lawyer to maybe recover a quarter of that ten years from now? And they know we won't, that's why they get away with what they get away with.
- CalChris 8y ago
  I don't know but you may have been the victim of 'liquidation preference' (and participation). Your perpetual startup never went public. Each of the investors, seed, A, ... has a preference in case of a liquidity event (exit) over earlier investors and a participation (multiple) as well. Your RSU was just at the bottom of the heap and there was nothing left. The founders would have had something equivalent to your RSUs but ... they were doing the negotiation. For example, IIRC, Anthony Levandowski cut his employees out when he sold 510 to Google. (So it shouldn't have surprised anyone at Google when he later screwed them as well.) https://www.invigorlaw.com/key-term-sheet-provisions-liquidation-preference/ https://www.invigorlaw.com/key-term-sheet-provisions-liquida... Edit: the article even says it: Today, if you’re an employee you’re now are at the bottom of the stock preference pile. In this case, I'd only work for a startup if my preference seniority was equal to that of the founders. And the article says that too: If you’re one of the early senior hires, there’s no downside of asking for the same Restricted Stock Agreements (RSAs) as the founders.

save_ferris 8y ago

Why don't startups offer actual equity grants instead of options? It seemed strange to me when I was starting out in my career that I needed to take a lower salary and options to exercise upon my exit, which wound up costing me thousands of dollars from that lower salary. Two years later, one founder forced out his two other cofounders, started a new company in the exact same space, and poached his best employees, essentially jettisoning the cap table in the process. The small frys who exercised their options were totally screwed. That was a real lesson for me on how crazy this stuff can be.

l2c1928 8y ago
Late stage private startups almost always grant RSUs. If they didn't it would be way too risky for most people to join because the cost to exercise would be very high.
howard941 8y ago
> Why don't startups offer actual equity grants instead of options? Great tax advantages. For ex one startup I worked for did it the other way resulting in recognizable tax income and everyone got hit with a tax bill. Fortunately when it was brought to leadership's attention they were enlightened enough to offset the tax bill with cash but don't expect that, ever.
andrew311 8y ago
Share grants would be seen as income by the IRS and most states and taxed at their Fair Market Value. Options on the other hand usually qualify as Incentive Stock Options that aren’t taxed at grant time and “when exercised, it isn't necessary to pay ordinary income tax. Instead, the options are taxed at a capital gains rate.” [1] Options are better up front because there is no outlay for the employee. They are a hassle down the road. However, if you exercise during a liquidation event your tax liability is probably covered. Stock is a pain upfront unless granted before the first round of funding or any real revenue when the stock value is very little. They are easier down the road, though. Just my two cents. HackerNews, please correct any errors in logic or how this stuff works. 1. https://www.investopedia.com/terms/i/iso.asp https://www.investopedia.com/terms/i/iso.asp

btilly 8y ago

To his suggestions, I have another. Offer internal Dutch auctions on a regular basis to provide an opportunity for investors/the company/etc to buy stock from employees at a reasonable price. This makes the value of the company, from the point of view of the employee, not "funny money" but something very tangible. With an opportunity to cash out long before it is public.

kurthr 8y ago
I'd be very careful with that... there are all sorts of internal/external events that can influence the perceived value of the company and information about them is not evenly distributed. Creating an environment where individuals in some groups can profit from this disparity (or even misinformation) is asking for ugly office politics.
- btilly 8y ago
  All possible solutions come with downsides. It is still an option to consider.
- jimbokun 8y ago
  Interesting, "insider insider" trading then, where some insiders are more inside than others.
conanbatt 8y ago
The easiest solution is that startup employees should be able to sell their shares in the open market, as they please. Then all the problems go away.
- btilly 8y ago
  That requires that you have IPOed. And that comes with its own set of complications. Though there are secondary markets arising for this sort of thing.
  - conanbatt 8y ago

thesausageking 8y ago

He glosses over an important point: it's now typical for founders to take money off the table as part of financing rounds, sometimes as early as the A round. Founders will request it as part of a funding round and, there's so much competition to invest in the top startups, that VCs go along with it. Decades ago, this wasn't the case. Founders waited for the IPO like employees. If you're an engineer sitting on $5m of vested stock in a decacorn, it makes financial sense to sell some of it. Today, companies make that really hard to do. If employees could easily sell their stock while the startup is still private, this would solve a lot of the problems.

nrmitchi 8y ago
It was mentioned about half-way through the article. > And finally, in many high valued startups where there are hungry investors, the founders get to sell parts of their vested shares at each round of funding. (At times this opportunity is offered to all employees in a “secondary” offering.) A “secondary” usually (though not always) happens when the startup has achieved significant revenue or traction and is seen as a “leader” in their market space, on the way to an IPO or a major sale.
goobynight 8y ago
No way they'll make it easier to sell. That's not solving a problem for the business. They need to keep the carrot dangling.
dalbasal 8y ago
If early liquidity wasn't an option for founders, this massive pre-ipo/private-ipo market wouldn't exist. Without early liquidity, a pre-ipo zuck/kalanick/etc. would be a paper billionaire with $0 in the bank and >$1bn "invested" in a risky tech startup. That's not financially or mentally sound, even by their risk lovin standards. If investors demanded every penny go towards growing the business, those CEOs would just IPO earlier to get liquidity. It's a necessary alignment of interests, if investors' interest is delaying the IPO. Employee options holders can't just decide to take a company public, so their interests can stay misaligned.
- 8y ago

jpmattia 8y ago

I think an important point was missed: Steve writes: > The first big idea is that unlike in the 20th century when there were two phases of funding startups–Seed capital and Venture capital–today there is a new, third phase. It’s called Growth capital. It used to be that The Public would provide the "Growth capital" via an IPO; Now the public is providing, I suppose, post-Growth capital via the IPO. In an current era where the market believes P/E ratios of 24 make sense [1], that has so far been viable. If more historically normal valuations return to public companies, or if the latest crop of unicorns fail to provide great returns for the IPO investors, I strongly suspect this new division of funding phases will come to an end. [1] https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-earnings-chart https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-ea...

markbnj 8y ago

> As Venture Capital emerged as an industry in the mid 1970’s, investors in venture-funded startups began to give stock options to all their employees. I don't understand this part of the post. When do "investors" grant stock options? When I did a startup back in the 90's the founders owned all the equity the day after the company was incorporated and a stockholder agreement signed specifying what each of us owned. We then sold equity to angel and venture investors by carving out a piece of the common in the former case, and issuing new preferred shares in the latter. Later the company granted ISOs to employees by an act of management, ratified by the board which did of course include investors. But at no time would I have said that the investors "shared their ownership" with employees. All current owners were diluted by the issuance of new shares or rights to new shares, but it was never a flat-out decision by the investors to share what they owned. It was a management decision.

breischl 8y ago
I imagine that was just a shorthand or maybe he misspoke. It would be a management decision, but they would most likely need to clear it with the investors. Frequently the funding deal between investors and management will even carve out a chunk of equity for incentives.

dman 8y ago

Thank you for writing this! This discussion is long overdue.

gumby 8y ago

A super trivial and tangental point but Fairchild was funded to make discrete semiconductors -- specifically transistors. In those days they were all assembled by hand! The chip (IC) was invented a year or so later.

geggam 8y ago

From my experience most startup stock are common so they dont get paid until the preferred get settled up. You can have 20k shares of stock and walk away with nothing even in an a successful IPO

bitL 8y ago

It's sad that VC/founder's greed and throwing early employees under the bus became the norm :-( I guess that's a sign of maturity of our field and an indication for bright people to move on to take risks directly, offer their services to companies as legal persons and ignore startups as employers.

olliej 8y ago

This is exactly the point I have been making: the equity grant structure for startup employees is not (or no longer?) compensates risk for employees

iblaine 8y ago

IPOs are increasingly turning into an exercise of the Greater Fool Theory [1]. I'm not sure if it's investors or employees who are the bigger fool. Investors can fall back on ratchets [2]. Lyft may sue a bank for helping pre-IPO investors short sell [3]. What does seem to be clear is the widening gap between smart money (investors) and dumb money (employees). [1] https://en.wikipedia.org/wiki/Greater_fool_theory https://en.wikipedia.org/wiki/Greater_fool_theory [2] https://www.investopedia.com/terms/f/fullratchet.asp https://www.investopedia.com/terms/f/fullratchet.asp [3] https://www.cnbc.com/2019/04/06/lyft-is-threatening-litigation-against-morgan-stanley-accusing-the-firm-of-supporting-short-selling.html https://www.cnbc.com/2019/04/06/lyft-is-threatening-litigati...

dgudkov 8y ago

>VC’s typically have pro-rata rights to keep their percentage of ownership intact, but employees don’t Either all shares must be diluted, or none. When someone's shares are diluted but someone's not, it's a scam. The concept of privileged shareholders is just wrong. The whole system looks overly complicated and corrupted.

6gvONxR4sf7o 8y ago
I believe pro-rata rights are rights to invest in further rounds. They can keep their percent ownership only if they contribute more money. This is like employees on vesting schedules, who can continue to get more options by continuing to work. Startup shares are a shitty deal, but this doesn't strike me as one of the reasons.
- jm20 8y ago
  Correct, you don't just "gift" them more equity, you have to pay more (usually a much higher per-share price) to keep that equity.
breischl 8y ago
Oh, and he didn't even touch on things like liquidation preference and participation. Basically says that even though they own X% of the company, they get paid out like it was 4*X. Or maybe they get $YY out before anybody else gets paid. This means that the percentage of the company your shares equate to is only a small part of the picture. You also need to know what deals were cut with every investor now _or in the future_ to know what your shares will be worth.

m0zg 8y ago

It never was a "good deal", it was always a lottery. And one that you're set up to lose if you're not a co-founder.

rmrm 8y ago

having worked at a lot of startups with various outcomes, I've come to firmaly believe the net preset value of your options is actually correct. If you take all the shares I've ever had options given on, and multiplied them by the strike price, it isn't far off from the ultimate amount of money they've been worth. The variance is high between each one, but taken together.. If you get a 100,000 shares at 0.10 each...they are likely over multiple trials going to be worth around 10K. Act accordingly.

deleted 8y ago
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shay_ker 8y ago

> Better yet, offer restricted stock units (RSUs). Restricted Stock Units are a company’s promise to give you shares of the company’s stock Do startups commonly offer RSUs? I suppose my follow-up is whether it's easy to do, using Carta or something similar.

dalbasal 8y ago

The weird thing is that this state of affairs (a) doesn't save investors very much dilution. Meanwhile, (b) options do a much poorer job of motivating/recruiting employees, (c) an even worse job of aligning interests and (d) the risk/downsides aren't reduced at all. If stock "values" start to drop, it can really make a company feel like a sinking ship. That's the risk of equity sharing. They can make bad times worse. This happens no matter how distant/unlikely a liquidity event is. The solution has been mentioned all over this thread: make them liquid somehow. Alternatively, stop doing options and do something else instead. Aren't startups supposed to be breaking conventions and being creative? I agree this Steve B's implication, the average stock option scheme is a vestigial artefact. Unless you're in a position (and of a mind) to negotiate terms, it's a checkbox.

matchagaucho 8y ago

Sure companies are worth more in 10-12 years. But when VCs are managing 7 year funds, their LPs may require returns sooner. I'm surprised this article didn't mention Investors ability to simply hold shares post-IPO. Leave it to the LP pension managers to decide how much upside they want to risk.

JohnFen 8y ago

I've never really considered stock options to be a good deal, really. There's a reason they're widely referred to as "wallpaper". Options are a bit like lottery tickets. All other things being equal, it's marginally better to have them than not, but their existence has never affected my decisions about where to work.

kabdib 8y ago

I made a bunch of money from ISOs at large, established companies. I made zero (well, negative, really) from startup stock options, even before things got really shifty in the 2000s. One startup that I left, that is now a billion dollar company, simply decided to "extinguish" the shares I bought a few years after I resigned. I was probably cheated, but it's not worth the effort to go after them and they know it. Treat startup options as wastepaper. You might get lucky, but it's really, really unlikely.

deanmoriarty 8y ago
I would be really curious if someone could shed some light on how a healthy company could simply decide to "extinguish" exercised shares. Like how exactly would they go about doing that, and do you have examples I can read up describing where and how this happened? I would understand if that happened when the company is in trouble (e.g. valuation dropping below the last preferred valuation, so preferences kick in, or as a result of the company having to honor very high liquidation preferences), but otherwise? The only couple very shady cases I know about where Facebook with the Brazilian cofounder (with a complicated legal process where they reincorporated the company into a new one or something like that) and Skype with the employees (who naively signed a clawback clause in their agreement stating that the company could repurchase shares in the future at the original grant value even if their price skyrocketed, or something similar). In all the other cases I know about where employees got screwed, it was because the company saw its valuation plummet and the investors preferences kicked in, in one way or another, so "extinguishing" common shares in that case is "expected" and more similar to a public company declaring bankruptcy and seeing the shareholders being wiped out while the bond holders can generally recoup something, since they have "preferred" terms inherent in the nature of the bonds.
- mrnobody_67 8y ago
  See Zynga, cancelling options prior to IPO: https://news.ycombinator.com/item?id=3220819 https://news.ycombinator.com/item?id=3220819
  - 8y ago

brownkonas 8y ago

I think another correction to the diminishing value of stock options and longer IPO horizon is that insane hours are less common now, even at the peril of the success of the median startup. It's also a result of the tight tech labor market and the wealth divide between new startup comp and FAANG comp. Why should I would disproportionate hours if there's another job with a more certain outcome that does not require this. Curious if others have seen a drop in hours expected from your average startup (separate discussion if longer hours is a key ingredient and overall a good thing).

paulddraper 8y ago
I think startup demographics are changing slightly. Fewer early 20 bachelors.
president 8y ago
If anything, I have only seen an increase in work hours in my peer circle. Which startups are cutting hours?

jiveturkey 8y ago

this is a contorted, misguided, wrong argument. as evidenced by the lack of a proposed solution. i could refute his arguments point-by-point but i'll just highlight a few. 1. in a couple of places, he notes that "employees" put in as much hard work as "founders" but don't receive equivalent compensation. this is an absurd comparison. the amount of hard work is irrelevant, it's the value you bring to the table. part of that value is via hard work, and part is via the unique (or not) skill set. the unskilled janitor or maintenance man might put in hard work, but is an easily replaceable skill. if in fact you think you are bringing as much value as the founders, but aren't getting rewarded, the solution is very, very, very simple: become a founder. 2. So while the VCs gain the upside from keeping a startup private, employees get the downside. What? Given the very well known, no excuses for not knowing this, fact that the large majority of startups fail, VCs take 100% of the risk, by virtue of laying out 100% of the capital. The employees get a salary during this time (no "downside"), and any upside is free money to them. Now this isn't a perfect rebuttal, but steve's argument is also lacking in nuance so i'll leave it there. 3. VCs have moved the liquidity goal posts _but_ haven't moved the vesting goal posts. Is he suggesting the vesting schedule needs to be longer?? To match liquidity??? this is nonsensical. the overriding problem, he suggests, is this new "growth capital" phase. i don't agree this has made the stock option deal "bad". yes, it changes the nature of it, but not to as negative a degree as he implies. if he wants companies to IPO earlier, well what happens is that your 1 basis point of options will be worth 10x less than if you stick it out. it's like people complaining about dilution: dilution isn't a problem ... your net cash value increases with each round. it's not really feasible to have the hoi polloi be able to liquidate options at each round.

thebyrd 8y ago

I've made money on my ISOs at every startup I was an early employee of. The secondary markets are fairly liquid if you know how to navigate them. None of the companies were in the Bay Area either.

jordanwlong 8y ago

Check out the Employee Stock Option Fund (www.esofund.com), we help employees fund the cost of exercise and any taxes. Our funding is on a non-recourse basis so we can help alleviate any risk (especially given the long time to exit that is mentioned here).

dustingetz 8y ago

If options are busted how should a startup compensate and align employees?

MobileVet 8y ago

I was part of a very well know incubator and a very early employee at a flagship company. Founder blew tons of cash and dilutions but that is part of it and I didn’t mind. What was ethically shady was shortly after I left with 4yrs vested they decided to restructure the entire company so they could attract investment. They took all the debt from the original company and put that in a shell company that then owned a portion of the new company. Guess where early employees’ stock went? The debt vehicle. I actually did make some money on the eventual exit, but probably 1 or 2 orders of magnitude off of what it would have been if my stock was in NewCo. Consider the tech we built was a major driver of the acquisition, it was frustrating. People are greedy, no matter how nice they are to your face.

seattle_spring 8y ago
A company I used to work for is in the process of doing this right now. Makes me feel really stupid spending ~10k exercising the shares.
- entangledqubit 8y ago
  While you're probably bound by some restricted shareholder agreement, you may get a lot of mileage by just asking a lawyer to ask some questions on your behalf. If this restructuring is going on in the context of some larger time sensitive deal, they may throw something your way to not screw up the timeline. Of course, this all depends on your tolerance for pain.
  - maxxxxx 8y ago
    I have heard that too. By raising an issue you may delay some deals so they may choose to pay you off just to get rid of you. But obviously there are no guarantees and hiring a lawyer may cost money.
  - MobileVet 8y ago
    Yea, I pinged the acting CEO... but I really should have had a lawyer make the inquiry to the founder & lead investor.

fisherjeff 8y ago

IMO, startup options should be treated like lottery tickets: some people might win big, but the EV is ~0. Negotiate compensation accordingly.

habosa 8y ago

There are so many absolutely horrifying stories in this thread about startups deliberately restructuring to take money away from rank and file employees. Of all the reasons I've been told not to take startup stock, this one is new to me. What can be done about this? At the very least can we name and shame?

gwbas1c 8y ago

I joined a company where my offer letter had two salary options: A higher salary with less stock, or a lower salary with higher stock. (It wasn't a very large difference.) About a year later, we were sold, and the payout from the stock did not justify the salary difference. In order to justify the difference, the payout needed to be about 20x. When I confronted the CEO she just changed the subject, and didn't understand why I stopped keeping it a secret that I was looking for another job.

atomical 8y ago
Why do you fault her for selling?
- gwbas1c 8y ago
  I don't! If the company wasn't sold I was going to find another job. The bigger problem was that she was setting general compensation far below what was competitive. The new parent company fired her, and gave us all big raises and retention bonuses.
lumost 8y ago
The problem in these situations is that your were offered "stock" as in a portion of the equity of the company, and given a complex financial instrument with undefined terms and indeterminate payout. You felt screwed when you discovered you'd been given something worth 1/20th of the dollar value. Startups have effectively given away their biggest talent attraction, why bother working for a high risk startup for "options" when you can work for a steady growing FANG with liquidity and real "equity"? From a talent acquisition perspective it doesn't make sense.
anonytrary 8y ago
To clarify, were you expecting a 20x payout on your stock, or was the payout was 20x less than what you were expecting? Either way, sounds like you got bamboozled when you signed the offer letter. I'd almost always take a higher salary at a startup. The vast majority of startups aren't anywhere near Facebook or Google.

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aiisahik 8y ago

The article is right but misses the biggest problem with options: the need to spend money you may never get back in order to have a chance to be paid anything. There are two ways this happens: - You leave the company after 4 years and have 30-90 days to exercise. The exercise will cost you $20,000. The company is nowhere near an exit. Do you do it? - When you exercise you are either immediately hit with a tax bill for NSOs or you get screwed on AMT with ISOs. You suddenly owe money to the IRS simply because the company received a very high 409A valuation just before you left. A liquidity event is nowhere in sight. You've taken a huge gamble by joining a fledgling company that pays little with a low probability of success. You toil for years an overcome tremendous odds to just keep the company alive. But now when you leave the IRS and the company itself wants you to take a final gamble with your hard earned cash. I used to be an attorney who drafted option agreements. Now I've been at two startups as early employees. The reason why this never comes up is because employees do not know what they are getting themselves into. The options are worth very little BY DESIGN. Unless you are among the first 5 hires, you will have no leverage to negotiate a better deal.

nojvek 8y ago
A number of startups screw over their employees with options. 90 days is a terribly short exercise window. Kinda like a scam in a way. But not all startups are like that. Where I work (Mixpanel), that window is 5 years. Which I feel is a much generous and fair offer. With stock options, I pay no tax. If the company liquidates, then I convert the options to real stock (yeah i’ll have to pay money to do that). If things go better, I hold that stock for one year and when I sell, I pay capital gains tax at a much lower rate on the gains. But. Big BUT, there’s a lot of assumptions. Things may not go well, may it doesn’t get valued as much, may be it takes longer than 5 years. Lots of may be’s. That’s part of the startup gamble. We are hiring btw if anyone is interested in analytics space. DM me.
- chauzer 8y ago
  But you have NSOs though, not ISOs right? From what I understand, ISOs are required by law to have a 90 day exercise window, so companies that offer more than 90 days after leaving a company are having ISOs converted to NSOs. When you exercise the NSOs, you still will have a tax bill.

deleted 8y ago

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pmarreck 8y ago

I feel like you almost need a business degree as a work-seeking technologist to understand all the financial structures and future implications at play, here

naveen99 8y ago

Other employees can liquidate shares in the secondary market too, fairly easily.