8 ms·

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 sal

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
- mlthoughts2018 8y ago
  Companies should either: - award RSUs that have a liquidity event as the final vesting requirement and don’t expire (so you are not taxed until you can sell, and don’t risk losing what you already earned), or - pay annual cash bonuses that are “grossed up” so that the after-tax amount of the bonus is enough to cover the taxes levied against the employee’s value of actual stock or vested RSUs, etc., and ensure the company bears that tax burden. I’d be more forgiving to fully bootstrapped companies, which are often fairer to employees anyway. Not willing to compromise at all for VC-backed companies, period. They also should be paying full market wages and the equity portion is solely meant to be competitive with the equity compensation or bonuses at public companies.
  - zrail 8y ago
    The IRS considers RSUs that don’t have an expiration date as being close enough to actual shares to be taxable income. There has to be a “substantial risk of forfeiture” to qualify for deferred taxation.
    - mlthoughts2018 8y ago
      In that case, then only the second suggestion.
      - phamilton 8y ago
        That's usually referred to as Phantom Stock, and is a thing.
- marcinzm 8y ago
  >Instead, the options are taxed at a capital gains rate As I understand it, they ARE taxed as income for all intents and purposes at exercise time (based on the value difference at exercise). They are not regular income but they are part of Alternative Minimum Tax income. You pay taxes on the greater of the two. The difference between exercise price and sales price is then taxed as capital gains assuming you held the stock for a year (or two?). The one trick to this is that if you exercise very early then the tax is on basically nothing (literally nothing if your option price and current value are identical). However, you still need to buy the options so it's not free but just tax free.
hangonhn 8y ago
Because you'll be taxed on something that often has no liquidity nor market. The estimated value on your stock may be $5 and you'll get taxed on that but if you were to go sell it you may only be able to fetch a fraction of that on the secondary market (if there is even one for those stocks), possibly not even covering the taxes you have to pay.
kurthr 8y ago
Maybe this used to happen earlier, but I only really saw this after the DotCom bust. In my case it was founders/execs issuing themselves new/preferred stock and diluting all their coworkers into oblivion on an exit. Granted, these were small shops ~30 people and the exits were small ~$100M, but the effects were devastating. Everyone who could quit, did. People for whom an extra few $100k would have been a big deal would throw drinks at founders in a bar. The code became an unmaintainable worthless mess and they basically failed to live up to the value they existed at. Why would someone give the founders such a deal? If they don't care about their employees to share 10%, they probably don't care about even medium term success.
- oh_hello 8y ago
  I lived through an experience very similar to this. The little people got peanuts. Two things really burned me. One was exactly the point you made, with such a small team it would haven't been much to make the payout go from pathetic to meaningful for the peons who put years into the company. Second the sale contract specified employees would continue to receive similar salaries. So our salaries did not change, options that took years to vest were cashed in for little money, and the company suddenly had plenty of extra money to go on a hiring streak.
- sytelus 8y ago
  Could you/should you ask founders if they have such unilateral dilution powers? How do you check for this when joining a startup? Should this be explicitly written in the offer letter you get?
  - kurthr 8y ago
    In general a majority stock holder(s) can rewrite the rules any way they like. You could have a poison pill written into your offer letter (requiring an immediate payout for certain events), but I don't think any founder/VC would sign it. But I AM NOT A LAWYER.
jm20 8y ago
A lot of smaller/early stage/seed startups actually do this. It's a restricted stock grant. And for the people saying they don't do it because of taxation on an illiquid asset, this is why 83(b)'s exist. They let you pay the full tax on a stock grant at time of the grant, not time of vesting. You get a 409A valuation to establish the Fair Market Value of your stock. That valuation isn't based on the same criteria that investors use, it is much more rigorous and based on income, cash in the bank, etc. You could very well have a company raise money at at $10MM cap and be "worth" less than $1MM. If you grant someone stock at that price, their taxable income will be negligible - usually only a few hundred to a few thousand dollars, and then they don't have a giant tax bill at the end. You still have to pay capital gains, but that only applies when you sell the stock, so you have the money to pay it.
- acjohnson55 8y ago
  That only works if you're a really early employee. Most moderately successful companies reach the point where their equity grants are worth enough that the exercise cost plus tax bill for an early exercise will be in the thousands.
deleted 8y ago
[deleted]

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

mlthoughts2018 8y ago
Companies should either: - award RSUs that have a liquidity event as the final vesting requirement and don’t expire (so you are not taxed until you can sell, and don’t risk losing what you already earned), or - pay annual cash bonuses that are “grossed up” so that the after-tax amount of the bonus is enough to cover the taxes levied against the employee’s value of actual stock or vested RSUs, etc., and ensure the company bears that tax burden. I’d be more forgiving to fully bootstrapped companies, which are often fairer to employees anyway. Not willing to compromise at all for VC-backed companies, period. They also should be paying full market wages and the equity portion is solely meant to be competitive with the equity compensation or bonuses at public companies.
- zrail 8y ago
  The IRS considers RSUs that don’t have an expiration date as being close enough to actual shares to be taxable income. There has to be a “substantial risk of forfeiture” to qualify for deferred taxation.
  - mlthoughts2018 8y ago
    In that case, then only the second suggestion.
    - phamilton 8y ago
      That's usually referred to as Phantom Stock, and is a thing.
marcinzm 8y ago
>Instead, the options are taxed at a capital gains rate As I understand it, they ARE taxed as income for all intents and purposes at exercise time (based on the value difference at exercise). They are not regular income but they are part of Alternative Minimum Tax income. You pay taxes on the greater of the two. The difference between exercise price and sales price is then taxed as capital gains assuming you held the stock for a year (or two?). The one trick to this is that if you exercise very early then the tax is on basically nothing (literally nothing if your option price and current value are identical). However, you still need to buy the options so it's not free but just tax free.

hangonhn 8y ago

Because you'll be taxed on something that often has no liquidity nor market. The estimated value on your stock may be $5 and you'll get taxed on that but if you were to go sell it you may only be able to fetch a fraction of that on the secondary market (if there is even one for those stocks), possibly not even covering the taxes you have to pay.

kurthr 8y ago

Maybe this used to happen earlier, but I only really saw this after the DotCom bust. In my case it was founders/execs issuing themselves new/preferred stock and diluting all their coworkers into oblivion on an exit. Granted, these were small shops ~30 people and the exits were small ~$100M, but the effects were devastating. Everyone who could quit, did. People for whom an extra few $100k would have been a big deal would throw drinks at founders in a bar. The code became an unmaintainable worthless mess and they basically failed to live up to the value they existed at. Why would someone give the founders such a deal? If they don't care about their employees to share 10%, they probably don't care about even medium term success.

oh_hello 8y ago
I lived through an experience very similar to this. The little people got peanuts. Two things really burned me. One was exactly the point you made, with such a small team it would haven't been much to make the payout go from pathetic to meaningful for the peons who put years into the company. Second the sale contract specified employees would continue to receive similar salaries. So our salaries did not change, options that took years to vest were cashed in for little money, and the company suddenly had plenty of extra money to go on a hiring streak.
sytelus 8y ago
Could you/should you ask founders if they have such unilateral dilution powers? How do you check for this when joining a startup? Should this be explicitly written in the offer letter you get?
- kurthr 8y ago
  In general a majority stock holder(s) can rewrite the rules any way they like. You could have a poison pill written into your offer letter (requiring an immediate payout for certain events), but I don't think any founder/VC would sign it. But I AM NOT A LAWYER.

jm20 8y ago

A lot of smaller/early stage/seed startups actually do this. It's a restricted stock grant. And for the people saying they don't do it because of taxation on an illiquid asset, this is why 83(b)'s exist. They let you pay the full tax on a stock grant at time of the grant, not time of vesting. You get a 409A valuation to establish the Fair Market Value of your stock. That valuation isn't based on the same criteria that investors use, it is much more rigorous and based on income, cash in the bank, etc. You could very well have a company raise money at at $10MM cap and be "worth" less than $1MM. If you grant someone stock at that price, their taxable income will be negligible - usually only a few hundred to a few thousand dollars, and then they don't have a giant tax bill at the end. You still have to pay capital gains, but that only applies when you sell the stock, so you have the money to pay it.

acjohnson55 8y ago
That only works if you're a really early employee. Most moderately successful companies reach the point where their equity grants are worth enough that the exercise cost plus tax bill for an early exercise will be in the thousands.

deleted 8y ago

[deleted]