15 ms·

Equity guide for employees at fast-growing companies

93 points by zt 6y ago

fatnoah 6y ago
>Importantly, these projections assume a successful outcome for your company and don’t account for relevant factors such as dilution, timing, and liquidation preferences. For me, this is the big one. I've never had ISOs in a company that had an IPO event, but I have had them (over 1% of total equity in one case) in two companies that were acquired. In both cases, there was nothing left once investors and/or founders got paid, so total value of my ISOs was $0.
- goodoldneon 6y ago
  How does that happen? If you own a stake in a company, how can it disappear like that?
  - tomnipotent 6y ago
    Preferred stock. Investors get their money first, then founders, then everyone else.
    - ska 6y ago
      Founders (and early investors) don't necessarily have preference. The thing about founders and possibly key individuals is that they can be taken care of other ways in the earn out, even if their equity ends up hugely devalued. It's one of the ways deals like this can get made, and one way employees can get left holding an empty bag.
      - foobiekr 6y ago
        This. Founders, at least critical ones, may be compensated by a payment to help complete an acquisition, especially in the event that the exit was not a good one. Founders and other employees who the acquirer wants to retain and the founders will then be given a retention package that vests over a few years. While the payment to support completing the deal generally goes to all of the founders and the CEO, the retention can, but usually doesn't include the CEO if not a founder or most non-engineering resources...
        fatnoah 6y ago
        Excellent point. This is what happened in the case where I was the VP Eng. Everyone in Engineering got low to high 5 figure cash payouts depending on seniority, and C-levels and VPs (only a group of 5) got low/mid 6 figure deals. Everyone then got joining RSUs at their level for the acquiring company. So, everyone made some money, but not from the ISOs.
      - tomnipotent 6y ago
        > Founders (and early investors) don't necessarily have preference It completely depends on the term sheet, but liquidation preference has been a thing for a loooong time. Also I meant to say "preference stack" instead of "preferred stock". > they can be taken care of other ways in the earn out The OP was asking why employees can make nothing during an acquisition, not if founders or investors are charitable. https://angel.co/blog/liquidation-preference-your-equity-could-be-worth-millions-or-nothing https://angel.co/blog/liquidation-preference-your-equity-cou...
        ska 6y ago
        > The OP was asking why employees can make nothing during an acquisition, Right, and one of the ways that can happen is that founders do not have preference and their stock goes to nothing with the rest of the common (e.g. an equity group has your debt and 2x preference, they get almost all of the sale price). But to keep the founders on side and "cohesion" through the transfer, they are offered money outside of the equity sale in the earn out terms. If all goes well they still make ok/good money on the deal, but none/little of it is from their equity. If you are engineer #47 you may or may not have a job after the acquisition but your equity value just vanished.
  - celim307 6y ago
    All equity is not created equal. Employee equity pool is usually the first to be diluted and the last to be paid out. Read your offer materials closely. You’ll want some anti dilution clause that gives pool refreshers. But 99% of the time investors will get paid out before employees or founders
  - TuringNYC 6y ago
    There are tiers of equity. Any money that comes in flows from the top tier downwards like a multi-step waterfall. Employees are usually in the bottom tier. You get what is leftover after everyone else partakes. https://www.nytimes.com/2015/12/27/technology/when-a-unicorn-start-up-stumbles-its-employees-get-hurt.html https://www.nytimes.com/2015/12/27/technology/when-a-unicorn... Some tiers also have multiples -- e.g., 2x first money out
  - deleted 6y ago
    [deleted]
  - foobiekr 6y ago
    If you exit under the money taken, exit under the money taken plus any preference multipliers, have founders that foolishly agreed to double-dipping schemes like participating preferences, and so on. There are myriad ways your common shares can go to zero even with an acquisition, even with an acquisition to the tune of hundreds of millions of dollars. The board can, basically, do whatever it wants, and you have no protection at all, unless you managed to get some kind of agreement into your equity agreement (e.g., Larry Ellison's anti-dilution clause).
  - cpascal 6y ago
    Liquidation preferences. Large investors can negotiate a liquidation preference with their investment. This means they will receive some multiple (1x, 2x, ...) of their investment from the liquidation proceeds. These investors can also be "participating members" which means after receiving their liquidation preference they can still receive their pro rata share of the liquidation proceeds based on their equity stake. So if a company was liquidated for an amount at or below the sum of the liquidation preferences there's nothing left for the shareholders to divvy up.
    - fatnoah 6y ago
      This is the correct answer for my situation.
  - shoo 6y ago
    > I often talk to startups that claim that their compensation package has a higher expected value than the equivalent package at a place like Facebook, Google, Twitter, or Snapchat. One thing I don’t understand about this claim is, if the claim is true, why shouldn’t the startup go to an investor, sell their options for what they claim their options to be worth, and then pay me in cash? > So how come startups can’t or won’t take on more investment and pay their employees in cash? Let’s start by looking at some cynical reasons, followed by some less cynical reasons. > There are a lot of differences between the preferred stock that VCs get and the common stock that employees get; let’s look at a couple of concrete scenarios. > Let’s say those investors that paid $300M for 30% of the company have a straight (1x) liquidation preference, and the company sells for $500M. The 1x liquidation preference means that the investors will get 1x of their investment back before lowly common stock holders get anything, so the investors will get $300M for their 30% of the company. The other 70% of equity will split $200M: your 0.1% common stock option with a $0 strike price is worth $285k (instead of the $500k you might expect it to be worth if you multiply $500M by 0.001). > The preferred stock VCs get usually has at least a 1x liquidation preference. Let’s say the investors had a 2x liquidation preference in the above scenario. They would get 2x their investment back before the common stockholders split the rest of the company. Since 2 * $300M is greater than $500M, the investors would get everything and the remaining equity holders would get $0. > Another difference between your common stock and preferred stock is that preferred stock sometimes comes with an anti-dilution clause, which you have no chance of getting as a normal engineering hire. Let’s look at an actual example of dilution at a real company. Mayhar got 0.4% of a company when it was valued at $5M. By the time the company was worth $1B, Mayhar’s share of the company was diluted by 8x, which made his share of the company worth less than $500k (minus the cost of exercising his options) instead of $4M (minus the cost of exercising his options). -- https://danluu.com/startup-options/ https://danluu.com/startup-options/
  - shoo 6y ago
    Separately from the pathologies of investing in startups as a mere employee, there are also more transparent mechanisms for public companies to dilute minority shareholders or force minority shareholders to sell their stakes: 1. A company can dilute existing shareholders by issuing more shares to raise capital. That said, if a company is at a high risk of bankruptcy, the value of a minority shareholder's diluted shares may be worth more than the pre-diluted shares if the company's balance sheet is bolstered by the new cash reserves. Some recent examples: 1.1. Rolls Royce recently performed a rights issue where existing shareholders were granted the right to purchase additional shares in the company for a particular price [RR]. Shareholders who do not want to be diluted need to pony up more cash to exercise the rights or otherwise buy additional shares to compensate for dilution. 1.2. Telsa raised an additional $5b cash by issuing more common stock on the market. [TSLA] If you were a Telsa shareholder with a 'buy and hold' perspective, if you believe that the current market price of Telsa shares under estimates the true value of those shares to you as a shareholder, then this action reduces the value of your shares. Conversely, if you believe the current market price of Telsa shares massively over estimates the true value of those shares to you as a shareholder, then this action might increase the value of your shares (e.g. the value of your claim to future earnings is reduced by dilution, but the tangible assets per share of your diluted shares may increase due to the additional cash reserves). 2. In some cases, a public company can be acquired and minority shareholders can be forced to sell their shares through a squeeze-out [SO], provided a majority shareholder owns at least 90% or 95% of the company (depending on jurisdiction). It might make sense for a majority shareholder / acquirer to do this if they believe their private value of owning the entire business is higher than the current "fair-value" market price per share, and they can force minority shareholders to sell at the current market price. In the worst case this enables majority shareholders to take advantage of temporarily depressed market prices and lock out minority shareholders from participating in future gains if the company's situation improves or is turned around. One arbitrary current example of an upcoming squeeze-out is the situation with hunter douglas group [HDG]. [RR] https://www.ii.co.uk/analysis-commentary/rolls-royce-rights-issue-all-you-need-know-ii513777 https://www.ii.co.uk/analysis-commentary/rolls-royce-rights-... [TSLA] https://www.sec.gov/Archives/edgar/data/1318605/000119312520312218/d25283d424b5.htm https://www.sec.gov/Archives/edgar/data/1318605/000119312520... [SO] https://en.wikipedia.org/wiki/Squeeze-out https://en.wikipedia.org/wiki/Squeeze-out [HDG] http://investor.hunterdouglasgroup.com/news-releases/news-release-details/agreement-recommended-all-cash-offer-eur-64-share-all-common http://investor.hunterdouglasgroup.com/news-releases/news-re...
- Elof 6y ago
  Same thing has happened to me 2x
  - MichaelZuo 6y ago
    Were there any warning signs, that you could recognize, the second time around?
    - endymi0n 6y ago
      Intransparency and closed rooms. Financing rounds with undisclosed value, less or equal to the last round. Financing rounds that are less than 3x of the last one. Too many financing rounds with slowing growth. Growth of less than 50% per year. Hiring Freezes. Founders leaving. None of this is a hard criterion, but more than one of them and the chances of your equity being worth something quickly appoaches zero.
    - ska 6y ago
      If your company is not doing well over time, there is a good chance the common stock is approaching $0 value. The longer this goes on, the more certain you can be. If you get a sense of deja-vu every time a C-level at an all hands says "next year we'll be profitable" , "we just need this funding round, and then" "we missed revenue targets this quarterb but" etc. then you are probably there already, or nearby. There are exceptions of course, sometimes a rough patch is just a rough patch.
      - icedchai 6y ago
        Yep, I've had this happen. The "rough patch" has been going on for years, with down round after down round. At some point, you have to accept it's not working out.
      - deleted 6y ago
        [deleted]
    - Elof 6y ago
      1 point by Elof 0 minutes ago | edit | delete [–] Totally missed this 10 days ago, but here are some things to consider based on my experience. Look at their funding. Not always bad, but have they taken a bridge round (something to keep them afloat while they get a bigger round together). Did they have a down round i.e. valuation stayed flat or went negative after they took more money. This almost always dilutes common stock way more then preferred stock and VCs usually have preferred. They often re-cap in this case as well (change the terms of the cap table). Basically any time VCs have the upper hand they will dilute common stock holders. Really, don't expect to get any meaningful amount of money unless the company sells for way way more than they raised or if the company goes public and the only way you're going to make the big bucks is if the company sells for a huge multiple while they are relatively small or goes public.
cs-szazz 6y ago
A few thoughts: I've seen Tender Offers mentioned a few times in various articles, but I've always been curious about how such an event would affect the 409a valuation. Are Tender Offers usually closer to preferred or common pricing? Does it just depend on the company and that's why there's so few resources? Also, I see liquidation preferences mentioned very very briefly, but in my opinion it's insanely important for prospective employees to get a sense of the cap table. Also, if you're joining very early and a sought after talent, negotiating a longer post termination exercise window is doable, rather than the typical 90 days.
- thomasdub 6y ago
  It's usually really hard to negotiate a longer post termination exercise window as an individual, as that will have to be written into the options plan (which requires board/investor majority approval and is generally a huge legal doc written before). However a lot of strong startups these days are offering all employees with longer (e.g. >2 years) experience the opportunity to exercise for 3+ years and sometimes significantly longer. https://github.com/holman/extended-exercise-windows https://github.com/holman/extended-exercise-windows is a good resource!
  - cs-szazz 6y ago
    Yeah love Zach's Github repo, I hope that a longer exercise window becomes the norm as more companies offer it to stay competitive.
oa335 6y ago
The table doesn’t make much sense to me. If the strike price is $1 for options on 100,000 shares, then my understanding is that the “Cost at exercise” column will be $100,000 no matter when you exercise. Am I missing something?
- bradleybuda 6y ago
  I'm pretty sure they're including the taxes paid in the cost at exercise. You're correct - the strike price remains the same regadless of valuation, but you need to pay taxes on the gains of converting your cheap options to expensive stock.
  - deleted 6y ago
    [deleted]
  - mywittyname 6y ago
    It's still confusing because the table contains "net tax obligations" which appears to be the taxes due if one were to liquidate the whole kit and caboodle at once. Instead, I think it needs a another column for additional gross income for purposes of tax liability in year of liquidation. As I understand it, when you exercise your options at $1.20, you must pay $100k to exercise, then you own taxes on the $20,000 in gains. When you exercise at $20, you must again pay $100,000 to exercise the options, and also pay taxes on the $1,900,000 in gains. And this fact is what causes early employees to walk away from so much money. There's a huge difference in viability of paying the tax bill on $20k of income vs. $1.9MM when the underlying assets are illiquid, and cannot be sold in part to cover the bill. Most people will be able to come up with another $6,000 or so to cover the taxes from an early liquidation. But it's substantially more difficult for most to come up with the $500,000 to cover the tax liability in the second case.
    - deleted 6y ago
      [deleted]
    - x86_64Ubuntu 6y ago
      >...and cannot be sold in part to cover the bill. Wait, so I can't exercise in July, get the money, and then pay the tax bill in February of the next year?
devy 6y ago
Interesting. It seems that Compound is a direct competitor of Carta (formerly eShares Inc.). Does anyone have experience exploring both of them? Pros and Cons? Btw, Carta has A LOT MORE content on Equity guide for employees.[1][2][3][4] etc. [1]: https://carta.com/blog/category/employee-resource-center/ https://carta.com/blog/category/employee-resource-center/ [2]: https://carta.com/blog/equity-101-stock-option-basics/ https://carta.com/blog/equity-101-stock-option-basics/ [3]: https://carta.com/blog/equity-101-stock-economics/ https://carta.com/blog/equity-101-stock-economics/ [4]: https://carta.com/blog/equity-101-exercising-and-taxes/ https://carta.com/blog/equity-101-exercising-and-taxes/ They even held workshops for startup employees at Union Square Ventures office in NYC a few years back in addition to a number of other meetups and talks at conferences.
- zt 6y ago
  I don't think they compete much at all right now: Carta primarily sells software to companies to manage their cap table. They're adding financial products, but all company-facing. Compound is a product-driven financial advisor to startup employees, founders, and others in tech.
- chrdlu 6y ago
  Hey! I’ve used both. They’re actually not competitors (Compound integrates with Carta). The difference? Compound sells to shareholders (Carta sells to companies). Compound provides holistic financial management services (in helping me manage my entire financial stack), including startup equity. The biggest benefit is they personalize everything to my situation (it’s a holistic experience). Would recommend trying it out!
braunshedd 6y ago
Exercise windows are a super important issue that are touched on briefly here, but worth expounding on. Early-exercise mitigates some of the issues of a short exercise window but only for employees with deep pockets. [1] [1] https://cs.stanford.edu/~rishig/90-day-exercise-windows.html https://cs.stanford.edu/~rishig/90-day-exercise-windows.html
ditonal 6y ago
Any companies that offer ISOs without at least a ten year exercise window is just spitting in your face and trying to leave an avenue to clawback your hard earned and well deserved compensation. It’s not that early stage equity is worthless. It obviously isn’t, it can be worth a ton. It’s the instruments that VCs and founders use to offer early stage equity to employees that is worthless. That is a huge distinction that’s worth emphasizing because when people say “oh it’s probably worthless” it’s not just saying that the company is unlikely to succeed, but that if it does succeed you will be scammed out of its value via exercise windows, dilution, getting common instead of preferred shares, etc
- lock-free 6y ago
  This is a bit extreme. I think short exercise windows are fair, it's the tax code that makes it suck. Multiclass stock should be illegal outright, while dilution is a known unknown you factor into your negotiation - depending on how early you join.
  - save_ferris 6y ago
    One of the biggest gripes I have with the current state of equity for employees is that it's treated like compensation while not being legally protected like compensation. A concrete example. I was courted by a company a couple of years ago to join their engineering team and I was pretty set on joining the company until I spoke with a former employee who told me that this company had reneged on giving him the option to purchase his ISOs because they didn't like that he was leaving after two years. That's completely unacceptable behavior for a company, and it completely changed the way I look at equity. A company can't come at for my already-cashed paychecks, but they can absolutely prevent me from purchasing my options for pretty much any reason.
    - scottjg 6y ago
      is that legal? if they issued you options... you have the "option" to purchase them?
ghouj 6y ago
I work at a public company, about half of my TC is stocks. I get them “for free”, and I can immediately sell them for real money (which I do and buy index funds). AIUI, startups “compensate” you in paper stock that you can’t sell, and even worse, they actually make you pay them for it! This seems like a completely terrible deal.
- TheDom 6y ago
  It's not a terrible deal, ISOs can be very advantageous from a tax perspective.
- gkilmain 6y ago
  I'm sure if you think its terrible you could always say you don't want the stock?
  - closeparen 6y ago
    Ah, but here at $startup we want team players who are fully bought in to our vision.
- tempsy 6y ago
  RSUs are taxed like income though, so from a tax perspective it’s pretty awful. Being early at a startup with options that you early exercise has far superior tax benefits.
  - aqme28 6y ago
    Why is that awful? It's compensation and should be treated that way.
    - tempsy 6y ago
      Because the tax treatment for options is far superior, especially if you’re relatively early. You’re paying 40%+ in taxes for RSUs as soon as you vest. If you’re able to early exercise stock at a startup you owe minimal taxes when you join a company and then when you sell you’re just paying long term capital gains taxes which is a lot lower than 40%.
buildbuildbuild 6y ago
Unrelated to the post but it's hard to trust a wealth management company offering a "Financial OS" which has no team page nor any Google-able profiles on AngelList or Crunchbase. edit: A Jordan is mentioned on their careers page, eight searches later I found them: https://news.ycombinator.com/item?id=20615760 https://news.ycombinator.com/item?id=20615760
burnthrow 6y ago
Unless you're willing to sacrifice several of your best years for the startup and hold a winning lottery ticket, your options are worthless, in fact they have negative value because you have to waste the fucking time and energy hearing about them and signing documents. There's your guide.
cs-szazz 6y ago
It's talked about a little, but there's two classes of shares (common and preferred). Usually startups will value your options in an offer using preferred, so they might say you have 100k options at a $1 value each, with a 5 cent strike. But the reality is even if you manage to get liquidity, perhaps through a secondary, you probably won't be able to sell at the preferred price! If you wait until IPO then common equals preferred and it doesn't matter, but it always felt wrong that the value of your options was only true if the company IPOs, versus taking in to account an appropriate discount.
- antognini 6y ago
  What is a typical discount for common vs. preferred shares? I'm sure it's pretty dependent on the specifics of the company, but I've found it hard to even get a range of values.
  - cs-szazz 6y ago
    It depends on how far along the company is, as IPO approaches it'll be a 0% discount. For a Series C-D, 60-70% discount isn't uncommon.
foobiekr 6y ago
Aside: why on earth would you use a picture of a V2 launch for this site?
- didgeoridoo 6y ago
  Photo credit is NASA 1950. Most likely a von Braun design, but not a V2.
- walshemj 6y ago
  Its probably the upsized v2 precursor to red stone maybe that came out operation paperclip at the end of ww2 wher the US and UK liberated missiles and scientists.
  - foobiekr 6y ago
    Thanks, I'm glad of that.
ridaj 6y ago
If the goal is to make life-changing amounts of money, the example they showed in the table means that it would be foolish to early exercise: if you win the ipo roulette, your life is going to change pretty significantly and in a very similar manner whether you make $4m or $6m. On the other hand if you get the more typical startup outcome, you're going to feel a big difference between making $0 and losing $100k...
- nojvek 6y ago
  4m and 6m is a pretty significant difference to be honest. I wouldn’t discount that margin of gains.
rdli 6y ago
This was an odd page to read. On one hand, it assumes some level of sophistication (what’s a 409A?). On the other, it leaves out some really big things that you care about with early exercise (e.g., QSBS). Regarding the thread on liquidation preference, I don’t think any amount of liquidation preference is on standard VC terms in this market.

93 points by zt 6y ago

>Importantly, these projections assume a successful outcome for your company and don’t account for relevant factors such as dilution, timing, and liquidation preferences. For me, this is the big one. I've never had ISOs in a company that had an IPO event, but I have had them (over 1% of total equity in one case) in two companies that were acquired. In both cases, there was nothing left once investors and/or founders got paid, so total value of my ISOs was $0.

goodoldneon 6y ago
How does that happen? If you own a stake in a company, how can it disappear like that?
- tomnipotent 6y ago
  Preferred stock. Investors get their money first, then founders, then everyone else.
  - ska 6y ago
    Founders (and early investors) don't necessarily have preference. The thing about founders and possibly key individuals is that they can be taken care of other ways in the earn out, even if their equity ends up hugely devalued. It's one of the ways deals like this can get made, and one way employees can get left holding an empty bag.
    - foobiekr 6y ago
      This. Founders, at least critical ones, may be compensated by a payment to help complete an acquisition, especially in the event that the exit was not a good one. Founders and other employees who the acquirer wants to retain and the founders will then be given a retention package that vests over a few years. While the payment to support completing the deal generally goes to all of the founders and the CEO, the retention can, but usually doesn't include the CEO if not a founder or most non-engineering resources...
      - fatnoah 6y ago
        Excellent point. This is what happened in the case where I was the VP Eng. Everyone in Engineering got low to high 5 figure cash payouts depending on seniority, and C-levels and VPs (only a group of 5) got low/mid 6 figure deals. Everyone then got joining RSUs at their level for the acquiring company. So, everyone made some money, but not from the ISOs.
    - tomnipotent 6y ago
      > Founders (and early investors) don't necessarily have preference It completely depends on the term sheet, but liquidation preference has been a thing for a loooong time. Also I meant to say "preference stack" instead of "preferred stock". > they can be taken care of other ways in the earn out The OP was asking why employees can make nothing during an acquisition, not if founders or investors are charitable. https://angel.co/blog/liquidation-preference-your-equity-could-be-worth-millions-or-nothing https://angel.co/blog/liquidation-preference-your-equity-cou...
      - ska 6y ago
        > The OP was asking why employees can make nothing during an acquisition, Right, and one of the ways that can happen is that founders do not have preference and their stock goes to nothing with the rest of the common (e.g. an equity group has your debt and 2x preference, they get almost all of the sale price). But to keep the founders on side and "cohesion" through the transfer, they are offered money outside of the equity sale in the earn out terms. If all goes well they still make ok/good money on the deal, but none/little of it is from their equity. If you are engineer #47 you may or may not have a job after the acquisition but your equity value just vanished.
- celim307 6y ago
  All equity is not created equal. Employee equity pool is usually the first to be diluted and the last to be paid out. Read your offer materials closely. You’ll want some anti dilution clause that gives pool refreshers. But 99% of the time investors will get paid out before employees or founders
- TuringNYC 6y ago
  There are tiers of equity. Any money that comes in flows from the top tier downwards like a multi-step waterfall. Employees are usually in the bottom tier. You get what is leftover after everyone else partakes. https://www.nytimes.com/2015/12/27/technology/when-a-unicorn-start-up-stumbles-its-employees-get-hurt.html https://www.nytimes.com/2015/12/27/technology/when-a-unicorn... Some tiers also have multiples -- e.g., 2x first money out
- deleted 6y ago
  [deleted]
- foobiekr 6y ago
  If you exit under the money taken, exit under the money taken plus any preference multipliers, have founders that foolishly agreed to double-dipping schemes like participating preferences, and so on. There are myriad ways your common shares can go to zero even with an acquisition, even with an acquisition to the tune of hundreds of millions of dollars. The board can, basically, do whatever it wants, and you have no protection at all, unless you managed to get some kind of agreement into your equity agreement (e.g., Larry Ellison's anti-dilution clause).
- cpascal 6y ago
  Liquidation preferences. Large investors can negotiate a liquidation preference with their investment. This means they will receive some multiple (1x, 2x, ...) of their investment from the liquidation proceeds. These investors can also be "participating members" which means after receiving their liquidation preference they can still receive their pro rata share of the liquidation proceeds based on their equity stake. So if a company was liquidated for an amount at or below the sum of the liquidation preferences there's nothing left for the shareholders to divvy up.
  - fatnoah 6y ago
    This is the correct answer for my situation.
- shoo 6y ago
  > I often talk to startups that claim that their compensation package has a higher expected value than the equivalent package at a place like Facebook, Google, Twitter, or Snapchat. One thing I don’t understand about this claim is, if the claim is true, why shouldn’t the startup go to an investor, sell their options for what they claim their options to be worth, and then pay me in cash? > So how come startups can’t or won’t take on more investment and pay their employees in cash? Let’s start by looking at some cynical reasons, followed by some less cynical reasons. > There are a lot of differences between the preferred stock that VCs get and the common stock that employees get; let’s look at a couple of concrete scenarios. > Let’s say those investors that paid $300M for 30% of the company have a straight (1x) liquidation preference, and the company sells for $500M. The 1x liquidation preference means that the investors will get 1x of their investment back before lowly common stock holders get anything, so the investors will get $300M for their 30% of the company. The other 70% of equity will split $200M: your 0.1% common stock option with a $0 strike price is worth $285k (instead of the $500k you might expect it to be worth if you multiply $500M by 0.001). > The preferred stock VCs get usually has at least a 1x liquidation preference. Let’s say the investors had a 2x liquidation preference in the above scenario. They would get 2x their investment back before the common stockholders split the rest of the company. Since 2 * $300M is greater than $500M, the investors would get everything and the remaining equity holders would get $0. > Another difference between your common stock and preferred stock is that preferred stock sometimes comes with an anti-dilution clause, which you have no chance of getting as a normal engineering hire. Let’s look at an actual example of dilution at a real company. Mayhar got 0.4% of a company when it was valued at $5M. By the time the company was worth $1B, Mayhar’s share of the company was diluted by 8x, which made his share of the company worth less than $500k (minus the cost of exercising his options) instead of $4M (minus the cost of exercising his options). -- https://danluu.com/startup-options/ https://danluu.com/startup-options/
- shoo 6y ago
  Separately from the pathologies of investing in startups as a mere employee, there are also more transparent mechanisms for public companies to dilute minority shareholders or force minority shareholders to sell their stakes: 1. A company can dilute existing shareholders by issuing more shares to raise capital. That said, if a company is at a high risk of bankruptcy, the value of a minority shareholder's diluted shares may be worth more than the pre-diluted shares if the company's balance sheet is bolstered by the new cash reserves. Some recent examples: 1.1. Rolls Royce recently performed a rights issue where existing shareholders were granted the right to purchase additional shares in the company for a particular price [RR]. Shareholders who do not want to be diluted need to pony up more cash to exercise the rights or otherwise buy additional shares to compensate for dilution. 1.2. Telsa raised an additional $5b cash by issuing more common stock on the market. [TSLA] If you were a Telsa shareholder with a 'buy and hold' perspective, if you believe that the current market price of Telsa shares under estimates the true value of those shares to you as a shareholder, then this action reduces the value of your shares. Conversely, if you believe the current market price of Telsa shares massively over estimates the true value of those shares to you as a shareholder, then this action might increase the value of your shares (e.g. the value of your claim to future earnings is reduced by dilution, but the tangible assets per share of your diluted shares may increase due to the additional cash reserves). 2. In some cases, a public company can be acquired and minority shareholders can be forced to sell their shares through a squeeze-out [SO], provided a majority shareholder owns at least 90% or 95% of the company (depending on jurisdiction). It might make sense for a majority shareholder / acquirer to do this if they believe their private value of owning the entire business is higher than the current "fair-value" market price per share, and they can force minority shareholders to sell at the current market price. In the worst case this enables majority shareholders to take advantage of temporarily depressed market prices and lock out minority shareholders from participating in future gains if the company's situation improves or is turned around. One arbitrary current example of an upcoming squeeze-out is the situation with hunter douglas group [HDG]. [RR] https://www.ii.co.uk/analysis-commentary/rolls-royce-rights-issue-all-you-need-know-ii513777 https://www.ii.co.uk/analysis-commentary/rolls-royce-rights-... [TSLA] https://www.sec.gov/Archives/edgar/data/1318605/000119312520312218/d25283d424b5.htm https://www.sec.gov/Archives/edgar/data/1318605/000119312520... [SO] https://en.wikipedia.org/wiki/Squeeze-out https://en.wikipedia.org/wiki/Squeeze-out [HDG] http://investor.hunterdouglasgroup.com/news-releases/news-release-details/agreement-recommended-all-cash-offer-eur-64-share-all-common http://investor.hunterdouglasgroup.com/news-releases/news-re...
Elof 6y ago
Same thing has happened to me 2x
- MichaelZuo 6y ago
  Were there any warning signs, that you could recognize, the second time around?
  - endymi0n 6y ago
    Intransparency and closed rooms. Financing rounds with undisclosed value, less or equal to the last round. Financing rounds that are less than 3x of the last one. Too many financing rounds with slowing growth. Growth of less than 50% per year. Hiring Freezes. Founders leaving. None of this is a hard criterion, but more than one of them and the chances of your equity being worth something quickly appoaches zero.
  - ska 6y ago
    If your company is not doing well over time, there is a good chance the common stock is approaching $0 value. The longer this goes on, the more certain you can be. If you get a sense of deja-vu every time a C-level at an all hands says "next year we'll be profitable" , "we just need this funding round, and then" "we missed revenue targets this quarterb but" etc. then you are probably there already, or nearby. There are exceptions of course, sometimes a rough patch is just a rough patch.
    - icedchai 6y ago
      Yep, I've had this happen. The "rough patch" has been going on for years, with down round after down round. At some point, you have to accept it's not working out.
    - deleted 6y ago
      [deleted]
  - Elof 6y ago
    1 point by Elof 0 minutes ago | edit | delete [–] Totally missed this 10 days ago, but here are some things to consider based on my experience. Look at their funding. Not always bad, but have they taken a bridge round (something to keep them afloat while they get a bigger round together). Did they have a down round i.e. valuation stayed flat or went negative after they took more money. This almost always dilutes common stock way more then preferred stock and VCs usually have preferred. They often re-cap in this case as well (change the terms of the cap table). Basically any time VCs have the upper hand they will dilute common stock holders. Really, don't expect to get any meaningful amount of money unless the company sells for way way more than they raised or if the company goes public and the only way you're going to make the big bucks is if the company sells for a huge multiple while they are relatively small or goes public.

cs-szazz 6y ago

A few thoughts: I've seen Tender Offers mentioned a few times in various articles, but I've always been curious about how such an event would affect the 409a valuation. Are Tender Offers usually closer to preferred or common pricing? Does it just depend on the company and that's why there's so few resources? Also, I see liquidation preferences mentioned very very briefly, but in my opinion it's insanely important for prospective employees to get a sense of the cap table. Also, if you're joining very early and a sought after talent, negotiating a longer post termination exercise window is doable, rather than the typical 90 days.

thomasdub 6y ago
It's usually really hard to negotiate a longer post termination exercise window as an individual, as that will have to be written into the options plan (which requires board/investor majority approval and is generally a huge legal doc written before). However a lot of strong startups these days are offering all employees with longer (e.g. >2 years) experience the opportunity to exercise for 3+ years and sometimes significantly longer. https://github.com/holman/extended-exercise-windows https://github.com/holman/extended-exercise-windows is a good resource!
- cs-szazz 6y ago
  Yeah love Zach's Github repo, I hope that a longer exercise window becomes the norm as more companies offer it to stay competitive.

oa335 6y ago

The table doesn’t make much sense to me. If the strike price is $1 for options on 100,000 shares, then my understanding is that the “Cost at exercise” column will be $100,000 no matter when you exercise. Am I missing something?

bradleybuda 6y ago
I'm pretty sure they're including the taxes paid in the cost at exercise. You're correct - the strike price remains the same regadless of valuation, but you need to pay taxes on the gains of converting your cheap options to expensive stock.
- deleted 6y ago
  [deleted]
- mywittyname 6y ago
  It's still confusing because the table contains "net tax obligations" which appears to be the taxes due if one were to liquidate the whole kit and caboodle at once. Instead, I think it needs a another column for additional gross income for purposes of tax liability in year of liquidation. As I understand it, when you exercise your options at $1.20, you must pay $100k to exercise, then you own taxes on the $20,000 in gains. When you exercise at $20, you must again pay $100,000 to exercise the options, and also pay taxes on the $1,900,000 in gains. And this fact is what causes early employees to walk away from so much money. There's a huge difference in viability of paying the tax bill on $20k of income vs. $1.9MM when the underlying assets are illiquid, and cannot be sold in part to cover the bill. Most people will be able to come up with another $6,000 or so to cover the taxes from an early liquidation. But it's substantially more difficult for most to come up with the $500,000 to cover the tax liability in the second case.
  - deleted 6y ago
    [deleted]
  - x86_64Ubuntu 6y ago
    >...and cannot be sold in part to cover the bill. Wait, so I can't exercise in July, get the money, and then pay the tax bill in February of the next year?

devy 6y ago

Interesting. It seems that Compound is a direct competitor of Carta (formerly eShares Inc.). Does anyone have experience exploring both of them? Pros and Cons? Btw, Carta has A LOT MORE content on Equity guide for employees.[1][2][3][4] etc. [1]: https://carta.com/blog/category/employee-resource-center/ https://carta.com/blog/category/employee-resource-center/ [2]: https://carta.com/blog/equity-101-stock-option-basics/ https://carta.com/blog/equity-101-stock-option-basics/ [3]: https://carta.com/blog/equity-101-stock-economics/ https://carta.com/blog/equity-101-stock-economics/ [4]: https://carta.com/blog/equity-101-exercising-and-taxes/ https://carta.com/blog/equity-101-exercising-and-taxes/ They even held workshops for startup employees at Union Square Ventures office in NYC a few years back in addition to a number of other meetups and talks at conferences.

zt 6y ago
I don't think they compete much at all right now: Carta primarily sells software to companies to manage their cap table. They're adding financial products, but all company-facing. Compound is a product-driven financial advisor to startup employees, founders, and others in tech.
chrdlu 6y ago
Hey! I’ve used both. They’re actually not competitors (Compound integrates with Carta). The difference? Compound sells to shareholders (Carta sells to companies). Compound provides holistic financial management services (in helping me manage my entire financial stack), including startup equity. The biggest benefit is they personalize everything to my situation (it’s a holistic experience). Would recommend trying it out!

braunshedd 6y ago

Exercise windows are a super important issue that are touched on briefly here, but worth expounding on. Early-exercise mitigates some of the issues of a short exercise window but only for employees with deep pockets. [1] [1] https://cs.stanford.edu/~rishig/90-day-exercise-windows.html https://cs.stanford.edu/~rishig/90-day-exercise-windows.html

ditonal 6y ago

Any companies that offer ISOs without at least a ten year exercise window is just spitting in your face and trying to leave an avenue to clawback your hard earned and well deserved compensation. It’s not that early stage equity is worthless. It obviously isn’t, it can be worth a ton. It’s the instruments that VCs and founders use to offer early stage equity to employees that is worthless. That is a huge distinction that’s worth emphasizing because when people say “oh it’s probably worthless” it’s not just saying that the company is unlikely to succeed, but that if it does succeed you will be scammed out of its value via exercise windows, dilution, getting common instead of preferred shares, etc

lock-free 6y ago
This is a bit extreme. I think short exercise windows are fair, it's the tax code that makes it suck. Multiclass stock should be illegal outright, while dilution is a known unknown you factor into your negotiation - depending on how early you join.
- save_ferris 6y ago
  One of the biggest gripes I have with the current state of equity for employees is that it's treated like compensation while not being legally protected like compensation. A concrete example. I was courted by a company a couple of years ago to join their engineering team and I was pretty set on joining the company until I spoke with a former employee who told me that this company had reneged on giving him the option to purchase his ISOs because they didn't like that he was leaving after two years. That's completely unacceptable behavior for a company, and it completely changed the way I look at equity. A company can't come at for my already-cashed paychecks, but they can absolutely prevent me from purchasing my options for pretty much any reason.
  - scottjg 6y ago
    is that legal? if they issued you options... you have the "option" to purchase them?

ghouj 6y ago

I work at a public company, about half of my TC is stocks. I get them “for free”, and I can immediately sell them for real money (which I do and buy index funds). AIUI, startups “compensate” you in paper stock that you can’t sell, and even worse, they actually make you pay them for it! This seems like a completely terrible deal.

TheDom 6y ago
It's not a terrible deal, ISOs can be very advantageous from a tax perspective.
gkilmain 6y ago
I'm sure if you think its terrible you could always say you don't want the stock?
- closeparen 6y ago
  Ah, but here at $startup we want team players who are fully bought in to our vision.
tempsy 6y ago
RSUs are taxed like income though, so from a tax perspective it’s pretty awful. Being early at a startup with options that you early exercise has far superior tax benefits.
- aqme28 6y ago
  Why is that awful? It's compensation and should be treated that way.
  - tempsy 6y ago
    Because the tax treatment for options is far superior, especially if you’re relatively early. You’re paying 40%+ in taxes for RSUs as soon as you vest. If you’re able to early exercise stock at a startup you owe minimal taxes when you join a company and then when you sell you’re just paying long term capital gains taxes which is a lot lower than 40%.

buildbuildbuild 6y ago

Unrelated to the post but it's hard to trust a wealth management company offering a "Financial OS" which has no team page nor any Google-able profiles on AngelList or Crunchbase. edit: A Jordan is mentioned on their careers page, eight searches later I found them: https://news.ycombinator.com/item?id=20615760 https://news.ycombinator.com/item?id=20615760

burnthrow 6y ago

Unless you're willing to sacrifice several of your best years for the startup and hold a winning lottery ticket, your options are worthless, in fact they have negative value because you have to waste the fucking time and energy hearing about them and signing documents. There's your guide.

cs-szazz 6y ago

It's talked about a little, but there's two classes of shares (common and preferred). Usually startups will value your options in an offer using preferred, so they might say you have 100k options at a $1 value each, with a 5 cent strike. But the reality is even if you manage to get liquidity, perhaps through a secondary, you probably won't be able to sell at the preferred price! If you wait until IPO then common equals preferred and it doesn't matter, but it always felt wrong that the value of your options was only true if the company IPOs, versus taking in to account an appropriate discount.

antognini 6y ago
What is a typical discount for common vs. preferred shares? I'm sure it's pretty dependent on the specifics of the company, but I've found it hard to even get a range of values.
- cs-szazz 6y ago
  It depends on how far along the company is, as IPO approaches it'll be a 0% discount. For a Series C-D, 60-70% discount isn't uncommon.

foobiekr 6y ago

Aside: why on earth would you use a picture of a V2 launch for this site?

didgeoridoo 6y ago
Photo credit is NASA 1950. Most likely a von Braun design, but not a V2.
walshemj 6y ago
Its probably the upsized v2 precursor to red stone maybe that came out operation paperclip at the end of ww2 wher the US and UK liberated missiles and scientists.
- foobiekr 6y ago
  Thanks, I'm glad of that.

ridaj 6y ago

If the goal is to make life-changing amounts of money, the example they showed in the table means that it would be foolish to early exercise: if you win the ipo roulette, your life is going to change pretty significantly and in a very similar manner whether you make $4m or $6m. On the other hand if you get the more typical startup outcome, you're going to feel a big difference between making $0 and losing $100k...

nojvek 6y ago
4m and 6m is a pretty significant difference to be honest. I wouldn’t discount that margin of gains.

rdli 6y ago

This was an odd page to read. On one hand, it assumes some level of sophistication (what’s a 409A?). On the other, it leaves out some really big things that you care about with early exercise (e.g., QSBS). Regarding the thread on liquidation preference, I don’t think any amount of liquidation preference is on standard VC terms in this market.