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An Engineer’s guide to Stock Options

738 points by olivercameron 13y ago

michaelochurch 13y ago
Two corrections: 1. OP says: Once you’ve cliffed, you have the right to buy shares in the company. "Cliffing", when used as a verb, refers to firing someone just before the cliff-- not an employee achieving it. It's something you'd rather avoid. 2. If the company isn't publicly traded, you should ask to see the cap table. If you're employee #30 and your share is 0.05%, that might be fair if it's a biotech that has already taken a $100M infusion from the venture capitalists (who'll typically take 90%, in that case). For a web startup, it's terrible. You need to know how much equity the investors, executives, and employees at various levels have, so you can evaluate your likelihood of getting an improvement if you perform well. Without the cap table, you don't know enough about the startup to decide whether to take a job there.
- deleted 13y ago
  [deleted]
- seiji 13y ago
  you should ask to see the cap table. I've asked that at every non-public company where I've had "options" and they've never complied. Just have to treat the options as confetti from then on.
  - mikestew 13y ago
    Same here. I keep hearing that platitude, and have yet to come across a company that will cough up the numbers. I've decided it's one of those things that sounds good on the face of it, makes sense, but isn't really true. But your final sentence is the best advice: treat the options as a potential windfall, but don't otherwise factor them into your decision.
  - michaelochurch 13y ago
    Just have to treat the options as confetti from then on. Agree. (1) Don't ever take a salary drop for options w/out cap table, and (2) don't make sacrifices that would hurt your career or home life because of them either. Most people in the startup world have evolved enough to get (1) but (2) is where startup culture tends to go off the rails-- people start working 80-hour weeks on career-incoherent grunt work for their options, blissfully unaware of the 10-100x larger grants given to all of the nontechnical VPs who go home at 3:30.
    - vladimirralev 13y ago
      Engineers are smart these days. Is anybody really doing 80h/week for shady options? I doubt it. Employees stuck in this position generally aren't so bright or don't have any other choice for some other reason. But still very rare.
- tptacek 13y ago
  Exactly what does the cap table have to do with your expected outcome, presuming you know the percentage of your allocation, the liquidation preferences and valuation, and the company's runway?
  - michaelochurch 13y ago
    You know whether it's probable that you'll get more equity, and what it takes to get there. Most engineers who join startups think that the 0.03% allocated when they join will be increased later on, and that the initial grant is just a "teaser". I mean, it has to improve, just because it's so ridiculously low, right? (Well, no. In fact, it usually won't.) Perhaps 5 percent of the engineers who join VC-funded startups would still join if they knew that (a) their equity allotments wouldn't improve, and (b) the founders wouldn't take a personal interest in furnishing them with the connections/credibility to be founders in their next gig. That number becomes closer to 1-2 percent when you're talking about good engineers.
    - tptacek 13y ago
      This is silly. Just assume that your allocation will not improve. If you're in a position to improve your grant later in your tenure, you'll either (a) know it, and secure it through negotiation, or (b) not know it and probably not get it. Having the cap table --- which you won't get anyways --- does not actually help you here. A feeling of entitlement isn't what gets you improved compensation. An understanding of your value on the market and a willingness to stand up for yourself is what does that. Put differently: so what if the cap table suggests you're unlikely to get an improved allocation? If you're worth an improved allocation, you'll get one or the company will lose you.
  - gatehouse 13y ago
    If you don't know who owns the company you don't even know who you work for. It might not matter to most people as long as the cheques don't bounce, but if you want to even hallucinate having a meaningful role in the direction of the company it starts to matter. I really don't know what people are willing to disclose to employees but the SEC rule for public companies is a 5% stake or more is disclosed.
- matthudson 13y ago
  > If you're employee #30 and your share is 0.05%, that might be fair if it's a biotech that has already taken a $100M infusion from the venture capitalists (who'll typically take 90%, in that case). Could you point me in the direction of some sources that back up the "90% [in the typical case]" claim? I'm genuinely interested in learning more.
  - crapshoot101 13y ago
    It isn't a claim that can be backed up more than anecdotally - it's the typical jihad without real data.
  - michaelochurch 13y ago
    Biotech has different rules. Investments tend to be much larger but the Vc's get a larger percentage. It's probably fairer and more straightforward than what happens to most web startups, where the initial take is a small percentage but the Vc's demand rapid growth and risk-taking. (That is, I'd rather the VC's take 90% upfront for $100 million than take 20% but ensure, by how they manage the company and the risks they force me to take, that they get 90% of the upside in the end.)
- patio11 13y ago
  You can ask feel free to ask for a pony in a salary negotiation, and in general I bow to no one in advising "ask for more", but that specific ask has the dual unhappy properties of being very awkward for founders to grant and yet not very useful to you the prospective employee. (Even an idealized employee who'd be capable of understanding what it meant.) "What was your most recent valuation?", "What is the size of my grant relative to the full dilution of the company as of today?", etc, get you more signal with less social awkwardness. I mean, at a minimum, it's more of an imposition than "Give me the salary details for everyone at this company", which is for better or worse radioactive almost everywhere, and in addition to similarly being against the corporate interest also tends to disclose privileged information about folks who wouldn't even be listed in salaries.csv. P.S. In my n=2 experience as a very small angel investor I am struggling to remember ever seeing the full cap table. I'd have to check my docs to see if I'm allowed to ask for it, but my limited social radar for the Valley suggests that's the sort of thing that would be socially contentious. Founders I invested in were very circumspect about getting explicit permission to be able to quote the fact of the investment publicly, to say nothing of the amount. P.P.S. Disregard the above if somebody who does this on a more regular basis suggests that you're more in touch with reality than I am. It's possible.
  - michaelochurch 13y ago
    Cap table isn't the same thing as salary. It's the (future, in case of options) ownership of the company. Cap table transparency would go a long way in making VC-istan honest because the equities in salary tend to be small while those in equity are massive. If engineers in a typical VC-istan startup found out that the non-tech VPs and "product people" working 10-to-4 were making $140k while they make $110k, nothing would happen. That's not enough of a difference to set most people off. If they found out that those people had 1% while they had 0.05%, it'd be epic. (That's why VC-istan hides cap tables. It doesn't want to have to admit that engineers are commodities to it.)
    - tptacek 13y ago
      You don't need cap tables to know that the employee equity is small compared to investor equity. It obviously is. Most everyone I talk to knows that. VCs aren't "hiding" it. If you don't want to work at a company where a pencil-pushing meeting-dwelling financier is going to earn an outsized reward compared to your efforts as a software developer, don't work for VC-funded startups. On the other hand, VC-funded startups tend to work on fun speculative problems, because they're powered by other people's money. What a "non-tech VP" makes has nothing to do with an engineer's outcome. Obsessing about what other people in the company make is unhealthy.
bsirkia 13y ago
Can you talk a bit more about the dilution an employee should expect if the company completes more funding? That could have a serious impact on your shares. Who usually gets diluted first? Founders? Previous investors? Employees? If you're an employee that received options and the company is doing another round of funding, should you be worried or on the front foot about finding out what will happen to your options?
- michaelochurch 13y ago
  Earlier investors usually have the option of reinvesting (at the new valuation) in order to maintain their proportion of the company. Typically, they also get the same terms (which tend to propagate to all the investors in the round.) This is why taking shitty terms early on can damage you, even if you think the 5x liquidation preference you took on that $1 million A round "shouldn't" matter. On its own, it's only $5 million, but you're likely to face MLP (and participating preferred, which is also horrible) in all future rounds. Founders and employees do not get to reinvest. Typically, when a VC-funded company is allowing employees to buy more equity is the last time to take that deal (it means the company is cash-poor and in bad shape). General rule: unless you're a founder, avoid taking the other side of any deal with VCs in it.
- arram 13y ago
  Everyone gets diluted when a company raises more money: founders, employees, and previous investors. Investors usually have ‘prorata rights’ which mean they are allowed to invest additional money at the new valuation to maintain their given percentage ownership of the company. Founders generally have the same class of stock as employees (common stock), and so are in the same boat. Investors have preferred shares. Preferred shares have a few special properties, but the most important is ‘liquidation preference’, meaning they’re first in line to get their money out if things go wrong. Sometimes investors have a right to a multiple on their money back: twice their money would be a 2x liquidation preference. One thing to ask about in the case of a company that has raised money on convertible notes. Since they haven’t actually sold equity, but only debt which will later convert equity, it’s worth asking if a given stake is before or after those notes convert. Generally, if things are going well, dilution isn’t worth worrying about. In any case, the founder will be just as diluted as any employees, so their interests are aligned.
mfkp 13y ago
Very interesting - I was unaware of the financing options until I read this article. Seems like it could be a good idea if you're unsure if the company will be successful long-term, a way of hedging your bet. Though I would hate to give up 20-25% of the potential upside, I'd consider this if I was on the fence about exercising my options.
arielweisberg 13y ago
I thought 83(b) only helps with RSU grants? For ISO grants I thought you can't do an 83(b) election? Can anyone clarify?
- inmygarage 13y ago
  While I am not a lawyer, this is a cut and paste from an email from our lawyers: "83(b)s are only for restricted stock." It is my understanding that you don't file an 83(b) for ISOs or any other type of options, only for actual restricted stock.
- ChuckMcM 13y ago
  That is correct. The 83(b) declaration is only valid for 'restricted stock' which is stock that is granted to you rather than as an option to buy. In those situations you acquire the 'right' to the stock over time (this is called vesting). And when you vest stock the IRS treats it like income and it gets added to your W2 as such. The 83(b) election allows you to take the entire tax hit immediately even though you don't have the ownership rights on the stock yet. You need to come up with the tax payment but since you "own" the stock even when it vests you won't pay additional taxes, and your ownership starts the clock on long term gains (vs short term gains). If the stock is going up an 83b can save you some money, if it is going down it makes it more complicated (you can write off up to $3,000 of "loss" per year of stock which is worth less than the 83b election price. I got to do that for just over 10 years on my dot com era 83b stock election. Generally places like Facebook or Google will sell some of your RSUs as they vest to cover the tax hit so its pretty invisible to you.
  - DanielRibeiro 13y ago
    Note that there are a few alternatives to this. Fred Wilson, from Union Square Ventures (who pg wrote about it here[1]), gave a 1 hour class on the subject[2]. He covered tax and mechanisms to avoid taking unecessary invetment gains tax. Another great post on this subject (which may be a bit dated nowadays) was this one[3]. Hacker News startup lawyer had also some great comments on its corresponding HN thread[4]. Note that it embeds the Introduction to Stock Options[5] that also had an amazing discussion on HN a few years ago[6] [1] http://www.paulgraham.com/airbnb.html http://www.paulgraham.com/airbnb.html [2] http://www.avc.com/a_vc/2012/04/mba-mondays-live-employee-equity-archive-and-feedback.html http://www.avc.com/a_vc/2012/04/mba-mondays-live-employee-eq... [3] http://gigaom.com/2011/06/05/5-mistakes-you-cant-afford-to-make-with-stock-options/ http://gigaom.com/2011/06/05/5-mistakes-you-cant-afford-to-m... [4] https://news.ycombinator.com/item?id=2623182 https://news.ycombinator.com/item?id=2623182 [5] http://www.scribd.com/doc/55945011/An-Introduction-to-Stock-Options-for-the-Tech-Entrepreneur-or-Startup-Employee http://www.scribd.com/doc/55945011/An-Introduction-to-Stock-... [6] https://news.ycombinator.com/item?id=3252290 https://news.ycombinator.com/item?id=3252290
antimora 13y ago
Taxes can be tricky depending what type of stock options you have. This recently found document tries to point out several strategies: THE STOCK OPTION TAX DILEMMA FACED BY PRE-IPO COMPANY EMPLOYEES BY BRUCE BRUMBERG, ESQ., MYSTOCKOPTIONS.COM EDITOR-IN-CHIEF AND CO-FOUNDER https://welcome.sharespost.com/system/resources/BAhbBlsHOgZmSSI3MjAxMi8xMi8yMS8yMS8zNS8wOC85MjUvU1BfV1BfT3B0aW9uVGF4XzEyMTExMi5wZGYGOgZFVA/SP-WP-OptionTax-121112.pdf https://welcome.sharespost.com/system/resources/BAhbBlsHOgZm...
hafichuk 13y ago
Any advice if the company is already public and they are offering stock options as part of the compensation package?
- amackera 13y ago
  Look at the share price on the market. If they option strike price is less than the market share price (and the market price seems like it will be steady or go up), might be a smart idea. IANAFinancialAnalyst.
nwatson 13y ago
I've "pre-exercised" before, with a meaning different from what's depicted here in the article. In the "pre-exercise", I was able to exercise the stock before I'd vested in it, with the understanding, of course, that the company would buy back my unvested shares at the exercise price if I left the company before vesting all the options. The disadvantage, of course, is that you pay for your stock up front, and will lose all or most of the money if the company doesn't pan out. There are several advantages ... Advantage: the price you exercise at is near the fair-market value of the Common Shares you purchase (and haven't yet vested in), so there's no immediate gain and so no immediate short-term gain tax consequences. You need to make sure to file an 83(b) form so you're telling the IRS you're paying your $0 tax up front, rather than monthly as your stock vests. (The disadvantage with the latter is that the difference between what you paid and what your stock is worth as it vests could be huge, and there's no way to liquidate your stock to pay that tax.) (There's also something about AMT in here, I'm kind of fuzzy, but I think consequences can be the same.) Advantage: your long-term capital gains clock starts ticking the day you buy the stock, even though you bought before any of it vested. When, three years down the road, you can liquidate your stock in that acquisition or IPO or secondary-market sale, you already purchased your stock three years ago, and pay only long-term gains. Otherwise, you'd buy the stock and sell on the same day, with the gains considered as short-term-gains/income rather than long-term gains. My personal outcome with pre-exercised stock: worked out OK twice, lost all my pre-exercise once, but overall I came out ahead on taxes even with the loss. YMMV. What the article says is "pre-exercise" is just an "exercise" -- you vested the stock, you have every right to purchase it even though the company's stock isn't yet liquid. The problem, of course, is that you may have a huge gain and no way to pay for taxes on that gain. (Edit: note about AMT, clarification.)
- kevinpet 13y ago
  What you're talking about is usually called early exercise. I don't see any reference to "pre-exercise" in the article.
- elwell 13y ago
  I would imagine if you are "pre-exercising" it's very early-stage, and the shares are probably going to be ~0.0001 cents each.
kylelibra 13y ago
Is there a good formula for figuring out taking a lower salary in exchange for options? For example: . Current Salary On Open Market = X Startup Salary = Y Option Value Today = Z . 4(X) = 4(Y)+Z(2) this is obviously the big IF, if people are saying think of it as windfall, maybe 1.5??
- JonFish85 13y ago
  I have to think that putting it into a formula is difficult. It all depends on risk, obviously: how certain is a person that the company will be worth something? On top of that, you have ability to get by at a given salary. If you have enough saved to live for 5 years with $1/yr salary, then you can afford more of a risk than if you can live for 6 months without a salary. Or if you can afford to live at half your salary, but without saving for retirement, where does that leave you? It entirely depends on the person and how risk-averse (or not) they are.
  - kylelibra 13y ago
    Good point, so I guess 2* would actually be some sort of factor of your willingness to take risk.
- imaffett 13y ago
  See the other posts. Someone had a good one "Treat options like confetti". I own a few options in companies I was at. One went under and the other did a "tech deal" and then divested it's assets. Both cases my options are worth about $0 :)
- svachalek 13y ago
  If you were going to do it from a pure accounting perspective, you'd take the expected value of the options + salary and compare directly. You should probably also figure in high value benefits like 401(k) match. The problem there is, the expected value is more or less the current market value of the options (if you believe in anything approaching an efficient market), which is more or less the strike price times the number of shares. So, often these are in the neighborhood of $10k over 4 years or $2500/yr. In other words, don't try to talk yourself into it from an accounting perspective.
7Figures2Commas 13y ago
There's some valuable information here, but a lot of detail is lacking. For instance, the post does not distinguish between incentive stock options (ISOs) and non-qualified stock options. The tax treatment is quite different. More importantly, technical details aside, I think it's important for a prospective employee to make some strategic decisions about equity up front. The author writes: > If the company seems reluctant to answer these questions, keep pressing and don’t take ‘no’ for an answer. If you’re going to factor in your options into any compensation considerations, you deserve to know what percentage of the company you’re getting, and its value. And in the next paragraph he writes: > I’d be wary of compromising on salary for shares, unless you’re one of the first few employees or founders. It’s often a red flag if the founders are willing to give up a large percentage of their company when they could otherwise afford to pay you. Sometimes you can negotiate a tiered offer, and decide what ratio of salary to equity is right for you. You can't have it both ways. If you focus on equity (by demanding that the company divulge detailed information about its share structure), you are sending the signal that equity is just as important or more important than salary, and thus opening the door to a negotiation that contemplates a trade of equity for salary. Precisely the thing that you want to avoid! Unless equity is expected to be liquid in the near future (i.e. you're at a company expected to go public in the near future), an equity-focused negotiation is more likely to benefit the prospective employer than employee.
- tptacek 13y ago
  I think you make a valid point but may have picked the wrong hill to fight for here, because there is no way to evaluate an equity grant without knowing the percentage associated with the grant. Even if you don't care much about equity, if you care about it at all you should be able to get that information.
  - 7Figures2Commas 13y ago
    > ...because there is no way to evaluate an equity grant without knowing the percentage associated with the grant. Even if you don't care much about equity, if you care about it at all you should be able to get that information. 1. Calculating a true percentage associated with a grant can be difficult. You can identify the number of shares of stock outstanding across all classes, the number of currently authorized shares, and the size of the option pool. But you don't know how much of the option pool will actually be used, how many options will vest, etc. 2. Unless you're an executive hire or unicorn, most companies will not give you all of the data necessary to meaningfully evaluate the equity grant. You can ask for it, as so many suggest, but asking for something that a) you almost certainly won't receive and b) that you're not trying to focus on (for the reasons I originally gave) is not very strategic. 3. At an early-stage, venture-backed startup (my comments are not intended to address late-stage, liquidity-all-but-certain scenarios), the equity structure of the company is likely to change considerably and perhaps unpredictably, rendering your initial evaluation all but useless. 4. If an early-stage startup is capable of offering you a satisfactory salary (at market or, these days, above market), you are far better off trying to ascertain what the company's runway is. Your biggest risk at a startup is not that you're going to join the next Facebook as an early employee and walk away with next to nothing but rather that the company is going to run out of cash.
JshWright 13y ago
I like thinking about shares as a virtual currency. Shareholders are speculating on that currency, and the company is trying to increase its value. Companies can inflate or deflate this currency depending on their performance, perceived potential or by issuing new shares. I consider myself a fairly smart person, who had a reasonable grasp on the basics of financial markets, currencies, etc. That simple paragraph just triggered a huge light bulb moment for me. It's suddenly a lot easier to reason about stocks, etc, than it was 5 minutes ago...
- AsymetricCom 13y ago
  We should start a thread about how ignorant you were before this awesome guide. I'm sure we can talk about all sorts of stupid things people believe while managing to learn nothing beyond the scope of the very basic article.
  - pistle 13y ago
    I liked how candid they were in their post and then you made all my malcontent proclivities surface. Now, I'm out to pile on and ruin their day as well. Blood in the water.
  - JshWright 13y ago
    Apparently I've triggered some deep seated angst... Let me try to clarify what I meant, and maybe you'll feel better? This post didn't present any new 'facts' for me. I was already aware of all the details he explained (and most, but not all, of the implications of those details). My point was simply that by framing shares as currency presented them in a way that I had never considered before, and that comparison caused a number of other things to 'click.' My apologies if my learning offended you...
    - adwf 13y ago
      I think it's safe to say he's just being unpleasant for the sake of it. The old adage of "If you've got nothing nice to say, don't say anything at all." springs to mind. I thought that shares as currency was an interesting analogy to draw too. Although I guess when you get down to it, anything that's reasonably fungible can be considered currency if you feel like it.
sarah2079 13y ago
This is very helpful, thanks. I was very surprised when I first learned that AMT will cause you to owe tax on your gains when exercising options, even if they are only on paper. (If the company is public or there is a private market, fine, but it is incredibly inconvenient to be taxed on something for which there is currently no market). This is an area where it can really pay to plan ahead.
- maxerickson 13y ago
  On the other hand, an expiring option for a non-liquid asset is not a good form of compensation.
joosters 13y ago
Quick question: Why should a company give share options to employees, and not plain old shares? Is this just because it's better tax-wise for the company?
- doki_pen 13y ago
  If they gave you shares you'd have to pay income taxes on those shares for something that may never make you any money. Most people wouldn't choose to do that.
  - joosters 13y ago
    But (assuming a startup or young company), the shares would have little value and so the tax would be small. Plus, if the shares became worthless you could offset that loss against future income (I guess?) View it like the company giving you a cash bonus - not many people would turn down the bonus, even if it meant there would be tax due on it. If you think the shares have future value, then paying the tax on their current price would seem a good deal. If you don't think the shares are value, then share options would be even worse. Admittedly you've still got to pay the tax up-front...
    - Peaker 13y ago
      If the shares are given after an investment of $1 million, then 0.5% of the company is $5000, just by a conservative evaluation that takes only the investment value into account. If you think the shares have a guaranteed future value, then the shares are better than the options. If you think the shares have a guaranteed lack of future value, then the options are free, whereas the shares will cost you. If you think there is substantial risk that the shares will have no value, then getting options rather than shares mitigates that risk. You only pay for that mitigation if you actually exercise the options, in which case the cost comes off of a big payoff, rather than an upfront payment out of pocket.
    - balls187 13y ago
      The difference is you can actually use your cash bonus to pay out the taxes on that bonus. For restricted-stock, you cannot sell the stock, and thus have to pay taxes out of pocket. If the company is public, you can sell some shares to cover this cost (typical for stock bonus awards), but as many tech companies aren't public, their stock is restricted such that you cannot sell it to other individuals.
grellas 13y ago
Really nice write-up explaining stock options. A few added thoughts sparked by some of the comments already made in this thread and otherwise: 1. The value of options is inextricably linked to tax and you need to understand the tax basics in evaluating the economic risks and benefits of holding and exercising any kind of option. With NQOs, you are taxed on the spread as ordinary income on the date of exercise (meaning, on the difference between what the stock is worth and what you pay to exercise). With ISOs, the value of the spread becomes subject to AMT and you can wind up paying large taxes that way in spite of the supposed tax benefits of ISOs. The way to avoid having a large spread subjecting you to such tax risks is to exercise as early as possible before the company value goes up much but you then need to take the economic risk associated with having to pay hard cash for stock whose long-term value is highly uncertain. Moreover, early exercise is not possible if your options haven't vested unless you specifically get an early exercise privilege as part of your grant. With an early exercise privilege, and particularly if the grant is made for a bargain price, you can early-exercise, file an 83(b), and (as long as you hold the stock for at least 2 years) get the equivalent of a restricted stock grant by which you pay no further tax until you eventually sell the stock at a liquidation event. In that case, you are also taxed at the lower long-term capital gains rates. Of course, in the early-exercise scenario, you do not get to bypass vesting and your shares remain subject to their original vesting requirements and can thus be forfeited in whole or in part if those requirements are not met. But early exercise does provide an elegant solution to most of the tax risks associated with options provided you are willing to assume the economic risks of paying for the stock up front. 2. Other than the early-exercise scenario, 83(b) elections are not required for option grants. Under 83(a) of the Internal Revenue Code, any service provider who gets property in exchange for services is taxed at ordinary income rates on the value of the property received. For example, if you do work for a startup and are paid in stock when you complete the deliverable, you are taxed on the value of the stock received. You are taxed on the value of that stock as it exists as of the date you receive it in payment for such services. So, if you do development work tied to a milestone, and you meet that milestone, and you get 100,000 shares for the work, you would be taxed on, say, the $1.00/sh that the stock is worth on the day six months or a year (or whatever) out when the milestone is met, and not on the $.01/sh that it was worth when the contract terms began. In contrast to this performance-based form of incentive, let us say that you get a time-based incentive by which you buy the stock up front for a nominal price but you must earn it out over time. With such a time-based performance incentive, which is what is called "restricted stock", you own the stock up front and you pay no tax at the time of purchase in the normal case where the amount you pay for it equals its fair value on the date of the grant. Because the stock must be earned out as part of a continuing service relationship, and is hence subject to a "substantial risk of forfeiture", there is a very important technical question under section 83(a) on what the date is on which you are deemed to have received the stock in exchange for your services. Well, the default rule under 83(a) is that you receive it on the date it is no longer subject to a substantial risk of forfeiture and that then becomes the relevant date on which the value of the stock is measured for purpose of computing the taxable service income on which you must pay tax. So, if you get your 100,000 share grant at $.01/sh, and you pay $.01 share, you pay no tax at inception. But, as that grant vests at, say, a monthly ratable rate over four years, the IRS treats you as having received 48 separate grants (one each month) over the four-year period. Thus, at each vesting point, you are treated as having received property in exchange for services under 83(a) and you pay tax on the difference between the value of the property received and what you paid for it. If you paid $.01 per share, and if the stock is worth $1.00 at a given vesting point, you realize $.99 worth of taxable income per share. In a venture whose value is rising quickly, in the absence of any saving mechanism, you might have as many as 48 separate tax hits (basically, having to pay tax on the difference between what you paid for your grant and the 409A valuation price placed on the common) just for the privilege of holding a piece of paper that may or may not ever have an ultimate cash value of any type. It is in this type of scenario, and only here, that 83(b) comes into play by providing that, in lieu of having to suffer under the default rule of 83(a), you can elect to pay all taxes up front on the grant and not be subjected to the often onerous workings of the default rule. This means that, for an 83(b) election even to be relevant, you must first own your stock (or other property) and that stock or property must be subject to a substantial risk of forfeiture. If you hold only an unexercised option, you do not yet own the stock and it is not subject to forfeiture (hence, 83(b) is not relevant). If you do an early exercise, though, and get stock under terms where it must still vest out and can be forfeited, then 83(b) does apply. But that is the only case normally where it becomes relevant at all to options. 3. Options really shine when they wind up on a level playing field with the preferred stock and they tend to dim commensurately to the extent they do not. Optimum case is IPO when all stock is (typically) forced to convert to common prior to the public offering and, thus, all shares participate equally in the benefits. This can happen too in big-scale M&A exits but a drop-off occurs on lesser ones in at least two ways: (a) where the total acquisition price is largely gobbled up by the liquidation preferences and/or management incentive plans; (b) where an acqui-hire occurs in which a few founders get a disproportionate share of the total value through employment arrangements made on the other side of the deal. 4. Given all of the above, and given that IPOs remain at far below the old bubble levels in frequency, it can be risky to lay out any excessive cash to exercise at any time before a liquidity event. Too many things can happen by which a seeming "sure thing" winds up evaporating before your very eyes, leaving you with no more than a pretty lousy capital loss that you get the privilege of deducting at the rate of no more than $3,000 per year unless you can find other capital gains to offset it against. 5. The 90-day tail for exercise upon termination of a service relationship applies only to ISOs and not to NQOs but, of course, ISOs have other advantages and they are what is typically offered in VC-backed ventures. In other types of ventures, where the company value is already somewhat high at the time of grant, I have seen executives bargain for and get NQOs with long exercise periods following termination just to have the flexibility to leave the venture if needed without being forced to forfeit the options. 6. In light of all of the above, having to pay an angel backer 25 or 30% of your gains to provide you with a risk-free exercise in an otherwise high-risk situation may be worth it even though the cost seems high on its face. It is a matter of preserving some decent part of your potential upside while giving up the rest to make the upside potential even a possibility for you given the tax risks involved. If IPOs come back strong some day, then you may be giving up too much at such a cost because they are the great leveler when it comes to weighing the value of options against other forms of equity holdings. Until that day comes, however, options remain a valuable but relatively high-risk way of deriving value from a startup if you need to part with any significant cash (either for the purchase or for the associate tax) for the privilege of hoping to profit from a startup. Again, for those who need to weigh their choices, this piece provides great insights and stands head and shoulders above the typical discussion of such issues. Great work by the author in making an otherwise dry and even formidable subject pretty accessible.
djm_ 13y ago
Does anyone have any UK specific advice considering stock options? ..and how does it affect things if these are offered to a contractor and not a FT employee, is that even possible?
- r4vik 13y ago
  I don't believe it's possible to grant them to a UK contractor in a tax-efficient manner
  - walshemj 13y ago
    Thats because you not an employee
- arethuza 13y ago
  From what I recall, the company needs to have an HMRC Approved Company Share Option Scheme [1] to allow the recipients of options to avoid income tax at the time they are granted. IANAL. These schemes are open to employees and executive directors - although it looks like there is a time requirement for directors [2] there doesn't appear to be one for employees. Maybe you could work as an employee one day a week and as a contractor for the remaining five and get the options as an employee? :-) [1] http://www.hmrc.gov.uk/manuals/essum/essum40105.htm http://www.hmrc.gov.uk/manuals/essum/essum40105.htm [2] http://www.out-law.com/en/topics/tax/share-plans/hmrc-approved-company-share-option-plans-csop/ http://www.out-law.com/en/topics/tax/share-plans/hmrc-approv... My main advice - if you think there potentially a chunk of money involved I would go and see an accountant or lawyer that knows the details of the current legislation and can give you detailed advice on what to do - I've done this in the past around options and the advice was worth every penny.
  - walshemj 13y ago
    mm I think that Revenue might see that as disguised employment and go after you under ir35 rules.
djm_ 13y ago
Does anyone have any UK specific advice considering stock options? ..and how does it affect things if these are offered to a contractor and not a FT employee, is that even possible?
brosco45 13y ago
They are like lotto tickets, mostly worthless, some are worth a lot.
- erbo 13y ago
  Exactly. These days, I'm inclined to say, "Put not your faith in stock options."
vikas5678 13y ago
Is it odd that almost every startup I or my friends have interviewed with refuse to answer the "number of outstanding shares" question? Have others had similar experiences?
- patio11 13y ago
  Without some notion of how much your equity grant represents of the company (by current dilution), the actual number of options you get cannot be sensibly valued. The total number of shares at a company is totally arbitrary. Seriously, when you register one, the state just asks you to pick a number. If a company won't tell you enough to calculate the percentage, that's like you asking "What's your offer for salary?", "Dollars. Definitely dollars.", "Can you be more specific?", "No. We consider exact salary offers to be competitively sensitive."
  - vikas5678 13y ago
    I agree, makes negotiation much harder. "We're giving you 25000 options"... but if I have no idea how much its potentially worth, I dont know what I'm saying OK to. This is often the case though, I'm quite sure.
    - patio11 13y ago
      Ask for a clarification. If you don't get one, gracefully exit the negotiation, because they're either stupid or not negotiating in good faith. You have better (no pun intended) options.
  - gabemart 13y ago
    Please forgive my ignorance, but if you know the number and price of the options, is the problem that you don't know the current valuation? Because it seems like if you know the price of the option, how many options you're being offered, and the current valuation, it's trivial to work out the number of outstanding shares. I guess the current valuation is privileged? Or that there is no current-valuation if it's been a while since the last round?
snorkel 13y ago
Here's the short version. Sell. Sell it all. As soon as you are legally allowed to, sell. Sell all of it. Taxes and maxes blah blah blah just sell it, take the cash, and be thankful.
- e1ven 13y ago
  This is talking about Stock Options, not pure stock grants. This means that "Sell it all" isn't quite as simple as you might suggest - First you need to "Buy it all". But there is often vesting, which means you can't buy it all yet.
dlevine 13y ago
You didn't mention the difference between nonqualified (NQSO) and incentive (ISO) stock options. The difference is key.
dsri 13y ago
>> You can think of a stock option as a Future. You probably shouldn't, as they are distinct terms. A futures contract obliges you to make the transaction on the specified transaction date, whereas an option gives you the option to do so.
mseebach 13y ago
What is the exact mechanism for "golden handcuffs"? Can the company prevent a vested option holder from exercising and then selling the shares to a secondary market investor immediately (offering them to the company for first refusal, obviously)? In that case, can't I just line up a secondary market investor, borrow the cash to exercise, sell, repay the loan and thus get out of the handcuffs?
- spacehome 13y ago
  No. The golden handcuffs arise from the fact that the employee doesn't have the cash on hand to exercise the options and pay the taxes since there is no liquid market from the shares. If the employee quits, then they forfeit the upside of the options since the options expire 90 days after terminating employment. So, if the employee wants to participate in the options' upside, he or she is forced to stay with the company until a liquidity event -- textbook golden handcuffs. It should be noted that Alex MacCaw and friends are offering a way out of this dilemma for 25-30% of the upside by supplying the cash required to exercise so that the employee can leave. This advertising is probably the whole reason Alex wrote the article.
  - mseebach 13y ago
    So, just to make sure, the thing I can't do is line up a secondary market investor, because there probably aren't any? And being that secondary market investor is what you're saying Alex MacCaw and his friends are?
    - spacehome 13y ago
      A secondary market investor is someone who will buy the shares from you after you've exercised. These people may or may not exist, depending on how attractive the company is. The shares you purchase from the company will likely be restricted, and you won't be able to transfer them for a year. After that year is up, you can sell it to whomever you wish. The company will have right of first refusal, but if it comes to that, you don't really care who buys the shares off of you (company or secondary market investor) because you get paid the same either way. This is technically different that what Alex is proposing, but the end result is fairly similar. He's offering to loan you money to exercise. You keep ownership of the shares, and the loan comes due if and when there is a liquid market for the shares. He's allowing you to move on from the company before any other investor is interested in the shares, but still provide upside to you if and when the shares are actually worth something. And he takes some cut because he's assuming the (very significant) risk that no other investor is ever willing to pay for the shares.
throwawayy123 13y ago
If I decide to leave a company in which I have partially vested stock options, would it be okay to ask my employer (or anyone else in my company) if they would be interested in buying the options off of me at the current valuation (EG, last amount of money raised)? Is something like this common, or would I get laughed out of the room? Similarly, how liquid are markets like Second Market in terms of liquidating option value at a startup that's raised multiple rounds of funding but has yet to exit or IPO? Are there angels (or networks of angels) that buy small amounts of pre-exit equity?
- balls187 13y ago
  If you don't exercise your vested options, they will automatically expire after a certain date. The company doesn't really have any incentive to purchase your options from you, however they will likely have a clause that gives the company first right of refusal--that is, if you plan on selling any shares prior to a liquidity event, you have to first offer them to the company for FMV. As to pre-IPO, post fund raise, your stock is typically Restricted stock units, which have clauses that prevent you from selling stock. It's possible, with board approval to issue a special class of common stock, that can be sold to outside investors. This is usually done to allow long-term founders to get some liquidity outside a liquidity event. This typically doesn't happen for most employee's though. In an IPO scenario, all outstanding shares convert to a single class of stock, which can be freely sold (after a lock-up period).
- prostoalex 13y ago
  There's not really a whole lot of incentive for a company to buy your shares, since they can always print more if needed. Liquidity highly depends on the company. SecondMarket, SharesPost and MicroVentures have online portals for buying+selling, but they also have a mailing list with people potentially interested in a secondary market transaction, so worthwhile exploring that option.
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- lmartel 13y ago
  Super irrelevant--unless you're trying to say that employees should never strike their options, which is probably not good advice.
willvarfar 13y ago
And here's a nice guide from way back in 2004: http://www.ftpress.com/articles/article.aspx?p=170920 http://www.ftpress.com/articles/article.aspx?p=170920 What's interesting is that this chap Ivan Goddard is doing the Mill processor, and that has an interesting company structure; OotB has an agreement to incorporate, and they keep renegotiating it. He explains this in this talk: http://www.youtube.com/watch?v=Bxga49vukQ8 http://www.youtube.com/watch?v=Bxga49vukQ8
egometry 13y ago
Pretty god. I've been recommending David Weekly's short e-book on this matter for years... specifically as mandatory reading for engineers taking their first or second job. Learn from our mistaaaaakes! http://www.amazon.com/Introduction-Stock-Options-David-Weekly-ebook/dp/B0055PQ4H8 http://www.amazon.com/Introduction-Stock-Options-David-Weekl...
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tejay 13y ago
What about profit-sharing instead of options/warrants/shares? We've found that it dampens the 'build-to-flip' mentality and lets us all enjoy the fruits of our labor while we're building the company, not afterwards =).
anon_nsotax 13y ago
Can someone comment on determining fair market value of a private company? I exercised NSO stock options of a private company after being vested for a year. Everything I read indicates I need to declare the spread of current FMV with the value of the option grant date. How do I determine the current FMV if their is no market though?
- richardburton 13y ago
  You'll need to ask the owners of the company for the 409A valuation.
- philjr 13y ago
  Some good commentary by Fred Wilson about 409a's... http://www.avc.com/a_vc/2010/11/employee-equity-the-option-strike-price.html http://www.avc.com/a_vc/2010/11/employee-equity-the-option-s...
elwell 13y ago
What if you're too lazy to exercise your share?
- balls187 13y ago
  Usually the Employee Share agreement has a clause that states that when you leave the company (or even in change of control scenarios) any vested stock options must be exercised by 90 days, otherwise their forfeit back to the company.
  - joshuapayne 13y ago
    This is important. The 90 day time period is a typical clause in your options agreement. It is not universal. You should check for this and other "standard" clauses in your options agreement to ensure that your company isn't sneaking something past you when you're signing on.
gesman 13y ago
Red flags (from personal experience): - "We will give you a big share of our (of-course-soon-to-be-facebook-or-google) company (15%+ in stock options) if you'll agree to work for us for close-to-nothing". - Senior officers starting leaving the company one by one. - Senior officers giving small promises that have tendency not to materialize. - Senior officers do not have any/good exit track record. Opposite would be a green flag.
- kika 13y ago
  I'm not getting #1. Essentially, they're offering you a "founder grade" share of the company. Why not?
  - phillmv 13y ago
    Depends on your appetite for risk. It's just a sign that it's really risky, and the other founders obviously think the odds of it succeeding are low and are asking you to put in sweat equity, as it were.
  - gesman 13y ago
    If you jointly owns IP - that's fine. But if you're only an employee albeit a proud owner of large chunk of options, it's possible that real founders are just testing the market at your expense.
    - kika 13y ago
      With 15% you can have a seat in the board or at least some voting rights. Having that it would be more difficult to just dissolve the company without any real reason. But generally speaking you're right, thanks.
      - gesman 13y ago
        Solid cubicle quite often is a better financial investment than a shaky board :)
puppetmaster3 13y ago
lol, none of this matters. the terms are, what the terms are, you can just try to get more shares and more $.
unreal37 13y ago
I'm waiting for the day in the near future when an article on stocks begins with "Stocks are a lot like Bitcoin..."
yogin 13y ago
Thank you for this, I have to admit I've been quite confused about this for some time. Great explanation, it finally makes a lot more sense to me!
dmourati 13y ago
Read Venture Deals by Brad Feld. It will make you more knowledgeable then 99.9% of all the people in venture funded companies and put you on the level playing field with the VC's.
xerophtye 13y ago
This was truly a great article and i have bookmarked it for later reading (i haven't read all of it yet). But perhaps i can expand on this explaining what "options" are in the first place. Ok imagine a situation where stock X costs $100 today. Alice thinks that the price will go considerably up, bob thinks it'll go down. So they make a deal, one year from now, Alice will buy shares of stock X from Bob at $104 dollars[1]. Now if Alice's prediction is right, she'll make a profit by buying low ($104) and selling high (at the then market price). If bob's prediction is right, he'll profit by buying low (market price) and selling high($104). This is called a Forward Contract. Problem with Forward Contracts are that they put you in an obligation to make that transaction, no matter how much loss. What if the price falls and Alice doesn't wanna buy from bob? So then instead of a Forward Contract, she'd get an option (a "Call" option to be specific). This will give her the option to either buy the shares at the agreed upon price (called "strike price") if it is favorable, else do nothing. Well what about Bob? He can get into a "put" option (with someone else) that gives him the option to sell stock X if it is favorable. Pretty neat huh? but the difference here is, Forwards are free (except for tax etc) and options cost a "premium" to get into. But since options COST something, that means you can SELL them as well and make money off of that. And their prices vary just like the price of stock varies. Hope this helps
jeff558 13y ago
Haha, investment advice from a guy in his early twenties. Thanks but no thanks.
nraynaud 13y ago
I have a related question: I have some non-privileged stock in a private company, and I want to sell it (I want the money and I don't care about the future of a company I don't work for anymore). Who could be an interested buyer?
- prostoalex 13y ago
  http://www.sharespost.com http://www.sharespost.com http://secondmarket.com http://secondmarket.com
jisaacks 13y ago
So what happens when the company exits before you are vested?
- prostoalex 13y ago
  Most stock plans have triggered vesting. So it's possible to start a job on Monday, have the company acquired on Tuesday and immediately vest for all 4 years going forward.

738 points by olivercameron 13y ago

Two corrections: 1. OP says: Once you’ve cliffed, you have the right to buy shares in the company. "Cliffing", when used as a verb, refers to firing someone just before the cliff-- not an employee achieving it. It's something you'd rather avoid. 2. If the company isn't publicly traded, you should ask to see the cap table. If you're employee #30 and your share is 0.05%, that might be fair if it's a biotech that has already taken a $100M infusion from the venture capitalists (who'll typically take 90%, in that case). For a web startup, it's terrible. You need to know how much equity the investors, executives, and employees at various levels have, so you can evaluate your likelihood of getting an improvement if you perform well. Without the cap table, you don't know enough about the startup to decide whether to take a job there.

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seiji 13y ago
you should ask to see the cap table. I've asked that at every non-public company where I've had "options" and they've never complied. Just have to treat the options as confetti from then on.
- mikestew 13y ago
  Same here. I keep hearing that platitude, and have yet to come across a company that will cough up the numbers. I've decided it's one of those things that sounds good on the face of it, makes sense, but isn't really true. But your final sentence is the best advice: treat the options as a potential windfall, but don't otherwise factor them into your decision.
- michaelochurch 13y ago
  Just have to treat the options as confetti from then on. Agree. (1) Don't ever take a salary drop for options w/out cap table, and (2) don't make sacrifices that would hurt your career or home life because of them either. Most people in the startup world have evolved enough to get (1) but (2) is where startup culture tends to go off the rails-- people start working 80-hour weeks on career-incoherent grunt work for their options, blissfully unaware of the 10-100x larger grants given to all of the nontechnical VPs who go home at 3:30.
  - vladimirralev 13y ago
    Engineers are smart these days. Is anybody really doing 80h/week for shady options? I doubt it. Employees stuck in this position generally aren't so bright or don't have any other choice for some other reason. But still very rare.
tptacek 13y ago
Exactly what does the cap table have to do with your expected outcome, presuming you know the percentage of your allocation, the liquidation preferences and valuation, and the company's runway?
- michaelochurch 13y ago
  You know whether it's probable that you'll get more equity, and what it takes to get there. Most engineers who join startups think that the 0.03% allocated when they join will be increased later on, and that the initial grant is just a "teaser". I mean, it has to improve, just because it's so ridiculously low, right? (Well, no. In fact, it usually won't.) Perhaps 5 percent of the engineers who join VC-funded startups would still join if they knew that (a) their equity allotments wouldn't improve, and (b) the founders wouldn't take a personal interest in furnishing them with the connections/credibility to be founders in their next gig. That number becomes closer to 1-2 percent when you're talking about good engineers.
  - tptacek 13y ago
    This is silly. Just assume that your allocation will not improve. If you're in a position to improve your grant later in your tenure, you'll either (a) know it, and secure it through negotiation, or (b) not know it and probably not get it. Having the cap table --- which you won't get anyways --- does not actually help you here. A feeling of entitlement isn't what gets you improved compensation. An understanding of your value on the market and a willingness to stand up for yourself is what does that. Put differently: so what if the cap table suggests you're unlikely to get an improved allocation? If you're worth an improved allocation, you'll get one or the company will lose you.
- gatehouse 13y ago
  If you don't know who owns the company you don't even know who you work for. It might not matter to most people as long as the cheques don't bounce, but if you want to even hallucinate having a meaningful role in the direction of the company it starts to matter. I really don't know what people are willing to disclose to employees but the SEC rule for public companies is a 5% stake or more is disclosed.
matthudson 13y ago
> If you're employee #30 and your share is 0.05%, that might be fair if it's a biotech that has already taken a $100M infusion from the venture capitalists (who'll typically take 90%, in that case). Could you point me in the direction of some sources that back up the "90% [in the typical case]" claim? I'm genuinely interested in learning more.
- crapshoot101 13y ago
  It isn't a claim that can be backed up more than anecdotally - it's the typical jihad without real data.
- michaelochurch 13y ago
  Biotech has different rules. Investments tend to be much larger but the Vc's get a larger percentage. It's probably fairer and more straightforward than what happens to most web startups, where the initial take is a small percentage but the Vc's demand rapid growth and risk-taking. (That is, I'd rather the VC's take 90% upfront for $100 million than take 20% but ensure, by how they manage the company and the risks they force me to take, that they get 90% of the upside in the end.)
patio11 13y ago
You can ask feel free to ask for a pony in a salary negotiation, and in general I bow to no one in advising "ask for more", but that specific ask has the dual unhappy properties of being very awkward for founders to grant and yet not very useful to you the prospective employee. (Even an idealized employee who'd be capable of understanding what it meant.) "What was your most recent valuation?", "What is the size of my grant relative to the full dilution of the company as of today?", etc, get you more signal with less social awkwardness. I mean, at a minimum, it's more of an imposition than "Give me the salary details for everyone at this company", which is for better or worse radioactive almost everywhere, and in addition to similarly being against the corporate interest also tends to disclose privileged information about folks who wouldn't even be listed in salaries.csv. P.S. In my n=2 experience as a very small angel investor I am struggling to remember ever seeing the full cap table. I'd have to check my docs to see if I'm allowed to ask for it, but my limited social radar for the Valley suggests that's the sort of thing that would be socially contentious. Founders I invested in were very circumspect about getting explicit permission to be able to quote the fact of the investment publicly, to say nothing of the amount. P.P.S. Disregard the above if somebody who does this on a more regular basis suggests that you're more in touch with reality than I am. It's possible.
- michaelochurch 13y ago
  Cap table isn't the same thing as salary. It's the (future, in case of options) ownership of the company. Cap table transparency would go a long way in making VC-istan honest because the equities in salary tend to be small while those in equity are massive. If engineers in a typical VC-istan startup found out that the non-tech VPs and "product people" working 10-to-4 were making $140k while they make $110k, nothing would happen. That's not enough of a difference to set most people off. If they found out that those people had 1% while they had 0.05%, it'd be epic. (That's why VC-istan hides cap tables. It doesn't want to have to admit that engineers are commodities to it.)
  - tptacek 13y ago
    You don't need cap tables to know that the employee equity is small compared to investor equity. It obviously is. Most everyone I talk to knows that. VCs aren't "hiding" it. If you don't want to work at a company where a pencil-pushing meeting-dwelling financier is going to earn an outsized reward compared to your efforts as a software developer, don't work for VC-funded startups. On the other hand, VC-funded startups tend to work on fun speculative problems, because they're powered by other people's money. What a "non-tech VP" makes has nothing to do with an engineer's outcome. Obsessing about what other people in the company make is unhealthy.

bsirkia 13y ago

Can you talk a bit more about the dilution an employee should expect if the company completes more funding? That could have a serious impact on your shares. Who usually gets diluted first? Founders? Previous investors? Employees? If you're an employee that received options and the company is doing another round of funding, should you be worried or on the front foot about finding out what will happen to your options?

michaelochurch 13y ago
Earlier investors usually have the option of reinvesting (at the new valuation) in order to maintain their proportion of the company. Typically, they also get the same terms (which tend to propagate to all the investors in the round.) This is why taking shitty terms early on can damage you, even if you think the 5x liquidation preference you took on that $1 million A round "shouldn't" matter. On its own, it's only $5 million, but you're likely to face MLP (and participating preferred, which is also horrible) in all future rounds. Founders and employees do not get to reinvest. Typically, when a VC-funded company is allowing employees to buy more equity is the last time to take that deal (it means the company is cash-poor and in bad shape). General rule: unless you're a founder, avoid taking the other side of any deal with VCs in it.
arram 13y ago
Everyone gets diluted when a company raises more money: founders, employees, and previous investors. Investors usually have ‘prorata rights’ which mean they are allowed to invest additional money at the new valuation to maintain their given percentage ownership of the company. Founders generally have the same class of stock as employees (common stock), and so are in the same boat. Investors have preferred shares. Preferred shares have a few special properties, but the most important is ‘liquidation preference’, meaning they’re first in line to get their money out if things go wrong. Sometimes investors have a right to a multiple on their money back: twice their money would be a 2x liquidation preference. One thing to ask about in the case of a company that has raised money on convertible notes. Since they haven’t actually sold equity, but only debt which will later convert equity, it’s worth asking if a given stake is before or after those notes convert. Generally, if things are going well, dilution isn’t worth worrying about. In any case, the founder will be just as diluted as any employees, so their interests are aligned.

mfkp 13y ago

Very interesting - I was unaware of the financing options until I read this article. Seems like it could be a good idea if you're unsure if the company will be successful long-term, a way of hedging your bet. Though I would hate to give up 20-25% of the potential upside, I'd consider this if I was on the fence about exercising my options.

arielweisberg 13y ago

I thought 83(b) only helps with RSU grants? For ISO grants I thought you can't do an 83(b) election? Can anyone clarify?

inmygarage 13y ago
While I am not a lawyer, this is a cut and paste from an email from our lawyers: "83(b)s are only for restricted stock." It is my understanding that you don't file an 83(b) for ISOs or any other type of options, only for actual restricted stock.
ChuckMcM 13y ago
That is correct. The 83(b) declaration is only valid for 'restricted stock' which is stock that is granted to you rather than as an option to buy. In those situations you acquire the 'right' to the stock over time (this is called vesting). And when you vest stock the IRS treats it like income and it gets added to your W2 as such. The 83(b) election allows you to take the entire tax hit immediately even though you don't have the ownership rights on the stock yet. You need to come up with the tax payment but since you "own" the stock even when it vests you won't pay additional taxes, and your ownership starts the clock on long term gains (vs short term gains). If the stock is going up an 83b can save you some money, if it is going down it makes it more complicated (you can write off up to $3,000 of "loss" per year of stock which is worth less than the 83b election price. I got to do that for just over 10 years on my dot com era 83b stock election. Generally places like Facebook or Google will sell some of your RSUs as they vest to cover the tax hit so its pretty invisible to you.
- DanielRibeiro 13y ago
  Note that there are a few alternatives to this. Fred Wilson, from Union Square Ventures (who pg wrote about it here[1]), gave a 1 hour class on the subject[2]. He covered tax and mechanisms to avoid taking unecessary invetment gains tax. Another great post on this subject (which may be a bit dated nowadays) was this one[3]. Hacker News startup lawyer had also some great comments on its corresponding HN thread[4]. Note that it embeds the Introduction to Stock Options[5] that also had an amazing discussion on HN a few years ago[6] [1] http://www.paulgraham.com/airbnb.html http://www.paulgraham.com/airbnb.html [2] http://www.avc.com/a_vc/2012/04/mba-mondays-live-employee-equity-archive-and-feedback.html http://www.avc.com/a_vc/2012/04/mba-mondays-live-employee-eq... [3] http://gigaom.com/2011/06/05/5-mistakes-you-cant-afford-to-make-with-stock-options/ http://gigaom.com/2011/06/05/5-mistakes-you-cant-afford-to-m... [4] https://news.ycombinator.com/item?id=2623182 https://news.ycombinator.com/item?id=2623182 [5] http://www.scribd.com/doc/55945011/An-Introduction-to-Stock-Options-for-the-Tech-Entrepreneur-or-Startup-Employee http://www.scribd.com/doc/55945011/An-Introduction-to-Stock-... [6] https://news.ycombinator.com/item?id=3252290 https://news.ycombinator.com/item?id=3252290

antimora 13y ago

Taxes can be tricky depending what type of stock options you have. This recently found document tries to point out several strategies: THE STOCK OPTION TAX DILEMMA FACED BY PRE-IPO COMPANY EMPLOYEES BY BRUCE BRUMBERG, ESQ., MYSTOCKOPTIONS.COM EDITOR-IN-CHIEF AND CO-FOUNDER https://welcome.sharespost.com/system/resources/BAhbBlsHOgZmSSI3MjAxMi8xMi8yMS8yMS8zNS8wOC85MjUvU1BfV1BfT3B0aW9uVGF4XzEyMTExMi5wZGYGOgZFVA/SP-WP-OptionTax-121112.pdf https://welcome.sharespost.com/system/resources/BAhbBlsHOgZm...

hafichuk 13y ago

Any advice if the company is already public and they are offering stock options as part of the compensation package?

amackera 13y ago
Look at the share price on the market. If they option strike price is less than the market share price (and the market price seems like it will be steady or go up), might be a smart idea. IANAFinancialAnalyst.

nwatson 13y ago

I've "pre-exercised" before, with a meaning different from what's depicted here in the article. In the "pre-exercise", I was able to exercise the stock before I'd vested in it, with the understanding, of course, that the company would buy back my unvested shares at the exercise price if I left the company before vesting all the options. The disadvantage, of course, is that you pay for your stock up front, and will lose all or most of the money if the company doesn't pan out. There are several advantages ... Advantage: the price you exercise at is near the fair-market value of the Common Shares you purchase (and haven't yet vested in), so there's no immediate gain and so no immediate short-term gain tax consequences. You need to make sure to file an 83(b) form so you're telling the IRS you're paying your $0 tax up front, rather than monthly as your stock vests. (The disadvantage with the latter is that the difference between what you paid and what your stock is worth as it vests could be huge, and there's no way to liquidate your stock to pay that tax.) (There's also something about AMT in here, I'm kind of fuzzy, but I think consequences can be the same.) Advantage: your long-term capital gains clock starts ticking the day you buy the stock, even though you bought before any of it vested. When, three years down the road, you can liquidate your stock in that acquisition or IPO or secondary-market sale, you already purchased your stock three years ago, and pay only long-term gains. Otherwise, you'd buy the stock and sell on the same day, with the gains considered as short-term-gains/income rather than long-term gains. My personal outcome with pre-exercised stock: worked out OK twice, lost all my pre-exercise once, but overall I came out ahead on taxes even with the loss. YMMV. What the article says is "pre-exercise" is just an "exercise" -- you vested the stock, you have every right to purchase it even though the company's stock isn't yet liquid. The problem, of course, is that you may have a huge gain and no way to pay for taxes on that gain. (Edit: note about AMT, clarification.)

kevinpet 13y ago
What you're talking about is usually called early exercise. I don't see any reference to "pre-exercise" in the article.
elwell 13y ago
I would imagine if you are "pre-exercising" it's very early-stage, and the shares are probably going to be ~0.0001 cents each.

kylelibra 13y ago

Is there a good formula for figuring out taking a lower salary in exchange for options? For example: . Current Salary On Open Market = X Startup Salary = Y Option Value Today = Z . 4(X) = 4(Y)+Z(2) this is obviously the big IF, if people are saying think of it as windfall, maybe 1.5??

JonFish85 13y ago
I have to think that putting it into a formula is difficult. It all depends on risk, obviously: how certain is a person that the company will be worth something? On top of that, you have ability to get by at a given salary. If you have enough saved to live for 5 years with $1/yr salary, then you can afford more of a risk than if you can live for 6 months without a salary. Or if you can afford to live at half your salary, but without saving for retirement, where does that leave you? It entirely depends on the person and how risk-averse (or not) they are.
- kylelibra 13y ago
  Good point, so I guess 2* would actually be some sort of factor of your willingness to take risk.
imaffett 13y ago
See the other posts. Someone had a good one "Treat options like confetti". I own a few options in companies I was at. One went under and the other did a "tech deal" and then divested it's assets. Both cases my options are worth about $0 :)
svachalek 13y ago
If you were going to do it from a pure accounting perspective, you'd take the expected value of the options + salary and compare directly. You should probably also figure in high value benefits like 401(k) match. The problem there is, the expected value is more or less the current market value of the options (if you believe in anything approaching an efficient market), which is more or less the strike price times the number of shares. So, often these are in the neighborhood of $10k over 4 years or $2500/yr. In other words, don't try to talk yourself into it from an accounting perspective.

7Figures2Commas 13y ago

There's some valuable information here, but a lot of detail is lacking. For instance, the post does not distinguish between incentive stock options (ISOs) and non-qualified stock options. The tax treatment is quite different. More importantly, technical details aside, I think it's important for a prospective employee to make some strategic decisions about equity up front. The author writes: > If the company seems reluctant to answer these questions, keep pressing and don’t take ‘no’ for an answer. If you’re going to factor in your options into any compensation considerations, you deserve to know what percentage of the company you’re getting, and its value. And in the next paragraph he writes: > I’d be wary of compromising on salary for shares, unless you’re one of the first few employees or founders. It’s often a red flag if the founders are willing to give up a large percentage of their company when they could otherwise afford to pay you. Sometimes you can negotiate a tiered offer, and decide what ratio of salary to equity is right for you. You can't have it both ways. If you focus on equity (by demanding that the company divulge detailed information about its share structure), you are sending the signal that equity is just as important or more important than salary, and thus opening the door to a negotiation that contemplates a trade of equity for salary. Precisely the thing that you want to avoid! Unless equity is expected to be liquid in the near future (i.e. you're at a company expected to go public in the near future), an equity-focused negotiation is more likely to benefit the prospective employer than employee.

tptacek 13y ago
I think you make a valid point but may have picked the wrong hill to fight for here, because there is no way to evaluate an equity grant without knowing the percentage associated with the grant. Even if you don't care much about equity, if you care about it at all you should be able to get that information.
- 7Figures2Commas 13y ago
  > ...because there is no way to evaluate an equity grant without knowing the percentage associated with the grant. Even if you don't care much about equity, if you care about it at all you should be able to get that information. 1. Calculating a true percentage associated with a grant can be difficult. You can identify the number of shares of stock outstanding across all classes, the number of currently authorized shares, and the size of the option pool. But you don't know how much of the option pool will actually be used, how many options will vest, etc. 2. Unless you're an executive hire or unicorn, most companies will not give you all of the data necessary to meaningfully evaluate the equity grant. You can ask for it, as so many suggest, but asking for something that a) you almost certainly won't receive and b) that you're not trying to focus on (for the reasons I originally gave) is not very strategic. 3. At an early-stage, venture-backed startup (my comments are not intended to address late-stage, liquidity-all-but-certain scenarios), the equity structure of the company is likely to change considerably and perhaps unpredictably, rendering your initial evaluation all but useless. 4. If an early-stage startup is capable of offering you a satisfactory salary (at market or, these days, above market), you are far better off trying to ascertain what the company's runway is. Your biggest risk at a startup is not that you're going to join the next Facebook as an early employee and walk away with next to nothing but rather that the company is going to run out of cash.

JshWright 13y ago

I like thinking about shares as a virtual currency. Shareholders are speculating on that currency, and the company is trying to increase its value. Companies can inflate or deflate this currency depending on their performance, perceived potential or by issuing new shares. I consider myself a fairly smart person, who had a reasonable grasp on the basics of financial markets, currencies, etc. That simple paragraph just triggered a huge light bulb moment for me. It's suddenly a lot easier to reason about stocks, etc, than it was 5 minutes ago...

AsymetricCom 13y ago
We should start a thread about how ignorant you were before this awesome guide. I'm sure we can talk about all sorts of stupid things people believe while managing to learn nothing beyond the scope of the very basic article.
- pistle 13y ago
  I liked how candid they were in their post and then you made all my malcontent proclivities surface. Now, I'm out to pile on and ruin their day as well. Blood in the water.
- JshWright 13y ago
  Apparently I've triggered some deep seated angst... Let me try to clarify what I meant, and maybe you'll feel better? This post didn't present any new 'facts' for me. I was already aware of all the details he explained (and most, but not all, of the implications of those details). My point was simply that by framing shares as currency presented them in a way that I had never considered before, and that comparison caused a number of other things to 'click.' My apologies if my learning offended you...
  - adwf 13y ago
    I think it's safe to say he's just being unpleasant for the sake of it. The old adage of "If you've got nothing nice to say, don't say anything at all." springs to mind. I thought that shares as currency was an interesting analogy to draw too. Although I guess when you get down to it, anything that's reasonably fungible can be considered currency if you feel like it.

sarah2079 13y ago

This is very helpful, thanks. I was very surprised when I first learned that AMT will cause you to owe tax on your gains when exercising options, even if they are only on paper. (If the company is public or there is a private market, fine, but it is incredibly inconvenient to be taxed on something for which there is currently no market). This is an area where it can really pay to plan ahead.

maxerickson 13y ago
On the other hand, an expiring option for a non-liquid asset is not a good form of compensation.

joosters 13y ago

Quick question: Why should a company give share options to employees, and not plain old shares? Is this just because it's better tax-wise for the company?

doki_pen 13y ago
If they gave you shares you'd have to pay income taxes on those shares for something that may never make you any money. Most people wouldn't choose to do that.
- joosters 13y ago
  But (assuming a startup or young company), the shares would have little value and so the tax would be small. Plus, if the shares became worthless you could offset that loss against future income (I guess?) View it like the company giving you a cash bonus - not many people would turn down the bonus, even if it meant there would be tax due on it. If you think the shares have future value, then paying the tax on their current price would seem a good deal. If you don't think the shares are value, then share options would be even worse. Admittedly you've still got to pay the tax up-front...
  - Peaker 13y ago
    If the shares are given after an investment of $1 million, then 0.5% of the company is $5000, just by a conservative evaluation that takes only the investment value into account. If you think the shares have a guaranteed future value, then the shares are better than the options. If you think the shares have a guaranteed lack of future value, then the options are free, whereas the shares will cost you. If you think there is substantial risk that the shares will have no value, then getting options rather than shares mitigates that risk. You only pay for that mitigation if you actually exercise the options, in which case the cost comes off of a big payoff, rather than an upfront payment out of pocket.
  - balls187 13y ago
    The difference is you can actually use your cash bonus to pay out the taxes on that bonus. For restricted-stock, you cannot sell the stock, and thus have to pay taxes out of pocket. If the company is public, you can sell some shares to cover this cost (typical for stock bonus awards), but as many tech companies aren't public, their stock is restricted such that you cannot sell it to other individuals.

grellas 13y ago

Really nice write-up explaining stock options. A few added thoughts sparked by some of the comments already made in this thread and otherwise: 1. The value of options is inextricably linked to tax and you need to understand the tax basics in evaluating the economic risks and benefits of holding and exercising any kind of option. With NQOs, you are taxed on the spread as ordinary income on the date of exercise (meaning, on the difference between what the stock is worth and what you pay to exercise). With ISOs, the value of the spread becomes subject to AMT and you can wind up paying large taxes that way in spite of the supposed tax benefits of ISOs. The way to avoid having a large spread subjecting you to such tax risks is to exercise as early as possible before the company value goes up much but you then need to take the economic risk associated with having to pay hard cash for stock whose long-term value is highly uncertain. Moreover, early exercise is not possible if your options haven't vested unless you specifically get an early exercise privilege as part of your grant. With an early exercise privilege, and particularly if the grant is made for a bargain price, you can early-exercise, file an 83(b), and (as long as you hold the stock for at least 2 years) get the equivalent of a restricted stock grant by which you pay no further tax until you eventually sell the stock at a liquidation event. In that case, you are also taxed at the lower long-term capital gains rates. Of course, in the early-exercise scenario, you do not get to bypass vesting and your shares remain subject to their original vesting requirements and can thus be forfeited in whole or in part if those requirements are not met. But early exercise does provide an elegant solution to most of the tax risks associated with options provided you are willing to assume the economic risks of paying for the stock up front. 2. Other than the early-exercise scenario, 83(b) elections are not required for option grants. Under 83(a) of the Internal Revenue Code, any service provider who gets property in exchange for services is taxed at ordinary income rates on the value of the property received. For example, if you do work for a startup and are paid in stock when you complete the deliverable, you are taxed on the value of the stock received. You are taxed on the value of that stock as it exists as of the date you receive it in payment for such services. So, if you do development work tied to a milestone, and you meet that milestone, and you get 100,000 shares for the work, you would be taxed on, say, the $1.00/sh that the stock is worth on the day six months or a year (or whatever) out when the milestone is met, and not on the $.01/sh that it was worth when the contract terms began. In contrast to this performance-based form of incentive, let us say that you get a time-based incentive by which you buy the stock up front for a nominal price but you must earn it out over time. With such a time-based performance incentive, which is what is called "restricted stock", you own the stock up front and you pay no tax at the time of purchase in the normal case where the amount you pay for it equals its fair value on the date of the grant. Because the stock must be earned out as part of a continuing service relationship, and is hence subject to a "substantial risk of forfeiture", there is a very important technical question under section 83(a) on what the date is on which you are deemed to have received the stock in exchange for your services. Well, the default rule under 83(a) is that you receive it on the date it is no longer subject to a substantial risk of forfeiture and that then becomes the relevant date on which the value of the stock is measured for purpose of computing the taxable service income on which you must pay tax. So, if you get your 100,000 share grant at $.01/sh, and you pay $.01 share, you pay no tax at inception. But, as that grant vests at, say, a monthly ratable rate over four years, the IRS treats you as having received 48 separate grants (one each month) over the four-year period. Thus, at each vesting point, you are treated as having received property in exchange for services under 83(a) and you pay tax on the difference between the value of the property received and what you paid for it. If you paid $.01 per share, and if the stock is worth $1.00 at a given vesting point, you realize $.99 worth of taxable income per share. In a venture whose value is rising quickly, in the absence of any saving mechanism, you might have as many as 48 separate tax hits (basically, having to pay tax on the difference between what you paid for your grant and the 409A valuation price placed on the common) just for the privilege of holding a piece of paper that may or may not ever have an ultimate cash value of any type. It is in this type of scenario, and only here, that 83(b) comes into play by providing that, in lieu of having to suffer under the default rule of 83(a), you can elect to pay all taxes up front on the grant and not be subjected to the often onerous workings of the default rule. This means that, for an 83(b) election even to be relevant, you must first own your stock (or other property) and that stock or property must be subject to a substantial risk of forfeiture. If you hold only an unexercised option, you do not yet own the stock and it is not subject to forfeiture (hence, 83(b) is not relevant). If you do an early exercise, though, and get stock under terms where it must still vest out and can be forfeited, then 83(b) does apply. But that is the only case normally where it becomes relevant at all to options. 3. Options really shine when they wind up on a level playing field with the preferred stock and they tend to dim commensurately to the extent they do not. Optimum case is IPO when all stock is (typically) forced to convert to common prior to the public offering and, thus, all shares participate equally in the benefits. This can happen too in big-scale M&A exits but a drop-off occurs on lesser ones in at least two ways: (a) where the total acquisition price is largely gobbled up by the liquidation preferences and/or management incentive plans; (b) where an acqui-hire occurs in which a few founders get a disproportionate share of the total value through employment arrangements made on the other side of the deal. 4. Given all of the above, and given that IPOs remain at far below the old bubble levels in frequency, it can be risky to lay out any excessive cash to exercise at any time before a liquidity event. Too many things can happen by which a seeming "sure thing" winds up evaporating before your very eyes, leaving you with no more than a pretty lousy capital loss that you get the privilege of deducting at the rate of no more than $3,000 per year unless you can find other capital gains to offset it against. 5. The 90-day tail for exercise upon termination of a service relationship applies only to ISOs and not to NQOs but, of course, ISOs have other advantages and they are what is typically offered in VC-backed ventures. In other types of ventures, where the company value is already somewhat high at the time of grant, I have seen executives bargain for and get NQOs with long exercise periods following termination just to have the flexibility to leave the venture if needed without being forced to forfeit the options. 6. In light of all of the above, having to pay an angel backer 25 or 30% of your gains to provide you with a risk-free exercise in an otherwise high-risk situation may be worth it even though the cost seems high on its face. It is a matter of preserving some decent part of your potential upside while giving up the rest to make the upside potential even a possibility for you given the tax risks involved. If IPOs come back strong some day, then you may be giving up too much at such a cost because they are the great leveler when it comes to weighing the value of options against other forms of equity holdings. Until that day comes, however, options remain a valuable but relatively high-risk way of deriving value from a startup if you need to part with any significant cash (either for the purchase or for the associate tax) for the privilege of hoping to profit from a startup. Again, for those who need to weigh their choices, this piece provides great insights and stands head and shoulders above the typical discussion of such issues. Great work by the author in making an otherwise dry and even formidable subject pretty accessible.

djm_ 13y ago

Does anyone have any UK specific advice considering stock options? ..and how does it affect things if these are offered to a contractor and not a FT employee, is that even possible?

r4vik 13y ago
I don't believe it's possible to grant them to a UK contractor in a tax-efficient manner
- walshemj 13y ago
  Thats because you not an employee
arethuza 13y ago
From what I recall, the company needs to have an HMRC Approved Company Share Option Scheme [1] to allow the recipients of options to avoid income tax at the time they are granted. IANAL. These schemes are open to employees and executive directors - although it looks like there is a time requirement for directors [2] there doesn't appear to be one for employees. Maybe you could work as an employee one day a week and as a contractor for the remaining five and get the options as an employee? :-) [1] http://www.hmrc.gov.uk/manuals/essum/essum40105.htm http://www.hmrc.gov.uk/manuals/essum/essum40105.htm [2] http://www.out-law.com/en/topics/tax/share-plans/hmrc-approved-company-share-option-plans-csop/ http://www.out-law.com/en/topics/tax/share-plans/hmrc-approv... My main advice - if you think there potentially a chunk of money involved I would go and see an accountant or lawyer that knows the details of the current legislation and can give you detailed advice on what to do - I've done this in the past around options and the advice was worth every penny.
- walshemj 13y ago
  mm I think that Revenue might see that as disguised employment and go after you under ir35 rules.

djm_ 13y ago

Does anyone have any UK specific advice considering stock options? ..and how does it affect things if these are offered to a contractor and not a FT employee, is that even possible?

brosco45 13y ago

They are like lotto tickets, mostly worthless, some are worth a lot.

erbo 13y ago
Exactly. These days, I'm inclined to say, "Put not your faith in stock options."

vikas5678 13y ago

Is it odd that almost every startup I or my friends have interviewed with refuse to answer the "number of outstanding shares" question? Have others had similar experiences?

patio11 13y ago
Without some notion of how much your equity grant represents of the company (by current dilution), the actual number of options you get cannot be sensibly valued. The total number of shares at a company is totally arbitrary. Seriously, when you register one, the state just asks you to pick a number. If a company won't tell you enough to calculate the percentage, that's like you asking "What's your offer for salary?", "Dollars. Definitely dollars.", "Can you be more specific?", "No. We consider exact salary offers to be competitively sensitive."
- vikas5678 13y ago
  I agree, makes negotiation much harder. "We're giving you 25000 options"... but if I have no idea how much its potentially worth, I dont know what I'm saying OK to. This is often the case though, I'm quite sure.
  - patio11 13y ago
    Ask for a clarification. If you don't get one, gracefully exit the negotiation, because they're either stupid or not negotiating in good faith. You have better (no pun intended) options.
- gabemart 13y ago
  Please forgive my ignorance, but if you know the number and price of the options, is the problem that you don't know the current valuation? Because it seems like if you know the price of the option, how many options you're being offered, and the current valuation, it's trivial to work out the number of outstanding shares. I guess the current valuation is privileged? Or that there is no current-valuation if it's been a while since the last round?

snorkel 13y ago

Here's the short version. Sell. Sell it all. As soon as you are legally allowed to, sell. Sell all of it. Taxes and maxes blah blah blah just sell it, take the cash, and be thankful.

e1ven 13y ago
This is talking about Stock Options, not pure stock grants. This means that "Sell it all" isn't quite as simple as you might suggest - First you need to "Buy it all". But there is often vesting, which means you can't buy it all yet.

dlevine 13y ago

You didn't mention the difference between nonqualified (NQSO) and incentive (ISO) stock options. The difference is key.

dsri 13y ago

>> You can think of a stock option as a Future. You probably shouldn't, as they are distinct terms. A futures contract obliges you to make the transaction on the specified transaction date, whereas an option gives you the option to do so.

mseebach 13y ago

What is the exact mechanism for "golden handcuffs"? Can the company prevent a vested option holder from exercising and then selling the shares to a secondary market investor immediately (offering them to the company for first refusal, obviously)? In that case, can't I just line up a secondary market investor, borrow the cash to exercise, sell, repay the loan and thus get out of the handcuffs?

spacehome 13y ago
No. The golden handcuffs arise from the fact that the employee doesn't have the cash on hand to exercise the options and pay the taxes since there is no liquid market from the shares. If the employee quits, then they forfeit the upside of the options since the options expire 90 days after terminating employment. So, if the employee wants to participate in the options' upside, he or she is forced to stay with the company until a liquidity event -- textbook golden handcuffs. It should be noted that Alex MacCaw and friends are offering a way out of this dilemma for 25-30% of the upside by supplying the cash required to exercise so that the employee can leave. This advertising is probably the whole reason Alex wrote the article.
- mseebach 13y ago
  So, just to make sure, the thing I can't do is line up a secondary market investor, because there probably aren't any? And being that secondary market investor is what you're saying Alex MacCaw and his friends are?
  - spacehome 13y ago
    A secondary market investor is someone who will buy the shares from you after you've exercised. These people may or may not exist, depending on how attractive the company is. The shares you purchase from the company will likely be restricted, and you won't be able to transfer them for a year. After that year is up, you can sell it to whomever you wish. The company will have right of first refusal, but if it comes to that, you don't really care who buys the shares off of you (company or secondary market investor) because you get paid the same either way. This is technically different that what Alex is proposing, but the end result is fairly similar. He's offering to loan you money to exercise. You keep ownership of the shares, and the loan comes due if and when there is a liquid market for the shares. He's allowing you to move on from the company before any other investor is interested in the shares, but still provide upside to you if and when the shares are actually worth something. And he takes some cut because he's assuming the (very significant) risk that no other investor is ever willing to pay for the shares.

throwawayy123 13y ago

If I decide to leave a company in which I have partially vested stock options, would it be okay to ask my employer (or anyone else in my company) if they would be interested in buying the options off of me at the current valuation (EG, last amount of money raised)? Is something like this common, or would I get laughed out of the room? Similarly, how liquid are markets like Second Market in terms of liquidating option value at a startup that's raised multiple rounds of funding but has yet to exit or IPO? Are there angels (or networks of angels) that buy small amounts of pre-exit equity?

balls187 13y ago
If you don't exercise your vested options, they will automatically expire after a certain date. The company doesn't really have any incentive to purchase your options from you, however they will likely have a clause that gives the company first right of refusal--that is, if you plan on selling any shares prior to a liquidity event, you have to first offer them to the company for FMV. As to pre-IPO, post fund raise, your stock is typically Restricted stock units, which have clauses that prevent you from selling stock. It's possible, with board approval to issue a special class of common stock, that can be sold to outside investors. This is usually done to allow long-term founders to get some liquidity outside a liquidity event. This typically doesn't happen for most employee's though. In an IPO scenario, all outstanding shares convert to a single class of stock, which can be freely sold (after a lock-up period).
prostoalex 13y ago
There's not really a whole lot of incentive for a company to buy your shares, since they can always print more if needed. Liquidity highly depends on the company. SecondMarket, SharesPost and MicroVentures have online portals for buying+selling, but they also have a mailing list with people potentially interested in a secondary market transaction, so worthwhile exploring that option.

deleted 13y ago

[deleted]

lmartel 13y ago
Super irrelevant--unless you're trying to say that employees should never strike their options, which is probably not good advice.

willvarfar 13y ago

And here's a nice guide from way back in 2004: http://www.ftpress.com/articles/article.aspx?p=170920 http://www.ftpress.com/articles/article.aspx?p=170920 What's interesting is that this chap Ivan Goddard is doing the Mill processor, and that has an interesting company structure; OotB has an agreement to incorporate, and they keep renegotiating it. He explains this in this talk: http://www.youtube.com/watch?v=Bxga49vukQ8 http://www.youtube.com/watch?v=Bxga49vukQ8

egometry 13y ago

Pretty god. I've been recommending David Weekly's short e-book on this matter for years... specifically as mandatory reading for engineers taking their first or second job. Learn from our mistaaaaakes! http://www.amazon.com/Introduction-Stock-Options-David-Weekly-ebook/dp/B0055PQ4H8 http://www.amazon.com/Introduction-Stock-Options-David-Weekl...

deleted 13y ago

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tejay 13y ago

What about profit-sharing instead of options/warrants/shares? We've found that it dampens the 'build-to-flip' mentality and lets us all enjoy the fruits of our labor while we're building the company, not afterwards =).

anon_nsotax 13y ago

Can someone comment on determining fair market value of a private company? I exercised NSO stock options of a private company after being vested for a year. Everything I read indicates I need to declare the spread of current FMV with the value of the option grant date. How do I determine the current FMV if their is no market though?

richardburton 13y ago
You'll need to ask the owners of the company for the 409A valuation.
philjr 13y ago
Some good commentary by Fred Wilson about 409a's... http://www.avc.com/a_vc/2010/11/employee-equity-the-option-strike-price.html http://www.avc.com/a_vc/2010/11/employee-equity-the-option-s...

elwell 13y ago

What if you're too lazy to exercise your share?

balls187 13y ago
Usually the Employee Share agreement has a clause that states that when you leave the company (or even in change of control scenarios) any vested stock options must be exercised by 90 days, otherwise their forfeit back to the company.
- joshuapayne 13y ago
  This is important. The 90 day time period is a typical clause in your options agreement. It is not universal. You should check for this and other "standard" clauses in your options agreement to ensure that your company isn't sneaking something past you when you're signing on.

gesman 13y ago

Red flags (from personal experience): - "We will give you a big share of our (of-course-soon-to-be-facebook-or-google) company (15%+ in stock options) if you'll agree to work for us for close-to-nothing". - Senior officers starting leaving the company one by one. - Senior officers giving small promises that have tendency not to materialize. - Senior officers do not have any/good exit track record. Opposite would be a green flag.

kika 13y ago
I'm not getting #1. Essentially, they're offering you a "founder grade" share of the company. Why not?
- phillmv 13y ago
  Depends on your appetite for risk. It's just a sign that it's really risky, and the other founders obviously think the odds of it succeeding are low and are asking you to put in sweat equity, as it were.
- gesman 13y ago
  If you jointly owns IP - that's fine. But if you're only an employee albeit a proud owner of large chunk of options, it's possible that real founders are just testing the market at your expense.
  - kika 13y ago
    With 15% you can have a seat in the board or at least some voting rights. Having that it would be more difficult to just dissolve the company without any real reason. But generally speaking you're right, thanks.
    - gesman 13y ago
      Solid cubicle quite often is a better financial investment than a shaky board :)

puppetmaster3 13y ago

lol, none of this matters. the terms are, what the terms are, you can just try to get more shares and more $.

unreal37 13y ago

I'm waiting for the day in the near future when an article on stocks begins with "Stocks are a lot like Bitcoin..."

yogin 13y ago

Thank you for this, I have to admit I've been quite confused about this for some time. Great explanation, it finally makes a lot more sense to me!

dmourati 13y ago

Read Venture Deals by Brad Feld. It will make you more knowledgeable then 99.9% of all the people in venture funded companies and put you on the level playing field with the VC's.

xerophtye 13y ago

This was truly a great article and i have bookmarked it for later reading (i haven't read all of it yet). But perhaps i can expand on this explaining what "options" are in the first place. Ok imagine a situation where stock X costs $100 today. Alice thinks that the price will go considerably up, bob thinks it'll go down. So they make a deal, one year from now, Alice will buy shares of stock X from Bob at $104 dollars[1]. Now if Alice's prediction is right, she'll make a profit by buying low ($104) and selling high (at the then market price). If bob's prediction is right, he'll profit by buying low (market price) and selling high($104). This is called a Forward Contract. Problem with Forward Contracts are that they put you in an obligation to make that transaction, no matter how much loss. What if the price falls and Alice doesn't wanna buy from bob? So then instead of a Forward Contract, she'd get an option (a "Call" option to be specific). This will give her the option to either buy the shares at the agreed upon price (called "strike price") if it is favorable, else do nothing. Well what about Bob? He can get into a "put" option (with someone else) that gives him the option to sell stock X if it is favorable. Pretty neat huh? but the difference here is, Forwards are free (except for tax etc) and options cost a "premium" to get into. But since options COST something, that means you can SELL them as well and make money off of that. And their prices vary just like the price of stock varies. Hope this helps

jeff558 13y ago

Haha, investment advice from a guy in his early twenties. Thanks but no thanks.

nraynaud 13y ago

I have a related question: I have some non-privileged stock in a private company, and I want to sell it (I want the money and I don't care about the future of a company I don't work for anymore). Who could be an interested buyer?

prostoalex 13y ago
http://www.sharespost.com http://www.sharespost.com http://secondmarket.com http://secondmarket.com

jisaacks 13y ago

So what happens when the company exits before you are vested?

prostoalex 13y ago
Most stock plans have triggered vesting. So it's possible to start a job on Monday, have the company acquired on Tuesday and immediately vest for all 4 years going forward.