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Why worry about stock options at all? There is a spectrum of outcomes. On one end the startup flops, or is bought for so little that your share, even if paid ou

by mcdoug 12y ago

Why worry about stock options at all? There is a spectrum of outcomes. On one end the startup flops, or is bought for so little that your share, even if paid out, is close to 0. On the other end you have Google, Facebook, Instagram, etc. Companies where 0.5% is worth quite a bit of money. The problem is that the majority fall in-between, where your stock options will be worth nothing, yet the company will sell for a decent amount of money. So what you should do is value the stock options at 0. If you have the spare cash, buy them as early as you can, but don't count them for anything. They are a lottery ticket that your company is the next Google and like any lottery ticket they are likely worth nothing. If the startup is offering to pay you half of what you'd make elsewhere, waving stock options at you telling you they'll make you rich, consider if they just handed you a pile of lottery tickets and half a paycheck. If you'd still take it (maybe you really like the people, or want to work in this field), go for it. Otherwise, they are just trying to get your for a far cheaper price than you'd get elsewhere.

gregrata 12y ago
> buy them as early as you can, Careful on this one - when you buy, it's a taxable event. The spread between what the IRS thinks the company is worth and what you paid is taxable. You have to pay that NOW. I've known people that were screwed on this - strike price was around 1, value by IRS was 8 (based on funding rounds). By the time the person could sell the stock, it as worth .013. Fun!
- ewindisch 12y ago
  IANAA (I am not an accountant)-- This is not true, or not necessarily. It's calculated for AMT, so if you're already paying AMT, or would be paying AMT with the addition of this income, then yes: You'll be paying that tax now. This is true for many in California with the high state taxes and a relatively high gross income (versus national averages). However, if the intrinsic value portion of your exercise (i.e. fair market value minus your strike price) as an addition to your AMT worksheet does not indicate you'll owe AMT for the year, then you will NOT see a tax event. This will be true for many non-Californians exercising after their first year, or even after 4 years, depending on the growth of the fair-market-value. If you are at risk of paying AMT and your intrinsic value is in the low 6-figures (or lower), one solution might be to wait until the beginning of a new tax year, exercise, and quit your job... then take a year off from wages and work for equity (i.e. form your own startup). You'll avoid paying the 26% on that money due at exercise. If you've been paying AMT in the past, you'll even get a tax credit at the end of the year. Obviously, this plan is not without risks, should only be carried-out if you believe in solid growth in the startup for which you own equity and believe in the ability of the new startup you're founding and/or joining. Also, and obviously, you should consult with an actual accountant before considering this crazy idea ;-)
  - dlubarov 12y ago
    Sounds like you're describing ISOs, while the parent was describing NQSOs. With NQSOs, the (market value - exercise price) spread is taxed as ordinary income at the time of exercise.
    - ewindisch 12y ago
      correct -- for ISOs.
- dglass 12y ago
  This can go both ways. You can buy in with a strike price of 1.00 while the IRS value of your company is still low, say 2.00. You pay the taxes on the 1.00 difference since the IRS counts that as income, and you become a shareholder. If your company raises funding in the future and the price goes up to 5.00 it's all profit (aside from capital gains tax when you sell, but chances are you'll pay long term capital gains since you're already a shareholder and these things don't happen overnight). This is better than buying in after the round of funding where you'd pay taxes on the difference of 4.00. This is why it can be a good idea to exercise your vested shares before a round of funding where the price will go up. It's a trick to minimize your taxes. Not saying there's any less risk in purchasing the shares of a startup however.
amirmc 12y ago
> "Why worry about stock options at all?" Because they do matter and are still part of the compensation package. There's still a significant difference between a payout that equates to two year's worth of salary vs another that pays out one year's worth.
- briandear 12y ago
  It's a lottery ticket. If statistically most startups fail, then statistically most options are worthless.
ditonal 12y ago
It's really unfortunate, because there are many engineers like me who would gladly take a pay cut if we were brought in as collaborators and offered real equity deals. Instead we are brought in as serfs to build their 'vision', with no input of our own or recourse if bad management runs our projects into the ground, and offered financial instruments that are obviously rigged against us. No engineer who understands personal finance and seriously values his tech career would be an employee at a startup over an established tech company today. Founders still behave like VC money is scarce and engineering talent is plenty. I am seeing many of these companies struggle to ship competitive products due to lack of engineering talent, and so I am hoping we see these startups fail and lose to big tech companies that value their engineers, and force the VC funded startup scene to totally re-evaluate their 'standard' offers so that those of us who would prefer smaller teams can join one on fair terms.
- harryh 12y ago
  What do you think fair terms look like for, say, the first 100 people at a tech company where you have 50 engineers, 20 product people, 20 sales people, and 10 business people? All roles will of course have varying levels of seniority and experience.
  - ditonal 12y ago
    Preferred shares and invitations to board meetings. If I'm taking a pay cut, I'm an investor and want to be treated like one. If you're so big that you can't offer real equity, you're not a startup, youre an established business, so you should start paying competitive salaries and not use the "We're a startup" excuse to distort the market to your benefit. And competitive means it actually competes, not "competitive".
    - harryh 12y ago
      I don't think you understand the purpose of preferred shares or board meetings.
      - 12y ago
iykwimthrowaway 12y ago
I'm very curious about the middle part of this spectrum, since I'm currently in it: I'm an early employee with a significant chunk of options (high single-digit %), and the company is profitable and valued at (to my understanding) somewhere well over 10x the total amount of funding we took (I've heard talk of 40-50x). Management is explicitly not looking for an exit: they just want to keep building this company for the long term. My salary started on the low side for my career, but was reasonable, and it has slowly ratcheted up over time to the point where I think it's certainly fair but I could be making more elsewhere. On the whole, it feels like I have a large chunk of (potential) ownership in something very successful. My question is: how does this actually benefit me in the big picture? I'm approaching the 10 year date when my options agreement is going to EXPIRE, and it's still unclear to me whether I should exercise them, because as far as I can tell, they're just very expensive (when you consider the tax implications) paper. What's the endgame for this success story putting cash in my pocket? Profit-sharing? Other than the usual big-bang exits you read about, I have no clue.
- hga 12y ago
  This is a general big problem, especially with the moribund post-SarBox IPO environment. Before those days, my father made more than a little money arranging cash-outs for founders of such companies, and there's absolutely no assurance you'll ever see a cash out. But this strikes me as a problem your company ought to care about, especially if your options were part of a compensation package with below market salary, so maybe bring it up with the relevant people? It does them little good to get people like you upset, take a reputational hit, etc.
- ditonal 12y ago
  Are you invited to board meetings? If not, considering yourself a "potential owner" when you're not invited to the meetings where owners decide things means you are very confused about things. There's a reason why when a company goes public, the quarterly minutes at board meetings become public as well, because you aren't really an owner if you're excluded from even learning about the biggest of decisions. What you should do depends heavily on whether you have common or preferred shares. If you have the options to buy common shares, which you probably do, they're worthless so don't even bother exercising them, the people who are invited to the board meetings have all sorts of routes they can take so that your options will become meaningless, so to spend the money to exercise and pay the capital gains on them is madness. My advice is to recognize that you have a sunk cost (look up sunk cost fallacy) and jump ship. Keep applying to companies like Google, Facebook, Amazon, Microsoft, and other larger companies until one makes you an offer, and those companies will give you real compensation packages and stock plans that you will be able to easily turn into American dollars in a year.
serve_yay 12y ago
Totally agreed, they're not likely to be worth anything. Maybe they will! But probably not, and getting your hopes up is counterproductive. But then maybe I've just read one too many stories about people's options turning out to be worthless, even when one would expect otherwise.
kwisatzh 12y ago
I think there is a deeper conversation to be had over here -- many outfits in the valley seduce engineers and the talent with this spiel of making money, while as you say the chances of this happening is very rare. In expectation, one would probably make more money working at FB/Google/Apple over a lifetime than at a random startup. Founders would likely prosper, and of course investors will likely recoup their money but most of the time a staff engineer wouldn't make much. I feel that the VCs in the valley are running this racket of seducing and exploiting talent, all the while knowing that most folks wouldn't get much out of the hard work. I suppose one can make a case of Wall Street being more fair in terms of wages distributed as a function of effort (and ensuing results) put in.
bbcbasic 12y ago
Then why work at a start-up at all?
ryanSrich 12y ago
> If you have the spare cash, buy them as early as you can Why would you want to do this? Wouldn't it be better to wait until the company is about to be acquired or IPO so you're not spending money on something of no value?
- ilyanep 12y ago
  I am not an accountant, this is not tax advice. You're usually correct, except for two things (in the US): 1) Holding stock for a year before selling is taxed at the lower long-term capital gains rate (~20% vs ~39.6% at the highest brackets). 2) Exercising an ISO is seen as a taxable income for the purposes of the Alternative Minimum Tax, so exercising late (when the difference between FMV and Strike Price is high) has a higher chance of incurring an AMT burden, whereas exercising early does not incur an AMT burden (because the spread is small) nor a normal tax burden (because this is how ISOs work).
- justrudd 12y ago
  Depends on the type of options you have. If you have ISO, yeah. I'd probably wait because there are "games" you can play to not impact your total tax bill for the year (i.e. not trigger AMT). If they are NQSO, the difference between your option price and market price is a taxable event. So if your option price is $1 and the company IPOs and has a price of $12 when you exercise, you owe taxes on $11 per share (this is a gross oversimplification). Now if you had purchased before the company is acquired/goes public, the price might just be $5 so your overall tax bill is lower. You exercise at a lower price and hope the price goes up.

by mcdoug 12y ago

gregrata 12y ago

> buy them as early as you can, Careful on this one - when you buy, it's a taxable event. The spread between what the IRS thinks the company is worth and what you paid is taxable. You have to pay that NOW. I've known people that were screwed on this - strike price was around 1, value by IRS was 8 (based on funding rounds). By the time the person could sell the stock, it as worth .013. Fun!

ewindisch 12y ago
IANAA (I am not an accountant)-- This is not true, or not necessarily. It's calculated for AMT, so if you're already paying AMT, or would be paying AMT with the addition of this income, then yes: You'll be paying that tax now. This is true for many in California with the high state taxes and a relatively high gross income (versus national averages). However, if the intrinsic value portion of your exercise (i.e. fair market value minus your strike price) as an addition to your AMT worksheet does not indicate you'll owe AMT for the year, then you will NOT see a tax event. This will be true for many non-Californians exercising after their first year, or even after 4 years, depending on the growth of the fair-market-value. If you are at risk of paying AMT and your intrinsic value is in the low 6-figures (or lower), one solution might be to wait until the beginning of a new tax year, exercise, and quit your job... then take a year off from wages and work for equity (i.e. form your own startup). You'll avoid paying the 26% on that money due at exercise. If you've been paying AMT in the past, you'll even get a tax credit at the end of the year. Obviously, this plan is not without risks, should only be carried-out if you believe in solid growth in the startup for which you own equity and believe in the ability of the new startup you're founding and/or joining. Also, and obviously, you should consult with an actual accountant before considering this crazy idea ;-)
- dlubarov 12y ago
  Sounds like you're describing ISOs, while the parent was describing NQSOs. With NQSOs, the (market value - exercise price) spread is taxed as ordinary income at the time of exercise.
  - ewindisch 12y ago
    correct -- for ISOs.
dglass 12y ago
This can go both ways. You can buy in with a strike price of 1.00 while the IRS value of your company is still low, say 2.00. You pay the taxes on the 1.00 difference since the IRS counts that as income, and you become a shareholder. If your company raises funding in the future and the price goes up to 5.00 it's all profit (aside from capital gains tax when you sell, but chances are you'll pay long term capital gains since you're already a shareholder and these things don't happen overnight). This is better than buying in after the round of funding where you'd pay taxes on the difference of 4.00. This is why it can be a good idea to exercise your vested shares before a round of funding where the price will go up. It's a trick to minimize your taxes. Not saying there's any less risk in purchasing the shares of a startup however.

amirmc 12y ago

> "Why worry about stock options at all?" Because they do matter and are still part of the compensation package. There's still a significant difference between a payout that equates to two year's worth of salary vs another that pays out one year's worth.

briandear 12y ago
It's a lottery ticket. If statistically most startups fail, then statistically most options are worthless.

ditonal 12y ago

It's really unfortunate, because there are many engineers like me who would gladly take a pay cut if we were brought in as collaborators and offered real equity deals. Instead we are brought in as serfs to build their 'vision', with no input of our own or recourse if bad management runs our projects into the ground, and offered financial instruments that are obviously rigged against us. No engineer who understands personal finance and seriously values his tech career would be an employee at a startup over an established tech company today. Founders still behave like VC money is scarce and engineering talent is plenty. I am seeing many of these companies struggle to ship competitive products due to lack of engineering talent, and so I am hoping we see these startups fail and lose to big tech companies that value their engineers, and force the VC funded startup scene to totally re-evaluate their 'standard' offers so that those of us who would prefer smaller teams can join one on fair terms.

harryh 12y ago
What do you think fair terms look like for, say, the first 100 people at a tech company where you have 50 engineers, 20 product people, 20 sales people, and 10 business people? All roles will of course have varying levels of seniority and experience.
- ditonal 12y ago
  Preferred shares and invitations to board meetings. If I'm taking a pay cut, I'm an investor and want to be treated like one. If you're so big that you can't offer real equity, you're not a startup, youre an established business, so you should start paying competitive salaries and not use the "We're a startup" excuse to distort the market to your benefit. And competitive means it actually competes, not "competitive".
  - harryh 12y ago
    I don't think you understand the purpose of preferred shares or board meetings.
    - 12y ago

iykwimthrowaway 12y ago

I'm very curious about the middle part of this spectrum, since I'm currently in it: I'm an early employee with a significant chunk of options (high single-digit %), and the company is profitable and valued at (to my understanding) somewhere well over 10x the total amount of funding we took (I've heard talk of 40-50x). Management is explicitly not looking for an exit: they just want to keep building this company for the long term. My salary started on the low side for my career, but was reasonable, and it has slowly ratcheted up over time to the point where I think it's certainly fair but I could be making more elsewhere. On the whole, it feels like I have a large chunk of (potential) ownership in something very successful. My question is: how does this actually benefit me in the big picture? I'm approaching the 10 year date when my options agreement is going to EXPIRE, and it's still unclear to me whether I should exercise them, because as far as I can tell, they're just very expensive (when you consider the tax implications) paper. What's the endgame for this success story putting cash in my pocket? Profit-sharing? Other than the usual big-bang exits you read about, I have no clue.

hga 12y ago
This is a general big problem, especially with the moribund post-SarBox IPO environment. Before those days, my father made more than a little money arranging cash-outs for founders of such companies, and there's absolutely no assurance you'll ever see a cash out. But this strikes me as a problem your company ought to care about, especially if your options were part of a compensation package with below market salary, so maybe bring it up with the relevant people? It does them little good to get people like you upset, take a reputational hit, etc.
ditonal 12y ago
Are you invited to board meetings? If not, considering yourself a "potential owner" when you're not invited to the meetings where owners decide things means you are very confused about things. There's a reason why when a company goes public, the quarterly minutes at board meetings become public as well, because you aren't really an owner if you're excluded from even learning about the biggest of decisions. What you should do depends heavily on whether you have common or preferred shares. If you have the options to buy common shares, which you probably do, they're worthless so don't even bother exercising them, the people who are invited to the board meetings have all sorts of routes they can take so that your options will become meaningless, so to spend the money to exercise and pay the capital gains on them is madness. My advice is to recognize that you have a sunk cost (look up sunk cost fallacy) and jump ship. Keep applying to companies like Google, Facebook, Amazon, Microsoft, and other larger companies until one makes you an offer, and those companies will give you real compensation packages and stock plans that you will be able to easily turn into American dollars in a year.

serve_yay 12y ago

Totally agreed, they're not likely to be worth anything. Maybe they will! But probably not, and getting your hopes up is counterproductive. But then maybe I've just read one too many stories about people's options turning out to be worthless, even when one would expect otherwise.

kwisatzh 12y ago

I think there is a deeper conversation to be had over here -- many outfits in the valley seduce engineers and the talent with this spiel of making money, while as you say the chances of this happening is very rare. In expectation, one would probably make more money working at FB/Google/Apple over a lifetime than at a random startup. Founders would likely prosper, and of course investors will likely recoup their money but most of the time a staff engineer wouldn't make much. I feel that the VCs in the valley are running this racket of seducing and exploiting talent, all the while knowing that most folks wouldn't get much out of the hard work. I suppose one can make a case of Wall Street being more fair in terms of wages distributed as a function of effort (and ensuing results) put in.

bbcbasic 12y ago

Then why work at a start-up at all?

ryanSrich 12y ago

> If you have the spare cash, buy them as early as you can Why would you want to do this? Wouldn't it be better to wait until the company is about to be acquired or IPO so you're not spending money on something of no value?

ilyanep 12y ago
I am not an accountant, this is not tax advice. You're usually correct, except for two things (in the US): 1) Holding stock for a year before selling is taxed at the lower long-term capital gains rate (~20% vs ~39.6% at the highest brackets). 2) Exercising an ISO is seen as a taxable income for the purposes of the Alternative Minimum Tax, so exercising late (when the difference between FMV and Strike Price is high) has a higher chance of incurring an AMT burden, whereas exercising early does not incur an AMT burden (because the spread is small) nor a normal tax burden (because this is how ISOs work).
justrudd 12y ago
Depends on the type of options you have. If you have ISO, yeah. I'd probably wait because there are "games" you can play to not impact your total tax bill for the year (i.e. not trigger AMT). If they are NQSO, the difference between your option price and market price is a taxable event. So if your option price is $1 and the company IPOs and has a price of $12 when you exercise, you owe taxes on $11 per share (this is a gross oversimplification). Now if you had purchased before the company is acquired/goes public, the price might just be $5 so your overall tax bill is lower. You exercise at a lower price and hope the price goes up.