Hold on, if we get this wrong we may be lowering the value of everyone's options and hurting startups. Are there any added protections here against high turnover in infancy-stage startups?
For 30(?) years since the invention of stock options there has also been a de facto added protection against high turnover in infancy-stage startups, where having to rehire and retrain employees is extremely costly. Pre-IPO you basically had to pick a team and take it to that level of maturity before you could leave. You couldn't hop around seed-level startups without giving up your options, usually.
What's changed now is startups are staying private longer, leading to unfair scenarios. E.g. you're at a >$1B company with >100 employees for 6 years and you still lose your options. Traditionally a company would have gone public by that time, but now it's not, so we need a fix.
But if you overcorrect and now eliminate that added protections for younger startups, you risk creating an incentive to leave companies just for the sake of options portfolio diversification. Why bet on one team when you can bet on three, since even 1/3rd of a unicorn that makes it is worth more than 100% of the one that doesn't. And that individual decision leads to higher turnover which can kill infant startups.
Bottom line this fix should be more carefully targeted at what has changed to exacerbate unfair situations, namely startups that have reached "should be public" levels of maturity, yet are still staying private.
The internet has made it more clear that being an early startup employee will be worse in almost all possible cases compared to working at google even when you get to the $1 billion 'unicorn' status.
For example, I was a jr. engineer at a stage A $5 million startup with ~%0.4 of the company in stock options. When it reached its $1 billion valuation 4 years later, my options with dilution were worth x25. But $500k/4 years is $125k/yr, which is pretty close to the stock compensation working at google. But these options were not cash equivalent like google's stock, and I had to drop it all on the floor because of the 90 day window. I lost $500k in compensation because I decided to work at the startup vs. google.
Imagine if your employees had a good amount of savings and could easily afford the $10-20k it costs to pre-exercise their options in your infant stage startup. Then these rules are pretty moot. It takes advantage of people who don't have the money to pre-exercise options, who tend to be younger people.
Also it's unfair, investors can diversify their income sources, while employees cannot.
That's rough. $1B sure feels like a point where a company has graduated from infancy/childhood to being able to handle some turnover. Having said that, valuations a year ago were pretty crazy so maybe they really weren't.
I have to say that's a heck of a lot of dilution, too. 200x growth in valuation vs. only 25x in your stake? What's that, over 85% dilution?? Sounds like that juicy unicorn valuation was only achieved by a lot of fundraising rounds under presumably not awesome terms. Not that that makes you feel any better.
I'm thinking there should be some kind of extra incentive for early stage teams to stick together, but with a more explicit maturity point. It used to be IPO/acquisition. Now that IPO is often farther off there should probably be some other metrics. What are they? Valuation? Number of employees? Length of employment? Revenues? Some combination?
You give them stock straight out with a 'reverse vesting' buyback schedule and you cover the tax. If that starts becoming 'too expensive' because of taxation / valuation reasons for the company, then you've reached the size where you give 10 year options or RSUs.
US startup stock options push the tax externality to their employees. In somewhere like canada, your tax bill is due at liquidation, not at the purchase of options. It makes a lot more of this problem go away. For most early stage employees that do well in a tax scheme like canada's then paying $20k for stock in a large valuation company isn't nearly as painful as paying $20k + $100k in AMT tax.
I think that would probably be reasonable for most angel investment and stage A teams. It isn't a stretch for the company to pay an extra $10-30k for a stock transaction where %60 of it cycles back to them anyway for a total of $4k-12k of a tax bill.
Also another way to value the stock to give to early employees is to treat them as investors investing the $500k+ or whatever equivalent they are giving up for 4 years and giving them that as their stock where you foot the tax bill. Also giving them the same visibility and protections that those equivalent angel investors would get.
The percentage points you start giving up for that although starts becoming too large for most founder's tastes, and thus we get the current situation we have today. Many engineers tell themselves, why should I join an early stage startup when I can do so much better as a founder with a similar risk profile?
edit:
I realized you want a way to keep the golden handcuffs that are unique with the US tax law and current equity structure to incentivize poor-ish early employees to stick around without creating an incentive to fire them with back loaded options.
You could create a second stock option reward for the early employees with a company performance + time condition vesting condition and pay the tax bills by giving them the stock right away.
Pinterest's long term stock option expiry date is contingent on being with the company 2-3 years, otherwise it goes back to the same 90 expiry window I think.
You could try many structures, and the market will respond to it compared to their other offers. A good way to start is to explicitly state what you actually want, and then engineers could state what their price is for that ask in comparison with what they can get.
Pinterest also didn't enact that until they reached a multi-billion $ valuation and hundreds of employees. They did it when they already knew they could handle turnover. Earlier stage companies might need longer.
But then it's hard to set a definite timeframe. What you want is to incentivize sticking together as an effective team to reach a point of maturity, to maximize the chances of getting there and thus the options being worth anything. It's probably more about size and valuation. That's what was nice about effectively tying it to IPOs (when IPOs happened earlier). Going public was a decision that the board made when they company was "ready".
I think the reason why pinterest did this was as a vanguard of what you see here in the article now. There are still many companies that are in pinterest's position and do not do what they did.
The engineer market in SF right now is very highly heated, and this kind of incentive makes an offer from pinterest far more appealing. That and people are starting to compare notes and make articles on medium and others really spelling it out is probably hurting recruiting and this is coming out as a response.
Why should I care more about the company and "turnover" than the people whom the current system gives an incentive to fire so they get screwed under current equity regulations?
Are any of the markets for employee equity seeing much action?
You should be able to:
1) Get a loan from somebody who wants in on the startup to exercise the option.
2) Exercise option.
3) If company decides to buy back option via first right of refusal you return the loan plus a nominal increase and you pocket the difference in valuation between rounds minus the loan fee. If the company lets you sell it to the person than they get the equity in return for their early payment.
Do most stock grants disallow this transaction? Or is there not much of a market for these sort of third party buyers?
For #1, I tried multiple places such as ESO fund, etc. They were not interested. I also tried selling directly.
You also have to get a lot of paperwork together, that you usually don't have and it can take months as the company drags it's feet in giving it to you. There wasn't paperwork preventing this at the company I was at.
If anyone is thinking about a startup offer, I would suggest getting equityzen's documentation checklist upfront. It can take longer than you think, and a few months later, people who were interested in buying might not be anymore.
I was trying this a little less than a year ago, so it isn't as correlated to the current issues today.
Also I would try to get the stock paperwork agreement that they will have you sign for your options. Very surprisingly, for even some big superstars today it is very hard to get this from them until you start working for them. There can be hidden gotchas like after exercise stock buyback options at the current FMV. Or restrictions that even stop you from doing things like ESO fund.
"Imagine if your employees had a good amount of savings and could easily afford the $10-20k it costs to pre-exercise their options in your infant stage startup."
Although, one trope about startups is that they usually pay crappy, so the likelihood of any given employee having significant savings is low.
You're going to get a lot of hate for this comment, but it's probably the smartest top level comment in the thread. I've struggled with this issue a lot. Personally I think it should be solved with creative vesting schedules. Instead of vesting evenly over 4 years, vest some shares over time but save a big chunk that vests at exit.
Basically build in a big "you stayed until the end" equity bonus.
Right now I think the problem is that people think of their vesting schedule as when their stock becomes theirs and that's not really true. And most startups encourage (or at least do not dissuade) this illusion. That's a problem worth fixing.
Exactly. Be upfront. Ben Horowitz spoke critically on this topic, responding to Sam Altman's post on equity which is the genesis of all this. Really mandatory viewing. [1]
Sam was in the room and added that he is "revising" his recommendation because "there needs to be more incentive to stay." (@26:00)
I personally haven't seen Sam post about his revised position. Would be great if he did.
Ya, I saw the Ben/Sam exchange when it happened. And I have to say, as huge of an admirer of Ben as I am, I think he gets it a bit wrong here. As you said above, startups are staying private longer. Much longer. This creates some really bad situations that you really can't address merely by being upfront with people. I don't think Ben really acknowledges this fact.
Yes, agreed. He identifies one things that has changed: securities law that now makes it possible to extend options exercise windows past 90 days, whereas previously it was practically impossible. But the bigger thing that's changed is companies are staying private longer.
Ben's strongest point is in asking "Why now?" Options have been this way since the 80s. What's changed? Nobody is examining that as closely as they should. Maybe most of us are young and hubristic and tend to discount the past. But as engineers we should all possess a certain conservatism, a healthy skepticism to changing systems that have been stable for a long time. We must look closely to ensure there are no unintended consequences.
I think it is very notable that Sam Altman said he has revised his position to require stronger incentives to stay. Early stage startups need incentives to stick together as a team. If you don't have any extra protections at the earliest stage, then you're going to have smart, happy employees face the powerful economic logic of leaving to diversify their options portfolio. And that's not good for the value of anyone's options.
> Options have been this way since the 80s. What's changed? Nobody is examining that as closely as they should. ... we should all possess a certain conservatism, a healthy skepticism to changing systems that have been stable for a long time.
The same argument could be applied to the way VCs used to do business with founders (with respect to tactics, terms sheets, etc). Arguably, that was stable for a long time too (but seems to have changed in recent years). It's just a reformulation of "We've always done it this way".
Except those terms were looked at very closely. I haven't heard anyone think through the impact of this on early stage startup turnover. This is introducing a massive incentive to leave that has never existed. It may promote shorter tours of duty.
unfortunately the whole idea of unvested options actually gives companies incentives to fire engineers. If a big chunk comes around late in the 4 yrs, then "opps we outsourced your job 1 week before vesting 90% of your options." . I would love to think no one would do this, but its happened to me (and the rest of the team) 9 months into our vesting. As well people get funny when a lot of money is involved, nice people do abnormal things when millions/billions are on the line.
Ya, that's a reasonable point. You could probably do something creative with vesting-on-termination clauses of some kind but at that point are we layering hack on top of hack? I dunno.
If startups do not want high turnover, they're free to offer above-market-rate salaries or a contract mandating a longer notice period on both sides. Overwhelmingly, they've chosen at-will employment instead.
Perhaps infant startups do not deserve "great talent". Engineers shouldn't have to give up cash for lottery tickets, especially when many founders won't even include the number of outstanding shares, preferences, etc. in the options agreement!
If you had the outstanding shares and preferences in the options agreement wouldn't you have to have everyone resign every time someone exercised their options (changing the number of outstanding shares) or they raised money?
However I agree founders should be up front about the financial/investor makeup of the company.
I got my options agreement which said I was entitled to N options at P price. No other information was provided, so not sure how I'm supposed to value them other than $0.
I assume that the options are intended for people that are bad at math.
>I assume that the options are intended for people that are bad at math.
It does appear to be a way to get employees for cheaper than market rates by taking advantage of an arbitrage in employee lack of understand of the financial and legal issues concerning stocks.
It's not about what one "deserves", it's about protecting infant startups from high turnover. One year is extremely high, potentially fatal turnover rate for companies with <30 employees.
"It's not about what one "deserves", it's about protecting infant startups from high turnover."
Why should any of us care about that? High turnover is a very good signal that the company is a bad one. If the company dies because of it, it was probably for a good reason.
It is only a good signal currently, because in order to voluntarily leave the employee would have to give up their options. That means they're really unhappy and don't believe in the company.
However if you change it so that early stage employees can take their options with them, then it becomes a question of "do I triple down on this one company or do I spread myself out over three." And most investment advisors will tell you to diversify your portfolio. So there is a real risk that this will lead to high turnover, even among happy employees.
That investment advice is for when you don't have inside information. Presumably for teams of fewer than 30 employees most employees should have a good idea of the financials and a lot of knowledge about company performance.
I don't buy that. Maybe one or two people will, but the vast majority of people won't. If they're happy, they're not going to want to risk that by going to a new company where they might be miserable, unless they're severely underpaid and are getting a huge pay bump.
There is a huge financial incentive in the form of diversification. You'll own stock in 3 potential unicorns instead of 1, tripling your chances of getting rich.
Because it's early stage, even just one year's vesting is enough to get you rich if the company makes it. So do you stay and triple down on one stock or spread it out? Especially when equity is such a large component of your compensation at that stage of company? Investment diversification is a rational economic decision that a lot of smart people will make.
The current system forces teams to stick together until IPO/acquisition, maximizing the chances of the options ever being worth something. It should be made more explicit, but it's not necessarily a bad thing (for employee options holders who want them to be worth something).
There are (few) people who do this today. They find angel-level companies as a contractor, get paid in stock + a little bit of cash upfront and do about 10 companies a year. It's the employee equivalent of angel investing. SV law firms do a form of this too.
I can't do something like that due to immigration, but I envy the flexibility.
No. You are vastly overestimating this "diversification" thing. We're not talking about a portfolio here, we're talking about someone's day job. Most people are not going to want to job hop that often unless they hit upon a string of really crappy companies.
And quite frankly, you're basically saying that the company should not have to compete for employees. Which is such an absolute shit of an opinion that I can't even begin to tell you why.
When 20-50% of your compensation is stock then absolutely diversification becomes a consideration. While you may consider it a "day job" separate from "a portfolio", smarter economic actors may see otherwise.
If you remove all financial incentives to stay after hitting a one year cliff there is a pretty strong force towards diversification that seems like it would lead to higher than desirable turnover. You can't just ignore that incentive.
The financial incentive to stay is continued vesting of presumably more-valuable options, about which you have inside knowledge -- the state of development, the sales pipeline, high performance from founders, a deeper understanding of the industry, etc. It doesn't take much job hunting to realize as an employee you're taking a bigger risk than the company. There's some crazy people out there and some really terrible bosses. The same way it's really difficult to evaluate an employee in an interview it's just as hard to evaluate a working environment, a boss, whether the ceo is a meddler with the attention span of a hummingbird, etc. A sane boss with a solid development process that doesn't encourage late nights or lead to incredibly fragile software and/or heroic, stressful ops efforts is worth a hell of a lot.
You just want to leverage golden handcuffs to retain employees... I think honesty all around is the best method. Unfortunately, that further devalues the (already low imo / in my advice) value of options and suggests people are much better off going to established companies.
If the company is more valuable a year later, with good prospects, then the size of the low price of the original grant (which will now vest monthly via standard terms) provide an incentive for staying. So could an additional performance grant, or salary increase.
I guess people hate this idea. But it'll probably only hurt a few founders, who would have been losers anyway; VCs and employees will ultimately be better off.
TBH, many resumes have people who change companies every year or two. It's pretty rare to find a resume where someone stays at a company for many years unless they have a very good reason to.
Would you feel okay with an employment contract like this: "Your salary is $150k, but if you leave in less than ten years there will be a fee of $50k/yr."
That'll lock them to the company, too, and prevent turnover.
Really? How about early startups protect themselves by treating employees fairly and not trying to lock them in with equity tricks many don’t understand. The fact you suggest this course seems to indicate a certain level of disdain for employees. Try the carrot, not the stick.
Yes, IMO, this is added protection against turnover. The main protection any startup has against turnover is whether founders treat employees fairly and honestly, whether founders foster an environment where employees are valued, empowered and have a strong sense of identity.
This puts a stop to giving something then taking it back because of legal fine print you didn't read when you signed up all starry-eyed. If it's happened to you, the first time it stings a little when you want to take advantage and can't, and leaves the impression that you got tricked, then after that, you get just a little bit jaded. By agreeing to stick by your word that stock is part of the compensation package, you build trust.
Anyway, vesting schedules are already the main contractual level protection a startup has against turnover. Betting on three teams takes, at a minimum, three years. And then you're just trading options at one company for another. Might be a good bet, might not, but this doesn't change that equation at all, right? If you want to move around to collect different stocks, go for it.
It absolutely changes the equation. Ask an investment advisor whether you should put all your money in one stock or diversify your portfolio. What will she say?
Pre-IPO startups have had an added protection against this turnover pressure, which is actually stronger than vesting. It forces teams to stick together until IPO/acquisition. This change would now be taking away. Worth thinking through the consequences, because if startup turnover shoots up then nobody benefits, most of all stock option holders.
I meant that having a 10 year window vs a 90 day window for exercising options doesn't change the reasons to decide whether to diversify, not that you should or shouldn't diversify. The question of whether to diversify is independent of the terms on your options.
I'm not sure I understand- you're saying the 90 day exercise window is a stronger anti-turnaround measure than the vesting cliff? How so? The vesting cliff says you don't get anything unless you stick around, usually for a year, and you don't get it all until four years. Or 3 or 5, whatever. That's a pretty strong anti-turnaround measure. The exercise window doesn't automatically prevent anything, as long as you can afford it, you can walk away and still buy your stock. Some people buy their stocks and some don't, so if you're a pre-IPO startup, the vesting schedule adds a deterrent to leaving 100% of the time, and the 90 day exercise window adds a deterrent to leaving less than 100% of the time. Don't forget you can buy as much stock as you can afford, when you have the option, but if you don't have the option in the first place, you get nada.
I do appreciate your stopping to examine any possible unintended consequences, btw, I just don't forsee this causing any problems with turnaround. And it seems like it does solve a real problem with claiming options are part of compensation and then making it harder to realize any benefit. I do honestly believe this could help lower turnaround overall.
> you're saying the 90 day exercise window is a stronger anti-turnaround measure than the vesting cliff? How so?
Because practically nobody could utilize that exercise window pre-IPO so it functioned essentially as an "IPO/acquisition cliff" on top of the regular vesting schedule.
Do you see what I mean? If you leave before IPO/acquisition you lose your options. Not after 1 or 2 years, but however many years it takes to get to that point of maturity. You have to stick together as a team to make it there.
That's bad when companies get to, say, Pinterest or Uber levels and push off their IPO, and that's what needs fixing. But we should be extremely careful about overcorrecting in a manner that hurts vulnerable early stage startups, where the financial logic of leaving to diversify options is strong. Why triple down on one high-risk stock when you can move after a year and diversify your holdings? That kind of logic applied on a large scale could kill small startups which can't handle that kind of rotation. You have to have added incentive at the baby stage to stay and grow the company to maturity.
So? Stock options are a form of compensation. If I vested those options, then I deserve to keep them. If a startup can't otherwise retain people, it has bigger problems.
I am not your indentured servant, no matter how much you wish me to be.
Employees of seed stage startups who have typical option grants can already hop around once they reach the 1 year cliff, since at the seed stage, the strike price is small and the valuation increase won't be substantial. You're maybe out of pocket $X00~$X000, which is a small fraction of one's base salary.
Since both the 90 day exercise window form of the options and this 10 year exercise window form of the options will both have the 1 year cliff until first vest, the ability to hop around is roughly equal for both.
Agreed... why not find a way to allow employees to get liquidity by selling their equity as part of funding rounds?
The fact that founders sometimes are able to participate seems to imply that it's a possibility for regular employees too if the appropriate legal docs were standardized.
Could high turnover in infancy stage startups be addressed by instead of giving 10 years from grant date you give 'time employed' from leaving date? Better than the current 90 days but still gives incentive to stay with a company for a reasonable length of time.
We're excited to make 10 years the new standard option exercise window for startup employees. Each of us have personally experienced someone close to us dealing with the stress of trying to exercise their options within 90 days and it sucks.
We'd like to see more companies making this change, we'll be keeping the public list of YC companies who have either implemented or pledged to implement an extended window, updated here: https://triplebyte.com/ycombinator-startups/extended-options
Hey harj! The article and plan is really interesting. I wanted to read more of the details and comparisons, but it seems the link from the sentence "We’ve created a summary of the gory details on both the business and legal aspects here" just brings you to the triplebyte homepage. Do you happen to have a direct link to that page?
I'm just reading the docs now and I am probably not understanding how they work, but it seems to say that employees have 3 years from the termination date, not 10 years as you mention. I'm assuming I'm misunderstanding how this works.
I dont understand these things much but I think encouraging employees to exercise their options as early as possible is better thing to do when the value of those stocks is dirt cheap.
Am I correct in reading the blog post that there are no downsides to having 10-year options?
> As Sam Altman wrote, this is an unfair situation and needs to be fixed.
And Ben Horowitz criticized his stance and Sam said he would be rethinking the way he communicated his position. Was that ever taken into consideration?
While this would be great, I'd personally like to see the tax code change - being taxed on the "value" of something you can't realize, and my NEVER realize, is crazy.
Most of the time I've been at a startup as a founder/early employee, the strike price was low enough that I'd be willing to take a roll of the dice and just exercise, if I was going to leave. It's usually 10's of thousands of dollars.
By the time I started vesting a fair amount, the TAX on that was non-trivial - 100's of thousands if not more. Something I personally can't really do.
Sorry but this doesn't fix it, it just delays the inevitable.
The main problem is that startups are offering options instead of restricted commmon stock. That means the new hire is paying for stock as an investment. That's not a benefit at all.
I have talked at length elsewhere on HN [1] about the system we use to give employees actual common shares, at current strike price, and delay any taxes until exercise so they have zero out of pocket expenses until they have to pay taxes (usually only capital gains).
Does anybody know of a startup where common stock is issued right away (or let's say after a probation period), and then the employee issues options back to the startup, which expire at fixed intervals corresponding to the vesting schedule?
For an early startup, this would mean when there is a liquidity event, almost all of the gain would be capital gains.
In Canada, it would be even better: people can defer taxes on stock and option grants until disposition (sale/bankruptcy). And the stock could be placed in a registered (i.e. tax-sheltered) account.
Early startups can do this. The problem for larger (valuable) startups is that the grant of stock would be taxed (as income). Options get around this. (The tax law makes the rather dubious claim that options granted at the market value of the company have zero value.)
The main tax benefit of options is that you don't have to pay taxes until you exercise them (convert them into real stock). So even if you get the options at a discount then you don't have to pay until you want to convert them / cash them in (i.e. cost to exercise is $15 and the value per share when they are granted is $20).
You can do stock grants with repurchase rights (which essentially vest); this is how founders usually get THEIR shares.
I see no reason not to do this for every employee in the first year or pre-Series A at a startup; the tax consequences of a grant of common stock are minimal when the common stock is worth little. We did this at a startup where I worked in 2007. I'd do it in the future. (the one "downside" is that people who have vested become real shareholders, which can trigger some information/reporting rights, but you'd have a very small number of people pre-A, and I'm pro information transparency.)
The other thing which would be interesting to me: startups offering shares via their own 401k.
Many early stage startups will use early exercise options with a clawback mechanism.
After the 409a valuation of the startup gets too high, this option becomes much harder for employees, which is why you don't generally see it outside of the earliest stages.
> After the 409a valuation of the startup gets too high, this option becomes much harder for employees
(Disclaimer: I am not a lawyer, not your lawyer, this is not legal/tax advice, etc.)
As I understand it, it's not just the valuation, but also the tax implications. If the options (as granted) are worth more than a certain threshold (~$100K), you can't early-exercise them without losing ISO tax treatment on the value in excess of the $100K threshold. This threshold is on an annual basis, so not exercising them early means that you quadruple[0] the amount that will be eligible AMT (which is preferable to ordinary income tax).
[0] Assuming the standard vesting schedule, in which 1/4 of the shares are made available each year
>and then the employee issues options back to the startup
In effect, yes. When the employee purchases the stock, they sign a contract to sell their stock back to the company (with the number of shares to be sold left blank). Their vesting schedule establishes how the number of shares that the company is allowed to repurchase decreases with time, normally with a 'cliff', which removes the need for a probation period.
Yes. This is almost exactly what we do, but it's not an option that the employee is issuing it's a promissory note that is collateralized with the shares.
I've personally had to deal with these decisions and know many friends who struggled with figuring out how they could possibly pay for exercising their vested shares, in some cases after they were laid off and had no choice in the timing.
If I were getting a job, I'd only consider offers with extended exercise windows. If they combined it with a more back-loaded vesting schedule [1], I wouldn't mind and would evaluate that. But dealing with the 90 day exercise window is black and white: it isn't worth all the potential trouble and risk you can be forced to take on.
1: 20%/20%/30%/30% instead of 25%/25%/25%/25%, or 6 years instead of 4 years
Does it really matter that much? If you're a first-50 employee, then maybe your shares will be worth a decent amount of money, but your exercise price will be very low (most likely). If you're not a first-50, your options probably won't be worth all that much anyways--is it really worth discarding working for a company based entirely on your exit strategy?
If the stock has appreciated in value, your exercise price may be low but your AMT bill may be high even if you have no liquidity at all. In my case I paid more in AMT than I did to exercise all my shares, though both individually were large and incredibly risky investments.
I could afford the risk and it did eventually work out for me, but some people can't afford the risk or frankly don't want to deal with the incredible complication of doing it. Just trying to figure out what your AMT bill might be involves doing your entire tax return based on projections, which depending on what time of year you are leaving could introduce quite a bit of inaccuracy and guesswork.
If you have an extended exercise window you just don't have to worry about it. If you want to take the risk of early exercise to get better tax treatment, do it. But if you don't (which I suspect will be the majority of people), all of the complication goes away completely... just sit on your options and exercise-and-sell when/if you get a chance at liquidity.
On the other hand, converting your options to NQSO means that you pay income tax on the spread at the time of conversion. This sucks equally badly in the situation you've described: you're stuck with a big tax bill, at your income tax rates, based on fictional income.
The only good option (pardon the pun) here is to allow your employees to early exercise.
It's not just the exercise price... it's the taxes on the illiquid gains that really fsck you! Eg. you're granted $100k in options over four years. You want to depart the company now, when the shares are worth 100x. You pay your $100k to the company to exercise, but now you also owe taxes on $9.9M in gains -- and you can't sell any of that stock to pay the $3.3M in taxes to the IRS.
With a 10-year option, hopefully the company gets (or can offer) some liquidity to help you pay the IRS when you exercise later.
I was employee # ~45,000 and my stock options were still worth ~$400K. Not exactly a startup, but startup employees stand to gain even more.
Stock compensation benefits anyone who holds stock in a company that grows unexpectedly. The meme that it's worthless is because many startups don't actually grow. However, if the company isn't growing, why are you even working there?
Unless I'm mistaken, even if your exercise price is low, you may still owe a crapton (technical term) in taxes if the company has a high enough valuation.
As much noise as I hear about this, it's not really that simple. In my estimation, lengthening the exercise window just ensures that dilution will happen faster. If you have 5% of a company locked up by people who no longer work there, you have to find a way to reward current employees. Sure, cash is one way, but it might be easier to issue more stock, most likely of a different class. It might sound good on paper, but ultimately I really don't think this (edited: "this" = extending the window) will have any real positive impact for employees leaving the company.
> If you have 5% of a company locked up by people who no longer work there, you have to find a way to reward current employees
We need to get past this line of thinking. Why do companies not say the same thing for the salaries they've paid former employees? "Boy, I wish we could get back the $30,000 we paid Bob between July 2011 and October 2011."
We don't say that because the employee earned that and once they've earned it, it's out of your account and into theirs. Stock, though a different mechanism, needs to be thought of the same way. If someone has worked there long enough to vest that stock, they should have the option available to own that stock. Just because they made the company successful enough to not be able to afford to exercise their options in time doesn't mean we should take that possibility away from them.
Whether or not it was intended years ago when it became a norm, the 90 day exercise window, at this point, is a surrogate mechanism for companies to steal compensation from employees after the fact. That's horrible.
Sure it will. Keeping options is strictly better (for the employee) than not keeping options. Vested options are compensation for work that has been done. Everything you say can be true, but that does not mean that companies should not let their employees keep their options.
Next up (and the harder problem imo) is for companies to feel like they have enough leverage vs investors (mainly institutional VC) that they can be "nonstandard" in their option contracts (particularly during seed and A rounds). It's no coincidence that the companies that have taken the lead on this front are the startup darlings and/or repeat founders who have considerable leverage against funders (including YC companies, since their cred boost makes being nonstandard much easier than those without the brand).
We've made huge progress in that direction over the last 5 years as ZIRP made money cheap (and since the main leverage investors have against companies is the scarcity of funding, their leverage has decreased dramatically since the 80's). But as the funding mania crescendo of 2015 has passed, ZIRP is being wound down, and as private and public market valuations of small young tech companies plummet, I am not sure if that trend will continue into the future.
If there is one cohort that can band together to change the status quo, right now, that would be the YC companies. I am hopeful that enough momentum can be built over the next small handful of years by these companies so that "what is normal" can change permanently.
I understand the Fed moved the overnight rate up to 25 basis points. It isn't going to last. Rates are going to stay low for the foreseeable future for a laundry list of macro economic reasons -- the easiest to cover is the USA cannot afford to raise rates as it will increase the global consolidation of capital in the US causing severe issues for EU and AP regional (bond primarily) markets. The yield of the 10 year Treasury should show that money is still flooding in and it is still hard to find quality returns: https://ycharts.com/indicators/10_year_treasury_rate
This is great! I hope this becomes the new norm for all new startups. If a start-up doesn't want to follow this then it really shows the values founders believe in and the kind of company they want to build.
Is this kind of plan unpopular with VCs; shark and Gordon Gekko ilk?
Slightly off-topic: The title made me wonder if it was going to be about the vast difference in equity grants between founders and employees (oh well).
But back on topic, harj et al. what's your opinion of Restricted Stock for early employees? I believe the issue is just that granting Restricted Stock once the company / share valuation is high enough is a definite tax impact. But it seems like nearly every pre-Series-A company could give the early employees 100% Restricked Stock. Is there some reason I'm missing that this never seems to happen?
Edit: s/RSUs/Restricted Stock/ since that's what I actually mean (the weirdness of RSUs remains funny).
If you are starting at a pre-Series-A company you are probably much better off getting options (that you early exercise) instead of RSUs to get cap gains tax treatment.
Ya. That's prolly a good idea in many cases. You just have to be careful that the FMV doesn't climb too high, and employees correctly handle their 83b paperwork or there will be tax problems.
Honestly I suspect this is why it isn't more standard. It's kind of a pain in the ass to get right. Options are just easier.
@Harjeet thanks for writing this up and putting the work into.
Imo our industry needs this. Atm there is very little incentive for experienced people to join early stage start-ups as non-founders vs starting their own thing. Tikhon summarized this quite well: https://medium.com/@tikhon/founders-it-s-not-1990-stop-treat...
Making options more employee friendly by default in our industry is an important & good first step!
@harj - How do you feel about granting cash bonuses to employees at pre-determined intervals to cover the tax cost of exercising their options? It seems like that would solve a lot of these issues, but also give the employee the flexibility to keep a small amount of cash if they'd prefer that over the risk of owning stock.
An example: I join a $5,000,000 Series A startup with a 1% equity grant that vests evenly over four years. At the end of each year, I get a $5000 bonus for the purpose of paying taxes on exercised options. It's a bit more than the tax cost for the first year, and likely a bit less in the later years, but after 4 years I've been given $20,000 which should be enough to cover most of the tax burden. If I leave at the end, I still have a 90 day window to exercise them and the money in the bank to do so. I could just keep the cash, exercise them at the end, or exercise them for a cheaper cost each year.
That doesn't seem too unreasonable for post Series-A startups cost wise. An extra 5k a year is nothing compared to the cost of a developer overall.
How about this - the company agrees to purchase And give to the employee any options that are vested and un-exercised for two years and agrees to cooperate w a declared set of known secondary buyers. Employees are on their own for the taxes and can always decline.
* It extends the retention effect of equity since it starts kicking in at year 3 and extends smoothly forward.
* It has no cash impact on the company since its buying the shares from itself.
* In the early years the tax impact should be minimal. In later years there should be secondary buyers who can give employees enough cash to cover the tax liability at the cost of offering a discount.
* It discourages the pure lottery players since it requires the employee to either cover the tax burden or engage a secondary firm and deal w the discount they require.
* The downside for the company (aside from increased dilution vs the status quo) is that it establishes a clear market price for common equity which can be disadvantageous.
It scares me that this could be used to justify stock options as having a value other than $0, and could be used to drive down real actual cash money salaries. I'm fine with the current situation because I have no plan to act on the options anyways - I don't invest in lottery tickets either.
If you believe that the stock options of the startup you're at are worth $0, you should just ask for a market salary with 0 equity. Many companies will give you a sliding scale of cash / equity.
As I understand it the major problem is that engineers need a lot of cash to get even more cash if they exit the company and need it in 90 days. Possibly very naive question...couldn't you include a clause along the following line in your funding round(s): "Investor X guarantees that they will offer to cover the necessary cost to exercise all options in return for Y%".
So basically if engineer A leaves and could exercise options the investor must offer a "bridge loan" with guaranteed ROI (either cash or just keep the equivalent options).
Good investors shouldn't mind this clause that much (I'd think) as it takes away one major point of worry for engineers and lets them concentrate on their job from day 0.
"Many employees don’t have the money to exercise their options within such a short window and lose them."
Sounds like an excellent opportunity for a business. Providing short term loans, taking x% or the exercised options. Although I am not familiar with US laws that cover this area.
I really doubt whether that would work. The loans aren't necessarily "short term", as the term is pretty much not known, the shares are the lowest on the totem pole when it comes to payout and you have absolutely no control over the company. That's a lot of risk, and if the cost of exercising options is so high as to be difficult, the shares probably don't have the upside that might be required to make it work.
My bad, misunderstood the nature of these type of options. I was making the assumption that the options could be exercised and then sold straight away. Eg, employee has option to buy during this window at a strike of 1.1, current value 1.3. I presumed the issue was raising the initial (options x preferred price) cash plus any taxes/fees involved.
I believe most companies whose stock is publicly traded provide this for their employees. If you have stock in, say, Google, when your stock vests, you can have it sold and take the difference directly--no loan needed. I've never done such a thing, so it's only hearsay on my part, but that's how I've understood it to be.
It's called a cashless exercise. You exercise and sell the stock right away so you don't need to have the money to buy.
However the problem is most startups in this case are not liquid so you cannot sell your shares (with some exceptions). Google and other public companies give you direct shares via RSUs since they can sell part of your shares to cover the taxes.
Does having a bunch of vested, 10-year-window options on the books of a startup affect its valuation? Would a potential buyer look at that and think "That's a liability!"?
For 30(?) years since the invention of stock options there has also been a de facto added protection against high turnover in infancy-stage startups, where having to rehire and retrain employees is extremely costly. Pre-IPO you basically had to pick a team and take it to that level of maturity before you could leave. You couldn't hop around seed-level startups without giving up your options, usually.
What's changed now is startups are staying private longer, leading to unfair scenarios. E.g. you're at a >$1B company with >100 employees for 6 years and you still lose your options. Traditionally a company would have gone public by that time, but now it's not, so we need a fix.
But if you overcorrect and now eliminate that added protections for younger startups, you risk creating an incentive to leave companies just for the sake of options portfolio diversification. Why bet on one team when you can bet on three, since even 1/3rd of a unicorn that makes it is worth more than 100% of the one that doesn't. And that individual decision leads to higher turnover which can kill infant startups.
Bottom line this fix should be more carefully targeted at what has changed to exacerbate unfair situations, namely startups that have reached "should be public" levels of maturity, yet are still staying private.