
Employee Equity - dko
http://blog.samaltman.com/employee-equity
======
jstrate
I've worked at two startups, including one YC. Both were acquired by larger
tech companies. I was employee #3 at one and rebuilt most of a broken codebase
in the other. I got nothing out of either WRT options. I agree with the author
on point 4 but I don't think more options are the answer, I should have just
asked for a higher salary I would have been better off. Startup-bucks are even
worse than a lottery ticket, because of tax complications and money required
to cover strike price.

Now I work at a large tech company in SV and wont be involved in another
startup unless I'm a founder.

~~~
marvin
Has anyone stopped to think what a massive failing of the startup part of the
industry this is? Practically everything I read online indicates that if you
consider your stock options to have any value at all even in a moderately
successful company, you are a major sucker and about to get exploited.

Surely this must reduce the quality of the talent pool available to new
startups, as the experienced developers conclude that other options are a
better use of their time.

~~~
apinstein
We came to this conclusion as well; we decided to do bonuses based on Y/Y
revenue growth rather than equity. The bonuses are not capped.

This allows us to:

1) Justly reward our employees to the upside (with cash, delivered semi-
anually) if things go according to plan

2) Automatically controls costs if we don't perform as a team

3) Achieve upside fairness across early vs late employees since we can adjust
the bonus % as we hire each new person

4) Eliminates oddities due to variations in company valuations where swaths of
employees end up underwater due to bad luck of timing

Downsides:

1) the tax treatment of bonuses as income rather than capital gains is
nominally worse; but given the complications with options, it probably works
out better for all but HUGE equity gains

2) this plan might not work well for a company that will be pre-revenue for
many years, but that should be a pretty far outlier case.

All-in-all this allows us to offer the opportunity for employees to earn
above-market comp without having hope they get lucky with company growth,
market timing, and their timing of joining the company.

It's been 3 years now and so far, so good!

~~~
lukego
Cool :-).

I worked at a very successful company that used a similar model: flat 50% of
profits paid to employees as bonus. This worked fantastically well in the
short term. Now, 10 years later, the company is still very successful but the
upside has all shifted to the owners due to departures, renegotiations, and
new hires not getting the same terms. So at 3 years it looked very pro-
employee but at 10 years it looks very pro-owner.

Would have been really "interesting" if there had been a liquidity event...

~~~
trevelyan
The owners stuck around. Why didn't the employees? Serious question... were
people fired for having too remunerative packages? Or did people just move on
mostly?

~~~
lukego
Many people just moved on over time for non-monetary reasons.

------
philovivero
I worked as one of the very early founders of Digg. I bought my options.
Obviously they're worth nothing, yet I owe the IRS about $120k. This threatens
to destroy all my savings, retirement, and credit for 10 years.

ISOs are not only worthless 95% of the time, they're also actively EXTREMELY
DANGEROUS 50% of the time if they're not simply worthless.

My suggestion: get a salary, and buy just-IPO'd stocks from companies you
believe in.

If you find yourself ready to buy some ISOs, I further recommend you
IMMEDIATELY sell them, as in have the buyer sitting there with you as you
purchase the ISOs, and do the trade instantly thereafter. Take the short term
capital gains hit. Do not hold onto them no matter what any CPA or tax
attorney tells you unless they can talk at length about ISO+AMT Tax Trap and
assure you you cannot possibly have that happen to you.

~~~
otterley
Don't you get to credit AMT charged against worthless ISOs in later tax years?

------
x0x0

       The best solution I have heard is from Adam D’Angelo at Quora.  The idea is 
       to grant options that are exercisable for 10 years from the grant date, 
       which should cover nearly all cases 
    

That is an awesome idea, and really classy on Adam's part.

~~~
lettergram
I think 180 - 365 days seems far more reasonable. It's ridiculous to have the
company shares tied up with the inability to give them back to other
employees.

~~~
x0x0
And that's why options are (mostly) a scam. If you leave before a liquidity
event for any reason (they may not come, they take a long time, life
circumstances, poor career growth, employers like to give shitty raises),
you're stuck either investing often tens of thousands of dollars into an
illiquid investment while paying taxes on it right now, or giving up your
options. Sweet deal for employers either way. So when they hand out those
option grants they probably get to apply a 50% discount or more to exercise.

Not to mention employers often try to avoid even telling employees what
fraction of the total company their options represent, and definitely don't
care to share their participation multiples. They're often very happy to let
you think that in the case if a liquidation event, you get (exit amount) *
(your ownership fraction) which just isn't true.

@apta: see [1] for a numerical example. You get taxed twice (or three times if
someone is stupid) on typical ISOs:

1 - on grant, if the strike is less than the fmv (there are huge tax penalties
for this, both for you and your employer, so it oughtn't happen)

2 - on exercise when you convert the option to a stock, on the spread between
fmv and strike (but probably amt, depending on the type of option; it's mildly
complicated)

3 - on sale of the stock, on the spread between the sale price and your basis

[1]
[https://news.ycombinator.com/item?id=7611512](https://news.ycombinator.com/item?id=7611512)

~~~
apta
> you're stuck either investing often tens of thousands of dollars into an
> illiquid investment while paying taxes on it right now

I am not really familiar about this area. It is a one time price to pay to
purchase the stock options, is that correct? Furthermore, where does tax come
into play? Don't you only get taxed if you decide to sell the stocks to
generate income?

~~~
zminjie
From how I understand it, when you decide to exercise your options (pay the
strike price), you owe taxes on the different between your strike price and
current fair market value even if you don't sell the stock. Most of the time,
this counts as AMT (Alternative Minimum Tax) if you don't sell the stocks
within the same tax year.

~~~
encoderer
You have to report the "paper capital gains" for AMT purposes but that doesn't
necessarily subject you to paying the AMT. And if it does, you will at least
get AMT credits you can apply towards future tax years.

------
birken
The problem with the 10%/20%/30%/40% thing is that if the company shoots way
up in value, an employee could theoretically be fired after two years and not
capture much of the value they helped to create. It also doesn't necessarily
need to be malicious [1], sometimes companies change and a person's skills
aren't as valuable anymore.

If I were a prospective employee I would never take a deal like this, because
it is really difficult to have that much trust in a company and founders that
you likely don't know that much about. I can't say the standard 4-year vest
with a 1-year cliff is the most optimal situation, but from an employee
perspective it is way better than 10/20/30/40.

1: Though it could be, I know there was a story about something happened at
Zygna like this

~~~
brudgers
The scenario is little different from any other where someone lacks a
controlling interest. Controlling interests can sell the company to another
company they control at a price that suits their interests. They can issue
shares to dilute equity and use the shares to acquire a company which they
also control. Any legal action agaist such practices can be defended on the
company's dime.

In other words, if scumbags control the company, scumbags control the company.
Fortunately, most people aren't scumbags.

~~~
kamaal
>>Fortunately, most people aren't scumbags.

No one is.

But money changes things. Let's there are two best friends, you offer the
first person some money to back stab the other. The guy may not agree. However
keep raising the offer and at some point of time when the figure hits a
$X0/$X00 million I bet the guy's intentions will change.

Every one sells, its just the number that differs.

~~~
hga
No, some people _are_ "scumbags". I once worked for a company that suddenly
ran out of it's startup money source and was forced to do a deal with a couple
of "angel" investors ... who turned out to be devils.

They wrote into the agreement certain metrics that the company would have to
meet after launch, and did everything they could to prevent it reaching those,
e.g. firing the guy would would have made the sales, our multi-talented lawyer
stepped up and made them. When Kleiner Perkins, who's connections could have
been a make or break for the company, cold called us, these devils blew them
off.

Their attitude was they'd rather have 100% of nothing (well, they probably
thought it would have been something), and the company essentially died when
13 of us resigned _en masse_ from the CEO down to all but one most junior
engineer. (And then we had to go to the state to get our back pay for that
partial pay period.)

I was in some of the last minute, try to save things face to face
negotiations; these guys were _malevolent_. Not sure how they achieved net
worths of 100 million and 500 million, but if they retained any control, they
sure didn't use that money for good.

------
andrewfong
I've been thinking of putting together something simple to analyze employee
option paperwork and add some plain English annotations to help employees
understand exactly what they're signing. Based on my experience, there's
something like 5 or so templates that cover 90% of the startups in the valley,
so shouldn't be too hard. Is there any interest in something like this?

~~~
jacobheller
We at Casetext are interested in this space as well. Our annotations
technology will undergo some major improvements in the near future, but even
the way they are today may be sufficient to meet your needs. Hit me up (jake
at casetext.com) if you want to work together to make this a reality. Here's
an example of what docs look like on Casetext now:
[https://casetext.com/contract/simple-agreement-for-future-
eq...](https://casetext.com/contract/simple-agreement-for-future-equity)

------
sparkzilla
As a founder I looked into paying vendors/employees with options, but have
found they are too brittle. Because option deals are created at the start of
employment they require a lot of faith on the part of the founder, who does
not know the employee's abilities or temperament. Options do not track well
with performance and cannot be adjusted easily. I also do not want to be in
the position of considering terminating an employee because they have more
options than what I think they are worth, and employees should not have that
fear either.

Instead I am working on giving vendors and employees a convertible note that
is based on their performance month-by-month. Let's say an employee or vendor
is taking $5000/month less than they should be because it's a startup. The
company credits them $5000 to their note each month (this can be more if
there's a risk premium), and adds any performance bonuses as well as they come
up. This lets management clearly track performance against the shares they are
giving, and lets the employee know that if they work more they can get more.
As time goes on the value of the note increases and the employee can converts
their note to shares at the current valuation (or a discounted valuation).

This seems a lot more flexible to me than options, and is less stressful for
the founder and the employee. Am I missing something?

------
skrebbel
Completely off topic, but I'm this post made me realise that Sam Altman went
from programmer to enterpreneur to financial guy. This post has _very_ little
ado with what he once started doing. He's a partner (and president) of an
investment fund now, a pretty odd career move once you take the pink Silicon
Valley glasses off.

This entire post is about finance. Not about business, not about products, not
about customers, just finance. Personally, I understand just about half of the
entire post.

To be clear, I don't think this is a bad thing. I envy Altman for
understanding this (and for _running YC_ at an age younger than mine, but
that's another thing). But that's not my point. What I wonder about, is
whether this is inevitable for successful enterpreneurs.

Is the path programmer->enterpreneur->finance the obvious one? Sam's path
might've been odd, given that his startup wasn't the next Facebook, but you
see the same in startups that _are_ the next Facebook, such as Facebook.
Zuckerberg used to be a PHP hacker and now he's this NASDAQ CEO. I'm not sure
about Drew Houston but all I read about Dropbox recently were acquisitions.

Does growing business make you a finance guy, or do you need to be somewhat of
a finance guy to grow a business? I'm really curious which is the chicken and
which is the egg here.

~~~
UweSchmidt
I was half-expecting him to advocate a "less equity for employees" stance
since, superficially, don't investors already compete with founders for
percentages?

Of course it makes sense on a higher level, e.g. when wanting startups to be
desirable workplaces, or wishing for their own ecosystem to be a fair place
etc.

So, maybe not your average "financial guy"...

~~~
benhamner
There's several factors that make this irrelevant.

1) YC's incentives look very different from VC's: they get common shares, not
preferred. This means their incentives are more aligned with the founders than
with future investors (for example, if a VC has a controlling stake in the
company & wants to fire the founder and dilute the common shares to basically
nothing, then YC gets similarly diluted).

2) The dilution effect of the option pool on YC's shares is trumped by the
dilution effect of future investments on YC's shares. If expanding the option
pool has a marginal dilution affect but dramatically increases the likelihood
of success, then that's a no-brainer for YC to push for.

3) YC's business model is dominated by the extreme outlier successes (e.g.
Dropbox, AirBnb). Thus, YC does better by doing these three things better:

A. Increasing the likelihood that future successes are funded by YC (i.e. the
founding team chooses YC early on)

B. Increasing the probability that a startup will become an outlier success.

C. Given that a startup is becoming an outlier success, multiply that success
to the extent possible.

This piece hits nicely at each of those points. For A, YC takes a leadership
role in how to structure a cap table, making founders look more to YC. Also,
YC startup employees (ie future YC founders) think better of YC. For B and C,
once a company grows beyond the founders, each employee makes very meaningful
decisions on a daily basis that impact both the company's likelihood of
success and magnitude of success. Aligning these employee's motivations with
the company's further helps make these decisions better for the company.

------
diziet
It's quite difficult to compete with Google and their revenue/cash hordes when
it comes to salary / total comp. Especially if you price the options at the
last round's price and discount them some more.

Imagine a well to do company of 2 founders (in SF/Bay Area) and a team of 3-4
others that raised a seed at 10m cap. They want to grow their team headcount
to 15 and are busy hiring, running servers, etc. They can offer a 100k salary
(more than enough to live on) to a sort of senior engineer or PM and want to
compete with Google on total comp. Let's say they need to make up the other
100k difference in comp & salary with options. Over 4 years, you're looking at
a 4% equity chunk to one employee, the 6th person joining the company.

Not that I think numbers in line with this aren't realistic (I do agree with
Sam that more generous equity grants are better), but for most companies that
make a 15% option chunk for employees it's difficult to rationalize a number
like that.

Edit: Also, that puts the equity comp of that 6th employee (or 10th, because
in most cases you will have a similar equity bracket for those people) at
about 1/8th of the founders, not the 1/200th that Sam mentioned. I wonder how
many people have made offers to employees with a similar comp plan.

~~~
keithwarren
100K is not more than enough to live on, if you live in the Valley and have a
family (say 3 kids) then 100K barely buys you a comfortable lifestyle. I know
that is not the point of this thread but so much focus of these discussions
seems to pivot around a 22 year old college dropout who lives with roommates
in a shared apartment.

When you reach a certain point, say your mid-30s and you have kids your
financial obligations can extend far beyond what people think is necessary to
'live on'. You have retirement contributions, savings for college, long term
care for family (most people believe it or not, have to help their parents out
at some point).

~~~
ska
And that's why in the latter case, an early stage startup may not be for you.
You join later, with a higher salary, when it has stabilized and looks to be
going somewhere. And without the risk, you don't expect the equity to offset
it. Pretty simple, really.

~~~
Iftheshoefits
An equity offering of 1-5% doesn't offset the reduced salary. That equity
typically doesn't imbue the recipient with the same authority as the founders'
equity imbues them. Yet, for example, Hire #1 in a two-founder startup is
pretty darn close to sharing 1/3 rd of the risk as the founders. It's just
that his risk is assumed to be amortized over the term of his tenure and
slightly reduced by a salary, so it has the _appearance_ of being
significantly less than it really is, even though neither component of that
assumption is valid.

~~~
paulbaumgart
Being able to raise a seed round is a non-trivial hurdle and is not something
most engineers can do. Compensation isn't really about risk (which is low for
everyone involved given the current employment market), it's about value and
opportunity cost.

------
mikepurvis
I'm curious about this bit:

"It causes considerable problems for companies when employees sell their stock
or options, or pledge them against a loan, or design any other transaction
where they agree to potentially let someone else have their shares or proceeds
from their shares in the future in exchange for money today."

What are the problems with these schemes? I'm presently employee #1 at a
startup, and 99.9% of my present net worth is tied up in illiquid paper
there—the rest is a 10 year old station wagon and some Ikea furniture.

I'd really like to be able to pledge my options for a loan to buy a house, so
I'm curious to know the issues which may arise from such an arrangement.

------
DanielRibeiro
Great post by Sam. For employees, I'd also refer to Alex MacCaw's _An
Engineer’s guide to Stock Options_ [1]. Alex used to work at Stripe, and at
the end of his article he shares some intersting bits of stock tax alternative
not covered by Sam:

 _If you can’t afford to exercise your right to buy your vested shares (or
don’t want to take the risk) then there’s no need to despair – there are still
alternatives. There are a few funds and a number of angel investors who will
front you all the cash to purchase the shares and cover all of your tax
liabilities_

And he goes further:

 _If you’re interested in learning more about financing your stock options
then send me an email[2] and I’ll make some introductions. I’ve set up an
informal mailing list, and have a group of angel investors subscribed who do
these kinds of deals all the time._

[1] [http://blog.alexmaccaw.com/an-engineers-guide-to-stock-
optio...](http://blog.alexmaccaw.com/an-engineers-guide-to-stock-options)

[2] the link is to alex at alexmaccaw.com

------
mikeleeorg
Very interesting. I like this train of thought. I have a lot of developer
friends that would rather (and are) pursuing their own entrepreneurial ideas
than join an existing company. While I wholeheartedly support that, the flip
side is fewer startup-savvy developers available to join other startups.

There are a lot of reasons why they are pursuing their own ventures. A common
one is: "It's not worth it to be an employee of a startup. You need to be a
founder. (Or maybe employee #1-5.)" You may disagree with that belief, but
it's certainly a belief many hold. Sam's suggestions may take this reason off
the table.

~~~
tensafefrogs
> "It's not worth it to be an employee of a startup. You need to be a
> founder."

Yup. If you can get a job at a tech company that offers high compensation, you
will likely make more there (and gain lots of great experience) than you will
at a startup.

Look at the value over 4 years: \- Startup salary (~$100k-ish) vs. Tech co
(~$140k-ish+) \- Startup equity could be worth $1,000,000 if you get 1% and
the company sells for 100 million (obviously there can be other factors here,
but lets just use that number) \- Large co. Stock grant could be 150k-200k+(or
more!) over 4 years, and you'll likely get refresher grants on top of that
each year. And the stock price will likely go up over those 4 years. So after
year 4 you are making quite a bit off of your vesting stocks.

There's also a pretty good chance the startup will fail, which would net you
nothing but a sub-market salary for the last few years, so it will be harder
for you to negotiate a higher salary at your next gig. Or if you are acqui-
hired, you'll get some small hiring bonus and then have to wait 4 more years
for your new stock to vest.

To me, the only time joining a startup and taking below-market compensation is
if you are just starting out and want to gain some experience you might not
get at a more established company, or perhaps your skills aren't up to par so
you can't get past the interviews[1].

Or maybe you just like the "startup culture", and that's cool, but why not
start your own thing instead?

[1] Note that if your startup gets acqui-hired, you'll probably have to
interview anyway, which could result in not getting an offer!

------
jbkp
You know, it's funny, I read things like this from time to time: "so if I have
0.5% of company and it gets acquired tomorrow for $100 million dollars, will I
get $500,000?" and I remember that I am in this exact scenario, and have no
idea what the answer is. I've been an employee at a startup for 2 years now. I
joined when I was young, naive, and broke — I don't even remember if I read
the paperwork before signing it.

Does anyone have any advice for how to go about learning more about employee
options? I realize I sound dumb, but better late than never.

Some questions I've always had but have been too afraid to ask:

\- How does one exercise their options?

\- What taxes are there and when do you have to pay those?

\- In the above scenario, what factors are involved in me actually getting
that $500k?

\- What questions aren't I thinking of because I don't know enough about any
of this? For example, I've never asked about my options since signing the
paperwork: was there something I would have had to do already that I haven't,
and will likely screw me in the future?

P.S. Throwaway for anonymity (because I am embarrassed to have to ask!).

~~~
x0x0
I've exercised before. Typically, you email hr and say, "I want to exercise";
they send you some paperwork which you fill out; you write the company a
check. _DO NOT DO THIS BEFORE UNDERSTANDING TAX CONSEQUENCES._ You will
typically pay tax on the spread between strike (your price per option) and the
fair market value (fmv) which is set by the board and often updated quarterly.
This can also be a backdoor way of a board tightening those golden handcuffs;
if you where early enough the taxes may well exceed the strike price. You
should also be able to get the fmv by asking. Keep in mind these shares you're
buying may well be completely illiquid and the irs wants their taxes right now
anyway.

A numerical example: 20k shares with a strike of $0.11; fmv of $0.39. Then I
write the company a check for 2e4 x 0.11 = $2200 dollars and report income to
the irs of 2e4 x (0.39-0.11) = $5600 (for amt).

A nuance is if the company is succeeding, it can be worth it to buy options
when they vest; it starts the clock ticking on long term capital gains and can
roughly half your tax bill if and when you can actually sell the share. Which
reminds me: you will pay taxes twice: once when you exercise the option to
turn into a share, and again when you sell the share. If you are lucky enough
to go public the company will often get a firm that handles all this for you
and just gives you a check net of all taxes.

A good accountant will cost $500-ish (or less) to go over your situation in
detail. It's worth the money. If you already pay ab accountant, not someone at
hr block or similar people who just know how to fill out paperwork, they may
go over your situation for much less money.

Also, you must understand amt; that can bite hard. If you don't understand
amt, see that accountant.

~~~
philovivero
And be sure the accountant knows what he's talking to. I did that and it was
still fail, because they didn't understand ISO+AMT Tax Trap.

As someone who's lived through this, immediately (as in the same hour you
purchase the ISOs) sell the ISOs. All of them. Take the short-term capital
gains hit. The alternative can and will destroy you.

~~~
delive
Going for long term capital gains will only destroy you if the stock falls,
which can happen in any investment.

If there is enough confidence in the stock, a happy medium can be to sell
enough ISO's at the time of exercise to cover the tax cost for that year.
However, if the stocks you have are a massive % of your overall (potential)
wealth, short term tax on a big # is still better than long term gains on a
volatile #.

------
lpolovets
This is a great post, and I agree with almost everything Sam wrote. I think
problems #1 and #4 are unfair (you might get less than you deserve, or less
than you thought you were getting), but problems #2 and #3 are extremely
unfair (you can't take what you've earned with you if you leave the company,
or you have to pay taxes on something that has no liquid value and might not
have any value in the long run).

I'd love to get Sam's (or anyone else's) thoughts on the 10%/20%/30%/40%
4-year vesting schedule that was mentioned. I don't like this schedule for two
reasons:

1) It creates larger discrepancies in what employees earn over time relative
to each other. If employee #1 joins today and gets a 2% grant, and employee
#20 joins in 2 years and gets a 0.2% grant, then in year 3 of the company,
employee #1 will vest 30x as much as employee #20, instead of 10x with the
current 25%/25%/25%/25% scheme.

2) This scheme seems to replace and/or ruin refresher grants. Currently, if
you do a good job, you get refresher grants every year or two. With the
10/20/30/40 system, you're already getting higher and higher compensation over
time, regardless of performance, and the bump from refresher grants while you
are vesting your original grant becomes minor. Furthermore, the drop from what
you vest in year 4 to what you'd vest from just refresher grants in year 5
becomes much more dramatic and much more likely to push someone to look for
other work.

What do others think?

~~~
gfodor
The back-weighted scheme is also problematic because sets up a perverse
incentive to consider letting people go at the end of their second year unless
they are all-stars, since the company ends up keeping 70% of that equity and
gets 2 years of hard work out of the person. With an even weighted scheme
there is no time-dependent tradeoff like this to be made, the employee
continually earns shares at a fixed rate and as long as they are contributing
managers never have a hard "decision point" to make with regards to their
shares.

------
awicklander
There's another option that people never seem to talk about. Treat people
well, give them a good working environment, and give them a fair salary based
on the fact that they don't have any equity.

Most engineers I know with stock options and a discounted salary would have
been much better with a higher annual salary and no stock options at all.

~~~
prostoalex
This is attractive for someone out of college, but if you're trying to attract
someone senior with a YouTube/Google/LinkedIn/Facebook/Twitter exit in their
resume (and sometimes multiple of those, not that uncommon in the Valley),
your fair salary is likely to be less than the total package they can get
elsewhere.

~~~
Iftheshoefits
In that case odds are the startup doesn't have sufficient funds to pay for the
talent it (thinks it) needs. I'd argue that this means the startup is: a)
mistaken about its needs; b) poorly run; or c) a bad idea (e.g. the price the
target market is willing to pay is insufficient to support even the optimally
efficient startup's costs to provide service).

~~~
argonaut
This misses the point. Prostoalex's point is that a senior engineer can pull
$300k+ at a place like Google/Facebook/etc., all while working less than 9
hours a day with lavish perks.

When a senior engineer goes off and tries to work at a startup, it is
precisely _because_ they want to try playing the lottery (with a very fat
equity slice), not because they're going out to try and get a ultra-
competitive cash salary.

------
aferreira
Regarding the question of knowing what percentage of total equity your stock
grant represents, most companies that are not incredibly early stage will
simply not tell you.

Pushing the subject further will make you look like you're nosing around where
you shouldn't, often leading to the offer being dropped (this has happened to
me).

Not to say it wasn't a not-so-great company to start with, but a dropped offer
is a dropped offer.

~~~
minaguib
That really makes no sense.

"Here are options to buy 10,000 shares"

"Umm. Thanks. Is that a lot ? Is it peanuts ?"

Without knowing the second number you might as well _not_ be having that
discussion.

~~~
aetherson
Yeah, it's crazy. But it's super-common. I always ask how many shares are
outstanding, and nobody ever has the information at hand. It's like they said,
"We're going to give you 10,000 units of some currency. But we won't tell you
whether it's a Zimbabwe dollar (current value: $0.002) or a Euro (current
value: $1.38)."

------
jpasmore
Tax laws make this more complex than it needs to be. It would be ideal to
eliminate options altogether and compensate employees with stock.

Take the market value of a job minus the amount the employee is actually paid
(the startup discount) and pay the discount in stock -- common shares (VC's
will be in preferred). All employees should get 2% of salary as a starting
point in shares. Allow employee's to buy additional shares by forgoing comp or
simply investing. Peg share price and timing of share grants to Rounds or any
investment (Notes).

Perhaps have repurchase rights only if terminated for cause. Doesn't matter if
someone comes in for 8 months but adds value during that period, so vesting
concept is eliminated.

Would need IRS to change grant from ordinary income to capital gain type of
treatment where taxes are paid when some actual liquidity/transaction occurs.

------
gibybo
Vesting options at a startup are really like second-order options. If they
were granted to you immediately they would just be ordinary options: you have
the option to buy the stock at the strike price. However, since they must vest
over a period of time in which you are sacrificing a higher salary, you are
also given the option of whether to continue vesting those options (by staying
at the company) or not (leaving the company).

The second-order option is what makes them valuable. Most startups either grow
aggressively during those 4 years or they die. If they fail early, you don't
have to sacrifice much salary for the now worthless options. If they are doing
well, the options are now worth much more yet you are still only sacrificing
the same amount of salary for them.

The problem is that the value of this presents a direct conflict between the
company and employee. When the value of the unvested options grow, the company
can reduce the unvested amount (or fire them if they don't agree)[1] because
it will be disproportionate to the value the employee is providing. Note that
they don't actually have to go after the unvested shares to recapture this
value. They can go after any other form of compensation they are providing
since it will still be more than the employee can get elsewhere. Essentially,
this means the employee's upside potential is severely limited. Since the
value of a share in a startup is based almost entirely on a massively higher
future value, this tremendously reduces the value of typical startup vesting
options.

If I worked for a startup I'd want straight equity. Find the value of the
common stock and pay 10-30% of my salary in common stock. The amount of shares
will float as the value of the company does, but this is required in order to
keep incentives aligned. I'll pay the tax out of my salary (at ordinary income
rates). If the company succeeds, almost the entire value derived from the
equity will still be taxed at capital gains rates.

[1] See Zynga, Skype, and probably many others we never hear about.

------
jboggan
I'm going to be in a position soon to start hiring people and I've been
thinking long and hard about this. I do think that engineers tend to get the
short end of the stick when it comes to options, even when the nominal
percentages sound good. I can think of friends who were early engineers at
"successful" companies that took an awful long time to see any real money, let
alone the vast majority who get nothing.

I'm seriously considering a profit sharing / options system where options are
only vested in quarters that are unprofitable and profit sharing occurs
otherwise. I know that this wouldn't be different at all for many start-ups
that have little chance of profitability early on, but for those that do it
could be a very interesting way to align interest and not screw the employees.

------
danbmil99
Has anyone had experience with "early exercise" of (non-ISO) options? As I
understand it, this strategy lets you treat them for tax purposes as if you
bought the underlying stock, meaning no tax liability at vesting or exercise,
and capital gains are all you pay at final sale.

The downside is you have to pony up for the full strike price of all the
shares at hiring. Works great if the company valuation is still nominal (ie
before a 'valuation event' such as series A, though there may be cap note seed
investment already)

One could imagine a company offering a hiring bonus that covers the cost of
early exercise (padded for expected tax loss).

Maybe the real problem is this shit is complicated. Then again, we're
programmers, right? Don't we do complicated by nature?

~~~
ridgeguy
I have experience with early grant of non-ISO shares, which may be different
from what you're asking about.

I was granted shares (on a vesting schedule) at the time of formation of the
company. I paid tax up front on the entire potential share grant when the
shares were valued at $0.000001/share, which was a reasonable valuation at the
time (very high risk, no tech proof, no demonstrated market, etc.). Although I
have a significant # of shares and a significant % of equity in the company,
the tax I paid was quite affordable. See 83(b) election.

If it pans out and I sell my equity, I will pay long-term capital gains on the
difference between the valuation at the time of my 83(b) election and the sale
price. If it doesn't pan out, I'm not exposed to AMT or other tax weirdnesses
that other posters have noted. I found this mechanism useful.

~~~
danbmil99
You were granted shares, similar to founder's stock. I'm talking about
options, which have a strike price. In my scenario, you in effect exercise
(buy) the shares _before_ they vest, which is on its face kind of impossible.
One way I've heard it done is you sign a letter authorizing the company to buy
back the unvested shares if you leave -- in effect, you buy the shares,
simultaneously giving the company an option to purchase them back, and that
option vests backwards over time -- the longer you stay, the less shares they
can buy back. Under this rubrick, you owe no taxes at all, since money flows
from you to the company, therefore there is no taxable compensation. For the
company, I assume it's like any investment round, they sold stock for working
capital.

Damn complex but worth it to avoid IRS woes.

~~~
hundt
"One way I've heard it done is you sign a letter authorizing the company to
buy back the unvested shares if you leave"

That is the only way I have heard of early exercise working.

"Under this rubrick, you owe no taxes at all, since money flows from you to
the company, therefore there is no taxable compensation."

To be clear, the way this works is that the time of exercise you have income
(AMT only for ISOs, regular income for other options) equal to the difference
between the fair market value and your exercise price. So you owe no taxes if
your exercise price _is_ the fair market value, which is usually the case if
you exercise soon enough after the options were granted. It's not about which
way cash is flowing, it's about whether what you get back in exchange for the
cash is worth more than the cash you are paying.

"I assume it's like any investment round, they sold stock for working
capital."

I'm more hazy on this, but I don't think it would normally be similar to an
investment round, because in an investment round typically new shares are
issued; in this case you are buying shares that were previously issued for the
employee stock pool.

~~~
danbmil99
I don't think there's any real difference between issuing new shares and
selling shares from a pool. Shares can be issued but if they're not actually
sold to anyone, I believe they have no effect on the capital structure of the
company. Perhaps the issued shares have some effect on valuation metrics, but
that's subjective voodoo anyways...

------
porterhaney
Adding to Sam's post I'd like to see employees made aware about tools like
83(b) elections to decrease their tax liability.

~~~
x0x0
do you (or anyone else) know what happens if you do an 83b election then leave
the company before 4 years?

Also, this doesn't really help post A, particularly if you're getting pretty
senior and have a bunch of experience. At my last place, I would have had a
$50k bill to do an 83b. I could write that check but goddamn is that a lot of
cash to part with.

edit: thank you @rosser

~~~
the_watcher
Ask to forward exercise when joining. From what I understand, there isn't a
negative impact on the employer, you are just being granted RSU's that they
have an option to buy back for $0 before your cliff, and then convert to ISO's
at your cliff. You can file that 83b election immediately, which will
substantially drop your tax burden.

~~~
x0x0
right right, but I have to (1) come up with $50k in cash (in my example), and
(2) if the job isn't working out, I want the fraction of my initial payment
back upon leaving and it isn't clear this happens...

~~~
Matt_Mickiewicz
Early exercise makes the most sense for seed stage companies where the
exercise price is still low... at companies where you have to spend $50K or
more to exercise, I've seen loans being handed out by the company to its
executives to make it possible for them to take advantage of it.

~~~
lhnguyen09
Any insight into why a company wouldn't allow forward exercising? The
legal/finance team at my company refused to do it, though I wasn't given an
explanation why.

~~~
hundt
* It's extra hassle/paperwork.

* Employees have less incentive to stay because they won't run into the AMT "handcuff" situation (where if they leave they have to exercise their options or lose them, and they can't afford to pay the taxes to exercise the options).

* More employees will actually exercise their options before liquidity, which means more minority shareholders.

------
semerda
Mary Russell & Chris Zaharias are trying to do that here
[http://stockoptioncounsel.com/](http://stockoptioncounsel.com/) with a bill
of rights endorsement by educating folks on stock options and their rights.
There are all sort of clauses and tax implications around given options that
confuse people. Most end up believing the % they got will make them a
millionaire.

This is a great opportunity for Freakonomics to dig into the state of stock
options in startups.

When I was in my 20s I was more gullible by all the talk of stock options and
becoming a millionaire from them. However I never stopped investing in
property and after 10 years I am happy I continued investing into tangible
assets that I was in control of. Stock options is a lottery at best. And as
you get older, and learn the value of money and your time, you see the
opportunity costs clearer.

As a side note, I've been through an IPO and fed all the brain wash leading up
to it. Reality is always far from the dream. Many people don't like to talk
about their failures only successes hence you hardly ever hear about this.

Now saying all that, there are the minority that strike it rich either by
being an early employee of a startup that goes big (small % of something
large) or are a founder of a successful startup when the stars align.

Employee compensation in startups will need to change as more folks start to
realize the opportunity costs.

My word of advise, invest in yourself and stuff "you are in control of".

------
ChuckMcM
I am a fan of giving options every year with a performance multiplier. That
way the high performers are rewarded with more options and your available
options are more accurately divided amongst the employees who have made the
most impact.

When you are not yet cash flow positive as a startup you can give 'bonuses' in
options rather than in cash.

I don't know if we could figure out a portion that employees could contribute
to additional investment rounds if they wanted to take some money off the
table.

~~~
enjo
How do you define performance? It's a fantastically difficult thing to define.
In my experience every attempt at this (at least for engineers) ends up in a
situation where people are putting their effort into maximizing metrics as
opposed to furthering business goals.

We completely decouple performance reviews from compensation. Full stop.

~~~
prostoalex
What? Why? Don't the overachievers then become bitter knowing that the guy
next desk to them is making more by working less, just because he was better
at negotiating at some point?

~~~
enjo
We solve that through careful hiring, and not being afraid to part ways with
folks who can't get the job done satisfactorily.

Interestingly we decouple the two precisely because of what you're describing.
When you start singling out specific people, other folks who are also doing
very good work pretty quickly become disinterested in their job. That's bad.

Even worse, measuring ACTUAL value to the company is really really difficult
(I'd suggest that it is impossible). So now you are in real danger of driving
your most valuable people, the ones your system failed to recognize, out the
door. That's bad news.

~~~
prostoalex
Do you then have a flat compensation that's known to everybody in the company?

~~~
enjo
We do not currently, but we've considered it.

------
zck
There's another effect of the ten-year exercise window.

Remember how Facebook was "forced" to go public because so many people owned
stock? ([http://www.businessinsider.com/why-the-sec-will-force-
facebo...](http://www.businessinsider.com/why-the-sec-will-force-facebook-to-
go-public-2011-1)). Well, if there's a ten-year exercise window, some of the
people will hold their options and not exercise them. My -- albeit limited --
understanding of the situation is that those people are not counted as
stockholders. They have options, not stock.

So the ten-year exercise window is also good for the startup, because it
delays the time until the startup has to publicly disclose its financials.

------
HowardMei
As far as I know, Huawei was the only real employee-coshared company on the
planet issuing dividends attached 'virtual' stocks to their employees where
virtual means stock ownership validity tied to the employment.

Engineers working in Huawei bought shares priced at net asset value with
salary or bank loans and gain dividends at a yearly ROI around 17%~75%.

This unique 'communist' capital structure was created due to lack of venture
capital and outside financing. It's also an experiment before China fully
adopting western style corporation law.

Huawei has a complicated capital structure of founder (1.42%) + employee union
(98.58%) which scared many big investors away and hindered it from IPO.

Recently, Huawei adjusted the virtual stock policy to freeze its capital
structure because the structure complexity incurred a lot of accusations from
the US government and harmed its growth in several major markets.

Alibaba also failed to request change of Hongkong IPO rules to apply employee-
partnership to protect its senior employees.

Therefore, employee equity isn't merely about internal profit sharing or
fairness at all. Investors or traditional capital markets don't like the
'communist' flavored capital structure.

Employee option is the only viable solution before some one totally disrupt
the current capital market.

------
brudgers
Altman's post suggests that the context needs changing. I suspect it needs
changing to keep up with some of the very changes YC has wrought - changes to
VC and the creation of startups and the options available to the sorts of
employees startup founders need.

The issue is that the new startup culture has diversified power and our
concept of 'business founder' is out of date. A software company founder is
not the analog of a white shoe law firm partner. A personal realtionship with
Jeff Bezos isn't why people buy toasters from Amazon or host their SAS on AWS,
because it's not some Rolodex full of 30 year of golf course relationships and
keeping the jobs of bureaucrats secure that make it rain. "On the internet
nobody knows you're a dog.* [1] Or cares that you're a founder.

While I agree with Altman that something needs to change in the direction of
making employee's richer ,I think he probably doesn't go far enough. The
problem isn't so much tax code as capital structure and the rigidity of
company structure that results.

A key hire is a key hire because it changes the company. Ideally, a company
would change it's structure to reflect that change. Ideally, a company's
capital and corporate structures would be agile as in development.

Key employees are just as exposed to the 'you can be a founder' meme as
everyone else, and they're in a better position to pursue it than most. A
founder shouldn't expect talent to hang around making them rich. In terms of
game theory, I think of it as a founder's dilemma. Altman's piece suggests YC
might be seeing it too.

In the current context, a founders's 30% of a $40,000,000 exit is better than
even a 1% employe share of a $1,000,000,000 one - much better perhaps than the
numbers would suggest because 30% gets a seat at the table, and that old Mark
Cuban idea of looking around the table? Well if you're not at the table, the
worst case is you're just dead money picking up the tab for someone's boat
payment.

[1]
[http://www.paulgraham.com/hiring.html](http://www.paulgraham.com/hiring.html)

~~~
tptacek
If this was true, YC would see a trend of companies failing not because they
failed to find a product/market fit, but because they had a fit and failed to
execute when a key engineering employee left.

And yet YC is forever telling people to focus on "building something people
want", above all else. Jessica Livingston just gave an interview listing the
things that caused startups to fail; it was a short list, and included
"founder breakup" and "failing to build something people want", but not "key
engineer leaves".

This squares with ~15 years of experience, mostly in startups, a significant
chunk of it in the valley. Recruiting is important, team building is
important. But the value of any one "key" developer is lower than your comment
makes it out to be. Loss of a key engineer is, for most companies, even in
highly technical spaces, easily survivable.

Orthogonally, I'd also suggest you think of a Venn diagram. Draw a circle for
"highly effective and appropriately specialized engineer". Now figure out
where the circle is for "wants to found a company", and the circle for
"intrinsically capable of founding a company", and the circle for "has life
circumstances compatible with founding a company".

I get to talk to a _lot_ of developers --- I hire them, at what I believe is a
reasonably fast clip, and I work at a consultancy to software development
shops --- and I think this notion that everyone wants to found a startup is
the product of a lot of HN echo. Most developers do not in fact want to start
companies. Starting a company is stressful and, believe it or not, even if you
can wangle your way into being a founder many times in a row, it isn't the
most reliable path to retiring wealthy.

~~~
brudgers
I'm not sure that failure is necessarily the form in which such a problem
would manifest itself - I've been around enough businesses to know that they
can muddle through personnel changes. But it tends to impede short term
progress and create stress for those remaining after a key employee leaves -
the sorts of problems the alleged no-poach agreements allegedly sought to
mitigate.

Now there may be something else that motivated Altman's essay, but it is
almost certainly related to YC and the idea of improving employee equity
appears to have been seen as a potential solution to some trend in their data.
I think that YC came to believe turnover was impacting rates of return, and YC
has had to think about ways to mitigate it. They're at the point now where
they would have that data and some companies in their portfolio are mature
enough where brain drain has a significant impact. For example, they could be
running regressions around on former employees of portfolio companies applying
to YC against the return rates of investments in the former employers.

There's the pursuit of better returns in there somewhere, and I reserve the
right to pull another theory out of my ass at a later date.

------
zosegal
I think the Wealthfront Equity Plan is pretty interesting:
[http://firstround.com/article/The-Right-Way-to-Grant-
Equity-...](http://firstround.com/article/The-Right-Way-to-Grant-Equity-to-
Your-Employees)

------
logfromblammo
I can only speak for my own experience, but everyone I have ever known has
always been screwed by options. As such, I automatically assign a value of $0
to any options attached to an employment offer. You can pretend that yours are
worth more thanks to your unique structuring as much as you like, but thanks
to everyone else in the industry, you will still have to convince your
employee that you are not just spewing delusion at him.

While I can't prove it, I believe I was once fired just to prevent my options
from vesting.

As an employee, you're really better off with zero options and a higher salary
99.9% of the time. But that means the owners have to sell more of their equity
to make payroll.

If you want to be a nice guy and keep the early employees eligible for big
payouts, take your share of the buyout/IPO and give them bonuses out of that.
No one trusts the option plans any more.

------
pyrrhotech
the real villain here are the VCs and to some extend YC for promoting them.
VCs are the ones who perpetuate the myth of "work 80 hours a week for a
startup at 50% market rate and you'll be rich in 4 years". In reality, they
take all the preferred stock so that even if the company sells out for double
or more what it was worth when you join, you end up with nothing. I've worked
at a startup that sold for 4x what it was worth when I joined, and I still
ended up with nothing. A couple guys who had been there longer ended up with a
few thousand dollars. What a scam!

Work at a large, established organization and earn your fair market rate at a
40 hour work week, and start your own company on the side if you want to get
rich folks. I'd never work for any startup again unless I was the founder.

------
rdl
I don't think the 4/1 aspect of vesting is a particularly big problem. If you
are enjoying your job at 4 years, the job has probably changed substantially,
and you can renegotiate for a refresher grant.

I don't see any problem with restricted stock pre series A, when equity is the
biggest consideration for employees. As long as financing is notes, the common
hasn't yet been priced, so you can just use a very low value.

Willingness to issue refresher grants is easy for CEO and board to change.

I don't think you need to be as open as buffer, but being open with percentage
ownership and financials seems obvious.

RSUs with a performance modifier already cover most of this for larger
companies. Something like that for startups probably wouldn't work since so
much of the risk is company-wide vs. individual.

~~~
prostoalex
Most people don't know how to renegotiate, and by the time they need to do it,
they've negotiated their compensation at some other place and are giving a
2-week notice.

Founders/management need to be proactive about this. Good school of thought on
this is Andy Rachleff of Benchmark / Wealthfront
[https://blog.wealthfront.com/the-right-way-to-grant-
equity-t...](https://blog.wealthfront.com/the-right-way-to-grant-equity-to-
your-employees/)

~~~
rdl
It would be cool if people got a "career manager" who helped them with this
kind of stuff on an ongoing basis (at least within a given job, if not across
companies for the duration of a career).

If you trust the founders, they can probably help you up to ~50 person
companies like this, but there is an inherent conflict of interest.

------
mrmch
Would it be within the YC wheel house to provide standard employee equity
agreements (just like the YC note)?

------
aetherson
I don't understand why options are taxed at exercise. You aren't getting money
out of the transaction. If you have an option to buy a share at $1 (when the
share is valued at $10), and later you sell at $50, why isn't the tax
treatment just that you have a $49 capital gain? Why do we instead do a $1 ->
$10, and then a $10 -> $50 tax thing?

~~~
robrenaud
The stock is an asset that has value. This view makes a lot more sense when
the stock is liquid and you can go and get rid of it right after you exercise
your option.

I agree that this totally sucks if there is no easy/public market for the
stock.

~~~
aetherson
The option was an asset that had value as well. We do not generally charge
capital gains on assets with values until they actually get turned into money.
If a stock that you bought traditionally appreciates, or your house does, you
don't pay cap gains on it unless you sell the asset in question.

I appreciate that in this case you're turning an asset into a slightly
different asset, and that's not like just ordinary appreciation, but I don't
know why it really matters. A rule of "capital gains gets charged when you
turn an asset into cash" makes sense.

------
runT1ME
>Perhaps the best way to think about it is to try to come up with a total
compensation package with the same expected value (using the company valuation
of the last round, or a best-efforts guess if it’s been a long time since the
round) as the employee would get at a big company like Google

Am I missing something or is this saying people should be offered an
'expected' equal compensation package to what they would get at Google? What
would the incentive be? Google is a company with quite a bit of projected
longevity, career progression, and very good perks. Why would I choose a
startup with inherently greater risk for only the same reward?

~~~
the_watcher
I think he is saying to use the "expected value" calculation that guys like
Michael O. Church and the others who warn of the dangers of overvaluing
options. Generally, this applies a heavy discount to the potential value of
the options to account for the increased risk. So the compensation package
should be salary + EV(options) ~= big company. That leaves substantial upside
in the case of a success (and if you are joining a company and taking any
options at all instead of salary, you should be betting on this anyway).

Google may not be the best company to pin to, since they offer pretty generous
stock grants from what I understand.

~~~
x0x0
The problem with ev calculations is variance (as Michael O, et al, will no
doubt forcibly assert.) Employees in the bay area housing market are probably
better off taking a lower ev with a corresponding much much lower variance.

~~~
the_watcher
That's probably all true. My only point was I don't think Sam was saying to
make the compensation package that equals what you'd get at Google based on
the most optimistic outcomes, but on a true, expected outcome using some
broader averages (which leaves room for upside).

------
johnrob
_The easiest would be if the IRS would agree to not tax illiquid private stock
until it gets sold, and then tax the gain from the basis as long-term capital
gains and the original value as ordinary income._

I think employees would be more than happy to treat all of this as ordinary
income, if that would make it more appealing to the IRS.

~~~
prostoalex
Why? Worst-case AMT rate is 28%, worst case income tax rate is 39.6%. If you
have a choice and means, you want to pay AMT.

~~~
johnrob
It's a quid-pro-quo. Right now, if a company gives you private stock you have
to treat it as income and pay taxes for it. It's not real income yet, since
you can't sell it, but you pay taxes. Later on (hopefully), the stock turns
into real money and you pay the (lower) long term capital gains rate.

What I was proposing was: Hey IRS, if you let me skip the taxes early on, I'll
pay a higher rate down the road. I will gladly sacrifice long term upside for
short term risk in this particular case (since the odds are already so heavily
skewed in the other direction).

~~~
prostoalex
> Right now, if a company gives you private stock you have to treat it as
> income and pay taxes for it. It's not real income yet, since you can't sell
> it, but you pay taxes.

I think RSUs do exactly that. They're taxed at conversion time which typically
coincides with a liquidity event. At issue time they're not treated as income
precisely due to restricted nature of it.

~~~
johnrob
After some googling, I agree with you. RSU's are much better than options.
So... The solution to the problem of better compensating employees could
simply be giving RSU's in place of options.

~~~
prostoalex
Yeah, from employee standpoint RSUs are generally better. Late stage companies
(GOOG, FB, AMZN) universally grant RSUs. For an early stage company I could
see a few counterpoints why not go the RSU route:

1) ISOs are still tax-advantageous if you have the means to exercise them. It
turns out that most of the senior hires that arrive at a rapidly growing
company are hired for experience, and quite often are wealthy, so for them
ISOs are a better deal. Probably minor detail, but with all else being equal a
wealthy hire for VP of Sales or VP of Engineering position is more motivated
to go the ISO route.

2) Companies nowadays stay private for longer periods of time, and private
company shares are getting more liquidity bit by bit (SecondMarket,
SharesPost, Equidate). For someone who left the company selling a portion of
their holdings, either to get some spare cash, or/and to cover the tax bill
associated with ISO exercise, would be nice. RSUs rob employees of that
opportunity - the R is gone when company says it's gone.

3) There's certain advantage to companies having golden handcuffs on people.
Frequently that means that your earliest or most productive hires are not even
shopping around, since they know their share of equity is material, and they
are aware they cannot cover the tax bill, so might just as well enjoy the
current job.

~~~
johnrob
I think RSUs are universally better for employees because your downside risk
is zero. You'd have to be extremely confidant to be willing to risk money for
the sake of tax savings (I suppose if the exercise price is low enough it's a
non issue).

------
DavidWanjiru
The thing I try to think about in the context of me being the owner of a
successful business, and not necessarily in software, is profit sharing, as
opposed to equity sharing. Profit is a degenerate case of equity, in the sense
that a large (albeit not whole) part of why you want to own equity is to own a
share of the profit. At any rate, at the level of employee options, you want
own enough equity to play the decision making role that holding equity enables
you to. Beyond that, the value a market assigns to equity you own is (should
be!) ultimately dependent on the profit that will accrue to that equity. At
the same time, profit sharing is a lot less messy and much more rewarding to
employees than equity. Sure, you're not getting a share of this asset that
you've helped build, but from what I'm hearing, the story is the same with
options. And profit should be easier to "give away" than equity from the
founders' perspective, I think. I realize that sharing profit is complicated
when businesses are in the red, but on the whole, I suspect there might be
better value in the idea for all involved. Not that I have any idea about how
exactly to go about sharing this profit, assuming it exists, I don't. I just
happen to think it might be a more satisfactory path to take, assuming the
fork on the road reads "Equity Sharing" this way, "Profit Sharing" that way.

~~~
msoad
How many of YC startups are profitable in their first five year?

------
mschaecher
Back-weighting seems backwards to me, especially for early employees. They
receive less options for the risky, earlier stage and more options for once
things are stable and proven. Most startups won't even make 4 years, and
therefore early employees who take that risk can end up with almost nothing if
a sale or IPO occurs in, say, 18 months after starting employment.

------
dalef
Great article, but I am still not really understand some of the part of the
whole picture. Can someone help here?

I am now working in a series A company, taking 0.13% of the company, 13,000
shares (options). At the other side, Pinterest offers me 30,000 RSUs which I
turned down because I thought Pinterest was already a late stage company.

But after I did these researches (including this post), I am wondering if I
made a right decision? my 13,000 shares will always be 13,000 shares, no
matter how much dilution we have in future, right? so does it mean even if my
company grew to the size of Pinterest in future, I still only have that 13,000
shares instead of 30,000 I could get from Pinterest easily with less risk?

Or all late stage startup companies have split their stocks otherwise I don't
see how joining a early startup for 13,000 would be any better

~~~
korzun
Number of shares you have does not mean much, if they close another round your
shares will be diluted.

------
STRML
I'm starting to see companies tossing around the idea of "Phantom Stock
Options"; that is, shares kept purely on paper that are never issued to the
employee. Upon a liquidity event, the employee can exercise the shares and be
paid their value as regular income.

This has some tradeoffs, some of them positive, some of them negative, but I
am far from an expert I would love some input from somebody who knows more.

It does appear to be vastly simpler for all parties, and completely eliminates
any possibility of a tax trap. However it seems to guarantee that you will be
paying income tax on the sale, which can be quite sizable. And the specifics
of what happens after you leave, voluntarily or otherwise, is incredibly
important considering that you are never granted any actual stock.

~~~
patio11
It is highly likely that the IRS would treat any instrument described as "Like
a stock option, except minus the tax treatment for stock options" as "a stock
option." The magic words to ask your accountant about are "substance over form
doctrine."

One of many consequences: an informal agreement, backed by paper or otherwise,
to give you compensation in event of an acquisition, where that agreement
survives your departure from the firm, is taxable at ordinary income rates on
at its fair-market value. This income is realized _in advance of_ the eventual
acquisition/sale. That's why startupers care so much about their 83(b)
elections, because otherwise that landmine _bankrupts people_.

------
lectrick
Maybe startups should abandon the stock market process entirely and issue a
new cryptocurrency instead. The founders can pre-mine whatever percentage they
wish and then pay employees in part in that currency, which would be traded on
an exchange the same way stocks currently are.

------
filmgirlcw
This is a fantastic article.

Sam is dead-on that the current situation isn't fair and often offers
employees little to no information about how the options work.

The 90 days to exercise thing is a real bummer -- for lots of reasons. As Sam
says, not every employee is in a position to relinquish that kind of money for
the options and taxes. I would say that if you are looking to go someplace
else, depending on the size of the company and the situation, it's not out-of-
line to try to value the options you won't get to exercise (or even the
exercise price) into your new salary. Most companies aren't going to be
willing to give you what you need to vest-out upfront, but it is a good way to
negotiate either a one-time bonus or higher salary.

------
applecore
_> Founders certainly deserve a huge premium for starting the earliest, but
probably not 100 or 200x what employee number 5 gets._

When the founders started the company, their equity was pretty much worthless.
When employee #5 is hired and gets 0.50% of the company, her equity presumably
has some dollar value. Employee #5 gets a better deal than the founders, even
though the founders have 100x more equity.

The only thing that matters is the dollar value of the equity at the time it's
awarded.

~~~
mikeklaas
The employee typically gets options, not equity. They are valued at the
current market value of the company and cost that amount to acquire. So the
value upon grant is 0[1].

[1] modulo accounting tricks

~~~
thecage411
It depends on what you mean by value; if you mean the price someone is willing
to pay for them this is clearly not correct -- otherwise every out-of-the-
money option would sell for 0.

------
ivan_ah
I wish there existed exit strategies other than IPO and being bought.

At the rate at which tech-giants are buying tech-startups, we'll end up with
very few, very large tech conglomerates. I'm not sure how efficiently things
run in these giant companies. More managers = more trouble and less autonomy
for the lower levels of the pyramid. Central management and the pyramid are
almost like communism, and we know how well that turned out...

Why can't a mid-sized profitable company pay out dividends to stock-holders?
Say growth mode for the first 5 years to reach profitability, then start
cutting cheques to founders, early employees, and first-round investors. I
know losing cash will probably hurt the company momentarily, and stunt the
growth of the business, but then you start a second round with a new pool of
employee stock and new investors come it to do another 5 years.

Basically, he/she who wants to, can smooth-exit after 5, 10, or 15 years,
while keeping the same company envelope, mission, and mid-sized company
culture throughout the company's life. I guess this would work only for
//very// profitable companies that end up with lots of cash in the bank, but
if you haven't build a profitable company after 10 years what's the point?

------
d2ncal
Great article. One thing that he forgets to mention is to let employees "Pre
Exercise" the options.

For a very young startup (even for Series A), the shares are still worth
pennies per share, and letting employees pre-exercise the shares not only
saves them from AMT but also lets the long term capital gains kick-in sooner.

Only a few startups that I've seen do this, and its really effective specially
for employees.

------
practicalpants
This is probably not the right vehicle to ask 'Am I being treated fairly?',
but I think I will anyways. The startup is pre Series A, I'm the first non
founding/non executive level engineer, I'm technically a contractor but
treated pretty much exactly like an employee (I know that's a whole separate
thing), I'm not the most experienced engineer, i.e. last year at my prior job
I was an intermediate level but this year I would be considered senior at most
organizations, I get a decent hourly rate, it's 95% remote, and my equity
percentage is... .25% with four years of vesting.

I could be wrong, but I've come to the conclusion that after dilution and
taxes, any thing short of a billion dollar exit isn't going to be compensatory
for my efforts. I don't know how correct my conclusion is, and whether I
should try negotiating for more.

~~~
dk8996
A few points; .25% seems low but; a) How close is you hourly rate to what you
would get normally?

b) Are you learning tech that will set you up to make big money?

c) Are you gaining insight about the industry that will set you up to be a co-
founder?

~~~
practicalpants
Interesting points, thanks for your comment.

a) It's actually about $15-20 an hour less going off of my last job. I do
consider it extra compensation that they are remote friendly, because I got to
do some world traveling while working and they were fine with it. But now I'm
back home in the Bay (...but also considering traveling again to make it worth
my while).

b) Nope, just web stuff I'm already used to doing. The CTO at least is
talented so I have learned from him.

c) Potentially. So far no specialized insights into opportunities for new
players in the space. Those insights may or may not come.

~~~
sbisker
Remember they're saving 6.75% of your costs by keeping you as a contractor
instead of a W2. And they're treating you as an employee, it sounds like.

In some states that's not even legal, _even if you willingly agree to it_ ,
because it's considered an abusive employee relationship and tax evasion (for
instance, Massachusetts.)

~~~
hga
Worse, for the company, is that unless your arrangement passes various tests
(e.g. do you have multiple clients? Who and how decides what you're going to
work on, etc.), the IRS can decide you really were an employee and hit the
company for that 6.75%, withholding for all of it, and interest.

Normally you have to go through a body shop to get around this (the Senator
who was responsible for this change in 1986 seemed to have been working on the
behalf of some big ones in his state).

------
fragsworth
> startups try to have very small option pools after their A rounds, because
> the dilution only comes from the founders and not the investors in most
> A-round term sheets.

Why is this the case? If you try to align the interests of the investors with
the interests of the founders, you'd find that this would put you at odds with
your investors.

A company's total value might be quite a bit higher by having the ability to
offer large amounts of employee options (just as an example, the ability to
easily hire media personalities with a big followings without breaking your
bank), which is good for both the founders and the investors.

I understand the investors are trying to protect themselves from the founders
deciding to give a ton of shares to their friends (and then potentially back
to the founders, in other ways), but I wonder if there is a better solution to
this.

------
sskates
I'll be forwarding this to our lawyer when we implement the legal paperwork on
our stock option plan. We already do 1) and 4) as much as we can.

If anyone here has any ideas of how else we can be more friendly to employees
with regard to equity I'm all ears.

~~~
mahyarm
#2 is the biggest one of them all. But it will be really hard to convince
start ups to do this, since it has a big golden handcuffs component to it if
the start up gets some decent momentum. #2 will also simplify tax planning
considerably.

------
PabloOsinaga
I totally dig these ideas - is there any consensus docs floating around we can
use for our employees? and/or is anybody implementing these ideas today? (
perhaps we can borrow their docs ). Thx

------
7Figures2Commas
There are a lot of things in this post that deserve to be addressed, like the
fact that the 90 day exercise period for ISOs after termination is based on
IRS rules, not arbitrary company policy.

But what really needs to be addressed is the fact that _employee_ startup
equity rarely produces the kind of reward that one would expect it to given
the outsize attention that is paid to it. Sam writes:

> As an extremely rough stab at actual numbers, I think a company ought to be
> giving at least 10% in total to the first 10 employees, 5% to the next 20,
> and 5% to the next 50. In practice, the optimal numbers may be much higher.

It's worth testing these numbers against real-world data. For this, I'll use
CB Insights' 2013 Global Tech Exits Report[1], which shows that:

1\. 1,825 private tech companies exited in 2013.

2\. Only 19 of them exited at a $1 billion-plus valuation.

3\. 45% of exits were under $50 million, and 72% of exits were under $200
million.

If you assume that the first 10 employees receive 10% of a company's equity,
and that each employee in that group receives 1%, a $200 million exit produces
up to $2 million before taxes for each of the early employees. A $50 million
exit produces $500,000. If you're making $125,000/year as a senior engineer,
$500,000 gross after 4 years is the equivalent of what you earned in salary
over the past 4 years. That's a nice bonus, but not life-changing wealth. $2
million is nicer, but if you plan to stay in the Bay Area, you might spend
half or more of that on a modest house or condo.

Once you factor in the cost of exercising your options, taxes, dilution,
liquidation preferences, lack of acceleration and the fact that a good portion
of employees leave before fully vesting, you can see that even in a scenario
where 10% of the company is given to the first 10 employees, employees aren't
likely to see the type of compelling returns that Silicon Valley dreams are
made of. Facebook and Twitter-like exits, where thousands of employees become
paper millionaires overnight and the earliest gain tens or hundreds of
millions of dollars, are the exception, not the rule.

What's worth considering further is the fact that 66% of the companies that
exited in 2013 had raised no institutional capital according to CB Insights.
So, as a prospective employee, in joining a venture-backed company (or a
company coming out of a prominent accelerator), you may be putting yourself at
a disadvantage even before you take into account the fact that employee equity
is most vulnerable to dilution and liquidation preferences at these companies.

Final note: CB Insights' 2012 Global Tech Exits Report[2] shows similar trends
to the 2013 report. In fact, in 2012, over half of exits were under $50
million and 76% of the companies that had an exit had not raised institutional
capital.

[1] [https://www.cbinsights.com/blog/global-tech-exits-
report-201...](https://www.cbinsights.com/blog/global-tech-exits-report-2013)

[2] [https://www.cbinsights.com/blog/tech-mergers-acquisitions-
de...](https://www.cbinsights.com/blog/tech-mergers-acquisitions-
deals-2012-report)

------
spo81rty
This is where having a startup outside of the valley is nice. Nobody where we
are (KC) really even expects stock options. We just pay a good competitive
salary and don't have to compete with someone like Google paying 2x as much.
We have given some people stock incentives but because we pay well and
competitively it isn't the primary compensation. The costs of running a
startup are so much lower here.

~~~
larrys
I'm curious why the people who are not in the valley don't go to the valley.

Is it because they:

a) aren't motivated to b) don't know what the potential is there may not even
know what is going on. May not even know about YC or VC's etc. c) don't think
there is potential there (think it's all over hyped and focuses on a few
people who win). d) have family obligations which prevent them from moving to
the valley e) Other reasons?

Thoughts?

~~~
runako
Reasons I've heard:

\- Cost of living relative to expected salary is too low.

\- Can work for big public companies that pay well in lower-cost areas.

\- Weather preferences.

\- Family lives thousands of miles away from SF.

\- Over 30, still interested in doing technical work.

\- Want to own a home, not a millionaire.

\- Interested in starting a business, low-cost matters if not going for VC.

\- Found interesting & challenging technical work elsewhere.

Etc.

This is kind of like asking why people didn't all move to NYC in the 2000s, or
Texas during the oil boom, etc.

------
mathattack
I've seen companies strategically fire people to get out of option awards. Or
grant very generous options, only to plan on firing the folks later. Very
shady business.

I've become a bigger believer in cash. Unless you TRULY believe the vision.

------
bankim
Kudos for a post focusing on startup employees and not founders!

------
joewallin
Congress should change the law so that the transfer of stock to workers is not
taxed. I am not sure why pro-worker legislation like this wouldn't be
supported.

------
bambam12897
I wonder what the author thinks of ESOPs and cooperatives.

------
emocakes
I worked at a startup, was employee number 4, and the 2nd lead developer after
the CTO, I got offered a pathetic 0.025% over 4 years. Options like that are
disheartening and really don't make you want to stick around for 4 years
getting paid dirt to eventually be able to claim your $20k worth of options.

I left and now am getting paid close to triple my old salary with options
getting close to 10% in a business model that is far more profitable than the
previous. I think lots of people just starting out in the startup scene get
taken advantage of and taken for a ride.

------
leccine
I have calculated my hourly rate including the money I would get after the IPO
with 40USD share price and it came out around 100 USD. This is extremely sad
given that I am senior engineer, imagine what somebody in a lower paid
position gets. I think generally speaking, it is not worth it to work for 12
hours a day for a startup and get 10K shares over 5 years. If you actually
work 8 hours and in your spare time doing a side project you might end up way
better. You could get the ideas from the 4hour work week book.

------
sscalia
Great article. It should read "How not to get fucked at a startup"

This coming from someone who got bent over a barrel.

------
ironhide
You either own the company or you're nothing.

~~~
ironhide
Down voted for telling the truth. That's the moment when you know you called
it right.

~~~
DanBC
You are currently at minus 7 karma.

You might want to re-evaluate your understanding of how karma on HN works. It
is rare for people making factually correct statements to be that heavily
downvoted.

------
derekrazo
You could run your start up as a co-op.

