
Guide to Your Equity - samuelcouch
https://github.com/clef/handbook/blob/master/Hiring%20Documents/Guide%20to%20Your%20Equity.md
======
tptacek
_Your stock options expire 10 years after they were issued or 30 days after
you stop working with Clef_

This market standard provision in startup employee equity agreements is
probably the single biggest obstacle to realizing a gain from employee equity.

What it means is that when you leave your job, if you want to capture any
potential upside from your options, you're required to execute them, paying
your own money for actual shares. Depending on the amount of equity you have,
this may or may not be a meaningful amount of money, but it is in any case a
painful decision to have to make.

Companies like Pinterest have done things to address this flaw; they allow
employees who no longer work at the firm to retain their vested options
without executing them for several years.

~~~
jessepollak
Thanks for the feedback! We just realized this document is actually out of
date with our legal contracts.

I've opened up a PR with the change here
([https://github.com/clef/handbook/pull/56](https://github.com/clef/handbook/pull/56)),
though it may be 10 years rather than 7, so I'm waiting for confirmation from
our CEO before merging :)

EDIT: Our CEO's response was: "this is more complicated than just changing
that number, give me some time to write the fully change up." Incoming!

EDIT #2: Updated with the 7 year number and a more depth explanation :) -
thanks @brennenHN!

~~~
SeoxyS
If I understand the rules correctly, an ISO that is exercised more than 90
days after leaving a job is treated as an NSO, which means that it will be
taxed at regular income tax rates instead of having the ability to be taxed at
long-term cap gains rate. (This could reduce their value by an additional
15%+.)

That said, it's irrelevant if you exercise and sell an ISO at the same time,
because short-term cap gains are taxed as income tax, too.

The real interesting term is having the ability to early exercise your entire
stock grant, _before_ it vests and before there is a spread between its strike
price and fair market value. (The company would have a repurchase right, to
implement the vesting schedule.) That way the cost is very low, and there's no
worry of having to exercise in the future when it could be taxed unfavorably,
and the clock for long-term capital gains starts early.

~~~
bradleyjg
If there's a repurchase agreement that allows the company to buy back the
stock for less than market value (and presumably accompanying transfer
limitations) I wonder if the IRS would take the position that it is income
only after the repurchase agreement expires at the FMV at that point in time.

~~~
trjordan
The way it works for founders is that you get actual stock, and vesting is
implemented with a repurchase right. The IRS considers the stock to be an
"asset at risk", meaning that you don't actually realize the value as income
until the repurchase right goes away. Because this happens over time, it
practically means founder stock is, by default, treated as being earned every
month. This is no big deal in the beginning, but if you change the valuation
of the company, suddenly each monthly stock grant has a discrepancy between
what you paid for it and what it's worth. Therefore, it's income, therefore,
you owe taxes on it.

The way to fix this is an 83(b) election, which lets you say, "No, I'm taking
the risk of this all up front. I want to pay taxes on it, even though the
asset is at risk." In this specific case, it's a no-brainer: there are no
taxes today, so of course I'll pay that $0.

If you want to do this with employee options, you have to set up early
exercise rights. I think early exercise is done via 83(b) for employees, but
I'm not 100% on that. My company isn't big enough that we've had to cross that
bridge :)

~~~
toast0
> If you want to do this with employee options, you have to set up early
> exercise rights. I think early exercise is done via 83(b) for employees, but
> I'm not 100% on that.

Yes, if you early exercise ISOs, you would want to file an 83(b) to pay the $0
ordinary income tax burden up front (and get long term capital gains later).
I'm not sure if you can file an 83(b) on an NSO.

~~~
brianwawok
Is $0 legal? I thought normally you gave the stock 1 billionth of a penny of
value and paid your $1 in tax.

~~~
SeoxyS
It's legal, not because the stock has no value, but because the spread (i.e.
the difference) between the strike price of the option (e.g. $0.01/option) and
the stock's value (e.g. $0.01/share) is $0. That's the profit, so that's what
you pay tax on.

------
mahyarm
Quick summary guide to what you want your option equity grant to be like:

1\. Must have an 83(b) election process, and give a bonus to cover pre-
exercise cost OR:

2\. No expiry after leaving the company, instead should just convert to NSOs
AND

3\. If possible, options should expire after 15-20 years with the longer time
horizons to IPO today compared to 7 years ago. Facebook for example took 8
years from founding to IPO. Even if you stay employed at facebook for the
entire time, you could have lost all of your stock for example.

4\. Vesting cliffs should be no longer than 1 year.

If you are unwilling or incapable to pre-exercise your startup stock, then
equivalent RSU grants are superior to stock option grants. Even most $1bb
startup employees have a very hard time finding people to buy their stock
outside of company secondaries when the company is private.

\----

What you give up at a startup as a sr. engineer vs bigco:

1\. Saleable within 1 year +$100k/yr equity grants. These equity grants can
then be used in other investments, such as a house down payment or otherwise.
Give them a bonus of %7 annual compounded interest.

2\. Higher salaries

3\. Bonuses

4\. Some benefits which may have high amount of financial benefits for your
situation, such as paid parental leave.

5\. Hours worked.

Make sure that the startup offer can beat a big co offer if a +$100mm sale
event happens by a good margin. If your startup offer cannot beat that, then
working at that startup will have a near certain chance of having a big
financial downside compared to working at bigco. Working at bigco is the index
fund of tech work, make sure your startup 'investment' at least has a chance
of beating the index fund.

------
toomuchtodo
> We have not undergone a 409A valuation to determine the current strike price
> of Clef stock.

Isn't a 409A valuation required every 6-12 months by the IRS?

EDIT:

"Section 409A requires the value of stock options be determined “by the
reasonable application of a reasonable valuation method” with two caveats: 1)
the grant price must reflect material information, often referred to as a
value creation event (i.e. the price paid in a recent financing); and 2), the
calculation of value must not be more than 12 months old. In practice, private
companies pursue 409A appraisals from independent qualified valuation firms
either immediately after completion of a financing or other significant
financial transaction (e.g. merger or acquisition), or, six to nine months of
elapsed time since the prior appraisal, whichever comes sooner (more mature
companies tend to pursue appraisals more frequently). The receipt of such an
appraisal should provide a safe harbor to employees with regard to a potential
tax liability as long as your company is less than 10 years old, you don’t
have a liquidity event within 12 months after the option grant or you don’t
have put or call rights on your company’s stock."

[https://blog.wealthfront.com/409a/](https://blog.wealthfront.com/409a/)

~~~
throwaway342526
Later they mention "(We are currently in the process of getting our 409A
Valuation)"

This might be fine if their compensation plan was formed in 2015.

------
rdl
You should include a Standard Offer Letter example showing employees what
their stock/etc. will be worth under various exit assumptions.
Showing/including the employee handbook at the same time is great, too.

(I'd like to make this a standard thing; would be happy to help with this.
Would need to find a lawyer willing to contribute time. I'd love a Standard
Human Readable Offer Letter Builder.)

~~~
dmor
Offer letter should be super standard. The offer letter generated by Zenefits
is a single page...

~~~
rdl
Which is insufficient to value the offer.

I want there to be an offer letter plus other materials which explain it. It's
meaningless to say something like "12000 shares of stock, vesting over 4
years." That may be the legally binding part, but there should be an appendix
or model which shows what that actually means.

The problem with making that a separate unsigned/etc. document is it isn't
legally binding in the same way an offer letter is.

There's additionally the insanity around "stock options must be approved by
the board at the next meeting after you're hired", which could be a quarter.
That seems stupid. There should be some cleaner way to handle that.

~~~
dmor
Oh yeah, usually i just send a spreadsheet. Even the stock options aren't
legally binding usually... they still get approved by the board _after_ the
hire is made. It is not possible to pre-approve them, but you can do it but
UWC (unanimous written consent) without holding a full board meeting. That's
what we do.

------
rdl
Looks interesting.

I'm not a lawyer, but:

1) I'd consider Restricted Stock/Founders Stock instead of options for pre-A
employees.

2) Early exercise should be an option; I'd personally not work at a pre-$50mm
val company without EE as an option.

3) Whoa you survived a long time before getting a 409A.

4) Should let your employees exercise options for years after leaving.

~~~
hesdeadjim
100% agree.

------
amluto
I'm surprised that there's no mention of an 83(b) election. I'm not a tax
expert (hah!) and you might be nervous about giving anything that could be
construed as tax advice, but I imagine you could safely say something like:

"While we cannot give tax advice, we strongly suggest that you consider making
an 83(b) election when you are initially granted employee stock options. If
you choose to make an 83(b) election, you may need to do so within 30 days of
joining."

As I understand it, this can be a Big Deal (tm).

~~~
js2
I believe 83(b) only applies to restricted stock grants, not ISOs, but I am
not an accountant.

I have worked for two startups early enough to take advantage of the 83(b)
election. In both cases, the companies assisted me with the election,
providing all the paperwork, etc.

~~~
daegloe
83(b) election still applies to any early exercise of stock options subject to
vesting. An important detail that is often overlooked.

------
BrainScraps
This is a game changer, especially for people who are new/inexperienced in the
Startup Compensation Lotto.

I wish more companies would approach this subject so transparently!

~~~
sr_banksy
Also makes the feedback / change process transparent! As long as all employees
use git.

------
hellbanner
When stocks lack dividend payment, can someone explain their intrinsic value
apart from market speculation &
[https://en.wikipedia.org/wiki/Greater_fool_theory](https://en.wikipedia.org/wiki/Greater_fool_theory)
?

~~~
AnimalMuppet
They mean that you own a specific fraction of the company (at least until the
stock gets diluted). If the company is worth $X, and you own Y% of it, then
your stock is worth $XY/100.

~~~
drewrv
If I own 5% of a laundromat that gives me 5% of it's profits each quarter,
then I have money coming in. What's the point of owning 5% of a company that
never pays shareholders a dime? It seems a bit like owning a piece of property
on the moon.

~~~
AnimalMuppet
The company itself is worth something. It's worth whatever it's worth to
someone trying to buy it, for example. As a general guide, it's worth some
multiple of its annual profit, with the multiple depending on how fast it's
growing and how much longer it's expected to continue growing.

~~~
hellbanner
With the idea that with 51%, you can control the company's choices, right?

------
boulos
If I weren't on my phone I might open a pull request for this, but in this
paragraph you suddenly use the term option to mean choice, I'd use choice
where appropriate to avoid confusion:

    
    
      This means that while you have more options regarding your equity, you will lose a significant amount of your options' value if you wait. In weighing your different options, you should consult a tax attorney to help decide what path makes the most sense for you.

------
powera
"The lower the exercise price for Common Stock, the more money your options
will earn you, so it’s in our best interest to make this price really low." \-
technically, while it's in the employee's interest to have the price be as low
as possible, isn't it in the company's interest to have the price be as close
to the 409A valuation as possible?

~~~
daegloe
409A valuations apply to Common Stock, which lack the preferences associated
with Preferred Stock (usually sold to investors). As a result, Common Stock is
typically priced at a significant discount. It's most certainly in an early
stage startup's best interest to keep the Common Stock price low, because it
offers more flexibility when incentivizing team members.

------
balls187
"So if a share of Clef stock is worth $1 today and we grow so it’s worth $20
in a few years, you’ll still be able to buy it for $1 (and then sell it
immediately for a profit of $19)."

Use more realistic numbers. The likelihood of your company going to $20 a
share, and with the ability of the share holder to "sell it immediately" is
very unlikely.

------
dmor
I commend you for sharing this. A couple issues for you to consider:

Share price isn't always set in that clean a manner, as you'll learn when you
fundraise. It's nice when your math works out like this: "if Clef is worth
$20m and we raise $5m, we are now worth $25m. If you owned 5% of $20m before,
you now own 4% of $25m (we sold 20% of the company, or, said differently,
diluted you by 20%). The 5% stake was worth $1m before the fundraise and the
4% stake is now worth $1m." but often you end up with a bit more complexity.
Beware simple examples can still set expectations. Converting notes with
discounts is one example of this. Preferred and common are not treated the
same way, and it is unlikely you will escape selling preferred shares to your
next investor.

Early exercise would actually be far more tax advantageous to your employees.
You can do this "cashless" as an even greater benefit.

------
omouse
_We have not undergone a 409A valuation to determine the current strike price
of Clef stock._

So basically, what you're saying, is that unless you're guaranteed to strike
it rich, it's better to ask for more salary, more vacation time or other
_tangibles_? Greeeeeat.

I would prefer profit sharing to stock options/equity or actual ownership that
means something, such as in a co-operative. It's great they want to make sure
they're building a company for the future, but cash now is always better and
even better is if it's guaranteed cash in the future too (as with profit
sharing where you can actually see the increase or with performance bonuses
where you can actually see if they're shrinking or growing).

------
choppaface
The section about granting ISOs to avoid a tax burden on _employees_ is
downright dishonest. Support 83(b) elections or outright bonus the employee
the strike and tax (I've personally seen this happen before). AMT is a
motherfucker.

------
kabuks
It's interesting that they offer people to take 0.1% more equity for a 5k
reduction in salary.

[https://github.com/clef/handbook/blob/master/Employment%20Po...](https://github.com/clef/handbook/blob/master/Employment%20Policies/Salary%20and%20Equity%20Compensation.md)

With a 6 year vesting schedule a new employee is 'buying' 0.1% worth of shares
for 30k in salary. A 30MM valuation, or 5X the 6MM cap on the convertible
note.

------
fosk
I would like to focus on those comments that are questioning if stocks are
just a way to trick employees in getting a lower salary. I believe that
regardless of the lifestyle you want to have, stocks have the potential to
make you really wealthy, way more than collecting salaries.

In startups a good salary will give you an affordable and stable life,
sometimes short-term security (because a higher salary like 200k/yr could only
last a couple of years until the startup cease to exist). On the other side
stocks are the best investment to drastically improve your finances. To put it
in layman's terms, it usually take many years, sometimes a lifetime, to buy
long-term security, a nice house and fast cars just by collecting a salary
month by month. Selling earned stocks can do all of that in 2/4 years. If it
doesn't, then move on.

It's a bet and a different type of gambling, therefore should be treated as
such. Now, if you can or cannot afford to gamble it's a different story. In my
experience people with families understandably lower their risks by preferring
a higher salary, while those who don't have any wife/kids prefer stocks.

Regardless of that, this doesn't change the fact that stocks have the
potential of being worth 10-20-30-N times a yearly salary, and sometimes that
qualifies them as a good bet to some people (and certainly it does for
founders and investors).

------
Too
Sorry if I'm missing something but what's preventing the employer from
creating stocks with 100000x liquidation preference for themselves after they
have given the employees their equity? That would mean the employees stocks
would be worth nothing at a sale? See also hellbanners comment about
dividends. What is the actual value of having the stock?

------
leroy_masochist
Thank you for posting this! It's a brave move and I think other companies
should do the same.

One question for you: do you have any restrictions on the sale of your stock
by employees before the stock is liquid? Specifically, do you have any
provisions that say the stock can't be sold without board approval before
shares are publicly issued on an exchange? I've had friends burned by this in
the past....they throw down 5-6 figures to exercise their options, pay the
taxes, etc after two years with the company, then find that they can't legally
sell the shares without board approval, which basically means they can't sell
until the stock is publicly traded. It's been particularly painful in one
friend's case because he tied up virtually all his liquidity for what he
thought was a very temporary basis in exercising the options, and now has no
clear timeline to monetization (company's last round was B, no IPO in sight).

------
kriro
That's a pretty solid summary even if you don't work for Clef. Very helpful
document.

A very good example to set for other companies. I'd love more "easy terms"
github repos with a "if in doubt consult a lawyer" clause. It communicates
that the company is interested in making sure that employees understand their
benefits well (I often get the impression many companies don't)

\---

The "golden handcuffs" are interesting. Are there any companies that ofer you
a credit at X% to buy your options when you leave? Say you leave and own 50k
options at aprice of 1$ and they are valued at 20$ now. Currently you have to
pony up the 50k or pay taxes after 90 days. Since the employer also has to pay
taxes it would make sense for them to offer a deal where you get "just the
profits -X" so to speak.

Are there any money lenders specialized in this? It's basically a "sure thing"
as long as you have the big lump sum up front.

------
CobrastanJorji
> This is a little bit of a roundabout way to give you ownership of Clef, but
> the reason we give options instead of straight stock is that it keeps you
> from being taxed on the stock until you actually use it. If we gave you
> $10,000 worth of Clef stock today, you would have to pay thousands of
> dollars in taxes this year.

Maybe I misunderstand, but this seems somewhat dishonest to me. Giving out
options instead of shares does not help the employee or or "keep you from
being taxed." Instead, it's a punishment for the company not growing. If the
value of the company does not increase in value before the vest date, the
options will be worth nothing, but shares would still have value.

~~~
Stasis5001
Not at all. If the company doesn't grow, there is no way any of the common
stock shareholders get a noticeable payout due to liquidation preferences.
Whether their ownership is in the form of options or stock does not matter.

------
tyre
This is interesting, specifically the outstanding convertible notes. If the
six year vesting is meant to communicate their company priorities, the over
30% (minimum, based on Series A) of the company owned by investors does too.

> $175,000 was raised on notes with a cap of $5m > > $1,683,555 was raised on
> notes with a cap of $6m

For the first set of notes, that is a minimum of 3.5% of the company. For the
second set of notes, that is a minimum of 28% of the company.

So for a pre-Series A company, you already have nearly a third of the company
owned by investors. That percentage is only going to go higher in the future.
If I'm an employee, I'd better hope my shares won't be diluted 30% in all
future rounds.

------
jman25
Isn't it sale date 2 years from grant, not exercise date 2 years from grant,
that matters for ISO vs NSO treatment? "Instead, if the employee holds the
shares for two years after grant and one year after exercise, the employee
only pays capital gains tax on the ultimate difference between the exercise
and sale price. If these conditions are not met, then the options are taxed
like a non-qualified option" from [https://www.nceo.org/articles/stock-
options-alternative-mini...](https://www.nceo.org/articles/stock-options-
alternative-minimum-tax-amt)

------
toadi
I'm the only one who read 50 hours at the office? Poor Americans :)

~~~
gohrt
where does it say that?

~~~
tomtai
[https://github.com/clef/handbook/blob/master/Employment%20Po...](https://github.com/clef/handbook/blob/master/Employment%20Policies/Working%20Remotely.md)

"we expect full-time employees to be at the Clef office between 45 and 50
hours a week""

------
geofft
This is the clearest document about how stock options work that I've seen yet.
That _alone_ is commendable, even if it weren't for other commendable things
like listing the denominator on what fraction of the company you own and
otherwise avoiding the usual employee-hostile temptations here.

------
tjholowaychuk
Unless I missed it somewhere it would be interesting to learn more about how
and when you can exercise and sell your shares. For example is it even
possible to sell a portion when the company is private? Back to the company or
to VCs? What if the company never goes public?

------
YuriNiyazov
Could you go into greater detail about what taxes does the company pays when
an NSO is exercised in a year when a person is no longer employed? Is it just
the employer's part of medicare and social security (7.5% up to 117000 as of
2014?) or is it something else?

------
lohop
This is the best thing since sliced bread. Resolved a lot of uncertainties to
me (an engineer) about how this stuff works.

------
throwawaymaroon
Guide to your equity: you should assume your equity is worthless just out of
the nature of startup risk.

Even if it ends up being worth something, you should assume that your employer
will do everything they legally can to dilute or otherwise devalue your
financial reward from equity.

Getting employee equity will always be, at best, a few crumbs from the loaf
you're helping to build.

~~~
rhizome
It's now possible to have a choice between a company whose benefits result in
only crumbs, and a company that offers slices.

