
How Startup Options and Ownership Work - prostoalex
http://a16z.com/2016/08/24/options-ownership/?utm_campaign=Mattermark+Daily&utm_source=hs_email&utm_medium=email&utm_content=33386773&_hsenc=p2ANqtz-8Yh06XfJ07IS_elY10dP8tl6Et3vg0oGecP6iW9E-6_zYuCaUP_bMpOXOVidvEs8wUZwZMrYurXUBx4DrTCsDpEFYUNA&_hsmi=33386773
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gortok
The article goes over stock options; but it doesn't address an alternate form
of equity; issuing early employees restricted stock awards (instead of
options).

From the receiver's point of view, Stock Options are a bad deal 99 times out
of 100, let's review the cases in which owners of options get screwed:

\- Company gets acquired, new terms are put into place.

\- Company gets acquired, company isn't good fit.

\- Company gets massive amounts of funding (those Unicorns), and due to the
increasing funding at each round, those with options are left with a hefty tax
bill and only 90 days to exercise if they leave

\- If you have stock options and are an employee of a early stage startup,
chances are you don't have the liquidity to exercise it. You're also not being
paid market value (since you have stock options) If you did have the capital,
you could have just invested in the seed round for a much better discount and
return.

\- If a company goes out of business

\- if A company stays private and doesn't offer an internal market

There are only a very few cases where employees with options are taken care
of:

\- Company sells and ensures there are triggers in the options \- Company
extends exercise period

\- Company goes public and employees are able to exercise their options with
the tax bill that goes along with that and still make money on their shares

We have a romanticized view of options because Google, Microsoft, Apple,
Twitter, Facebook, and a handful of other companies have hit the bigtime; but
that's the huge exception, not the rule, and yet we allow companies to treat
options as equal to salary, and they're not.

I know companies face reporting requirements if they have more than 50
shareholders; but the earliest employees should be compensated in a way that
respects their sacrifice and risk; and options don't do that. At best, options
are a placebo.

~~~
zaroth
Almost all your points apply exactly equally to restricted stock as it does to
options. In both cases you will have a vesting schedule, just in the case of
restricted stock it's usually a grant of the shares with no exercise price. In
both cases you want to file an 83(b) election so you are taxed based on the
FMV of the company when you receive the unvested shares (when the shares are
worthless) so that you will only owe capital gains later.

But more importantly, in both cases you end up exactly and equally screwed in
terms of you are holding the same class of stock (common) with the same
vesting terms (no, single, or double trigger acceleration), all the exact same
issues around dilution, liquidity, preferred shares, and unfair buyout terms
funneling cash to key executives, etc.

Equity is a massive gamble all around, and there's no magic bullet that I've
seen which can defray many of the inherent risks of owning common shares of a
private company which has perhaps a 1 in 100 odds of ever seeing a public
market or liquidity event that surpasses the total liquidation preferences.

~~~
xenadu02
IIRC 83(b) on options is not available unless the company allows you to pre-
exercise the options to turn them into shares prior to vesting.

So the vast majority of startup employees don't have the fancy tax-avoiding
scheme that founders and investors have.

~~~
zaroth
The only downside of early exercise I can see for the company is accounting
for the cash and being ready to buy-back unvested shares as-needed. Since the
tax implications are potentially massive for the employee, and we're talking
de-minimis work for the employer, early exercise should be a standard term on
all ISO contracts. I see this as an educational opportunity for Founders, and
if you see a contract without early exercise I certainly wouldn't hesitate to
question it.

~~~
chrdlu
Early exercise is great for the majority of situations. The 100k limit for ISO
options can be a potential downside. If there is a spread between the strike
price and the FMV, only the first 100k worth of shares will be considered ISOs
and the rest will be treated as NSOs. In the case of no early exercise, you
could get 100k of ISOs per year for the 4 years.

------
halifaxbeard
I remember asking for a cap table at a startup and in not so few words, was
told to fuck off.

At that point I realized it didn't matter how many options I had, I was going
to get screwed should there be an exit, and made my own.

~~~
iaw
I was granted 10,000 shares at a startup I worked for. I asked them "what does
a share represent as a portion of the current company?" "We don't divulge that
information."

I am not going to lock up a huge portion of my expendable compensation in an
"investment" that's designed to benefit people besides me on the hopes that
the company is one of the few successes to come to market. There are too many
horror stories going on right now that the VCs are trying to keep quiet for me
to trust most startups.

~~~
ap22213
I don't get this age of greed that we are in. The board and the VCs are making
hundreds of millions (and some of them already have that much), and they are
f'n pinching pennies for the first 20-30 employees that worked their ass of to
make their company work. Is it really going to hurt that much for like 10-15
people to make a few hundred grand? Geez. It wasn't this way (at least for me)
back in the mid-90s. I had been lucky to make some money back then, but I hate
that the 20-somethings are getting royally f'd over.

BTW, my CEO just gave me a significant bump in my options a few weeks ago. He
acted like it was a huge deal. But, with the 'right of repurchase' and all the
other BS clauses in my options contract, they're essentially worthless.

~~~
iaw
I've worked for the really rich. In my experience/opinion I don't think
they're evil but are focused on having more for the sake of having more. They
grew up in such a way that they believe they are more skilled/harder working
therefore more deserving of wealth than others. They also resent those that
don't do what they do but complain about not having enough wealth (even though
society would stop functioning were that to be the case).

There's usually something missing from their combination of empathy and
understanding which would allow them to care about the negative ramifications
they're having. Look at Bill Gates, I don't think he's a bad person but he
hurt a lot of people in industry and consumers to build Microsoft to what it
is by destroying the competitive landscape. Steve Jobs is a better example, he
proactively colluded to suppress wages and paid money for an organ that would
only prolong his life but could have saved someone else's (seriously, I
consider that an evil move).

One suggestion for you, it sounds like you're very angry about your current
work environment. Maybe it's time to find a new place?

~~~
HippoViolation
I used to be bitter about stuff like this but I've gotten over it.

The chances of getting wealthy by joining a small startup are very small. It
happens, but it's probably not going to happen for you.

If you really want to do well, you have to pull together the resources to
start a successful company.

On a different note, I used to work for an almost billionaire, they were
incredibly cheap. I often reminded myself that you don't make a billion
dollars by wasting money!

~~~
HippoViolation
AND on another note, I've noticed some founders want to put you on a 5 or even
6 year vesting schedule.

I should go back to welding.

------
gumby
This article mentions '“sticker shock” (or reverse!) [up]on leaving their
first startup.'

Companies can easily ameliorate this, especially for early employees, by
permitting early exercise. The 409a valuation rarely changes between financing
events so if you get 5000 $.50 options you can pay $2500, file 83(b), and not
have to pay any tax until (unless you sell). If you leave before your vesting
period is up the company pays you back what you paid for the unvested amount
-- again, not taxable. I always make sure this is in the stock plan.

There's some minor subtleties (you want to put a voting agreement into place
etc) but they require no heavy lifting at all, and they treat employees as
what they should be: valued members of the team.

Yes, in later rounds when the share price climbs, this is less useful so but
be it. It's annoying that 409a common valuations end up at about 20% of
preferred these days; I think it was more fair back when the board could just
determine that 10% was reasonable.

~~~
zaroth
I look at companies like Uber raising billions of dollars (with liquidation
preference) and losing billions of dollars in net operating loss each year,
and I can only hope for the employee's sake that they have a 409a valuation on
the common stock of exactly $1.

In reality they are probably handing out options with a strike price valuating
the common shares at billions of dollars and those options are likely worse
than worthless.

~~~
gumby
Indeed, as I mentioned, this doesn't help much in later rounds, but then again
in later rounds salaries increase as well.

But for the early folks (B round or before), why not give them the maximum
opportunity?

------
calcsam
Props to a16z for writing this up. Many of the practical problems that come up
with stock options result from having one sophisticated party (the company)
and one unsophisticated party (the employee).

When the details of their stock options become material, employees are often
surprised -- and usually not in a pleasant way. Many engineers become
disillusioned with stock options, and eventually the whole startup scene.

------
nshelly
> If [an ex-employee] knows (as a result of having been at the company) that
> the prospects of the business are looking grim or a product launch is
> significantly delayed, that’s important information a buyer would deserve to
> know in evaluating whether to buy the stock, and failure to disclose that
> information creates real legal jeopardy for the seller. This risk exists in
> a 90-day exercise program as well, but it becomes a lot more acute when you
> move to 10-year exercise periods.

It seems to me there would be a _lower_ risk under the 10-year exercise window
scenario. Under the 90-day window, the ex-employee would be forced to exercise
or lose all of their equity and thus liable for a large AMT bill. To mitigate
this, that ex-employee, with recent inside knowledge of the company's
operations, would look to the secondary market to unload some of those shares
and ease the tax burden unless their are strict transfer restrictions in
place, increasing the divide between cash-rich and cash-poor employees.

Under a 10-year exercise plan, the ex-employee would be less likely to
exercise (better to wait until the company's outcome is more certain) and
wouldn't need the cash to buy the shares and cover those AMT taxes.

> ISOs have better tax treatment for employees because the employee does not
> have to pay taxes at the time of exercise on the difference between the
> exercise price of the option and the fair market value of the stock

This doesn't seem to count AMT taxes which is the big elephant in the room. In
California and most high tax states, employees will have to pay AMT taxes on
the difference.

------
calvinbhai
I am curious to know when is the best time to ask all the questions about the
stock options. Before signing the offer letter / getting started or after?

Before may be a bad deal for startups, especially the ones that are keeping
everything all the equity details under wraps.

After is a bad deal for the employee who makes the move, and could be a major
bait and switch

~~~
patio11
If you don't know (minimally) the fully diluted count of shares in the
company, your option grant is as specific is saying that your salary will be
denominated in dollars and you'll be given more detail about it sometime after
joining the company, pinky-swear.

A company which won't provide enough information to value an option grant
contemporaneous with the written offer is being either abusive or stupid.
There exist employment opportunities at companies which are neither abusive
nor stupid. Take one of those instead.

~~~
crzwdjk
Sounds like I was right to pass on the company that promised me "4000 options"
and insisted that any details beyond that were strictly confidential and could
under no circumstances be disclosed to any non-employees. It seemed especially
suspicious in conjunction with the rest of their attempts at hard-sell tactics
that just left a bad taste in my mouth.

~~~
rmc
If they _really_ want it to be confidential, you could tell them that you'd be
willing to sign an NDA. And see if they tell you. :P

------
hesdeadjim
Has anyone ever heard of or seen a way that option holders don't get 100%
screwed if a company is acquired for less than the sum of the investors'
liquidation preferences?

~~~
harryh
Not earning money on options when the business isn't successful isn't getting
screwed. That's just life.

~~~
st3v3r
But the business got bought. That's not being not successful.

~~~
harryh
If a business gets bought for less than the capital invested, it's not a
success.

~~~
st3v3r
It's not a failure. And I'd say those who poured their effort into the company
should be entitled to some part of the purchase price, more so than people
who's only contribution was money.

~~~
harryh
You'd consider turning a $1000 investment into a company worth $500 a success?
OK, sure. You can have whatever opinion you want, but you're gonna have a hard
time finding other people who see the world the same way you do.

------
hkmurakami
The problem isn't that this information isn't out there. It is -- but you need
to (a) recognize that this information is important, and (b) know how and
where to find it.

Writing another blog post on a VC blog isn't going to solve the fundamental
problem of information awareness and discovery.

It's very much like basic personal finance. The hardest part is becoming aware
of the need to educate yourself in the first place. The second hardest part is
figuring out what you need to learn. Much of this awareness comes from
upbringing and is an element of social capital that we often take for granted.

Establishing a neutral, nonpartisan online resource under a transparent domain
name would be a plausible first step.

~~~
limeyx
I find getting screwed by the taxman a few times while the VPs and investors
make out like bandits motivates the research process too ...

~~~
hkmurakami
I'd like to think that we can figure out a way to not have the first timers
get screwed either.

------
gk1
I highly recommend also reading the book Consider Your Options[0]. It's an
easy yet very informative read.

[0] [https://www.amazon.com/Consider-Your-Options-Equity-
Compensa...](https://www.amazon.com/Consider-Your-Options-Equity-Compensation-
ebook/dp/B00PSGEK7U/)

------
iblaine
I was at a company that had an IPO, it did poorly and it was then that I
learned about a Full Ratchet. Those are terms in fine print that employees are
never told. Ugh...

------
fumplethumb
I'll admit that I probably have an unhealthy disdain for the financial sector,
but how do investors manage take on no risk in some of these options?

Reading the liquidation preferences section, particularly about double
dipping, was a little irritating. How common are these situations?

------
leekh
As an engineer I ask for more cash so I can use options. I usually get it.

What about the non-techinical employee? I generally feel marketing, sales, etc
are screwed in startups. How can a someone making < 75k actually use their
options?

------
idlewords
Just remember to multiply by zero.

------
iaw
Ironic article given the innate moral hazard for VC firms on the subject. The
interests of funding VCs and startup employees only align in unusual cases.

------
ditonal
Said the fox to the hen.

~~~
dang
Please don't post generically cynical comments to Hacker News. It degrades the
discourse here, even if your underlying assumption is right.

If you're aware of an inaccuracy in the article, or an important fact (as
opposed to swipe) that is left out, you could add value to the thread by
mentioning it.

