
When a Unicorn Startup Stumbles, Its Employees Get Hurt - igonvalue
http://www.nytimes.com/2015/12/27/technology/when-a-unicorn-start-up-stumbles-its-employees-get-hurt.html
======
ChuckMcM
I remember clearly when I was in a similar situation with the sale of a
company I helped start in 1999. All this gain on paper which required (because
of the Alternative Minimum Tax rule) that I pay taxes on gains I had not
realized. And then later realizing an actual loss. And the decade afterwards
of getting $3,000/year that I could claim against my taxes.

The only reason I'm not still claiming my $3,000 a year is that we had some
gains that could be offset by those losses in 2007 and 2008. Of course there
are the much higher fees to have your taxes prepared.

I agree with the Times that it is the non-executive employees who get the
worst of it, both because it may be the only investment they have (other than
their 401k) and they may not have any experience in managing risk.

For example, the article mentions, and my own experience mimics, that the
executives are in a bind when it comes to discussing company performance and
prospects. Legal risks abound if they mislead and existential risks abound if
they demoralize the company. It would be especially problematic when the
company has started the IPO process as Good had.

Then there is the greed factor that comes in on everyone's part. The board
turns down an $825M offer because they feel it is their duty, given they
expect the company is worth more than that. Employees don't cash out some of
their holding at $3/share expecting a bigger IPO lift. Both angry because
nobody came from the future to tell them, hey this is the best offer you are
ever going to get for this stock, take it. And so they "ride" the value down
and get angrier and angrier but its hard to know at whom.

When this happened to me, I was holding 10,000 shares of Sun stock that had
been $60 a share in 2000, that was going down and down and down. It later
reverse split 3:1 (so down to 3,333 shares) and sold for $9.50 a share to
Oracle or about $32,000. I was really angry at myself for "losing" so much
money. Of course it wasn't that I had "lost" the money, I never had it, it was
all on paper, I just hadn't converted at the time because I was hoping to
convert when it was even "more". Or put another way, my greed kept me from
selling something which could have paid off my mortgage at the time.

~~~
rday
>Employees don't cash out some of their holding at $3/share expecting a bigger
IPO lift. Both angry because nobody came from the future to tell them, hey
this is the best offer you are ever going to get for this stock, take it.

Quoting from the article:

>Employees had little idea that an outside appraisal firm had valued Good at
$434 million and the common stock at about 88 cents a share as of June 30,
according to investor documents and legal filings.

It just sounds to me like the greed on management's side trumped anything the
employees may have had.

Thanks for your story. I was part of a startup which sold as well. One
employee was left with a tax burden to pay off, and I broke out even ($0 from
sale, no tax). The founder took home money though......

I think it's important that people hear these stories when deciding what their
personal reasons are for joining a company.

~~~
ChuckMcM
I'm not arguing, but I would like to point out that you've just fallen into
the same trap I was discussing. According to the article the employees had a
chance to sell shares at $3 a share, _later it came out that an outside firm
felt the shares were worth less._ The trap is using information from later to
beat yourself up about what you didn't do then.

It is an easy trap to fall into, you're in your own future looking back with
more information than you had then, and you are seeing how you could have
acted differently for a much better result. And then you beat yourself up for
not acting differently. But the truth is it isn't your fault.

But the learning is, be more mindful of choices (and non-choices) and their
future financial impact. It is much easier (and desirable) to see the
"success" scenario, than it is the "failure" scenario, but if you work it out
and sell half when you have the chance, then you reduce future outcomes to
"only capturing half the value" and "giving up half the gain". Both of which
are more tolerable than "losing all value".

~~~
chockablock
The article details examples of 'information asymmetry' between employees and
execs, at the same point in time.

According to the article: -June 30: outside firm values common stock at $0.88
-'Late July': Board knows they only have 30-60 days of cash -'August': Some
employees buy common stock at $3.34/share

~~~
ChuckMcM
There is always information asymmetry, sometimes situational and sometimes
regulatory, its the foundation of the insider trading regulations.

The point is to know that there is information that you can't know which could
swing the decision either way, and information you do know which could be true
or false. And then objectively looking at your choices and deciding how much
risk you're willing to take and then owning that decision, no going back later
and beating yourself up for it because of something you didn't know.

As a startup employee, you need to be mindful of opportunities to convert your
non publicly traded stock (or options) into cash. And then decide when (and
if) those opportunities arise, what to do about it.

While some folks advise people to exercise their option when it vests so that
later when they sell it they can get long term capital gains treatment, I
advise them to not do this. My advice is based on looking at the four
scenarios:

1) Don't exercise your options, stock is worthless

Total win, you didn't lose any money in the process.

2) Exercise early, stock is worthless

Total lose. AMT tax paid which can only be recovered $3,000 per year, money
paid to exercise is all lost.

3) Don't Exercise, stock is worth 10x what you paid for it

Partial win, you get to pay for exercising the stock and the tax out of the
proceeds of exercising and selling it, but you are taxed at the ordinary
income rate and if you get into a high enough tax bracket a lot of deductions
get taken away.

4) Exercise early, stock is worth 10x what you paid for it

Total win, you sell your stock and pay a minimum of tax on it.

Three "win" scenarios, and 1 total lose scenario. You remove the total lose by
not exercising your option which leaves you with two "win" scenarios but not
winning as much as you might have (lower risk, there is no "lose" scenario)

------
jerf
Is there some other industry where, when a company stumbles, its employees
don't get hurt? I live in Michigan, and when the car industry "stumbled"
everyone I locally know at least knew someone who got hit, at the _very very_
least with long-term stagnant wages even as their responsibilities amped up to
cover the missing people, and they were the ones who came out relatively
unscathed.

I mean, the details of the article are all fine and dandy and interesting (no
sarcasm, there's nothing wrong with the facts and they're at least worth a
story), but the headline and framing seem to imply that there's some sort of
alternative?

The only problem unique to the tech-unicorns here is exercising stock options
when you can't pay for the taxes. Don't do that.

~~~
justinph
At least with the auto industry, the unions were able to offer some
protections for the worker. How many programmers belong to a union?

~~~
rebootthesystem
> How many programmers belong to a union?

Thankfully none.

One of the main reasons the car companies stumbled are unions. The whole thing
has degenerated to insanity squared.

For example, GM had a clause in their contract requiring them to not fire
employees displaced by technology or automation. In other words, if you
improve your workflow and process and can do the same work with 25 people
instead of 100, you can't fire the people you no-longer need. All incentives
to innovate in process and technology very quickly evaporate with such
insanity in place.

They reportedly had thousands of people show up for "work" every day drawing
95% salaries and full benefits only to go to this building, read the newspaper
and drink coffee all day.

Unions had their day and reason to exist. I am not proposing they need to
disappear. However, they need to mutate into something that works towards a
mutually beneficial and sustainable ecosystem.

By pushing for, and obtaining, ridiculous grants, they create short term
apparent gains and HUGE long term losses as thousands of people lose their
jobs when they industry they worked in simply crumbles under the weight of
onerous arrangements that cause them to lose the ability to compete and remain
financially viable. In fact, if you look at Detroit, one could argue the
unions went beyond costing people their jobs and companies their ability to
compete, they actually succeeded at destroying a whole city.

How is this, in any imaginable reality, good?

A couple of articles:

[http://www.wsj.com/articles/SB114118143005186163](http://www.wsj.com/articles/SB114118143005186163)

This one covers other issues:

[http://www.forbes.com/sites/realspin/2013/05/20/what-
explain...](http://www.forbes.com/sites/realspin/2013/05/20/what-explains-gms-
problems-with-the-uaw/)

From the Forbes article:

"A worker might be able to retire in his early 50s and collect an annual
pension of $37,500, paid wholly by GM. By 2008 there were 4.6 retired GM
employees for each active worker. Did anyone think this was sustainable?"

It's called "killing the golden goose".

~~~
Aloha
You earn a union.

You earn a union by not treating your employees well, if you knew the history
of the labor movement in the 30's you'd better understand how things got to be
the way they are, and why the relationship is adversarial, instead of
cooperative.

If your employees are trying to unionize its because of longstanding
grievances held by a significant minority if not majority of your workforce -
grievances that have either not been meaningfully addressed, or can't be
aired, because there is no workable mechanism to air them. It's not just pay
(though often is primarily pay - we'll put up with all sorts of shenanigans
for a big paycheck) if often as much about working conditions and esprit de
corps as it is pay.

If you don't want a union, pay your employees well (well above market), or
have a great working environment and instill a sense of pride and appreciation
in your management - and make it clear you value their contributions as well -
it's this balance of pay and working environment that keeps a workplace
healthy and union free.

The car companies stumbled because they had a high cost structure and they
ziged when the market zagged - while the union contributed to the high cost
structure, they had nothing do to with changing market conditions.

~~~
prostoalex
> If you don't want a union, pay your employees well (well above market), or
> have a great working environment

Third option seems to move the jobs out of the country, which is what happened
to highly unionized manufacturing sector.

~~~
rebootthesystem
It isn't about not wanting them. It's about them being constructive as opposed
to destructive in the long term.

~~~
prostoalex
Right. I'm just pointing out proponents of unionization usually pretend that
unionization costs zero to the workers' wallets. Well, there's the dues, but
in theory they pay for themselves in increased benefits, therefore any
rational employee should join the union.

The elephant in the room is the migration strategies the employer starts
exploring when faced with an added cost (offshoring, moving to a right-to-work
state, increasing automation, switching from vertical integration to third-
party contractors).

~~~
rebootthesystem
For many industries a hike in costs (with unionization related costs being one
example) triggers a chain reaction causing companies to seek lower costs. This
often means leaving the US or Europe.

Going to China isn't, as some like to put it, due to greedy executives. It's
actually due to responsible executives who are left with not choice but to go
to China. As competitors stared to offshore many, many years ago, companies
who did not were left with significantly greater cost structures and unable to
compete.

I had exactly that problem 15 years ago when my competitors started to
manufacture products in Korea while I was manufacturing in the US. And it
wasn't just about labor costs. Our supply pipeline can be incredibly
expensive. Our costs are higher every step of the way, the more you "touch" a
component or assembly the more cost increases. The same electronic components
--same part number, same manufacturer, not clones-- can cost five or six times
less in China due to supply chain advantages.

Sometimes I feel folks who push unions in the US and think they are good for
workers truly don't have a clue. All one has to do is try to manufacture
something, anything, in the US to start understanding why we can't think
1930's mentality will continue to work. Even something as seemingly simple as
a dog leash is almost impossible to manufacture in the US on a competitive
basis. People just don't get it.

------
ditonal
Very glad the NYTimes ran this piece. The only part they underplayed is they
made it sound like the startup "stumbled." No, it sounds like it went exactly
as planned. Blackberry got the acquisitions, investors got their money, execs
got their bonuses, and the rank-and-file got nothing. That isn't stumbling,
that's the playbook.

Tech employees need to wake up about common vs preferred shares, and that the
former are worthless. They are NOT worthless because they are "lottery
tickets" and most startups fail. They are worthless because they are designed,
as a financial instrument, to be fake equity with no real protection from
dilution and liquidation preference.

The most insulting aspect of common shares is that engineers get talked into
pay cuts on the premise that they get these options, essentially being asked
to invest a portion of their potential compensation into the company, but are
then told they don't deserve to be given real equity because they aren't
"real" investors.

I understand that from a founder's perspective, asking someone to give you
millions of dollars is significantly more challenging than asking someone to
take a 30% pay cut, so it's easy to give strong preference to the former. But,
supposedly and debatably, it's also difficult to recruit talent, and it's
going to be significantly more difficult as employees increasingly realize
that Common ISO's aren't "lottery tickets" they are "toilet paper". So either
startups are going to have to re-invent these equity packages, or the talent
will flock away from the VC companies and towards companies that can pay
salary. Of course, the VCs have a huge playbook to flood the market with more
talent to (taking $100 mil taxpayer money to fund the same bootcamps they
invest in to work for the same companies they hire via Obama's tech talent
shortage program, for example), so who knows.

~~~
rlucas
> Tech employees need to wake up about common vs preferred shares, and that
> the former are worthless. > ... > They are worthless because they are
> designed, as a financial instrument, to be fake equity with no real
> protection from dilution and liquidation preference.

You've muddled orthogonal concepts together here.

1\. Common shares are _not_ worthless. In general, just ask any founder who's
had a successful exit. Founder shares (unless purchased along side financial
investors for hard cash) are always common shares; if your straw man were
correct, then there would be no wealthy founders.

2\. Liquidation preference is a negotiated term which _does_ have a rational
basis for existing. Whenever you're putting in a larger proportion of the
company's cash than the ownership you're buying, it is crucial to have
protection against someone essentially liquidating the company for the cash.
Say investor X is putting in $8 into a company that has $2 in the bank, but X
is only buying 10% of the company. If the company is liquidated for that $10
tomorrow, X gets back $1 and the common stockholders get $9. (There are other
protections against a perverse liquidation incentive, too, but this is the
economic one.)

3\. The "real protection" from dilution is raising reasonable tranches of
capital at a monotonically increasing series of valuations, which valuations
actually correspond to a clearing price between bid and ask. Three key items
here: "reasonable tranche," "monotonically increasing," and "clearing price."

a. Reasonable tranche: raise reasonable sized rounds, because huge rounds
create weirdness (lopsided power, outsized compensatory "asks" by investors,
etc.).

b. Monotonically increasing: needless to say, down rounds are the big dilution
problems. Sometimes they happen because life isn't perfect and problems come
up. Sometimes they happen because the company screwed up and raised too much
at too high a valuation previously.

c. Clearing price: if the company and investor actually agree on the "true"
valuation then it's easy. If they still try to force a deal where the company
wants a crazy "optical" valuation that the investor doesn't really see, then
you'll get layering-on of sweeteners to make the effective valuation much much
lower than the notional, but all kinds of terrible side effects may accrue.

~~~
ditonal
Thank you for the informative response.

1) Ok, Google/FB common shares were worth something. Those are extreme
outliers in exits, and had ethical founders. But founders have another option
if they drive the common share value to nothing - retention bonuses. They can
say, ok we will make all the common shares worthless, but you can just give me
a huge package as part of the aquisition. So employees can't rely on founders
looking after common shares out of self-interest. If you read the article, it
looks like that's extremely similar to what happened in this case.

2) All these financial experts can figure out a way to protect their necks
without leaving the employees necks under the axe.

3) Real protection would also be voting rights, which generally preferred
shares get a lot more of, and then less tangible things like invitation to
board meetings, something mere employees accept is absurd to expect. As long
as employees agree to sacrifice compensation while being told they're not
investors and don't deserve to be treated like one, they're getting
hoodwinked.

~~~
rlucas
I have several friends and acquaintances whose exits as founders were in the
$5-500 M gross exit value range -- far from a Google / FB outcome.

Those people all made an entire career's worth of money, or more, all at once*
and with capital gains tax treatment to boot. (* well, after an earnout /
lockup)

They also exclusively held common shares.

The deciding factor is whether their exit value was a meaningful multiple of
the invested capital. If you raise $100 M and sell for $100 M then it's hardly
fair to expect a windfall. If you raise $50k and sell for $5 M it's very fair
to expect a meaningful personal outcome.

~~~
Swannie
"> Tech employees need to wake up about common vs preferred shares"

The important distinction is employee vs founder. You mention founders in your
comment.

Founders typically would hold a double-digit percentage of common shares.

Employees that might get offered 0.1% if they are an early hire, or less
assuming later stage (discounting exec hires here, because the OP of this
thread was about engineers).

Founders also typically got their common shares at a very low valuation -
let's say they were issued pre-money, then their value to the tax man might be
$200K (of a 2M pre-money valuation), but with a vesting schedule that makes
them tax efficient.

Employees typically get their common shares at a higher valuation, post money,
with a 200M valuation. Their 0.1% is also worth $200K to the tax man.

See how this is different?

~~~
dasil003
You're exaggerating for dramatic effect. First of all, 1-2% is not uncommon
for truly early employees. Second, it's quite typical for founders to work for
free for a significant length of time to get the company off the ground. If
the founders got the company to a 200M valuation with money in the bank to pay
salaries, explain to me why employees deserve to be in the same order of
magnitude shareholders as founders?

------
mikekij
This article highlights the need for two changes in the startup world:

1) We need a different term for the "post-money valuation" that VCs place on a
company after fundraising. It is not a valuation in the same way that a public
company is valued, due in large part to the preferred stock liquidation
preference. Employees hear about a $1B valuation and assume that the IPO or
acquisition price will be some multiple of that "valuation".

2) We need some tax reform that prevents employees from needing to pay a tax
bill with cash for illiquid shares in a privately held company. It makes
perfect sense for an employee of a publicly traded company to need to allocate
some of their stock grants to tax obligations, seeing as though they can sell
those shares at any time. But employees of privately held companies can't sell
their stock (usually), and needing to take real dollars to pay a tax bill on
those shares is just not the spirit of the law.

~~~
tomasien
I'm not sure we need #2 - we need companies to be better about not forcing
their employees to exercise options when they leave the company and we need
employees not to exercise options early to minimize the taxes they may have to
pay in a windfall. This can simply be executed by every company without any
government tax code reform needed.

~~~
marme
we need both what you suggest and tax reform around options. It is crazy that
you have to pay tax on stock you cant sell. It would be incredibly easy for
the IRS to just say when you execute an option that stock will always be
treated as regular income and can never get benefit of capital gains tax no
matter how long you hold it before selling. There are obviously many drawbacks
to this but at least you cant get screwed paying taxes on money you never
earn. This will never happen because the people lobbying for the current tax
codes are not the people getting hurt by these ridiculous AMT rules. AMT was
created to prevent people like steve jobs from collecting their entire salary
in the form of options and not paying any taxes but the people most effected
are clearly not rich CEOs like steve jobs

If i buy a plot of land work hard to build a house on that land i dont have to
pay tax on the increased value of the property until i sell it yet if i work
at a company and buy options as it grows i am taxed immediately before i can
realize a gain

------
tvladeck
Regarding the fact that the employees had to pay tax on what turned out to be
worthless shares:

They could have avoided this by waiting to exercise their options on the eve
of the liquidity event. In this case there would have been no risk. But they
exercised earlier presumably to start the clock on long term capital gains
treatment for the stock they received when they exercised.

They took risk they didn't need to take and they got burned. It's worth
keeping that in mind as another aspect to the story.

~~~
BlewisJS
You can't presume that they exercised early voluntarily. If you leave the
company, you typically have 90 days to exercise options or they are forfeited
back to the company. In other cases, they actually just expire after enough
time passes, which again forces employees to exercise before a liquidity
event.

~~~
tvladeck
Fair point. I did make that assumption.

~~~
JonFish85
Again though nobody forced them to exercise. It accelerates the timeline, but
it's not forcing anyone into anything more than having to make a decision.

~~~
tptacek
Typically, when you leave a company that issued you incentive options, you are
forced to execute within 90 days or forfeit the shares entirely.

------
arbitrage314
I'm going to keep repeating this comment until the world hears it--I think
most people joining startups are being taken advantage of without realizing
it. Sorry to be repeating myself:

If you're primarily interested in making money, or if you love the startup but
not the compensation, you should NOT work at that startup.

If you're a good developer, you can get a better deal by working at an
established company and simply investing. This has been true for every startup
offer I've ever seen. Ever.

I've considered lots of startup jobs because I believed strongly in the
companies. Every single time, however, I was able to get a larger chunk of the
company by keeping my current job and simply investing.

To give an example, my current job pays about $250k, and one year, I invested
$100k of that into a startup, leaving me with ~$150k of salary. This $150k +
startup equity was a better deal than the startup was offering in both salary
and equity (BY FAR). Plus, equity bought as an investor is much less tax toxic
than equity options received as an employee of a startup.

On the other hand, most people who work at startups aren't interested in
money. If that's you, that's totally cool!

~~~
Balgair
Thanks for the comment, but 'investing' 100k, a sum FAR more than almost
anyone reading the comment will ever see in their own bank accounts, is not
'investing' for most of us. Diversity and spreading the risk is bread and
butter for almost all of us. Throwing 100k into a company you believe in' is a
greater gamble than almost any reader could ever justify to their spouse and
expect to stay married. You live in a very different world.

~~~
arbitrage314
Yeah, good point--I'd recommend investing only $10k or $20k if possible.

One of my points, though, is that you are effectively investing $100k in the
company by taking a crap deal to work there (e.g., via a $25k pay cut over 4
years of work). For that $100k, you're getting much less than you would get by
simply straight-up investing $100k.

~~~
tostitos1979
Would you mind sharing a few things:

\- age \- Bay area/NYC or somewhere else? \- how do u deal with taxes, 401K
contributions and still have 100K leftover?

I am possibly overcontributing 401K (maxing the 18K allowed by the IRS) and
certainly overpaying rent (bay area :[). How the heck does one manage to
save/invest 100K even at that salary? As a soon to be father, I need to get my
act together asap.

~~~
arbitrage314
I'm 30 years old, and my rent is about $1200/month (I'm married, which helps
cut down on costs).

After taxes, $250k becomes $150k. After rent, food, staying alive, some
travel, etc., I'm left with about $100k disposable per year. Like most of you,
I don't really have nice things, fancy clothes, etc.

I would continue to max out contributions to retirement accounts, though! You
can invest in startups via IRAs and Roth-IRAs (I have done it).

~~~
0mkar
Thats interesting. Can you please share how you invested in startups via Roth-
IRAs? I am exploring ways to do something similar.

~~~
arbitrage314
I used a Pensco self-directed IRA:

[https://www.pensco.com/](https://www.pensco.com/)

------
alexatkeplar
By joining a late stage (vs early stage) startup as an employee, you are
trading execution risk for valuation risk.

At an early stage startup, your shares are essentially free to purchase -
especially if you join a company which hasn't had a formal external valuation
event (like a fundraise) yet. All your risk is around the startup evolving
into a successful business with a high value.

Join a late-stage startup, and most of the execution risk is gone. But the
company may already have an artificially high value attached - so you have a
lot of risk that your shares end up being worth significantly less than you
paid for them.

The real unicorn, for an employee, is a middle- to late-stage company which
has successfully executed, is growing, and ideally hasn't had any formal
external valuation events. There your shares are cheap to buy and extremely
likely to increase in value.

~~~
jonas21
> The real unicorn, for an employee, is a middle- to late-stage company which
> has successfully executed, is growing, and ideally hasn't had any formal
> external valuation events.

And, like a real unicorn, it doesn't exist. At least not in today's funding
environment.

~~~
alexatkeplar
No, I know a couple. Look for companies with around $10-100m annual revenues
and no external investors. If you speak to their owners, their biggest
frustration is, ironically, competing with unicorns for talent recruitment.

------
sarciszewski
> _Even worse, they had paid taxes on the stock based on the higher value._

That's the most annoying part of the entire article, and why I ask for salary
rather than equity. Keep your stock, I'd rather pay my bills.

~~~
encoderer
Joining public or late stage pre-IPO companies, equity provides the
possibility of real wealth. There is a great Wealthfront article about this --
that if you live in the bay area and have a normal nuclear family, you _need_
equity if you hope to pay for a house, college, etc.

I've seen this in my own life and in many colleagues, friends, and people I've
hired. It's not a guaranteed paycheck, but in the bay area getting a healthy
equity grant is part of the standard comp package. Without luck, it can be a
nice bonus. With some luck it can really move the needle. And with ISO's
especially you can choose when to pay taxes on the income.

I know that outside the bay area comp packages are structured differently --
and often less lucratively.

~~~
Avshalom
The problem here is that "the possibility of real wealth" is not "real
wealth". Not being dead provides "the possibility of real wealth" to
approximately the same degree as the equity offered to anyone past double
digit employee count. Even before that it's only factor unity above the
baseline of "not yet dead"

~~~
encoderer
It's a subjective term. But IMO, a few hundred grand after-taxes is real
wealth to somebody making $150k a year. It can bend the net-worth growth curve
of your life -- a huge home downpayment, elimination of your student loans,
etc. Be smart, take an educated risk, and IMO don't listen to people who say
equity is worthless.

~~~
Avshalom
A few hundred grand net absolutely is real wealth. To anybody really. But how
many people are seeing a few hundred grand after-taxes (after taxes!)?

~~~
encoderer
Over a 4 year grant? This is just a guess, I don't have the IRS database at my
hands. Maybe $200-300k after-tax sounds more reasonable? Like I said above --
"with some luck"

~~~
Avshalom
You have not yet actually made a guess you've just kept asserting that "a lot
of money" is "a lot of money" and I agree. A lot of money is a lot money. I
just think that modulo nobody is actually seeing a lot of money from start-up
employee equity.

~~~
encoderer
The problem is that it's not an easy thing to estimate. I know I've had equity
grants that I thought were worth $x but turned out to be worth $x * 4. But you
don't sell all of it at once, and you don't pay all of the tax bill when you
sell, so it's a very hard thing to know. $200-300k after taxes is, I'm sure,
not a rare outcome over a 4-year vest.

------
untog
The fact that some employees have to pay taxes based on the valuations that
VCs dream up terrifies me.

~~~
davidu
Only those who early exercise, or exercise their stock as it vests. They did
this to try and optimize for long-term capital gains.

For most employees who leave their option grants as options, there is nothing
to worry about.

When you are given a grant of stock options, you can sometimes ask the company
to let you exercise it early, and vest the shares instead of the options. If
you do this when the fair market value (FMV) of the underlying stock is the
same as when the options are granted, you will not be in a precarious tax
situation. However, many people wait a couple years before deciding to
exercise their options, and as a result, they need to recognize a paper gain
when they exercise later as the FMV is substantially higher. That's what
happened here. They exercised later, thinking the stock price would go even
higher, and they were wrong, but they had to pay taxes on that higher price.

While it's true they paid a lot of extra taxes, since they never recognized
the gains, they can roll that tax credit forward to cover future gains they
may get at some other point in the future. I'm not sure how long you can roll
these losses forward, but I think it's for a substantial period of time.

~~~
ardiem
Correct me if I'm wrong, but even with an early exercise (or an exercise of
vested options) where the valuation matches the strike price, that employee
would still have had to personally fork over the amount needed to purchase the
underlying shares. In the scenario described in the article, they've still
lost a substantial chunk of money if the valuation is now a fraction of the
strike price.

Secondly, while capital losses can be carried forward indefinitely, you can
only apply ~$3,000 per year (as a deduction, not a credit).

~~~
pc86
> _that employee would still have had to personally fork over the amount
> needed to purchase the underlying shares_

Then what is the difference over just buying the shares outright as opposed to
exercising options?

My understanding has always been that exercising options means getting a
benefit (the shares) which has a value (the strike price) and you subsequently
pay tax on that value.

~~~
sokoloff
You pay the strike price in cash and you get the shares. Your "basis" in the
shares is the strike price (what you invested).

You base your AMT tax calculation on the difference between the fair market
value and the strike price (that's the "phantom income").

When you sell the shares, your realized capital gains is based on the original
basis and you may have AMT basis that's different.

If you exercise and immediately sell, AMT doesn't factor in.

Concretely (and picking semi-random numbers): If your strike price is $10/sh,
the FMV is $25/share, and you have options on 1000 shares, you'd pay $10K to
exercise, get 1000 shares, and have $15K in AMT income to consider.

If those shares later soared to $40 and you sold, you'd have a capital gains
of ~$30K ($40K proceeds minus $10K basis minus commissions and fees).

If those shares instead crashed to $0, you'd have possibly paid AMT on the
phantom income and you definitely lost the $10K in cash.

------
throwaway1223
I interviewed at this company a couple years back and a huge selling point at
the interview was their upcoming IPO plans. They eventually gave me an offer
which I turned down because enterprise and security is a boring area to work
on. Based on these recent series of articles on startups, its becoming more
and more apparent that while starting a startup is a fantastic thing to do,
being an employee of one has mostly downsides. Its a much better career move
for non-founders to work for large established companies.

------
brown9-2
_Ms. Wyatt introduced BlackBerry’s chief, John S. Chen, who winkingly
apologized for how his deal makers had driven Good’s final sale price down to
$425 million, less than half of the company’s $1.1 billion private valuation._

I've never been a CEO or acquired a company but I think there probably aren't
too many worse things you could say to the employees of a company that you've
just acquired.

~~~
atonse
You should see how awkwardly he debuted one of the latest phones, and you'll
understand. Might just be social awkwardness. (Still sucks, but feels
microscopically less malicious).

------
zaroth
The biggest problem with employee equity is the taxes. Investors pay cash for
their shares, and the transaction is completely tax neutral. When a company
sells its own shares in exchange for cash, the IRS does not charge a penny.

But if an established company wants to get equity into the hands of its
_employees_ now you have a problem. The way the tax law is written, you have
basically 3 choices. Either the employee is paying you "fair market value", or
you are giving them options with a strike price at "fair market value" and
they can hope for future appreciation. Otherwise, if you try to just give them
shares, the IRS needs to be paid, and in cash! So, for example, to simply give
10% of outstanding common shares (an illiquid and diluting asset) to your
employees, you would have to pay 4% of your company's "fair market value" in
cash to the IRS!

The problem is all in how you define this "fair market value" thing. If you
sell some VCs equity along with what's basically a note payable (liquidation
preference) and then say the "value" of the company is equal to the total
raised divided by the percentage equity stake they received, all while totally
ignoring the 'note payable' \-- that's complete madness! And it's the world we
live it today.

If, alternatively, you first subtract off the top of any amount raised the
full amount of any liquidation preferences, then only the _remainder_ was
divided by the percentage equity stake to arrive at a valuation... For
example, raise $10m for a 10% stake with a $10m preference -- then for tax
purposes your common stock valuation should still be $0. Now you can grant
however many common stock shares you want all day long, and you don't bleed
cash to the IRS in order to do it.

Employees would still have to pay the full load of taxes on any _gains_ when
they sell the shares. But this fixes a huge challenge of fairly compensating
employees with equity without even dodging any fair share of taxes. Taxes
should be due and payable when liquid value is actually received, not before.

------
zaroth
The problem here is the valuation model for the common stock was broken.
Properly factoring in liquidation preferences and your 409a valuation of
_common_ stock would not have ever hit $4.29 per share with 229 million shares
outstanding. The fact that preferred shares sold for that price is completely
irrelevant, it's like saying the Tesla sells for $80k so we'll just value this
Nissan Leaf the same.

The IRS does not force these companies to improperly value the common stock.
It's just the default position they take because it's cheaper for the company
this way.

The 409a valuation is based on the price someone would pay for 100% of the
outstanding shares of converted-to-common shares. This is much lower than
preferred stock investment price (where the dollars are being put into the
company to grow it, not being paid to shareholders to retire). It's even much
lower than the secondary market price since that's the price for a small
percentage of shares -- try selling them all and the bid/ask would fall to
zero.

The price of illiquid common stock must reflect the risk-taking stance of
management and the Board. Even having an $800m offer doesn't have to boost the
common stock valuation so much because if management is declining those offers
and swinging for the fences you can reasonably factor in that risk in the
price.

Unless and until an actual IPO, companies should take a discounted future cash
flow model based on single-digit future growth to demonstrate the common stock
value is absolutely worthless, and everyone should be required to file 83(b).

We know its a lottery ticket, the tax code allows us to value it
appropriately. The real problem is companies straight out fucking up their
409a. Common stock shareholders at Good would not be crazy to consider a
lawsuit.

------
georgemcbay
I worked for this company (Good Technology) from July 2012 until Jan 2015 in
their San Diego office.

I never exercised my options (they clearly weren't worth the strike price I
had as a late joining employee at any time that I had vested shares) so no
skin off my back, though I do know people who got screwed by exercising
options because they left the company prior to the sale to Blackberry and were
essentially forced to exercise the shares or just lose them. (I'm all for the
trend pushing for much longer windows on this).

I also know a lot of people who came from companies this company aquired who
stuck around for the eventual big payout that was much bandied about by much
of the C-level management the entire time I was there who basically traded
years of sweat equity for nothing (better than walking away in the hole,
though!)

I found the article to be a pretty fair writeup of the events and a useful
warning to people on the risks of stock exercising prior to liquidity events.
This is a lesson I learned the hard way years ago (first dotcom boom), so I
didn't get burned this time, and actually really enjoyed my time working for
this company because the team in San Diego (which was pretty well isolated
from the teams at the Sunnyvale headquarters) was a great group of people to
work with, and I was paid pretty decently.

------
seanconaty
It is precisely the protections of preferred stock that led to the
overvaluation in the first place. [http://recode.net/2015/05/10/heres-one-
thing-all-the-billion...](http://recode.net/2015/05/10/heres-one-thing-all-
the-billion-dollar-unicorns-have-in-common/)

As a common stock holder, you should know that you'll be the last one paid, if
at all, because few companies can meet unicorn expectations.

------
mathgeek
> To pay those taxes, some employees emptied savings accounts and borrowed
> money.

Investing your life savings and/or loaned money into a single stock is always
a huge warning sign that you're being foolish.

~~~
caseysoftware
Yes, this strikes me as very Enron-ish throughout.

~~~
mathgeek
Interesting. In what ways? Enron was a public company that committed fraud.

~~~
caseysoftware
The management pushing the stock and painting a rosy picture while behind the
scenes the ship was sinking.

The employees putting everything they had (and then some) into a single stock
from their employer.

I don't know if there was criminal behavior involved but an imbalance of
information was in play that cost the employees everything and then some.

------
blizkreeg
This topic has been in conversation a lot recently. Yet I feel we only have
anecdotal data. I was wondering if we can get some real numbers on employee
outcomes. I created a spreadsheet that aims to capture this and hopefully, we
can get some real insights and conclusive data.

[https://docs.google.com/spreadsheets/d/1bIYwuz3bhRWPYazVamMD...](https://docs.google.com/spreadsheets/d/1bIYwuz3bhRWPYazVamMDGamwrawnEtvDe8K-ys-6KtU/edit#gid=0)

All data is anonymous. You don't even need to be logged in to edit.

What do people think of this?

~~~
dewitt
Real data is good, but that's not a good way to get real data.

I'm not a stats person, but it would seem to suffer from both an extremely
small potential sample (those who read your post), a self-selection bias
(those who gain an advantage by participating, e.g., the aggrevieved), and an
outright unsual candidate sample pool (Hacker News).

Perhaps try something like Google Consumer Surveys, and ask a one-two question
like: (1) are you currently working for a pre-IPO startup and (2) are your
options underwater. Or similar.

~~~
x0x0
It's going to be functionally impossible to get good data. Not least because I
suspect the vc industry really really doesn't want potential startup employees
to see the numbers. Or to think to hard about the wave of upcoming ipo
devaluations coming to unicorns (viz a recent discussion from Mark Suster
where 5/7 of 2015 large ipo exits where down rounds compared to previous
valuations [1]). If the numbers were amazing you'd see someone like First
Round giving exit surveys to all their companies and trumpeting the mean or
median outcome. Or even YC; they are probably in a position to collect that
data.

The best you'll be able to do is a site like glassdoor, with all the sample
bias that implies. But even with glassdoor, I've told a recruiter to go away
because their company pays poorly according to glassdoor. The recruiter then
whined about glassdoor, but since he didn't provide me with salary numbers,
what does he expect?

I've also pondered building a site similar to glassdoor to confidentially
discuss outcomes, but the best you'll ever be able to do is anecdata.

[1] [http://www.bothsidesofthetable.com/2015/10/18/venture-
outloo...](http://www.bothsidesofthetable.com/2015/10/18/venture-
outlook-2016/)

------
jackgavigan
It's interesting to compare this article with the coverage of the acquisition
at the time.

 _" When Good Technology announced Friday that it had sold itself to its long-
standing rival BlackBerry for $425 million in cash, it was a moment of triumph
for Good CEO Christy Wyatt."_ \- [http://uk.businessinsider.com/how-christy-
wyatt-sold-good-to...](http://uk.businessinsider.com/how-christy-wyatt-sold-
good-to-blackberry-2015-9)

~~~
rwmj
She made out like a bandit with $6m and no need to turn up to work ever again,
so for her I'm sure it was pretty triumphant.

The fact that the very first action of the acquiring company was to give her
enough money to never come back tells you all you need to know about her
ability as CEO.

------
arbitrage314
If you're going to work at a startup, ask for two things:

1\. No employee equity whatsoever, but a slightly higher salary to make up for
it 2\. The ability to invest in the the next round

I've worked at a startup and done #1 and #2 above, and it's working out great.
I'm very happy to be owning preferred shares.

~~~
startupnoub
arbitrage314:

Aren't you just lowering your risk, while simultaneously lowering your reward?

Eg, let's say you negotiate a 20k/year increase by not getting any stock
options. If you spend that 20k to invest in their next round, you'll be paying
for preferred shares, rather than common shares. Therefore, you'll be able to
afford about 5x less shares than if you were exercising employee grants. Am I
wrong?

Sure, you'll get preferred shares, but if the company does very well, your
ultimate reward will be less.

------
grandalf
The real question is, when do you "buy in" to a valuation.

Things are only worth what someone else will pay. So if you don't have
evidence that there is a buyer eagerly wanting to pay $5/share for the options
you are getting for $4/share, don't assume they are worth anything.

Because of dilution math, it's very rare for employees of all but unicorn
startups to cash in at anything close to the expected value of the shares.
That means that your 50K shares awarded after a $5M series A (on a big pre
money valuation) are not going to be worth much if the company sells for $10M
the following year.

Founders _should_ set up a chart that tracks the various possible outcomes and
lets employees understand what their options will be worth in those scenarios
and see what the founder would get in those scenarios. This would allow
additional shares to be given to valued employees if the company turns out to
be a beautiful white horse but not quite a unicorn.

The thing to be aware of is when the founder has the option of cashing out for
$10M and the employees effectively getting nothing. If this happens the
investors will have essentially lost interest and will potentially get their
investment back but will not mention the deal to anyone again. This is a sort
of perverse incentive because the founder will be inclined to deceive
employees into thinking a big exit is on the way, while simultaneously
negotiating a low millions acquisition and high salary at the acquiring
company.

In that scenario, the founder should have to renegotiate so that the most
valuable employees get at least 10% of the founder's payout, but employees
rarely have (or use) that much leverage with the founder.

------
kevinpet
Can anyone provide any info on what actually happened here? The article says
that the preferred was "worth" more, which is a pretty vague statement. I
interpret this as meaning that they didn't convert because their liquidation
preferences guaranteed a higher payout. What seems relevant to me, and anyone
else who works at a pre-IPO startup, is what were the things to look for ahead
of time.

According to Crunchbase, Good raised $291M in 4 rounds. Assuming those
investors owned 40% of the business, then at $1.1B, common was splitting $660M
(preferred would convert). At $425M, assuming 1x liquidation preference,
common is splitting $134M, an 80% decrease. I think you could get to the
numbers in the article assuming 1x participating or something similar.

This should have been pretty predictable to employees. You will not get rich
if your company sells for only 1.4x the total amount invested.

~~~
jcdavis
I think the bigger concern (as far as employees are concerned) in this
particular case is that the board turned down multiple more lucrative
acquisition offers.

In addition to all the other issues mentioned here, the preferred/common split
means that the preferred holders (ie the board) have much different
incentives/risks than common - they can afford to "swing for the fences" due
to the downside of liquidation preferences.

------
dsugarman
I imagine this is going to be a lot worse now with unicorn craze. It seems
like to some, any liquidation terms were acceptable to get to the $1b
valuation mark.

~~~
nemo44x
Indeed. Smart, young companies are refusing preferred share investments and
are willing to keep their valuation lower because of that. It's true that
you're selling a larger portion of your future for less money in many ways,
but you protect the founders and original investors as well as the employees
too.

Huge growth is important but it's also important to be smart about it. Selling
a part of your company for a bit less if often better than mortgaging the
common shares.

------
depsypher
Wow. Employees get hurt, and the CEO gets awarded "CEO of the Year"

[http://finance.yahoo.com/news/good-technology-chairman-
ceo-c...](http://finance.yahoo.com/news/good-technology-chairman-ceo-
christy-175400298.html)

------
brianmcconnell
Good/Visto alum here. I am just thankful that some omniscient hedge fund
people offered to buy my shares at a little over a buck a share five years ago
(hoping to cash in on their forthcoming IPO no doubt). This company was not a
unicorn. It was a tapeworm! Not at all surprised at the outcome, except that
it wasn't an outright courthouse auction of office supplies.

------
rwmj
Can the overpaid tax be claimed back?

~~~
Apes
Theoretically, but only over a very long period of many years. If it's a big
enough overpay, then it's possible for it to take many decades.

edit: Here's a VERY simplified overview: [http://www.wikihow.com/Claim-AMT-
Credit](http://www.wikihow.com/Claim-AMT-Credit)

~~~
toomuchtodo
I have enough overpaid tax at 33 to tide me over until death. Lessons learned.

------
sbov
Ultimately the problem seems to be preferred shares driving the valuation of
common shares. They obviously aren't the same, so I don't know why it happens.
I'm not a lawyer so I don't know if there's a way around this.

~~~
nemo44x
Fair Market Value drives the value of common shares, not preferred share
costs. FMV is derived using a formula the IRS has to project what a share in
the company is worth and it is usually far less than what the latest investors
paid.

------
willyk
For those interested in this topic, I suggest reading 'Venture Deals' by Brad
Feld. While it's broader than this topic, it does cover some of the
legal/technical elements of vc funding and exits, which help when trying to
understand outcomes such as this (i.e., preferred vs common shares, etc).
[http://www.amazon.com/Venture-Deals-Smarter-Lawyer-
Capitalis...](http://www.amazon.com/Venture-Deals-Smarter-Lawyer-
Capitalist/dp/1118443616)

------
tomasien
If you strip away all the logically questionable parts of this story, there
are 2 really important takeaways:

\- Companies: don't make employees exercise options when they leave the
company. I love the new "10 years to exercise" trend that has started to
emerge. \- Employees: don't pay taxes or exercise options early to maximize
your gains at an eventual exit. It makes no sense - keep the optionality.

------
iblaine
A similar thing happened to me. I joined a late stage startup with a market
cap of $1.5B. It IPO'd a few years later with some critics calling it the
worst IPO of the year. It now has a market cap of $600M. I felt betrayed by
execs who had nothing but glowing things to say about the health of the
business. I gave the company 2-3 quarters to show signs of hope then quit.

------
keithpeter
UK resident here: why were employees paying tax on the nominal value of the
shares? Is it not possible to structure the compensation so that tax is
payable when the shares are sold (capital gains) or on any _dividends_ paid on
the shares?

~~~
ryan-c
> Why were employees paying tax on the nominal value of the shares?

Alternative minimum tax, created in 1969 to target 155 high-income households
who were using too many tax loopholes. It was not adjusted for inflation, and
it did not anticipate rank-and-file employees receiving stock options.

> Is it not possible to structure the compensation so that tax is payable when
> the shares are sold (capital gains) or on any dividends paid on the shares?

Yes, but this requires the employee to pre-pay for the shares when they are
issued.

Normal tax rules do not consider exercising options to be a taxable event, but
AMT rules do. You can exercise options resulting in modest paper gains without
them being taxed.

------
Justsignedup
tl;dr -- if you are not a founder, your stock is never going to get as much
thought as a founder / investor's will. And also they make decisions on your
behalf, often which benefits them greatly, and you little.

~~~
ezxs
more like - if you are not an exec....

------
antoinevg
The only thing that scares me more than the current information asymmetry
between investors and startup employees is the thought of the kind of
structures engineers can come up with when their livelihood is at stake!

------
Spooky23
If Good was a unicorn, that definition needs some work. Good was in a downward
arc since 2011-2012 imo. How many new customers did they acquire compared to
Airwatch/MobileIron/etc?

~~~
sangnoir
"Unicorn" is rather well-defined (if somewhat arbitrarily):any valuation north
of $1bn qualifies a startup as a unicorn. In some cases - such as this, the
$1bn+ valuation is fleeting / illusory.

~~~
Spooky23
Gotcha. Usually you hear the term referring to Uber, Dropbox, etc. I never
would have put Good in that company. (Although Dropbox can't seem to make a
product that I am willing to pay for)

------
walshemj
The answer to this is to

1 ban these multi class share classes 2 reform employee share taxation so that
you only pay tax on a real liquidity event.

I know 1 is hard but 2 should be do able given SV's lobbying power.

------
lectrick
This sounds tautological...

------
randomname2
This article is written as if it's the startup's fault that tax laws are
irrational. Doesn't reflect well on the NYT.

~~~
jameshart
The decision to accept a deal which valued the employees' equity so low
compared to the VC owned equity is entirely the company's own.

I suppose you could argue that the tax system should be aware that common
stock valuation should not be inferred from preferred stock valuation...

~~~
tvladeck
The valuation of the company and the waterfall of the payment are two separate
things. Presumably this was the highest valuation they could have gotten (no
reason not to believe it given that it was a distressed sale). And the tax on
the common stock the employees received when they exercised their options was
based on the valuation of the common stock - so the tax system did correctly
handle that.

~~~
jameshart
They're not separate. The valuation of a thing is dependent on how much money
the owners of that thing are willing to accept for it. The common stock
holders' interests were poorly represented in the price negotiation. The
decision to structure stock ownership in that way is, again, entirely the
company's, not the tax system's.

Sure, employees share some responsibility for accepting compensation that
includes stock which can be sold on your behalf without your having any say in
the price you're willing to take... but companies choose to offer comp
packages which include that kind of stock precisely because it's hard for
employees to value, and it's easy for employees to overvalue.

~~~
tvladeck
> The common stock holders' interests were poorly represented in the price
> negotiation.

You're mistaken here. Your point rests on there being a possibility that
Blackberry paid the same amount for the company (the valuation), but common
stock holders got more (the waterfall). This was not possible.

~~~
jameshart
But the people negotiating the deal with Blackberry knew how the waterfall
would shake out. They elected to agree to a price where the share of the
purchase price distributed across common stockholders left many employees in a
bad place. That was a choice. As was structuring the ownership of the company,
and the compensation offers to their employees, in that way in the first
place.

~~~
tvladeck
Right, but we have to assume that Good could not have gotten a better price
from Blackberry. The alternative was even worse from the common shareholders -
a price of $0 for their shares.

They also could not have changed the waterfall. So I'm not sure what your
point is, really

