
Stock options are complicated - luu
http://www.benkuhn.net/options
======
xt00
In my experience most people at startups who leave end up not exercising their
options due to the cost of exercising them coupled with the fact that they may
be underpaid due to the assumption that their options may end up quite
valuable. So basically they pay somebody 90k/year then give them ~20k/year in
options. Then they quit after 2 years and have 90 days to buy like 50k worth
of stock at the strike price they were promised.

So they end up paying 50k to buy some common shares (not preferred). An
investor who paid 50k to invest in the company most likely got preferred
shares, so the young guy who paid 50k who probably can barely afford that is
now taking way more risk for a much smaller percentage of the company. If the
company goes under the preferred shareholders have a chance to get their money
back during a firesale of assets or IP or whatever, but the common shares are
screwed.

So I tell virtually everybody unless there is a well established secondary
market to sell your shares of your particular company, then don't take the
options.

I honestly think the 90 day exercise is totally ludicrous in the startup
world. I think that should be a major negotiation point with anybody who is
joining a startup. They should just insist on it no matter what.

~~~
pinot
Not to mention $90k person is likely leaving because they have low faith in
the company in the first place.

~~~
zenlikethat
Just playing devil's advocate here: So they are leaving because they have low
faith in the company, but still expect to be able to collect rewards on other
peoples' work years later if the company happens to succeed?

If they didn't have a high degree of confidence in the company, the safe bet
would always be to not exercise.

~~~
morgante
This mentality is dangerous and pernicious. We have vesting schedules for a
reason. They'd be reaping the rewards of their past work, not other people's
future work.

------
LouisSayers
I can't help but feel the system is highly rigged in favour of investors.

Many countries have tax incentives for investors, but when it comes to people
actually joining startups, investing their time and effort, then all you get
is a tax bill - and mostly at a highly inconvenient time to pay it!

It very much feels like the system is designed to keep the rich rich, and to
put the working (wo)man in their place.

~~~
beagle3
The US is probably the worst in this respect, and I heard Canada is quite bad,
but most of European tax systems follow the "pay taxes only when money comes
your way" principle, which puts all investors on equal footing.

~~~
mahyarm
What is the trap / bad part in Canada?

~~~
ar15saveslives
When you exercise your SO, you need to pay taxes, based on current price of
shares, even if you don't sell them right away. SO is a joke in Canada.

~~~
sokoloff
I fail to see how that's different from the US. Stock option exercises of
vested shares are taxable here, too.

------
up_and_up
After working at 4 different startups over the past 10 years I can tell you
with a very high certainty that the only people who will make much $$$ from
options are founders and investors.

Early Employees generally are shafted. Don't think your 20-200 basis points
will be worth anything at the end of it. Make a decent salary and avoid
companies that work you to death. Take it as a learning experience and look at
the options as pure monopoly money.

EVERYTHING is skewed towards founders and investors.

~~~
ThrustVectoring
Do you have voice and power in future negotiations about the direction and
equity breakdown of the company? If so, the promises are worth something. If
not, they likely are only worth enough to convince you to not sue about it,
because that's what the actual incentives are in future capital negotiations.

------
dkhenry
Stock options are not complicated. Most people who look into the details of
them will find them very plain and actually quite simple. The issue is you
don't often deal with this area of finance so it looks foreign until you spend
some time looking into the terms.

Your options are a contract between you and the company for you to buy shares
at a given price.

If the value of the shares is worth more then you pay, the difference is
income. "Value" is a 409a valuation ask your CFO what it when you execute.

Enter the accountant who will tell you how much your liability is for that
income ( it varies no more then a dozen other factors affecting your yearly
taxes )

Your shares are illiquid, and likely worthless. VC's and other institutional
investors have contracts with the company that means they will get paid well
before and much better then you. This should really be the first point since
you should have known this when accepting your compensation package.

~~~
hkmurakami
Agreed. Takes maybe a few hours to understand the terms.

BUT, most technical folks are very uninformed about investing and finance in
general. Many brilliant engineers at my previous employers were utterly
confused about their options as well as their decision making after IPO.

So I think the difficulty also stems from a lack of development in financial
acumen generally.

~~~
dkhenry
+1 for development of financial acumen. We can often point to people taking
out 18% APY car loans, or going to Payday loan vendors and say how silly they
are for not understanding finance, but we turn a blind eye when its the
finance that effects us ( even though one could argue that compounding
interest on a payday loan is probably more complex then your basic stock
option grant )

------
luisrudge
Just a bit off topic: I'm from Brazil, working as a contractor for a company
in the US. They offered me stock options and I'm totally lost about this. Not
only because this isn't normal in Brazil, but, the majority of the articles in
the wild only focus in the US scene. I want to know more about how this works
when you're not in the same country as the company. Will I be double taxed (in
US and Brazil)? On what rules I'll be able to exercise my options?

------
richardhenry
Regarding stock options expiring 3 months after leaving the company, it
doesn't have to be this way and a lot of startups are moving in the direction
of 10 year exercise periods.

I think Quora was the first to do this: [https://dangelo.quora.com/10-Year-
Exercise-Periods-Make-Sens...](https://dangelo.quora.com/10-Year-Exercise-
Periods-Make-Sense)

~~~
chimeracoder
> Regarding stock options expiring 3 months after leaving the company, it
> doesn't have to be this way and a lot of startups are moving in the
> direction of 10 year exercise periods.

This requires converting all options to NSOs, and the tax implications of NSOs
are not pretty. (From a _tax_ perspective, ISOs aren't great[0], but they're
much better for employees, by design).

[0] You have to pay AMT on the spread between the option price and current
value at the time you _exercise_ , whether or not the equity is liquid, so you
could end up paying a large tax bill only to find that the company goes
bankrupt before you have the opportunity to ever sell your equity.

~~~
epa
The kicker here is that the option life is 10 years, even if you have left the
company. So you can avoid tax by not exercising until you plan to sell. It
becomes a personal choice between 1) do i want the option still, even if i
quit, and 2) do i plan to have ownership in the company for a period longer
than a year before i sell. Typically most people would prefer 1 over 2.

Keep in mind for someone reading this comment, this is about private
companies.

~~~
beagle3
The other thing to keep in mind is that stock options (especially those given
to employees) tend to be much less protected than shares.

If you exercised, and another shareholder got unfair preferential treatment,
you have reason to seek compensation or sue. If you haven't exercised yet,
.... well ... not so much.

Also, many option contracts give you the right to buy X shares at price Y and
do not make special consideration for stock splits - e.g. a 2:1 split would
likely make your options worthless by halving the share price, and by halving
the percentage of the company that X represents.

So, waiting to exercise until you sell is a very good strategy, except when it
isn't - not very common, but you rarely get notified about these issues
beforehand, especially if you are no longer involved with the company.

------
helper
AMT and the 90 day limit on exercising after leaving a company are the main
things that make options painful. There has been some movement in the industry
to get away from the 90 day limit (by converting from ISOs to NSOs), but has
there been any recent attempts to get the AMT rules changed for ISOs? Does
anyone think the current AMT rules for stock options are fair? I'm curious how
this is viewed by people outside the industry.

~~~
smoodles
There was an effort last year to pass a bill to fix the AMT horror show with
regards to options last year.

[https://www.congress.gov/bill/114th-congress/house-
bill/5719](https://www.congress.gov/bill/114th-congress/house-bill/5719)

I think ironically to the bubble many of us live in the Silicon Valley, this
was proposed by a Republican and passed in the House. Never made it in the
Senate. A refreshing reminder good ideas still come from all slices of our
political spectrum.

~~~
dragonwriter
Everyone hates the AMT; very roughly Democrats think it's a broken tool for
addressing a real problem, and Republicans see the problem it addresses as a
good thing.

------
bogomipz
This is great write up. Kudos to the author for taking the time. I did have a
question about the following sentence:

>"If an employer gives you straight-up shares, then the IRS will tax the
shares (at ordinary income rates) when they vest."

What would be treated as income and taxes here, the strike price x the number
of options vesting? Is that correct? For regular worker bees this not very
much though right? For instance say an employee has 25 shares vest in a
quarter and their stick price is $20. 20 x 25 would be $500 more being taxes
as income. Or am I completely not understanding something?

If it is not the strike price being taxes as income what is it, since the the
value of an option is often unknown to rank and file employees let alone the
IRS.

~~~
idunno246
Shares vested x fair market value at vest. So you get 1000 shares when you
join, worth $1/share. 250 vest on your first year, and that's when tax is due.
But say the company grows and shares are $5/share. 5x250 is 1250 taxed income
on the anniversary. Normally at early stages you're talking many thousands of
shares though, that can increase rapidly.

The fmv is recalculated every year, or on any fundraise events. It needs to be
a defensible number or the irs will be upset

~~~
bogomipz
>"The fmv is recalculated every year, or on any fundraise events."

This is the piece I was missing. Thank you for the clear explanation.

That being said it would be interesting to buy exercise them just to see what
the company is actually valuing those options at, since this is often opaque
to the average worker. I wonder if it's possible to exercise a single option
and use it as a barometer of sorts to quantify you actual compensation? My
guess is no.

~~~
idunno246
I've never had a company refuse to give me the 409a valuation if I asked point
blank for it(just say you're considering exercising and it's important for tax
planning). It's important to keep in mind though they tend to purposely
depress that value. But investors get a premium because their stock has
legitimately more value than yours(liquidation preferences, board seats, etc).
And without a liquid market, if you do sell privately you end up taking a
large discount. I think the opacity is largely that it's difficult to value
things, not so much nefariousness

~~~
bogomipz
I see, I guess you just need to know to ask for it. I imagine many(most?) do
not. I find these discussions and these types of articles really helpful. I
would like to think we are all becoming more savvy about these a result.
Thanks for the tip.

------
calcsam
Stock options are definitely complicated, but so are your taxes. In fact, your
taxes are much more complicated. However, there exist reasonably good software
tools, eg TurboTax, to represent your taxes as a decision tree, and to walk
you through it.

The problem isn't really that stock options are complex -- it's that there
doesn't exist comparably good software for stock options.

I'm actually building software to solve this:
[http://www.optionvalue.io](http://www.optionvalue.io). Right now it covers
value in exit scenarios, but am currently building out exercise / tax
scenarios.

------
mcfunley
This doesn't mention transfer restrictions at all, and that's an altogether
different reason that options are complicated. It's a bad idea to assume that
you'll be able to sell private company shares, even if the company is popular
and you've heard of other people selling. The existence of a market for the
shares doesn't guarantee that you'll be allowed to get rid of them, because
the company can enforce all manner of restrictions on sales.

The market for stock in a private company tends to be very small. Existing
investors and prospective investors in the company can comprise most or all of
it. Those folks care more about relationships with the company than getting
their hands on a handful of employee shares. What this means practically is
that if the company doesn't want you to sell for any reason, the buyers won't
cooperate with you either.

If you're planning on selling, you should feel comfortable communicating this
to the company. And they should agree to it. And that assent should be very
recent and in writing.

You can find startups out there willing to buy derivatives on your exercised
shares, which is functionally similar to selling shares. But this is a mixed
bag, and you should read those terms carefully.

Read your option agreement. You'll note that among other things, it says that
the agreement can be amended by the company at any time to say anything at
all. Good luck!

~~~
greenleafjacob
> Read your option agreement. You'll note that among other things, it says
> that the agreement can be amended by the company at any time to say anything
> at all. Good luck!

That is likely not actually usable because there may be no consideration [1].

[1]
[https://en.wikipedia.org/wiki/United_States_contract_law#Con...](https://en.wikipedia.org/wiki/United_States_contract_law#Consideration_and_estoppel)

------
msencenb
I (respectfully) disagree entirely with this conclusion.

If you want to do analysis like this, you need to weight these numbers against
the possibility of it happening to get the expected value of each column. You
have also simplified the smaller exit values to not include investor
preferences (which means investors are first in line to get money, founders
second, employees dead last).

Additionally, most contracts do not allow for early exercise so lots of these
ideas are moot. If you do not have early exercise in your contract and you
leave the company it's usually a leading indicator of failure. Either the
company laid you off to reduce burn (do not under any circumstances buy stock
if you have been laid off), or you left the company for a
moral/business/whatever reason. In the latter case, it seems unwise to put
your money where your heart isn't.

If you are optimizing your life for the best chance of striking it rich do not
be a startup employee. Be a founder. Better yet, be an investor.

There are lots of reasons to be a startup employee, but being in it for the
options is not one of them. Treat them as worth $0 and negotiate for more cash
or things you care about like vacation or part time hours.

~~~
harryh
Founders and investors are generally at the same place in line. Both hold
common shares.

~~~
msencenb
If your investors have liquidation preferences, that's not true and can leave
founders with nothing depending on the exit.

If there are no liquidation preferences, then you are correct.

~~~
harryh
_sigh_

I meant to write founders and employees. Not founders and investors. Sorry.
Not sure I screwed that up. The screwup made my statement completely wrong.

Investors, as you helpfully point out, generally have preferred stock with
liquidation preferences and hence are "first in line."

------
puredlx
In case you're holding stock options of a US company but need to pay your
taxes in Germany I can highly recommend this article (in german):
[http://www.pinkernell.de/esop.htm](http://www.pinkernell.de/esop.htm)

------
jogjayr
Serious question: why does the IRS insist on valuing private company stock on
the basis of a 409a valuation without taking into account whether a market for
it even exists? The 409a is paid for by the company which (as the article
mentioned) has an interest in keeping it lower. And holders of common stock in
private companies, in most cases, can't actually liquidate their holdings
(leaving apart cases like pre-IPO Facebook which traded in secondary markets).
So the stock is effectively worthless no matter what the 409a says. There
shouldn't be tax due until there's a liquidation event that allows shares to
be sold.

~~~
brians
Given the tax scheme is published well in advance, they certainly seem to be
worth something---else who would take them?

~~~
jogjayr
Stock options and private stock are taken in the hope that they'll be worth
something someday, not because they're necessarily worth anything at present.

It's all well and good to say "X is the fair market value of this stock based
on factors y, z and a"* . But when no market exists (or severely restricted
ones where sellers have to take a loss) then that value is not relevant (or
should be discounted appropriately).

* I tried looking up (briefly) whether the absence or presence of a market for the company's stock is taken into account for a 409a valuation but couldn't find anything.

------
javitury
The recommendation to immediately transform your options to shares and sell
them is the exception rather than the rule. In this context, it is assumed
that options are very illiquid.

But in general, if you want to recover as much as you can, you should sell
your options directly. That is why the value of an American and a European
option tends to be the same.

[https://en.m.wikipedia.org/wiki/Option_style#Difference_in_v...](https://en.m.wikipedia.org/wiki/Option_style#Difference_in_value)

------
charlieegan3
I listened to a software engineering daily episode where this:
[https://github.com/jlevy/og-equity-
compensation#introduction](https://github.com/jlevy/og-equity-
compensation#introduction) was discussed. Found it cleared some things up.

------
Veratyr
I'm getting into trading options but I don't work for an employer who grants
them to me.

I'm curious, can you sell your options without exercising them or are the
kinds of options you get from an employer not the kind of options you buy from
an exchange?

~~~
jnwatson
The two types of options are similar in that they have the same general terms.
However, you cannot sell your ISOs on the CBOE, because they differ in
details, the most important one being that the exchanges only trade in options
for publicly traded companies.

That doesn't mean you can't sell your ISOs to someone else; there just isn't a
marketplace for it.

------
compsciphd
I wish I could purchase my ISOs within my IRA, avoid all these tax issues.

------
TheGRS
I still think start-ups should offer the equity, it helps motivation and
retention. But also offering a well-defined bonus program would give a lot of
the benefits to employees while not having to pay out as much in equity. Then
employees are getting the benefits of the company doing well even if their
stocks are still effectively worthless.

------
jonthepirate
This HN post nails it.

