
A Guide to Employee Equity - craigcannon
http://themacro.com/articles/2016/08/a-guide-to-employee-equity/
======
tyre
As an ex-Gusto employee, let me provide another side.

Gusto also has a company bylaw where they can veto any employee sale. Not
Right of First Refusal, but can flat out veto an employee selling stock to buy
a home, pay off student loans, start a company, etc.

This isn't covered at the time of hiring, nor present in the option agreement
provided to employees.

As an early ZenPayroll (now Gusto) employee and a leader of the culture up to
70 employees, I'm honestly embarrassed by the company's stance here. It's
hypocritical (in my opinion) to the values talked about by the company.

Employees should benefit from the success of the company they worked hard to
build. As a current founder, believe me I understand why founders get a much
larger share. But at least be transparent.

You can read about our approach to equity, and everything else, here:
[https://octopoedi.gitbooks.io/employee-
handbook/content/](https://octopoedi.gitbooks.io/employee-handbook/content/)

~~~
abalone
It should be presented transparently, but that's a pretty standard term and
there's a good reason for it. Those so-called secondary sales put more owners
onto the cap table which can cause accounting and investor-relations headaches
for small companies. Things like information rights, control issues,
regulatory responsibilities. At a pre-IPO stage, it can be good for the
company (including option-holders) to control who they invite in to own it.

Basically Facebook and a few others tried allowing secondary sales, had
problems, and since then the industry has retreated from that idea.

~~~
ncd
In the case @tyre mentioned above, the number of owners on the cap table would
have actually been reduced during the sale, not increased.

The problem is not with the spirit under which that clause was added to the
company's bylaws--the problem is the knee-jerk reaction by which they halted
any discussion of sales (and didn't try to find a solution that worked),
whether or not the proposed sale actually had a material effect on the cap
table. Not to mention that ROFRs exist to eliminate cap table problems
altogether.

Employees are unaware of these "veto" clauses, and continuing to hide them is
acting in bad faith. But of course companies don't want employees to be aware
of these clauses--it would become crystal clear how absolutely worthless
equity is for the vast majority of employees at startups (even at Valley
darlings like Gusto).

~~~
birken
As a preface, I'm as employee friendly as it comes for options and I've been
through the ringer on this whole option process.

I don't think it is fair for an employee of a private company to be upset that
they can't sell their shares whenever they want. There are more than just
issues of the cap table. If one person wants to sell shares then isn't it only
fair that everybody get the opportunity? So now it becomes a process. If the
company endorses the process, then it can potentially affect the 409A
valuation in addition to being a pretty big distraction and time sink.

So you can't just say because Employee X wants to sell shares and has a buyer
lined up, the company shouldn't get in the way. The most fair thing for
everybody might be to block the sale.

As a caveat to this, I believe that if founders sell shares then they should
also give employees a right to sell shares, and not doing so is reason to get
upset. However, if the founders aren't selling shares then I don't think it is
wrong for them to make everybody wait for an IPO, acquisition or a other
structured stock sale.

~~~
tyre
The founders of Gusto did sell shares, without a broader option for employees
(they hand picked some employees that they wanted to allow to sell shares.)

Regardless I think employees should be able to sell shares. We (Seneca
Systems) have a right of first refusal where we can choose to buy the shares.
In that case, we do get to choose the investors, indirectly, because we can
raise money to pay for it.

It really comes down to how you balance power between the two groups.
Personally, we believe that founders and investors have enough rights with a
RFR. We shouldn't have veto power over major life events for our employees.

Is it more inconvenient? No, not really. But it is a big deal for employees
that have worked their asses off to make our company what it is.

~~~
angersock
It is sad founders and employees are considered different groups here.

~~~
brianwawok
Why shouldn't they be? Founders put in the initial blood sweat and tears for
below market rates. Some guy hired at year 3 for market rate? Just an
employee.

~~~
JamesBarney
Because 95% of the time it's not market rate because the employee thinks his
equity is worth something, and founders never disabuse them of this notion.
And many owners pretend like the equity is some form of employee ownership.
Then they never inform them of the multitude of clauses that shift all
possible risk away from the company, founders, and investor onto the backs of
the employees.

Again I want to reiterate that all of this is great if the the company is
upfront with possible employees about how the deal is structured, and that the
employee is just an employee with a few lottery tickets so they might as well
be working at AmaGooBookSoft for twice as much money. And upfront the owners
told the employee that they definitely should not put in their blood, sweat,
tears, and family time into the startup because they're not a part owner, they
are "Just an employee".

~~~
brianwawok
Oh 100% agree, many startups abuse employees with fake kool aid and pretend
dreams. Not just startups, trading companies do this, sure other markets do
too. Talk a lot about the awesome that will happen down the road, but nothing
in writing (or writing that contradicts claims). Feel bad for people that sign
up for such bum deals...

------
abalone
Hi, thanks for the lucid interview. Why the 3 year minimum service period to
extend the exercise window?

 _> The main point is that if someone decides to not exercise and/or is not
able to exercise and they leave the company, their options typically have a
three-month expiration. So, unless the person exercises them within three
months after leaving, they lose those options, which is kind of crazy to think
about because the person has already invested time, already contributed to the
company, already meaningfully helped the business._

 _> So at Gusto... everyone that has stayed here at least three years, their
expiration changes from three months to ten years._

Doesn't everything just said about it being "crazy" to lose your options apply
if you leave at 2.5 years? You've "already invested time, already
contributed..." Why should you lose vested options, ever?

I asked Adam D'Angelo about minimum service periods and he responded that it'd
be more transparent to have a longer cliff. My perspective is that backloaded
vesting would be closer to the probable intended effect here (a barrier to
leaving early, but you don't lose everything).

Put another way... Aren't "minimum service periods" exploiting opaqueness to
make them seem like friendlier terms than longer cliffs or backloaded vesting?

~~~
terravion
This is a really tough policy to get right because there is a continuum of
cases. At one end, someone has vested shares and is pushed out for being
harmful to the company. At the other you have a valued loyal employee that is
going to business school for two years and hopefully coming back. It is a no-
brainer that the employee going to school should get the exercise period
extended--but if the toxic employee doesn't want to risk cash, why should the
staying employees take dilution on what was probably unhelpful service?

It is really hard to make a contract that fully reflects what's fair.

I think the thing that gets missed a lot in these discussions is that just
because default docs are super company favorable (i.e. assuming the former
rather than the latter), in the opposite case one can make an exception.

~~~
toomuchtodo
> It is a no-brainer that the employee going to school should get the exercise
> period extended--but if the toxic employee doesn't want to risk cash, why
> should the staying employees take dilution on what was probably unhelpful
> service?

Because in both cases, they earned their options. You can't take back their
salary compensation, why should you be able to take back their options?

> It is really hard to make a contract that fully reflects what's fair.

No, it isn't. If you've earned your compensation, you have earned it. Unless
you mean its difficult to write a contract where a company can weasel out of
their obligations when its suits their purposes; I would agree with that.

~~~
beambot
> they earned their options

Yes, and that option expires in 3 months after departing... In the same way
that publicly traded stock options (ie calls) typically have expiration dates.

Part of the conflict here is that "options" aren't "shares" \-- the option,
including all terms (such as execution windows) are what is earned. Everything
is known upfront. If you wanted comp to be around shares, then just issue
shares via RSPA and deal with the cap table consequences and extra legal
wrangling.

This entire "problem" is caused by tax code: you owe the IRS on gains from
option conversion, even though the underlying asset is entirely illiquid and
frequently non-transferrable. Sounds like a "real" solution is to lobby for
tax code changes.

EDIT: to be clear... I'm not saying I agree with short expirations after
departure. But there needs to be a clear distinction between shares, options,
and 'intent'. Clearly the existing two ways of comp are lacking since there
are either tax consequences (options) or out of pocket employee expenses to
purchase (shares).

~~~
terravion
And there really isn't any free lunch. Extended exercise periods have a real
cost to everyone that stays (the people who are increasing the value of the
option) at no cost to the departed person.

~~~
rdtsc
Right but the person who left was their earlier, during a riskier time, then
probability of failure was greater. So they jumped in when others might have
thought twice (remember most startups fail). Aren't those options a reward for
that?

------
ditonal
Gusto (people being interviewed) formerly known as ZenPayroll, fired an
acquaintance about a week before their options vested.

Now they are trying to educate people on equity? You would need a full-
semester class to explain the many ways in which VCs and their "startup"
cronies can screw you out of compensation (e.g, dilution, selling at a low
price and then using staying bonuses to kick in liquidation preference, 30 day
exercise windows making it financially prohibitive to exercise, etc). Do
companies even IPO anymore? If Uber still hasn't gone public, when do you
think Gusto is?

If these companies actually wanted us to value their equity, they would
reimburse independent corporate lawyers to review the contract.

Higher profile people like Zach Holman are already speaking up. It's going to
take a while, but I already see programmers realizing that the smart move is
either being a founder or going to work for GoogMicroAppleSoft. It's still to
be determined whether the VCs will finally realize their inability to hire is
their own damn fault and fix equity.

Only the naive and the financially illiterate accept these equity offers as
worth anything.

~~~
fosk
> If Uber still hasn't gone public, when do you think Gusto is?

IPO is only one of the exit strategies available, acquisitions being another
one (selling to the private market being another one, etc). A company doesn't
necessarily have to IPO in order to return a value to its shareholders.

~~~
enobrev
Unfortunately, an acquisition isn't necessarily all that valuable to
employees.

~~~
duaneb
How do you figure? If they've vested they'll make cash.

~~~
icedchai
Wrong. Have you ever been part of an acquisition? More than likely you are
given stock (or options, if you're still vesting) in the acquiring company.
This can happen several times over, as your acquirer is acquired. You may,
infact, never make any cash...

~~~
duaneb
Seems like a poorly negotiated acquisition if your employees don't get
anything of value out of it. Hell of a way to encourage work.

~~~
st3v3r
Depends on who's point you look at it from. The investors and the founders get
to make out pretty well, so to them it's a success. The acquiring company
doesn't have to pay a lot of employees actual money, and they give them
something which handcuffs them to the company for a while, so to them it's a
success.

------
JonFish85
These articles make front-page HN every couple of weeks and I find it very
tiresome. Stock options most likely aren't going to be "worth it" (which is
not to say that they're going to be entirely worthless, but $25k before taxes
isn't turning any heads).

Some bullet points:

* Stock options for common stock mean you're dead last in line for making money. Before you are banks/lenders/creditors, investors & board members, founders and any extremely talented management that were brought in.

* Unless everything goes absolutely amazing and according to plan, your options are not going to be worth much money. All it takes is one down round or a market downturn during your lockup and you're wiped out.

* If your company goes IPO, you have a long time before you can do anything with your shares. In the meantime, the market may not be kind, and your options might be underwater.

* If you get acquired, big flashy numbers can turn sour pretty quickly. "Top-billed" numbers (e.g. Company acquired for $2bn) can have a lot of fine print. Your options very well may be worthless, or you may be subject to lots of earn-outs that A) you probably won't hit or B) the acquirer has no real reason to help you hit them.

And that's not to mention the whole ball of fun that comes along with figuring
out your taxes. People (speaking mostly just about friends & coworkers) spend
_far_ too much time fussing about various outcomes and calculating things
when, at the end of the day, it's not worth worrying about. You're probably
not going to get rich off of stock options; negotiate for what you think
you're worth, but once you have, forget about them.

Of course, if you're a founder or a first-5 employee, the situation probably
warrants a lot more scrutiny and have your lawyer/accountant look over the
paperwork. But if you're not, it's really probably not worth more than an hour
or two of reading the paperwork and asking some questions.

~~~
hkmurakami
I help friends with assessing their job offers on a monthly basis and I agree.
(in fact I am meeting one friend this evening to silently be on a call with
him as they discuss his offer).

I tell them "Don't join unless you are happy with your base salary and won't
get anything else. Consider your options to be worth $0 when making a decision
to join or not join."

------
dawhizkid
IMO medium sized startups that have raised a lot of money are the worst to
join - still giving out options but are too expensive to consider early
exercise and too expensive to exercise if you end up leaving after 1 year.

IMO you should either join a super early startup that you really believe in
and pay a few thousand to early exercise OR join a proven late stage startup
that converted to RSUs and avoid paying for options in the first place.

------
sl8r
Several comments allude to liquidation preference / stock-participation for
preferred stock holders.

While both of these terms do bite into the common share stake, as others have
pointed out, their effect is model-able; so you can see where you stand under
different exit scenarios. Ask your employer, or get access to something like
Pitchbook, to find out:

1\. The amount of $ raised from investors, along with the % of equity in
common vs preferred shares.

2\. The liquidation preference (1.0x is common) for preferred.

3\. Whether the preferred stock participates (not doing so is common).

4\. What % of common equity your grant represents.

You'll then be able to draw a payout diagram (like this[1], written by Andy
Rachleff) showing how much you'll make for different exit prices. Be aware
that under some complexities, like the fact that later rounds will cause
dilution and that certain exit scenarios scenarios (like acquisitions) may
trigger a different liquidation preference for preferred stock.

[1] [https://blog.wealthfront.com/wildly-different-financial-
outc...](https://blog.wealthfront.com/wildly-different-financial-outcomes-
employees-acquisitions/)

------
Artlav
Interesting.

I thought "equity" meant just giving stock to the employees after they worked
X years, not the mess of complexity, taxes and spending your own money that it
actually is...

~~~
mgummelt
It mostly is with RSUs. Stock options are far more complicated.

~~~
hkmurakami
Even with RSUs, you'd have a tax obligation on illiquid RSUs if not for the
terminology used in the contract to delay the actual "vesting event" in order
to delay a tax event.

~~~
mgummelt
My understanding is that taxes for RSUs are typically withheld. See
[https://blog.wealthfront.com/stock-options-versus-
rsu/](https://blog.wealthfront.com/stock-options-versus-rsu/)

~~~
marcins
Depends on where you are - I believe that's the case in the US, but for
example in Australia when RSUs fully vest the value at vesting is included as
income on your tax return at the end of that financial year, so you don't
actually pay the tax until after you file and are assessed.

------
emilsedgh
_You should read this guide if you are:_

 _You’re a startup founder who wants to learn the basics behind offering
employee equity_

 _You’re an employer who wants to offer equity to new hires_

 _You want to be wildly entertained (and learn some stuff along the way)_

Where can I found such guide intended for employees who are being offered
equity?

~~~
johnhess
I really like this one: [https://blog.alexmaccaw.com/an-engineers-guide-to-
stock-opti...](https://blog.alexmaccaw.com/an-engineers-guide-to-stock-
options)

------
tn13
Despite reading many such articles there is one thing I have never understood.

Under what circumstances it is NOT a good idea to exercises as soon as
possible?

Only one scenario is where you have to pay a large sum for this early exercise
and you see a risk that the company might go out of business. But in such
cases if the amount is large you are probably at the wrong company in first
place.

~~~
spoonie
My understanding is that you may have taken a lot of equity in exchange for
salary, so much so that you literally can't afford to exercise any significant
portion of the options.

~~~
tn13
In that case you have already taken crazy risk and if you still have doubts
that company wont do well in future you should probably quit.

------
hkmurakami
Here's a cynical realization I had regarding options. It may be an unpopular
position but one worth articulating.

We like to believe (and are told, with marketing _spin_ ) from founders/hiring
managers that we're being given a block of options to purchase shares in the
company. We evaluate this grant, given the commonly presenting "key terms" of
strike price, company valuation, ownership %, etc., to have some value $X [1].

What we're not explained is that we're actually given a block of options with
expiration date of D (where D is most commonly length of tenure + 90 days).
What I hadn't realized before is that this D really makes a difference in the
value of an option.

Ask any trader about the value of an option, and they'll explain to you that
short dated options are the cheapest, and option contracts (ex: puts, calls)
become more expensive as the expiration dates become longer. Longer expiration
dates directly translate to a higher intrinsic value of those options.

So going back to the option grant given to the startup employee, we can see
that the expiration date clause on those options are a "key term" that is
rarely, if ever, a point of contention. People negotiate for a larger number
of options all the time (often trading salary for more options), but when's
the last time someone tried to negotiate and trade the number of options for a
_longer expiration_? That would actually be trading some amount of value for
another amount of value, but it's never done.

But this is something you could do if you wanted to open a position on say,
$AAPL, using options. You'd intently consider both the strike and the
expiration date for an $AAPL option, and look at how much each would cost. A
longer expiration contract with the same strike price will always cost more.
Some hedge fund managers have very long dated (3+ years), out of money (ex:
the strike price is higher than the current price) call options on Oil. Those
contracts would be much cheaper if they'd expire in 3 months, not 3+ years.

So when we say _" we've earned those options"_, it's not entirely accurate.
We've actually _" earned those options with expiration D"_ (and other terms).
Holding strike price constant, option grants with "equivalent value" with
different expiration dates would mean that the longer the expiration date, the
fewer options you should get.

Of course, figuring out the value of a longer expiration date would be
incredibly difficult. I certainly have no idea how to price this, especially
given that the value of the underlying asset (the company) is already a bit of
a black box in the first place. But this is something worth being aware of, so
that we can understand that there is real value at stake in the ongoing
expiration date discussion.

BUT -- we shouldn't forget that if the founders' intent truly is to "give Z%
of the company to an employee in a tax efficient manner" (like they say in all
their conversations), and if "the value of the option grant as computed by the
value of the underlying option contract" is not a concern, then the founders
will not actually be "giving up" any value since that value was inadvertently
created and was never intended to be claimed by the founders/company in the
first place. In this case, a founder who wishes to be consistent with herself
and her own narrative should definitely adopt a long expiration option
contract to make the reality of the situation as close to the narrative as
possible, given the legal limitations.

[1] I tell friends to consider their option grant as $X == $0 to simplify
things and protect themselves from being mislead, but all options do have some
nonzero value.

------
neom
We're trying to build things in a different way:
[https://www.linkedin.com/pulse/part-i-how-were-building-
stae...](https://www.linkedin.com/pulse/part-i-how-were-building-stae-john-
edgar)

The comments here have shown some new thinking for me about employee as owner,
love reading about it and welcome the input of others on building in a human
first manner.

------
driverdan
I stopped reading when I hit the part about 5 year vesting. Why would anyone
put up with such a long cycle?

~~~
hibikir
because today there are bigger problems with taking options than a 5 year
schedule? a 4 year schedule was important when a company wanted to go IPO
quickly, but today, where startups are private for 8+ years, and option terms
make selling the options in the secondary market very difficult, it doesn't
matter if you vest in 4 or 5 years: next liquidity event might be in 10 for
all you know.

I work for a company that is very likely to make it, but given that I don't
know when in the world we'd even attempt to go public, I count my options at
zero. Will I still be happy here in 2 years? 5? 8? I better get used to being
happy here until there is a liquidity event, or the equity is worthless to me.

I know people with 7 digits in paper vested options, but they can't exercise
them: It's hard to afford them, the taxes are killers. Until there is a
liquidity event, they have nothing, and all the promise of riches goes away 90
days after they leave the company. In practice, they might have a 10 year real
vesting schedule. I don't know about you, but I don't know that many people
that have stayed 10 years at a tech company.

So that's why the long vesting cycle is fine in practice: The real cycle to
getting cash out is even longer.

~~~
spoonie
Why can't you exercise and move on?

Are you an early employee with lots of equity at a low strike price and a low
enough salary that you can't pay the tax to exercise?

Are you risk averse and don't want to pay to exercise until you know there
will be a payoff?

------
pyrrhotech
long term capital gains tax can be up to 33% in CA:
[http://taxfoundation.org/blog/how-high-are-capital-gains-
tax...](http://taxfoundation.org/blog/how-high-are-capital-gains-tax-rates-
your-state)

~~~
siberianbear
I'm curious where this site came up with this 33% number. For California, I
calculated 20 (federal) + 3.8 (federal net investment) + 13.3 (state) = 37.1%

For states with no income tax (Texas, Nevada, etc.), I calculated 23.8% (20 +
3.8), but the site you referred to lists 25.0%

------
danieltillett
Are there any good studies on how much options motivate employees? I assume
there are a large percentage of employees who value options at zero.

