

Ask HN: What can go wrong with stock options? - an00nym00s

(posted anonymously for obvious reasons)<p>We're looking at stock options as a possible means to compensate people in our start-up, such as very early employees and founders who didn't get enough initial shares.<p>I'm interested in knowing what the HN community has observed in terms of problems that can happen with stock options, so that those can be covered in the options contracts that we end up creating.<p>Obviously this would all be checked with a lawyer eventually, but we'd like to avoid involving lawyers in the initial drafting of the conditions and the initial discussions of them.<p>It'd be great to hear stories of what can go wrong from the point of view of the company executives, from the point of view of the persons receiving the stock options, and from the point of view of more distant shareholders/investors. Any relevant links would of course be very welcome.<p>Basically, what should we worry about?<p>PS: Alternatively, if you know of other share transfer mechanisms that would be useful at a stage where just diluting the stock and buying the additional shares outright is too expensive, please do mention those too...a
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Shamiq
Strike price being set too high is one thing. The ability to sell those
options (rather than having to exercise them) -- this is an issue with the
liquidity of stock options. Rights after an individual leaves the company.

For the PS: There could be some financial engineering involved with creating
convertible bonds and selling those at a discount to employees. Again, we run
into liquidity issues.

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Shamiq
Here's something from the wikipedia page on Convertible Bonds:

Hybrid bonds typically are issued as loan capital, but the issuer retains the
right to exchange or convert the bonds into convertible preference shares with
similar conversion rights and income. The purpose is generally to ensure that
the bonds (as loan capital) have the tax offset-ability (against taxable
profits) of loan interest, and perhaps pay gross to qualifying investors. At
the same time, the ability to change the bonds into cumulative or non-
cumulative preference capital should mean that they pose less balance sheet
risk. The issuer only achieves the best of both worlds if the hybrid bond is
structured so that non-payment of interest does not constitute an event of
default.

<http://en.wikipedia.org/wiki/Convertible_bond>

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an00nym00s
Convertible bonds would still require paying for the shares, right?

Part of the problem is that the shares are too expensive for the recipients of
them to just buy them. Essentially, they should have been allocated as initial
founder stock but weren't (due to various reasons that I won't go into).

At the moment, from what I hear, stock options seem to be the best way to
allocate shares without needing a large transfer of money from the recipients
of the shares to the company (or some other party).

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Shamiq
Just to clear up, I am advocating zero-coupon convertibles.

Yes, you'll have to get the corporation to cover the cost of the shares.
However, convertibles will give you a tax break since they go onto balance
sheets as a liability, and so they effectively give you a ~35% discount.

The flip-side is that recipients will have to pay taxes on the implicit coupon
payments. You really need to talk to a corporate accountant to get more
details, and whether this is even a legal option for you, but definitely look
into it.

 _EDIT_

I misread your question. The payment becomes the responsibility of the issuing
corporation, not the individual receiving the stock. That is a more clear
answer :)

