
Startup Stock Option Changes - beninato
https://medium.com/@beninato/startup-stock-option-changes-5df706da0317
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diego
Backloaded vesting seems like a terrible idea. It puts the employee in a
really vulnerable position. As a company grows, the absolute value that a
given person generates should decrease relative to everyone else. The function
(relative value created this month / stock vested) decreases even more
quickly. This may create an incentive to fire (or at least not try to retain)
an employee after the first or second years. The founders may not need to
increase this person's salary because of the perceived value to come, so this
person may end up making less money than later employees.

I would not even think of proposing a backloaded vesting schedule to an
employee. There's nothing wrong with an even vesting schedule in terms of
employee alignment. If you cannot retain an early employee after year 1 or 2
you have other problems.

~~~
Stasis5001
I agree. I came across this once, and ran the following model. Assume you
assess the expected value of the equity grant to be, let's say, $100k over 4
years. Then this means your total comp will rise by $10k a year, which
probably is comparable to your natural gain in market value. Thus this is
equivalent to taking a similar offer except with $40k in equity with linear
vesting, and either getting a raise or switching companies to get the
$10k/year raise.

What this analysis omits is that the expected value calculation ignores the
fact that the equity far exceeding the expected value is correlated with a
desire to stay at the company, which makes the backloaded vesting irrelevant.

If you interpolate a bit to account for that correlation, I personally started
concluding the $100k offer became more like $50-60k, which dropped the offer
below market rate and I walked.

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rdl
When a company refuses to disclose the fully diluted number of shares, what do
you do? Assume it is the number of shares authorized (which you can find for
$20 at
[https://delecorp.delaware.gov/tin/GINameSearch.jsp](https://delecorp.delaware.gov/tin/GINameSearch.jsp))?

~~~
nemanja
That is the upper bound that is generally much higher than the fully diluted
count, so not a good proxy. However, it would be a fair assumption on your
part since you are not given the right level of transparency. At any rate,
probably best to be firm about the ask and just walk away if you dont get it,
since it is not a good sign for things to come. Unless, of course, you would
be okay to work there if they dont disclose you a salary (salary? dont worry
about it...)

~~~
rdl
Is it an absolute upper bound? Is there a legal prohibition against creating
derivative instruments (options, contracts secured by issuance of stock, etc.)
in excess of authorized-at-time-of-execution?

~~~
nemanja
in practice, it is set very high to cover all conversions and future capital
needs and then some. however, it can be increased if needed, with a
sharedholder vote.

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wdewind
I feel like this hardly touches on the main issues. It really doesn't matter
what % of the company you are given, there are tons of other factors (such as
the class of stock) that can effect your future dilution, as well as the value
of the options independent of dilution (for instance if there is a right to
repurchase your options are worth significantly less because there is a huge
risk component added to them). TLDR: it's your responsibility to understand
the agreement you are signing. If you can't, you need to give it to someone
impartial who does and can advise you.

Also, re: #3 after 90 days (3 months technically) the SEC eliminates many tax
benefits you get from your options being classified as ISOs, so while
extending the time you have to purchase is helpful, it's not like it's as
simple as giving you more time to exercise. Many things change after those 90
days that have nothing to do with your company's policy.

~~~
beninato
Not sure what you mean about class of stock. Almost all employee options are
common stock. Good point about repurchase rights. I should probably add a
section on that. On the 90 day issue, usually those ISOs are converted to
NQSOs after 90 days.

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johnrob
Possible downside to 10/20/30/40: does this make employees less mobile? From
the company perspective, if we all start imposing this schedule, it might harm
the recruiting pipeline. While startups all want committed employees, to what
degree are they depending on the fact that, in the case of success, they can
poach heavily from employees that have 1-2 years of tenure at their existing
jobs?

Side effects are always important to consider. The "law of unintended
consequences" is powerful.

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birken
A lot of great suggestions.

I'd consider lack of #1 and #2 as dealbreakers. Any company that doesn't allow
early exercise is being unfair to early employees for no reason, and not
providing basic cap table information makes stock options numbers impossible
to value.

#3 is great, but it is much more progressive. I'd value a company's offer more
highly if they offered this, but it wouldn't be a dealbreaker if the company
didn't.

As for number #4, I think 10/20/30/40 vesting is way too bottom heavy. The
problem is the employer can always fire you if they want, and if the company
blows way up in value in 2-3 years, they might prefer to fire you than give
you so much stock. This reportedly happened at Zynga so it isn't unheard of.
You'd hope to never join a company with this type of leadership, but as an
employee you don't have much power so it is good to be defensive about it.
Maybe I wouldn't mind a minor tweak like 20%/25%/25%/30%, but I'd prefer
25%/25%/25%/25% with a culture of refresher grants to high performers (which
accomplishes the same thing).

The difference between founder stock and employee stock options is already so
large, I don't think option holders really need to make any concessions (like
bottom heavy vesting) to get some common sense benefits to stock options.

It also is important to educate people about these differences. I hope that
companies that do #1, #2 and #3 have a nice guide on their offer letters
explaining why this is beneficial to potential employees.

~~~
SeoxyS
The problem with refresher grants (and the thing that people don't understand)
is that they tend to be near worthless due to the strike price. If the company
is doing well, and you've stuck around for several year, the price on the
options is probably so high you're unlikely to make much money off of it.

~~~
birken
In comparison to an early grant a refresher grant will be smaller and worth
less, but that doesn't make it "near" worthless.

First, if you have 7 years to decide if you want to exercise it, then every
stock option has risk-free upside regardless of the strike price. Without the
7-year rule then the upside isn't so clear cut, but that doesn't mean they are
near worthless at all.

Second, companies really don't grow that quickly. Over a 1 or 2 year time
horizon, even a really successful company will 2x-4x in value (and the common
stock might grow even less than this). If the strike price was low on the
original grant, the strike price will also probably be pretty low on the
refresher grant. Especially at early stages of a company's life when the
options are priced at essentially zero, even if you 5 or 10x the value, the
strike price will still be very low.

When you have more established companies and higher strikes prices, it is less
of an issue because there might be a shorter term path to liquidity which
takes away risk of exercising without being able to sell the stock.

~~~
SeoxyS
The dramatic difference in price is really between pre-funding to post-
funding. e.g. I know many companies where options were granted at 1c a piece,
even as seed notes and safes were given out, but as soon as the Series A
equity round hits, the 409A & thus options grant went up to $0.50+. That's a
huge difference.

That said, your point about having 7 years to decide is entirely fair, and
mostly negates that downside.

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ap22213
Honestly, 4 year vesting schedules give me almost zero incentive to work
harder.

The reason is this: These days, founders are more likely to try to make their
companies look attractive as acquisition targets than try to grow their
businesses long-term. Therefore, except for rare companies with exceptional
growth potential, an employee can expect the company to either fail quickly or
get acquired. So, rarely do typical startups last 4 years.

Further, since it's up to the board and the acquiring company to trigger full
vesting on acquisition, and since boards and acquiring companies have no
incentive to do so, most employees are left with much less than 4 years of
vested options.

~~~
SeoxyS
Any stock option worth anything will take 5-10 years to return. You'll know
early on if it fails, but any acquisition within the first couple years won't
return much to the rank and file.

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kspaans
This may be country-specific, but can options be put in tax-free accounts like
TFSAs (Canada), (N)ISAs (UK), or (I think) IRAs (US)? Wouldn't that mitigate
the capital gains tax issues?

~~~
SeoxyS
In the US, with enough foresight, they can be purchased through a Roth IRA,
which would prevent any tax from being applied. The (major) caveats are three-
fold:

1) The money cannot be touched until retirement. So… if it turns out to be
Uber and worth hundreds of millions, you can't touch _any of it_! It's
probably a good idea to only put 25-50% of your stock in the account.

2) You can only contribute a tiny amount yearly to an IRA ($6k I think). So,
the options strike price must be dirt-cheap for this to make sense.

3) Actually doing it is quite complex, and requires a third-party account
custodian. If you're accepting a random startup offer pre-funding (the only
time you'd have essentially free options, allowing #2 above not to be an
issue), you're unlikely to go through that trouble.

\--

The huge benefit, however, is that if you do succeed in hitting in big with
something that way, you'll have a gigantic Roth IRA balance, tax-free, and
you'll be able to use it to make other investments, whose cost basis _and_
profits will all be tax-free.

[https://www.google.com/?q=max+levchin+paypal+roth+ira](https://www.google.com/?q=max+levchin+paypal+roth+ira)

~~~
rdl
Are you talking about a "ROBS" (Rollover As Business Startup) thing? The IRS
hates them, but I believe they're technically legal.

I wasn't sure if you could do it with a Roth IRA vs. with a (non-Roth) 401k,
though.

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william_hc
Why do we give out options instead of stock in the first place?

~~~
rdl
Tax reasons and complications with having >500 shareholders (and shareholder
information, etc. rights in general), plus administrative costs.

Early on, you issue founder grants if you want, at common stock price, paid in
cash. A company is worth $100 in total, so you can buy 10% of it for $10.

Common and preferred can run separately in terms of price (although there's
some relationship between the two; more enforced now than in the past.)

After Series A, 1% of the company would be a real amount of money -- maybe a
$10mm valuation, so 1% would cost your engineer $100k at hiring. That's a lot
of cash for an employee to invest.

~~~
scurvy
> 500 unaccredited share holders. The JOBS act got rid of the 500 shareholder
> arbitrary limit. It's now 2000 total or 500 unaccredited.

~~~
rdl
The #1 reason for all of this is actually "that's how it has always been
done", which is strong motivation for non-core things in a startup.

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seattle_spring
My retention equity grant after an acquisition was 10/20/30/40\. I just left
after 2 years partially because I realized that the schedule was insulting and
I had barely vested a small slice of the pie.

~~~
rdl
I have a 2 year cliff (which I would hit 2 June 2016) on 4 year vest. I would
not recommend this to anyone on either side of any transaction.

~~~
beninato
I've never seen a 2 year cliff. Can you say what company?

~~~
rdl
Not standard at the company. Unique as part of acquisition.

~~~
beninato
Got it thanks. There are all sorts of nonstandard things that happen after
acquisitions. Too hard to capture those here.

~~~
rdl
1/2/3/4 is much more common in acquisitions than it is anywhere else, so maybe
the dystopia that is these kind of deals will become the norm for regular
hiring.

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beninato
Based upon the comments, I added some additions to the end of the post. Thanks
for raising those issues!

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sjg007
Definitely needs to change.

