
Startup Employees Invoke Obscure Law to Open Up Books - ojbyrne
http://www.wsj.com/article_email/startup-employees-invoke-obscure-law-to-open-up-books-1464082202-lMyQjAxMTA2NjI0NDQyNzQ1Wj
======
toomuchtodo
Interesting. My options agreement has a clause called "Waiver of Statutory
Information Rights" in which I waive my inspection rights of the company stock
ledger, a list of its stockholders, and its other books and records, and the
books and records of subsidiaries of the Company provided under Section 220 of
General Corporation Law of Delaware until the first sale of common stock to
the public.

Is this waiver clause enforceable?

EDIT: Let this be a lesson folks! Always have an attorney review your options
grant contract.

~~~
rdtsc
> Always have an attorney review your options grant contract.

Just curious, what if you had an attorney and they pointed that clause out.
Would it have made you reconsider the offer? I guess you can attempt to strike
it out from contract and see what happens, or more ask for more options
instead?

~~~
Bluestrike2
Honestly, if they're willing to put this clause in there in the first place,
it's unlikely that they'd be willing to negotiate it for anyone but high-level
hires. And that's iffy. They apparently have a very strong desire to keep
their financial data private, so the most likely outcome would be rescinding
your offer if you state that it's a deal breaker.

That said, I think it's a foolish clause for companies to try and force
through even though I can see their arguments for it. It puts the employee at
a distinct disadvantage, and invites future problems when the employee wants
to do something with their shares and has no choice but to sue for records
access. Requiring an NDA would be sufficient. Beyond damages, the stigma of
being the guy who broke their NDA and leaked financial data would pretty much
guarantee no startup would ever touch you with a ten-foot pole. As incentives
go, it's a strong one.

~~~
lsc
>Beyond damages, the stigma of being the guy who broke their NDA and leaked
financial data would pretty much guarantee no startup would ever touch you
with a ten-foot pole.

Is checking what lawsuits you participated in part of a normal employment
background check? It seems to me that most employers might avoid looking at
that sort of thing for the same reason they avoid looking at your family
status.

~~~
Bluestrike2
Not really, unless there's a reason for a more thorough background
check/investigation. My thinking was that such a situation would be the sort
of thing people would talk about. Investors would be upset if a leak harmed
their interests, founders would be pissed about a betrayal, other companies
would talk about it as a "this is why we need that clause" anecdote, reporters
might stumble on court filings, etc.Word gets around, and in a lot of ways,
the startup/tech communities are still small despite their size.

That said, it's just a hypothetical and there would be a lot of factors at
play in real life. But if it were at a startup with any sort of profile, or it
had well-known investors, I wouldn't bet on the news staying a secret.

------
conorgil145
Quote from the article:

"There have been hundreds of Delaware lawsuits to inspect company books says
Ted Kittila, an attorney with Greenhill Law Group. Most requests are settled
before a suit is filed, he says."

So, for the cases which went to trial, were the companies held accountable, or
were they able to skirt the law somehow? I'm curious whether employees who
brought the suits were able to claim damages if the value of their shares
changed materially in the interim where the company refused to release the
financial information which the shareholder was legally allowed to see. The
shareholder could claim that they would have sold if they were given
appropriate information which they were illegally denied? Thoughts?

~~~
rahimnathwani
Damages would only apply if the employee had the right to sell the shares, but
did not have access to the accounts. If the company only withheld the accounts
during the time when insiders were prohibited from selling, then there would
be no decision for the employee to make.

------
harryjo
My employer told me "Our last round valued us at $XXXX for YYY shares. you
have ZZZZ options at $WWWW strike price."

Is this unusual?

Of course this can be diluted, but it seems I had the numbers. I guess I
didn't know the updated numbers for future rounds, until buyback offers came
around or people quit and exercised and filed their taxes and shared numbers.

~~~
poof131
It’s fairly disingenuous to use the fundraising valuation. Investors have a
ton of preferences that make their shares more valuable. Probably cut that by
a third or ask to see the most recent 409a valuation. Walk through possible
exits with dilution, assess the likelihood of those exits, and try to make a
calculated guess at the payoff. In all likelihood it is less then working for
4 years at a big company and founders saying it isn’t are selling their book.
If they can’t make the follow on valuation gates and see an exit, you probably
won’t make anything. Even if they exit at the valuation when you joined, your
shares will likely be worthless as senior preference holders get their
guaranteed returns.

------
startup1411978
what are the cons of being fully transparent re the cap table and other
financial details when the startup is small (say under 50 employees)?

trying to properly analyze the cost/benefit ratio of 100% financial
transparency.

some potential risks:

* employees leaking financial details to press, future investors, competitors.

* employees getting upset over smaller equity stakes.

~~~
mikeryan
Employee's leaving the company en masse every time they realize you only have
3-6 months run in the bank.

~~~
st3v3r
I fail to see giving workers more information about the potential future of
their career, so they can adequately plan and change direction if they feel
the need as a bad thing. Just pulling the rug out from under them and not
giving them a chance seems pure evil.

~~~
zenlikethat
No one forces them to take the gig. If they're smart folks they should have
already done the math that "Hm, we're pre-profit, raised $X million a year ago
and burn about $15k * Y employees a month... We probably have about Z months
left!"

Seriously, burn is not that hard to ballpark, engineers who are smart enough
to code should be able to do this math and make a calculated risk.

~~~
gohrt
ballpark is nearly uses. The difference between X and 2X is huge and it's very
hard to make the estimate tighter, and you don't know what not-profit metrics
will impress investors to put more cash into further growth. Many many
companies run for 10 years pre-profit.

~~~
zenlikethat
If you're not prepared to take the risk of the company going under, why work
for a startup at all?

~~~
st3v3r
Completely irrelevant.

~~~
zenlikethat
How so? Understanding risk is not relevant to working at a risky-by-definition
startup?

------
sulam
Don't companies have to establish (and report to shareholders) the 409a
valuation regardless of anything else? Every private company I've had stock in
has done a quarterly 409a in order to demonstrate to the IRS that they are
fairly valuing options. Admittedly this is a bare number, without any of the
supporting material that may be of interest if one wants to do their own
valuation, so DE law is still interesting here, but for the sheer purpose of
valuing your stock 409a seems to do the job.

~~~
conorgil145
Do you know if the 409(a) report is required to be made available to stock
holders, or is it something the company can also hide? If the company reports
the valuation reported in the 409(a), is there anything else of value in the
report which stock holders would benefit from reading/being aware of?

~~~
jdavis703
I think the only time you get the 409(a) valuation is when you get the IRS
reports after execrcising.

~~~
sulam
My wife recently needed to know the 409(a) valuation of a company she owns
stock in and was able to get it within a couple days. Obviously YMMV, but
consider that we pay estimated taxes quarterly -- valuing those shares at
least once per quarter is a necessity.

------
angersock
Not having access to this basic information is one of the reasons I left my
job last year. When the CEO starts getting really weird about basic questions
like "How many people are invested in us? What does the equity pool look like?
How much of the company do my options represent?", it's time to look
elsewhere. The company had less than 10 people at the time, which made it even
weirder--and I'd been there for two years, as the first engineering hire.

~~~
conorgil145
I am intrigued by your story.

What reason did they provide for not answering your questions? Which
communication avenues did you explore before deciding to leave? Did you try to
negotiate with them?

Did you leave any options on the table, or did you exercise your options?

~~~
angersock
In the interest of helping fellow devs:

Reasoning presented was basically handwaving about "people wanted different
compensation (read: divide and conquer)"/"we don't have to tell you this". I
pointed out that, under my reading of the applicable law, I could exercise one
of my vested shares and then check the books for myself--they didn't like that
one bit. CEO got flustered when I brought the whole thing up--I'm sure they
could've dealt with things more reasonably, but being on the spot they fumbled
and erred on the side of "let's say as little as possible until we understand
what we're doing".

By contrast, I asked a friend of mine what his company cap table looked like
and he showed me the whole spreadsheet--a company with more investors, more
revenue, more customers, and more traction than the one I was working for at
the time. So, I couldn't by the "well we can't show you this" argument,
because it was obvious bullshit.

The main takeaway is that one of their senior folks (me) said "Hey, you're
paying us below market wages and are refusing to make up for that with
competitive equity: why?" and they failed to provide a satisfactory
explanation. If you choose to be secretive about that sort of thing, more
power to you--but you can't be surprised that you'll be seen as untrustworthy,
dishonest, and sheisty by people that ask the questions. If an intern wants
the cap table, then I can understand not spending the cycles--but people who
are building your teams, building your product, and doing the work your
C-level should be doing (grump grump) actually _do_ need that information to
make good decisions.

As for your last question, upon my departure my options were bought back for a
reasonable amount. You have to watch out for who pays taxes in such cases, but
that wasn't an issue. I'm pretty sure they did this so they wouldn't have
options outstanding to people that weren't working there anymore, because
_reasons_. It's pretty silly if you ask me. There are reasons for that sort of
thing, but those reasons didn't seem to apply.

------
andy_ppp
It sounds as though it's not particularly obscure and very very clear why it
is part of the law. If you have shares or a right to shares you should be able
to see who you are sharing with. Isn't that the very point of this law?

------
nieksand
Is this really considered obscure? I'm pretty sure I read about it in a Nolo
book on small business.

Anyway, be aware this applies to shareholders. Having an option to buy shares
is not the same thing.

~~~
jerf
While many people may not be able to swing exercising all their shares or a
generally-meaningful number of shares, you can exercise one.

As I type this I find myself wondering if it's not a bad idea to do in
general, so that you move from "options holder" to "stockholder". Comments
from those with experience?

~~~
mcherm
Hmm...

I exercised some of my shares in a startup I was part of, solely for the sake
of becoming a "stockholder" rather than just an options holder.

I felt good about being a stockholder. I did not get any enhanced access to
information about the company (for several reasons, among them that they were
pretty open anyhow and I didn't ask).

Company later closed down. Investors with classes of shares that were
guaranteed more than 1x return on their investment took all the value and
common stockholders got nothing. So, obviously, I lost money by exercising my
options.

So I suppose I got "feeling good about being a stockholder" for the cost of
what I paid for the options. And honestly, looking back on it I'm comfortable
with that. I wish the company had succeeded, but I'm glad I was part of it
even if it didn't, and what it cost me was not more than I could afford.

------
stillworks
Aren't several SV startups not even incorporated in California leave alone
Delware ? Most of them are incorporated in some tax heaven such as Cayman
Islands and such ?

~~~
pge
Most startups are incorporated as DE companies (most common) or in the state
of their founding (e.g. California). This is because the laws in these states
are well known and have been tested by a large body of cases that establish
precedent. As a VC investor, having a company incorporated outside the US
introduces additional legal risk.

~~~
cloudjacker
That awkward moment when the only law that the startup will be tested by will
be labor contracts in the state they operate in, and EEOC law at the federal
level, and other federal laws

Making their jurisdiction of incorporation completely irrelevant as the VCs
push for settlement quickly.

~~~
harryjo
Sure but why add EXTRA legal risk by incorporating in an X-factor state?

~~~
cloudjacker
It isn't extra legal risk. You simply have legal teams copying and pasting
incorporation structures and contracts, now they're about to get all their
company's financials leaked.

Delaware's Court of Chancery isn't even a perk for 99.9% of businesses.
Delaware's "body of case law" can be leaned on by courts in ANY state if there
is a conflict that state has never seen before.

~~~
MOARDONGZPLZ
> Delaware's "body of case law" can be leaned on by courts in ANY state if
> there is a conflict that state has never seen before.

That's kind of how it works, but not to the effect you hope. Delaware law
isn't binding outside of DE, so if another court looked at it, they would only
use it as guidance. Versus if a DE court looked at it, they would use it as
binding precedent.

Which is the benefit of incorporating in DE. That law is out there and binding
due to the large number of incorporations there and large body of case law
that has developed. So answers to random questions are really known and agreed
upon. Whereas with another state's court, if you can even get them to consider
DE law, you're praying that they side with DE law, which isn't always the
case. There's more risk.

There is an advantage to incorporating in DE, whether you believe that or not.
Even if the advantage is, like using Ruby or Node or something, that everyone
knows the law and it's well settled and boilerplate. You don't have to
reinvent the wheel.

~~~
cloudjacker
what you say is true, it is just not applicable to 99.9% of businesses. When
you have a dispute over capital structure and disclosure to investors, then
Delaware will be useful. And you can incorporate closer to when you get to
that point.

Reincorporation, foreign incorporation, and continuation corporations are
valid ways to switch jurisdictions when you need it.

Just reading Nolo.com and incorporating in DE for limited liability of your
pet project, even your pet project that may get employees, isn't necessary.

------
joeblau
I wish I would have known about this back in 2011 when I joined my first
California startup. While I did learn a lot on the job, the leadership team
was very shady about the value of the company and the shares. I eventually
ended up leaving and not exercising my options after the C-level execs were
switched out 3 times in 6 months, but having this info would have been great
to know.

~~~
r_sreeram
> I eventually ended up leaving and not exercising my options

Knowledge of this law might not have helped directly, since you're not a
shareholder if you haven't exercised your options yet. It may have spurred you
to exercise some/all of your options, just to be able to peek into the books,
though.

------
the_watcher
This is interesting. As a thought exercise, would it be possible to exercise a
single option? Based on the broadest reading of this law, that would entitle
the employee who exercised to request financial information. Partial exercise
would also be an option for those looking to keep some exposure to a former
employer but without the capital (or risk profile) to exercise their whole
grant

------
chmaynard
Another link to the same article:
[http://on.wsj.com/1OKFn27](http://on.wsj.com/1OKFn27)

------
kashkhan
transparency is good for everyone. It keeps companies honest.

~~~
fullshark
That means it's not good for companies.

~~~
xviia
and companies control what goes into the employment contracts.

so, I expect future contracts will include clauses for "voiding of employee
inspection rights" and not "company transparency".

~~~
npizzolato
According to another comment thread, those clauses are not enforceable.

------
mathattack
The spirit of this law is very noble. It protects minority owners of companies
from abuse by management or majority owners. Are there some unintended
consequences, though? Could a competitor buy 1 share from an ex-employee to
get access to the corporate accounts?

~~~
conorgil145
I suppose that would be possible, but I think that it is very common for
private companies to work into their stock agreements that they have right of
first refusal for stock sales. Therefore, they should theoretically be able to
restrict a competitor from purchasing their stock by simply purchasing it from
the seller themselves instead of allowing the sale to go through.

------
hackbinary
Uhm, if you have been offered 'Stock Options' that means you have invested
(sweat) equity, and therefore, I think, that you get to see the books, just as
any other 'investor'.

------
jhallenworld
Aren't the articles of incorporation public information? You should be able to
find the the percentage of equity that your options represent from this.

------
iwantitiwantit
Someone please make me an app that automates the process of filing these
requests!

------
andrewfromx
this is great for share holders but most employees are option holders.

~~~
jc4p
From what I can tell if you exercise a single option this still applies

~~~
andrewfromx
true, but how many employees do this? Often the company doesn't not allow them
to buy the options and do the 83b election thing.

------
known
Transparency begets trust

------
cm3
What's the point of stock options? It's a piece of paper that allows you to
buy stock if and when at a predetermined price. This price can be higher or
lower, you cannot know beforehand. It's not a replacement for a salary or a
stake in the company. I was handed out stock options myself for a company in
the past but it wasn't worth it to use them. I mean, unless you have options
from a unicorn, those don't amount to much. I have this impression that some
misrepresent options with stock.

~~~
deelowe
> What's the point of stock options?

I know it's hip with the kids to be cynical these days, but surely you jest...

> It's a piece of paper

The legal term is "contract."

> This price can be higher or lower, you cannot know beforehand.

Yep. That's kind of the point. Risk versus reward and all that.

> It's not a replacement for a salary or a stake in the company.

Not directly, no. Neither is health insurance, 401k, company provided meals or
other benefits, but all of these things are perceived by most to have at least
some marginal value.

> I was handed out stock options myself for a company in the past but it
> wasn't worth it to use them.

C'est la vie

> I mean, unless you have options from a unicorn, those don't amount to much.

Or, ya know, you end up with a company that has good growth potential and
those options work out in your favor, which is actually typically the case
btw. On average, the market has improved over time. I'm guessing you were
burned either b/c the company was high risk (which means you had the potential
to do VERY well conversely) or you were hit by the downturn which also
affected almost all stock, so not really related to options in that case.

> I have this impression that some misrepresent options with stock

Then some are idiots for agreeing to something they don't understand.

~~~
ta9090
> good growth potential and those options work out in your favor, which is
> actually typically the case

Typically the case? I'll wager that greater than 70% of startup employee
options never pay out.

~~~
deelowe
If you're going to limit the discussion to startups (I did not), then we need
to have a different discussion. I imagine all Facebook employees with an
employee number less than #1000 are quite happy with their options. As with
all things investing related, risk is proportional to reward. So, those 70%
that aren't paying off are offsetting the 30% that are paying off massively.

If you don't want to take this risk, choose a different industry. Traditional
corporations issue options all the time that pay dividends that consistently
net positive value. You may only get a few hundred/thousand per year, but you
can depend (somewhat) on the income they generate.

~~~
vacri
"30% pay out" is not the same as "30% pay out massively"

~~~
deelowe
You misspelled pedantic.

