
An Introduction to Stock & Options for the Tech Entrepreneur or Startup Employee - ekm2
http://ospflor63.stanford.edu/upload/An-Introduction-to-Stock-Options-for-the-Tech-Entrepreneur-or-Startup-Employee.pdf
======
Matt_Cutts
I would also recommend the book _Consider Your Options_ at
<http://www.fairmark.com/books/consider.htm> . It costs <$25 and will take a
few hours to read, but can save you from making very expensive mistakes.

I bought this book back in the early days of Google to make sure I was doing
everything right. It's boring but clear and helpful, which is about as much as
you can expect from a book about stock options.

~~~
dmix
I'm going to check this book out. But I've always had one nagging question
about vesting I haven't found a good answer for.

Say you have a bunch of shares vesting over 2-4 years.

Is it possible (or realistic) to make an arrangement that in the event of an
acquisition or liquidity event that your stock becomes full vested? Even if
its been less than the full vesting period?

~~~
drusenko
Acceleration usually comes as single-trigger or double-trigger.

Single-trigger is what you are talking about: when all of your options vest
immediately upon acquisition. It could be argued that this is unfair to those
that have worked their full time to earn their full options grant. Usually, in
this arrangement, a certain percentage of your shares are subject to the
trigger (so, 25% vest immediately, for example). I think it would be unusual
for 100% of your options to vest immediately upon acquisition: what if you
were acquired a month after you joined?

The second type is double-trigger. Let's say that you have 75% of your options
unvested in an acquisition, and you have 3 years remaining to vest at the new
company. If they fire you, you lose the rest of your options. Double-trigger
acceleration is where your options vest immediately if you are not fired "for
cause". That means that, as long as you are not being grossly negligent at
your job, the new company can't screw you out of your unvested options by
laying you off.

The one thing to remember here, is that a lot of this is subject to your
leverage over the company and the leverage the company has with its new
acquirer. All of these terms are subject to renegotiation in an acquisition,
and anything could change at any time -- look at what happened with Zynga.

Consider it a gentleman's agreement, for the most part. Good people will honor
it, shitty people might try to screw you. As with anything, you should only do
business with those you trust.

And finally, the absolute best way to make sure you get the full value of your
options (as an employee or a founder) is to always make sure you are
indispensable to the company. A company who needs you can't screw you.

(final note: IANAL, this is my understanding of how things work)

~~~
lemming
So in the case where you don't have accelerated vesting, what happens to
unvested options in an acquisition? Do they get converted to options in the
equivalent dollar amount of stock in the acquiring company on the same vesting
schedule? (Obviously subject to negotiation, YMMV etc etc...)

~~~
dgottlieb
With an acquisition I went through, none of the unvested options (after
acceleration) turned into anything (meaning those remaining shares were never
issued/created). However the acquiring company put forth their own stock
incentive plan in hopes of retaining employees.

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shawnee_
_Post-Enron, the government suddenly felt it was really important to have all
options be priced by third parties, even tiny three-person private companies,
so it’s now a legal requirement that if the Board wants safe harbor from
lawsuits, it must get a 409(a) valuation done every 12 months. These usually
cost around $8000 and are done by the most unimaginably braindead accountants
you can possibly imagine. Their job is to tell you a high price (say, 1/4 of
Preferred) and your job, amusingly, is to explain to them why your company is
Really On The Brink Of Absolute Annihilation so as to coax them into a 1/6 or
so valuation, which then the Board will accept. This process is time and money
you cannot afford, but the government mandates it._ (source: page 12 under
"Pricing")

At the core of this issue was (and still is) how "deferred compensation" can
be exploited by executives as golden parachutes. When execs can spread out
their compensation over time, the tax treatment of the compensation can be
minimized for the execs and maximized for the companies. Before 409a, the
reverse was true. Whenever corporate profits are earned they're either re-
invested or distributed -- only two ways to handle the money.

Before 409a, golden-parachute-type arrangements taxed execs when amounts were
actually (or "constructively") received as income. This tax treatment made it
favorable for employers to give deferred compensation as incentive -- lots of
it. Makes sense: amass huge liability for work that was never actually done on
profits that have not yet been earned. If you're an executive of General
Motors, or on the board of any large company, this pre-Enron way was good for
the manager getting deferred compensation, but bad for the company. Any future
profits go to the executives FIRST (whether or not those execs are even at the
company still!), and the short-term performance of the company and manager is
what they want to focus on.

There has always been a huge battle between corporate profits and executive
compensation. One of the best professors I had in grad school had done his
doctoral on golden parachutes, and this is a pretty interesting area.
Complicated, but interesting.

Unfortunately, we don't have any laws creating incentives for corps to give
profits to the common shareholders (in this case, employees receiving vanilla
stock options), just the laws that encourage companies and their (current and
former) executives to engage in tug-of-war over the distribution of future
profits. When this happens, very little of the value tends to trickle down to
Joe Shareholder .

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steve8918
Great article!

Does anyone have a link to a document that would detail the ways that you
could get screwed over by a startup? Or by VCs? I know there are tricks that
can be made via dilution, or something, but all I've heard are horror stories,
but no actual mechanics of how it was done, and what you should look out for
when looking at joining a startup.

~~~
jpdoctor
> _Does anyone have a link to a document that would detail the ways that you
> could get screwed over by a startup? Or by VCs?_

There's really no need, because it all falls under this category: You work
really hard, and then they use one of the many powers of the board to screw
you out of a payoff. I've seen punitive dilution, reverse splits plus new
issuance, firing before vesting events.

If you haven't looked up variable-reward experiments, it's worth a gander
because it bears a strong resemblence to startups.

------
DanielRibeiro
Relevant former discussion (with some great poitns from Grellas)
<http://news.ycombinator.com/item?id=2623182>

------
eykanal
This (extremely well-written) document has made the HN front page at least
once before. I think this is a testament to how useful this information is for
entrepreneurs. I didn't have time to read it in full last time, glad it's back
again.

~~~
wyclif
There's actually a couple of errors on the first two pages. Where can I submit
errata?

~~~
dweekly
Also, the author (myself) reads Hacker News, including this comment. :)

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tinco
Hey there's something I'm a bit confused about. The text talks about how when
you receive stock as an employee you pay income (gains) tax over them for
which they might not have the cash. Does this also hold for other stock
holders like the founders?

When the FMV has increased, do founders also have to pay taxes for their
shares?

~~~
d_r
To avoid this, vesting founders would presumably file an 83b election within
30 days of receiving the shares (mentioned in the PDF.) Then, they only have
to pay tax when they sell the shares. And if they held on to those shares for
over one year, this would be a smaller, capital gains tax.

Described in more detail here:
<http://www.grellas.com/faq_business_startup_004.html>

~~~
nickfromseattle
What is the definition of 'date of grant' in this sentence:

Procedurally, an 83(b) election must be made within 30 days of the date of
grant.

Is it when the vesting schedule says you vest?

Is it when the vesting schedule says you vest, and the stock is physically
sign over?

~~~
notbitter
Well that just scared the crap out of me. Fortunately, the rest of the net
believes that you have 30 days from the date of _purchase_.

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caffeine5150
Great guide overall – a couple of clarifications, though. The first sentence
of the Ownership section seems to confuse ‘authorized’ with ‘issued and
outstanding’ shares. The amount of shares authorized must be in your corporate
charter and requires shareholder approval to change. From that pool of
authorized, the board can then issue shares which then become the ‘issued and
outstanding’ shares. If you add in the amount of shares that could be issued
if all securities convertible into that class of stock were converted (e.g.
convertible debt, options, warrants) then you have fully diluted issued and
outstanding. Also, as someone pointed out, ISO vs. NSO has nothing to do with
employee vs. advisor: ISO’s are incentive plans/options that are designed to
meet certain requirements in order to allow favorable tax treatment.

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dudurocha
A book that I also find interesting, and give great insights in venture
capital, is the book wrote by Chris Dixon, <http://amzn.to/uQSXnb>. It's only
2,99 and give good and insightful advices for startups and venture capital.

------
drewda
Here is the original Scribd doc: [http://www.scribd.com/doc/55945011/An-
Introduction-to-Stock-...](http://www.scribd.com/doc/55945011/An-Introduction-
to-Stock-Options-for-the-Tech-Entrepreneur-or-Startup-Employee)

------
tomhallett
one question - the doc has a very standard "I'm not a lawyer so go get a
lawyer" which is understandable and appreciated. Could someone who is a lawyer
read the document over and give a thumbs up/down or give their notes on it?

obviously their notes wouldn't be legally binding either, but it would be a
step which would improve this already awesome guide.

~~~
dweekly
The Third Edition (which I'm working on) includes feedback from Michael
Sullivan of Pillsbury Winthrop.

------
rokhayakebe
Sometimes I feel it may be easier to build a profitable business and grow
using debt than to safely raise VC.

~~~
todsul
Do you mean bank debt or VC-style hybrid debt?

No bank in their right mind would give millions of dollars to a "coder" with a
"great" idea.

A bank (or any rational debt holder) has little interest in upside. Their
interest is capital protection and repayment.

Debt is typically divided between "asset lends" and "cash-flow lends". You can
get serious leverage with an asset lend, maybe 80% of equity, but that assumes
you have assets (less debt) as colateral. So if you want $3m, you need at
least $3m in equity.

As for cash flow lends, rational debt providers won't go anywhere near even 5
times for an unstable/unproven company. 5 times what? Usually some proprietary
measure of earnings (EBIT, EBITDA, EBITDA-C, NPAT, cash flow, etc, adjusted
for whatever the bank decides). So for $3m, you usually need $1m in cash-flow
already. Even then, you have to deal with monthly or quarterly debt covenant
reporting.

Most businesses who qualify for cash flow lends are relatively solid. That's
because the covenants are restrictive (and especially frightening for an
inconsistent business). A 5% drop in revenue can filter down to a serious drop
in the proprietary cash-flow calculation and have the bank calling its capital
the next day.

Compare that to a VC scenario. Imagine you've burnt through $3m, sales have
dropped, then the bank calls the entire $3m loan. Maybe in the US that stuff
flies, but in most responsible financial markets, that means you're toast for
5-7 years. You won't even get a mobile phone contract in some countries.

Of course there are business suited to traditional debt, but I can't imagine
the typical HN reader would look for serious capital from credit institutions,
unless of course they made serious money and they couldn't get VC for market
size reasons.

~~~
rokhayakebe
I do not know what the technicalities are for bank debt, but it seems that VC
money is easier to get, but has one million little hooks. With debt there
aren't usually hooks. You pay a fixed interest rate.

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Perceptes
This has a lot of really valuable information - thank you for sharing. I only
entered the working world a few years ago and I wish I had read something like
this before I had a job offering options so I wouldn't have been so clueless
about how to look after my long term interests.

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kens
If you're receiving NQSOs (non-qualified stock options) instead of ISOs, note
that the document is entirely confused about them. They have nothing to do
with advisors vs employees.

~~~
dweekly
Not confused; it's just typical for advisors to get NSOs and employees to get
ISOs.

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pagehub
Wow, this is so useful. Will get everyone to read it!

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dladowitz
Thanks for the article. I'm just going through the process of incorporating
now and this is helping solidify what I've been learning.

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yoramv
Shameless plug: I work at truequity (<http://www.truequity.com>) where we
provide a subscription based product, for start-ups, to manage stocks &
options. I think it really helps founders understand what happens to their
company when investors come in.

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fernandose
very useful thanks!

