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When a Unicorn Startup Stumbles, Its Employees Get Hurt (nytimes.com)
344 points by igonvalue on Dec 23, 2015 | hide | past | web | favorite | 267 comments

I remember clearly when I was in a similar situation with the sale of a company I helped start in 1999. All this gain on paper which required (because of the Alternative Minimum Tax rule) that I pay taxes on gains I had not realized. And then later realizing an actual loss. And the decade afterwards of getting $3,000/year that I could claim against my taxes.

The only reason I'm not still claiming my $3,000 a year is that we had some gains that could be offset by those losses in 2007 and 2008. Of course there are the much higher fees to have your taxes prepared.

I agree with the Times that it is the non-executive employees who get the worst of it, both because it may be the only investment they have (other than their 401k) and they may not have any experience in managing risk.

For example, the article mentions, and my own experience mimics, that the executives are in a bind when it comes to discussing company performance and prospects. Legal risks abound if they mislead and existential risks abound if they demoralize the company. It would be especially problematic when the company has started the IPO process as Good had.

Then there is the greed factor that comes in on everyone's part. The board turns down an $825M offer because they feel it is their duty, given they expect the company is worth more than that. Employees don't cash out some of their holding at $3/share expecting a bigger IPO lift. Both angry because nobody came from the future to tell them, hey this is the best offer you are ever going to get for this stock, take it. And so they "ride" the value down and get angrier and angrier but its hard to know at whom.

When this happened to me, I was holding 10,000 shares of Sun stock that had been $60 a share in 2000, that was going down and down and down. It later reverse split 3:1 (so down to 3,333 shares) and sold for $9.50 a share to Oracle or about $32,000. I was really angry at myself for "losing" so much money. Of course it wasn't that I had "lost" the money, I never had it, it was all on paper, I just hadn't converted at the time because I was hoping to convert when it was even "more". Or put another way, my greed kept me from selling something which could have paid off my mortgage at the time.

>Employees don't cash out some of their holding at $3/share expecting a bigger IPO lift. Both angry because nobody came from the future to tell them, hey this is the best offer you are ever going to get for this stock, take it.

Quoting from the article:

>Employees had little idea that an outside appraisal firm had valued Good at $434 million and the common stock at about 88 cents a share as of June 30, according to investor documents and legal filings.

It just sounds to me like the greed on management's side trumped anything the employees may have had.

Thanks for your story. I was part of a startup which sold as well. One employee was left with a tax burden to pay off, and I broke out even ($0 from sale, no tax). The founder took home money though......

I think it's important that people hear these stories when deciding what their personal reasons are for joining a company.

I'm not arguing, but I would like to point out that you've just fallen into the same trap I was discussing. According to the article the employees had a chance to sell shares at $3 a share, later it came out that an outside firm felt the shares were worth less. The trap is using information from later to beat yourself up about what you didn't do then.

It is an easy trap to fall into, you're in your own future looking back with more information than you had then, and you are seeing how you could have acted differently for a much better result. And then you beat yourself up for not acting differently. But the truth is it isn't your fault.

But the learning is, be more mindful of choices (and non-choices) and their future financial impact. It is much easier (and desirable) to see the "success" scenario, than it is the "failure" scenario, but if you work it out and sell half when you have the chance, then you reduce future outcomes to "only capturing half the value" and "giving up half the gain". Both of which are more tolerable than "losing all value".

The article details examples of 'information asymmetry' between employees and execs, at the same point in time.

According to the article: -June 30: outside firm values common stock at $0.88 -'Late July': Board knows they only have 30-60 days of cash -'August': Some employees buy common stock at $3.34/share

There is always information asymmetry, sometimes situational and sometimes regulatory, its the foundation of the insider trading regulations.

The point is to know that there is information that you can't know which could swing the decision either way, and information you do know which could be true or false. And then objectively looking at your choices and deciding how much risk you're willing to take and then owning that decision, no going back later and beating yourself up for it because of something you didn't know.

As a startup employee, you need to be mindful of opportunities to convert your non publicly traded stock (or options) into cash. And then decide when (and if) those opportunities arise, what to do about it.

While some folks advise people to exercise their option when it vests so that later when they sell it they can get long term capital gains treatment, I advise them to not do this. My advice is based on looking at the four scenarios:

1) Don't exercise your options, stock is worthless

Total win, you didn't lose any money in the process.

2) Exercise early, stock is worthless

Total lose. AMT tax paid which can only be recovered $3,000 per year, money paid to exercise is all lost.

3) Don't Exercise, stock is worth 10x what you paid for it

Partial win, you get to pay for exercising the stock and the tax out of the proceeds of exercising and selling it, but you are taxed at the ordinary income rate and if you get into a high enough tax bracket a lot of deductions get taken away.

4) Exercise early, stock is worth 10x what you paid for it

Total win, you sell your stock and pay a minimum of tax on it.

Three "win" scenarios, and 1 total lose scenario. You remove the total lose by not exercising your option which leaves you with two "win" scenarios but not winning as much as you might have (lower risk, there is no "lose" scenario)

This is the same trap that most stock traders fall into. I've spent a lot of time trading, and when I confer with some of my other friends who trade we always talk about how we bought too late, sold too late, sold too early, etc.

I came to the conclusion early that the only way a trader could be happy is if they bought at the very bottom and sold at the very top. Otherwise there was always a lingering sense of regret. The only way you could have done that is if you can see the future, which is obviously impossible, but your sense of regret doesn't think about that.

After that realization, I decided that I make my selling decisions based on best knowledge at the time of sale, and not to regret selling for higher later on, because it would be impossible to know if it went up further or not.

+1 :) Fortunately this comment is the least expensive way to learn that lesson.

Question: If you are a share holder (e.g. you've converted say 1 option to stock. Do you not get access to the outside appraisals?

Not generally. There are two things at work here, one is the 409a valuation which is somewhat formulaic and then there is the valuation of preferred shares which have different rights than common stock. Typically you have to own a preferred share to get rights to information about outside appraisals.

Can a common shareholder or anyone get a description of the preferred share holder rights? Is it in the articles of incorporation?

>> The board turns down an $825M offer because they feel it is their duty, given they expect the company is worth more than that.

I remember when Blackberry was in its patent fight with NTP and they made them some insane offer and NTP turned them down, much to the shock of Blackberry. I remember one of the Blackberry lawyers saying, "I'm not sure what they're waiting for, the offer we gave them would give every employee of the company $40 million dollars."

It was a total PR stunt to show the company's employees they were getting screwed by the owners.

Thanks for sharing your story.

When you got the stock, was it issued as option grant, or actual stock grant?

What would your advice be to people who hold most of their "investment" in a single companies stock?

Actually by that time it was all employee purchase program (EPP) stock. You could put up to 10% of your post-tax income into a plan that every 6 months would buy stock at either 85% of the market price, or the 'lock in' price, which ever was lower, and the lock in price was set the first time you started the program, held for 2 years and then reset each 2 years after that.

   > What would your advice be to people who hold most 
   > of their "investment" in a single companies stock?
Diversify. Especially if you are continually getting more of that stock (like RSUs or other options vesting). That is hard if you're not public and there isn't a secondary market.

A lot of people I knew in the dot com boom sold their stock and bought houses. That converted a fluctuating value asset into something they could live in regardless of its "value". They looked like geniuses in 2001. When we sold the company I had helped start I took a chunk of the proceeds and put it into a separate account to help my kids college education. (it wasn't a 529 but simply a named account that my financial planner helped set up).

Doesn't have to be fancy, putting proceeds into and S&P500 ETF is simple, low cost, and the S&P 500 has out performed a lot of single company stocks. (and underperformed some to be honest but you are trading future value against risk).

Awesome thanks for sharing.

While working at Boeing, their EPP allowed you to purchase Boeing Stock, or invest in a managed fund. This was post 9/11 so their stock was hurting, so I invested 90% into their stock.

These days in the startup world, folks are given Restricted Options, which don't offer a lot of flexibility.

Even with a public event, employees have a 180 day lockup period before they can sell any vested options.

   > Even with a public event, employees have a 180 day 
   > lockup period before they can sell any vested options.
It varies, when I was acquired in 1999 we could choose to dispose up to half our proceeds, it was negotiated as part of the deal. I also had an insane 18 month lockout which took me from pre-crash to post-crash and a 144x difference in stock price ($120/share vs $0.83/share)

I've always wondered about that. Isn't there some way you can hedge against that possibility, say, by buying puts? Or is that forbidden by contract?

I had a friend who worked at one of the early e-retailers. During the lockout period she was a multimillionaire (on paper), and by the time it ended her options were under water. It made me wonder if you could give up part of your potential payday for a little certainty.

Is there some other industry where, when a company stumbles, its employees don't get hurt? I live in Michigan, and when the car industry "stumbled" everyone I locally know at least knew someone who got hit, at the very very least with long-term stagnant wages even as their responsibilities amped up to cover the missing people, and they were the ones who came out relatively unscathed.

I mean, the details of the article are all fine and dandy and interesting (no sarcasm, there's nothing wrong with the facts and they're at least worth a story), but the headline and framing seem to imply that there's some sort of alternative?

The only problem unique to the tech-unicorns here is exercising stock options when you can't pay for the taxes. Don't do that.

At least with the auto industry, the unions were able to offer some protections for the worker. How many programmers belong to a union?

I'm a member of Prospect[1], a non-party-affiliated union for professionals. It's mainly good for getting legal advice if the company you work for tries to screw you over, so it's pretty relevant to the company/article being discussed (except Prospect is a UK union, but there are US equivalents).

The cost is relatively trivial compared to a programmer's salary - about £200/yr. Unfortunately you can't claim it against tax in the UK.

[1] https://www.prospect.org.uk/

Unions can't do anything about the company you're working for running out of resources. That's not what they are for.

The can ensure the pie is sliced more fairly tho'.

And lobby for more sane tax for employee share options.

They can help protect you from getting screwed over while the execs walk away with millions.

Not generally, no. The exception was the GM bailout, where the unions used political muscle to get moved ahead of secured creditors. That's the only case of which I'm aware, though.

More than you might think including a former CEO of a FTSE 100 Company who in the past was an activist and not just a member.

> How many programmers belong to a union?

Thankfully none.

One of the main reasons the car companies stumbled are unions. The whole thing has degenerated to insanity squared.

For example, GM had a clause in their contract requiring them to not fire employees displaced by technology or automation. In other words, if you improve your workflow and process and can do the same work with 25 people instead of 100, you can't fire the people you no-longer need. All incentives to innovate in process and technology very quickly evaporate with such insanity in place.

They reportedly had thousands of people show up for "work" every day drawing 95% salaries and full benefits only to go to this building, read the newspaper and drink coffee all day.

Unions had their day and reason to exist. I am not proposing they need to disappear. However, they need to mutate into something that works towards a mutually beneficial and sustainable ecosystem.

By pushing for, and obtaining, ridiculous grants, they create short term apparent gains and HUGE long term losses as thousands of people lose their jobs when they industry they worked in simply crumbles under the weight of onerous arrangements that cause them to lose the ability to compete and remain financially viable. In fact, if you look at Detroit, one could argue the unions went beyond costing people their jobs and companies their ability to compete, they actually succeeded at destroying a whole city.

How is this, in any imaginable reality, good?

A couple of articles:


This one covers other issues:


From the Forbes article:

"A worker might be able to retire in his early 50s and collect an annual pension of $37,500, paid wholly by GM. By 2008 there were 4.6 retired GM employees for each active worker. Did anyone think this was sustainable?"

It's called "killing the golden goose".

You earn a union.

You earn a union by not treating your employees well, if you knew the history of the labor movement in the 30's you'd better understand how things got to be the way they are, and why the relationship is adversarial, instead of cooperative.

If your employees are trying to unionize its because of longstanding grievances held by a significant minority if not majority of your workforce - grievances that have either not been meaningfully addressed, or can't be aired, because there is no workable mechanism to air them. It's not just pay (though often is primarily pay - we'll put up with all sorts of shenanigans for a big paycheck) if often as much about working conditions and esprit de corps as it is pay.

If you don't want a union, pay your employees well (well above market), or have a great working environment and instill a sense of pride and appreciation in your management - and make it clear you value their contributions as well - it's this balance of pay and working environment that keeps a workplace healthy and union free.

The car companies stumbled because they had a high cost structure and they ziged when the market zagged - while the union contributed to the high cost structure, they had nothing do to with changing market conditions.

> If you don't want a union, pay your employees well (well above market), or have a great working environment

Third option seems to move the jobs out of the country, which is what happened to highly unionized manufacturing sector.

It isn't about not wanting them. It's about them being constructive as opposed to destructive in the long term.

Right. I'm just pointing out proponents of unionization usually pretend that unionization costs zero to the workers' wallets. Well, there's the dues, but in theory they pay for themselves in increased benefits, therefore any rational employee should join the union.

The elephant in the room is the migration strategies the employer starts exploring when faced with an added cost (offshoring, moving to a right-to-work state, increasing automation, switching from vertical integration to third-party contractors).

For many industries a hike in costs (with unionization related costs being one example) triggers a chain reaction causing companies to seek lower costs. This often means leaving the US or Europe.

Going to China isn't, as some like to put it, due to greedy executives. It's actually due to responsible executives who are left with not choice but to go to China. As competitors stared to offshore many, many years ago, companies who did not were left with significantly greater cost structures and unable to compete.

I had exactly that problem 15 years ago when my competitors started to manufacture products in Korea while I was manufacturing in the US. And it wasn't just about labor costs. Our supply pipeline can be incredibly expensive. Our costs are higher every step of the way, the more you "touch" a component or assembly the more cost increases. The same electronic components --same part number, same manufacturer, not clones-- can cost five or six times less in China due to supply chain advantages.

Sometimes I feel folks who push unions in the US and think they are good for workers truly don't have a clue. All one has to do is try to manufacture something, anything, in the US to start understanding why we can't think 1930's mentality will continue to work. Even something as seemingly simple as a dog leash is almost impossible to manufacture in the US on a competitive basis. People just don't get it.

> if you knew the history of the labor movement in the 30's

News flash: We are nearly one hundred years away from the 30's. Just because things made sense then (and they absolutely did) does not mean they make sense today.

What I am putting on the table is a verifiable mathematical fact. No opinions here. Fire-up Excel and do the math. Not sustainable. And that's the point. I didn't say unions need to evaporate, I said they need to mutate into something that truly works for a sustainable common goal. Today, for the most part, they do not. And we all pay for it in one way or another.

In other countries, they do work, just not here in a bunch of cases (the auto workers are a worst case).

I'm not trying to justify the adversarial relationship the UAW takes with the big three - but as the old saying goes, it takes two to tango, and for a long time, neither side was willing to change the status quo. Not all unions are the same, many have what could more be described as a partnership.

I don't have much in the way of sympathy with the Big Three however, they rather than really negotiate when times were good, they agreed to absurd contract provisions - a little pain now, can save a whole lot of pain later.

The reason GM as you pointed out had 4.6 pensioners for every worker, is General Motors used to be a much much larger company - in 1970, GM had 395,000 UAW workers, in 1998, 210,000 and in 2007 had around 75,000, today (February of 2015) it has around 50,300. So in, 1998, it was roughly 1/2 its 1970 size, 2007, it was around 1/5th - today its around 1/7th.

1/5th is awful close to the 1:4.6 ratio you pointed out.

As far as the 20 years and you're out provisions? I have a friend who worked for GM for 20 years, he has - bad hearing, bad knees, bad ankles, bad feet - plus 15 years of exposure to chemicals in the paint booth - then another 5 of working in a stamping plant. He earned every dime of his pension, and paid for it with ill health, and a diminished quality of life for his remaining 20-30 years on the planet, because essentially he's a man in his early 40's with a body of someone 15 years his senior.

While I have sympathy for your friend, nobody forced him to stay on.

I have a couple of friends who own air conditioning and heating companies. They do very well now, yet they both started with one beat-up truck crawling in attics by themselves to earn a living. Years later they have employees and do well. They have both gone through surgeries of all kinds due to the punishment they subjected their knees and bodies to during their years crawling in attics doing duct work.

I know graphic artists who have had multiple surgeries on their wrists due to carpal tunnel injuries.

Carpenters who have lost fingers due to unfortunate accidents. And musicians with permanent Tinitus due to playing in loud environments for twenty years.

I spend my days working in front of a computer, probably 80 hours a week. There are consequences to that as well.

I guess the point I am trying to make is that all activities come with consequences. Yet not one of these people were forced to take and keep these jobs. Let's not blame employers for providing work people take freely. I am not justifying negligence in the case of unsafe working conditions. That is a criminal matter.

Why would he leave, yes the work is physically hard, and mentally monotonous, but the reward and pay is great - thats the tradeoff - they go in work their 20 years, and come out beat up and somewhat broken, and get a decent pension out of it.

Would he have stayed on without the great pay, benefits and pension? probably not, not enough financial reward for the work, he's smart enough to do anything he decides he wants to. That on some level is the price of doing business - or was at least for a long time - the UAW gave concessions to save the Big Three in the form of a two tier wage structure, which the big three appear to be willing to gradually eliminate the two tier structure - or at least bring them closer together now that they are financially healthier.

The thing is, I'd bet money though, if if I looked into it, you'd find autoworkers in each company (or anyone doing heavy assembly like that to be similarly well paid, relative to their local wage).

The autoworkers are not really a good analog for what a programmers' union would be.

If a programmer's union formed it would probably be a trade union more similar to the NFL Players Association, or the Writers Guild of America, than a labor union for relatively unskilled workers. The NFL, Hollywood, and TV have obviously not been harmed by doing deals with these unions.

I don't know anything about he NFL (rich players, high class problems). Various Hollywood associations were crumbling under the weight of their unsustainable pension obligations. The solution is always the same, financing of some sort that kicks the problem forward a few years for someone else --or the next generation-- to deal with. That is morally and ethically wrong.

Ah, yes. The unions got GM to kill electric vehicle investment.

Ah, yes. The unions got GM to become lazy with quality and innovation in the 60's and 70's when GM had 60%+ market share.

Ah, yes. The unions forced automobile manufacturing management to take huge pay packages.

Ah, yes. The unions with their silly demands for a 40hour work , and sick leave (which the majority of Americans still don't have)

Read something other than wall street journal and forbes to get better info about unions.

I was in a union for almost ten years. I was young and was told I had to become a member if I wanted that job. Please spare me the empty pro-union hit points. I have seen, from the inside, just how caustic they can be. I was Union Steward for my last year. All I can say is, disgusting.

I'm having a hard time taking the links seriously. The WSJ article is behind a paywall so I am unable to read it. However, it's dated 2006 which would mean it was authored at the height of Wall Street "shenanigans" (for lack of a better term) while the Forbes article appears to be a canned editorial written by the Ayn Rand Institute.

I understand your point. The beauty of it is: This is math, not opinion. If you doubt any of it, all you have to do is fire-up Excel and work the numbers.

For example, try to answer the question about how GM can survive, grow and innovate when it has nearly 5 retired employees for every one current employee. And, every single one of those retirees is drawing a huge percentage of their salaries as their pension, for life, as well as enjoying tremendous paid benefits.

The problem here is the divide between people who have business experience and those who do not. Any small business person understands, without having to run any calculations, that having the cost of a position multiplied by 6 (because you are paying 1 active worker and 5 retirees) is utterly unsustainable. Or that, installing a series of automated welders while not being able to lay off 50 people is a formula for bankruptcy.

Do you hire a gardener, cleaning service or pool person? Imagine having to continue paying them 80% of their monthly fees after they retire. And then you have to hire a new service to do the job.

Now you go out and buy a robotic lawn mower, vacuum or pool cleaner.

And you can't fire them.

You have to continue paying those service providers for a service they will not be performing because their contract says so. Forever.

Get the point?

We can engage in the fallacy of attacking the source all we want, yet, it is impossible to attack the math, which is the point here. These arrangements are mathematically predetermined to result in the destruction of companies and jobs unless Superman comes down from the skies and brings with him a supernatural solution of some sort.

Or, we pretend all is well, grab some tax money to continue propping them up and shift the problem forward to another generation. Which is exactly what we've been doing with both unions and government programs.

I think I may be one of the few people who up voted you, only because I think you raise an interesting point. Yes, the auto industry unions caused a shot storm. But do you honest, y think that a modern union, (which learns from the lessons of the past) would really be a bad thing?

I'm still not sure about the value of unions, but I think it is an area that should be explored with a modern mindset.

Unions are important. They give voice to people within companies who have tens of thousands to hundreds of thousands of employees. Most people are not adept at negotiating for anything. So, yes, conceptually, they are a good idea and they should not go away. I never proposed that they disappear.

The problem is that American unions succeeded at entering into a destructive feedback loop where union management had to justify their existence (and huge salaries) by always grabbing more and more for the membership. Even to the point of the ridiculous examples I laid out from the automotive industry.

This seems to be a common failure in both government and organizations such as unions: Past a certain point it is nearly impossible for management to go to their members and say something like "We need to stop asking for more on pensions, salaries and benefits because we are going to cause damage to the future viability of this company".

Why? Because of pandering or populism. There's always a sick would-be leader who will step in and counter that with gifts-a-plenty while vilifying the guy who proposed moderation or, the unthinkable, cut-backs and concessions in order to ensure things remain viable for the greater good.

That's the mechanism that has turned a lot of unions (not all) in to agents of destruction rather than responsible participants in an ecosystem. Union members are NOT bad people. They, like anyone else, would like to live better, earn more and retire well. They trust and follow the people they hire to represent them, the union leaders. This leadership, high on power and, yes, in cooperation with incompetent company executives ultimately fails their membership by creating situations where the company's own survival becomes mathematically impossible.

You know, what's interesting about this is that down-votes fail at masking reality. We have an entire city, if not a state, to serve as evidence for the sheer destruction caused by the combination of bad union leadership when combined with incompetent corporate management. Had these companies not been bailed out to the tune of billions of dollars Detroit would have cratered under the weight of an utterly unsustainable equation.

I'm fairly sure that most car company employees in Germany are represented by a union, the IG Metall. Germany's car industry is still doing fine.

European unions don't function as US unions do. They are far, far more benign. They would never make deals that would result in the utter destruction of the company their very members work for. American unions have succeeded at delivering amazing short-term gains for their members at the cost of killing companies and industries. Ask any old-timers in the printing industry if you want to start grokking the subject.

But wouldn't all unions regardless of where they are from have similar goals and mechanism as you described earlier, such as their leadership wanting to stay in leadership (pandering if need be to stay there) and their members wanting to have good pay, benefits, etc.? What makes the European unions different from the U.S.?

>> The only problem unique to the tech-unicorns here is exercising stock options when you can't pay for the taxes. Don't do that.

Ok, sure, but what do you do when you have all of this equity vested on paper and either 1) you get fired, or 2) you want to leave the company?

ditonal's comment (currently below yours) is relevant here. Doesn't look like they stumbled to me!


The auto industry in Michigan didn't stumble. It crashed, hard. You can't compare that to a company selling for half a billion dollars and expect to be taken seriously.

Very glad the NYTimes ran this piece. The only part they underplayed is they made it sound like the startup "stumbled." No, it sounds like it went exactly as planned. Blackberry got the acquisitions, investors got their money, execs got their bonuses, and the rank-and-file got nothing. That isn't stumbling, that's the playbook.

Tech employees need to wake up about common vs preferred shares, and that the former are worthless. They are NOT worthless because they are "lottery tickets" and most startups fail. They are worthless because they are designed, as a financial instrument, to be fake equity with no real protection from dilution and liquidation preference.

The most insulting aspect of common shares is that engineers get talked into pay cuts on the premise that they get these options, essentially being asked to invest a portion of their potential compensation into the company, but are then told they don't deserve to be given real equity because they aren't "real" investors.

I understand that from a founder's perspective, asking someone to give you millions of dollars is significantly more challenging than asking someone to take a 30% pay cut, so it's easy to give strong preference to the former. But, supposedly and debatably, it's also difficult to recruit talent, and it's going to be significantly more difficult as employees increasingly realize that Common ISO's aren't "lottery tickets" they are "toilet paper". So either startups are going to have to re-invent these equity packages, or the talent will flock away from the VC companies and towards companies that can pay salary. Of course, the VCs have a huge playbook to flood the market with more talent to (taking $100 mil taxpayer money to fund the same bootcamps they invest in to work for the same companies they hire via Obama's tech talent shortage program, for example), so who knows.

> Tech employees need to wake up about common vs preferred shares, and that the former are worthless. > ... > They are worthless because they are designed, as a financial instrument, to be fake equity with no real protection from dilution and liquidation preference.

You've muddled orthogonal concepts together here.

1. Common shares are not worthless. In general, just ask any founder who's had a successful exit. Founder shares (unless purchased along side financial investors for hard cash) are always common shares; if your straw man were correct, then there would be no wealthy founders.

2. Liquidation preference is a negotiated term which does have a rational basis for existing. Whenever you're putting in a larger proportion of the company's cash than the ownership you're buying, it is crucial to have protection against someone essentially liquidating the company for the cash. Say investor X is putting in $8 into a company that has $2 in the bank, but X is only buying 10% of the company. If the company is liquidated for that $10 tomorrow, X gets back $1 and the common stockholders get $9. (There are other protections against a perverse liquidation incentive, too, but this is the economic one.)

3. The "real protection" from dilution is raising reasonable tranches of capital at a monotonically increasing series of valuations, which valuations actually correspond to a clearing price between bid and ask. Three key items here: "reasonable tranche," "monotonically increasing," and "clearing price."

a. Reasonable tranche: raise reasonable sized rounds, because huge rounds create weirdness (lopsided power, outsized compensatory "asks" by investors, etc.).

b. Monotonically increasing: needless to say, down rounds are the big dilution problems. Sometimes they happen because life isn't perfect and problems come up. Sometimes they happen because the company screwed up and raised too much at too high a valuation previously.

c. Clearing price: if the company and investor actually agree on the "true" valuation then it's easy. If they still try to force a deal where the company wants a crazy "optical" valuation that the investor doesn't really see, then you'll get layering-on of sweeteners to make the effective valuation much much lower than the notional, but all kinds of terrible side effects may accrue.

Thank you for the informative response.

1) Ok, Google/FB common shares were worth something. Those are extreme outliers in exits, and had ethical founders. But founders have another option if they drive the common share value to nothing - retention bonuses. They can say, ok we will make all the common shares worthless, but you can just give me a huge package as part of the aquisition. So employees can't rely on founders looking after common shares out of self-interest. If you read the article, it looks like that's extremely similar to what happened in this case.

2) All these financial experts can figure out a way to protect their necks without leaving the employees necks under the axe.

3) Real protection would also be voting rights, which generally preferred shares get a lot more of, and then less tangible things like invitation to board meetings, something mere employees accept is absurd to expect. As long as employees agree to sacrifice compensation while being told they're not investors and don't deserve to be treated like one, they're getting hoodwinked.

I have several friends and acquaintances whose exits as founders were in the $5-500 M gross exit value range -- far from a Google / FB outcome.

Those people all made an entire career's worth of money, or more, all at once* and with capital gains tax treatment to boot. (* well, after an earnout / lockup)

They also exclusively held common shares.

The deciding factor is whether their exit value was a meaningful multiple of the invested capital. If you raise $100 M and sell for $100 M then it's hardly fair to expect a windfall. If you raise $50k and sell for $5 M it's very fair to expect a meaningful personal outcome.

"> Tech employees need to wake up about common vs preferred shares"

The important distinction is employee vs founder. You mention founders in your comment.

Founders typically would hold a double-digit percentage of common shares.

Employees that might get offered 0.1% if they are an early hire, or less assuming later stage (discounting exec hires here, because the OP of this thread was about engineers).

Founders also typically got their common shares at a very low valuation - let's say they were issued pre-money, then their value to the tax man might be $200K (of a 2M pre-money valuation), but with a vesting schedule that makes them tax efficient.

Employees typically get their common shares at a higher valuation, post money, with a 200M valuation. Their 0.1% is also worth $200K to the tax man.

See how this is different?

You're exaggerating for dramatic effect. First of all, 1-2% is not uncommon for truly early employees. Second, it's quite typical for founders to work for free for a significant length of time to get the company off the ground. If the founders got the company to a 200M valuation with money in the bank to pay salaries, explain to me why employees deserve to be in the same order of magnitude shareholders as founders?

> 2) All these financial experts can figure out a way to protect their necks without leaving the employees necks under the axe.

Liquidation preferences are not the default in startup financing. They show up when money on better terms is not available.

Any management team is free to walk away from a term sheet that has liquidation preferences spelled out towards a term sheet that has VC buying common shares with no downside protection whatsoever, if such term sheet exists.

Let's do a thought experiment, you have a pie that you need to allocate, and you need to allocate it to the following groups.

Founders Investors Non-Founding Executives Non-Founding Employees

How do you allocate the pie fairly? How how do you ensure that risk is properly rewarded?

That all makes sense, but potential startup employees still need to be educated about the reality that common shares are much less likely to be worth much than preferred shares. Specifically, if a startup asks a potential employee to take a below-market salary with an option package -- which happens all the time -- the potential employee is best advised to value the option package at zero. The real reason, if there is one, to accept a below-market salary at a startup is intangible: experience and connections.

Edited to add: your item 1 overlooks the fact that founders hold a much larger piece of the company than any post-founding employee. An exit that makes a founder wealthy may do nothing more than compensate an employee for the salary difference.

> may do nothing more than compensate an employee for the salary difference.

if that.

of course this is HN so that's entirely reasonable because founding a company is a massive risk but being employee number 5 at a company that might go under in 3 months is fine.

I'm not well-versed enough in investment to reply to your comment on purely financial grounds, but I still see a problem -- how often are those steps actually taken in practice? How would it even be possible for an employee to know that the founders have taken (and will continue to take) responsible steps with their funding rounds?

Part of the issue at question is whether it's worth it for employees to bet on founders having done (and continuing to do) the right things with regards to investment. So when assessing the risk/reward of equity over cash, an employee now has to not only examine the marketability of a company's product and sales, but also whether they can trust the founders, board, or whoever to be responsible with equity dilution and valuations.

Given the huge variety of unknowns (and very high risk of dilution or lack of a liquidity event), as a non-startup-employed observer I have to say I'm very confused as to why startup employees take effective pay cuts for stocks.

All of which is true but until the larger community of founders and investors buy into the rational basis for their existence those common shares do not provide any incentive for a competent programmer to take the risk of working for a startup rather than for an established company.

I agree 100% with this. Employees should be suspicious that they have access to an investment nobody else does - invest now!

I've seen countless friends get burned in various ways believing they would be getting rich soon from their options and then fizzle. Either through the company just never having a liquidity event or being sold for less than previous valuation rounds.

The worst is I've seen people reject job offers that were far superior in cash compensation because they had a recent big option grant. A friend of mine stayed on at a place even though he didn't get a cash raise but instead was given some options that vested over a few years in addition to the options he already had, some of which were vested. Did it not ring a bell that a company that can't give him cash but can instead offer compensation out of thin air in the form of options is in trouble?

And then there are the golden handcuffs were an employee is scared to leave because their options have too high a fair market value and their tax costs would be considerable. Further limiting their career growth.

I've seen the other side too where friends have taken home a really nice pay day after liquidity - but it is the exception and not the rule.

I recommend joining young companies that are willing to pay you a lot of cash for your exceptional ability and experience (execution is critical at this stage across the entire company from engineering to sales) and maybe take it easy on the option grants. Some stock is fun but don't count on getting rich on it.

Employees do have access to an investment to an investment nobody else does. It's just that they need to do due diligence on par with or better than an investor to avoid getting taken advantage of.

I've turned down more startup jobs than I can count. When I interview at a startup, I thoroughly research their market, their competitors, their product, and their business model. I ask questions about how they came up with the idea, and how they know other people want it, and what questions they asked when they did their market research, and how the idea has evolved in response to new information. How did the team meet? What's the company culture like, and what do they value? I ask about financials - are they profitable? What's their runway? What's their revenue and revenue growth rate? Is it recurring revenue or revenue for one-off contracts? What's their churn rate? I ask about funding - who is their VC? How many rounds have they taken, what's the preference overhang, how many more do they anticipate taking? (And then in my head, I'm running over the financials to see if this squares with their growth & revenue plans.)

If they're cagey about this, I walk. Some companies are, and that's their right, and I'm not going to work for them. Others are very impressed that I'm doing this level of due diligence, because it shows that I view my time there as an investment, and will invest the same level of diligence and effort into the job itself.

Equity compensation itself is not the problem. Equity itself is great for employees - they have an information advantage over every other shareholder of the company (including the VCs), and if they're an early hire, they can have a meaningful effect on the value of that equity. But to take advantage of this, they need to do due diligence as if they were an investor - they are, after all, they're investing their time, which is far more valuable than a VC's money. Equity is much more highly levered than salary - its value depends on how events play out, not just on what you've agreed beforehand - and so you should make sure you have enough information to make a reasonable guess at its value before accepting it.

This post is so good I think you should expand it into a longer blog post and submit it to HN for further discussion. "How to evaluate a startup job" or some such.

I'm tempted to start a blog someday, but my own startup takes precedence (or maybe it doesn't but should, I've been spending far too much time on HN lately), so when I do come up with ideas I often just post them as a HN comment or jot down a first draft in Google Docs for later cleanup. I can make note of this one and maybe come back to it someday, though.

In the context of parent and grandparent, what do you look for when doing your due diligence to evaluate the risk of the employees getting screwed on common shares when every other stakeholder makes money?

The first two things would be the amount of funding taken, and the preference overhang. If you know that a company has taken $300M in funding and that their last round of $150M had a 3x liquidation preference with a 1x preference on earlier rounds, then you can do the math to figure out that any exit under $600M is going to leave the common stock worthless. If you know your ownership percentage (and every startup employee should), you can then do the math to figure out how big an exit the company would need to have the desired financial outcome, eg. if you own 0.01% of the company, it would need to exit for $10.6B before you become a millionaire. Go judge the size of the market, growth rate, and profitability yourself to see if that's likely.

In Good Technology's case, just look at Crunchbase:


There are red flags galore for startup employees there - the funding history started with a Series E in 2005, with the company supposedly founded in 1996. That's the time to ask about the company history, which the article says started as a startup that bought Motorola Mobility's business. Every funding round since then was either private equity or debt (!!), along with a secondary sale.

If I saw just the Crunchbase investment history and heard that it was a startup that purchased a spun-out portion of Motorola, my immediate reaction would be "This isn't a startup, this is a mature private company with a business model that requires large infusions of cash." (I've actually been burned in the public markets by a similar company - mature companies should not need regular cash infusions.) And I'd value the company accordingly - most likely, I wouldn't take the job there at all, but if I did, I'd assume that salary and experience is all I'm going to get.

Given the financial acumen and street smarts involved, it almost sounds as if there's a possible role for someone acting as an agent for potential startup employees: not an employment agency which gets a lump sum when an employer fills a vacancy, but a talent agent getting something like the traditional ten percent, or two-and-twenty, or whatever, of the employee's ongoing earnings. Not that dealing with talent agents is always a wonderful experience either, of course...

As part of the market research for a previous startup, I talked with plenty of recruiters who would love for their to be a market for software talent agents. If you're curious why such a market doesn't exist, read Aline Lerner's article "Why talent agents for engineers don't exist":


tl;dr: Agents exist when it's hard to get a job. It is not hard to get a job in software right now. If your company mistreats you, you figure that out pretty quickly and move on to a company that doesn't mistreat you. There's no need to pay anyone to make that happen; in fact, you can get paid a significant amount more just by asking around.

You hear about stories of startup employees getting screwed because the software engineering labor market (particularly for startups) is expanding rapidly now, and so there are a large number of employees who have no experience in the industry. These people are easy prey for a good salesman who wants to make their sham company seem like one of the winning startups. But it takes only a couple months for most smart employees to catch on, and move to another job.

My first couple tech jobs were at startups where I was paid below market rate. The first one had some serious shenanigans going on when it went down in flames; the second had no shenanigans, it just wasn't going anywhere. But I left, and my compensation very quickly caught up with and then surpassed what I thought possible. I probably ended up significantly better off, financially, by taking the hard knocks early and learning the lessons myself rather than paying an agent 10% to handle everything for me.

As they say, "when someone with no experience does business with someone with lots of experience, the person with no experience gains some experience."

> Did it not ring a bell that a company that can't give him cash but can instead offer compensation out of thin air in the form of options is in trouble?

This is not an accurate heuristic for "how good is a company doing." There are many legitimate reasons you'd want to pay someone in stock instead of cash.

> And then there are the golden handcuffs were an employee is scared to leave because their options have too high a fair market value and their tax costs would be considerable.

This is definitely something to consider. If your options agreement allows you to early exercise you can avoid all of the tax penalty and remove the golden handcuffs if you exercise immediately (before you have realized a gain) and file your 83-b with the IRS. If it doesn't allow early exercise you probably don't want anything to do with it.

> I recommend joining young companies that are willing to pay you a lot of cash for your exceptional ability and experience (execution is critical at this stage across the entire company from engineering to sales) and maybe take it easy on the option grants. Some stock is fun but don't count on getting rich on it.

I'd recommend learning as much about business as possible, and consider working at a startup an investment, and you an investor. If you aren't comfortable investing then you shouldn't be working in startups. There is basically no reason to work at a startup if you aren't favoring the equity ($, work-life balance, perks etc. are all going to be better at BigCo).

In the exceptional cases where they got a nice pay day, was the company unable to pay cash? If not then there's the answer why no bells ring.

It's true, the media loves the story of the regular folks who struck gold when their company went public and that resonates with typical employees who don't understand the financial constructs that make up many VC deals.

There is extremely good advice in the parent post. For those new to the game, please read it closely.

I've been with 5 startups over the last 15 years. Each had developed good, commercially-viable, revenue-generating tech. But, in all cases, instead of going IPO, each was acquired. And, usually they were acquired by other investors' or board members' companies (sometimes at a loss). I would love to know the actual statistics for how many 'ground floor' developers get rich on options, but I'm guessing that it's very few.

Startup culture is cool - I love it. They give me piles of money to experiment and develop new stuff and build new products. If you have an 'inventor mindset', like a casual work culture, and like to see shit get done, it's a great way to go. But, unless you're a founder or very early employee, make sure you negotiate for market-rate compensation with reasonable working hours.

Of course, this all depends on the specific company and its board, but generally the options game is a scam. I've made a decent amount of money over the last 15 years - enough to retire on. But, very, very little of that was from a big startup cash-out. Instead, I just negotiated my salary and benefits effectively, saved a ton, and invested as much as I could.

Compound interest is your friend; your employer's stock options? not so much.

"Compound interest is your friend; your employer's stock options? not so much. "

This x 10. I wish people realized this more often.

> And, usually they were acquired by other investors' or board members' companies (at a loss).

Holy shit is that even legal? It seems like a giant conflict of interest.

"No conflict, no interest" -- John Doerr

Information asymetry is the way people get screwed over in financial transactions. Most potential startup employees have no idea what common or preferred shares are. Let alone all of the other details like dilution, liquidation preference, tax implications of employee stock options and lack of liquidity in private securities. Potential startup employees should learn about these things and understand how to protect themselves. I'm sure the startups prefer to hire sheeple.

Of course they should...on top of all the new tech stacks and modern dev paradigms because, of course, engineers have an infinite ability to learn.

I'm not disagreeing with you, per se, but I do marvel at the sheer volume of information young engineers are expected to grok these days...

The beauty is that any engineer who masters this information will come to realise that they hold all the keys to the kingdom.

Where can one learn about these?

Search for those terms in google and see what type of explanation makes the most sense to you. There are textbook definitions, legal explanations and more business oriented explanations. Read through threads like these specifically for people's anecdotes about how they got screwed over.

There's this scene in "the big short" where Eisman is talking to the credit default swap sales guys from one of the big banks. He's never traded credit default swaps before so he knows that he is at a disadvantage. He asks the sales guys, "How do I get f*cked in this deal?" And then he sticks around until they explain the scenarios to him. That's a really good lesson about financial securities. There are so many embedded options that each have a different payout scenario. You need to understand what are the potential future scenarios and how do they impact your position.

"Consider Your Options" was recommended at one private company I worked for that was nearing exit http://fairmark.com/books-fairmark-press/consider-your-optio...

The best articles of incorporation I saw had preferred stock for the founders, but any acquisition or liquidity change would convert all preferred shares to common 1:1 and instantly vested all options.

It did cause some interesting tax issues for people when we were bought, but I don't think I'd sign any other set of terms now.

But then, the founders were very classy.

By having multiple classes of stock, the founders were unable to take advantage of pass-through taxation via S-Corp Designation. The losses incurred by a company at early stages offset personal tax liabilities by a significant amount.

Having an acceleration clause isn't anything out of the norm though. I negotiated an acceleration clause if upon we took qualified investment of a certain dollar amount.

This wasn't a US firm, so US tax laws wouldn't have applied. I'd definitely consult a local accountant when setting up a company.

Genius :-)

I see basically two kinds of equity compensation.

The first is "what the founders have, but less of it." It's very difficult for the founders to make a boatload of money off the company without also compensating you. These have some sort of value - if the founders want to make $10MM off it, you're getting something like $100K.

The second is everything else. There's an obvious incentive to screw over the "founders don't have this" class of equity, so I value these at zero. This includes the vast majority of stock options.

Most of this seems like a reasonable comment, but are you actually angry that people are learning to code?

Absolutely not! I do, however, think it's extremely questionable when VCs lobby for taxpayer money to fund for-profit bootcamps that they invest in to train people for the skills their companies need. It's outsourcing the cost of training to the taxpayer, all while driving up the value of their bootcamp investments. Instead, these companies should drop their "we're a poor startup that needs people who can hit the ground running", and actually train people themselves. These "startups" are funded by extremely well-off VCs who could afford it. They shouldn't ask the middle class to pay for it for them.

Democrats and VCs have a very tight nit relationship.



One nit to pick: "tight-knit"

According to the article, employees had the opportunity to sell their "worthless" shares for $3/share.

Throwaway account, reporting on the secondary market!

Companies will often do everything in their power, including running roughshod over their contractural and legal obligations, to prevent employees from selling stock on the secondary market. If they're not total jerks, they will encourage you to participate in "internal buybacks". Unfortunately, these buybacks are run as a service for investors, presenting them massively undervalued in exchange for loyalty.

Regulators have just begun to take interest in the abuse of transfer agency by privately-held companies distributing shares in lieu of compensation. Similar attention should be paid to the information provided to prospective employees at the time of hire, when the decision to accept stock in lieu of cash is made.

In my case,

* Internal buybacks ("tender offers") were actually all above the current (publicly-listed) stock price. Private valuations can be pretty inflated. I think it's a good idea to take these and diversify.

* My company did use a backchannel to stop me from selling privately to one of their investors before the IPO (at roughly double the current market price). So I think the spirit of your comment is right.

So, are these shares massively overvalued or massively undervalued?

It seems like the anti-equity crowd here will never be happy. They want cash when the company offers equity, and equity when the company arranges for an offer of cash.

Prior to the deal, on the secondary market, while all of their managers were telling them that the shares would only massively increase in value.

This is while the Board was still sitting on the information that the company was tanking in value, and they thought their shares were valued at $4 or more. Not after the sale.

Investors made ~no money on this deal. That's not the playbook.

Most of your comment is just wrong.

EDIT: Ah yes. Downvotes. On Hacker News you get to pick your own facts. Lolz.

Sure, the primary objective is a huge IPO. It's the playbook in the sense of it was plan B to break even by cutting employees out. Investors might have not made out, but they broke even, and scratched the back of execs who can repay the favor in other contexts.

What do you mean cutting employees out? Cutting them out of what? Their were no returns made on the investor's capital. There's nothing to be cut out from.

Taking investor's money and building a company that is only worth the value of what the investors put in and then being pissed you didn't get rich in the process is pretty nuts.

Who's talking about getting rich?

If investors are breaking even then employees deserve to at least not be losing out thanks to taxes. Preferably they should get enough return to roughly make up for any salary loss they took in exchange for equity.

If the VCs start raking in cash then employees should too.

The story here is execs made money (6 million for the CEO), VCs roughly broke even, employees got screwed over. That, IMO, is completely immoral and shouldn't be allowed to happen.

Employees only lost money due to taxes because they tried to manipulate their tax rates. There's really on the employees, not anyone else.

I agree with you about the CEO.

"Manipulate their tax rates" --- how very callous! VCs pay very little taxes on their take (carried interest), CEO walks away with 6+ million, and employees who have spent a big chunk of their most valuable resource --- their time --- try to set their long term capital gains clock ticking, taking on a huge tax risk in the process. Calling that tax manipulation is just outrageous.

This article highlights the need for two changes in the startup world:

1) We need a different term for the "post-money valuation" that VCs place on a company after fundraising. It is not a valuation in the same way that a public company is valued, due in large part to the preferred stock liquidation preference. Employees hear about a $1B valuation and assume that the IPO or acquisition price will be some multiple of that "valuation".

2) We need some tax reform that prevents employees from needing to pay a tax bill with cash for illiquid shares in a privately held company. It makes perfect sense for an employee of a publicly traded company to need to allocate some of their stock grants to tax obligations, seeing as though they can sell those shares at any time. But employees of privately held companies can't sell their stock (usually), and needing to take real dollars to pay a tax bill on those shares is just not the spirit of the law.

I'm not sure we need #2 - we need companies to be better about not forcing their employees to exercise options when they leave the company and we need employees not to exercise options early to minimize the taxes they may have to pay in a windfall. This can simply be executed by every company without any government tax code reform needed.

we need both what you suggest and tax reform around options. It is crazy that you have to pay tax on stock you cant sell. It would be incredibly easy for the IRS to just say when you execute an option that stock will always be treated as regular income and can never get benefit of capital gains tax no matter how long you hold it before selling. There are obviously many drawbacks to this but at least you cant get screwed paying taxes on money you never earn. This will never happen because the people lobbying for the current tax codes are not the people getting hurt by these ridiculous AMT rules. AMT was created to prevent people like steve jobs from collecting their entire salary in the form of options and not paying any taxes but the people most effected are clearly not rich CEOs like steve jobs

If i buy a plot of land work hard to build a house on that land i dont have to pay tax on the increased value of the property until i sell it yet if i work at a company and buy options as it grows i am taxed immediately before i can realize a gain

The law states options lose ISO status 90 days after termination. http://www.mystockoptions.com/faq/index.cfm/catID/36274DB1-D...

Regarding the fact that the employees had to pay tax on what turned out to be worthless shares:

They could have avoided this by waiting to exercise their options on the eve of the liquidity event. In this case there would have been no risk. But they exercised earlier presumably to start the clock on long term capital gains treatment for the stock they received when they exercised.

They took risk they didn't need to take and they got burned. It's worth keeping that in mind as another aspect to the story.

You can't presume that they exercised early voluntarily. If you leave the company, you typically have 90 days to exercise options or they are forfeited back to the company. In other cases, they actually just expire after enough time passes, which again forces employees to exercise before a liquidity event.

Fair point. I did make that assumption.

To your point though, and to press it further - if companies require that you exercise your options in a window after they vest or they expire - they were never really options to begin with. In essence, the vesting schedule on expiring options is a timeline for you forking over risk-filled cash or forfeit part of your "compensation."

The advice seems to suggest if their options expire if you don't buy them at a certain point (except for leaving the company, which makes sense), say no and ask for cash. If they can't pay, now you know where you really stand.

Again though nobody forced them to exercise. It accelerates the timeline, but it's not forcing anyone into anything more than having to make a decision.

Typically, when you leave a company that issued you incentive options, you are forced to execute within 90 days or forfeit the shares entirely.

This is often repeated wisdom, and it is quite wrong.

If the liquidity event involves the public stock market in any way e.g. IPO, merger, acquisition with a nontrivial part of the proceeds paid in shares of a public company - then you are forced to execise on one hand, and have a lock-up period, usually 6 months, forced by the underwriters or SEC rule 144.

That is, there is a mandatory 6 months wait between the forced exercise and the effective liquidity event.

This applies to investors as well as employees, BTW: I was bitten by this as an investor -- a modest 5X return on investment after 2 years turned out to be less than 2.5X return (still nice), but the taxes were paid on the 5X numbers, and the end result net of taxes was therefore 1.1X -- and it would have been a loss if everything happened in the other half of the year (luckily, I was able to net the gains with the losses because the 6 month lockup was april-october; but had it been october-april, even that wouldn't have been possible).

In two other tax regimes I've operated in, you are only ever assessed taxes in the event you can take money into your pocket. The US system is ridiculously unfair in this sense.

You're making the point that if there were a liquidity event they'd be forced to exercise.

I made the point that they didn't have to exercise when they did, and if they had waited they wouldn't have taken on any risk about the price of the stock they were receiving.

Note how those are not mutually exclusive.

But beagle3's point is that the lock-up period means you still take on risk even if you wait until the liquidity event. Perhaps this is less risk in many cases, but it still isn't zero.

> They could have avoided this by waiting to exercise their options...

The article refers to "stock grants" and refers to the fact that "Top sales employees were awarded with annual bonuses of 20,000 shares of common stock".

IANAL but AFAIK, receipt of stock grants would trigger an income tax liability on the value of the shares at the time they were granted.

Tax treatment of stock grants and options is very complicated and so dependent on details that it seems somewhat unfair to jump to any conclusions based on assumptions which are almost certainly incorrect.

The wider the gap between the exercise price and the fair market value the more AMT you will owe on the shares when you exercise. By making a speculative investment -- by exercising early -- you will owe minimal AMT at exercise time and more capital gains later when you sell.

There are very real tax advantages to exercising early.

If you really believe in the company and it's a rocket ship (some rockets explode mid-flight or stall though!) then I'd recommend buying some shares early on to hedge for the reason you state. But I probably would't early exercise 4 years of options on your first day at the company.

Some companies sell part of your stocks (on your tax level) to pay tax in your country as soon as the options vest without your say.

I'm going to keep repeating this comment until the world hears it--I think most people joining startups are being taken advantage of without realizing it. Sorry to be repeating myself:

If you're primarily interested in making money, or if you love the startup but not the compensation, you should NOT work at that startup.

If you're a good developer, you can get a better deal by working at an established company and simply investing. This has been true for every startup offer I've ever seen. Ever.

I've considered lots of startup jobs because I believed strongly in the companies. Every single time, however, I was able to get a larger chunk of the company by keeping my current job and simply investing.

To give an example, my current job pays about $250k, and one year, I invested $100k of that into a startup, leaving me with ~$150k of salary. This $150k + startup equity was a better deal than the startup was offering in both salary and equity (BY FAR). Plus, equity bought as an investor is much less tax toxic than equity options received as an employee of a startup.

On the other hand, most people who work at startups aren't interested in money. If that's you, that's totally cool!

Thanks for the comment, but 'investing' 100k, a sum FAR more than almost anyone reading the comment will ever see in their own bank accounts, is not 'investing' for most of us. Diversity and spreading the risk is bread and butter for almost all of us. Throwing 100k into a company you believe in' is a greater gamble than almost any reader could ever justify to their spouse and expect to stay married. You live in a very different world.

Yeah, good point--I'd recommend investing only $10k or $20k if possible.

One of my points, though, is that you are effectively investing $100k in the company by taking a crap deal to work there (e.g., via a $25k pay cut over 4 years of work). For that $100k, you're getting much less than you would get by simply straight-up investing $100k.

Would you mind sharing a few things:

- age - Bay area/NYC or somewhere else? - how do u deal with taxes, 401K contributions and still have 100K leftover?

I am possibly overcontributing 401K (maxing the 18K allowed by the IRS) and certainly overpaying rent (bay area :[). How the heck does one manage to save/invest 100K even at that salary? As a soon to be father, I need to get my act together asap.

I'm 30 years old, and my rent is about $1200/month (I'm married, which helps cut down on costs).

After taxes, $250k becomes $150k. After rent, food, staying alive, some travel, etc., I'm left with about $100k disposable per year. Like most of you, I don't really have nice things, fancy clothes, etc.

I would continue to max out contributions to retirement accounts, though! You can invest in startups via IRAs and Roth-IRAs (I have done it).

Thats interesting. Can you please share how you invested in startups via Roth-IRAs? I am exploring ways to do something similar.

I used a Pensco self-directed IRA:


I see and agree to your point, taking that kind of cut in salary is an investment of that magnitude. However, there are not many people that could even afford to put 2k, let alone 10k into a company. For most, putting in the time to help a friend, possibly valuing the time at 10k and giving that to them for free, is a much easier and safer bet. I know that makes little sense in terms of dollars, but no-one I know of, save some very busy consultants, have anywhere near 10k to 'invest'. However, most folk I know of have a few weekends and hour after work to 'invest' and help a friend out, possibly worth 10k in time.

It's like you didn't even read his full comment. His point was that he makes enough money that he can invest $100k a year and still make the same salary he'd get at a startup.

> a sum FAR more than almost anyone reading the comment will ever see in their own bank accounts

You're joking right? Engineers make six figures and can easily save $100k if they try. Your retirement account should have seven figures by the time you retire.

> Thanks for the comment, but 'investing' 100k, a sum FAR more than almost anyone reading the comment will ever see in their own bank accounts, is not 'investing' for most of us.

To the extent that is true, neither is taking a salary hit on that order in exchange for equity from your employer.

The contention GP makes is that even ignoring the opportunity for diversified investing, from a financial standpoint, getting a job with an established company is strictly better than a startup in most cases, since you can exceed the pay and equity (and equity in the startup) of the startup job with the bigco job.

That the bigco job also gives you the option of diversifying your equity investments to manage risk, while the startup job does not, reinforces, rather than counters, that argument.

Many people who join startups have "invested" an opportunity cost of similar magnitude. If the company they're working for goes south, they've lost the better salary they could have had at the larger company, they've lost their job, they've lost their health insurance, they've lost their equity they have in their company, et cetera.

That doesn't seem like much in today's hot market, but ask anybody who went through a crash how much a stable job is worth.

If you're not comfortable investing ~100K in a startup, you probably shouldn't join one.

> Thanks for the comment, but 'investing' 100k, a sum FAR more than almost anyone reading the comment will ever see in their own bank accounts

Assuming that the majority of HN readers are software developers, I actually don't think that's true.

While I agree that investing $100k into a company is a big gamble, it's important to realize that's precisely what you're doing if you give up a BigCo job for a startup one with a $25k pay gap and vesting over 4 years.

I disagree because it is not true all startups offer less than market-base salary.

If a startup has VC backing then there is absolutely no reason for the startup to offer less than market salary. If a startup does not have money to pay employees then founders should raise more. Or sell more. Employees are not VCs. Simple. Also look this way: if start up is not offering market salary, then think this way: how that startup is going to attract talent from established companies (whose expertise are needed if that startup wants to become big).

On the other hand, If a startup has no VC backing and you are offered less than market salary you are then you should act as investor / co-founder. That will be definitely less money but it can be a great experience: money is not everything.

You bring up a good and interesting point.

From what I've seen, startups almost always pay less than market, but they make up for it in four different ways:

1. Quality of life and work: employees at startups get to touch more things, work on more exciting projects, eat free food, play ping pong, be a part of a tight-knit culture, etc. A lot of people highly value this, and I don't blame them!

2. Employees mistakenly overestimating the value of their options, their probability of success, and the uniqueness of the startup culture.

3. Related to both #1 and #2, hiring employees that don't care about money and/or haven't taken finance 101.

4. Related to #1, #2, and #3: hiring employees that are so excited about the startup that they don't care about the deal they're getting.

I've NEVER seen a good engineer get a better offer at a startup than he/she would've gotten at a large company, but it's certainly possible.

> 1. Quality of life and work: employees at startups get to touch more things, work on more exciting projects, eat free food, play ping pong, be a part of a tight-knit culture, etc. A lot of people highly value this, and I don't blame them!

It's not worth 10s of thousands of dollars a year when you can get a lot of that (or all it) at a company that will pay you more.

>If a startup does not have money to pay employees then founders should raise more.

> then think this way: how that startup is going to attract talent from established companies (whose expertise are needed if that startup wants to become big).

THANK YOU so much for saying this

> If you're a good developer, you can get a better deal by working at an established company and simply investing.

This cannot be emphasized strongly enough. Even if you suck at investing, take a look at the max fluctuations for Valley's finest - AAPL, GOOG, FB or NFLX. Starting as a very late employee at any of those places with companies well past IPO stage with original equity package pegged at 1.5x-3x the annual salary, with annual/biannual refreshers and occasional performance bonuses yields a very secure future.

Of course, there's a bit of survivor bias here, but employees of a publicly traded company generally have a better idea of the company direction.

Can you explain how you were able to invest 100k into a startup without being an angel investor?

It is not difficult be qualified as an 'angel investor' to the eyes of the SEC, which really means you met the qualifications of an accredited investor. All you need to qualify is a salary of 200k per year, as the OP said he was making 250k which means he qualified. While 200k seems like a lot i would guess the top 10% of engineers in silicon valley are making at least this much. With 10-20 years experience in software development or if you move up to manager you can reach this salary at any major tech company


Most startups are more than happy to take your money. Just email or meet with the founders, explain your enthusiasm for the company, and you're usually good to go!

For higher-profile deals, though--e.g., Uber--you wouldn't be able to invest such a small amount.

> Most startups are more than happy to take your money. Just email or meet with the founders, explain your enthusiasm for the company, and you're usually good to go!

I would be highly skeptical of any startup founder who is going to take money from just anyone. Taking in random investment dollars could come back to bite founders and company in the ass pretty badly. From the time demanded by the investor, to working on subsequent financing rounds, you could really shoot yourself in the foot by doing this.

This is one reason why Angels are more sought after than "friends and family."

> For higher-profile deals, though--e.g., Uber--you wouldn't be able to invest such a small amount.

No. For late stage investments, even if you had the capital, you're beholden to the terms dictated by whomever is leading the round. They're not going to invest large sums of money and want to share rights with just anyone with the cash.

While it's true that founders won't take money from just anyone, I actually think a software engineer with experience in the industry would be a great investor.

They can give you insight on tech problems/scaling, help with hiring, offer connections, etc. (Basically, most of the things you're looking for from investors besides money.)

A software engineer investing in your company is pretty different than your real estate mogul uncle trying to get in.

Doesn't this just apply to those with either sufficient net worth or earned income to qualify as an accredited investor? Or have you heard of startups taking the money of some new graduate making less than $200k/year with insufficient net worth?

In the US, this is the definition of Accredited Investor[1].

The SEC allows companies to sell shares privately, using Regulation D. Regulation D has a number of rules that govern it, such as, you cannot generally solicit your offering (for example: take an ad out in the NYT annoucning you are raising money).

You can raise unlimited funds from Accredited investors (see link). You don't need to provide information (via prospectus) to these investors, as it's assumed they have the acumen to obtain and understand the information to understand the investment being made.

Companies can also raise funds from up to 35 non-accredited investors. However, in doing so, must ensure due diligence that those non-accredited investors can bare the economic burden, are made to understand the investment, etc.

By and large, that amount of work is more than enough to turn some founders away from dealing with non accredited investors.

In certain cases, a pre-seed, initial funding round may come from a "friends and family" round.

The SEC recently passed a law allowing selling shares via Crowdfunding, but because it's fairly new, the risk* to future Venture rounds is unknown, and I'd expect founders to be tepid with adopting Crowdfunding as a viable method to raise money.

[1] http://www.ecfr.gov/cgi-bin/retrieveECFR?gp=&SID=8edfd12967d...

* Venture Capitalists (afaik) haven't published an opinion on crowd funding, so founders may inadvertently risk future startup financing rounds if they screw up their capilization table with a crowd funding round.

Yeah, typically you have to make at least $200k/year or have a net worth of $500k (the term is "accredited investor").

Thanks to a new law, though, you no longer have to be accredited to invest small amounts.

I believe it's net worth of a million dollars (http://www.investor.gov/news-alerts/investor-bulletins/inves...). I've been following the crowdfunding legislation and it seems like there may be additional requirements to accept such investments if you are an early startup with just friends & family investments.

But the bottom line, I think, is that to do the strategy you suggest, you currently need to be an accredited investor if the startup is not already setup for crowdfunding.

Excluding primary residence :)

Specific to the US, my interpretation:

Prior to SECs recent ruling which allows companies to sell shares (aka securities) by crowd funding, companies are allowed to sell shares to Accredited Investors, the definition of which is regulated by the SEC. Further, they can also sell shares to non-accredited investors, but with added due diligence required by the company.

An individual can meet the definition of an accredited investor, without being an "Angel Investor." Angel Investor is a term for someone who is known for, as part of a financial strategy, investing their own money to startups.

> my current job pays about $250k, and one year, I invested $100k of that into a startup, leaving me with ~$150k of salary.

Sorry to nitpick, but how exactly does the math work out if the $100k is presumably drawn from post-tax income?

I would also imagine that you get a MUCH better deal and probably higher preference by investing versus being an employee. Which is also not a great message to send employees.

Yes, in addition to the amazing tax benefits of investing rather than being an employee, you get preferred shares.

I also want to add that I know of a startup which allowed employees to trade off salary for equity in a way that completely screwed their employees. E.g., they gave their engineers something like either 0.2% and $150k, or 0.3% and $100k.

This implied a valuation of $200 million (since an employee would trade off 0.1% of the company for four years of $150k instead of $100k--for an added $200k bonus, and $200k / 0.1% is $200 million).

At the time, though, the company was selling shares to investors at a valuation of $50 million.

In other words, they were charging employees quadruple the price for equity. I'm thinking about writing a blog post on it.

Early in your career, startups can offer flexibility and growth opportunities which you wouldn't have otherwise.

One of the best jobs I've ever had was at a startup. I was still in college at the time, but they recognized the value I delivered and:

* Paid me a great full time salary even though I was staying in classes

* Let me run a full team, giving early management experience (great for my resume)

* Meaningful equity

No "established" company would have done this. It was a little crazy to do (who lets a college student run a tech team?), but I had a great experience and so did the team. Even if my equity is ultimately worthless, I will still have gained from taking that job.

Moreover, not all startup jobs offer poor equity terms. I've never worked at a startup for less than 1% (often much more than that) and always value my stake at less than half the VC valuation.

Even if I never make any money on a startup, I'll still endorse doing a startup early in your career. Later on, the calculus definitely shifts as mature companies are both more formulaic in their compensation and also offer benefits which become more important with age.

How did you invest in a startup with only $100k? Was this a seed-stage thing or were you a small contributor to a later round?

I was a small contributor in a later round (series A or B).

I think I asked this from you in another thread - but this advice feels difficult to follow. Are you in SF? Do you work at a company like Netflix which is known for paying very high salaries? Or are you not fully a developer, but in management? Because national labor statistics show that even the top quartile of salaries is still much lower than this, so I'm not sure how realistic it is for even the HN crowd to just up and make $250k programming.

The number is "high" as a single datapoint, but only due to an inflated SanFran economy. A $250k SF job adjusted to where I live in Dallas is actually considerably less than I make. I would need nearly $370k in SF dollars to do the same thing.


Actually, one small correction to your math.

You should adjust, for cost of living, only the part of your paycheck that you will be spending while living in that area.

E.g., supposed SF is twice as expensive as Dallas. If you make $100k in Dallas, and you typically spend $70k of it in Dallas while saving $30k (to spend later in life somewhere else), you would need to make $70k x 2 + $30k = $170k in SF (for an overall adjustment of 1.7) rather than $100k x 2 = $200k in SF (for an overall adjustment of 2).

Then again, if you're planning on living somewhere for the rest of your life, it's safe to assume that whatever money you make in that place, you'll also be spending in that place. Therefore, in that situation, multiplying by 2 would be correct after all.

Right I'm well aware of the cost of living, but he did answer that he was 30 and living in SF. I live in Boston which is of relative cost-of-living (and salary) parity to SF, but you don't see $250k jobs being advertised for Google, Twitter and Microsoft here in Boston. I also feel like that number is inflated because a big portion of that likely comes beyond base salary (stock options, etc).

Absolutely agree!

Ah, sorry I didn't respond before.

I live and work in SF at a large company (not Netflix, but something pretty similar). I'm 80% a coder, 10% a manager, and 10% a data scientist, and I love my job. $250k salaries are very common at large companies these days--you just need to stick around and work hard for a few years.

Even if you make $150k, my advice stands, but you should probably invest smaller amounts than $100k, obviously.

Same age as you, but in Boston, so relatively similar salary/cost-of-living. One question is - are you actually making $250k base? I feel like for many of these large companies, that's the total compensation package, and much of that "total" is around bonus and stock options. Is it more about sticking around than it is about getting in as a high-level engineer, or is it the pay grade? If I walk into Google and get hired as a senior engineer, most salary reports in the public domain show me making far less than $250k base, even in SF.

Boston and SF are NOT comparable these days in terms of cost of living OR job market. Boston is probably #2, but it's a fairly distant #2.

$250k is a normal salary for an engineer with say 10 years experience in the Bay Area. It won't all be in a monthly paycheck, some of it will be in bonuses, restricted stock, etc., but it will be bankable and spendable annually, not locked away in illiquid assets (at least at a large company). Companies with long vesting schedules will supplement the early years with hiring bonuses until shares start to mature.

And this is why rent on a 2BR apartment in Mountain View will run you $3000 per month, and a 900 sq ft condo convenient to nothing in particular runs $850,000.

I think it's funny that everyone is stuck on your $250k salary and not focusing on the point that you were making.

Thanks for the comment but when you say you invested 100K in a company - are you talking about publicly traded companies, investing via the secondary markets, or both ?

You cant invest 100K in uber right now ....

> On the other hand, most people who work at startups aren't interested in money. If that's you, that's totally cool!

If that's you, you're an idiot.

By joining a late stage (vs early stage) startup as an employee, you are trading execution risk for valuation risk.

At an early stage startup, your shares are essentially free to purchase - especially if you join a company which hasn't had a formal external valuation event (like a fundraise) yet. All your risk is around the startup evolving into a successful business with a high value.

Join a late-stage startup, and most of the execution risk is gone. But the company may already have an artificially high value attached - so you have a lot of risk that your shares end up being worth significantly less than you paid for them.

The real unicorn, for an employee, is a middle- to late-stage company which has successfully executed, is growing, and ideally hasn't had any formal external valuation events. There your shares are cheap to buy and extremely likely to increase in value.

> The real unicorn, for an employee, is a middle- to late-stage company which has successfully executed, is growing, and ideally hasn't had any formal external valuation events.

And, like a real unicorn, it doesn't exist. At least not in today's funding environment.

No, I know a couple. Look for companies with around $10-100m annual revenues and no external investors. If you speak to their owners, their biggest frustration is, ironically, competing with unicorns for talent recruitment.

I pretty much agree that's a higher probability way to make money. I think "the real unicorn" is working for and with good people though.

> Even worse, they had paid taxes on the stock based on the higher value.

That's the most annoying part of the entire article, and why I ask for salary rather than equity. Keep your stock, I'd rather pay my bills.

Joining public or late stage pre-IPO companies, equity provides the possibility of real wealth. There is a great Wealthfront article about this -- that if you live in the bay area and have a normal nuclear family, you need equity if you hope to pay for a house, college, etc.

I've seen this in my own life and in many colleagues, friends, and people I've hired. It's not a guaranteed paycheck, but in the bay area getting a healthy equity grant is part of the standard comp package. Without luck, it can be a nice bonus. With some luck it can really move the needle. And with ISO's especially you can choose when to pay taxes on the income.

I know that outside the bay area comp packages are structured differently -- and often less lucratively.

The problem here is that "the possibility of real wealth" is not "real wealth". Not being dead provides "the possibility of real wealth" to approximately the same degree as the equity offered to anyone past double digit employee count. Even before that it's only factor unity above the baseline of "not yet dead"

It's a subjective term. But IMO, a few hundred grand after-taxes is real wealth to somebody making $150k a year. It can bend the net-worth growth curve of your life -- a huge home downpayment, elimination of your student loans, etc. Be smart, take an educated risk, and IMO don't listen to people who say equity is worthless.

A few hundred grand net absolutely is real wealth. To anybody really. But how many people are seeing a few hundred grand after-taxes (after taxes!)?

I'd love to see real data on what percentage of tech workers who receive equity ACTUALLY end up cashing out for over, say, $100K. Not a HN Survey, because of course everyone here has $10MM in equity, a mansion on the Peninsula, and a supermodel spouse. But a real survey across the huge tech company landscape, in and out of Silicon Valley.

Over a 4 year grant? This is just a guess, I don't have the IRS database at my hands. Maybe $200-300k after-tax sounds more reasonable? Like I said above -- "with some luck"

You have not yet actually made a guess you've just kept asserting that "a lot of money" is "a lot of money" and I agree. A lot of money is a lot money. I just think that modulo nobody is actually seeing a lot of money from start-up employee equity.

The problem is that it's not an easy thing to estimate. I know I've had equity grants that I thought were worth $x but turned out to be worth $x * 4. But you don't sell all of it at once, and you don't pay all of the tax bill when you sell, so it's a very hard thing to know. $200-300k after taxes is, I'm sure, not a rare outcome over a 4-year vest.

if you live in the bay area and have a normal nuclear family, you need equity if you hope to pay for a house, college, etc.

Then holy hell am I glad I don't live in the Bay area. Because, as the article demonstrates, there is zero guarantee that the equity you have will be worth anything. That you'd depend on such a thing to pay your mortgage and send your kids to college? Madness.

It's not like you sign a contract that says you must remain here for 20 years. Read the Wealthfront article linked in a sibling comment.

Wealthfront article mentioned (i think) https://blog.wealthfront.com/college-vs-retirement-savings-s...

Not exactly true since select bigcos pay quite well these days.

It's all about risk. Unfortunately, this risk did not pay off.

If you want risk, be an entrepreneur. If you want security, be an employee for a big company.

And I suppose I should add, "If you want to get screwed over, be an employee at a unicorn startup," based on this new information.

I'm not as pessimistic as most here, but start-up employee really is the worst of all worlds.

1. Reports vary but the general consensus seems to be lower pay than a Fortune 500 or similar for more demanding hours.

2. If you're offered equity it's an insulting fractional percentage (how can you be offered 0.1% and not let the profanities fly?), and will need to use actual money to exercise the options.

3. There are tons of stories of completely incompetent and/or corrupt founders literally locking the door on employees (Zirtual et al).

4. I'd be remiss if I didn't at least bring up the insane (comparatively) COL of the Bay Area compared to even other large US metropolitan areas.

I'm not going to start railing about VC-istan because I do think the degree to which the system is rigged gets overblown, but if you're going to be involved in start-ups it doesn't make sense to be anything other than a founder, C-level-for-hire employee, or investor IMO.

I always find it funny when startup founders believe that they are taking on more "risk".

So when the company isn't doing well, the founder lays themselves off first right? No? Hm, seems like the rank and file employee takes on the risk there...

Not to mention that it's probably a lot easier for a founder to get another job than their employees. Oh and by the way, the founder has been paid more, has gotten more stock and has probably had investors pay for a lot more nice dinners/drinks than their employees.

But yeah, the founders deserve to be compensated much higher because of this "risk", yes indeed.

As someone whose best friend started a business that is being grown organically (no seed money, no investors, no venture capitalist, just an idea), my perspective is probably different than most of HN's.

The risk he endured was literally starving. If it wasn't for us, he very well might have.

Considering I work for the biggest hospital chain in the world, I just had to seek new employment because they closed our 'division' down without notice. Security is an illusion, or temporary at best.

Risk is real. And it resides in all places of employment. You have to hedge your bets.

There are several options one must weigh when they are deciding on job offers.

Where you work is so important and yet so many people seem to put such little effort into negotiation, risk assessment, runway, overall comp, etc. etc.

If you're taking equity in place of a market rate salary you better to be absolutely 100% sure you know you're taking a massive risk and forfeiting real dollars for hypothetical dollars that 9.999/10 will never exist.

Note: A great read about equity http://blog.alexmaccaw.com/an-engineers-guide-to-stock-optio...

While that does suck... they exercised early for the capital gains tax treatment. If there was no risk involved, it doesn't really deserve a lower tax rate.

in most standard startup contracts you are forced to either exercise when leaving the startup (30-90days) or forfeit them

Which is to say nothing of the fact that it's still an investment in a company, and carries with it risk, including a full loss.

Anyone implying that owning equity in a company has any guaranteed payout, even on acquisition, is being intentionally misleading, I think.

The fact that some employees have to pay taxes based on the valuations that VCs dream up terrifies me.

Only those who early exercise, or exercise their stock as it vests. They did this to try and optimize for long-term capital gains.

For most employees who leave their option grants as options, there is nothing to worry about.

When you are given a grant of stock options, you can sometimes ask the company to let you exercise it early, and vest the shares instead of the options. If you do this when the fair market value (FMV) of the underlying stock is the same as when the options are granted, you will not be in a precarious tax situation. However, many people wait a couple years before deciding to exercise their options, and as a result, they need to recognize a paper gain when they exercise later as the FMV is substantially higher. That's what happened here. They exercised later, thinking the stock price would go even higher, and they were wrong, but they had to pay taxes on that higher price.

While it's true they paid a lot of extra taxes, since they never recognized the gains, they can roll that tax credit forward to cover future gains they may get at some other point in the future. I'm not sure how long you can roll these losses forward, but I think it's for a substantial period of time.

The premise of this argument is that the people who earned those options remain employees until the company gets liquid. If you leave, you're usually required to execute.

Correct me if I'm wrong, but even with an early exercise (or an exercise of vested options) where the valuation matches the strike price, that employee would still have had to personally fork over the amount needed to purchase the underlying shares. In the scenario described in the article, they've still lost a substantial chunk of money if the valuation is now a fraction of the strike price.

Secondly, while capital losses can be carried forward indefinitely, you can only apply ~$3,000 per year (as a deduction, not a credit).

2 approaches:

1) you pay the strike, and pray the valuation continues to rise through any IPO, buyout, etc..

2) arbitrage - you pay the low strike, then sell in the secondary market for more, and hopefully realize a one-time profit after cost frictions.

From the article, sounds like most of the afflicted here were playing strategy (1), while there was some window to execute on (2) though many may have not noticed it.

> that employee would still have had to personally fork over the amount needed to purchase the underlying shares

Then what is the difference over just buying the shares outright as opposed to exercising options?

My understanding has always been that exercising options means getting a benefit (the shares) which has a value (the strike price) and you subsequently pay tax on that value.

You pay the strike price in cash and you get the shares. Your "basis" in the shares is the strike price (what you invested).

You base your AMT tax calculation on the difference between the fair market value and the strike price (that's the "phantom income").

When you sell the shares, your realized capital gains is based on the original basis and you may have AMT basis that's different.

If you exercise and immediately sell, AMT doesn't factor in.

Concretely (and picking semi-random numbers): If your strike price is $10/sh, the FMV is $25/share, and you have options on 1000 shares, you'd pay $10K to exercise, get 1000 shares, and have $15K in AMT income to consider.

If those shares later soared to $40 and you sold, you'd have a capital gains of ~$30K ($40K proceeds minus $10K basis minus commissions and fees).

If those shares instead crashed to $0, you'd have possibly paid AMT on the phantom income and you definitely lost the $10K in cash.

Mostly correct, with one correction:

You can apply carried forward capital losses against 100% of your capital gains PLUS an additional $3000 in each future year.

> they can roll that tax credit forward to cover future gains they may get at some other point in the future. I'm not sure how long you can roll these losses forward, but I think it's for a substantial period of time.

IIRC it's only 7 years. For people who do a lot of transaction, that's enough. For employees that get to invest 3-4 years in a company to make a profit on equity, it's actually quite rare to make use of this.

Also, everyone keeps forgetting that even liquidity-event-induced-exercise very often doesn't come with the liquidity that makes it profitable: In the case of a public stock exchange event, the 6-month lock-up period required by SEC rule 144 (and/or the underwriters), the stock can go down 90%, which means you pay 15-60% taxes on imaginary gain, even if you played your cards perfectly. This one also applies to investors.

I interviewed at this company a couple years back and a huge selling point at the interview was their upcoming IPO plans. They eventually gave me an offer which I turned down because enterprise and security is a boring area to work on. Based on these recent series of articles on startups, its becoming more and more apparent that while starting a startup is a fantastic thing to do, being an employee of one has mostly downsides. Its a much better career move for non-founders to work for large established companies.

Ms. Wyatt introduced BlackBerry’s chief, John S. Chen, who winkingly apologized for how his deal makers had driven Good’s final sale price down to $425 million, less than half of the company’s $1.1 billion private valuation.

I've never been a CEO or acquired a company but I think there probably aren't too many worse things you could say to the employees of a company that you've just acquired.

You should see how awkwardly he debuted one of the latest phones, and you'll understand. Might just be social awkwardness. (Still sucks, but feels microscopically less malicious).

Also can you imagine being an employee at that meeting?

Not only are your share values decimated (literally), you're now working for walking dead BlackBerry assuming you're not soon laid-off.

The "deal makers" didn't drive down the value of the company. Good did it themselves. They were hemorrhaging money. They did not have the stronger position at the negotiation table.

A company I was working for was acquired and the first thing the new management said in the initial meeting was that they had no interest in owning us. They were only acquiring the company because another office had government contracts they wanted. Also, our equity was worthless now. But don't worry, because no one is getting fired! (Instead everyone resigned within a few months)

The biggest problem with employee equity is the taxes. Investors pay cash for their shares, and the transaction is completely tax neutral. When a company sells its own shares in exchange for cash, the IRS does not charge a penny.

But if an established company wants to get equity into the hands of its employees now you have a problem. The way the tax law is written, you have basically 3 choices. Either the employee is paying you "fair market value", or you are giving them options with a strike price at "fair market value" and they can hope for future appreciation. Otherwise, if you try to just give them shares, the IRS needs to be paid, and in cash! So, for example, to simply give 10% of outstanding common shares (an illiquid and diluting asset) to your employees, you would have to pay 4% of your company's "fair market value" in cash to the IRS!

The problem is all in how you define this "fair market value" thing. If you sell some VCs equity along with what's basically a note payable (liquidation preference) and then say the "value" of the company is equal to the total raised divided by the percentage equity stake they received, all while totally ignoring the 'note payable' -- that's complete madness! And it's the world we live it today.

If, alternatively, you first subtract off the top of any amount raised the full amount of any liquidation preferences, then only the remainder was divided by the percentage equity stake to arrive at a valuation... For example, raise $10m for a 10% stake with a $10m preference -- then for tax purposes your common stock valuation should still be $0. Now you can grant however many common stock shares you want all day long, and you don't bleed cash to the IRS in order to do it.

Employees would still have to pay the full load of taxes on any gains when they sell the shares. But this fixes a huge challenge of fairly compensating employees with equity without even dodging any fair share of taxes. Taxes should be due and payable when liquid value is actually received, not before.

The problem here is the valuation model for the common stock was broken. Properly factoring in liquidation preferences and your 409a valuation of common stock would not have ever hit $4.29 per share with 229 million shares outstanding. The fact that preferred shares sold for that price is completely irrelevant, it's like saying the Tesla sells for $80k so we'll just value this Nissan Leaf the same.

The IRS does not force these companies to improperly value the common stock. It's just the default position they take because it's cheaper for the company this way.

The 409a valuation is based on the price someone would pay for 100% of the outstanding shares of converted-to-common shares. This is much lower than preferred stock investment price (where the dollars are being put into the company to grow it, not being paid to shareholders to retire). It's even much lower than the secondary market price since that's the price for a small percentage of shares -- try selling them all and the bid/ask would fall to zero.

The price of illiquid common stock must reflect the risk-taking stance of management and the Board. Even having an $800m offer doesn't have to boost the common stock valuation so much because if management is declining those offers and swinging for the fences you can reasonably factor in that risk in the price.

Unless and until an actual IPO, companies should take a discounted future cash flow model based on single-digit future growth to demonstrate the common stock value is absolutely worthless, and everyone should be required to file 83(b).

We know its a lottery ticket, the tax code allows us to value it appropriately. The real problem is companies straight out fucking up their 409a. Common stock shareholders at Good would not be crazy to consider a lawsuit.

I worked for this company (Good Technology) from July 2012 until Jan 2015 in their San Diego office.

I never exercised my options (they clearly weren't worth the strike price I had as a late joining employee at any time that I had vested shares) so no skin off my back, though I do know people who got screwed by exercising options because they left the company prior to the sale to Blackberry and were essentially forced to exercise the shares or just lose them. (I'm all for the trend pushing for much longer windows on this).

I also know a lot of people who came from companies this company aquired who stuck around for the eventual big payout that was much bandied about by much of the C-level management the entire time I was there who basically traded years of sweat equity for nothing (better than walking away in the hole, though!)

I found the article to be a pretty fair writeup of the events and a useful warning to people on the risks of stock exercising prior to liquidity events. This is a lesson I learned the hard way years ago (first dotcom boom), so I didn't get burned this time, and actually really enjoyed my time working for this company because the team in San Diego (which was pretty well isolated from the teams at the Sunnyvale headquarters) was a great group of people to work with, and I was paid pretty decently.

It is precisely the protections of preferred stock that led to the overvaluation in the first place. http://recode.net/2015/05/10/heres-one-thing-all-the-billion...

As a common stock holder, you should know that you'll be the last one paid, if at all, because few companies can meet unicorn expectations.

> To pay those taxes, some employees emptied savings accounts and borrowed money.

Investing your life savings and/or loaned money into a single stock is always a huge warning sign that you're being foolish.

I would say it is much worse when that stock is your employer's. Yet, people still gladly take their employers stock (or options) as compensation (whether straight up comp or in a retirement plan.)

Yes, this strikes me as very Enron-ish throughout.

Interesting. In what ways? Enron was a public company that committed fraud.

The management pushing the stock and painting a rosy picture while behind the scenes the ship was sinking.

The employees putting everything they had (and then some) into a single stock from their employer.

I don't know if there was criminal behavior involved but an imbalance of information was in play that cost the employees everything and then some.

The tragedy of Enron was the automatic investment plans in the 401k for most employees. The default choice was Enron stock. Also, depending on the nature of the matching contribution, Enron stock might have benefited from a larger matching employer contribution percentage or discounted share price. This is why 401k plans now offer various choices that are suitable and diversified for most people.


A defined benefit plan could have prevented this tragedy. It's funny though. Defined benefit plans are mocked at by large firms but increasingly being used by wealthy individuals/families and their small businesses. Nothing beats government subsidized PBGC insurance for the future retirement plans of America's job creators.

Various accounts of the Enron saga include anecdotes of employees happily (and being encouraged to) invest most or all of their 401k in Enron stock.

I believe before the collapse Enron's management would berate employees who sold stock in their 401-ks. Management actively mislead their own employees. I've heard this from a number of sources (including a family friend who left Enron a couple years before the collapse.) Obviously, take my comment with a grain of salt since it's mostly based on anecdote.

This topic has been in conversation a lot recently. Yet I feel we only have anecdotal data. I was wondering if we can get some real numbers on employee outcomes. I created a spreadsheet that aims to capture this and hopefully, we can get some real insights and conclusive data.


All data is anonymous. You don't even need to be logged in to edit.

What do people think of this?

Real data is good, but that's not a good way to get real data.

I'm not a stats person, but it would seem to suffer from both an extremely small potential sample (those who read your post), a self-selection bias (those who gain an advantage by participating, e.g., the aggrevieved), and an outright unsual candidate sample pool (Hacker News).

Perhaps try something like Google Consumer Surveys, and ask a one-two question like: (1) are you currently working for a pre-IPO startup and (2) are your options underwater. Or similar.

It's going to be functionally impossible to get good data. Not least because I suspect the vc industry really really doesn't want potential startup employees to see the numbers. Or to think to hard about the wave of upcoming ipo devaluations coming to unicorns (viz a recent discussion from Mark Suster where 5/7 of 2015 large ipo exits where down rounds compared to previous valuations [1]). If the numbers were amazing you'd see someone like First Round giving exit surveys to all their companies and trumpeting the mean or median outcome. Or even YC; they are probably in a position to collect that data.

The best you'll be able to do is a site like glassdoor, with all the sample bias that implies. But even with glassdoor, I've told a recruiter to go away because their company pays poorly according to glassdoor. The recruiter then whined about glassdoor, but since he didn't provide me with salary numbers, what does he expect?

I've also pondered building a site similar to glassdoor to confidentially discuss outcomes, but the best you'll ever be able to do is anecdata.

[1] http://www.bothsidesofthetable.com/2015/10/18/venture-outloo...

It's interesting to compare this article with the coverage of the acquisition at the time.

"When Good Technology announced Friday that it had sold itself to its long-standing rival BlackBerry for $425 million in cash, it was a moment of triumph for Good CEO Christy Wyatt." - http://uk.businessinsider.com/how-christy-wyatt-sold-good-to...

She made out like a bandit with $6m and no need to turn up to work ever again, so for her I'm sure it was pretty triumphant.

The fact that the very first action of the acquiring company was to give her enough money to never come back tells you all you need to know about her ability as CEO.

If you're going to work at a startup, ask for two things:

1. No employee equity whatsoever, but a slightly higher salary to make up for it 2. The ability to invest in the the next round

I've worked at a startup and done #1 and #2 above, and it's working out great. I'm very happy to be owning preferred shares.


Aren't you just lowering your risk, while simultaneously lowering your reward?

Eg, let's say you negotiate a 20k/year increase by not getting any stock options. If you spend that 20k to invest in their next round, you'll be paying for preferred shares, rather than common shares. Therefore, you'll be able to afford about 5x less shares than if you were exercising employee grants. Am I wrong?

Sure, you'll get preferred shares, but if the company does very well, your ultimate reward will be less.

That's a very interesting approach!

The real question is, when do you "buy in" to a valuation.

Things are only worth what someone else will pay. So if you don't have evidence that there is a buyer eagerly wanting to pay $5/share for the options you are getting for $4/share, don't assume they are worth anything.

Because of dilution math, it's very rare for employees of all but unicorn startups to cash in at anything close to the expected value of the shares. That means that your 50K shares awarded after a $5M series A (on a big pre money valuation) are not going to be worth much if the company sells for $10M the following year.

Founders should set up a chart that tracks the various possible outcomes and lets employees understand what their options will be worth in those scenarios and see what the founder would get in those scenarios. This would allow additional shares to be given to valued employees if the company turns out to be a beautiful white horse but not quite a unicorn.

The thing to be aware of is when the founder has the option of cashing out for $10M and the employees effectively getting nothing. If this happens the investors will have essentially lost interest and will potentially get their investment back but will not mention the deal to anyone again. This is a sort of perverse incentive because the founder will be inclined to deceive employees into thinking a big exit is on the way, while simultaneously negotiating a low millions acquisition and high salary at the acquiring company.

In that scenario, the founder should have to renegotiate so that the most valuable employees get at least 10% of the founder's payout, but employees rarely have (or use) that much leverage with the founder.

Can anyone provide any info on what actually happened here? The article says that the preferred was "worth" more, which is a pretty vague statement. I interpret this as meaning that they didn't convert because their liquidation preferences guaranteed a higher payout. What seems relevant to me, and anyone else who works at a pre-IPO startup, is what were the things to look for ahead of time.

According to Crunchbase, Good raised $291M in 4 rounds. Assuming those investors owned 40% of the business, then at $1.1B, common was splitting $660M (preferred would convert). At $425M, assuming 1x liquidation preference, common is splitting $134M, an 80% decrease. I think you could get to the numbers in the article assuming 1x participating or something similar.

This should have been pretty predictable to employees. You will not get rich if your company sells for only 1.4x the total amount invested.

I think the bigger concern (as far as employees are concerned) in this particular case is that the board turned down multiple more lucrative acquisition offers.

In addition to all the other issues mentioned here, the preferred/common split means that the preferred holders (ie the board) have much different incentives/risks than common - they can afford to "swing for the fences" due to the downside of liquidation preferences.

What most likely happened was that investors together owned closer to 80% of the business and possibly had liquidation overhangs and some sort of anti-dilution that ended up in a similar situation.

That's what liquidation preferences and overhangs do for companies that raise 100m+, they eat in the common.

I imagine this is going to be a lot worse now with unicorn craze. It seems like to some, any liquidation terms were acceptable to get to the $1b valuation mark.

Indeed. Smart, young companies are refusing preferred share investments and are willing to keep their valuation lower because of that. It's true that you're selling a larger portion of your future for less money in many ways, but you protect the founders and original investors as well as the employees too.

Huge growth is important but it's also important to be smart about it. Selling a part of your company for a bit less if often better than mortgaging the common shares.

Wow. Employees get hurt, and the CEO gets awarded "CEO of the Year"


Good/Visto alum here. I am just thankful that some omniscient hedge fund people offered to buy my shares at a little over a buck a share five years ago (hoping to cash in on their forthcoming IPO no doubt). This company was not a unicorn. It was a tapeworm! Not at all surprised at the outcome, except that it wasn't an outright courthouse auction of office supplies.

Can the overpaid tax be claimed back?

Theoretically, but only over a very long period of many years. If it's a big enough overpay, then it's possible for it to take many decades.

edit: Here's a VERY simplified overview: http://www.wikihow.com/Claim-AMT-Credit

I have enough overpaid tax at 33 to tide me over until death. Lessons learned.

Ultimately the problem seems to be preferred shares driving the valuation of common shares. They obviously aren't the same, so I don't know why it happens. I'm not a lawyer so I don't know if there's a way around this.

Fair Market Value drives the value of common shares, not preferred share costs. FMV is derived using a formula the IRS has to project what a share in the company is worth and it is usually far less than what the latest investors paid.

For those interested in this topic, I suggest reading 'Venture Deals' by Brad Feld. While it's broader than this topic, it does cover some of the legal/technical elements of vc funding and exits, which help when trying to understand outcomes such as this (i.e., preferred vs common shares, etc). http://www.amazon.com/Venture-Deals-Smarter-Lawyer-Capitalis...

If you strip away all the logically questionable parts of this story, there are 2 really important takeaways:

- Companies: don't make employees exercise options when they leave the company. I love the new "10 years to exercise" trend that has started to emerge. - Employees: don't pay taxes or exercise options early to maximize your gains at an eventual exit. It makes no sense - keep the optionality.

A similar thing happened to me. I joined a late stage startup with a market cap of $1.5B. It IPO'd a few years later with some critics calling it the worst IPO of the year. It now has a market cap of $600M. I felt betrayed by execs who had nothing but glowing things to say about the health of the business. I gave the company 2-3 quarters to show signs of hope then quit.

UK resident here: why were employees paying tax on the nominal value of the shares? Is it not possible to structure the compensation so that tax is payable when the shares are sold (capital gains) or on any dividends paid on the shares?

> Why were employees paying tax on the nominal value of the shares?

Alternative minimum tax, created in 1969 to target 155 high-income households who were using too many tax loopholes. It was not adjusted for inflation, and it did not anticipate rank-and-file employees receiving stock options.

> Is it not possible to structure the compensation so that tax is payable when the shares are sold (capital gains) or on any dividends paid on the shares?

Yes, but this requires the employee to pre-pay for the shares when they are issued.

Normal tax rules do not consider exercising options to be a taxable event, but AMT rules do. You can exercise options resulting in modest paper gains without them being taxed.

There's tax due on incentive stock options (ISOs, I think I have the name right?) when you exercise the option. So, if my layman understanding is correct, you get an offer to pay a discounted price on company stock whenever you want (usually based somewhat on valuation when you're hired). Then, the company's valuation increases (all on paper and in private, not public market price corrections, just whatever investors think is "fair"), and you exercise your stock option. The difference between the price you paid (your option price) and the value of the share (as determined by the private valuation) is now taxable income in the eyes of the IRS. You will owe taxes on stocks that might still end up being worthless, and your employer also has the power to prevent you from selling them before they go public/are bought out.

I'm not an expert on this, but when you exercise stock options you have to pay taxes on the fair market value at that time.

In some cases it might make sense to exercise stock options before you can actually sell them (e.g. if you expect the price to keep going up to save on taxes or if you're leaving the company when you typically only have a limited amount of time to exercise or lose those options).

So in these cases you now own the stock and paid taxes on it, but if the stock price falls drastically after that you might have actually paid more taxes than the stock is worth now.

tl;dr -- if you are not a founder, your stock is never going to get as much thought as a founder / investor's will. And also they make decisions on your behalf, often which benefits them greatly, and you little.

more like - if you are not an exec....

The only thing that scares me more than the current information asymmetry between investors and startup employees is the thought of the kind of structures engineers can come up with when their livelihood is at stake!


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