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Ask HN: Is it just me or do a lot of people not know how stock options work?
90 points by stockoptionsta on Dec 20, 2016 | hide | past | web | favorite | 87 comments
I work in a startup in San Francisco. We're profitable & growing, about 30 people now. I'm one of the first engineers so I have a good chunk of stock options.

A lot of times when I talk to my friends (mostly engineers, mostly in their middle 20s) about stock options they don't even know the basics.

A few examples from my life:

* A coworker left the company right before the end of his first year. He had ISOs, and it wouldn't be that expensive to buy them, but he still decided to leave right before the 1 year cliff date to go work in another company.

* A friend of mine did not sign his stock options paperwork when his employer gave it to him more than 1 year ago. I guess he was just lazy, didn't want to sign something he did not fully understand. I don't know all the details but I assume if he signs it now he loses 1 year of vesting, the grant price will be higher — just not the greatest decision / attitude imo.

* Another friend left the company where she had stock options, 6 months later she found out that the company was sold. She remembered about the stock options and asked me for advice. She did not know much about the topic so I told her roughly what her options were, told her about the 90-day rule. I later found out that she ended up getting some money from her past employer.

I know that there's a conversation [1][2] about changing some of the technicalities around stock options, but I think there might be an even bigger problem — many employees don't understand the basics of stock options, hence they don't value equity as much as employers / investors do.

Or is it just me and my friends?

1. http://blog.samaltman.com/employee-equity

2. http://blog.triplebyte.com/fixing-the-inequity-of-startup-equity

many employees don't understand the basics of stock options, hence they don't value equity as much as employers / investors do

The fact that I know the basics of stock options is precisely the reason I don't value equity as much as employers or investors do. I can count on two fingers the number of companies whose stock options put money in my pocket, and one of them is Microsoft. I would need many hands to count the number of ways a company can screw me out of a payday on options.

Point is, for the vast majority of people knowing or not knowing the first thing about stock options won't make a lick of difference in their bottom line. What people need to know about options: sign the paperwork when it's given to you, and on the outside chance the options end up being worth anything your coworkers will give you some half-assed advice, which is one's trigger to go talk to a financial advisor.

Otherwise, spend your mental energy on how to increase your 401K contribution. That's guaranteed to involve real money that you can benefit from, and you should bone up on maximizing the potential.

big companies like Microsoft/Google/etc don't even offer most of their employees stock options, but instead they offer RSU (Restricted Stocks Units). Those are easier to understand, there's no exercising decision to be made, you just need to know your vesting dates. The biggest decision is : Do you want to sell your stocks before or after the 1 year Long term capital gain wait, but that decision is common to all stocks.

> The biggest decision is : Do you want to sell your stocks before or after the 1 year Long term capital gain wait, but that decision is common to all stocks.

The decision is more along the lines of sell now vs. sell later. The LTCG decision is not nearly as important. The conventional wisdom is just to treat the RSU as the same as salary by selling immediately upon vesting. Since you're already employed and paid by them, holding equity in the company you work for is unnecessary additional risk.

If you're working in the Bay Area and making average wage for a software developer, your marginal tax rate is going to be 28%+. If waiting 12 months means you can lower your tax burden to the long term capital gains rate of 15%, that's a no brainer.

AIUI, RSUs are treated as normal W-2 income when they vest.

Right. Your cost basis is the price at vesting, so it's the same as if you bought the stock at market with cash for the same price.

so is the capital gains tax only on the profit from the stock? wouldnt it be better just to sell instantly and not have so much of your money tied up into one asset anyway? Sorry if these are basic questions

Yep and yep. Not basic at all, this stuff is only simple once you already know how it works.

When the RSUs vest you usually have the option to take all and pay the appropriate tax when tax season comes around OR take a reduced amount to cover the taxes. Do you recommend/have a preference? What are the pros and cons?

I'm at a company that automatically sells enough RSUs at vest date to cover withholding (the remainder is deposited alongside the regular salary). So that decision is made for me. No matter which option I'd take, I'd use the one that allows me to move as much money into retirement accounts, 401(k) etc. as quickly as possible.

big companies like Microsoft/Google/etc don't even offer most of their employees stock options, but instead they offer RSU (Restricted Stocks Units).

Microsoft used stock options when I worked there, hence my use of it as an example.

MSFT was one of the big model companies for stock options and sharing the wealth around. I think they got rid of their stock option plan sometime under Blamer when the stock started paying a dividend.

That's correct. It was shortly after Steve took over as CEO. At the time a lot of options were underwater and Microsoft offered a buy-back plan where one could get a lump-sum payment in place of those options. In retrospect taking the buyback was the right decision as the Microsoft options had a 10 year expiry and most of the underwater options didn't climb back within their 10 year window.

Which, in turn, sets up a vicious cycle, because employers know that employees don't value equity as much as a cash-equivalent benefit, and respond rationally to that incentive by reducing equity grants. (This is a positive claim, not a normative one).

On the contrary, because it has a low perceived value they make up for it with volume. Look at how Uber throws insanely high paper-valued equity to its hires. Similarly when I worked for a startup I was promised almost a full percent of a company they expected to grow to a hundred-million dollar valuation. $1m for a year's work? Can't go wrong with that.

(Side note: I didn't get the equity as I was conveniently laid-off a few days before my cliff vesting date. Lovely...)

I've never met an entrepreneur who didn't expect their company to grow to a huge valuation. Did you believe them? Your 1% would probably be diluted down to 0.25%... maybe less... by the time they hit that valuation. Factor in the salary you possibly gave up. Factor in the taxes. Factor in the odds of even having a liquidity event. Your expected return is a lot less than $1M.

> $1m for a year's work?

It's usually 4 years vesting. So obviously, it is NOT $1M for a year work.

Sorry, yes, it was to vest over 4 years, but extra stock would be added annually - so after 4 years my equity might be $4m cumulative, which is $1m/yr on average.

No you won't... unless you've got that in writing... and even there it's not guaranteed.

Companies say all kind of fake promises, don't trust them. Sadly, being laid off on your last month is a lesson of that ^^

Ouch. Did they reach $100MM valuation or were they below that?

They're still in submarine mode, though with fewer employees there now than when I was there. They have enough VC funding to last them a couple of years of zero revenue, though a friend of mine who is still there says they've secured a couple of high-profile business deals. That's all I know.

The founder has a good track record - though I think he's looking to sell it before it gets that big. My friend there thinks whatever stock options he has will simply be diluted by equity sales during future investment rounds anyway.

I haven't seen that happen but I totally believe that it does. So there's two different ways things go haywrite because nobody knows how options work.

I've done the other way around. Leaving before 1 year and not giving a f* about options.

Even if the company makes it big later (hundreds millions), a diluted infinitesimal percentage is peanuts compared to a better offer right now.

By the way, totally used the imaginary lost-stock as leverage in the negotiation. That was probably the best way to cash it out. :D

When seeking unvested equity matching, what kind of evidence does the hiring company typically seek to verify your request - or do they just take you by your word?

I wonder if I could apply to Google or Facebook and claim I have $2m of unvested equity from an unnamed startup...

Noone verifies anything. It's the usual dance where you say what it will take for you to join them and they ask your current salary.

Should be part of that conversation: The £10k of stocks you'll loose when joining them [low minimum, at current valuation].

It was named startup (that noone knows). It was featured in various news as a top X startups to watch in the UK.

Keep in mind when you say "stock options," it can mean different things. The first thing that comes to my mind when you say "stock options" is options trading on publicly traded companies. That is buying and/or selling contracts of puts and/or calls.

The second is "stock options" at private companies as compensation, which is what you are referring to. There are many variations on how this works.

I've seen companies, as a bonus, grant what amounts to a call option that can't traded and only exercised at some point in the future. This may be free or you might have to pay for it.

I was once given stock as a bonus at a startup, making me an owner. Being an owner didn't pay me any sort of dividend, but it massively complicated my income taxes by giving me a K-1 in May (after April 15th). Additionally, I owed tax on my percentage of ownership, which was really a pain. The other gotcha but I wasn't allowed to be an owner unless I worked there. So when I quit, I got cashed out at "fair market value," which was a B.S. number they made up and gave me a couple thousand dollars. I also got diluted by half while I was an "owner." The experience made me very leery of ownership. Now I just look for salary.

You're right, I thought it would be clear from the context that I'm talking about employee stock options.

It seems like your experience with stock kind of proves my point and reveals the employee side of this problem — because you didn't fully understand how all these things work, and no one explained it to you — you had much different expectations.

And now, instead of incentivizing you to stay, you employer leaves you frustrated and basically incentivizes you to leave.

Yeah, I agree, that is a good way to put it. The K-1s were such a mess... I think I got 15-20 pages worth of complex tax documents. It was especially messy since we had a part ownership of another company in a different state. I don't consider myself a financial dunce either (I can handle W-2s and 1099s fine). Employee stock purchase & RSU awards at big companies are honestly so much more straightforward (and fair).

The way I got diluted also made me really take the advice to heart I always hear on HN - when there is a buyout, the executives will be the ones at the table arguing for themselves to get paid. But nobody is going to be there for you.

So is that why companies issue options instead of direct equity because it spares the employees the hassle of dealing with actual ownership issues (K-1s, additional taxes, etc)?

The problem with looking at just salary is that salaries all tend to cap out (in my area, Seattle, you'll be hard pressed to find anything above $160k, when you get to that point compensation really starts to skew in favour of equity - especially as RSUs or Options - sometimes an order of magnitude greater than salary (e.g. "Partner"-level rank at Microsoft is easily $1m/yr in RSUs, but only about $200k/yr in salary.

No, this is not just a problem you're having.

I was an early engineer at Zenefits and found myself holding stock options seminars to explain this stuff to the rest of the engineers.

I built optionvalue.io as a calculator to help people answer some basic questions about what their stock is worth, and I'm building it out more to answer questions (eg, tax implications and exercise windows).

I've talked to grellas and some other folks with a long, long history dealing with this stuff. There seems to be some consensus that:

(1) People now are more educated about stock options than they've ever been.

(2) That's a pretty low bar.

"I was an early engineer at Zenefits and found myself holding stock options seminars to explain this stuff to the rest of the engineers."

This is a tricky position to be in, considering that in this sort of situation, you're generally explaining to people a small subset of the ways that they can get screwed. As much as it might seem nice to see people spending lots of time trying to figure out what their stock options are worth, it's not worth the time or effort. By the time you have it figured out, it's changed. And the future is so unknown. If everything goes great and the company hits all of its targets, stock options will be worth something. If there's a bump in the road, you're toast.

The simplest heuristic to use is to assume the company exits at its latest valuation and do the calculations of what your options would be worth in that case.

Then, understand when your company could (at soonest) go public, given that growth rates will slow down at a rate around what comparable companies exhibit.

Obviously it's still a crapshoot, but this will give you a value for E(x) and timeframe.

> assume the company exits at its latest valuation and do the calculations of what your options would be worth in that case.

Sure, but even in this case, you have no idea what the provisions of that round are, most likely. The investors may have asked for better returns (money-back + participation), there may be lines of credit that have to be paid back first, there may be loans that are paid off the top. My point is that most non-executive employees can't get enough information to make an accurate assumption. It's possible, maybe even likely, that if you exit at your latest valuation, your stock is worth $0 of actual money when on-paper, it was worth something significant.

If cash-out is around latest valuation, weird terms will only change the $ amount by <10% or so.

If cash-out is less than the latest valuation, then it starts mattering. At ~40-50% of latest valuation, common shares can end up effectively worthless, for example Good Technologies.

That's a really nice tool, well thought-out, and the calculations it does are spot on. However, I think it's based on one pretty big assumption: that the shares that investors buy are the same as the shares that you would get through your ISOs. They typically are not the same, with the investors getting preferred shares that are superior to your common shares. Furthermore, terms like liquidation preferences and "participation" can make the preferred shares much much more valuable in many types of liquidity events. So in all, I worry that this tool does more harm than good. Even given all the information you solicit from the user it is still very hard to say what the options/shares are worth. Typical errors in the estimate could be an order of magnitude or more.

That is a pretty big assumption, and I would like to highlight it more.

The reason why it's a reasonable assumption is that in any material outcome, common share preferences converge to preferred share preferences.

Yes, once in a while you have an exit at 0.3x to 0.8x latest round where the investors are made whole and common share holders take an excessive haircut or are wiped out entirely. Good Technologies is an example here.

But looking at VC returns, almost all come from ~5x+ exits: "home runs". In fact, most VCs will block acquisitions at less than 2x latest round valuation except in case of corporate distress.

I agree, there are cases where the values converge. They are, however, a very small percentage all startup outcomes. Most outcomes for venture-backed startups are wind-downs, or small-time acquisitions. In these cases preferred shares are much more valuable. Since what you're trying to do here is assign a current (expected) value to the employee's options, focusing on the "home runs" for the VC is not helpful.

Just checked your option value calculator. I understand you're still building it out but wanted to say nice work so far!

Something like this that's easy and clear could be really useful. Like some of the "estimate tax refund" calculators online, while details of the US tax code can be information overload, going through guided steps on an estimate calculator a person can learn a ton of key info. Cheers and GL.

Thanks! Am building out more stuff & would love to hear your take. My email is in profile, would shoot you an email but don't see your contact info?

When it comes to stock options, HN has taught me two things:

1. They are worthless, as >90% startups fail and you won't be getting anything in that case.

2. If they are not worthless, you might not be able to afford paying for them anyway [1].

Add to that how difficult it is to get a simple, clear answer to the question "how do I invest my money?". So yes, I wouldn't be surprised if most people didn't know how stock options work.

[1] https://news.ycombinator.com/item?id=10811570

I feel like I've matured on this question over the years, so to caveat #1:

90% of options are worth nothing if you count by companies granting, but probably 90% of options are worth something if you count by people receiving grants.

How does that work? Because companies which grow and become worth something hire a metric ton of people and give all of them options. If you're of the opinion that most engineers in San Francisco work for a seed stage startup, you're just straight up not correct. It only seems that way because of availability bias.

Thus the reason for this comment: it's very, very dangerous to get people in our industry thinking "options are ipso-facto worthless" when our industry builds packages for substantially all engineers where they're a material portion of one's compensation. You can find all-cash offers out there, particularly from non-tech employers of engineers, but the standard in our industry is cash plus a substantial equity component, and (as someone in the industry) you really, really need to have a deeper understanding of equity than "all equity is worth zero."

Though the capitalist in me says "If one really thinks that all equity is worth zero, you will find many people willing to take yours off your hands at pennies on the dollar once that becomes feasible for your company."

> you will find many people willing to take yours off your hands at pennies on the dollar once that becomes feasible for your company

If this were true options would be a lot more valuable. But it turns out by the time a company gets to the point where there is any liquidity for their options, that company has probably passed the inflection point where you are past your 90% mark and it is obvious that it is so.

Due to the way option agreements are structured (right of first refusal, exercise time limits, etc) its virtually impossible to sell non-public options for employees who do not wait out a liquidity event (which is another downside to options that companies seem to discount too much).

Even though anecdotally, I have made some money on option grants, I now see them as a symptom of cargo-cult management practices.

A few weeks ago, a co-worker asked me for advice about a new (to us) employee stock purchase plan, and I basically said, "don't shit where you eat."

Messing around with your employer's stock isn't a wonderful idea. Most people should just be blindly investing x% of their income in a robot-managed index fund. Fewer people should also be investing in only those businesses they understand well enough to independently analyze. And if I were in any position to really analyze the financials of my employer, well, now I'm subject to insider trading gotchas.

But as a peon-level employee of a company, I am always in the very first group of people to be lied to whenever anything goes wrong. Everything is fine. Continue working as usual. Don't worry about office shutdowns and massive layoffs. I'd always tend to overvalue my employer's stock (or frantically shotgun resumes to other potential employers).

For the purposes of incentivizing better productivity, the company could be adding cash bonuses to my paycheck. It's very simple, and great for my morale (barring memberships in the Jelly-of-the-Month Club, Sparky). My current company has done it a few times. When you hide the "extra free money" behind a stock-shuffling scheme, it makes me think you're up to something sneaky.

Also, I don't consider it wise to be heavily invested in the company that is my primary source of ordinary income.

Think of it this way: would/could you buy the option/stock on the open market if the company wasn't offering it up in the conference room? I wouldn't. Only if I were already 100% financially secure otherwise would I ever invest in my employer directly. And guess what? 100% financially secure means that I can quit, right now, and not have an employer, freeing me to invest in whatever damned-fool thing I want.

If you're taking financial advice from random people on the Internet, the only place you should be investing is robot-managed index funds, and not doing anything on the side until after you have already maxed out your 401(k) contributions.

So I basically value options as "this company would rather generate massive amounts of additional paperwork and hassle than just give me an equivalent value in cash bonuses."

To play devil's advocate though, you are being provided more information than the external market would be by virtue of being an employee of a company, and also someone working in the industry, etc.

Having more information at your disposal to evaluate a company means that option grant is worth more to you than to a random person on the street, which is why the company will pay you in options. It's better for the company, since they would rather sell equity to you than to a random person, and it's better for you, because you are an informed investor and know more than just from reading balance sheets.

That said, IMO you should basically only work at a startup that you think will be successful. Given that, you should buy as much equity as you can afford to. From a financial perspective, working at a startup then not taking equity is just throwing away a big chunk of informational efficiency. If you just want a cash paycheck, go work at a big company instead.

The only rational reason to work as an employee of a startup is for better job titles, working conditions, and professional development (from tougher challenges). Getting paid in lottery tickets is not sound investment strategy.

You may be a better informed investor if you pick the locks on the filing cabinets in the C-level offices after the bosses go home, and bug all the conference rooms, but it is unlikely that will make you better at estimating the future market value of the company, or at evaluating potential buyout scenarios. In any case, I never thought that spying on my bosses was a good idea. I just heard the lies, saw through the BS, and started sending out resumes. Or I got blindsided and started sending out resumes.

You should only work at a startup that will support the lifestyle you desire. If you were really critical to the company, you would have a contract and genuine equity, rather than being "at will" with a promise of options vesting later. Your primary concern should be "can the company continue to pay me for my work this month?", and your secondary concern "can they pay me next month?", and so on. As an employee, you are a replaceable worker-for-hire.

If you want to win big at the startup game, be a co-founder with undilutable equity. If you want to invest prudently as an employee, you can play the entire market rather than just one small, potentially volatile company, and a bigger cash paycheck makes that easier to do.

Employee option grants just seem like a con to make peon-level employees feel like they have more agency and more emotional connection with their employer than they actually do. The anecdotal success stories of option grants that actually pay off are necessary to keep the game going, just as state lotteries have to blow some money on oversized checks, balloons, and confetti whenever someone wins the jackpot.

The company's money does not come from a vacuum. No matter what amount of profit you get from an option grant, the company could have given it to you in a different, less complicated way. If you exercise 1000 options, and have to sell 500 of the shares to cover the exercise price, the company could have just granted you 500 shares directly, and still had 500 left to give out later. The hand-wavey sort-of-options are 100% there to benefit the company, and its owners, and their tax preparer, not you.

> Getting paid in lottery tickets is _not_ sound investment strategy.

Anecdotally, I know someone personally who was an early employee at multiple startups at all IPO'd. Some of those IPOs happened years after he had already left.

He's now a millionaire many times over because he had the acumen to pick winners, and that's specifically what he was looking for when he made his choice on where to work. This is obviously not general investment advice, because you have to have an eye for picking winners. But he certainly recognized that 1) he had an opportunity to get equity for cheap and 2) he knew more than the general market and took full advantage of that fact. He even diversified by working somewhere until his options vested, then moving on, while not waiting for exit.

My point still holds: if you don't tolerate risk and want to get paid in cash, don't work at a startup.

Your moralizing and demonizing of startup compensation seems misplaced here -- the #1 biggest reason they pay in equity and options is because they are short on cash and long on equity. Founders spend a lot of time trying to raise cash from investors, so turning employees into de facto investors is a cheap and convenient solution.

> ...turning employees into de facto investors is a cheap and convenient solution.

And also unethical, in my opinion. If startups treated their investors like investors, and their employees like employees, they would be able to hire people without needing to look at risk tolerance as a hiring qualification. Perhaps coincidentally, young, single people have a much higher risk tolerance than older people with families. If avoiding the appearance of age discrimination is at all important

They would even fare better if they refrained from treating employee-investors as a lower class of investor, that can be diluted to oblivion while the higher classes of investor still get paid.

Your anecdotal acquaintance sounds like an investor first, who just happened to be able to get hired as an employee. If you job hop while collecting discount equity opportunities, and leave before the success of the company is ultimately determined, how much of that value comes from the work you do, rather than your evaluation of the company and your co-workers? I presume that if the initial evaluation was off, he'd scarper for greener pastures in the middle of the night without waiting for anything to vest?

You can't do that in most of the US. Away from the west coast and the Boston-to-DC corridor, there may only be one or two startups in town that need tech employees, if any. If you're in a college town, there may be few dozen, built around somebody's thesis work. If you don't like the local job scene, you have to move your entire household somewhere else. The startups follow the expectations of the investors, and the investors are looking at the coastal unicorns. I just get sick of all the cargo-culting of SV startup culture, y'know? It only works there because it's there, and I'm not even sure that "works" is the right word to use.

As a counter-argument to this, the employees at Enron were pretty blindsided (for the most part) when their stock was wiped out.

Naked accounting fraud on the level of Enron is exceedingly rare though. But all the other reasons a company can go belly-up (bad product, bad customer base, no roadmap, stopped doing R&D, etc.) are usually much more visible to an employee than an external investor.

I agree with what you are saying about not having too many eggs in a basket. I have seen many variations on ESPP:

1) You can buy the stock at market value on some set date by paycheck deductions (but you avoid that commision!). Worthless, not work doing IMHO.

2) You contribute up to N% of your salary at M% discount on the stock. I would do this and sell immediatley. There was a small risk associated with that of a big market movement, but in my case M was 15%, so that made me feel comfortable. It worked out to some free money.

3) There was a 6-month window. The company took the lower of the prices at the start of the window or end of the window AND applied a discount. That was awesome. A big rise in 6 months led to big gains. If the stock was tanking, you still got the discount. I would still sell immediately.

Last time I checked, the (US) tax rules stated that if you sold ESPP shares or exercised employee options grant shares before a year had elapsed, the gain was to be reported as ordinary income on your W-2 and taxed accordingly. So you might as well send 28% of the sale to the IRS immediately, to avoid trouble later on.

Anecdotally, I once sold some shares/options, so the same gain was reported in my W-2, again on the 1099 from the brokerage, and apparently one more time from my consumer bank when I transferred the funds from the brokerage using a printed check. The IRS said "Screw your return. We're changing it, because you had additional income you didn't report. Pay up, Buttercup." Well, that "additional income" was actually the same pile of cash, photographed at different times from three different angles. It took 10 years and way too many hours of writing FOIA requests and explanatory letters to sort out. The outcome was not what I would ever consider fair, but as I no longer need to fight it any more, I'm content to write off my losses as an educational expense.

Your experience with an ESPP is about 99% likely to be better than mine. But before you take the free peanut butter, take a quick look around for any levers connected to a gigantic spring. Poke it with an 11-foot pole a few times.

It's but one of the several reasons why I mentally model the US government as neckless slab of meat that is 7'6", 400#, and a crack shot with an infantry rifle, yet with the ethics of a 4-year-old toddler. At all times, stay out of its line-of-sight, and if you ever need to interact with it, you'd better bring it candy and flattery.

Don't bash the Employee Stock Purchase Plan without getting more info though. Maximizing that and immediately selling (i.e. I never actually held my company's stock) netted me about $10k over the course of a year. The standard ESPP rules (buy at price today or price 6 months ago whichever is lower at a 15% discount with immediate selling) are even more advantageous than 401k rules but not all are standard.

Easier said than done, but you if there's any likelihood at all of success, you should make damn sure you have cash on hand to exercise.

Otherwise, you are literally losing a winning lottery ticket for want of pocket change.

Then you have limbo... worth a lot on paper but no liquidity events planned.

Some employers don't help either. My wife just received an offer from a pretty well funded company (Series B >$20M) and all they would tell her about the options package was number of shares and vesting schedule. When she asked to how many shares are in the company (to calculate her potential ownership %) she wasn't given an answer. When she asked for a rough estimate of the current value of those shares if vested, they basically just said "trust us, this is a good package." That experience reinforced my belief that you should assume the equity is worth $0 and not factor in the stock grant when evaluating an offer (unless you are at the company super early).

There are 2 things which people are very financially illiterate about these days. Stock Options, and how income taxes work. You've covered the former, with the later I've seen confusion with how progressive tax brackets work, how deductions work, etc. All you can do is to make sure you understand it, and be careful of the advice you get from others.

I was taken aback when I realized just how few people understand the United States progressive tax system and how income tax brackets work. That misunderstanding is so pervasive (in my experience) that I can't even imagine people having a general understanding of how deductions work at all.

There seems to be a general rule of thumb among investors and founders I've talked to that the vast majority of options won't vest or will go unpurchased, and as a result it seems many have tried to keep things as opaque as they can. As a CEO and Founder I find this incredibly troubling and I believe it's contributing to why so few folks value sweat equity anymore. I've written a few thoughts on this before for anyone interested: https://medium.com/busyness-time/part-i-how-were-building-st...

To add to all of this, most people really don't understand the tax implications of options (whether they're ISOs, NSOs, or not options at all but instead are RSUs).

It's hard to explain those without looking at a person's individual situation (the company, the initial value, the current valuation, and the person's tax bracket), which is why there's not a lot of talk about them. But the taxation can very easily be the tipping point between "definitely worth it to exercise" and "definitely not worth it to exercise", so it's really important to understand them.

True. But it's also important to not view taxes as the thing in deciding what to do.

I had options that I could exercise (at a big, publicly-traded company, so I didn't have the startup, no-liquidity issues to worry about). My options were worth quite a bit of money. I had already exercised enough to put me at the edge of the next incremental tax bracket. On about December 15, I was looking at it, and thought it was a really tempting price, but... taxes. I decided to wait for January.

Three days later, our company made an offer on another company. The stock market didn't like it. Our stock went down. I lost more than the taxes would have been.

Moral: When money is growing on trees, pick it.

Disclaimer: That isn't always good advice. If the price had continued to go up, it would have been really bad advice. But too much focus on taxes is also bad advice.

> Moral: When money is growing on trees, pick it.

The problem is that taxes can quite literally cause you to lose money.

For example, exercising options (at a gain) is a taxable event whether or not the options are actually liquid. In fact, if you're an early employee and your startup has been very successful, you could literally be looking at a tax liability of tens or even hundreds of thousands of dollars, even if your strike price is only a couple thousand dollars. (That would be the case if you were a very early employee and the company was very successful - ie, the exact situation we think of as the "upside").

If you leave the company (voluntarily or not), you have 90 days to decide whether or not to exercise those options and pay the taxes immediately, even though you won't get to actually sell the underlying shares until a liquidity event happens. There's no guarantee that the liquidity event will give you the same (or higher) price, and even if those options tank, you don't get your taxes back.

So, if those options subsequently tank to "only" double what they were worth when you joined the company as employee #1, you might think "hey, that's great - I made a 200% return on my equity". Except, you didn't - because the taxable amount was 100 times that - so you're deeply in the red.

(These numbers are all made up, but the orders of magnitude I'm talking about are quite realistic under the parameters I described.)

We give basic details in our offer letters, are open about all the details, have an employee focused scheme (i.e. 10-year exercise window), and when we do the grant paperwork for new employees (we do it in batches because of all the government stuff involved, we're in the UK), we give those employees a talk on how it all works, set expectations, etc.

I think we're fairly good at this, and most people I've spoken to in the company know enough about it to not hit any of the issues above - i.e. their vesting schedule, strike price, exercise window, etc.

Pardon my ignorance, but I did a search on this thread for the word "lawyer" and there was no match.

My stupid question: Doesn't San Francisco have good lawyers who are specialized in this stuff? I mean, a lawyer who's getting paid by you, not by the company.

I'm not advocating complete ignorance of the matter, but there are people who know the ins and outs of this and are aware of most of the missteps through which they can guide you.

My point is that having a lawyer also serves as a deterrent and sends a signal you're not to be hustled. It also tells you about the people you're dealing with: the company not liking it should set off your spidey sense.

I mean, the first thing someone who's hustling would do is to be offended you're taking precautions because it hurt his feelings that you don't "trust him". It's not that you don't trust him.

These things are just like prenups. People's feeling about them stems from the assumption that at the time they're activated, they'd be feeling the same for each other as they are now, which is not true. By the time a prenup is activated, people usually hate each other, and a prenup serves to protect you from the future version of them, and them from the future version of you. The versions that hate each other. There's a reason billionaires have the cheapest divorces, and artists/athletes have the most expensive ones.

Add me to your example list, I knew nothing till recently (now I know a non-zero amount, still close to zero). I was talking to Docker earlier this year, and really appreciated the recruiter spending about 30 minutes (and told me several times to do additional research) just explaining how options work.

On another note, this recruiter at Docker was hands down the best recruiter I've worked with. 45 minute initial phone conversation to explain the product and roadmap before even scheduling the first phone screen.

let me augment this with a real world example of why knowing about stock options is important for those cases where you need to understand why _not_ to exercise.

recently I left a company after 3 years, with a decent chunk of options in my comp. the company is not publicly traded, is still deep in the red, is still trying to raise more rounds of venture capital (thus increasing dilution), and has no exit in sight for the foreseeable future.

My cost to exercise my options at their strike price would have been just over $8000 bucks, and then there would be additional taxes on top of that for whatever the face value of the purchased shares would be. These are illiquid assets, mind you, so the face value would be taxed, but there were no buyers, so it's just an outright loss.

I left those options unexercised. I certainly didn't feel like donating $8000 bucks to my former boss' checking account and then paying extra taxes on it all for the privilege of sitting on illiquid assets for an indeterminate number of years (with a high probability of the stock never being worth anything at all).

Understanding the structure and fees and taxes of the options is very important specifically so you don't go and throw good money after bad in situations like this.

I know it may seem like a long read, but I highly recommend taking the time to look the document over if you have/will have stock options from your company. The part about early exercising covers a calculated risk that can potentially save you thousands if not hundreds of thousands in taxes if your company does well.

In answer to your question, the answer is "Yes, many if not a majority, of tech employees are clueless about stock options." I've thought about the reasons for that, and mostly they are around actual use.

Every startup, and nearly every company, that I've worked at had "the talk" about stock options, they went over ISO, NSO, and RSO. They talk about taxes and gains and tax law. They talk about vesting and cliffs and blackouts and strike prices. They dump a ton of data on your head.

And the problem is they are dumping it onto people who have absolutely no way to connect what they are saying to their own personal existence, and so they forget all of it. It is human nature, a brain defense, what have you that when you are given information that you only barely understand and has no immediate relevance to your situation, you promptly flush it out of your brain.

That all changes once the options are actually worth money and can be exercised and sold.

Once options have value they become relevant and generally a co-worker or someone more clued in will do something like buy a new car "using their options" or even just a new bike or TV. And that will trigger the questions, "Hey I think I have options maybe I should figure out if they are worth money." Sometimes this happens when you are being laid off or fired and you are given 90 days to exercise your options or lose them.

At that time, the information you develop about options will stick in your head because you needed it to accomplish some task, which ideally rewarded you with some extra cash that you didn't know you had access to. Later in the year this action will trigger you learning a lot more about the tax code than you wanted to know :-).

Can anybody share some info on how taking stock options in a US company differs from a UK one? A lot of the reading applies to US market. I'm wondering if any of the advice is not transferrable.

Also, I believe that this is a good read - https://blog.alexmaccaw.com/an-engineers-guide-to-stock-opti...

In the past I worked for a UK company from the UK which was owned by a US parent, where employees in the UK were granted options in the US company under the HMRC Enterprise Management Incentives (EMI) scheme: https://www.gov.uk/tax-employee-share-schemes/enterprise-man... . I think without the scheme if I had exercised an option (whether to hold onto the share or to sell immediately) then I would have owed income tax on the difference between the strike price and the current value i.e. the discount my employer effectively gave me. I think I would have owed the tax even if I was forbidden to sell the stock (e.g. if the company had stayed private). With EMI there was no income tax on exercise and I only owed capital gains tax when I eventually sold the stock.

Probably not as the UKs tax treatment Is much much more employee friendly.

If an approved share save scheme hits big as BT.A did 18 months ago you can make £150k Tax free as one of my friends did.

I think there might be an even bigger problem — many employees don't understand the basics of stock options, hence they don't value equity as much as employers / investors do.

That, and for the fact that their holdings percentage-wise are, in the vast majority of cases, typically negligible. Or even if they might potentially, in theory, be worth something, almost no one has time to investigate the company's business fundamentals to a sufficient degree to determine what chance they actually have of panning out, and hence, whether it's even remotely worth the risk.

Anyway, it's definitely not just you, it's a lot of people. The HN search engine (hn.algolia.com) is really quite good; in addition to the links others will be posting here, try some targeted keyword searches, and to read as many articles as you can on the subject. While they may not be all tailored to your specific situation, gradually the general subject will become less opaque.

I worked at a pre IPO company a few years ago and it was an exception to find people who understood how things worked. Hell, even I missed some details back then, and it was only after I put in hours of research that I developed a decent grasp of the tradeoffs and deadlines. I still don't really know how to do AMT though.

There are a couple of startups that make it a point to early through what their equity means with new hires. But this puts power into the hands of employers since some will be well meaning and some will mislead.

It's unfortunate that we don't have a "yo-yo" knowledge with a easy to remember URL we can point to. Plenty of great articles out there, including by prominent VCs. But it requires a lot of digging.

>It's unfortunate that we don't have a "yo-yo" knowledge with a easy to remember URL we can point to. Plenty of great articles out there, including by prominent VCs. But it requires a lot of digging.

This seems impossible; stock options just aren't simple. There is no way for most employees to get enough information in a reasonable amount of time to make an accurate estimate of their stock options' worth.

Employees probably aren't privy to bank loan terms (e.g. converted to preferred shares in certain conditions, over time). They aren't privy to the preferred share terms (past, current or future). In the case that an employee has to purchase their shares prior to a liquidity event, they have no way to know what the future holds in terms of dilution.

It's an exercise in futility. Even if you make logical guesses, guesses are worth very little. If the economy tanks, and suddenly there's a cash crunch, your best guess may not apply. Even if things go WELL (but not smashingly well), you can get screwed by weird preference issues, dilutions or other shenanigans that weren't public knowledge that kick in.

An option to buy stock puts you last in line for money. If everyone else gets paid (vendors, banks, VCs and founders), you'll get a share of what's left (after a lock-up period). There's no good way to know what that's worth.

I will suggest it is probably not just you and your friends. I am more financially savvy than most people I meet and I really don't know much at all about stock options. I imagine I would try to find out if it were being offered as part of my compensation package, but I think stock options are a fairly sophisticated financial concept and most people will not really understand them.

I say this as someone who worked in insurance, which is a financial services industry subject to federal financial regulations, such as Gramm-Leach-Bliley. So, it is not just my opinion that I know more about finance than average, I also have relevant training. And I only have a vague, hand-wavy idea of what you are talking about.

it wouldn't be that expensive to buy them

I hope you are taking into consideration the capital gains tax when it comes to the difference between strike price and the current fair market value of the stock. If a company is growing fast or takes on money, this can change alot in even a year.

The IRS doesn't care that you may not be able to actually recognize that gain because you cannot actually sell the stock, it's considered a gain nonetheless and you will owe tax on it.

I have been in a situation where the FMV of my stock changed by 10x in the span of a year and by the time I could have actually bought any stock the tax bill would have bankrupted me.

You're talking about AMT, right?

You're right, there are situations when people can't exercise their options simply because of the high tax bill.

In this particular case, with the company I'm talking about I am fairly certain (simply because I'm doing the same calculations for myself) that if he exercised his options it would not trigger AMT.

Only ISO options trigger AMT. NQSO triggers regular income tax on exercise for spread between strike price and FMV.

As far as I'm aware almost option grants are NQSO because ISOs have a bunch of other limitations that make them annoying or untenable depending on the grant size.

This has always been the case. I've been in Silicon Valley for ~20 years, and even back during the dotcom days, most employees didn't know much about stocks, let alone stock options. Given the fact that it's such an important part of Silicon Valley life, you would think that people would educate themselves more, but it hasn't happened in 20+ years. It's just human nature, and some people don't care, or think it's too complicated and ignore it.

One could also see this as a large-scale demonstration that employees, in general, disagree with your assertion that stock is an important value of Silicon Valley life. It's important to founders/CXX types and venture capitalists, sure, but so far as I can see it is rarely useful for everyday workers to pay attention to their stock packages, because they are usually worthless, and opportunities to make a decision that has a meaningful impact on their value are very rare.

This bears posting, it explains actual stock options, not what employees/employers bandy about as "stock options".


I understand the basics of actual stock options, but get confused by employee stock options. What would you say is the difference?

You have 3 significant "problems" with employee stock options:

1) need to exercise them upon leaving: when you leave a company, a company might force you to exercise the stock option within 90 days of leaving (and this takes cold hard cash too!). This gives you stock in the company, BUT:

2) taxes: you have to pay taxes on "fair market value" of this income

3) illiquidity: you can't sell it (now, and potentially ever)

There are multiple blog posts dedicated to this problem, if you want to read more and at least try to understand all the caveats and the gotchas. I am still learning those, so take this advice with a grain of salt.

Can someone point me to a good guide to stock options?

I've been with a large company since graduation, with Restricted Stock Units granted to me, vesting over time as a nice bonus now and then. But in January, I start with a start-up, and I'm going to learn the reality of how stock options work first-hand. I'd like to know how to make sure I do the best I can with them.

I think there is a difference between investing in stocks and receiving equity.

Since investing in stocks is so troublesome, no way to beat the market, why even bother to learn about it? And when it happen, rarely to have the chance to get equity, I think its normal.

On paper I'm worth enough to pay off my mortgage. In reality I'm most likely never going to see a liquidity event for the startup from which I bought options.

The only time stock was worth something tangible for me was when I was a bootstrapped founder.

No more Stock options in large companies, they offer RSU's... meaning you have to work for a startup In order to get Stock options. If you join a startup without knowing about stocks then you should start a landscaping business instead...

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