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An Introduction to Stock & Options for the Tech Entrepreneur or Startup Employee (stanford.edu)
475 points by ekm2 on Nov 18, 2011 | hide | past | favorite | 43 comments

I would also recommend the book Consider Your Options at http://www.fairmark.com/books/consider.htm . It costs <$25 and will take a few hours to read, but can save you from making very expensive mistakes.

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

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

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

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

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

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

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

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

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

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

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

> A company who needs you can't screw you.

When you combine this with the famous Charles de Gaulle quote ("The graveyards are full of indispensable men"), you properly understand the predicament.

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

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

> Is it possible (or realistic) to make an arrangement that in the event of an acquisition or liquidity event that your stock becomes full vested?

Note that the reverse is also possible: A change-of-control which restarts the vesting clock.

A familiar refrain with questions like this one is "negotiate for that."

The best thing you can get out of these kind of books/articles (IMHO) is empowerment to think independently about the terms you need, and to speak intelligently about those terms in a negotiation.

Don't buy one just to hear about what everyone else has or has not successfully negotiated in the past. That's interesting and relevant, but it's peripheral.

Get the deal you feel you need, or walk. At worst, they'll remember the kid who wasn't a sucker, and you'll respect yourself in the morning.

Update: Do as I say, not as I do. :)

Yes. This is dependent on the terms of the exit but is fairly common.

To be eligible for acceleration depends in most cases on your position in the company. If you are higher management or of critical importance for the company because of your talents, you probably have more chances to get accelerated vesting on your stock options.

Yes, this is called acceleration.

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

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

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

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

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

Great article!

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

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

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

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

I too would like to see a 'bad options contract' or at least highlights of what would make one.

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

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

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

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

The author gives his email address at the end.

there is contact information at the bottom of the document.

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

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

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

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

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

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

Is it when the vesting schedule says you vest?

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

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

Does anybody know of something similar for the UK?

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

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

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

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

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

I agree, esp one with financial background.

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

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

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

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

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

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

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

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

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

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

The current era has the lowest interest rates of several generations. It is well worth considering.

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

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

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

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

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

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

very useful thanks!

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