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Ask HN: My startup has concealed from me that it raised funding. What to do?
193 points by mendacium on Mar 6, 2015 | hide | past | favorite | 107 comments
I'm a founding engineer at a startup and just found out that the founders have concealed an investment from me leaving me with a potential tax bill on $10,000s of income that I had not received.

I did my best to keep my story within 2000 words but I couldn't shorten it anymore without leaving off important details so I posted the full text here: http://pastebin.com/xLLNUF0H

I feel so disgusted and cheated right now. I had worked for this company for almost 3 years doing everything possible to maximize its chance of success: from working overtime to meet deadlines to answering support emails on weekends, and now I find out that they've kept this investment (and the tax implications that go along with it) hidden from me for over a year. I'm left thinking that they concealed it so they wouldn't have to give me a raise, but I am more concerned about the tax implications of these shares. I had to leave work early yesterday when I found out about this and I don't think I'll be able to come in to work today. What should I do? Should I confront the founders about this? Is there any use in contacting a lawyer?

Well despite the fact that this is very stressful, I would start with the maxim that one should employ Hanlon's Razor[0] and not ascribe to malice what can adequately be explained by stupidity.

It's quite possible, nee probable, that they are just disorganized and genuinely thought you already knew, or that it didn't matter, or otherwise were clueless or inexperienced enough to not really understand what had happened.

I think it would be a mistake to get into it with them on a war footing. Early stage companies like this make mistakes of this kind all the time, and it's not necessarily a sign that the whole ship is doomed. If they have the ability to get revenue and investment and pay salaries and whatnot it's possible that there's a positive outcome in the future.

I would schedule an initial consultation with a lawyer who deals with these kinds of things. Get a referral and schedule an hour or so to go over it with them. They'll probably charge you a few hundred bucks, or even waive it if you have a close friend or existing client of theirs refer you.

Sit down with a lawyer, bring the docs, and explain what happened and get some sense of the implications. Then approach the founders with the attitude that it must be an administrative mistake or misunderstanding. If they are evasive or otherwise shady that should become clear quickly. If they are genuinely concerned and want to help fix the problem then great. But personally I wouldn't blow up your relationship with everyone until you have a better idea which of those two scenarios is more descriptive.

[0] http://en.wikipedia.org/wiki/Hanlon's_razor

OP should consider this a good lesson (and one that I learned going through an acquisition); unless you're a founder, you cannot control "the deal".

Unless you're in the room when the chips are (re)divvied up, you have to trust someone else to advocate for you. And after tolling away for a few years, trading your life for the promise of a better future through being acquired, ultimately you end up in a shitty position.

Don't be diluted in thinking the founders will "take care of everyone".

Your only leverage in the end is to walk away (and try and blow up the deal or company, if you're that critical). And if you do walk and they don't stop you and counter offer, you probably weren't going to get anything anyway.

> Don't be diluted in thinking the founders will "take care of everyone".

The normal phrase is "...deluded in thinking...", but in this case, "diluted" is probably appropriate.

I am amused.

Staying on topic...

If you've got any significant stake in the company, you do have an interest in any deals being made. Sometimes it is the case that the current shares will be diluted so that the new investment can be accepted. It depends on how much was reserved at the start.

So you may have been holding stock that was worth 5% of the company, but after the investment it could now be less. It really depends on how the deal was structured (how much for how much basically).

You may not (as a non-founder) have a say in the terms of the deal, but you need to be kept informed.

I've seen cases where the founders will dilute themselves, but not the smaller holders, to try to be fair to them, but that doesn't always happen.

Maybe its time to read up on your corporations by-laws, which may spell out how and when they have to notify you of these sorts of changes.

> and try and blow up the deal or company

Never do that. Not only does it create bad blood, which could only be bad for you in the long run, it may also leave you open to a lawsuit.

The business world is often about shoveling shit. People who always get their revenge tend to have no friends and lots of burned bridges.

>Not only does it create bad blood, which could only be bad for you in the long run, it may also leave you open to a lawsuit.

Don't buy this fud. There's nothing illegal about walking away from a shitty deal. Whatever your motives just plainly state "this deal no longer makes sense for me".

If you're a great engineer, then have some self respect, and walk away from a shitty deal. Go somewhere else where they respect the people that build value.

And if you aren't a great engineer, you weren't going to get anything anyways, so go somewhere that will raise your game and better positions you for the future.

>People who always get their revenge tend to have no friends and lots of burned bridges

There's a big difference between being bitter on a daily basis vs coming to terms with your past three years that are basically only going to net you an extra 100K (which you could easily get hustling in a few months consulting in SV).

Think deliberately about what you're toiling away for. An extra 20K? An extra 100K? REALLY? All the extra weekends for years is worth that? Get mad at yourself. Demand more. And if they deny you, walk, and position yourself better next time.

Walking away from a deal is one thing - deliberate harm is something else.

At one point I was at a company that had built a web product for another company. The external party decided they weren't going to pay their bill, and at the time we'd been covering the cost of hosting several of their servers for months. Obviously our first reaction was that we'd just turn them off but our lawyers told us in no uncertain terms that we couldn't. It would be obstruction of business and we would definitely be found to be in the wrong. (This was in the uk)

I'm curious how that story played out.

Was the external party eventually forced to pay the bill for hosting their service during the time it was being disputed since you couldn't just turn it off?

Good question!

They tricked us into signing up to some sort of gentleman's agreement where they folded the company and re-launched as a charity (or something weird like that). Basically, they said, if you chase us for the money, you'll take us down, then you won't get any money. If you let us do this our way you'll get your money if it all works out. So they fairly well held us to ransom.

I don't recall how it all worked out in the end but we definitely got some (all?) of the money - I recall my boss telling me we'd received a payment a good year or two later!

I was pretty amazed at how few rights and options we had in the situation. We had the lawyers talking us through our options at every step and they said there wasn't a lot else we could do.

That was one of a catalogue of mischievous plays I witnessed there. We were a company that were very honest and ethically sound so it was always sort of shocking to see others acting dishonestly.

The whole situation ended up being somewhat overshadowed by the accountant nicking £50k from the company savings!

I've definitely learnt to make sure you're covered as much as possible in business. Always get everything in writing and be aware that sometimes people don't act in good faith. At my current startup, my co-founder and I have a fairly all guns blazing approach to people not paying their invoices on time (we start chasing before it's even late).

First, I was against doing intentional harm. I absolutely think s/he should walk away, but making enemies doesn't solve any problems and certainly could create some.

Second, you seem not to understand the difference between "breaking the law" and "getting sued". Intentionally screwing over a company can be both legal and lead to a lawsuit that you end up losing.

1) You are critical to the company's success yet..

2) They don't want to compensate you to your liking..

3) So you walk. Yes, this is meant to intentionally hurt the company with the only lever that you have (your skill set and institutional knowledge).

You working for this company costs you opportunities elsewhere.

You're convincing yourself to stay because it "doesn't solve any problems and certainly could create some." Your vague fears are holding you back.

But if we get rid of these vague fears, here's what we know is certain:

1) You're critical to the success of the company.

2) But you're not going to be compensated to your liking

3) And you're costing yourself other opportunities by sticking around.

Quit being scared, look them straight in the eye, and say "I am walking unless I get X,Y,Z." If they say no, then kindly resign and don't look back. Bring on the lawsuit (highly doubtful).

There is no way you're going to end up getting sued for leaving, intentionally or not, regardless of your intentions if employment is at-will (and most likely it is).

> People who always get their revenge tend to have no friends and lots of burned bridges.

Walking away from a bad deal isn't about getting revenge, it's about looking out for yourself (because no one else is).

yes, it's expected that you'll never do or say anything bad about past jobs(/companies/environments/people). But other side of this status quo is enabling all the assholes to be assholes and just helping them to continue behaving/acting like they do.

that's a bit offtopic though.

This type of withholding of information prevents others from making informed choices.

"Don't burn your bridges" implies that these are bridges worth preserving--sometimes they aren't, and you're doing others a favor by letting them know.

aantix: "Don't buy this fud"

I think that smt88 was referring to trying to blow up the company, which I agree is bad juju.

That doesn't mean OP shouldn't walk (as fast as possible) out of there if he or she isn't taken care of.

>blow up the company

I meant this in the context of you're a critical engineer, and by leaving, you leave the company handicapped. You're critical to their success, but yet you don't feel like they're looking out for you. Walk.

Is there even a reason the co-founders would do this with malicious intent? Is there possibly any financial gain they could realize out of not telling the other co-founder? Could it be an attempt to make him leave (he only owns 3%) before fully vested?

I very much agree with you, likely not malicious.

"quite possible, nee probable, that"


"...quite possible, nay, probable, that"

I always thought it was the latter. Are these the same? i don't think so, but i'm not great with language rules.

No, "nee" is a French import meaning "born" used to introduce someone's birth name when it differs from their current name (and, sometimes, by analogy, to introduce the original name of a product, etc., when it differs from the current name.)

"nay" was the word that was almost certainly intended in GP.

So if it went down exactly as you said, you can relax, you don't have to worry about any extra bills to pay.

Two things that are important here are that the "official" valuation of the stock is what company counsel said it was, and if they had changed the valuation of the stock, unless there is only 'preferred' stock (unlikely) your common (likely) stock hasn't changed value at all.

When you did the last stock exercise if the CEO mislead you on the price it is their problem not yours.

Finally, and this is really really important, when you are not publicly traded the stock can be worth anything you say it is worth. The 409a process is one which allows the company to have a way of valuing the common stock but it doesn't come into play, generally until you have enough investors to make the calculation significant.

There is so much misinformation in this thread.

I would consider that perhaps your facts are wrong. Perhaps the first investor did a convertible note. Perhaps he did a loan.

First thing I would do is calmly talk to the CEO directly and tell him what the CFO told you and why it makes you concerned.

There's no reason to be disgusted (yet) from reading your pastebin.

And even if it's true, then you simply need to ask the company to cover your tax burden and then move forward with getting back to work.

This is not that big of a deal.

You shouldn't be in bad shape tax-wise. I don't know Canadian tax law - but in the US, you only get taxed when you sell the shares. Capital gains would not be recognized if you exercised the options and held onto the shares.

Since you have been exercising your options - you are a shareholder in the company (or a member depending on the structure) and I would imagine that the company's operating agreement would require them to disclose any funding rounds to you. I'd get a hold of that if you can.

It sounds like you're working with amateurs, so I'd pass it by a lawyer to determine the real impact on you - but I wouldn't flip out until you get the entire picture. They may be planning on diluting the hell out of you or they may just not know what the hell they're doing.

I'd say it's too early to tell.

> Capital gains would not be recognized if you exercised the options and held onto the shares.

That's not exactly accurate in the US. You need to pay income tax - not capital gains - on the spread between the strike price and the fair market value. Since the company is not publicly traded, the fair market value needs to be assessed. The IRS has rules on how to do this, but many companies use independent third party auditors to do this, though an early stage company probably would not do this.

Once an investment has been made, a fair market value has been established, and you need to report the difference between the strike price and the investment price as income when you exercise options. Capital gains applies when you later sell the stock for a gain.

Edit: Though I should point out, this is only for non-qualified stock options. If the options are tied to performance metrics, for instance, this may not apply.

Edit 2: See here for a discussion of this: http://www.investopedia.com/articles/optioninvestor/07/esoab...

he can't pay income tax if he's never received the income.

"I will be left with a tax bill on $10,000s of additional "income" that I never received"

Actually, and unfortunately, in the US, that's how it works.

His paper gains are taxed. It's not quite "income" but it's taxed that way.

That actually depends on if the options were ISO's (where you'd only have to account for the spread in AMT calculations) or non-Quals where yes you'd have to pay regular tax on the spread at exercise time.

If he's really a founding engineer though he should have filed an IRS 83B election and basically paid close to zero tax on all this


You are correct in that capital gains are only triggered at the time of sale. But that has little to do with the OP's problem which is the taxable benefit he gets when buying the shares.

As an employee, if I buy shares of a company at a discount then that discount is taxable income -- not capital gains. Buying the shares as they vest is a way to minimize this tax. The adjusted cost base of the stock is changed to become the fair market value (on which the tax has already been paid) so that when they're eventually sold, the difference between ACB and sale price is a capital gain which only pays half the tax.

In his case he could end up paying taxes at full marginal rate on an inflated amount, and if the company goes under, gets a capital loss that a) doesn't offset the taxes paid earlier and b) is not usable until he gets capital gains elsewhere.

The CRA lets you carry the taxable benefit forward until you sell the stocks. I'd suggest talking to an accountant, not a lawyer. Also see http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/...

This is correct for Canada too - Please seek advice of a tax professional and not on the internet however:

In a private corporation where an employee is issued stock options, a taxable benefit exists ONLY when you sell the shares for a profit. Unless this is a public company or a non-Canadian controlled company, you will not face a tax liability. Just make sure both owners and any majority investor is a Canadian resident.

Now - there is another question - when you were given the options, were they in the money at the time. This is to say, were the options priced below the FMV at the time of the option being given to you? If they were not, or there was likely no way to tell at that time (they were worthless, and were priced accordingly which it appears), then you will be eligible for an additional tax credit on the gain (it is approximately 50% of the capital gain, it is substantial). Please do your own research in this regard. Also keep in mind selling shares of a QSBC (Qualified small business corporation) means you get up to $800K in TAX FREE gains, once in your life. This is called the life time capital gains exemption. Please do your research here. You likely will pay no tax at all on the capital gain.

> In a private corporation where an employee is issued stock options, a taxable benefit exists ONLY when you sell the shares for a profit.

I really don't think so. There are many cases in Canada of people getting screwed by buying and selling at the wrong time.

If you buy options and immediately sell them, you have the cash to pay the taxes.

If you buy and hold, you are likely to have tax owing. i.e. buy a share at $0.01, where it's FMV is $1.00. You have $9.99 of either capital gains or income, and you have to pay taxes on that.

If the shares later go to $0.00 in value, well, you might have a non-refundable tax credit. But that doesn't matter when you've paid taxes on value which is valueless.

I don't agree. If the shares dropped to nil, you would be able to claim an ABIL (allowable business investment loss) for 100% of the drop in share price.

For example: 1) Your share is worth 0.0001. 2) The company goes bankrupt/insolvent/no longer carries on business 3) You include $10-0.0001 * 50% in your income as employment income for the benefit you recieved from options. The tax base of the shares is now $10. 4) You claim a business investment loss of $10 per share. This can be deducted against all income. This in effect negatives 2x the tax you would have had to pay.

Please keep in mind this does not apply to public companies or large non-small business companies. Only to this example he has proposed. Again i suggest approaching a tax accountant.

+1 for talking to a Canadian tax lawyer. Also, you may want to ping company counsel about why he or she advised you the FMV was so low given that there was at least one investor. Maybe there's a really simple explanation that we're not aware of. The first investor may have invested using convertible debt rather than actual shares or options. Some founders (falsely, I think, but it's debatable) believe debt has no impact on the FMV of the company.

> in the US, you only get taxed when you sell the shares

That's not quite correct with regards to US tax law at least. You can get taxed on the spread between the price you pay and the "fair market value" of the shares received.

It's quite possible to get nailed with an insane tax bill in situations like this. You can end up in a situation where a company raises money at high valuations, and that spread is high, generating a tax bill of hundreds of thousands of dollars on a supposed million dollar spread, and then the company implodes and the shares are worthless, but that tax bill is still there -- leading to a horror story of being taxed on a percentage of the millions of dollars you supposedly got but never realized a dime from. This has happened to real people and is "a very bad thing" to say the least.

> leading to a horror story of being taxed on a percentage of the millions of dollars you supposedly got but never realized a dime from.

If the shares a complete loss and liquidated that way, you also have a capital loss for the millions of dollars which can be applied against income for tax purposes; this may end up somewhat less than offsetting the tax bill depending on your other income because of tax rates; you do end up paying (for employer-provided options) the payroll tax for the spread in any case, but then, the main part of that is limited by the annual cap on SS taxes, so for most of anything in the millions, you'll only be paying, on the payroll tax side, the Medicare portion.

But, in any case, that risk (plus the long term capital gains benefit) is why, if you have confidence in the company, you exercise options as early as possible; you only delay exercise if your confidence in other uses of the money vs. the company's stock is such that the risk that you'll exercise at a point where the tax burden is higher is a cost worth paying for the other use of the money.

(Note also that if you get equity directly instead of in the form of options, you pay taxes -- payroll and income -- on the fair market value at the time you get the equity, too; which is equivalent to an option with a $0 strike price. So, its not like options that you choose whether and when to exercise are any worse in that respect.)

In the US, at least, the problem is that you realize the gain in a single tax year, but there's a limit on capital loss writeoffs so you have to spread that over a multi-year rollover. It doesn't balance.

Also, we have AMT (alternative minimum tax) which gets triggered by this kind of scenario--exercise and hold--and really ends up screwing you due to outdated but not updated calculations that assume anyone making over 150k or so is "rich".

> If the shares a complete loss and liquidated that way, you also have a capital loss for the millions of dollars which can be applied against income for tax purposes; this may end up somewhat less than offsetting the tax bill depending on your other income because of tax rates; you do end up paying (for employer-provided options) the payroll tax for the spread in any case, but then, the main part of that is limited by the annual cap on SS taxes, so for most of anything in the millions, you'll only be paying, on the payroll tax side, the Medicare portion.

This depends on the tax jurisdiction; as the OP indicated, in Canada capital losses cannot be deducted against ordinary income, which the difference of (FMV - strike) would be assessed as. (I believe in the US, up to $3,000 of losses can be deducted against ordinary income)

You can't necessarily offset the tax bill from the gains with the tax savings from the loss. That's the horrible "gotcha" scenario that makes everyone worry, and is in fact a real risk in these scenarios.

I looked around to find a overview of how this works with some case study examples, and this is the best I could come up with in 5 minutes of googling: https://www.sharespost.com/docs/the_stock_option_tax_dilemma...

I'm not sure your statement about "capital loss" is correct. I know people who have gotten burned by this. They still ended up writing a big tax check at the end of the year despite having worthless shares. The tax code is definitely not fair.

EDIT: other people have pointed out that capital loss is capped, which makes sense. So while it may be true that you can claim capital loss, my understanding has been that it never compensates for the tax you're already liable for when you exercised.

"but in the US, you only get taxed when you sell the shares. Capital gains would not be recognized if you exercised the options and held onto the shares."

In the US this is a completely false statement.

As the FMV increases of your exercised options, you are responsible for paying taxes at the /time of exercise/ between the strike price and the FMV of that stock.

Once you pay those taxes, you do not need to continue to pay taxes as the FMV increases. The reason you pay at exercise is because you are exercising options that are already "in the money" even though you obviously have not yet realized that actual gain since you didn't sell the stock.

Sucks, but it's the way it is.

Thats only true for non-qualified options.

ISO's were specifically designed to get around this issue (but you may still get hit w/AMT on the spread)

At least in the US, AMT can apply even when capital gains taxes don't. The exact conditions are very complicated.

In the .bomb era, some people exercised their options and kept their shares. When April 15th rolled, around they had a massive tax bill and now-worthless stock -- because the discount is treated as income but capital losses are limited to $3,000 a year.

Yep, this is the right answer: don't panic, lawyer up.

Yes, you have been cheated quite seriously. Consult a lawyer immediately, especially since the (Canadian) tax filing deadline is soon. Do not press the issue with the founders until you've received thorough legal counsel.

Another problem, however, is that even if you do confront them and get to claim what's rightfully yours, you're probably going to be asked to leave the company. It's worth noting this as you plan ahead.

Anyway, I'm very sorry to hear this. That's disastrous.

> going to be asked to leave the company

I think this is moot. Such a disaster would indicate bad shit is happening. Lawyer up asap.

Don't create any problems, specifically don't:

1. Stop going in to work (at least without a good reason such as health). 2. Confront anyone, at all. 3. Degrade your work (in as much as you can help yourself). 4. Talk about it, even here or elsewhere.

All of these things will likely be brought up if this goes to court. Don't damage your image.

Recognize you cannot trust your employer, so no point in confronting them or asking anything. Try to be all smiles and don't give anything away. You don't want them to start digging for information on their side.

Get a lawyer. I hope you can afford that. It will be hard to find one but persist.

Write down all details you can remember right away with dates and times, including overtime hours, special projects, extras you performed, reviews of your work and performance, comments that may matter, copies of your email, etc.

Good luck sir... Apologies this happened.

First: this situation sucks. :(

Second: Yes, consult a tax attorney. Your own attorney, not theirs. Don't talk to the founders. You need to know where you're at first. Legal500 could be a decent starting point: http://www.legal500.com/c/canada/tax.

It could very well be that they disregarded some security rule (i.e. notification of a capital increase or something like that) and can now be sued for your situation (in the event it's too late to fix things).

One thing to consider if you get a capital gains tax loss is that you usually can offset it against other gains. Do you know if you can carry that loss forward in Canada, or do you need to use it in the same year?

Given an S&P fund tends to return around 7% (averaged) per annum, you can actually use it over several years if you can carry forward the loss indefinitely.

Third: Time to look for a new job.

> Do you know if you can carry that loss forward in Canada, or do you need to use it in the same year?

"You can use a net capital loss to reduce your taxable capital gain in any of the three preceding years or in any future year."


There are legitimate reasons to exercise early, if you think the business will be sucessful.

1. You avoid the tax issues the OP faced if you exercise at a lower valuation.

2. It's also more tax efficient if you plan to hold the shares or wait a few years to sell.

It sounds like your bosses are ethically challenged. With 3%, you are an employee and not a cofounder.

Instead of suing them, consider writing it off as a loss and learning experience and move on. As a minority shareholder, they can dilute you out of your shares and you would have no recourse.

I can't imagine writing this off. He's been seriously wronged, to the tune of quite a lot of money. The raise alone (promised in writing, never delivered) is probably substantial, considering it's been about a year since it should have happened. The tax issue seems less clear, but I have a hard time imagining you wouldn't be liable if you hid important investment details from a shareholder and therefore caused him a huge tax liability.

In any case, it certainly seems worth talking to a lawyer to see if there's a case, and if there is a case it's absolutely worth pursuing. If you let people get away with this behavior, you just encourage more of it.

It doesn't really pay to win $50k in a lawsuit paying $30k on legal fees, plus the years it takes for the legal system to run its course.

A lawsuit is a lot of stress.

There's no guarantee he'd win.

The corporation can be bankrupt when/if he wins.

You can't keep working there after you sue them or your lawyer sends them a threat letter.

There's no point continuing to work with dishonest people. Given their dishonesty, the shares are probably worthless.

The impression I'm getting is that he's going to have to pay taxes on the difference between the strike price of $0.0001/share and the investment price that's now established, to the tune of paying $10,000s of dollars for what are likely worthless shares if/when he stops working for them.

If that is correct, at this point nobody wins. At best from his viewpoint, the company covers his tax bill (or I suppose establishes a new investment price a lot lower through bankruptcy or whatever). Much more likely is that he's going to have to weigh whether suing them and the likely payoff of that will be higher than the tax bill; hmmm, he'd better get a reading on whether he can pierce the corporate veil and go after them directly. Heck, he also needs to see if he can arrange a payment plan with the tax authorities, as others have mentioned; that bill will be due very soon, whatever the final outcome of a lawsuit is.

They're indeed snakes, the shares are indeed almost certainly worthless, but not for the purposes of his 2014 personal tax year :(. ADDED: unless, as others have pointed out, the investment was structured as debt instead of equity.

Yet another example why non-founder options/stock is frequently a negative.

You may be right, but he may also have an easy case. The point is, talk to a lawyer before deciding what to do. It could be that there is no case and pursuing this would be completely pointless. It could be that this is a complete slam-dunk for both damages and legal fees and it's completely worth doing. Or it could be somewhere in between, but he needs to know where he stands before deciding.

He needs an accountant more than a lawyer.

You can usually negotiate a payment plan. Plus, he gets a credit when he sells or writes off the shares,

All important points. If he is financially strapped by a five-figure tax liability (presumably that's the income he'd be taxed on, meaning the actual bill is less than half, possibly quite a bit less), there is no way he can afford to take these two folks to court. Even if it's a large tax bill ($10-20-30k+) it's doubtful he can afford a lawsuit on top of that. If the Canadian revenue system is anything like the US's IRS, I sincerely doubt they're going to let him wait to pay that for the year or two (or more) it would take for this to resolve itself in the judicial system.

Even if he can afford everything, it still may not be worth it, even if his goal is just to prove a point/stick it to the dishonest cofounders.

So you've been exercising options and therefore own stock - don't companies have a legal requirement to inform existing stockholders when an investment happens?

You should talk to a CPA [edit: sorry, Canada - CGA], not an attorney, first.

You are upset about something that might not be an issue. You haven't mentioned what type of stock options you have (in the US there are ISO and NQSO, and - upon a quick check - it appears there are different types in Canada as well, with differing tax treatment). Omitting that detail in addition to the ... unusual way in which you exercised them makes me think you may have more of an academic familiarity with the process.

It would have been nice if the founders told you about the investment, but your reaction is completely out of proportion with what happened. Lawyering up [edit: distinct from a consultation] will be the equivalent of ending your career track with them and burning your bridges entirely.

And really, if the market value of your options has increased, consider the positive side of that news if you own 3%.


First time I read this topic. I didn't read the pastebin, just the comment and was wondering how someone was a founder and not be included in the valuations/investment side of things, or at least informed.

Then I read the link. How is this consider a 'founding engineer'? Are people looking so much to be founders that they call themselves that even they are obviously employees (first one but still employee). He got a salary and generous (aha) stock options, that doesn't make him a founder one bit. Heck, I was offered equivalent equity at a start up just to serve as technical director and shape up their initial development team, so how in god's name is 3% something a 'founder' has?

Wow. I know nothing about investment, VC's, convertible notes, etc...but the one thing I DO know is that if you're THIS hesitant to talk to your co-founders about company issues, your partnership is in trouble. Communication is key and asking HN about it is not going to help. Why even consider lawyering up when you're going on rumors and hearsay and haven't even given them the chance to explain?

"Co-founders???" "Partnership???"

If there's one thing this event makes clear, he's hired help.

The best approach is to go directly to the founders and ask them to help you. Literaly use those words. Such an approach makes them stake their integrity and avoid hostility. Ask them for assistance. Best way to resolve a conflict. Keep calm, talk with the people involved and voice your concerns directly. Be cool, don't act frantic. Ask every possible question, and tell them how it made you feel, do not keep you thoughts hidden, level with them. The most important - be patient and cool. Find out everything you can. It will become clear quickly, either you're being screwed or there's been a mistake. Then you can choose a course of action. Even if you're being screwed, act cool be patient and firm. Deal with it professionally.

I'm hung up on the fact that you are exercising your options. Why? If the options are set to expire that quickly then something else is amiss as well. Generally you exercise options only when you intend to sell or leave the company and would lose those options. From what you described, you gave no reason for exercising the options.

I'd speak with the founders and enquire why they never executed the agreement, that is the raise that was conditional on getting funded. From a contract point of you, you should be eligible to receive that money.

From a trust point of view you can no longer trust these individuals. Without trust in a small organization I don't see the point in sticking around.

He was exercising options because it is very cheap and he thought it had no tax impact. This also starts the clock on long term capital gains rules. It makes sense for early stage companies.

You might be thinking of this for more established companies where the exercise might require tens or hundreds of thousands of dollars. That's a very different situation.

Your assumption is incorrect regarding the reasons for exercising options. Early exercise of options often garners positive tax benefits for the optionee.

That's a good point. What I left unstated, and what I was wondering was if this individual was given guidance by the founders to exercise his options. Thereby effectively reducing his salary further, when he already stated that his salary was an issue of contention. Something I'd be guarded about.

However, you are right, if this company succeeds, he saves some money on taxes by owning stock early.

I believe this is different in Canada. i.e. The "clock" starts when the options are granted and not when the options are exercised.

My guess is he's young or this is one of his first early stage startups.

The amount of people I know that were employee #1-3 and exercised all there options cause they were cheap and then found out about capital gains they owed I can count on 3 hands if I had them.

I can give you a good recommendation for a lawyer that I've used in the past. I don't want to post his name here, since the primary reason I like him is that he doesn't over-bill or charge too much, but his work is pretty good. The way he does this is by refusing to meet in person or other time wasters like random coffees. Other lawyers are better for networking, but if you just need startup related paperwork done email me (even anonymously) and I'll do an introduction.

He works out of Toronto.

This is my personal experience. So take it as a sample of one.

A CTO, a decade younger to me, sought my advice on a similar situation - Founder-CEO divvied up equity in new and unfair ways without telling the CTO. The CTO wanted to raise hell, and take his loyal team members with him and basically handicap the company.

I advised him against doing this.

My view is - Even an unfair portion can mean real (but reduced) value, only if the company succeeds. And to that end, a rational angle will be to not act in a way, that damages value.

I told him to let his displeasure be known and leave but with his calm intact. And whatever, he had to do, meditate, jog, or whatever, to bring a calm mind to the table, he should do it.

He resigned, told the team that he built, that his initial pitch about the company doing interesting things are still true (which he truly believed), but he was leaving.

Fast forward a year and half, the company got sold for two-digits (Million USD), and he got a handsome payout, and the founders apologized.

He still wonders if the outcome would have been the same if he had acted in a way that damages the company.

Your first responsibility is to your peace and calm. Abstract yourself out of the deal, a business deal at that. Not worth your angst.

You are now faced with a number of decisions, namely: financial, emotional, moral and a business decision in general.

On the financial front, the decision is easy to remedy, if the other founders are willing. Ideal scenario is (a) Your 3% equity is fully-vested (b) 3% equity cannot be further diluted (c) you get retrospective compensation and (d) You get another good raise.

Morally, you have been wronged. It is tempting to take the high ground and take full offensive on principal alone (fight) or cut all ties (flight). But a moral victory won't last long when you need to find a new job, when you realise your stake is gone or if the company gets a big exit 2 years down.

Emotionally, you have every right to be upset and you'll need to find a way to deal with it. My own two cents is, "don't be a wuss" or anywhere near that frame of mind--you'll come out stronger and smarter, whatever happens.

In terms of making a value-judgement business decision, your best outcome is that things get reconciled and you put this all behind yourselves, they apologise, you build a rapport with them and have discussions on how this can be avoided in the future. You may need to highlight to them all that you have given to this company and you are willing to reconcile if they are. You should probably not go in to work for 3-4 days (I am presuming they know you are upset and why) and wait for them to contact you during this time. If they contact you and are showing any signed of reconciliation your conversation should be about (a) how they can make things right financially (all 4 points above) and (b) how to avoid this in the future so that the company can have a strong moral standing. During this time, you should prepare for the worst and talk to a lawyer with the correct expertise.

Given the amount of money involved, the potential damage to your career, and the possibility that you will have deadlines related to tax returns/payments coming up after which you might not be able to fix some of this, I would suggest you do the following, concurrently:

1. Find an accountant.

2. Find a lawyer.

3. Keep written notes of everything, including copies of any relevant electronic communications and details of anything significant that was said to you verbally or on a call, by whom, and when.

4. Possibly start recording any future calls, but check the legality of doing so in your jurisdiction and any notice requirements first. (Don't ask the Internet, ask your lawyer.)

5. Don't talk to anyone at work about what you're doing until you've received proper professional advice.

Make sure the accountant and lawyer are yours, not the company's. Their advisors will have a conflict of interest and can't/shouldn't advise you personally as well. In any case, there is a possibility that the company lawyers and/or accountants have committed serious breaches of professional ethics and/or crimes here.

Make sure all your records are completely under your control, so if they kick you out of their electronic systems and the building at a moment's notice you still have all your evidence.

And from a practical point of view, don't assume malice or that this will end badly, because it may well just have been a naive but innocent screw-up, but do assume that whatever happens you might need another job by the end of this process and plan accordingly just in case.

And obviously don't post any more details publicly.

When in doubt, it is best to ask an Attorney. It was a good idea to ask the company lawyer but you cannot always take their word as their job is to tell you what they want you to hear in the best interest of the company. The information might have been withheld from you as you were not a C-Level executive or similar or higher in the company.

When joining a company if you are a founder always insure the titles are correct as they do make a difference even if you are a founder. If you are not a C-Level executive, apart of the board or an investor the groups under them will always be the last to find out what is going on. If your in the C-Club you are always in the mailing group list for all the important meetings and are expected/invited to all of them. To be honest though, it appears you were left out because you were not family and they probably just considered you as just an engineer that they gave some stock too and not really privileged to the company inner workings or financial activities.

Looks like there is plenty of good what-to-do advice already, so I'll just give some how-to-do advice:

Use the Teddy Roosevelt tactic of speak softly but carry a big stick (you already have one, since you're the engineer and the product is on your shoulders). As in, hint to them that you have sought legal counsel and that, if worse comes to worse, you wouldn't mind sudo rm -rf the entire code base. Be sure to be in the passive tone and say things like, "I had no choice but to be forced to seek advice from counsel", "this project means more to me than my life, and it saddens me greatly to see you guys do this to me", "please don't force me to take all time and effort I've put into this and go away forever", "I want to be working on fixing this and building a future, than crying at home and writing bitter memoirs", etc.

In general when speaking to them, highlight the fact you're the victim and (in the words of 4chan) the betafag. This is because you people are already in a highly emotional confrontation, and if everyone gets their backs up, chances are everyone except the lawyers will lose money (also, lawyers don't do anything except charge and tell you to settle, so you can't depend on them). The point is to act nice, but hint between the lines the lifeline of this business as well as the reputations of everyone involved is in your hands.

If the founders give in or compromise to your demands (which they should if you act like a reasonable human being who they have hurt and not an aggressive asshole out for revenge), let it all be water under the bridge - the founders have, no doubt, learned their lesson from this also and will improve in the future. But if they don't, don't sudo rm -rf the entire repo, instead, just write up your story, publish on HN, and go find work elsewhere (there is no sense in throwing good money after bad).

Threatening to ruin the business is not 'seaking softly', nor is it likely to end in the best outcome.

You have every right to feel disgusted and cheated among other things but don't assume those feelings to be true.

However hard it might be, keep your mind clear and free of things that might upset you. Remove yourself from the circumstance mentally as if you were advocating on a friend's behalf. Don't let your emotions cloud your judgement. Sometimes you can become so jaded that you manufacture self-fulfilling prophecies.

With a clear head, exercise every option possible. I'd absolutely contact a lawyer and plan for a future that looks dramatically different but don't jump ship quite yet. Talk with your legal advisers about what the best next steps are and carefully execute in conformance with their advice.

Figure out what's really going on but be prepared in every aspect possible (emotionally, financially, legally) for whatever might be around the next corner. Don't get caught on your heels.

Best luck to you; it seems like a very unfortunate situation.

Caveat: At least in the US and ASFAIK :-

As long as the company provided you with the properly assessed strike-price and FMV for your options at the time of exercise (upon which they become shares) I don't think the founders are obligated by law or otherwise to disclose any investments to their employees.

Even though you may be a founding engineer, officially you are still an employee. You are not on the board of directors and/or until the time of exercising options you were not a shareholder. Hence the company likely has no obligation to provide you with the details of the company's financials.

On the other hand if you exercised your options based on incorrect FMV the company provided then the additional tax burden would not be your fault but I am not sure in your situation what recourse you have. As others may have suggested your lawyer should be able to answer that.

The best course of action is to just go along with it while you get legal council. The more information you can glean while you're working there will only help strengthen your case. If you simply lawyer up and confront the owners, they'll go into bunker mode, fire you and then lawyer up themselves.

Act normal, and continue to work and essentially collect as much as evidence you can. You can drop hints, talk to people to find out what they know, etc.

The more you know, you can start to build a timeline and the implications that the company was effectively doing this behind your back for nefarious reasons. The more you have documented, the more you strengthen your case so when its time to actually threaten them with legal recourse, you'll have all the evidence you need while they'll be scrambling to build a defense.

Hope this turns out well for you!

How does one go about finding an attorney in these situations?

As you talk to legal counsel, you might possibly ask if you could get a tax shelter of some kind - it may not be feasible, but sometimes colleges will take donated real estate, for example, and the pay an annuity. So say a farmer had a piece of land, it increased to a million, and wants to avoid capital gains. In some cases donation of assets can result in doing something good for an institution but also getting ongoing income out of it.

Not sure it applies to capital gains with options/alternative minimum tax, but a tax lawyer might know.

If the tax bill does turn out to be like the price of a car, aside from taking some form of legal action, or if it fails or is not possible, then you can make payment arrangements, so that in theory, paying off the tax over time will maintain your ability to keep hold of the asset of the options.

This might not be true in Canada, but in the States when investors buy preferred shares with a liquidation preference (even 1x non-participating) the common share valuation can still be quite low, even possibly still PAR. It's called a 'thin common' valuation strategy.

The general idea is, what is the value an investor would have paid without any of the additional rights granted by the preferred shares? Usually for early stage startups the answer is reasonably close to "$0" -- the deal would never happen without the preference. The common shares are often still worthless, in reality and for tax purposes as well, after a Series AA and sometimes even after Series A.

It seems that you are over-reacting. Ask nicely for a clarification about exactly what form that first investment took. if, as others pointed out, it was a convertible note, the stock price may not be impacted.

The fact that the company lawyer gave you the stock price indicates that they are not lying to you. So your taxes are probably fine. The only thing questionable is whether they should have given you the raise they promised in writing upon raising funding. If the amount they raised is small, I can see how the founders would think it's too low to trigger the raise.

So overall, everything may just be fine. By the way, you are not a co-founder, you are the first employee.

I'd suggest talking to the cofounders in a non-accusatory manner. Startups are often disorganized and crazy and my guess is that the tax implications of your shares didn't even cross their minds because there are so many things going on. Also, what was the previous investment amount? If the previous investment is from a family or friend, my guess is that it's more of a bridge than an investment to keep the company afloat until true investment comes in (not enough to raise salaries). Either way, I'd give them the benefit of the doubt and not jump to conclusions too early before talking to them.

Usually there's no need to exercise until you either leave the company or there is some sort of acquisition. As you found out, it can be problematic. Did you have a specific reason to do that?

You should definitely talk to a lawyer and an accountant. I could see an argument where your gains would be based on the company's 409A valuation, which can be significantly lower than what the last investors put in.

Based on what you wrote, I am not seeing a bad intention from the founders. seems like talking to them might be helpful.

Exercising the options makes it harder for him to get screwed later on. Also it can put you in a better position later on when you sell because you pay capital gains tax on the appreciation of the stock rather than ordinary income tax on the options.

This works because stock is considered an investment where as options are not considered investments (according to the tax code) and by holding the stock for more than a year it's considered "long term" and thus it gets classified as capital gains.

Ultimately I think it's a very smart thing to do especially if the company says that the stock is valued at $0.0001/share meaning that he can exercise 1000 shares per $1. The only time there's ever a downside to exercising early is if your strike price is substantially above $0/share meaning that it might cost a sizable sum. If it's free -- or nearly free -- to exercise, there's really no reason not to.

Unless of course you end up in a situation like this person has.

From the pastebin:

> "contingent on raising target angel round of financing".

My English is not good enough, so I'm not sure what this means, in particular "target".

If their "target" was $100.000 and they "only" raised $99.000, are they forced to give you the raise?

[Also, as other said, with a 3% you are not a "engineer founder", you are only a "engineer first employed". In any case, talk to a lawyer.]

There should be a provision somewhere in your operating agreement that tax liability on unrecognized income will be paid by the company -- look for that. Additionally, if it's an LLC (or even a partnership), you can look for something called Profits Interest http://www.gilaberttax.com/2014/01/14/profits-interest-vs-ca...

You should talk to a lawyer and/or accountant but this doesn't sound right at all. First, why are you buying your options? In he US you typically don't acquire them till you leave the company. I also don't see how you could rack up that sort of tax bill on a company and shares that cheap. You should also consider asking the "company" to help you out with the tax bill. This all just doesn't sound right.

Link to details: http://pastebin.com/xLLNUF0H

Sorry to hear this.

The tax problem is a common one and one of the major downsides to equity compensation in some situations. I've never heard of your particular situation where they didn't keep you informed of the valuation, though. That's fairly awful. I would be livid.

Trust is one of the most important things in a start up. If this was an oversight that's one thing but if not, then walk away and get a better job. There are plenty out there. It's near to impossible to work effectively with people you don't trust.

You should ask a lawyer before confront founders in order to know your options.

Never, ever exercise options unless you have a market to immediately sell into OR otherwise have means to cover the potentially significant tax bill. This bit so many people in the dot-com boom. Options should be exercised and a portion of the received stock immediately sold to cover the tax which will be due on the exercised vs strike price. This is one reason that restricted stock in the US is MUCH better tax wise. In the US you can file an 83-b election and receive tax treatment on the basis at time of purchase, which for most startups is effectively 0.

NEVER EVER exercise options unless there is a real market in which you can realize value from the received stock directly UNLESS you REALLY know what you're doing (read: have money and a good accountant/lawyer).

How do you conceal that in a small venture?

Sounds like you have a real communication problem in that company if something like this can happen and nobody has a clue.

>leaving me with a potential tax bill on $10,000s of income that I had not received.

This is why I formed a C Corporation and not an LLC.

This really has nothing to do with it at all. In fact, an LLC can elect different forms of tax treatment, including being taxed as a C or S corporation.

Find a startup that treats engineers better. Get another gig and then consider your legal options.

Just leave, do your own thing. Ask for 83b elections. Lawyer will cost more than your tax bill

"Ask for 83b elections."

He's in Canada. As others have pointed out, at the very least he needs to engage an accountant to find out exactly what the tax implication are.

To those saying the OP shouldn't talk to the founders: why? I'm just curious.

By doing what they did they've already proven bad faith, talking to them now just warns them.

Better to seek legal counsel and have them talk to the founders.

They've already lied to him.

He needs to know what his choices are before he talks to the founders so he knows if what they're saying is bullshit or not.

Do you really have any other options except to hire a lawyer?

Is there any use in contacting a lawyer?

YES. YES. For the legal and accounting implications, you need to see people who understand them. I can't help you there. I know enough to know that you absolutely need a lawyer on your side (and don't fall into the trap of trusting the company's lawyer).

Career-wise, you need to move on. First, working with a pair of brothers or a couple or a father/son duo is generally a bad idea. Others' pre-existing relationships to or within power put you at a career disadvantage and you should avoid them when possible. Call that a lesson learned. Second, they obviously didn't see you as important enough to the company to know what's going on. Don't expect that to change. They've shown their hand; now show your back as you walk out the door.

That said, don't burn bridges and read Smushman's reply. Don't put anything in writing that you wouldn't want in the New York Times. (I know that that's cliche advice, but here it applies. Be extremely cautious, is what I'm saying.) There's a good chance that if you go into court, these guys will attack your character and reputation and the quality of your work, even if they've been cordial to this point. (I've seen startup breakups. They're ugly.) You can't prevent that but don't give them any ammo. Just find another job, give 2 weeks' notice, and move along.

Have someone check your references and report back. You'll be shocked at how willing "jilted" startup founders are to tarnish the reputations of exes who "quit on" them. Risk-averse corporations don't give bad references but cowboy founders who've never believed rules apply to them will say all kinds of shit. If you get a bad reference, you need to reach me offline (michael.o.church at gmail) and I'll tell you how to fix that up.

Don't stick around because of vesting unless you stand to gain millions. By all means, get what is rightfully yours based on the time that you have worked, but don't put your career at risk. These founders don't see you as the same class of human (most tech founders don't, because they have the investor-level connections and you don't) and that's not going to change.

Good luck. Above all, don't get angry and try not to hate your soon-to-be ex-bosses. It will just cloud your judgment. This is extremely common and a lesson that a lot of people have to learn the hard way. Given the circumstances, you'll probably get some money out of it but it probably won't be anything close to what you want or think you deserve.

Get a lawyer.

Group everyone involved into a room, stand in front of the only exit, and calmly announce that nobody gets out until you receive an explanation. State the facts neutrally as you know them, and ask if they are accurate.

Actually let people out once they have explained. There is no reason to start kicking ass until you have a complete picture.

Once you have a complete picture, decide whether it's time to start kicking ass, and by what method.

I'm going to assume you're not being literal, but FYI, I sat on a kidnapping jury that was essentially this. Don't trap people, even for a moment; it's quite illegal.

I'm being literal. It works.

If you look at my posting history, you'll notice that I have little care for the laws of man. Do the right thing, always. If it's legal, good for the law. If it's illegal, break the law.

But break it properly, so that after you're done breaking it, it will take a long time for legalists to repair it and people have time to consider that they may be better off without it.

Now in this case, locking people in with you is excessive. But, making it clear that it's easier to say truth than to push you aside is appropriate.

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