What you need to know about employee stock options

by barretts • 13 years ago

94 60 13 years ago

JonFish855• 13 years ago

Best thing to do: forget about them. If and when the time comes, you'll know what to do. Glance at when they expire, mark it on your calendar, and when you're within a year or so of that date, if you're still in business, consider it. More often than not, they'll be worth little to nothing (especially once you factor in any taxes that come along with them). Don't waste time or energy trying to figure out how much they're worth, because it'll change a thousand times before you actually do anything with them.

barretts6• 13 years ago

That's good advice, but I still think it's useful to know the company valuation at grant time -- just as a baseline.

vladimirralev2• 13 years ago

If you forget about them, then they don't serve the purpose of being incentive though. This doesn't work in anybody's favor.

JonFish855• 13 years ago

That's a fair point, but I think it's more dangerous to look at them as anything more than a lottery ticket. Since startups are more likely to fail than to succeed (no matter how hard you work), don't set yourself up to be disappointed. It's great to be excited that on paper you could be worth $10m, but when you get acquired and the money you thought you had is suddenly worth only $50k and after windfall taxes you walk away with $30k, it can be disappointing. Especially if you take that $30k and divide it over, say, 4 years -- $7500/yr. You probably gave up more than that in salary.

Anyways, I guess my point is not to view the stock as being worth anything--it's too easy to get attached to the "paper value" (or even potential value) of the stock. Focus on the learning & networking aspects of the job, not the payouts.

erbo• 13 years ago

If there's one thing I've learned from hard experience, it's "Put not your faith in stock options." I was granted them twice, and in neither instance did I actually see a dime from them. (In the first case, it was right in the middle of the Bubble, and by the time I left, they were so far underwater as to require a ROV to find. In the second case, I was laid off six months after joining the company...and on the Thursday before 9/11. Talk about lousy timing.)

pkaler• 13 years ago

Best thing to do: forget about them. If and when the time comes, you'll know what to do.

That is terrible advice.

If you work at a startup then compensation will be a mixture of salary and equity. You should know your worth and negotiate your number when joining a startup. You should understand the details of the last financing: how much was raised? who were the investors? how long is the runway? what were the high-level economic terms of the deal?

You should ask around to see what is fair market terms for the options you should receive. You should do a search on angel.co/jobs and look at comparables.

Read Venture Deals by Brad Feld and Jason Mendelson even if you are not a founder. Founders and investors know this stuff. If you are naive going into your employment you may end up being screwed out of upside.

Get your papers straight.

JonFish855• 13 years ago

Sure, use it as part of your negotiation up-front, keeping in mind that 2% of $0 is still $0. If things go incredibly well, with a ton of luck, maybe you'll get something. Maybe it's part of your compensation, but it's a pretty useless part: you can't spend it for many years (usually at least 4, assuming you can sell after they all vest), and it's not guaranteed. You get the percentage of the scraps--after the VCs have taken their cut, and the founders have taken theirs. Call it compensation if you want, and certainly it's good to have some skin in the game, but there's no good reason to really follow it that closely after you've signed on with the company.

Once they're in your employment contract, forget them. Stick them in a file cabinet someplace marked +4 years and see where things go. In that time, there will (probably) be more rounds of funding, which will dilute your shares. Things will change: valuations, personnel, perhaps executives. Don't waste time re-calculating your options all the time, it's an exercise in futility.

rhizome• 13 years ago

I thought that once, and the company wound up getting acquired by a huge company at the 8mo mark.

beefxq4• 13 years ago

People like you typically ends up with nothing.

JonFish855• 13 years ago

How do you figure?

kitcar• 13 years ago

Anyone else getting "Please sign in to view this" ?

fintler• 13 years ago

It loaded the article right away for me. Chrome Mac 28.0.1500.95 here with Ghostery and Adblock running.

varelse2• 13 years ago

Nothing about liquidation preference, which can make these options absolutely worthless even in the midst of a seemingly successful acquisition.

http://venturebeat.com/2010/08/16/beware-the-trappings-of-li...

I was once at a startup that was offered a $100M buyout. This would have netted me maybe $200K except that the liquidation preference obliterated all profit for the founders and employees. So instead, the CEO chose to ride the thing into the ground. He went on to make the big bucks at his next gig though.

JonFish855• 13 years ago

Sounds like the founders took some pretty poor funding...

hef19898• 13 years ago

But I, well how do I put it, have to smile a little bit about his actions.

By the way, learned yet more about these things in this article and the venturebeat-link.

barretts6• 13 years ago

That's fair, but my understanding is that employees don't get liquidation preference - investors do. So yeah, if there's a lot of stock out there with liquidation preference, your employee options can be worth a lot less. But as far as I know, there's no way to determine that ahead of time.

tptacek• 13 years ago

I'm not following. Your prospective employer needs to tell you about liquidation preference obligations they have for you to value your options. The way you as an employee determine that ahead of time is to ask.

beefxq4• 13 years ago

If you don't give people their fair share...

varelse2• 13 years ago

Not in this case, even the CEO would have walked away empty-handed. Too many funding rounds had transpired with ever-increasing multipliers on the liquidation preferences.

Still, I think there's an argument that had he taken the buyout, he personally could have argued that he delivered for the investors and that would have gotten him to round 2.

loumf• 13 years ago

This is surprising. I would expect the investors to renegotiate to get the deal done or the acquirer to pay the CEO and employees via signing/retention bonuses and salary.

A $100 million dollar pie can be split in a way to make people happy if they are reasonable. The cap table and liquidation preference is a starting point to negotiation.

couradical2• 13 years ago

Everything you need to know except taking an 83b election? That doesn't seem very comprehensive. If you're serious about getting out someday - keeping an extra 10-20% of your exit seems prudent to me.

jeremybencken• 13 years ago

When a startup grants stock options to its key people...83(b) has no bearing on any of them except for one special case. If options are granted to key people who are given the right to exercise them early...

http://www.grellas.com/faq_business_startup_004.html

couradical2• 13 years ago

Fair enough, I wasn't thinking only options grants, but rather equity as a whole.

jaredhansen• 13 years ago

Useful, but a far better and more complete guide is here (via dweekly):

http://www.scribd.com/doc/55945011/An-Introduction-to-Stock-...

alain94040• 13 years ago

Yes, title is highly misleading. "Everything" you need to know? More like two things you need to know, and I won't mention these other 5 that are actually more important.

Basically bad advice.

barretts6• 13 years ago

It's a jump to go from saying it's not "everything" (which it isn't, and which I don't claim in the post) to saying it's bad advice. From my experience helping friends who had no idea how to manager their options and whether to exercise them and even how much they're worth, this information would have been very useful. What do you think would be better?

barretts6• 13 years ago

That doc looks great, definitely adding to Evernote. Thanks.

the_watcher2• 13 years ago

Always drives me crazy when friends join startups and talk about their options. Them: "They gave me 5000 stock options!" Me: "What's the strike price? How many shares are outstanding?" Them: "What?"

danielweber• 13 years ago

I have to share my war story of trying to get prospective employees and offering them 2000 shares, 0.1% of the company. Only to find out they someplace else that offered them 50,000 shares, because 50K > 2K.

And, no, it's not the case that I'm better off without these people.

the_watcher2• 13 years ago

That's an aspect I have to admit I didn't consider. What do you do if your prospective employees simply don't understand options and don't ask the right questions when getting offers? 2,000 shares of 10000 outstanding is much better than 50,000 out of 1,000,000,000. Many highly intelligent people I know simply have never had this explained to them. Maybe the solution is if you are giving them a great deal that you think can compete with any other reasonable offer, you make sure to explain thoroughly what it means and how to evaluate competing offers?

njudah• 13 years ago

"You don’t owe any taxes until you sell the shares."

This isn't true; if you exercise - and don't sell - your options, you will be subject to the AMT. (Alternative Minimum Tax). During the original Internet bubble (and bust) this caused significant hardship for many people. Tip - don't take tax planning advice from random blogs.

dasil003• 13 years ago

Yeah, pretty irresponsible for an article that says "all you need to know". You absolutely need to know the ins and outs of this if you have a significant number of options on a company with an increasing FMV. You own AMT on the paper gains between your strike price and the current FMV. However this only applies if you don't sell the shares. If you sell the shares before the end of the calendar year then the AMT calculation is nullified and you just pay taxes on your actual gains.

In a dotcom bubble scenario this can make the difference between owing millions of dollars of taxes despite having never seen a dime and owing your standard income tax on actual profits.

barretts6• 13 years ago

That's a fair point, I didn't really take AMT into account. Feel free to leave a comment on the post, it's useful information.

textminer• 13 years ago

It can be hard to sell those shares when there's no market, no? I recently left a small startup in which the AMT hit would've been $26k, with no possible way to recoup that from selling the shares themselves (outside of a scheme like the ESO Fund, which issues non-recourse loans on the upside of a stock option sell, covering you for the tax and exercise costs.)

WalterBright2• 13 years ago

The real problem is if you exercise, but don't sell, you owe tax based on the exercise price. If the stock subsequently tanks, you may wind up owing far, far more in tax than you have assets.

Yes, this happened to a friend of mine. The stock options financially ruined him.

Go see a real CPA tax accountant. Don't wing this stuff, don't rely on advice from the internet.

vladimirralev2• 13 years ago

This is very far from "everything". There are many startup scams out there right now that would appear legit according to this guide. I've seen startups that delay valuation, so that you pay higher prices for stock. Sometimes you are outright asked to actively improve the perceived value of the company so that that more you work, the more money you will end up paying to buy the stock later. It is important to know that startups are legally required to give you strike price no lower than the valuation, but they are actually allowed to give you any price higher than the valuation without disclosing it. There are a ton of subtle ways the founders can screw you over if they want. If they don't have your back 101%, the options are worthless. Anyone with financial background would laugh at what some developers are asked to sign.

mrgreenfur• 13 years ago

If you've got them, here's the trick: - hold your shares for 1 year and pay cap gains tax instead of: - selling shares before 1 year and paying income tax

prostoalex• 13 years ago

If the stock appreciated enough to make the LTCG trick worthwhile, it appreciated enough to generate AMT liability at the point of exercise.

wooster• 13 years ago

Flagging because this isn't even close to everything you need to know, and the treatment of ISOs is overly simplistic.

As others have mentioned in the thread, David Weekly's guide is a much better resource.

birken• 13 years ago

There are a couple key omissions (though there are many -- this is not a particularly substantive article):

- When you are joining a company, the first question you should ask is "How many outstanding shares are there?" All you really care about is the % of the company you are potentially getting and the current value of the company.

- The AMT is a big deal that can heavily impact your life when you exercise options. There is no point in getting to the details here, but if you happen to be lucky enough to be working for a company that has gone up significantly in value, the AMT can be an expense to consider when exercising options. It can also indirectly affect: a) Whether or not financially you can leave a company (because if you leave you are forced to exercise your options) or b) If you should exercise your options early for smart tax planning

-----

Kudos to the author for trying to inform people, but if you work for a successful startup and have questions about stock options, do not listen to this article at all and talk to an accountant!

greghinch• 13 years ago

"All you really care about is the % of the company you are potentially getting and the current value of the company."

Respectfully disagree: what you care about is strike price, share price, and quantity. Percentage can be a good indicator, but ultimately, those 3 figures are what will determine your payout. As a hypothetical, getting 10% of a company with a strike price just shy of the share price on exit is still pretty worthless.

georgemcbay• 13 years ago

The share price for the types of companies this article focuses on is generally unknown (as anything other than wild ass guesstimates) at the time this would be a concern for new employees. Percentage of ownership isn't unknown and thus may be more useful, but ultimately neither is a guarantee of anything since either way you can be virtually wiped out by future dilution if you're just a common share pleb, which is by far the norm for non-founder early employees.

coin• 13 years ago

Grrr, why disable pinchzoom?

BigBalli• 13 years ago

I feel like it's a bigger picture than what is described. There are more options and details to each: http://giacomoballi.com/paid-at-startup-salary-equity-shares...

WalterBright2• 13 years ago

Don't ask for advice on the internet. If there is real money involved with stock options, engage a CPA tax accountant to help, now. Really. If you just lazily let things slide, you could find yourself in a deep hole due to the tax rules. (One friend of mine paid no attention and found out he owed more to the IRS than his net worth.)

It's like if you've got a medical problem - go see a real doctor.

fizx• 13 years ago

This is a terrible article. It makes no mention of 83b elections or AMT, and contrary to the article, you will pay taxes on exercise.

Real advice: Research "83b elections" heavily before joining, negotiate well, and if the company is succeeding as well as, say Nest or Pinterest, start shopping for an accountant to tell you more.

matthewmcg• 13 years ago

For incentive stock options, at least, you can't make an 83(b) election.

eqdw• 13 years ago

So....... how bout them NSOs and the tax I'll owe on them?

Clearly it wasn't all I need to know

michaelochurch2• 13 years ago

A good start, but I want to add more.

This may seem unrelated, but there's a difference between poker and slots. Both are "gambling", but one has a performance effect and one doesn't: if you're good at poker, you can make money at it (of course, many people lose). With slots, there's no skill. If it's viewed entertainment, fine; but don't think it should take a major place in your lifestyle because it's just going to lose you money. Playing slots is not a sound financial move. For some (top ~2% of poker players) poker is.

I'll get back to that.

Now... let's say that you're a typical 28-year-old programmer making $120,000 per year in a cushy corporate job. Your financial advisor comes to you, one day, and tells you that you should invest $30,000 of your annual income in penny stocks. Not only that, but it's a single and illiquid penny stock, with tax implications you don't fully understand. Oh, and the company issuing it is your employer and has about a 20% first-year chance of firing you without severance ("for performance" because tech startups never do an honest layoff; they'd rather hurt your reputation than theirs by admitting contraction) and invalidate your investment (called "cliffing") outright. That's your financial advisor's proposal: buy illiquid penny stocks from your boss.

What would you do? You'd fire the fuck out of that financial advisor, that's what you'd do.

Yet there are plenty of people who'd work for $90,000 (instead of the $120,000) plus "equity" whose expected value is much, much less than $30,000-- maybe $10-15k at-valuation, from the perspective of VCs who have a much higher risk tolerance, who also get control of the company and preferred shares in the deal.

It's a shit deal. Don't take it.

Now, back to poker vs. slots. If you're a founder, your equity holding (which is likely substantial, unlike typical employee bullshit) is more like poker, because your performance at your job can have a macroscopic effect on the company. Your ability and performance directly affect your payoff (of course, there's a lot of luck, too). You're still gambling in the abstract sense that everything (even driving) is a gamble, but you're taking bets on yourself, which any self-respecting person would do.

If you're an engineer or, really, anyone outside of the top O(N^0.25) executives, you're playing slots because nothing you do will have a real effect on the macroscopic performance of the firm. You're betting on people and factors over which you have no influence. Even whether you get that full that 4 years or are fired first is (let's be honest here) outside of your control.

Employee equity is a nice-to-have for an otherwise good job paying a market salary (if not above-market, to account for startup risks) but it doesn't justify taking the kinds of pay cuts involved at most of these startups.

nostrademons2• 13 years ago

The first 10 employees hired (most of whom should be engineers at a tech startup) have a huge effect on the trajectory of a startup. One bad hire there will sink the company.

I know Google employees with employee numbers in the hundreds that had a measurable (and very visible) effect on the success of the company.

michaelochurch2• 13 years ago

The first 10 employees hired (most of whom should be engineers at a tech startup) have a huge effect on the trajectory of a startup. One bad hire there will sink the company.

If that's true, then why aren't they given more equity and more respect?

At least in New York, it's a lot more common to hire unproven 22-year-olds at ~60-70k and 0.25% for the first 10 employees. Of course, a couple of those will turn out to be really good, but that's not a hiring strategy you'd take if one bad hire could sink the firm, because you're also going to take in a couple of bozos.

A single bad executive, yes; a single bad engineer, maybe, but founders don't act as if that were the case.

mahyarm• 13 years ago

You know all of this financial ruining AMT bullshit and brain damage with non-liquid start up stock would disappear if the stock options didn't expire in a few months when people leave.

I'd much rather sacrifice what ever special treatment ISOs get and the %5 tax difference from long term capital gains in exchange for a far less risky form of compensation. Whats even worse there is nearly zero upside and all downside for this amount of risk for the employee.

trustfundbaby• 13 years ago

There are lots of ways that your stock options might become “non-qualified” stock options, though. If you exercise them less than a year after receiving them, or sell them less than a year after exercising them, you could owe a ton of money to Uncle Sam. At this point, it’s best to call your accountant.

I wish they'd gone into this more ...

gjm11• 13 years ago

I am increasingly of the opinion that seeing "medium.com" in the URL is an excellent predictor of a mediocre lightweight article. (Just as seeing "physorg.com" in the URL is an excellent predictor of a recycled press release that's usually less informative than the original press release -- but I've beaten that drum enough already.)

What you need to know about employee stock options

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