Wait, wouldn't the AMT apply to his desired all-ISO scenario anyway? This is an actual problem; people can't afford to buy their ISOs either because of the AMT. What's the actual damage here done by NSOs?
Yes, there would probably be a lot of AMT to pay, but the taxes aren't immediately due as it is with non-quals / NSOs. Furthermore, the AMT can be used as a credit in later tax years depending on how one does their accounting... ISOs are very complicated.
When one exercises an NSO, the company must legally withhold or collect money somehow (at the very moment of the exercise) to cover the employee's tax liability. When the stock is not public (or upon an employee's election), the employee must pay cash up-front. Thus it can be impractical or impossible to gain anything from NSOs while the company is private. Another factor is that even if the employee can cover the taxes, the shares could lose potentially all their value at some later time. In this case the employee loses MORE than the value of the stock because they're also out of pocket for the taxes paid. (I've personally gone through essentially this latter situation).
I've heard of Uber employees getting special deals from banks and mutual funds that forward them cash to exercise the shares; in exchange the banks get some percentage of the shares (or nothing if Uber does not IPO by some date). There are some ROFR issues here (pre-IPO Facebook employees tried to do similar things) so I'm not sure how well it actually works. It's certainly damn complicated.
I've personally had ISOs, NSOs, RSUs, and another special other type of stock agreement at different points of time. I've had an accountant charge me $1800 to handle some ISO / AMT complexities on stock that didn't make me much money (I actually had net losses on most of the shares due to taxes). I've had managers, directors, and legal teams give me false or misleading information about what ISO / NSO packages were worth. These games are really not worth it for stock packages worth (even in the very best of outcomes) ~$1m or less. (Unless you're a laywer or biz-dev kinda person and enjoy them! )
My recommendation for makers / individual contributors: request RSUs if possible and prefer a simpler path to having taxes-paid money in the bank. Outstanding employees who really move the needle deserve exec teams who can deliver compensation that's valuable without tax games. Employee time should be spent on product and furthering the craft, not legal BS.
Any examples of pre-IPO companies handing out RSUs? I've seen posts about that on HN but it doesn't seem to be proven in the field. I've read that FICA taxes may actually be due on vest with RSUs, so either the employee pays or the cash-strapped pre-IPO startup spends cash on that, both of which are dumb when there are fully tax-deferred instruments available.
A smaller delta fix here would be to convert ISOs to NSOs with a very long exercise period (10 years) so you don't have to pay taxes until you can sell to cover the tax. I can think of several companies doing that now e.g. Pinterest.
Uber is pre-IPO and is currently issuing RSUs? Facebook also issued RSUs before IPO as far as I know. Right, that approach might not be possible for early startups. The Pinterest & Quora approaches here are pretty great and the companies have put in the time to have useful, rigorous discussion to validate the approach. Quite the opposite of what Uber seems to have done here with the ISO conversion & improper communication.
Another option for early startups is to support 83(b) and to, well, bonus the employee the strike so they can exercise immediately. I've seen a case where a key employee demanded they get a big bonus to cover a large strike in a new, large grant. (And he got it, and was butthurt over the bonus unexpectedly putting him in a higher tax bracket...). Facebook has handed out $100k signing bonuses to new grads... On one hand this all makes employee comp more expensive, on another hand there's the absurdity of CEOs and investors making several orders of magnitude more than the most influential employees.
Using double trigger vesting (the RSUs vest only when both the normal vesting period is up and the IPO/exit happens), the tax situation can be managed. I know of pre-IPO startups doing RSUs.
Sorry for the late reply but... doesn't double trigger vesting mean you forfeit the equity if you leave before the second trigger?? That's insanely employee-unfriendly. Extending NSO exercise windows is so much simpler.
> Sorry for the late reply but... doesn't double trigger vesting mean you forfeit the equity if you leave before the second trigger?? That's insanely employee-unfriendly.
That is right. These typically make sense only when the IPO is imminent.
> Extending NSO exercise windows is so much simpler.
Agreed.
