In this market, I tend to think of options as incentives, and not as replacements for salary. Salary gets me in the door and work hard, great people and culture make me want to be there and evangelize, and options incentivize me to work my ass off. (I'd work my ass off without options, but the options really make it easy to say "I will do everything in my power to make this succeed" instead of "I'd rather go spend time with my friends tonight").
To put it a slightly different way, I can't pay my rent with options. You can offer me all the options in the world, but my landlord doesn't accept them as payment. Therefore, you cannot simply exchange salary for equity.
I received an offer from a company a year or two ago, and they offered me a salary almost 50% below my then-current salary, and then some equity. When I tried to negotiate on salary, the CEO berated me for ignoring the equity. The problem is that as far as equity is concerned, it's worth $0 until you exit. There's a potential for millions, but my lottery ticket is also worth potentially millions of dollars. My landlord won't accept my lottery ticket as payment.
Long story short, Aaron is correct: startups need to rethink the whole equity component. It's valuable -- but it's not valuable in the same way that salary is, especially in today's market.
> I'd work my ass off without options, but the options really make it easy to say "I will do everything in my power to make this succeed" instead of "I'd rather go spend time with my friends tonight"
Just curious: are you under 25? Not meant as ad hominem -- I know tons of engineers who have this attitude from 22-25, but the closer I get to 30 the more I realize on a deep level that I'm going to die someday and I have a finite amount of time to love others, watch sunsets, laugh, meet interesting people, etc. It's gotten to the point where I have trouble relating to newly-minted engineers because they seem stoked to work until 9 PM in exchange for Nerf guns and the illusory promise of a liquidity event.
Definitely not under 25. I've built startups for many people over the years (both as full time as a consultant/contractor), and at this point look at work on someone else's idea as dollars first, equity is gravy. Why? Early engineers take a hit on salary and any equity stake is quickly diluted. It is pretty common for engineers post series-A to potentially end up with a higher equity stake than someone that came in after seed funding when you factor in dilution. This is common.
These days I look at startups as an opportunity to have a significant impact, build something interesting, but what am I giving up for the particular company? Can I gain the same benefits through other channels?
I recall a YC event where companies were pitching looking for talent. At least the Justin.TV guy was honest and said "we work our asses off", the startup that pitched "we work together, we play together, and we hang out with our customers at 9pm trouble shooting" -- great if you just moved to the area and don't have other outlets.
I've had some grate discussions with a few YC companies recruiting, some were wrong fit, some wrong match, some wrong time. In general, positive.
But the original thread is right...for a lot of the talent some companies want, compensation needs to match the talent level desired and equity/option, that crap shoot needs revamping.
Forgive my assumption. So when you're referring to equity in a company, you're talking about a founder-sized chunk of the company and not the 0.1-0.5% pittance that an engineer hired under a technical co-founder would receive? If so, that makes total sense -- and I think in both cases, whether 0.5% or 20%, it's best to view equity as gravy -- but 0.5% of a pre-Series A company should not be a reason to work 70 hour weeks for 12-36 months.
I just had an offer that had, depending on chosen comp .1% to .17% equity with a 10k loss in salary all for an extra .07%. By the way, they have a lot of convertible notes and are pre-series A. I turned around with a counter offer/request that pointed out the equity is largely worthless with no anti-dilution provisions, while seemingly gearing up for a heavy dilution.
Maybe I don't properly understand equity, but if two founders each take 20%, an employee pool is created with 10%, the convertible notes eat another 20%, and the seed ate 20%, this leaves 10% of shares available. How are you only going to take dilution if it increases your employees existing share value if you need funding to survive and have very little shares to give up leading into a series A?
If I'm a founder and I own 100% then give up half the company to investors, that 50% I give up better improve my overall outcome by at least 2x. Usually that's reflected in the overall valuation.
Looking over PG's post it is about whether you should take equity and improving your outcome/valuation. Outcome seems vaguely defined and is used both as valuation and the chance of success. You as an employee want people to follow this as your own ownership drop isn't a big deal if your company becomes worth hundreds of millions through only favorable PG equation deals.
The chance of failure as a startup is significantly higher than its success. Plus, not everyone can achieve favorable offers that adhere to PG's equation. This is what real life is like, so you have to take into account unfavorable offers having to be accepted to possibly keep the lights on. Additionally, I threw up a quick scenario on http://www.tejusparikh.com/projects/equity_calculator/index....
I used a similar offer as mine, using .1% with rounds that had 1 million @ 1 million pre-money valuation, 5 million @ 15 million, 30 million @ 100 million and finally a sale of 200 million. The difference between 10k salary over 4 years in this scenario comes out to be a net gain of ~13k for an individual at the startup.
In my particular case if I switch this to a .17% offer and take a 10k salary cut, I am actually losing roughly 1k running through a scenario like that without factoring in the interest on 40k.
I'm happy to accept dilution, and will dilute the value I consider the shares accordingly. Since there are plenty of ways to dilute out shareholders, I'll pretty much dilute the value of those shares down to slightly above $0.
The skeptic in me makes me think - because VC's set the rules mostly as they are the one who provide capital; They do wan't to make sure they get the most out of their investment with best possible terms.
I agree - salary is what you negotiate on and equity is gravy. I took my current offer because I was happy with salary. If equity never pans out oh well.
Also to everyone else if a founder wants to pay you a lot with equity, you have to wonder how confident he or she is in long term value. If they really are going to be worth so much, why aren't they clutching those shares more tightly and throwing cash at you instead?
If you are getting founders shares as a founding member of the team, that is one particular calculus that I alluded to but do not address.
If you are a "founding engineer" but not really getting founding shares, but the typical fraction to a couple of percent that is one thing.
If you are a non-founding C-Level title that is another scenario to discuss.
If you are an early engineer, that is basically the same as "founding engineer" above.
If you are getting non-founding equity as an early employee, you have to be aware of of dilution after each round. In nearly every case, an early employee post Series-A likely will be getting pay more and more equity than an early non-founding employee.
Which is an excellent point that I deleted because it felt off-topic. I'm to the point where I want to work hard from 10-6 then go be a human, instead of working from 10-9 with lots of Nerf gun fights and Reddit breaks.
This is a valid point, but go to almost any startup pitch event where potential talent is in the audience -- "Work hard, play hard" comes to mind.
My favorite learning experience (from a startup perspective) is also the one I think was the biggest failure. So much tech and a lot of dedication on my part, but looking back, the lost time with my wife. All of it really due to a lack of planning and an over commitment by management expecting engineering to step up. I don't ever recall being asked for estimates, just what needed to be done. I was in my tunnel at the time, building things.
I look back and the pre-devops, "devops" call at 1pm on a Saturday (after a 60+ hour week, they didn't have / hire sys admins before launching) was basically the end of line for me. Thankfully, the wife and I were driving back down 1 from SF to the Central Coast. We took our time and nourished the lack of coverage.
You're absolutely right, and I'm not sure that the parent would disagree with you.
However, the grandparent specifically formulated the choice as a dilemma: (I'd work my ass off without options, but the options really make it easy to say "I will do everything in my power to make this succeed" instead of "I'd rather go spend time with my friends tonight"), and that is probably what the parent was referring to.
I totally agree. I don't like the term "working hard", it doesn't mean anything. I'd rather use "efficiency". If you work 70 hours but you do as much as someone working 20 hours, I don't consider that you are working hard.
About the low wages for startup employees with high equity; I don't find it right as if you want to attract great workers, you need to offer them something now and not only something which might come possible in the future. Even if you have very high hopes to become a successful startup, this is never 100% sure. Startups have to look forward but people tend to look at present.
I'd rather use "effectiveness" than "efficiency". Doing in in 20hrs what takes someone else 70hrs is efficient, but it may not be effective. There's no point getting loads done if the work is low value. It's more important to focus on doing valuable work than getting lots done imo.
I was a little slow. It took me until 28 to have the epiphany. What finally brought me there was a diagnosis of hypertension and a realization that I hadn't dated in close to 6 years.
Now I'm close to 48. Having more control over my time is worth more to me than the possibility of a big pay day.
This. It seems that it's acceptable in tech culture to use "you have too much stock" a reason to even underpay founders. This is busted logic, as the company could explode at any time, not to the fault of anyone in particular (but sometimes yes).
So far, I think I've been in 3 decent startups that all of which failed and do not exist anymore. None of them exited cleanly. Some might, but you might not want to stick it out that long, and those are often hard commitments to make depending on the work environment.
New grads and skilled developers alike should never be seduced by "we can't pay more , because we are startup, because we'll give you more options". Not only is the probability of success a factor, but so is dillution, and so is the chance that you won't see that money for 8-10 years even if things go well (long after a company is acquired).
Many sales can end in a net-loss, or only VCs get paid out. Sometimes the CEO nets a really nice private deal to run the new company (and has also been extracting a nice salary all along, probably).
Stock is free to give out, so a company is going to try to give you that instead of money. While it can be nice, possible payouts for most are going to be low, and often enhanced salary over that N years would have been better - and especially from an expected value calculation perspective.
Obviously, there are exceptions, but I'm a big believer that companies should share profits, and probably evenly, without regard to title hierarchy instead. I'd also scrap or outlaw 'executive' bonuses when the employee bonuses are not along the same lines in terms of flat value (not % rate).
Amen. Not such a good notion to trade salary for options, when that extra salary could have been invested all that time. $10k in 2005 is equivalent to $17k in 2015, $21k if you consider dividends reinvested.
The options are an investment. It's just that they're "out of the money" when issued. Modal payout is zero, the maximum possible has been tens or hundreds of millions; what is the expected value? Hard to say.
Giving out stock has potential tax implications for the employee. She could be on the line for taxes for that stock without actually having any increase in liquidity.
Stock is not free. Equity is expensive if you're working for a good company. As a founder I would much rather pay out cash , but that's generally not what people are after (esp director, vp level)
I stopped taking options given away by startups seriously on November 10, 2011 [1]. Maybe stock is not "free", but employees should discount the nominal value a lot more than they seem to. What's a good ratio, as a rule of thumb? 1:10? 1:100?
At any rate, employees should not take them seriously in comp negotiations until they are well into FU money territory, should they ever pay out at a reasonable valuation after accounting for underhanded shit like excessive dilution and claw-backs.
It's pretty free. Hacker News loves the corrections. All good.
I founded and ran a good part of an A-round startup for a while.
I'm aware what stock does to equity, but it has minimal value to employees if it's not going to be a thing, and for a startup watching burn rate, it's pretty freaking free.
Are you going to give it all up and waste the option pool? Of course not. To me, I'd rather have employees with a good chunk of the equity because they were all doing a good chunk of the work, but I also want to see them treated well in stock. And you know your thing might not work out. Being stingy to employees with stock doesn't feel right.
I don't believe in founders hording stock when everybody working for them built a good chunk of what they sell. They should keep a decent chunk, but sharing stock well is basic ethics and costs nothing on the burn rate. It's the same reason I don't believe CEO's should make 50x of what an employee makes in a given year.
Stock is pretty cheap to give away in a startup. It's not cheap in a private company. I do especially object when it's used in lieu of market-rate compensation on the hope of future gain, with "we're giving you lots of stock" and then expecting the long hours and then it doesn't pay off for folks.
I used to also believe this, and would parrot it every chance I got, but I've since changed my tune.
It's hard to value options. Really, really hard. Saying they're worthless, though, is lazy and counterproductive.
If you're joining a seed-stage private company, then yeah, it probably makes sense to so heavily discount the options package that maybe it is close to worthless.
But if you're joining a series C that's on the road to IPO or acquisition (look to see if their job listings include the word "compliance" anywhere), and the company has real revenue and growth, ignoring the options package just does you a disservice.
It's a lottery in the beginning... at some point later it becomes more of a calculated risk. Given a valuation and percent ownership, you have a good starting point. You can then discount based on future dilution, risk of failure, time horizon, etc. No, it's not a science, but automatically ignoring the value of an equity package is just as emotional a decision as a starry-eyed assumption of startup glamor.
Being granted equity as a bonus is an incentive. Being granted equity in lieu of salary is asking me to invest in the company.
Let's say I'm asking for X salary. If the company offers me Y salary and W equity such that Y + W = X, then what they have done is gotten me to spend W of my salary investing in their company. If this pays off as an investment, that's great, but it isn't due to their generosity, but rather my investment. In fact, since I'm limited to investing in only their company (instead of being free to invest it in whatever I want), it is a large burden.
If they offer me Equity, W, such that Y + W > X, then (Y + W) - X is compensation (and X - Y is my investment in the company).
To sum up, if a company says, "We will pay you X salary, as long as you invest W in equity in our company" this is not in any way as valuable as X salary. W is a burden on me, not compensation. It is money I am giving them, not the other way around!
For this reason, I always negotiate salary independent of equity.
>Being granted equity in lieu of salary is asking me to invest in the company.
That is exactly right and I think what people are missing here. I mean even legally if you look at options purchases, you are literally investing. Even with stock grants, unless the company defers the strike tax through a loan mechanism, you will pay taxes as though it were real income.
> In fact, since I'm limited to investing in only their company (instead of being free to invest it in whatever I want), it is a large burden.
There's two ways to look at this. Yes, you're locked into investing in just the company, but you're also being given the chance to invest in something that's not available to the general public. These investments are risky, but often very good.
I'm currently coming to the end of my 4-year vest in a company that was acquired 9 months after I started. I gave back some salary in exchange for more options when I started since the company looked very likely to exit. That investment, over the past 4 years, has quadrupled. Even in a bull market, there aren't many stocks that have ~40% annual returns over that time. And that's not even accounting for the fact that these kinds of investments are better from a tax standpoint (flexibility to avoid AMT, long-term cap gains, etc).
As others have said, it's not a simple decision. You're being given an investment opportunity that is normally only available to VCs. But unlike VCs, you can't diversify across a portfolio. But, also unlike VCs, you can directly influence the success of the company...I learned after our acquisition that in the few short months I was there, some of my actions played a significant part in us getting acquired. It's a really unique investment opportunity that's available to very few people. It doesn't make stock options as a class of investment good or bad bets, the exact details of every situation determine that, which makes it very hard to make blanket statements like many people are doing here.
At series C you are not likely to get a significant enough position to make it worthwhile. If they do indeed have revenue then they should be able to pay you a decent salary.
This is the way I look at it:
A 50% chance to make $100K in 5 years with an interest rate of 5% is worth:
($100K * 0.5) / (1.05 ^ 5) = $39K
And if you have credit card debt then you should be discounting at something closer to 15%.
If you are coming on after a series C you won't be getting any significant equity unless you are joining as leadership, and even then you are in the club and going to be well compensated anyway.
Saying they are worthless shows that you have zero skills at probability. A way to look at options is the way a good poker player tries to play when the bad beat pot is particularly high.
It depends more on how many bad hands you can afford to play on before netting a good hand. A good poker player may still fold if they've got a crappy hand because they know they're only going to enrich the pot for somebody else in this round, and by folding they stay in longer.
If you're joining a series C that's close to IPO, they should be able to pay market-rate, or close to. You're also not really going to be getting a significant amount of stock from it, and it won't be worth all that much, relatively speaking.
I know a couple Boston-local companies with Series C's (one's on D now) that still try to play the "but options!" game as an excuse to not pay people. (A manager at one tried to guilt-trip me into working more by saying "you're one of our highest-paid engineers" at a number that was about market for a senior when I'd joined; they had multiple principal-level engineers on staff. When I left a few months later, my cash compensation jumped 25% when moving to a staff-level role.)
Options are not how you pay people. Options are how, along with good raises, you keep them from leaving as the good parts of working for a small, nimble company leach out.
To first order options are worthless. I've worked for venture-funded startups, angel-funded startups and started my own company on debt and nerve, and the only one that worked out was my own thing. The rest... well, I have a lot of pretty wallpaper in the form of option certificates and the like.
Anyone who makes decisions based on the prospective value of options is a sucker. They are a nice bonus when they work out.
You're right that options in a reasonably well-established company can have some value, but such companies can also afford to pay a decent salary, and should.
> I tend to think of options as worthless, until they vest
This is a good idea, but I'm not sure it takes things far enough.
For the majority of developers, options are often not especially valuable even when they vest. The most common value outcome of a success/sale seems to be "modest bonus" (4 figures to low five figures) rather than a jump up to a different economic class. I suspect many devs could do as well by going out and getting new job offers every year or two, assuming reasonable negotiation skills.
Over many years as an employee for startups, I was employee number 24 of a $30M cash acquisition exit. The result was 6 figures, but just. Effectively it was a year's salary.
That's all my options were worth and to get that return, I worked for about 20 startups over 2 decades... only one paid off.
I got a huge windfall from a year and a half I worked for just 50bp, as employee #5 and a principal contributor.
Do the math. Cut 30MM in half, and give half to investors. That leaves 15MM. Divide that 24 ways and nobody's getting 7 figures. But of course, that's not how it works; at 30MM, even an extremely egalitarian division of what's left after investors recoup is still going to get you into low 6 figures.
The problem for this person isn't that 30bp is a stingy allocation. It's that for a company with 24 employees - or, very conservatively, a 4-5MM annual burn - 30MM simply isn't a very good exit, no matter how big that number sounds.
Which is why I will only work with unicorn chasers at this point. I can't stomach working for large, established companies any more, but there needs to be enough cheese to go around.
Sure, $30m isn't a great exit from a VC fast growth point of view, but with burn rates as you stated (if their revenue is about their burn) it's at or better than the traditional 5 x Static Revenue figure used for more established buyouts.
Of course in crazy VC world this is probably supposed to be $12billion valuation or some nonsense to be worth it.
For the fee of taking half the company, in this situation the VCs:
-- Cut the valuation by %90. If we had been allowed to execute the founders vision (which could have been done bootstrapped) we would have exited close to $300M. (A competitor went that route, they started after us, exited before us for > $300M
-- Set us back by 6-18 months. One of the decisions forced on us by the VCs was to build on top of [another one of their portfolio companies technologies, we'll call it FOO], but FOO didn't have the performance or features we needed. Literally lost at least half a year on the product because of this (And a whole lot of money paid to FOO and their consulting arm.)
-- Forced us to sell before we were ready. When the economy looked like it was turning the VCs needed to raise cash to make their funds look successful, and decided that we weren't going to get 5 years after investment, since they could offload us now for a nice multiple they did so.
It happens this company could have gone without the VC round and bootstrapped its way. If it had done so, it probably would have exited for around $1B, maybe much more given that it was kicking google's ass.
Usually, the problem is the opposite. A 30MM acquisition is a limping outcome for a VC. Usually, the problem is that the team wants to sell, so that equity will be worth something, and VC wants the company to shoot the moon, because a 1.5x outcome doesn't move the dials, and the model is that the 10x's pay for the 0x's.
There's not a lot you can do as an employee about mismanagement that results in crappy outcomes. But it's an orthogonal concern to how equity is allocated. The commenter upthread was right when they said: part of your job as an employee is to pick the right company to work for.
That's the theoretical view of the VCs that they propagandize and that is accepted pretty widely.
The reality is, VCs are herd animals, and when the herd is spooked they make a lot of stupid decisions.
I've seen this more than once-- a later company was forced to sell for $10M, by the VCs, during another "oh the money spigot might be turning off!"
It is not an orthogonal concern-- how was I to know the VCs were going to screw us over? The return would have been dramatically better if that hadn't happened.
So the lesson learned is-- the right company to work for is one where the founders either don't take VC money or are very distrustful of VCs and only take it on favorable terms.
Once again, these aren't so much opinions as they are mathematical facts. The modal outcome for a portfolio of startup A rounds is a 0% return on investment. If fully half the companies in a portfolio exit in the money --- which seems wildly optimistic --- and their average return is 150%, the portfolio loses money.
Nobody is entitled to venture capital. Plenty of people start companies without it.
Yep, but I couldn't care less about the portfolio, and the founders shouldn't either. You're pointing out why VCs need big exits, and even a profitable one like this one may not be profitable "enough", but that "enough" is their portfolio view.
From a founder view, we shouldn't be carrying the weight of the effective cost of the fact that the VCs can't pick companies worth a damn and want to make it up on us, if we happen to be good.
Nobody is entitled to venture capital, and starting a company without it is a good idea.
And VCs are not entitled to more equity & control than makes economic sense for the founders. That's what I'm opposing, but I don't think you disagree.
You very much do care about the economics of VC if you need their money to build your company. No professional investor will give you terms that will lead to them losing money; that's irrational.
People don't sell equity to VCs because they've been snake-charmed by them. They do it because if you need 2MM+ for your company, they're the only realistic option. Ever talk to a bank about a line of credit against receivables? That's a fun conversation.
Yeah, I agree. For VC funded, the investors won't be getting a good return (if any) on their investment. They'll probably lose money after all the venture banking fees are out of the way.
I think the question of what is a good return these days is a bit crazy. For this size company VC's should be looking at wanting a $150-300m exit on the low end. But unicorns are polluting this kind of idea.
For non-VC funded (bootstrapped, etc.) it's about an expected sale price for an established minimally growing company.
Here's the ground truth: if you build a company with someone else's money, they're going to get a huge chunk of the upside, and the original management is going to retain control only as long as they hit their numbers.
Hopefully, nobody is saying employees shouldn't be wary of VC funded companies. They definitely should.
No, that's not the ground truth. That's the rationalization that founders tell themselves to justify being screwed over.
If you take someone else's money, they should get ownership proportional to their investment, yes. Their impact on whether original management retains control should be proportional to their ownership.
The problem is, the crazy ideology of VC worship that has taken hold allows VCs to get disproportional control and chunk of the proceeds.
People are saying that founders shouldn't be wary of VCs. VC blogs are full of propaganda and rationalizations for giving them more control and more upside than is proportional to their investment. When the blogs make it to HN, the commentary is universally in support wit the rationalization that "they're taking risk, they need to protect it". They are taking a lot less risk than the founders who can only work for one company, nota portfolio... and the risk VCs are taking is covered by their equity. They don't need second and third helpings of control and equity to cover the risk.
I'm getting downvoted for saying VCs are idiots. (elsewhere people are getting upvoted for saying "Deniers are morons", so it's not the name calling. Its' the "if I can just get thur YC and get VC funding I'll have it made!" ideology that pervades HN.
> I'm getting downvoted for saying VCs are idiots. (elsewhere people are getting upvoted for saying "Deniers are morons", so it's not the name calling. Its' the "if I can just get thur YC and get VC funding I'll have it made!" ideology that pervades HN.
No, there's a critical difference between your statement and that one: VCs are an identifiable class of people. Saying they're all idiots (something you don't know, couldn't possibly know, and indeed is not only false but obviously so) is attacking a specific group of people. "Deniers are morons", while obviously not a high-quality thing to say, is closer to a tautology. Both break the HN guidelines, but the former is worse.
This is not ideological. One needn't agree with everything every VC ever did to insist that calling them all idiots is wrong, breaks the site rules, and is correctly downvoted.
Sam once wondered whether we should make it explicitly against the HN guidelines to attack whole classes of people. At the time I said that sounded too legalistic. But it stuck in my head, and I have to say that every example I've seen come up in practice since then has suggested the value of such a rule. This is a good example.
I'm certainly not here saying "if I can just get thur YC and get VC funding I'll have it made!". I bootstrapped my last company and am bootstrapping this one. The mathematics of VC are a big part of why.
I don't understand the question. If the money isn't very valuable, it buys less equity. Companies who raise money typically talk to tens of firms looking for the best terms.
This isn't even good snark. It doesn't make sense. Venture capitalists aren't investing their own money. They're taking money from other people's pension funds. They can't just give people's retirement funds to software developers to be nice.
You're certainly not paying for 24 people's salaries for 3 years with a $3m investment unless the company hits profitability very quickly (within the first year).
True, but I think lots of folks here have no idea how much revenue you have to bring in to cover 20+ employees. Lots of people think it's just salary*20.
Well in a software company salary is generally the dominating factor, so it is on the order of what you mentioned (times a multiple depending on how cushy the amenities). In my unqualified estimation, the multiple can kill you... seems like about 2x salary for SF, 1.6x for NYC, though my company prides ourselves on keeping it a lot leaner than many of our compatriots.
I think that multiplier is what bane was alluding to. Incidentally, your numbers seem low for software devs - I'm fairly certain I cost well over 2x salary (NYC). Although my company prides itself on compensating well, so maybe most startups run a lot leaner than that.
What % of the company do you think the 24th employee should get?
Obviously it's highly variable depending on the role. #24 could be a COO or could be a receptionist. But for the sake of argument let's assume they're a mid level engineer (taking a stab at what MCRed might have been at the gig in question).
The percentage really doesn't matter. Assume that you could get a $150K cash/stock at a public company (meaning concrete valuation). A startup offers you $80K and says "here is equity to make up the difference". If you assume three years and a 10% chance of them being worth something that means you need RSUs worth at least $2.1M to meet expected loss of salary. I highly doubt you are getting that.
Here's what 20 years of experience working for startups has taught me:
-- Either be a founder if you want to be there in the early days.
-- Or join a "sure thing". EG: Google, Twitter, Facebook about a couple years before they went public were already household names and really well known.
I don't know how much upside you get joining a sure thing like that, but that's how you make sure your options will come into money.
Being employee number 5-100 of the average Silicon Valley startups is a losing proposition because the risk adjusted value of your options will never compensate you for your lost salary. (especially if you have to live in California- you're better off working for a startup in Austin than California due to the cost of living and tax situation. The higher salaries in California don't cover the difference.)
And yes, blame me, I turned down being employee number 13 at what became a $6B enterprise software company. Would have been CTO or way up in the executive team because they were a bunch of biz guys who needed a hacker. Instead I worked for just a year for a small business (not really a startup this was before "startups")
But it's damn hard to tell the difference at those early stages.
And when questions like "what's the total number of shares outstanding on a fully diluted basis?" (back when companies would say "You'll get 10,000 shares!!!!111!!") are met with "sorry that's confidential" during the hiring process, it is a bit difficult to do proper due diligence.
When you think about that $6B company, which if you are human you will do from time to time, don't forget to remind yourself of the other companies you turned down in the same timeframe. You know, the ones that went out of business. :)
This seems like good advice. There's definitely a "valley" where low (but not "Founder-low") employee numbers get all the risk and disproportional reward. But, I wonder, really how much someone hired at Google, Twitter or Facebook a couple of years before IPO _really_ got. We're still probably talking "nice bonus" money rather than "life changing windfall" money. And, for "nice bonus" money, it makes more sense to go for the security of a public BigCorp.
If you were at Google as a mid level engineer in 2002 (2 years before the IPO) you DEFINITELY made life changing windfall money. DEFINITELY. Take whatever guess you seem have in your head and multiply it by 10. Probably more than that.
(I started at Google in 2004 and did pretty well.)
There is another facet to your second point, I think. Even if the upside from the "sure thing" two years before they IPO is not great from a financial perspective, the career growth is much faster than joining a mature mega-corp. For example, many people who joined Google/FB/Twitter a year or two before the IPO are very senior at those companies now. Granted, not everyone who joined Google in 2004 is a VP, but the probability of rapidly growing your career as the company grows is much higher than for someone joining Microsoft in 2004.
That fast career growth leads to either 1) High compensation ten years later as a director/VP or 2) Exec roles at sure-thing unicorns with meaningful equity, should they choose to leave Google/FB/Twitter.
I think there are two justifications to go early stage if you care about the financial aspects:
1) Be the founder, as you said
OR
2) You have concrete reasons to believe that the company has a meaningful competitive advantage in a large market.
These examples are far and few. For example, Google in 1998 had a meaningful competitive advantage, but Facebook in 2004 certainly did not. WhatsApp in 2010 did not, but I'd argue with Carmack, Oculus might have had (although unsure in this case). As you said, it's really hard to say at such an early stage.
Of course, if financial upside is not a major concern, then impact, agility, working on interesting stuff, avoiding mega-corp red tape, are all valid reasons to go early stage.
The biggest downward ticks to my personal net worth have been due to me relying on skills that I dont exercise often. Over time I have calibrated my judgement to mark the value of infrequently exercised skills to zero even though I might think I am a natural at them.
VCs are terrible at this. I can't tell you how many times in the past 20 years I've heard VCs say things like "you should move into [tangentially related area that we can't add value to that just had a big exit]"
For instance, when youtube got bought, VCs were all interested in investing in online video companies. At that point, though, Youtube had already been bought! They were like 5 years too late.
That might well be true, the point I was trying to make was that as an employee its dangerous to make decisions based on the belief that you are great at picking winning teams / companies. Sure VC's are bad it too, but theyre sensible enough to do it with other peoples money.
It's not a simply "$100k/$30M = Equity" situation, and I wasn't expecting people to go into this much detail.
My equity at hiring time was probably %1.5, I think. But there was vesting, of course, and also a whole lot of unsavory business, mostly perpetrated by the VCs.
Trying to go into the detail and tangle out exactly why I got what I got would be just airing a lot of drama from the past and not really applicable to others.
I only presented those numbers because they're two objective facts from the best payout I got working for a startup.
Assume we're talking about a senior developer and come up with math that reasonably gets #24 above 100 basis points. It's not impossible, but it's pretty tricky.
Remember, in a lot of companies, the founders are diluted way back below 10%.
To put this in perspective that's a lot less than last years share options (5 year plan) at BT. The last sharesave to vest returned >£100,000 Tax free if you had the max amount.
BT is a multi billion dollar company, not to mention that sharesave isn't the same as an equity compensation.
Share As You Earn SAYE is a savings plan in the UK which allows employees to save money from their salary in company shares.
The UK has really weird schemes because people have historically had no pension or savings plans from their employees (most PAYE workers still do not have pension as the date mandated by law is always being deferred).
With SAYE as far as i know the employer is not allowed to grant you equity, what they can do is give a fixed yearly rate (usually heavily discounted) for share purchases, but it's not as sweet as it seems.
The dividends and the equity rights from the shares belong to the employer not the employee, this is basically a way to allow employers issue shares (in large volumes) without losing control over the company, having to do payouts, and decreasing the market value of their normal shares as SAYE shares are not tradeable.
It also allows employers to bypass various laws preventing normal employees from having too high of a share of the company, and ties employees to their employer since not only do they rely on it for their salary but also as their investment/savings provider and since SAYE plans are either 5 or 3 years long it pretty much means that invested employees will not living the company during the SAYE period unless they want to lose their investment (and yes they will lose it).
BT's Sharesave is also a "unicorn" and from the current buy-in value it will probably won't repeat it self, yes a few people who saved up the max amount (225 GBP a month) gotten about 80K in return. But and this is a big but those were the 1st shares issues at 80p per share, when they matured the shares closed at over 300pp/s the last round of the SAYE program had a buyin of 250pp/s so pretty much no one will see these returns again.
P.S.
The money you gain for SAYE Isn't tax free you pay capital gains tax on it if you sell them once they are matured.
Also since SAYE with all of it's bells and whistles is a company options plan (with heavy tax incentives to the employer) it's still a risk, some people got huge returns others didn't since the share price was lower than the option price.
Err no the UK used to have very good pensions schemes.
BT has a FS scheme unfortunetly now closed to new entrants and its DC pension matches up to 8 or 10%
The shares you get from share saves are real shares none of this multiple share lasses with different voting powers.
And I certainly get the divi from mine. And yes this years BT is a v good one. And I did 400% roi from my REL shares a couple of years back and you can normaly mitigate any tax by sensible use of ISAs and using your CGT Alowance.
And there are share schemes for high performers on top of that I know people that got some the share save is what everyone gets.
I think you are confusing state pension with employer pensions, employer pension contribution are only now being mandated by law, and most companies which use PAYE and are under 50 employees still do not have to do it, the dead line now is 2018 but it's been pushed back all the time.
The shares you got from Sharesave would be "real" shares only if you bought them at the end of the maturation period if you cashed out you wouldn't get to keep any shares, and you don't have voting rights or dividends for those shares while they are in Sharesave.
What does the base rate have to do with it now you don't have to buy an annuity.
And saving tax now at 40-50% and only paying standard rate later is a no brainer and if you can do it via salary sacrifice and get some or all of the NI added to the pensions
If the base rate was higher then property would be a lesser investment.
It's entirely crazy. I just asked for more cash and chucked the money on the commodities market. My portfolio is worth 178% what it was 12 months ago. Sod tax. Sod pensions.
That cash goes into house. That house I live in. Better interest rate. Sell when the kids have moved out. Live off cash, dumping bits of it in various other investments to avoid inheritance tax in the future.
Yes. I work in the finance sector and deal directly with the providers that sell this shit ironically.
The tax relief was nullified instantly by the discussion with my employers that sort of went "give me another £10k or I go work somewhere else".
Meh.
I don't actually have a problem paying tax. I've learned to consider my income after tax, not before. Maximising the difference is easier through getting the initial captial larger than it is reducing the difference and doing the associated paperwork (and periodically getting buggered by HMRC). I can still move up another £30k if I want to but the current place is convenient.
how is it not? you get options that you can exercise at some point in the future - you have to pay to exercise options in the USA.
The main differences are that for approved schemes HMRC doesn't screw you like the IRS does and if you leave early you can exercise your options and the is far less chance of being diluted.
The UK has an allowance for a company option plan which allows employees to buy stock also.
Save As You Earn is different, you get options, but you don't buy in for them directly.
SAYE allows the employer to deduct upto 225 GBP a month (pre tax) from the employees salary and put it into an investment scheme that ties that money into a share options plan.
The shares have a set value at the entry into the scheme and the company "allocates" an amount of shares based on the end savings projects for that period.
At the end of the period when the options mature you can decide to cash out get your "deposit" + a proportional revenue from the shares maturation value, or to buy out the option at the set price and own the shares fully.
The payout out, the control over the stock, and some other factors are quite different than just a simply option scheme when a company allows employees to buy option/shares or gives it to them as pure compensation.
Basically the best way to describe SAYE is like an ISA/401K but one which the employer controls, and also greatly benefits from.
Now don't get me wrong SAYE schemes especially for low paid employees in freshly privatized organizations can yield good payouts, not always, but they usually do especially when the organizations are too big to fail like BT.
It also allows companies in industries which are barred from regular employee share/options like banks for example to grant employees a share investment plan.
But it's not some magic nifty employee empowerment plan, it's much more beneficial to most employers than it is to employees.
How are unvested and unexercised options in the USA any different to share save? you don't get the dividends until you vest and you cant vote them until they vest.
And BT does have other share schemes I know as my PM got some as a bonus for his work for the millennium dome - these tend to be kept quiet in fact my pm though it was a joke by some of v senior mates
That you actually don't buy anything?
Until the Sharesave contract ends the money you "save" is just a normal savings account with a fixed interest rate set by HMRC/Treasury.
Basically BT gave you a very wierd option, the strike price is granted when you enter the SAYE contract e.g. 2010, but the actual share option is given when the contract matures 2013/2015.
To put it in a more simple term, SAYE is a fancy "ISA", basically some one in the British government figured it out that most employees cannot buy into stock options at any reasonable strike price, SAYE only allows you to give a discount of 20% from the stock price on contract entry.
After 3/5 years you get a lump sum which you saved + the interest rate and a bonus which is derived from the tax allowance SAYE savings. You can use that bonus to exercise the option you got based on the strike price you had 3 or 5 years ago if the difference is good enough and you buy the stocks and sell them you might get a very nice amount which you pay capital gain tax on, if there's not much difference or the stock price is lower than the option strike price well then you pretty much saved about as much as you would in your minimal interest cash ISA.
What you'r PM got i think is SIP, Share Incentive Plan it's another approved scheme that allows companies to grant company stock to employees, it's works very differently than SAYE.
No fixed rate, no tax free bonus, it's taxed as income tax yada yada.
Factor in taxes and that would be way less. More like six months salary. Factor in inflation on top of it and that would be more like four months salary.
That's why they are trying to pay you with them. For them it's a one-way bet. It's sadly just another case of pushing risk onto the worker and not really passing on much of the upside.
It's also information asymetry. A classic financial arbitrage move. The founders offering the employees options understand all of the terms and scenarios that people in this thread are discussing, but most potential employees are not aware of these factors. Many potential employees will discuss their offer with trusted "experts" in their personal network who also are not familiar with the multiple scenarios that can devalue these options. Making complex financial deals with another party who is less sophisticated is always great for business. That's why employees should be even more careful when negotiating compensation with startups. If you can't spot the sucker at the table then the sucker is you.
And if the company decides to screw you over, it's really easy. If the pie is so huge that it's worth you getting a lawyer to fight back, generally 1) they aren't so selfish, and 2) they realize you will get that lawyer to fight for your piece.
There's 10 ways for you to get devalued to 0 and you have to avoid all of them to make a payout.
In my experience it's the opposite: the fact that employees generally either (a) regard options as worthless or (b) round allocations down to the nearest 100 basis points is a reason not to use them in compensation: the implied discount employees give them makes equity comp very expensive.
In fact: for this reason, I'd be especially wary of companies trying to buy a few thousand dollars of annual fully loaded cost with large amounts of equity --- it suggests extreme naivete.
In the life of every company there is a moment when there is not enough money to hire the next two people, but there is also a feeling that hiring those two people would take the company to the next stage so much faster as to make the hiring worthwhile. At that point you either raise more money directly from investors, or offer more equity to prospect employees, or hold back on the growth.
Raising extra money takes time, so it may not fit with the timing of things. Holding back should probably be preferential to giving away equity, however somethings growth is unusually important, for example when you're in the middle of a land-grab.
IF there's enough liquidation preferences, even a successful exit in the $50M range could leave nothing more than a fraction of your annual salary for everyone but the founders.
Every dollar taken in investment reduces the likelihood of regular employees cashing out unless it boosts the ultimate stock price and success chance of the company significantly.
Too much money is chasing too many companies so the founders are tempted to take the money, roll the dice and hope they become a Facebook, even though the odds of that are extremely slim.
This is the difference between a "startup" and a business. Startups used to be a phase of business, but it's become it's own thing now.
A business will not take money it doesn't have to, realizing that profitability will fund growth. (And to be honest, I don't see a lot of mechanisms by which VC money funds growth-- all of the successes hit a viral growth loop or opened a massive unmet need... the VC money just made product development easier... mostly after the tornado started.)
Actually you should count on them always being worth $0. Not only for compensation purposes but for your personal psychology. It's better to tie yourself to reality.
There's been a couple of stories here in the past where employee stocks have literally been worth $0 when they vested, due to financial shennanigans pulled by the founders.
options should be seen in the same vein as bonus money - they don't exist until the money is in your hands. Some people work at places where bonuses can be relied on like bedrock, but usually I see people struggle to get their promised bonuses.
It's very easy for shares in a liquid-seeming exit to be worth nothing, even with no shenanigans. For instance: raise a B round, and then sell for low 8 figures. Liquidation preferences will wipe out most of the outcome. People lose perspective about this, because they only see the final number (and the "employee shares worth 0"), but if you raise 20MM and then sell for 20MM, it's not hard to see why the shares aren't worth anything.
The founders do too. The venture capitalists, on the other hand, are deploying money that isn't theirs. It feels like you can argue that to the extent they do anything to cushion the outcome for startup team members, they have to be doing it at the (ultimate) expense of pension fund stakeholders.
I don't know how strictly true that is in most cases, but it's a factor worth considering.
I think of pre-IPO options as worth just more than zero. (I'd rather have them than not have them, but not by enough to give up significant salary). The possibility of dilution in most option agreements, combined with the time until vesting and the possibility of the company failing, means that it's impossible to put a solid floor under their value. I've made 5 figures from pre-IPO stock options twice. Nice, but hardly worth taking a pay cut for.
Options in already-public companies are quite a bit less risky. I consider employee stock grants in a healthy public company to be worth about 75% of the current value of the stock. (The discount is because of the vesting period. If I change jobs, I lose some of the stock. If I stay at the job just to get the stock, when there's a better opportunity elsewhere, I lose that opportunity.)
Even if options vest, they could still be viewed as worthless. E.g., Pre-ipo company, 4 years pass, all your shares vest, however Company might tank in the next 5 years, goes bankrupt, never gets bought out nor goes IPO, your vested shares are worthless.
It's like being paid in IOU: "1% of this lottery ticket's winnings".
There's multiple layers of risk and trust, too many dependencies. The transaction is too complicated and takes too long to complete. So the probability for exceptions to occur is great, and handling for those exceptions will likely fail due to the complicated nature of the transaction.
%0.01 Because even if it's %1 at the time you join, by the time the lottery ticket can be cashed in it will be diluted, plus liquidations preferences, etc.
Or you take a discounted salary in exchange for stock, and after all is done you earn barely more than if you had just went somewhere else for full salary (if you are lucky you get that much).
Or you have a disagreement with your boss and leave, and while you are gone the company devalues the shares of everyone who left "because they aren't contributing any more."
But even if you're fully vested, if you can't sell your shares, they're essentially worthless (technically the term is probably "illiquid asset"). Until there's an "event" (IPO, acquisition, probably more), they can't be turned into real money.
And if you leave the company they actually cost you money, since you have to pay out of pocket to exercise them (for stock that may end up never being sellable) and you also have to pay AMT taxes based on the latest company valuation.
Can't stress this enough. If you have Employee Incentive Options is way better to exercise them as soon as they are vested than to wait (if thinking of exercising at all). When you exercise them you pay AMT on what they are worth when exercised (of course the "fair price" is a hidden secret left for the CFO). As time passes, the "fair price" is probably going to keep increasing, but with no liquidity and inability to sell your options you are stuck with the AMT with the fair price at the moment of exercise
Which is a risk, especially in companies where the strike price is close to $100/share. If it's going to be in the $10k+ range, is it really worth it to potentially reduce your future tax burden? Maybe. But it's also possible that your shares aren't worth that exercise price. Speaking only for myself, in my experience I decided to wait to see if the price was ever justified before buying the shares, and if it means a higher tax, then so be it. Otherwise, if it means walking away from vested, unpurchased shares, so be it.
Yep. Just because you CAN early exercise does not mean you can afford to do so.
I was fortunate because I was able to early exercise shortly after grant but when I knew the company was going public. Had to borrow some money to do so, but the couple hundred I probably paid in interest was more than made up for in the tens of thousands I saved in income taxes.
It takes the right scenario, to be sure. At the time I had no mortgage interest deduction so I could afford a double-digit paper AMT gain; I was still only subject to normal income taxes.
In theory when you leave the company, if it has not gone public, you get paid back the money you put in. In practice, if it goes out of business, you just lost all of the money you put in.
I don't think the strike price is really important, it's the exercise amount that matters. But there's certainly an element of risk, and saving money on taxes is nice, but not losing money is nice too.
Yes it is a risk, and it's worth careful thought. Mainly I just wanted to make the point that you don't have to wait until they vest. A lot of people don't realize that.
This advice could be risky. If they assign stock to you and you exercise it and there is any different between the current value and your strike price, that can be exactly what triggers the AMT.
If you exercise and sell at the same time, you will pay short-term income taxes, but without any AMT to worry about.
When the stock is assigned to you then there should be no difference between the current value and your strike price. That would be very unusual. That is why I was saying that waiting until you vest might not be a good idea because by then you might have an AMT issue.
I agree that exercising and selling can be a good strategy but we're (mostly) talking about private companies here where that may not be an option due to a lack of liquidity.
It should be noted that the choice to allow "early exercise" is made by the company granting the options. While it might be a good tax strategy, you do not (to the best of my knowledge) have any guaranteed right to be allowed to exercise your options until they vest:
That's an expensive lottery ticket. I used to do that, but on my 3rd startup now and yet to see anything. I could have bought a new car with what options I've converted.
Not all illiquid assets are worthless. It's specifically the combination of being prohibited from selling and no prospects for ever receiving a dividend that make these shares worthless. In fact, a share you cannot sell but does pay dividends is very similar to the kind of revenue- or profit-sharing arrangements the author suggests.
Yup. I ended up quitting my day job to work in a startup just a week before my options would have vested at the 2 year mark. That was several years ago and that company still hasn't been sold.. those options would still today be worth nothing.
Agree. Also the return on the options should also be compared to a risk-free/conservative rate from the additional savings from the higher salary.
In somewhere with a high cost of living like SV increases in pay can significantly increase what you can save each year.
Say you take a $100k offer and equity compared to a $120k salary offer. Now lets say on $100k you save $10k year, and if you're on $120k between tax and a bit of extra spending you save $20k.
You've doubled your savings which you can put towards other investments. In this example its another $10k/year you could put into an investment property, stocks or whatever.
Or just go to Vegas each year and play a game of roulette.
This is waaay over simplifying things. How much options are we talking about? 10% of the company? That's hardly worthless. Public company? Private? What stage is the company at? Secondary markets exist all over the place.
I think you really have to put it in context. There are companies that are objectively "pre IPO". That's no guarantee, but it's a probability. So you can start to make educated guesses at Expected Value.
If you're joining as the 5th or 50th guy, your options are probably a long-shot and they're not really worth considering. But if you're joining a pre-IPO company i suggest that you minimize salary and maximize options. There are a lot of great outcomes in the $50-250k/year range in option value. It's no lotto ticket, more like an extra salary in addition to your base salary. And it's tax advantaged!
The latest shitty clause that Valley companies are including in their options contract prohibits you from selling fully vested and exercised shares even if you have a willing buyer.
Apparently companies saw all the employees getting rich from private companies like Palantir and Facebook pre-IPO and considered that a problem to be solved. Check your contract, you probably don't "own" the stock you think you do.
as an employee, if you are lucky/skilled enough to end up at a successful startup, and you aren't very careful with tax issues, you can find yourself stuck: if you leave, you have to exercise, and immediately owe hundreds of thousands of dollars (or more!) on a completely illiquid asset that you can't sell. Which doesn't even take into account the potential for that asset to become less valuable.
That's not a decent way to treat people. Startups don't write the tax code, but many are willing to take advantage of it to control people this way.
After you put your 4 years in, you should be free to re-up or leave. Not free to leave if you are willing to risk all your liquid assets and/or borrow heavily.
That's a different issue - that many options agreements require exercising within 30 days of leaving (or so). There's no reason it has to be done that way. There are very good reasons that restricted stock is, well, restricted.
And if one person leaves it's not likely to materially affect the business as everyone else keeps it going.
Another point of view is that if all the early employees disappear at the 4 year mark (or whenever they feel they've vested "enough") that could cause very serious problems for the business. There is an element of a prisoner's dilemma here and it's not unreasonable to think about ways to keep people from defecting.
I'm operating under the assumption that most people aren't counting down the seconds until they can leave, but some will want to. Four years is a long time, and 10+ years to IPO is a quarter of your career.
I'm saying they shouldn't consider a solution being something that restricts they're employees. They should be looking at why people want to leave, instead of how they can prevent people from leaving.
That's the value in derivatives. Equidate & others like it avoid all these problems by selling the economic interest of the stock without adding shareholders.
There are some very tricky legal issues for companies when employees start selling on the private market. I will admit that I'm not terribly well versed on them, but IIRC these private sales essentially forced Facebook into an IPO that they weren't necessarily ready for.
Well, on one hand it is a pain the buns for the company in facilitating secondary transactions. On the other, it makes good sense that it should be doable. The secondary markets like Sharespost/Secondmarket don't seem to have made much progress in getting companies on board.
There are a few other secondary solutions, including mine (full disclosure: co-founder of EquityZen here).
Ultimately the company (the issuer of the options) holds the cards on these transactions. For a robust secondary private market, you need to:
- keep the company aware of the transactions, and understand their transaction process (right of first refusal, board approval, other transfer restrictions)
- provide that the buyer has been vetted and is an appropriate entrant on the company's Cap Table
- ensure that you are non encroaching on the company's own plans to provide systematic liquidity to their employees
- keep an audit trail of the transaction process to ensure no leakage of sensitive (or non-public) information
We're headed in the right direction. Pinterest deserves credit on a few different fronts:
1) Allowing employees to extend their window to exercise their options once they leave the company
2) Providing liquidity to their employees
I'm curious to hear from any hiring managers on this thread: do you think that offering liquidity/financing solutions for exercising options/helps attract better talent?
I'd actually like to lay the blame where it belongs, at the feet of YCombinator (the incubator, not the commenter crowd). YC's boilerplate options plans included share transfer restrictions and made early exercise (83b elections) out to be the bogeyman. Almost every YC company has the same option plan because of PG's tutelage. People copied these plans because "hey it's what YC does."
Let's be perfectly frank and talk about the facts here:
1) There is zero cost to the company to allowing 83b elections. All it does is remove the possibility of golden handcuffs (which are very effective when a new unicorn is minted every week).
2) There is no more "500 shareholder rule" after the JOBS act. It removed that. There is no penalty for having lots of shareholders -- especially when most stock transferred has no voting rights and no disclosure rights. Facebook "paid the price" for having lots of shareholders but in reality they did not. GS's investor vehicle took care of that. Facebook was not "forced" to go public. They went public at an incredibly old age as far as growth companies go.
3) There's an almost non-zero cost to have another company (like SecondMarket) handle share registration and transfers. It's not a huge overhead. Consider it your Nerf ammunition cost for the quarter.
4) The state of current stock option agreements is not to help you the employee. It's for the benefit of the company. Option agreements in the 80's and 90's did grow out of an altruistic "hey we're all in this together" theme. Today, it's "hey I have to give you these things because everyone else does, but if it were up to me, you would get bupkis and free meals."
Full disclosure, I work at a YC funded, non-unicorn. My shares (on paper) are worth a fair amount of money, and I need several $100k to buy the shares and pay taxes. I feel like I'm in a not-uncommon state. I know my options are technically worth zero right now since I can't sell them for anything (that is the definition of worth), but I know my wife will divorce me if I quit and walk away from them.
I've heard that Uber is supposedly the worst at this. There's no timeline specified in the option agreement. You must offer them right of first refusal, but there's no mention of timeliness. They can (and do) choose to ignore every share transfer that comes up in a board meeting (unless you're in the elite inner circle and are allowed to sell shares).
tl;dr Don't even consider a position at a company whose option agreement won't let you early exercise and won't let you freely transfer shares.
The typical thing I've seen is 1/4 of your options will vest after 1 year, upon which 1/48 of your options vest every month thereafter. Other companies may do it differently.
Also if you leave the company early, you will usually have to pay some trivial amount (possibly thousands though) to keep the options.
This has at least been the case at all startups I've seen.
With the 1-year cliff in place, I'd rather options just be given to departing employees, as it seems like payment for their work.
The vast majority of new option grants for VC-backed companies are under the 1/48 monthly with a one year cliff.
More companies are now switching to converting ISO grants to NSO after you leave a company, and allowing a longer term to exercise. Pinterest famously allows, in some cases, employees to have up to 7 years to exercise vested shares after leaving [0]. Most companies do not do this (yet). Exercising an ISO grant can be much more favorable taxation wise than exercising a non-qualified NSO grant.
If you give shares to an employee, it will likely be a taxable event, as the IRS sees this as taxable compensation.
Also, most grants are at non-trivial strike prices. If you're a super early employee, you might have grants at a very low price, usually a few cents. However, the vast majority of grants are at much higher strike prices where exercise costs are processed in the tens to hundreds of $thousands.
Exercising and taxation are a difficult topic that very few fully grok.
If you're likely to hit AMT, the difference isn't as stark. It can be really easy to hit AMT especially if you've been at a firm long enough that your strike price is considerably lower than the current fair market value (latest valuation).
NSO also has a few other downsides. For employees, when you exercise an NSO, you actually have to pay tax at the time of exercise - the company withholds it and reports it as ordinary income tax (pay taxes in addition to the cost to exercise).
ISO grants can also have horrible tax implications, but you at least get a bit more flexibility as an employee -- this is also why November/December tend to have a disproportionally high number of exercises, as people get a full picture of their potential AMT liability caps.
When a company's valuation is skyrocketing and liquidation is highly likely (IPO or other M&A event), you'll often see companies offering early exercise, which can help avoid huge AMT hits, so employees are exercising when their strike price == the company's current fair market value.
often much more than thousands -- I've personally spent $12k in strike price alone, not to mention the potential tax implications which can be ruinous if you aren't careful
Not exactly true. You can get pretty rich in ~15 years if you save and invest a good percentage. The average American consumer is incapable of doing this, of course. Why save when you can spend, spend, spend?
Let's say that you get paid $100k for 5 years, then $150k for 5 years, and then $200k for 5 years. Nominal. So you take home $80k, $120k, $150k.
You invest half of your take-home salary, so $40k, $60k, $75k.
You invest everything at 4% real return.
That about $1 million after those fifteen years.
It's....... pretty rich, sure. It's also a LOT of savings. I'd say it's possible to get rich on salary if your salary gets high early and fast, or by the time you retire, maybe less so in fifteen years.
But, if you're able to stick to the plan you outlined you're probably living on $40k the entire time, which means you can live the rest of your life on that $1 million, due to the assumed 4% real return and 4% withdraw.
I've made more money investing in stocks and options than I have from options. Over 20 years as an employee (so excluding time as a founder) my returns from investments is 2-3X the return from startup stock options.
And that's as only a part time investor. I like sure things (like I knew in 2001 from an understanding of economics that there would be a housing bubble and that it would eventually burst. I was never able to buy CDOs against the market, but I did profit from it until 2007 when things got crazy and I got out of the market-- a year early but I'll take it.)
I suspect most people can't do this... but they can buy a house or two in up and coming areas, and put extra salary into that. Rent one out, get your mortgage paid by your tenants and you're building a real estate empire... slowly, but it can make you rich.
I'm very surprised when I discover how uncommon it is for [even] our industry to invest in equities. Somehow stock in a company makes more sense to most than compound returns.
It's even more surprising when I find 30 year olds who haven't figured out to use the company match on their 401k yet.
In other words "It's easy to make money if you have a lot of it already"?
Useful advice for a micro-fraction of the population, but this sounds like advice on "How best to wax your yachts" compared to even the average developer.
But that's not "getting rich off of salary". That's gambling on the stock market. Sure, there are plenty of people who hit that jackpot too, but let's not lump that together with the idea that 9-5 salary is a way to get rich.
Investing in the stock market is not a game of chance. You may lack the skill or discipline to engage in that activity, and that's fine, don't do it, put your time elsewhere, such as the real estate method I described.
Calling it gambling, however, is dishonest, and is popular among those who want to use that characterization to serve the purpose of denying people the opportunity to invest. For instance, despite working in startups for 20 years, regulations prevent me from being an angel investor (though it seems its common in california to simply ignore those regulations) ... because people like you think that I shouldn't be allowed to decide where to invest my money. Yet I could go to Las Vegas and blow $100k in a weekend.
So, no, it's not gambling. It's investing. And shame on you for saying otherwise.
"People like me"? I think you're reading way into my comment. I don't care what you do with your money, it's yours.
Gambling is defined as "an enterprise undertaken or attempted with a risk of loss and a chance of profit or success." That's exactly what people do when they buy a stock or invest in a start-up. They just go to sites like E-trade and Schwab to do it rather than PokerStars. Unless you know of some risk-free stock where chance is not a factor (I'm all ears).
A gambling game where the house historically doesn't win (if you don't try to day trade). And historically, your money doubles in ~7 years.
> Sure, there are plenty of people who hit that jackpot too
Yes, many people hit that jackpot.
> let's not lump that together with the idea that 9-5 salary is a way to get rich.
There are many well off upper middle class that own multiple homes this way and retire at a reasonable if not early age, with a net worth that will leave substantial amounts to their kids.
These people called "executives" can. Programmers generally don't, unless they're very good and very mercenary, and even then "rich" means "7-figure net worth and the ability to consult at a decent rate as much as one wants". Which isn't bad at all but isn't VC MegaBux.
> (I'd work my ass off without options, but the options really make it easy to say "I will do everything in my power to make this succeed" instead of "I'd rather go spend time with my friends tonight").
that implies that it is somehow better to work 24/7, when in fact often you get your best ideas when you are away from work, with friends, working out and so on, all things that are just as important to remain fresh and not burn out.
Considering that until you exit you can't know how much your options are worth (due to valuation, dilution, quarter results during the lockdown period after going public, etc. etc. etc.) to me options are worth $0 and do not come into play at all when evaluating a job at a company.
From my perspective it's all about what I'd be working on and with: is it something I believe in? is it something that has a chance of success? is it something I would see myself happy to work on every day? are the people I would work with people I can mesh well with? All of those are a lot more important than a lottery ticket.
Another thing you might want to consider on the hiring side is that paying way below market salaries and offering options instead you are likely to attract employees that find that agreeable, which might or might not be who would help you be successful: sometimes it might be better hiring a single experienced developer at market than 2 less experienced ones that are willing to work for cheap, especially towards the beginning when it comes to making architectural decisions that might stick around for a long time and come back to bite you later.
You could work your ass off and make your company a huge success, but due to vesting and liquidity preference wind up with nothing. Unless you have enough skin in the game (read, you are an investor or founder), your options mostly useless.
That is not actually the case! You found a company with idea X, which turns out to be a terrible idea that takes 3 rounds of funding to find out how terrible it indeed is. You pivot to idea XY, work your ass off and find traction! Take another round to grow and exit for 100mm. You're rich! All thanks to your great work! Too bad you were diluted to all hell in the previous rounds and you're not actually rich.
My point is that the company's success is defined in terms of current revenue and future prospects. Your personal definition of success in determined by the delta in the value of your stock options between when they were issued and the present.
Given that a seasoned and in-demand engineer can make anywhere from $250K to $500K annually working for a big co, without a 3-letter title and 3-letter title equity, there seems little incentive to accept $150K or less and ~0.5% or less equity.
Calculate your expected return over the next 5 years. Most startups come up really short.
I wouldn't even call this inflated in the valley anymore. There are outliers making serious money right here, right now. Such a salary pairs nicely with our lovely $1M+ median house price to insure we can never afford to buy one without living like a monk or going up to our eyeballs in debt. If you don't believe me, then just who's buying those $2M+ houses that stay on the market a week or two? SPOILER ALERT: Double income couples each making that kind of money.
In fact, I'm making the kind of money from my first post (not bragging, you asked for evidence). But what's really funny are the isolated unicorns out there making $1M+ annually because they were both very smart and very lucky to have the specific skills for a hot technology that ignited a runaway bidding war between giants. I have never been close to that lucky but I have witnessed it firsthand.
As for me, my offers are $250K+ when I've interviewed for big co or late stage startup positions. In contrast, my startup offers are $150-$200K with 0.7% or less equity. The startup offers are completely uninteresting to me at that level. I'm better served branching out on my own which I may or may not do someday (YOLO and all that).
Congratulate yourself, because you are, for sure, a fortunate outlier! I don't doubt that there exist engineers out there making $250K+, but they are definitely not the norm, big company or small. Check out a bigger sample of Bay Area companies on Glassdoor. My bet is you'll find the middle 90% to be between, say, $90K and $150K.
Every level 5 (senior) engineer at Google and Facebook converge around $250k in total yearly income (probably more for facebook recently since their stock tripled in the past year).
Really? My starting salary as a level 1 engineer in the first dotcom boom was $115K. Now had I taken a more fun (but as it turns out in reality frequently not very fun) job in the game industry, that salary would have been ~$70K. This of course is an industry segment with its own crazy outliers.
Fortunately, someone sensible figuratively smacked me upside the head and convinced me to take a more practical job (which ended up pretty fun actually).
A) I am not a (major) outlier (or many of my friends are major outliers too). Bottom line: Senior Engineers can make $250K+ today. Burn that into your synapses. The Netflix listings already posted here demonstrate that. I know Facebookers and Googlers making twice that or more and they weren't even acqui-hires. Glassdoor (valuable information source it is) IMO oversamples the discontent. Senior engineering positions at hedge funds can be $800-$900K.
B) Sure, without getting too specific, I started out as a videogame developer writing games entirely in assembler, branched out to multi-processor and multi-user games also in assembler, and that set me up nicely for writing device driver code for Windows and that's how I got my first gig in the valley.
You can follow exactly in my footsteps by really learning C/C++ and how to optimize it on x86 processors or whatever takes their place down the road. I'm not writing x86 much anymore, but I'm still writing very low-level parallel code, and it is next to impossible to find people who are really good at this because they've either been snatched up by Big Co and hedge funds making far more than I do or they're nowhere near as good as they think they are.
But who knows what they future will bring, so don't follow it exactly but instead go learn the things that are both in demand and that people complain are too hard. That's what worked for me. When game developers said 3D was too hard, I jumped into it. When game developers said multi-core was too difficult, I mastered it. And those are the skills that led to my biggest paydays(1).
1. You can of course make $100M doing nothing but Ruby/Javscript/Python (and especially PHP), but that wasn't the path I took (though sometimes I think I should have).
> But who knows what they future will bring, so don't follow it exactly but instead go learn the things that are both in demand and that people complain are too hard. That's what worked for me. When game developers said 3D was too hard, I jumped into it. When game developers said multi-core was too difficult, I mastered it. And those are the skills that led to my biggest paydays(1).
That sounds like a rather neat advice right there.
I know Google, Facebook, etc. also do but those salaries are probably reserved for the van Rossum's (Google/Dropbox) and the Lerdorf's (Etsy) of the world.
No, they're not. Google paid me well to be the equivalent of an NCG python script kiddie. I'm the one that got bored and failed to convince them they ought to be making using of the skills that made them notice me in the first place.
I'm no van Rossum, but I'm pretty good at the thing I do.
I've been contacted recently about a VC firm offering $350k+ for a frontend developer to own the frontend web app. I had to turn it down due to lack of flexible hours, but it otherwise intrigued me.
I also have been told by a friend that his brother ran a company that was acquired by Google for $100m, and suspects that his brother makes several million $ a year from Google (he wasn't ever told how much) - that is probably more of an outlier though.
There is a very strong incentive when you make that kind of money to not let anybody know that you make that kind of money. There's zero upside and lots of downsides - jealousy, people asking for money, awkward conversations, competition in your niche skillset, etc.
I feel you. It seems like the very high paid tech workers prefer to be incognito. This makes sense since they must have an essential and scarce skill set to bring in that kind of money.
I think the bigger problem is that the current VC trend (which means the current startup trend) is to extend extra, long term rounds of private financing, which lead to positive exits pre-IPO, but only for preferred shareholders ... of which most individual contributors at startups are not, rendering "equity" almost completely worthless regardless.
This. A while ago I was looking for a job. I had offers from large companies at N00k per year with bonus. CEO of start up offered me 50% less of the combined salary and bonus and then explained he was making that up with equity. My counter point was that he was asking me to invest 50% of my total compensation over what could be 5+ years in the company and if that was the case the equity compensation should be higher to reflect that risk premium as well.
We didn't see eye to eye on that and I work at a large company now.
Yeah, i think it's important to do the math. And do that math together. Say, 1000 shares @$20. how many companies make it to IPO? let's be generous and say 10%. What are the odds you'll still be there in 4 years - even with the best of intentions 95%? That right there is down from $20,000 to $1900. Also, that's in future dollars, so inflation will eat away another 3-4%. $50 dollars a month more at some other company wins by over $500.
They are not worthless, but it's important to value them accurately.
The odds are good. Unfortunately, founders often take a very low salary. That's not necessarily bad, but the emotional effect can be "if I'm struggling, so should you".
It's similar to people who don't take vacation and think it puts them on the moral high ground.
Worse, even with the %50 pay cut (or worse!) many startups expect you to take, the amount of options you're given are really trivial.
It is possible to value options using black scholes or other valuation metrics. But every time I've run the numbers the present day value of the options is never even 1/10th of the value of the salary you're asked to give up.
I've concluded the only way to do a startup is to be one of no more than 3 founders.
Then, if the shares pay off, the return might be worth the risk.
Know of any good web-apps or other easier to use programs for the layman to calculate these things? Thank you for mentioning these formulas too. These give a person something to argue with.
There's probably an even simpler model than that. Consider the pay cut you'd take to work at the startup... how much equity did the seed-round investors get for that much money? Multiply that by 1.5-2x (just a guess, perhaps someone has a better idea) to account for their liquidation preferences.
If that's less than your equity stake, then take the corporate job and use the extra cash to invest in startups.
Good idea, but then you are relying on what they told you the investors put in for that equity. If you can find another method to verify that info, all the better. Also, you are correct in saying that you should get at least that valuation matching, if not more due to the seat you put in.
Your potential payout is your number of shares x the share price.
So let's say that comes out to $100K.
You have to discount that to present value. Money is worth more now than it is in the future.
Assuming an interest rate of 5% and there being a liquidity event in 5 years that is (1.05 ^ 5).
So $100K in 5 years at 5% is worth $78K now.
You also have to factor in risk. There are various models but I like to simply multiply by the probability of exit.
So if there is a 10% chance you will see something then I take the $78K and multiply by 0.10 which comes out to $7.8K.
Also, if you exercise early there is even more risk. Let's say you paid $10K for them. That $10K invested at 5% would have netted $10K * 1.05 ^ 5 = $12.8K.
So you are risking $12.8K to make $78K. But I would compare it as $12.8K vs the adjusted average expected return ($7.8K).
The amount (and degree) of variables is so large that the exercise is essentially worthless. How can you estimate the share price or probability of exit?
You can't really but if you were to think about it that's how I would go about it. You can test different values and probabilities that you think are (likely|conservative|optimistic) and go from there. That gives you a range and a ballpark for different scenarios.
Personally though, if I can't predict something with > 90% accuracy/reliability then I'm not interested in investing in it.
This indicates that what you're looking for at the moment is cash, not ownership over assets. This is fine. However, this preference is by no means universal. I imagine that beyond certain amount cash isn't useful anymore and you begin looking for ways to invest it anyway.
Generally, cash loses value due to inflation, but offers high liquidity (you can spend it right away). Many other assets offer capital gains, but are a lot less liquid (you cannot easily sell them, e.g. the options in the blogpost).
I wonder to what degree the preference for cash expressed by the author of the blogpost may be driven by low interest rates (which reduce the appeal of many types of illiquid assets) and low inflation (which increases the appeal of cash) thus tipping the balance of incentives in favor of cash. Probably not the whole story, but may be a factor?
The point made was that options and salary are not fungible. Which is true, they're not. Working for a very constrained kind of investment asset is not the same as working for a salary.
You cannot always invest in what you choose. Generally, illiquid assets are both difficult to sell and difficult to buy. In particular, investing in pre-IPO startups may be hard unless the startup chooses to do crowd-founding, you know the founders or are a venture capitalist.
As someone who was a 1st employee at a small startup (who made the mistake of accepting 50% below salary for a few percentage points of equity), this rings very true to me.
However, my empathy goes out to early-stage (pre Series-A companies)...how do you get those engineers then if you, yourselves, have no money and know that equity doesn't pay the bills. Is it through revenue/profit sharing? Cause I would imagine if I wanted to start my own company, and I was looking for someone post-founders in a pre Series-A environment, I can't imagine my seed investments would give me enough cushion to hire near market rates.
Just playing devil's advocate here, but I wholeheartedly agree we need to compensate startup employees better.
Just as a point of comparison, there are financial engineering positions from small companies that put in their ads, "extremely high compensation." Risk is usually advertised in the internet space by the absence of that kind of committment to and confidence in the employee's contributions.
As a student, I used to see all high valuations of upcoming companies, and think that getting options at a startup is the best strategy for an employee, and one can get a shortcut to be rich. Then, I woke up and realized its not really true 99.9% of the time.
Are lottery tickets worth $0 until the drawing happens?
No. They are worth $2, or the price you paid for them. Likewise, pre-exit options do have value (as you note), but it is nonsense to simultaneously say they are worth $0.
Maybe the reason this is harder to grok is options don't have an established market price like lottery tickets do. Their early-stage value is simply a negotiation between employer and recruit (note: it's not the strike price). But it's a mistake to conclude that they have no dollar value, yet are worth something, just because negotiating a dollar value is awkward and hard.
> No. They are worth $2, or the price you paid for them.
Depends how you're defining worth. The ticket has multiple "worths". The first is probably around $2 which is what you could theoretically sell it to someone else for. The second is the expected value of the payout based on the prizes, odds and number of tickets sold. This worth could be $1 or $1.74 or it could be greater than $2 (think about the case where the prize is really high).
There is no way you could sell a lottery ticket for the price you paid for it. You could probably sell a $2 lottery ticket for $1...maybe. I know I wouldn't buy it...I would just buy the $2 ticket at the store and avoid the complications of the ownership trail and possible fraud.
> There's a potential for millions, but my lottery ticket is also worth potentially millions of dollars.
In reality, not even that is true for most options and most employees.
For most companies, even doing well and going to an IPO or acquisition isn't going to make more than a handful of employees rich.
Unless you get in very early (employee 10 or earlier maybe) or the company does amazingly well (think Facebook or Microsoft), you're generally not going to get rich off of stock options. If the company does really well you'll buy a new car and pay off your house, but the chances of retiring early are pretty low.
I have lots of options from various startups over the past 15 years. IPOs that got pulled, owners that refused to sell when they had the chance, bad management choices, etc.
Options are the equivalent of lottery tickets. Great if you number comes up, recycling if they dont.
There are plenty of people who join startups for the upside, and would gladly give up a certain amount of salary for options. Especially super-experienced people who are well-off, and would rather have more equity.
I prefer Wall Street's model of annual profit sharing.
VC-istan: you can get dicked out of your bonus for reasons you don't understand (liquidation preferences, vesting resets and cliffing) or that are purely political and lose 6 years' worth of expected bonus.
Wall Street: you can get dicked out of your bonus for reasons you don't understand or that are purely political and lose 11.9 months' worth of expected bonus.
I'd rather have the losses be limited, and have more opportunities for negotiation and revision. Wall Street's system is just better. We may not like that industry, but the facts are clear.
You're the second person on this thread to bring vesting (and "cliffing") into the same sentence as liquidation preferences. They seem like totally unrelated concepts.
Preferences are a trap (for everyone in the company, founders included): if the company takes money at an ambitious valuation, their investors probably have terms that claw back their money if the company sells for an unspectacular number.
Vesting and cliffs are pretty straightforward. You get no equity unless you last a year. You get get your equity in pieces over 4 years. That's pretty much the only sane way for a company to operate, and it's how every well-managed company runs.
I'm not sure what you mean by "vesting resets". How do you reset someone's vesting schedule?
I've long wondered about something, but I haven't been able to figure it out. This may be my best chance.
What is the difference between the following two compensation strategies:
(1) You get 100 options, that vest at 1/4 after one year and 1/4 after every following year.
(2) You don't get any options now. You will get 25 options, which can be exercised immediately (or whatever the equivalent status is of vested options), after one year. And similarly three more times.
I assume it's 30% (a) taxes, 65% (b) psychology, and 5% (c) something that happens if there's an IPO or other exciting event?
In short, where can I read about what startup compensation is, why it is the way it is, and the math behind how much it's worth?
The main difference would be the strike price of the options, which can make a huge difference in both taxes and income at a liquidity event. Assuming the company is growing over time, you absolutely want option 1. The strike price is determined by a 409a evaluations.
Example: assume the valuations each year are 0.10, 0.20, 0.30, 0.40, 0.50 and the sale price is $1 at year 5.
In option 1 your strike price will be $0.10 for all 100 options so should you choose to exercise you have to pay $10, netting you $90. You can choose to exercise these as they vest, paying $2.50 each year. If you choose to exercise on vest, your cost is the same, although you potentially will owe AMT.
This means that if you make enough money you essentially have to declare the difference between strike price and current value as income. This means you will have to potentially pay taxes on an extra $25 over the four years.
In option 2, exercising the options will require $5.00, $7.50, $10, $12.50 for a total of $35. This means you only make $65 in the sale.
And just to see if I understand correctly, if you exercise on vest, you have an extra $25 of taxable income over the four years, but then $25 less at year 5? There is no sense in which you have more taxable income; its distribution over time has merely changed.
The answer is that they're not the same options. Your respondents are assuming the strike price is FMV at the time the options are issued, which will be different at different times. There may be good reason for that assumption, if it's somehow prohibited to later issue options based on an earlier FMV, but it should have been called out because it's changing more things than just what you'd intended to ask about.
when you declare your income you subtract your cost basis from the sale price. In 1 you paid $10 and sold for $100 = $90 profit you have to pay taxes on. In 2 you paid $35 and sold for $100 = $65 profit. It isn't the time at which you exercise that makes the difference, it is the higher strike price.
EDIT: to be clear, 1 and 2 refer to the original differences in the first post. If we are comparing different exercise time with the same strike price, then the taxes are nominally the same (Because the income tax % you pay depends on your income, you might be able to save money by exercising in a year when your income is low).
Yes once upon a time companies could set whatever they wanted for the strike price but not anymore. I think there might still be a way to do it with complex bookkeeping but AFAIK everyone just uses the 409a value.
The normal way it works: you get 1/48th of your allocation every month you work there, EXCEPT that you don't get the first 12 months worth until you stay for a whole year --- the first 12 months are "all or nothing".
Why is it phrased as 1/48 of my (say) 48000 optipns/shares vest rather than a fixed amount of 1000 options/shares are awarded every month?
Alternatively, why aren't salary offers phrased as "you will get $640,000, which vests at 1/48 per month"? (Usually you'll hear "your salary is $160,000 per year and we do payroll monthly.)
It's much easier on the accountants and the share spreadsheets to just assign you 48000 shares and make up funny 'vesting' rules than to update the spreadsheet every month to add 1000 shares for you. It's literally just ease of bookkeeping.
When the accounting and law professions catch up with the tech I think we'll see this all being much simpler, as with government and driving licenses and all the other pointless bureaucracy. But judging by how slowly bureaucracy moves, don't hold your breath.
When a company issues an employee an option at below its fair market value, it has literally created income for the employee, not in a funny accounting sense but in reality.
Replacing vesting with options artificially discounted to the FMV of the company at hire might not be different fundamentally from vesting, but it seems like there's lots of ways to abuse the capability of issuing discounted options.
When an option vests today with a fair market value from four years ago, the company has "literally created income" for the employee. But for whatever reason, this isn't a taxable event. I was inquiring as to the reason for this difference in treatment.
Options at the money are also incredibly valuable, and even more so when they're for a startup (hence their usage in compensation). It's instructive to look at the prices for at-the-money options on, say, GOOG 1--2 years out to see how much they're worth on the open market (easily 10% of the current stock price).
Possibly among other issues, because if you grant options to an employee that are below the fair market value of the company, you've just created immediately taxable income for the employee.
As far as I understand, granting an option now with a currently "fair" strike price which "vests" in the future (but only if the person is still employed), does not create a taxable event at the time of vesting. However, granting an option in the future at the exact same strike price at the exact same time, creates a taxable event.
So my understanding is that option vesting is "simply" tax-preferred.
Vesting resets wouldn't apply to an IPO, but they'd apply to an acquisition where the bought company is paid-for in stock and vesting applies to the new stock.
Let's say that the employee has 0.4% (after dilution) of BuzzFlop with a 4-year vesting cycle. After 2.5 years, BuzzFlop is bought by Hooli for $100M in Hooli stock. The employee doesn't get $250k in walk-away cash, but $250k in Hooli stock, subject itself to a vesting schedule (and possibly a "refresher"). If that employee gets cliffed (which can happen in a merger) then none of that stock ever vests.
I'm confused how that could work. Let's take the same employee but have them leave the company, executing their options, just before Hooli acquires them. How do they end up vesting at all?
Are you saying: the vesting schedule on your as-yet unvested stock might reset when the company is acquired?
How often does that happen? How often does the exact opposite thing happen --- accelerated vesting on change of control? Because that other thing also happens.
It happens all the time. More often than not the C-level will get a bonus on employee retention and tie the new stock vesting schedule up with that retention period. They in the meantime are able to immediately get bought out.
I think Michael has a very legitimate position here, and one that is not well understood at all.
As a side note, I think Netflix' strategy of paying people a lot of money with no stock/rsu's/options is the right one.
Strong agree on cash over options. I like how I understand Bloomberg to do it, too: internally liquid equity; ie, equity that is practically immediately as good as cash.
In 2008, what happened to me was instant vesting and something like an 8:1 exchange for the acquiring (public) company's stock. It wound up paying out very little, just about equalizing on a low-end salary for the year and a half I was there (acquisition at 1yr). I was employee ~#5 out of 9 or so.
> I prefer Wall Street's model of annual profit sharing.
The difference is that Wall Street has profits to share. A standard company has much less profits than Wall Street, and a startup loses money. Find a way to create a company that creates a positive value for the society while having Wall Street like profits, and I can guarantee you will become rich.
It's perhaps even more clear if you just work in sales rather than engineering for a tech company. Then you have predefined, measurable performance goals and are paid for meeting or exceeding for them each quarter.
Another really important, highly negative, combination of these factors is if you want to leave the company.
If the company is public, then you can essentially leave whenever you want, exercise the options and sell the stock to pay the costs (exercise price + taxes).
But if the company is private, you have to pay the exercise price + applicable taxes (which can exist even if you only have theoretical gains) yourself, without the ability to hedge your risk and sell the still illiquid stock. If you have ISO stock options, you have 90 days after you leave (or are fired) to figure this out or lose the stock options altogether.
So if you are joining a company with the following combination of elements:
1) High exercise price (the math is: # of options * exercise price... is this a lot of money or not)
2) ISO stock options or the stock option plan gives you limited time to exercise after you leave
3) No reliable system to sell the private stock
Then you should add in a further discount on the stock options, because there may be situations where you cannot afford to reap the benefits of the options if you leave (or are fired) before there is reliable liquidity for the stock.
Just a heads up, the 90 day out clauses are usually put in there by the company lawyers. The only rule the IRS has is that ISO options flip to NSO after 90 days[0].
Take a look at the Pinterest options plan[1], where Pinterest actually gives you 7 years from when you leave to exercise. Your ISO options just flip to NSO after 90 days.
The ISO -> NSO switch can have severe tax consequences for the employee. Even if your company doesn't expire your options in 90 days, consider exercising within 90 days anyway (and talk to a tax lawyer, etc.).
One not-as-obvious reason why companies are reluctant to set long expiration dates on options is because it means former employees take up space in the cap table even if they have no intention of ever exercising that option. The company essentially has to treat those shares as having been purchased, without having received any cash for said purchase. Cap table cruft can make it harder to negotiate subsequent funding rounds.
In this situation it would be great if there were something similar to the 83b letter for non-founder employees. I know too many people who have exercised options when leaving a company (and paid a hefty tax) only to see the value of the resulting equity trickle down to 0.
Yes, but if the 90 day expiration is in the plan, then it is 90 days. It doesn't matter why the lawyers put it in there, though IRS treatment is a reason why it is very common. You aren't going to be able to negotiate changes in the stock option plan with a company you are thinking of joining.
If you are working at a company like Pinterest with a more employee-friendly option plan, then you should value the stock options at a higher value as compared to less employee-friendly plans. I ultra-long expiration periods are awesome, and they are another practical method to deal with the longer period to IPO. These types of options aren't as good as having liquidity for the stock, but with them you can be sure that if you vest the option and the company value goes way up, you'll get the benefit from that.
I've been hit with this too and it's not pretty at all.
If anyone else is concerned about this, you should talk with your CEO/legal team about early exercise options which can remove a lot of the risk of massive tax liabilities. From my understanding, some companies offer an early exercise option where you pre-purchase the shares and then instead of being able to buy the shares after they've vested, the company instead gradually loses the right to buy them back at the original strike price.
I'm not a tax lawyer, but Google "section 83(b) election" and you'll find more information.
What you're describing is called "restricted stock" (not to be confused with "restricted stock units", which are entirely different). The idea is that you actually buy the shares upfront at the current 409(a) (legal) valuation, but the company has a right to buy them back if you leave. Founders usually get their shares this way, because at the time of founding the valuation is essentially zero. Early employees may take this route too, but usually the company switches over to options after a funding round forces a non-negligible valuation. Some companies (like mine, at least so far) continue to let new employees choose.
The amount you would pay for restricted stock is exactly the same as what would otherwise be your strike price for stock options, assuming the same number of shares.
For an employee, the major down side of choosing restricted stock (assuming non-negligible valuation) is that if the company fails and the stock ends up being worth nothing, you don't get that money back. Whereas with stock options, you have more time to find out if the stock will be worth anything before you buy into it.
The up side is possible tax advantages, but of course I cannot give tax advice.
(All this is information I've learned while being the founder of sandstorm.io; I am not an expert in these things.)
PS. Don't forget to file your 83(b). (Any time you say "restricted stock" to a startup founder, they will instinctively reply with "Don't forget to file your 83(b)".)
You can also sometimes early-exercise an option (if the company authorizes it when they make the grant), which ends up being in practice a lot like buying restricted stock while still technically an option, and I think that's what the parent was referring to.
Weird, what is the reason to do that instead of restricted stock? It sounds functionally identical except more complicated and with possibly worse tax implications.
I'm sure there's some silly accounting reason having to do with option pools and cap tables.
Well since it's an option, the recipient has the choice to either exercise or not exercise, and they can early exercise at any time they'd like, not just on day one, so it's more flexible for the recipient.
On a restricted stock grant, the recipient has to either pay for the shares on day one, or the company gives them to the recipient for free and the recipient incurs a tax liability for the value of the stock on day one.
> you have to pay the exercise price + applicable taxes (which can exist even if you only have theoretical gains) yourself...
Is this certain? My understanding is that the spread between the current stock price and exercise price _can_ be taxed at the AMT rate. And if you were to sell the stock, you can get any taxes paid back in the form of an AMT credit. Still liable to pay capital gains or short term gains tax though at the sale. Without the AMT credit, it would essentially be double taxation.
If you don't have a seat in the board room, you are at the mercy of the board as to whether your options retain any value.
It's very easy for the board to completely dilute you to nothingness, and having exercised, well, the attitude is "fuck you" because there is nothing more you can give the company.
But isn't that really a question of whether or not you can find people who will work for the salary your offering? If you can't you raise what your willing to pay until you find someone who will right?
Or is it "We should make options always remunerative?"
In which case they aren't really options are they? They are just salary so why not just switch to a fixed + variable salary system like so many folks do. Heck you could even go all pay to perform like sales folks have been paid for ages, "Get this code done, you get paid, don't you don't." I personally don't think that incents the best choices but it can motivate.
If you want to write into your corporate by laws that every round of funding includes a 10% of the shares in the funding must come from employees common stock, and you always divide by 'n' (the number of employees that want to participate) the amount of stock they can contribute, well that is ok, except your converting common to preferred in that case and the SEC is going to ask a lot of questions about that.
There is the perception that founders of unicorns are rich, but trust me, they aren't, what they are is "rich on paper" and when they can't raise any more money and they are running out of cash on hand, the founders stock is going to be worth just as much as the employee's stock, which is near 0. So it will all even out. There are a lot of people who were working in the Bay Area during the 90s (and I'm one of them) that were multi-millionaires on paper at some point, and that same paper because worthless sometime later before it could be converted into cash. Did I "lose" 12 million dollars? No, of course not. I never had 12 million dollars, what I had was a concatenation of increasingly improbable if statements which if the 'true' path was followed to the end, could be converted into $12M. Since not all of those if statements resolved true, the actual result was about $83,000. Lots and lots of people had the same sort of experience.
Aaron, if you're reading, what problem are you trying to solve?
I think it's more along the lines of "the old way we used to value and award options/equity isn't very compelling for employees these days. We need to think of better ways to give employees ownership."
That's a real problem for people trying to start a company without a lot of cash. If it's to be useful as compensation, equity should be valuable, but it's not because the payout is so uncertain and so far away. Throw in terms that leave multiple opportunities to kiss the whole payoff goodbye just because of life (or worse yet, get screwed over by the IRS), and it's no wonder employees don't particularly value equity.
Typical option agreements are not terribly effective, so you may as well just pay cash unless there is a better way to distribute ownership in today's environment.
It's not a simple problem to solve. Saying "give more equity" doesn't really do it if the problem is that the likelihood of seeing a payout is too small. And making the payout more certain is not easy.
If that is the problem, to make it more compelling, then you're simply advocating a pay raise.
Equity is called compensation but anyone who is working at their second startup should understand that calling that is misleading at best. Since the average tenure at the 'first startup' is about 2 years, consider it a 'masters program' in learning about what is and what is not compensation.
So if you're going to take equity in lieu of cash you need to understand how to compute the expected value of equity. And in early stage companies its almost always zero. In an acqui-hire sort of situation it is zero and your retention package is based entirely how important you are to making the eventual use of the technology successful. Doesn't matter if your a founder or not, if you're not useful you get nothing, if you are you get something.
But lets step back and ask the question again, if "equity" is the deciding factor in your decision as an employee to join a startup, then you are clearly doing it wrong. If you want equity to mean something, join a company that is already publicly traded, then those ISO options or RSU have real dollar value that you can compute using Black-Sholes or any other method. Stock in a pre-series B startup exactly equivalent to the collected wishful thinking of the founders and investors. And all of them know that if they get their money back they will count themselves lucky.
What is broken then is not how we compensate people coming into startups, it is the misconceptions they have about how startups work, and the fundamental fact that "stock in a startup" is even on the list of things they want. All you can ever ask for is interesting work, people that are fun to work with, and enough salary to pay the bills and put money into a 401k. If you have all of those as an employee than any stock you get that happens to become valuable is all bonus.
A pay raise would do it. But actual money is hard to come by in an unprofitable high growth company. What is really desirable is a way to distribute equity in a way that is not so complex from a legal and taxation stand point, is manageable for employers, and is understandable by employees without a finance degree. That's a pretty hard problem, and the shift in exit patterns over the last 10 years has made it even more difficult.
The realization of the ideal that you can just get a percentage of the company for putting in your time working hard is largely elusive. I think that is the problem to solve. I'm not terribly optimistic there is a way to solve it outside of "don't give as much equity since nobody wants it", but I like to think there are smarter folks out there who can come up with something.
Chuck - the problem I'm trying to solve is that there's a mismatch in expectations around the value of options in comp discussions. The options are often a large portion of comp, so that's pretty bad.
The pay to perform model could work, but that would raise burn quite a lot, which is something startups should be very careful about.
End of the day, options are an imperfect way to incentivize employees, and they work better when both sides are thinking about them right.
Ok, that is helpful. How is the expectation being set? Do you feel like people are lying to prospective employees about the possible value or are the prospective employees lying to themselves?
Lets consider other scenarios, people buying a lottery ticket. They choose to believe that its possible it will be worth millions but the expectation is that it will be worthless. Do we put up a large explanation about how unlikely it is to win anything in the lottery so that people will stop buying them?
I get that especially young people with little experience will delude themselves into believing a big chunk of equity will mean a big payday later, and take a lower salary to secure a larger chunk. But it isn't that anyone has forced them, they are just inexperienced. They will likely not get any extra benefit and the next job they will negotiate harder on the salary and be less swayed by equity. At some point they might be "cash only" type of people, no equity required.
The biggest problem with stock in my mind is that the investors aren't aligned with the company. The investors want a payout, period. If they can fire everyone and sell off the two patents and get 2x their money back, fine, they will do that. They want the company to be successful so that their investment is worth more, but they don't really care how it is worth more really.
Equity "payouts" haven't changed a whole lot in 30 years. There are an extraordinary number of millionaires and billionaires in the tech industry (compared to other industries) because of the wide and generous distribution of shares. Not everyone is a winner, but nobody really works at only one company either. Five to ten companies is more like it, and often the equity grants from one or more of those companies provides additional financial liquidity to the employees.
I'd agree that first time startup employees are often way more optimistic about their stock than more seasoned employees are, but I have never met anyone who has been through 2 or 3 such companies to have unrealistic expectations any more. That is why I have a hard time seeing what we can do to change it, on the job training is on the job training.
Sounds like this is an employee education problem at its root. Naive job candidates are evaluating offers and way overvaluing their equity compensation, sometimes even allowing it to substitute for cash. As discussed in a separate thread, the consensus is that options (vested or not) in a non-liquid company should be valued at or close to $zero. This could be an education job for college Career Services.
Coming out of college, very few people can even conceptualize risk, randomness, and the possibility of a variety of outcomes. Pretty much the whole education system is based on a series of "If you take this action, you will be rewarded in this way" choices - if you complete your homework, it's 10% of your grade, if you bomb the midterm, it's 33% of your grade, your GPA is the average of all your classes, if you make a 3.0 GPA you can keep your scholarships and if you maintain a 3.5 for 2 semesters you make the dean's list. Get good grades and good SAT scores and you'll get into a good college and be set for life.
I've often wondered whether the best education that you could give youngsters would be a course that was probabilistically graded. If you work hard and ace the tests, it would increase the chance that you get a good grade - but your final grade also depends on things like the teacher's mood, the roll of a d20, the stock market performance on grading day, and whether the school gets a fat alumni donation that quarter. But I can imagine the public outcry if such a policy were enacted. Parents would sue the school, claiming that they've ruined their kids' chances for getting into a good college.
I've made this point before, but since it's a bit relevant here, I'll make it again (sorry to repeat):
If you're primarily interested in making money, or if you love the startup but not the compensation, you should NOT work at that startup.
If you're a good developer, you can get a better deal by working at an established company and simply investing. This has been true for every startup offer I've ever seen. Ever.
I've considered lots of startup jobs because I believed strongly in the companies. Every single time, however, I was able to get a larger chunk of the company by keeping my current job and simply investing.
To give an example, my current job pays about $250k, and one year, I invested $100k of that into a startup, leaving me with ~$150k of salary. This $150k + startup equity was a better deal than the startup was offering in both salary and equity. Plus, equity bought as an investor is much less tax toxic than equity options received as an employee of a startup.
On the other hand, most people who work at startups aren't interested in money. If that's you, that's totally cool! I wish I could care less sometimes.
This is something else that needs to change: "equity bought as an investor is much less tax toxic than equity options received as an employee of a startup"
Even if your competing offer is ~$150k, it still makes sense to not work at the startup ALMOST every time (given that you are trying to maximize money--most are not). I've seen a few exceptions, but startup offers are usually that bad.
Also, based on my convsations with literally hundreds of startup engineers, I have seen three trends:
1. They care very little about how much they are getting paid due to being passionate about their work (awesome!)
2. If they do care about money, they are under the false belief that their startup options are worth more than than that startup's investors were willing to pay for them in the secondary market (i.e., the price of a nearby round)
3. They are almost always talented enough to get a high-paying job somewhere else
Although it's sometimes a bit of work to find these opportunities, there are enough people with good ideas who need money these days. Friend of a friend-type stuff.
Occasionally, after talking to a startup about a potential employment opportunity, I'll ask if I can simply invest. They are usually flattered that someone would be so excited, and they are usually quite happy to take your money.
A final option is to invest in one of these new index funds that track startup performance. E.g., the SharesPost 100.
I haven't ever tried that, but I'll certainly consider it if I ever feel strongly enough! For early-stage ventures especially, the quality of the people seems to matter a lot. Therefore, there's a high probability I'd know the founders (or at least some employees) before I put in any money, and therefore, cold emailing wouldn't be necessary.
Treat options as wastepaper. They're lottery tickets. If they are worth something someday, then great, good job.
But you can pour yourself into a company heart and soul, one with options and one without, with exactly the same outcome: Zero. And to a large degree the outcome is not only not under your control, it is often under the control of predatory entities who do not want you to realize any return.
As an employee, get a competitive salary because the chances verge on certainty that those options will be worth zero, no matter how hard you work and no matter how much you think your contributions will move the needle.
The equation is different for honest-true-and-blue founders. But for a worker bee, sure, make a show that options are interesting to you, but don't trade them for cash compensation, it's a bad deal for you.
Interesting article but it fails to mention a significant source of liquidity for startup shares (both currently and historically):
Acquisition by a publicly traded company.
IPO isn't the only way to obtain liquidity, but what's interesting is just like companies are shunning IPO they are also shunning acquisition.
We don't normally get to know about failed acquisition offers but Snapchat's $3bn offer by Facebook is a great case in point. A few years ago practically no one would have turned down that kind of offer, which would have also created a liquidity event for everyone currently employed at Snapchat. Various factors today mean someone like Evan Siegel was prepared to turn that down.
I'd love to see more discussion about that as much as the IPO market itself.
Equity, unlike salary, can be crammed (dilution not correlated to valuation or investment) away to an arbitrary degree at each funding event. Surprising not to see this mentioned.
Every time you see a small company change CEOs you are probably seeing all the employees who have been there since the beginning crammed away into nothingness so the new CEO can get his 6%. The old CEO and execs won't walk away with nothing so it comes out of the share of the rest of the employees.
I can tell when a company I have worked at is going to get a new CEO because I get a notice in the mail telling me that my ownership has been further crammed away into nothingness. This happens months before the actual handoff.
Options at a small company are definitely not in your favor. Options at a pre-IPO company might be a different story, but pre-IPO you can get a real salary and the options just bump your income up a bit.
Interesting things happen after you exercise. From now on I will always exercise one share once I reach the first cliff.
My thoughts on options are pretty much identical except I would say "worthless" no "worth less".
I would also add that with an option position you are most likely giving up a higher salary and the opportunity cost that comes with it.
An extra 30K each year invested at 5% in 5 years is worth more than 200K lump sum in 5 years (200K discounted at 5% for 5 years is $157K).
You also have to factor in the probability of an exit. I just multiply the probability by the expected future amount. So 10% chance of exit in 5 years with a predicted equity position of $1M I would only count it as $100K. Discount it for 5 years and it is even worse: $78K.
Of course you also have to factor in taxes. If you are already in a high bracket and in CA you are going to be paying 9.3 CA + 28 Fed + 6.2 FICA = 43.5%. So more salary is pretty much worth half as much. You might have to worry about AMT as well.
Of course with a capital gains, assuming you exercised more than a year ago (possibly earlier with ISO options) then you will be taxed at only 15%.
But you have also given up that cash and the associated opportunity cost. In effect, instead of a "free" lottery ticket taxed at 43.5% you now bought an expensive lottery ticket, for the option (hehe) of only being taxed at 15%.
I'm on my 3rd startup and have equity in all of them and have yet to see a single penny.
Honestly with tax brackets that high, and the chance of getting any equity so small, I'm more tempted to start a business on the side that can be taxed separately than try for a higher paying job.
The way I pick a company to work at now is more based on what kind of personal and career growth it will offer, and also how much I will like working there.
I didn't quite follow your scenario, but of course you'd be paying 9.3 CA and 28 Fed on your salary as well. And you wouldn't be paying FICA on capital gains.
One of the big issues here is that once employees start selling common stock, the strike price of the options can no longer be set at a large discount to the latest valuation as it can when the only transactions are the preferred stock shares that are sold when the company raises money from VCs.
One of the most attractive things about employee stock options is that the strike price is often set at 30-40% of the valuation of the latest financing round. So a company that just raised (preferred) money at a $500m valuation can give their employees options with strike prices around $200m or less. Therefore, the employee can believe that they have a "locked-in" gain day one.*
If employees sold their common shares at anywhere near fair value at the same time the company was raising the round, they would likely sell at a price between $400m-$500m a very slight discount to the preferred shares. Any future option grants given would have to have a strike price reflective of these recent common-stock transactions, and companies would no longer be able to use the low strike prices of options to attract employees.
Obviously, this is just one trade-off among many and in no way means that companies shouldn't allow more sales of employee common stock over time, but its worth understanding the many reasons companies currently are resistant to doing so as much as individual employees would like.
*Obviously, common shares should be priced at a discount to preferred shares but almost everyone I've talked to in the VC/startup community believes that the 60-70% discount applied is extremely generous as it implies that up 60-70% of the value the VCs investment is in downside protection (ie the debt-like element) rather than upside potential (ie the equity-like element), a pretty nonsensical amount for a high-risk, asset-light VC investment.
You're discounting the value of preferred stock vs common stock. Funding rounds sell different series of preferred stock. The relationship from common to preferred stock is loose at best, despite what any 409a "valuation expert" claims.
> The first is a founder pledge that they will do everything in their power to let common holders sell into secondary markets above a certain valuation
And that is where any company, big or small, would lose me. I've been burned too many times by all kinds of people -- from co-worker to VP -- promising to do "everything in their power" to do this or that. Weasel words like those are worth nothing at all.
Options are just a fancy lottery ticket. I have learned to consider their value as $0 when evaluating a prospective employer's compensation offer; they have lost all incentive power.
The premise should be simple I think... pay people competitively with actual money for the work they are actually doing right now. If there is a chance their work could lead to a huge paypay... then give them a claim to a sliver of that payday. Don't cross the streams.
I would like to see someone actually attempt to quantify the chance a random employee (that comes in post series A) at a random startup actually cashes out more than a years salary from stock options.
Everyone would like to think that working their ass off at some start-up increases the chance of being in the big leagues, but I just have never seen it personally happen.
I've spent 15+ years working at small companies/startups, and I have yet to see options that actually resulted in a fraction of what my salary was. I also don't personally know anyone that hit the big time either.
So, do it because you love it and are happy with your current situation, not because you think your going to hit the lottery. I have now twice in my life created products that sold well, and made everyone enough money to live off. But never have I ever even been near a situation where I created a product that made tens of billions. And frankly I don't know anyone who has done that. The few millions a product got sold for here or there, wasn't enough to put even $100k in any single persons pocket.
I was going to write a blog post about this as well from the employee said based on a some quotes from Marc Andreessen. I just listened to an interview where Dan Primack interviewed Marc Andreessen and Marc made some really good points about timelines for public and private companies. Marc said:
> the time frame for how public companies think and how they are able to invest has shortened dramatically and correspondently the time frame for how private companies can think has elongated. [1]
> they (investors) tell the public company give us the money back this quarter and they tell the private company "no problem, go for ten years"
After I listened, I wondered why a talented employee would want to stay at private company that is going to take 10+ years to IPO?
"They note that the average time to IPO is now 11 years vs. 4 in 99, and that the overall number of tech IPOs is plummeting as privately funded companies raise huge late stage private rounds instead."
What part do the increased regulatory requirements for public companies play in this? Might this be one of the unintended consequences of Sarbanes-Oxley?
Yes definitely. Increased regulatory requests means it takes longer and costs more to go public.
The Emerging Growth Company Act (EGC) helps this somewhat: companies with < $1b in revenue have less reporting requirements if they file to go public. Most VC-backed companies that do an IPO will leverage this.
Clearly, the benefit of staying private (and still being able to raise $100M+ rounds) outweighs the consequences of illiquidity for employees....at least in the eyes of the founders and management.
This is for the special case of options in successful startups, a problem which affects well under 1% of the workforce.
Nobody is going public because borrowing is so cheap, resulting in round after round of leveraged private equity. This may change when the Fed starts cranking up interest rates around the end of this year.
Also, the new JOBS act rules for small IPOs are now in effect. So far, nobody seems to have done much with them, but that's now an option for companies at the point they need a follow-on round.
In my experience, you might see a startup get bought once or twice in your career. It happened to me. While it has been amazing for both my career and my income, I have not seen anyone around me get a dime from equity. If you get bought, it's probably not going to make you rich - if anything, you might get a bit of dough, get into a great shop, and have to make some utterly disturbing choices like pick up and relocate. This week. Do it go or you're out of a job.
I think lot of these idiosyncrasy stems for arcane SEC rules like 500 investors and restrictions on IPOs. Startups and tech community should lobby to change all these. Why can't we have full fledged public exchange where anyone, any startup can come in and sell its stock with no restrictions at all. If people want to buy in to their vision, sure let them be. Lot of rules around IPO and SEC are placed to protect the general public from fraud and prevent their confidence evaporate from investments. But let's say if you build an exchange called "High Risk Securities Exchange" and let anyone list themselves, publish their stocks and allow anyone buy or trade them as they like then lot of artificial artifacts we see today will be gone. These kind of trading exchanges can live side by side of conventional public exchanges.
One thing we need to understand is that starups most likely won't have money to pay same amount as their established counter parts. All they have is their vision to sell and that means options must remain critical part of their offerings. If IPOs are fizzling and employees don't get rewarded for the risks they took then ultimately existence of startups itself is at risk.
I think what we need to understand is that we shouldn't underestimate how naive people are when it comes to the chance of going home 'big', and how exploitative big companies can be of such naivete. Imagine big company X, listing a shady company Y (no official connections to company x though) which has a few employees and some very vague hocus pocus documents discussing their promise. Y gets a few googly eyed people who don't do their homework to buy in, by selling stock owned by X. Stock prices go up naturally, and then when all the stock is done, big company X closes up Y (discard office premises etc but keep the legal entity) and move on to their next similar venture. Money is laundered back into X's bank accounts and the thieves come out on top yet again.
It's not like the current system stops people from being gamed, but any of these types of systems are bound to be exploited by the "evils". Cartels are formed in the shadows, markets are manipulated. I love the idea of a public market as an official process, but I'm not sure if it can be done without the system becoming polluted.
Options should be thought by employees as a future bonus based on performance - a "thanks for sticking around when there was lots of hard work to do". Meaning your salary should be market rate and not lowered in exchange for options.
It's been a while, and I can't find it right now, but somebody once put together an analysis of average employee payout for companies with exits that valued the price of the options above their strike price (meaning they were actually worth something). My memory is hazy, but they found that a tiny fraction of employees managed to make something under $20k per year worked out of their options. And many of them were working under market rates for their services meaning the financial outcome, the years of belt-tightened living, and missed opportunities came out to something like under $10k extra compensation per year worked.
On the flip side, I know from personal experience, you can learn more in startups than in more traditional businesses, and so the experience you gain might be worth more to you over a career than any specific financial compensation.
Basically go into startups as an employee expecting to learn, but don't expect a big pay out. If you get one, count yourself lucky and enjoy.
> companies need to standardize their secondary sale and options repurchase practices
I realize this is somewhat trolling, but like Benedict Evans joked in the recent a16z podcast on this topic traditionally that's a process called... IPOing.
>The third reason for why individual options are probably worth less now than they used to be is that both employer and employee need to account for the fact that the time until IPO or liquidity is longer than it used to be. This is a big issue. To get the true value of offered comp, employees need to add their offered salary to the present value of the options offered. When calculating that, the further out the payout, the less it is worth today
This assumes a constant payout, which defeats the purpose of options. If there were a set date and set payout, the company should just offer cash bonuses or similar.
The value of an option increases the further the expiration date is [0]. He even says:
>You can be pretty sure that a company currently worth $10mm won't be worth $1b in 3 months, so you have a reasonable band of expectation.
Sure, but it might be in 5 years. You're granted an option as a bet that it might grow that big by the time you cash out - not to lock in some set amount of compensation 3 months from now.
Maybe I'm missing his point. Sure, employee compensation might need to be rethought - but not because options are a bad tool. Companies grant options at an early stage because of the long time horizon and high volatility [1]. That's what makes them valuable. If you want your compensation to be liquid and predictable, you should probably just ask for more cash.
Has anyone used a service like https://www.equidateinc.com. They help you "sell" the right to buy your stock options to a third party. From their site:
> Traditional stock sales are time consuming, expensive, and clutter a company's cap table. Now it's easier: the Equidate contract transfers the economic upside and downside of your shares without actually selling them. It honors all exisiting transfer restrictions on your stock, and your identity is kept private throughout the entire process.
> The contracts Equidate has designed have aspects similar to both a derivative contract and a asset-backed loan. The result allows an investor to purchase the rights now to the economic upside/downside of a share now, without going through the complications of adding additional shareholders to the company's cap table or the hassles of a secondary stock transaction, postponing any transfer of shares until the company is ready.
Public companies have already rethought this. They give equity compensation in RSUs (i.e. options with a strike price of 0), rather than options with a strike price at the current valuation.
With RSUs, you are rewarded for meeting high expectations. With options, you are only rewarded if you dramatically beat already very high expectations.
If IPOs are getting significantly delayed and are potentially at risk of not happening at all,[1] we need to change how compensation is structured.
Not sure that this is the best opening argument here. With things like the JOBS Act passing, Reg A+ and such getting off the ground, my hypothesis is that we'll see an acceleration in the rate at which companies are able to get to the IPO stage. If anything, in the short / near-term future, we'll see an increase in value of paper. The whole point of offering equity to shareholders and stakeholders is to have people (ownership theory) who are rooting for and/or willing to work toward group success.
The problem, of course, is that executives at far too many companies use equity like a dangling carrot... demanding more than reasonable time for even a basic ROI for the people whose risks are the riskiest (early employees).
1) The company could offer to buy back options at market rate.
2) The company's current investors could offer to buy equity from employees. The majority of investors returns come from a small number of portfolio companies, for those companies that are doing well the investors want a bigger stake even if it comes in as secondary.
3) Companies could appoint designated investors who could buy secondary stock from employees. Successful companies typically have over-subscribed rounds, companies could allow those investors who they like but couldn't get into the round to buy employee stock.
The general reason (2) and (3) don't happen is that individual employees don't have that much stock and the overhead involved makes it not worthwhile. But potentially there could be a solution which involves bundling together stock into meaningful amounts.
Options and equity are financial instruments. Like mortgage, but with different rules.
With a mortgage, you're buying a present house with your future income. Presumably because you cannot afford to pay for it in cash right now.
With options, the startup is compensating you for your present work with a future share of ownership of the company you're helping to build. Presumably because it cannot afford the risk of accepting the fixed expense of your salary right now.
It's hard to tell whether the author is right that the current compensation structure needs to change. The real question is: are there potential employees around the labour market who accept the risk and prefer the potentially large future bounty over fixed income at present?
The first is a founder pledge that they will do everything in their power to let common holders sell into secondary markets above a certain valuation, say, $500mm.
How many VC backed startups get to that sort of valuation without going public? At the $1bn mark, globally, there are 98[1]. I imagine it's possible there are 50 times that number at $0.5bn, but that's still a pretty small number out of all the startups there are. To fix compensation we need things that are going to move the needle even for relatively small companies.
I'd consider tossing profit sharing into the compensation package. Not instead of, but in addition to. The 'CFO' could commit a (minor) portion of profit to profit sharing, perhaps on a tiered basis. Add that into the package, and the employees have a bridge between their (below market?) salary and in-money options that gets more cash in their pocket as the company starts to succeed. I'd even go so far as to say that motivating employees to strive towards a profitable business structure is a more pure motivator than equity.
Salary is the only hedge employees get that is congruent to the liquidation preference preferred stock provides passive investment. It is increasingly important because capital is finding 1x liquidation preference in a startup investment a reasonable alternative to parking cash in near zero interest rate bonds. The same institutional investors who used to buy IP's can now provide capital directly and the beneficial outcome gap between passive capital and employee equity is increasingly wide.
As a hiring manager I have found that this adjustment already started occurring about two years ago.
Firstly, the market for technical talent is so competitive right now, that cash is an easy way to compete for people and salaries have been driven up.
More importantly, people have become far more sophisticated about options and what a payoff is likely to look like. Ten years ago I would never be asked a question like "how many shares are there outstanding on a fully diluted basis" but now I hear it essentially all the time.
>> Thank you for writing this. Start-up comp is effed. I'm 30 and have worked at a few start-ups that didn't make it, thus the cut I was taking in salary never turned into anything better. I had to cut my losses at this point in life and head to a public company that was able to pay me a lot more, plus signing bonus, plus stock options that had real value, plus restricted stocks. Maybe I just got lucky. But my expectations now are well above what I've been given in the past.
What about the increase in shares being sold in the private markets, and during financing rounds? Wouldn't that help make up some of the opportunity lost by staying private?
There's a simple solution here: make employee options liquid during major fundraising events. So when you close your round B/C/etc, give employees 30 days or so to exercise their options at the pre-money valuation. If you're nervous about employees exiting too early, pick a high valuation (say, $50M) and the option exercise clause doesn't kick in until then (at that point dilution shouldn't be an issue).
I'm probably going to get a lot of negative comments. I've a simple theory for compensation. First, pay me salary and bonus for my work that I deserve in a given market, for a set of skills and experiences I'll be bringing in. And second, give me stocks for the risk I'm taking on a nobody inc. 9 out of 10 companies or hiring managers don't give a second thought about failed startups and its stories.
How crazy would it be to say something along the lines of:
"OK, I'll accept your offer but I want to be paid for overtime, and have [some] freedom to work in personal projects/consulting (as long as they don't expose 'trade' secrets from the company)"
It's like saying, I'll take your low pay + stocks but you will also be risking that I start making more money on my own and leave.
Founder here. Not sure what you're talking about. Talented people are expecting healthy salaries in this market and decent chunks of equity. I'm the least paid person on our team, take significant risk ( if the ship goes down I go down with it ) and I have just 6x more equity upside than our top compensated employee (who makes 3x my salary now).
I was at a startup company where an employee wanted to sell his stock and had a buyer, and the company said "no, if you want to do your own sale, you will need to hire an auditor in your own dime to determine the value, and we won't let your auditor see the books."
And this company was above average in not pulling dirty tricks.
Another thing that would make the options worth more (less of a risk) is if the company started making a profit they started issuing dividends.
This is not likely to happen though because the company is going to be focused on growth and then an exit and they can't grow as fast if they are paying out their profits instead of reinvesting them.
If you believe that options are worthless and will always be worthless, aren't you tacitly saying you believe the company is worthless and will always remain that way?
So why are you even working at that company to begin with?
Is it because people are fatigued by having their options amount to nothing?
In some situations startups just don't have enough money to offer and the only thing that they could give is stocks. In those cases it is a matter of negotiating bigger cut of options to compensate for small salary.
I don't mean to sound too dismissive, but this article is bunkum. SO I guess by the author's logic, Michael Bloomberg's net worth is zero because Bloomberg LP never went public? The private market is illiquid, but fundamentals will always trump liquidity. If you own equity, that equity - assuming there is no dilution or deterioration in the fundamentals of the underlying business - is wealth. Employee stock options are a different matter, but deep in the money options are essentially as good as partial ownership. it may be harder to assess valuation in a private market, but it's done nonetheless.
Mr. Bloomberg's privately held equity undoubtedly makes distributions to its shareholders. Stock that does not pay dividends and is unlikely ever to do so is not wealth; it's just a piece of paper. And if you cannot legally sell it to someone else, it's effectively worthless as there is no way to convert it into something of value. The exception is if you have a majority of the voting rights, but that's not what this article is about.
There are many liquidity events that are not in the set of 'IPO' events. But the issue remains that liquidity is a core element of asset value. Many later stage financing events can be structured to provide limited liquidity to founders and early investors; the issue is that this may not help all employees equally. The IPO is useful in this case.
Bloomberg is an owner. While an employee that owns stock is technically an owner, it's not a significant distinction because they are in such a minority that they have no control over the stock, and are therefore at the whim of the majority owners. It doesn't mean the options are worthless, but they have to be discounted.
I owned stock in a company that will, very likely, never go public or get acquired. It doesn't need to. Because of the shareholder agreements, I could only really sell back to the company. Sometimes they were amenable to buying, other times they weren't. Essentially, I was playing in a monopoly market, except the monopoly was on the buyers side. Fortunately for me, the majority owners were much more generous than they needed to be. Without that, I wouldn't have been able to make anything from the stock.
You're missing the point. A typical options agreement today is not able to be exercised after you quit, even if you're vested. You might have 30 days. IPO is likely a decade away or more, if there is one at all. Where is the liquidity going to come from in an industry that doesn't tend to make profits until well down the road?
There are numerous tax pitfalls along the way were you can get absolutely ruined if you do it wrong. Exercising options can very easily become a non-trivial investment in actual cash.
None of these details are particularly predictable when you start out.
Ownership is ownership, but details matter. There is a long way between signing an options agreement and true ownership, liquid or otherwise. The longer that path, the less certain the payoff, and the less valuable the options.
"When shares can only be sold in private transactions on secondary markets, and, increasingly can only be sold with the consent of the company, the options are actually worth less."
In economics, you often deal with situations where an asset has devalued below another asset's value. The first asset still has value, but relatively less than the second.
This is different from an asset which has zero value. Some economists enjoy the wordplay of "worth less" (first meaning) vs "worthless" (second meaning)
In this instance, it looks like the article is describing how increasing controls further devalues the options.
Edit: For instance, if the company decides on each attempt if you're allowed to exercise the option, you might value it at 25% of the stock price, or lower. Even moreso, you can't be certain that the company will still exist when your options can be traded for cash, which should devalue the options even more in your perspective.
It should be the net same as if you're working for someone, and they paid you with an IOU for 1% of the money they might win from a lottery ticket. So the value might be infinitesimally small, but not zero.
The point here is that due to the factors the author noted (and probably others), the perceived value of options in nonpublic companies is now low enough that many (most?) candidates/employees no longer consider it relevant. I happen to agree with that choice, regardless of whether the expected value to the employee of the options is actually zero or just some very small number. We can debate the true ev of an option, we can apply various formulae to attempt to compute it, and we can each agree to devalue various restrictions differently according to our own preferences. But I think we can probably agree that in many if not most situations, the value of the options to the employee is too small to affect the decisions that employee is going to make. It doesn't matter whether that value is zero or $50 or $5000, it matters only that it's too small to be material.
To the extent that this is a problem for founders/owners, it's largely of their own making. It seems like it should be easy enough to correct if they want to, but they will have to give up many if not all of the wildly favorable (to them) terms and/or give up more equity to their employees to do it. The alternatives all involve paying more cash, which is probably the right answer for everyone anyway; it's disappointing that the author didn't even seriously discuss the possibility of simply paying higher salaries in lieu of equity. Apparently that's simply taboo.
it's disappointing that the author didn't even seriously discuss the possibility of simply paying higher salaries in lieu of equity. Apparently that's simply taboo.
I think most people would like that, but options can be created out of thin air, while money cannot.
I have, for twenty years, used stock option agreements as a cheap alternative to toilet paper. I was talking with a friend who says he knows one guy that cashed in $8k worth one time. I prefer a bonus plan or profit sharing.
But the original response to my original comment was informative.
I read the article, based on the title, thinking "I wonder what the author is going to address regarding employee compensation." Was it addressing performance? Or perhaps socially valuable contributions which have been traditionally under-compensated (such as teaching)?
No. It was bemoaning how stock options offered to employees by a corporation might, might, be "worth less" when restricted sale is applicable.
Just so we are all on the same page, here is the definition of "stock option" as provided by Merriam-Webster:
> 2 : a right granted by a corporation to officers or employees as a form of compensation that allows purchase of corporate stock at a fixed price usually within a specified period
(source: http://www.merriam-webster.com/dictionary/stock%20option)
The article then went into great depth skillfully supporting the author's thesis, done from the perspective of a partner at Y Combinator. All well and good, but what wages do "other people" make?
The median household income in 2010 was $49,445 USD. The census does not mention stock options, though I think it reasonable to assume most US workers do not receive such consideration.
Within this thread, "MCRed" shared their experience with stock options:
> Over many years as an employee for startups, I was employee number 24 of a $30M cash acquisition exit. The result was 6 figures, but just. Effectively it was a year's salary.
Since "MCRed" states the options were worth "a year's salary", it is safe to state that "MCRed" made at least $100,000 USD per year.
And "varelse" writes:
> Given that a seasoned and in-demand engineer can make anywhere from $250K to $500K annually working for a big co, without a 3-letter title and 3-letter title equity, there seems little incentive to accept $150K or less and ~0.5% or less equity.
All of this leads to this simple, direct, question: how much do you think people outside of "tech" make in their jobs? Based on the median household income quoted above, the likelyhood is 1/5 to 1/10 what "varelse" estimates (which I think is high nationwide) and minimally 1/2 what "MCRed" was once given above and beyond a paycheck for at least the same amount.
We, all of us in tech, need a reality check. There are literally millions of people in the US along (not including 6.5+ billion other people in the world) which do not come close to "just" the base salary many of us enjoy. And before anyone says "but the market demand...", I say be honest with yourself.
And yet many are boo-hoo'ing over "gee, I didn't get Even More(TM)!"
I tell ya what. Stop by the Walgreen's on Market and 9th (IIRC) in San Francisco and ask someone working there whether or not their stock options offerred to them when hired was worth it for making $50,000 USD less per year. For bonus points, present the same question to the Uber driver dropping you off.
PS: "MCRed" and "varelse" are only two representative examples. Other statements in this thread would serve equally well and I bear no malice toward either "MCRed" or "varelse."
Who are you making that argument to? If your company is making absurd profits, you should be tap into it as an employee. Comparing your earning to people elsewhere isn't going to mean anything unless the money is there as well. And saying "Oh, but other people don't make any money" doesn't mean that they shouldn't make money. Or that people in the tech sector developing the social tools and economic methods to make for fairer compensation wouldn't also apply elsewhere.
You're not going to convince people that they should except peanuts from a multi-billion dollar industry because "there are starving children in Africa(TM)." That's not a progressive argument.
The commentary is meant for all, which is why I posted it on its own and not in response to a particular person. This is also why I said "'MCRed' and 'varelse' are only two representative examples. Other statements in this thread would serve equally well and I bear no malice toward either 'MCRed' or 'varelse.'"
My intent was to give a different perspective to a person reading it.
> If your company is making absurd profits, you should be tap into it as an employee.
No, a company which employs a person agrees to remunerate the employee at the rate agreed upon by both parties. The amount of profit a company makes is only relevant to this in the context of how long the employee's check(s) will cash.
> You're not going to convince people that they should except peanuts from a multi-billion dollar industry because "there are starving children in Africa(TM)." That's not a progressive argument.
This is a straw man[1] as I said nothing about convincing people to accept "peanuts from a multi-billion dollar industry." What I did say is that people in tech (myself included) need to have perspective that not everyone makes the kind of money we make. Ignoring this leads to situations such as the rally in SoMa last month entitled "evict techies" and other similar expressions of resentment.
Feel free to ignore this perspective, me, or anything anyone else says or does. It matters not to me. Based on the reception my original post has received, it looks like I need to learn to do the same.
The whole concept of options as something to supplement salary is bullshit. It essentially means that as an employee, you're hedging the risk and taking a lower salary for it.
In addition to you taking the risk of that option, even in the most optimistic outcomes for the company, your shares could have been watered down in various ways.
You could work for a startup for a year and get fired early on and receive no options.
The whole thing is a employees getting ripped off. We keep telling ourselves there's a rose garden after we get X.
I recommend the book "How to stop worrying and start living" by Dale Carnegie.
Not to discount the OP's points, but this smells like the tech industry equivalent of your worst Facebook friend—the one with a penchant for selfies with Starbucks skinny vanilla lattes—hashtagging an inane event with "whitepeopleproblems".
To put it a slightly different way, I can't pay my rent with options. You can offer me all the options in the world, but my landlord doesn't accept them as payment. Therefore, you cannot simply exchange salary for equity.
I received an offer from a company a year or two ago, and they offered me a salary almost 50% below my then-current salary, and then some equity. When I tried to negotiate on salary, the CEO berated me for ignoring the equity. The problem is that as far as equity is concerned, it's worth $0 until you exit. There's a potential for millions, but my lottery ticket is also worth potentially millions of dollars. My landlord won't accept my lottery ticket as payment.
Long story short, Aaron is correct: startups need to rethink the whole equity component. It's valuable -- but it's not valuable in the same way that salary is, especially in today's market.