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What I Wish I'd Known About Equity Before Joining A Unicorn

What I Wish I'd Known About Equity Before Joining A Unicorn

Disclaimer: This piece is written anonymously. The names of a few particular companies are mentioned, but as common examples only.

This is a short write-up on things that I wish I'd known and considered before joining a private company (aka startup, aka unicorn in some cases). I'm not trying to make the case that you should never join a private company, but the power imbalance between founder and employee is extreme, and that potential candidates would do well to consider alternatives.

None of this information is new or novel, but this document aims to put the basics in one place.

The Rub

Lock In

  • After leaving a company, you generally have 90 days to exercise your options or they're gone. This seems to have originally developed around a historical rule from the IRS around the treatment of ISOs, but the exact reason doesn't really matter anymore. The only thing that does matter is that if you ever want to leave your company, all that equity that you spent years building could evaporate if you don't have the immediate cash reserves to buy into it.

  • Worse yet, by exercising options you owe tax immediately on money that you never made. Your options have a strike price and private companies generally have a 409A valuation to determine their fair market value. You owe tax on the difference between those two numbers multiplied by the number of options exercised, even if the illiquidity of the shares means that you never made a cent, and have no conceivable way of doing so for the forseeable future.

  • Even if you have the money to buy your options and pay the taxman, that cash is now locked in and could see little return on investment for a long and uncertain amount of time. Consider the opportunity cost of what you could otherwise have done with that liquid capital.

  • Due to tax law, there is a ten year limit on the exercise term of ISO options from the day they're granted. Even if the shares aren't liquid by then, you either lose them or exercise them, with exercising them coming with all the caveats around cost and taxation listed above.

    Does ten years sound like a long time? Consider the ages of these unicorns:

    • Palantir is now thirteen years old.
    • Dropbox will be ten years old this year (2017).
    • AirBnB, GitHub, and Uber are all within a year or two of their ten year birthdays.
  • Some companies now offer 10-year exercise window (after you quit) whereby your ISOs are automatically converted to NSOs after 90 days. This is strictly better for the employee than a 90-day window, but as previously mentioned, ten years still might not be enough.

  • Golden handcuffs kick in fast. The longer you stay with a company, the more equity you build, and a decision to leave becomes that much harder. This can culminate to the point where early employees have modest liquid assets but are "paper millionaires", and have to make the hard decision to throw all that away or stick around until their founders allow them some return.

Liquidity Events

  • No time horizon for any kind of liquidation guaranteed. In fact, no liquidation event is ever guaranteed, even if the company is highly successful. One could be at 1 year out, 5 years, 10 years, or never. We've seen a lot of evidence in this day and age that companies are staying private for longer (see the list above).

  • The incentive to IPO between employer and employee are not aligned. Employees want some kind of liquidation event so that they can extract some of the value they helped create, but employers know that allowing employees to extract that value might cost them some of their best people as they're finally allowed the opportunity to pursue other projects. One more reason to stay private for longer.

    • Although the above is one reason that founders don't want to IPO, it's not the only reason. Many of them do believe (rightly or wrongly) that there is another 10x/100x worth of growth left in the company, and that by pulling the trigger too early on an IPO all of that potential will be lost. For a normal founder, their company is their life's work, and they're willing to wait a few more years to see the canvas fully realized. This is a more noble reason not to liquidate, but from an employee's perspective, is still problematic.

Founder/Employee Power Imbalance

  • Founders (and favored lieutenants) can arrange take money off the table while raising rounds and thus become independently wealthy even before they make true "fuck you" money from a large scale liquidation event. Employees cannot. The situation is totally asymmetric, and most of us are on the wrong end of that.

  • Even if you came into a company with good understanding of its cap table, the ground can shift under your feet. New shares can be issued at any time to dilute your position. In fact, it's common for dilution to occur during any round of fundraising.

Private Markets

  • Private markets do exist that trade private stock and even help with the associated tax liabilities. However, it's important to consider that this sort of assistance will come at a very high cost, and you'll almost certainly lose a big chunk of your upside. Also, depending on the company you join, they may have restricted your ability to trade private shares without special approval from the board.

Valuations

  • Especially in early stage companies, equity is offered on the basis of a highly theoretical future valuation number. Sam Altman recommends offering the first ten employees 10% (~1% each), which could be a big number if the company sells for $10B, but consider how few companies actually make it to that level.

    If the company sells for a more modest $250M, between taxes and the dilution that inevitably will have occurred, your 1% won't net you as much as you'd intuitively think. It will probably be on the same order as what you might have made from RSUs at a large public company, but with far far more risk involved. Don't take my word for it though; it's pretty simple math to run the numbers for a spread of sale prices and dilution factors for yourself before joining, so do so.

Tender Offers

  • Some companies acknowledge the effect of drawn out phases of illiquidity on employees and engage in a tender offer to give employees some return (google around for some examples). I don't want to overstate this because receiving a tender offer is strictly better than the alternative, but keep in mind that one will probably be structured to minimize the amount of value you can extract. They're also very likely be infrequent events. Read the fine print, run the numbers, and consider how much your annual return to date will actually be (including all the time you've spent at the company, not just the year of the offer). It's probably less than what you could've gotten in RSU grants at a public company.

Working Environment

  • This isn't equity related, but it's worth considering that the environment at a big unicorn isn't going to be measurably different from a big public company. You're going to have little impact per employee, the same draconian IT security policies, lots of meetings, and fixed PTO. In the worst cases, you might even have to use JIRA.

I'm Doing It Anyway!

So you decided to join a private company anyway. Here's a few questions that I'd recommend knowing the answer to before accepting any offer (you'd be amazed at how infrequently this information is volunteered):

  • How long is my exercise window if I leave the company?

  • How many outstanding shares are there? (This will allow you to calculate your ownership in the company.)

  • Does the company's leaders want it to be sold or go public? If so, what is the rough time horizon for such an event? (Don't take "we don't know" for an answer.)

  • Have there been any secondary sales for shares by employees or founders? (Try it route out whether founders are taking money off the table when they raise money, and whether there has been a tender offer for employees.)

  • Assuming no liquidation, are my shares salable on a private market?

  • Has the company taken on debt or investment with a liquidation preference of more than 1x? (Investors may have been issued > 1x liquidation preference, which means they get paid out at that multiple before anyone else gets anything.)

  • Will you give me an extended exercise window? (After joining I realized that most people's window was the standard 90 days, but not everyone's. Unfortunately by then I'd lost my negotiating leverage to ask for an extended term.)

It's really tough to ask these without sounding obsessed with money, which feels unseemly, but you have to do it anyway. The "you" of today needs to protect the "you" of tomorrow.

Summary

Working at a startup can be fun, rewarding, interesting, and maybe even lucrative. The working conditions at Silicon Valley companies are often the best in the world; it's quite conceivable that you might want to stay there even if there was never a possibility of a payoff. But don't forget that as far as equity is concerned, every card in the deck is stacked against you.

The correct amount to value your options at is $0. Think of them more as a lottery ticket. If they pay off, great, but your employment deal should be good enough that you'd still join even if they weren't in your contract.

I don't say this just because of the possibility that your startup could fail, but also because even in the event of success, there are plenty of scenarios where getting a payout will be difficult. Say for example that five years in you want to try something new, or want to start a family and need a job that will pay you well enough to let you afford a starter home in the Bay Area (not easy). Your startup Monopoly money will put you in a precarious position.

If you're lucky enough to be in high enough demand that you can consider either a public company with good stock liquidity or a billion-dollar unicorn, give serious consideration to the former.

@mdiscenza

"In the worst cases, you might even have to use JIRA." What a gem! Thanks for putting this together!

@cob16
cob16 commented Jan 18, 2017

@mdiscenza Whats wrong with JIRA ?

@rstormsf

I tried asking tough equity questions while I was interviewing at startups, and the outcome is usually like this: "What is your motivation? Money? Well, we are looking for someone who wants to change the world without thinking about the money too much. Please find more passion for something you truly love. " And you can't say you are passionate about making more money. Red flag.
Founders want to create an illusion for all employees like you shouldn't know all about this, we will take care of it for you. However, they don't care about you, and they will rip you off as soon as they get an opportunity to do so.

@michaelochurch

@cob16 As a bug-tracker, it's fine. I think he's referring to the standard software open-plan bullpen, where all work has to be tracked in Jira and broken up into tickets, because engineers are viewed as untrustworthy children and every hour of work has to be tracked.

Strong software engineers hate being typecast to ticket jockeys and will quit, so the programmers manning such companies tend to be mediocre at best... but this is the norm for "unicorns" these days, which are not tech companies so much as marketing companies that use technology.

@bshlgrs
bshlgrs commented Jan 18, 2017

@rstormsf -- I think the trick is to wait until you have an offer, and then talk about your requirements re compensation.

@hiteshsharma

it was a good article unless you mentioned JIRA. you pissed some people off :)

@mydpy
mydpy commented Jan 18, 2017

"In the worst cases, you might even have to use JIRA."

@mdiscenza For some reason this statement stood out to me above the others too. Haha.

@matthewsommer

@cob16 JIRA is really great if it's set up correctly, but there are many configuration options and usually too many cooks in the kitchen who set it up, so it can end up being a mess at a lot of companies. If it helps add any weight to my opinion I was a JIRA admin at Tesla and GoPro. I hate it when people badmouth JIRA, it can be awesome.

@neoadventist

Never JIRA. Hope they don't mess up Trello.

@andrerfneves

Great write up. Thanks for sharing.

@johnxie
johnxie commented Jan 18, 2017

Simple yet informative article, thanks for sharing.

@pauldraper
pauldraper commented Jan 18, 2017 edited

I'll bite: what do you prefer to JIRA? Bugzilla? Mantis? Collective memory?

@ianchanning
ianchanning commented Jan 18, 2017 edited

You write a 9900 character article about useful things around stock options. Then 9 out of the 13 immediate comments are over 4 of those characters.

Excellent piece. Perhaps you could add in the best ways to ask these questions given @rstormsf comment.

@KMontag42
KMontag42 commented Jan 18, 2017 edited

Very, very well written.

The correct amount to value your options at is $0. Think of them more as a lottery ticket. If they pay off, great, but your employment deal should be good enough that you'd still join even if they weren't in your contract.

If people want a tl;dr it is that line.

Having suffered from many of these issues first hand, I can attest to the painful accuracy of this write up.

@taariq
taariq commented Jan 18, 2017

Thank you for this very informative piece. Excellent at uncovering the hidden gotchas in Unicorn job offers. JIRA? So many tears...so long ago...

@patrickkelso

Even worse if you're Australian the Tax Office will tax you on the difference between strike price and fair market value the year you get the options, not the year you buy them, the year they vest. So you end up owing tax on options you might never buy and then have to claw back the tax money on. If you're Australian get professional advice from an accountant who is familiar with options, because I promise you the American based (and they're almost all American based) startups don't have a clue about our laws or the implications for you.

@j1nglee
j1nglee commented Jan 18, 2017 edited

Other things to look at with regards to options - depending on the role:

Double trigger acceleration on the options - sometimes on an acquisition, certain teams have their utility nullified and become cost-cutting targets. (i.e. finance, techops, etc). So shortly before, or after the acquisition, those teams get nuked and if they haven't hit their 1 year cliffs, they're screwed.

In too many places, you will not get an honest answer to these questions. In my past, a few months after I joined this one startup, the CFO held a lunch and learn session on stock options. Lots of questions were asked that had zero meaning (i.e. just sound bites, but nothing that would actually help employees ascertain the value of their options offer i.e. "if the stock goes to 1000 per share, does that mean that I made xyz per share?"). Mine was the denominator question - i.e what is the number of fully diluted shares outstanding (to figure out how the number of basis points that my options grant entailed). The CFO lied to all of our faces. A few weeks later the CFO resigned and moved on to another gig. There were no additional lunch and learns held during my time at that startup on stock options.

There's other evil things that investors can do to your equity portion of compensation. Example: Skype - http://blogs.reuters.com/felix-salmon/2011/06/24/upgrading-skype-and-silver-lake-to-evil/

Really, there's no substitute for digging in deep and reading line for line the options agreement that you're getting when coming onboard at a startup. Agreements are not always cookie cutter.

@hobzcalvin

This is wonderful. I think it's missing one important point that I didn't know:

If the company sells, Preferred Stock investors (not you) get paid back first.
The bit about > 1x liquidation preference mentions this, but even if investors have a 1x preference, they still get paid back before you do if the company sells for less than invested capital. Even if you buy 1% of the company after you quit, if it sells for $3.5M but $4M was invested, you will walk away with nothing.

(I was asked as a favor to the CEO to sign a document stating I supported a sale that meant my options—which I had paid thousands to exercise, tax liability notwithstanding—were worth nothing. Ouch.)

@colorfulfool

@michaelochurch People start a company in one of the most expensive places in the world, take billions in funding and then try to shame you for thinking about money!

If profitability were proportional to hipocrisy, there would be no failed startups in the Valley.

@AndrewMaguire

Good article, but you should definitely add a paragraph on Early Exercising your options. You're right that when you exercise you need to pay taxes on the delta between strike price and value per share at the time of exercise; however, some employers allow employees to exercise their options before they have vested, i.e. "Early Exercise". The cost of exercising options at the initial strike price is often not that much because the 409a valuation is almost always much lower than the VC "valuation" with all its securities and preferences. If you exercise your options when they are granted or before the 409a changes, you will not have to pay any taxes on the gain until a liquidity event. If you leave the company before you are fully vested, the company has the right to buy back the unvested shares.

Early Exercising has another massive benefit, which is that it starts the clock on long term capital gains tax treatment. If you hold stock for 1+ years at the time of liquidity, you pay long term capital gains, which has a substantially lower rate than than short term capital gains. If you exercise at the same time as a liquidity event occurs, you will pay short term capital gains.

The downside is that if the company fails, you lose the value you paid to Early Exercise, so that's the downside vs. waiting until a liquidity event.

As an employee you should always ask upfront if you have this right and factor it carefully into your analysis. The most savvy people I know invariably early exercise if the cost doesn't create serious financial discomfort. If you're at an earlier stage company with a low valuation (and super low 409a) and you are a regular employee, it's a no brainer.

@listingboat

Worse yet, by exercising options you owe tax immediately on money that you never made. Your options have a strike price and private companies generally have a 409A valuation to determine their fair market value. You owe tax on the difference between those two numbers multiplied by the number of options exercised, even if the illiquidity of the shares means that you never made a cent, and have no conceivable way of doing so for the forseeable future.

Got screwed by this in the early 2000s. Had a large number of shares that exercised in two phases. Half immediately - no difference in strike price and 409A valuation (9 cents). 1.5 years later the other half - 4 dollar difference.

I had no idea. The company would have investors come in and tell us to 'exercise! exercise!'. Yet not one ever mentioned this.

My cost? $40K of taxes on equity I could not sell. Ludicrous. Never got it back.

@billoneil

Quick note to add to @AndrewMaguire the tax form related to early exercise is the 83(b). You need to remember to file it the same year you early exercise. I'm no accountant, just something I read when researching on my own.

@aloukissas

If the words "JIRA" and "badge" come up, run :)

@vkarpov15

I think you might be mixing up ISOs and NSOs. NSO is the one where you pay US income taxes immediately upon exercising, ISO is the one where you don't. Never accept NSOs, they often add ~50% to your exercise price for no additional benefit.

Another point worth discussing is the fact that even if you exercise your options and become a full fledged shareholder, getting rudimentary financial information to monitor the value of your investment is also an uphill struggle.

@patmoore
patmoore commented Jan 18, 2017 edited

@billoneil - You need to file a 83b election within 30 DAYS of the exercise. If you wait until later (even if the same year) it is too late.

fyi - 83b election is a SIGNED letter sent certified mail w/your social security number to the IRS:

"On MM/DD/YYYY, I am exercising ISO STARTUP.CO shares at $X price with a fair market value of $Y. These shares have not vested yet. I am doing a 83(b) election. I am electing to be taxed in the current tax year for gain which is $0. "

Assuming X=Y.

Include a self addressed stamped envelope and a second copy. In a few weeks, you will get the copy back stamped as received.

Save that stamped copy like gold. That is the only record you have.

Note that you better sign it and have social security number and all other details on the letter. If there are any errors by the time you discover them you are outside the 30 day notification window.

83(b) is not a standard form but a reference to the tax code.

@oferze
oferze commented Jan 18, 2017

Great piece, and 2 comments, one for the author and one for other commenters:

  1. About 7 people commented about JIRA so far, not including the ones that replied to them.
    To these people I'd say: you'll probably be stuck in your 9-5 jobs for a long time. You focus on a side joke, which happens to be the one thing that you really understand and have something to say about (since it's technical) but actually, you should have been focussing more on what the author had to say about options. This is much more important to your career than using or not using JIRA.

  2. To the author: worth putting a disclaimer at the beginning, that it's all based on US law. It's different in other countries, albeit many things are common.

@patmoore

oh yeah - also a paper gain for illiquid stock is taxed AND can subject you to AMT - alternative minimum tax : which wipes out most deductions.

Insist on being able to early exercise with 83b election.

@w2ttsy
w2ttsy commented Jan 19, 2017

Great article, and very well researched.

One extra point that would have been is the cost of excising can often be missed when joining, especially if you're in a well established startup.

It is not worthwhile electing to take options if the strike price is already massive and you can't afford to exercise the options. For example, a large unicorn has a strike price (when you join) of $93 per option (AirBNB for example). You have 10k options as part of your remuneration. When you go to exercise these options, you're on the hook for $930k + taxes on that... It might be ok if you've churned from another successful role and have money in the bank, but for many that's not the case. For late joiners, stock options can be extremely expensive to buy into, to the point where its probably better to take extra salary in lieu of options and then buy stocks in other companies and make your money there.

@sfsunset

Terrific write up @yossorion . If people are focussing on the JIRA sentence you are entirely missing the point. This writeup is about how the common person gets sucked into the glitz and glamor of the startup world without truly understanding what the potential payout can be. I spent 10 years at a start up and left, the company is now in its 13th year and there is no liquidation event in sight. Even if there is one, I now realize that with investor liquidation preferences and dilution, my potential payout is going be crap for all the years of blood, sweat and tears. Purely in financial terms I would have been better off with RSU's at a reasonably successful public company (and with less stress). I joined another start up and realized in 6 months that besides a shitty management team and weak product (my mistake in viewing things with rose tinted glasses because I was so fed up with the previous start up I had been for 10 years) and massive amount of shares outstanding that my potential payout was going to marginal, infact at this place I did not even buy my vested stock (I left after 14 months). Now I am doing the next best thing, I am on my own, consulting and trying to see how I can carve out a profitable business whether or not it is a unicorn ever is irrelevant at this stage for me.

@gayanhewa

Good read!

@geddski
geddski commented Jan 19, 2017

Great article! This is consistent with what I researched before exercising my shares in a company. I didn't know about the 10 year cap, that's interesting. I decided to go ahead and exercise, even knowing the risks. Hoping to see a return on that investment someday.

Hilarious point about Jira, and so true. The software is bad, yes. But the real problem is it's a manager's tool for exerting control. Some devs do just fine in that circumstance, others have a really hard time.

@foo10101
foo10101 commented Jan 19, 2017 edited

I am just an engineer. I don't understand a lot of the terms and concepts necessary to understand the linked article. I tried going through the Wikipedia articles for the terms I was interested in but I don't think I can make sense of it all without a kind teacher to help me out. So here I am turning to you, to be my teacher. Here are the questions I have. If one of you could answer just one question from this list, it would help me a lot. I am sure it would help other people like me.

While answering, please quote my entire question with the Q so that people don't have to scroll up and down to correlate the answers with the question.

Q1. Quote from article: "Your options have a strike price and private companies generally have a 409A valuation to determine their fair market value. You owe tax on the difference between those two numbers multiplied by the number of options exercised." My question: What is strike price? If I have accumulated say $30K worth of options, but I can afford only $10K, can I buy only $10K worth of options while leaving the startup?

Q2. Quote from article: "Due to tax law, there is a ten year limit on the exercise term of ISO options from the day they're granted. Even if the shares aren't liquid by then, you either lose them or exercise them, with exercising them coming with all the caveats around cost and taxation listed above." My question: Say I get buy ISO options for 30000 options for $30K from a startup while I leave the startup in 2017. Say, that startup still remains private in 2027. What are my options? Am I going for a total loss of $30K? If the startup hasn't gone IPO, how can I possibly exercise my 30000 options in 2027? What does the article mean by "exercise them" in this case? Does "exercise" mean buy the 30000 options for $30K or does "exercise" mean selling the options for a possibly larger price after the startup goes IPO?

Q3. Quote from article: "Some companies now offer 10-year exercise window (after you quit) whereby your ISOs are automatically converted to NSOs after 90 days." My question: How is NSO different from ISO? When the article mentions that NSOs are "strictly better" does it mean that I don't have to pay a penny to buy the NSOs but they remain in my account for free?

Q4. Quote from article: "Employees want some kind of liquidation event so that they can extract some of the value they helped create" My question: What are the events that count as liquidation events?

Q5. Quote from article: "Even if you came into a company with good understanding of its cap table" My question: What is the cap table? Why do I need to know this number? Can you explain this with some examples?

Q6. Quote from article: "New shares can be issued at any time to dilute your position. In fact, it's common for dilution to occur during any round of fundraising." My question: How does additional funding dilute my position? If I bought 30000 ISO options at say $1 per option, and I can sell it one day for say $2 per option, I am still making money. Why does it matter if additional funding occurred between buying and selling?

Q7. Quote from article: "If the company sells for a more modest $250M, between taxes and the dilution that inevitably will have occurred, your 1% won't net you as much as you'd intuitively think. It will probably be on the same order as what you might have made from RSUs at a large public company, but with far far more risk involved." Can someone show some approximate calculation for this? This is what I see: 1% of $250M is $2.5M. Say I lose 30% in tax I am still left with 0.70 * $2.5M = $1.75M. Can one really earn $1.75M from RSUs? The RSUs I have got at large public companies are of the order of $10K to $50K only.

Q8: Quote from the article: "Tender Offers". Can someone elaborate this? Can a startup force me to return my options in exchange for tender offers? Or is it a choice I have to make, i.e. to keep the options or go with the tender offer?

Q9: Quote from the article: "How many outstanding shares are there? (This will allow you to calculate your ownership in the company.)" How? Can you provide an example to calculate my ownership? Can you also provide an example of what that ownership means for me, if the company is sold for say $200M? Can you also provide another example of what that ownership means for me, if the company goes public and the price of each stock option is $10 after it goes public?

Q10: Quote from article: "Have there been any secondary sales for shares by employees or founders? (Try it route out whether founders are taking money off the table when they raise money, and whether there has been a tender offer for employees.)" What does this mean? How does it affect me?

@AndyDentFree

@patrickkelso said

Even worse if you're Australian the Tax Office will tax you on the difference between strike price and fair market value the year you get the options, not the year you buy them, the year they vest

There are more nuances to that since July 2015 especially if you're talking a startup and less than 10% equity. Details here

@keyuls
keyuls commented Jan 19, 2017

As @foo10101 said, someone needs to elaborate to all this term. Can someone please explain these 10 questions? As an engineer or developer perspective need to understand all these things before joining any company.

@jlevy
jlevy commented Jan 19, 2017 edited

Great article and discussion. We've linked it from another GitHub-based guide on this topic. It covers a bit more on concepts etc, and anyone is welcome to contribute there too.

@abscondment
abscondment commented Jan 19, 2017 edited

@foo10101: I'm an engineer, too, but here's my non-lawyer understanding of a few of your questions.

  • Q1: You don't need to exercise all of your options. An option is simply the ability to buy shares at a fixed price. So, yes, you could purchase only 1/3 of the shares available to you.
  • Q2: Exercising that option means buying the shares. It is this option that expires. If you exercise, you buy the shares and own them.
  • Q4: Merger, sale, IPO. Something that turns shares of stock into cash.
  • Q5: The cap table shows who owns what shares. It lets you know exactly how shares many there are, and therefore what percent you own. You should not expect full knowledge of the cap table, but understanding how many shares have been issued is key. It's important to know because you can't reason about your upside from a sale without knowing if you own 10%, 1%, or 0.01% of the company.
  • Q6: New funding means an investor is issued new shares in exchange for capital. Issuing new shares reduces the percent of the company you own. If your shares are worth $1 each, and the company doubles the number of shares issued without changing its valuation, you're suddenly holding $0.5/share. To get to $2/share in the future, your company needs to get 4x the value you just had. This could be entirely feasible for a startup. It's important to consider because each investment sets the bar higher for getting anything from your equity, and how much higher varies greatly.
  • Q7: A few thoughts:
    1. RSUs are taxed as income, so ISOs have an advantage here.
    2. If you have 1% as a non-founder, you joined the startup early on. Most startups that attain a $250M exit have taken funding, with significant dilution. After several rounds of financing, you might actually own only 0.5% of the outstanding shares, for example. Combine that with liquidation preferences, and you will see far less than 1% of a sale.
    3. Yes, one could earn $1.75M from RSUs. Most people will not. That's a very large initial grant + great stock price performance over 4 years.
  • Q9: Yes.
    • Say you are given 10,000 options, and the company has issued 1,000,000 shares. You own 1% of the company (10,000/1,000,000).
    • But wait! As an employee, you have common stock. Investors have preferred stock. So if the company sells for $200M, you might not get exactly 1% of that -- the investors take get cut first. Here is an example with numbers.
    • When your company IPOs, your options still allow you to purchase stock at a low, pre-IPO price. So if your purchase price is $1/share as above, and the market price for your company's stock is now $10/share, you can sell them and make $9/share.
@sheanmassey

Just swinging by to confirm that JIRA is my PITA.

@cavill
cavill commented Jan 20, 2017

Does the company's leaders want it to be sold or go public? If so, what is the rough time horizon for such an event? (Don't take "we don't know" for an answer.)

Great article, though I disagree with the above quote. It's better (and likely more truthful) to say 'we don't know' than give a disingenuous answer.

@reiz
reiz commented Jan 20, 2017

Thanks for writing this. I enjoyed reading it. Specially like the note about JIRA 👍 .. JIRA is so typical for big Enterprises like LDAP, Active Directory, Outlook and Eclipse. I prefer more light weight tools ;-)

@otrenav
otrenav commented Jan 21, 2017

Thanks for publishing this. It's useful.

@IvanVergiliev
IvanVergiliev commented Jan 21, 2017 edited

@foo10101 also an engineer but I've seen a bunch of Equity Plans so here are my two cents.

Q1: If I have accumulated say $30K worth of options, but I can afford only $10K, can I buy only $10K worth of options while leaving the startup?
A: Sample quote from Stock Plan: "The Administrator may require that an Option be exercised as to a minimum number of Shares [...]" (for example, the one here). So there could be a lower bound on the number of shares you can exercise - if you have less than that, you have to buy all the options when you leave. I think there can also be a "batching" requirement - say, if you have 35k shares and you can only buy batches of 10k, you can buy 10k, 20k, 30k or the whole 35k. I can't confirm this from an option agreement right now though.

Q6: How does additional funding dilute my position? If I bought 30000 ISO options at say $1 per option, and I can sell it one day for say $2 per option, I am still making money.
A: True, if your options are now worth 2x more, you are making money. However, dilution means that for your options to become 2x more valuable, the company will have to grow (potentially much) more than 2x in valuation. Another way to structure this is that if you were advertised being granted 1% of the company, dilution will bring this number down.

@LisaDziuba

Nice article,
many simalar points with recently published article by Scott Belsky Don’t Get Trampled: The Puzzle For Unicorn Employees

@avocade
avocade commented Jan 21, 2017

Love that this became a what's wrong with Jira topic from second 1! Gotta love these tubes.

@ShaneLewin23
ShaneLewin23 commented Jan 23, 2017 edited

@rstormsf and others, during the recruiting process, any firm is always happy to talk about good news. It's a very, very safe bet that if they 'dont know' its because its not favorable for you; and perfectly reasonable for you to assume so.

As to "we only want people who are not motivated by money", in my experience hiring and talking with startups, this sentence is a big red flag. Anyone joining a startup should expect to give up salary in exchange for equity, and that equity should be (on reasonable exit criteria) worth about 5-10X the amount of money you're giving up. Thats a fair trade.
Typically, founders who are very worried themselves about money make statements like the above. It should be viewed with skepticism.

@master0v

Thanks!

@samv
samv commented Jan 24, 2017 edited

I read all of this, and I definitely concur with your early statement that "None of this information is new or novel". But it's true that few people have a good grasp of this stuff, and it is passed around as secrets shared in 1:1's and other such venues. So 💯 for sharing it and bringing attention to these important issues.

First of all, you need to consider the Employee Stock Options fund. This group, based in Silicon Valley and founded in 2012, solve all or almost all of the problems in the section about "the rub". The way it works is that you first take your share options paperwork to ESO fund. If the fund likes the look of them (generally, due to lack of public information on private companies, this means "have they funded in the last 2 years?" plus some proprietary secret sauce decision making), then they'll make an offer to pay your expenses for them. They pay for the exercise money, and all payable AMT that accrues in the future for holding those shares. In return, they get a cut. Exactly how big depends on just how hot they think that start-up is. This involves the employee signing a contract granting ESO limited right of attorney to perform the transaction to transfer to ESO once the shares are liquid.

So you get the best of both worlds. Keep 80% of your imagination instead of 100% but don't worry about the cash outlay or tax implications. To make up the 20% you lost, just dream bigger.

As for the questions that you recommend asking in the interview, I'd say that this is largely bad advice. The last question about a negotiating position is definitely insightful, but the others could really come across as self-serving, especially if you ask someone who has no idea about such technicalities. For instance - the question about trading shares in a private market. The reason shares in a private company can't just be sold to anyone (without board approval of the company) is due to federal disclosure laws. Those laws state that as soon as there are more than 500 shareholders (IIRC) then the company must disclose detailed quarterly financial reports. At which point, generally they may as well IPO because their financials are public. So, the general practice is that you can't sell to people who don't already hold shares, or do anything that would increase the number of shareholders and tick them closer to that disclosure time bomb. So why would you ask about that?

I guess my main point is, those are good questions to be answering for yourself, somehow - but I really, really suggest that you should NOT ask those kind of questions in a job interview. Casually pry them out of someone during the obligatory lunch during that all-day engineering interview, perhaps - but most of the questions are kind of rude and improper and will just result in you getting a bad reputation.

One last thing - generally, you can exercise ISOs as soon as they vest. It's a good idea to do this regularly, eg quarterly. Save up some of that paycheck from when you first start in an earmarked account for exercising your options. Sometimes the problem isn't really that the shares are expensive, it's just that you didn't budget for them. A few hundred bucks a month can quickly add up especially if you stay put for 2-3 years, and then it seems like a massive chunk of cash. Plan for it. There's many peripheral benefits to exercising while still employed - you pay less tax if you sell after 2 years of share ownership, so start that clock ticking as soon as possible. And the other reason is to avoid the lock-in mentioned in the article. The risk-adjusted yield of ISOs at growth tech companies is second to none - these are good assets to own; especially if you are diversified.

@hmehendale

Also worth reading (and possibly linking to in the original post), is the Open Guide to Equity Compensation

@ummahusla

Thank you 👍

@adityar7

It is indeed true that founders typically have the power to benefit while screwing employees, and that should not be the case. However, the first few employees (until the company reaches Seed or Series A) are basically putting faith in the founder to not screw them. Unless these guys value equity substantially as part of compensation, companies won't get off the ground (if you've never run a company, you won't get "why"). And then we'll all be screwed.

@richardhaven

"The correct amount to value your options at is $0. Think of them more as a lottery ticket"
This is good. How much is a lottery ticket worth? How much is a lottery ticket worth when the odds are not only hidden, not fair or random, and can change by the founders ?

A magic phrase is "liquidation preferences". It is the stated way that a company buy-out would affect employee options. The number does not actually matter because the employees will get whatever the founders choose to give them from the buy-out money. The magic of the phrase is that the HR person you say it to will know that you know that hiring options in a startup are worthless, and they might give you more money.

As for the taxes: the only way to get a tax liability is to gain a profit. If one gets options and does not exercise them, then one is investing in the stock. If that stock them drops in value, one still owes for the receipt of the option. Choosing not to exercise an option immediately is foolish.

@gaia
gaia commented Feb 9, 2017

salable = sellable.

great article!

@jt-gilkeson

A few more things to be aware of:

  1. Early Exercise / Exercising in general - if your valuation falls significantly, the company may reprice stock options to the lower value, anyone who has already exercised does not get to participate - additionally if you leave, the company most likely won't purchase back your unvested shares since they are underwater.

  2. Acquisition - in some circumstances, the company may choose to sell off the products and employees and leave the old company as a shell - if this happens, your exercised stock will not generate a payout and the shell is most likely to go to 0.

  3. Someone said you don't pay taxes upon exercise of ISOs - this may not be correct - the spread at time of exercise for ISOs is taxable if you are subject to AMT (and exercising the stock may make you eligible for AMT).

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