There was a PE firm that came around about 4-5 years ago trying to raise money on this very premise.
Their thesis was that
- startups would remain private longer.
- employee's lost their options when they leave
- longer periods to go public means more employees return options to the pool which means employee option pools can be smaller
- longer private periods leads to more rounds raised which benefits investors over employees as the former can participate on each round to keep from being diluted
- exits would come eventually and the investors would always have superior terms, I believe that they were working under the assumption that investors would never have mandatory black out periods after IPO so they could essentially participate in the opening day IPO pop.
This is one of the coolest and most maddening things about finance. Every time you think you've come to a big realization, usually you find out that someone else came to the same conclusion many years ago and has been making money "arbing" it out ever since.
Where are all these secondary market companies "arbing" it out on employee stock option liquidity? The market should be HUGE, both for locked-in employees, and for buyers who want a small discount on hot startups.
This would totally solve the 90-day exercise period problem for the employees, without requiring company goodwill.
Some companies like ESOFund, 137 Ventures, EquityZen can do deals without company involvement, with a non-recourse loan with limited upside/downside, or a forward contract with cash delivered today, and the certificate held as collateral until IPO, when it is transferred.
There are increasingly share restrictions (which some consider unenforceable) on sales/transfers, loans, etc. First-hand knowledge online is scarce and lawyers give unclear answers due to the novelty of these deals. Can the company find out? Intervene? Sue? Are they likely to? Do we need a public case and TechCrunch headline in order to find out what the outcome is? How different is self-financing vs. a rich relative vs. angel vs. a marketplace investor?
Edit: It seems like I misunderstood, and the investors are investing in the company itself, not buying employee shares on the secondary market. The major point still stands though.
Seems like a pretty good investment thesis (especially if they were truly ahead of the curve here).
Except I doubt the last bullet is accurate. I'd be very surprised to find that even 10% of tech IPOs have significant preferred investors not subject to a lock-up. Underwriters really, really don't like holders (even small ones, but especially big ones) being able to sell right off the bat. And if the market is flooded with VC investors dumping shares just after the offering, then there may well be no "pop" to participate in.
Maybe I'm missing something, but that doesn't really sound like a "thesis" but rather just an identifying mispriced securities ("arb opportunity" also works).
I agree with the latter that the late stage market for startup growth capital likely did not price this advantage in, and that the PE fund had an edge. But even at that stage there are winners and losers, and I would think that a thesis would still need to resemble the kind that Series B investors must concoct, and be able to sift out the winners from the losers.
In any case I appreciate you sharing this info. It's enlightening.
Well ESO fund has been around for 3 years-ish. VCs also do this ad-hoc sometimes too with employees. I think other older engineers have known this to be a 'problem' too for many years.
It's interesting to see the popular response to this thread being one where people think employees are better off with salary over options.
This seems crazy to me as I have watched many close friends cash out options from companies including Google, Yelp, Apple and Pandora and buy houses (some with cash), start companies, become investors and/or take long sabbaticals with the proceeds from their options. With salary there is a clear upper bound and the tax on W2 income is simply the worst. I would say that at least in the Bay Area, options are a good bet and much better bet based on what I've seen.
Startups are always a gamble for everyone involved. But outside of the financial industry, where 6 and 7 figure cash bonuses are common, I think options are superior to other forms of compensation if you're trying to optimize for gaining a "life changing amount of money" in less than say 10 years. High salary could only compare if you are very good at minimizing tax and maximizing the money making potential of your salary though investments (requiring additional work). But if you're going to have to invest anyway, why not work for a company you believe in and have a chance at influencing the company's success as well as your own?
> I have watched many close friends cash out options from companies including Google, Yelp, Apple and Pandora and buy houses (some with cash)
I have watched friends get paid a smaller salary, hoping for a great exit only to find their options diluated or the company just simply failing.
Now you probably only have lucky and successful friends or that friends who didn't get enough cash to buy a house are probably not in the back of your mind, as nobody wants to advertise either their failure or failure of their friends.
It just get chucked to "oh well, startups are risky". But then the winner get famous and everyone talks about them, making it seem like joining a startup and accepting options instead of a good salary is a sure way to succeed.
Notice, this is the same process the lottery system uses. We make fun of those people, but it is the same idea. Lottery always havily publicizes their winners, that is not just random marketing but a very useful tactic -- make everyone believe they can win took -- "Look at him, they got a huge giant check, so can you". If they televised ever single lottery loser, nobody would buy the tickets.
Having a significant portion of your portfolio in options on one company, which also happens to be the company you work for, is overconcentrated. The usual (good) advice is that people should diversify their portfolio, and believing in your company is not a good reason to not do that. Maybe it'd help to think about it in reverse: if you had all your money in cash, would you then buy all those options in your company to get the same portfolio? (Note: perhaps you would, but it's generally considered to be a bad idea.)
This is like someone winning the lottery then telling you to liquidate your retirement fund and buy powerball tickets.
Yeah, if you worked for Google back in the day, you could actually do this. Now? With the crowded landscape of tech companies competing to provide services, except for the few services who have one or MAYBE two companies that completely own the field? You'd be insane to take options.
The idea of taking higher salary over options is basically summed up in the "why your dentist is rich" chapter in Fooled by Randomness. It's "safer" and you'll be relatively rich over all outcomes.
Additionally you can theoretically invest the extra money over your vesting period of the options at whatever $insert ETF produces as an annual return.
Setting all the monetary issues asside I'm not sure if I'd prefer more money or more options on a philosophical basis. I feel like I'd go for options because if you work at a startup you should share the vision and work there because you believe it's awesome stuff that will change the world. OTOH taking the salary might make you less prone to certain biases and more "objective" in everyday work (+not overinvested in one outcome).
tl;dr: I think I'd take the options package if I'd work at a startup because if I wouldn't I'd have to question why I work there in the first place
If you assume that you will be screwed out of your equity, it makes sense to be compensated entirely with cash up front.
And with companies like Uber that seem to plan to never have an IPO, and also this meme that it's good to screw ex-employees out of their vested shares, it's not necessarily an unreasonable assumption.
Are you talking about options being the entirety of one's financial compensation? Because I wonder how people who work without a salary manage to pay the bills every month.
> the tax on W2 income is simply the worst
As opposed to getting taxed on what you eventually make from your options?
That you have four close friends who have made significant windfalls is a bit of an anomaly. There are far more people that have lost on that gamble(trading salary for options) than there are that have won. Give it another ten years of working at startups and it won't look so crazy.
I'm mot even sure how you "optimize for gaining a "life changing amount of money"? That's like saying you are going to optimize for luck. There a substantial amount of luck involved in seriously "cashing out" on a startup.
My experience has been that you never get enough influence over the company's success to make a significant difference, and the options don't pay off frequently enough to rely on.
For my own part, I've been at this for over 20 years and I've never come close to making any significant amount of money from options. They have lost all incentive power. Pay me cash money now, and I'll invest it however I please.
So, companies that exist in that tiny portion which are actually hugely profitable? Most companies aren't, and most options are worth little to nothing at the end of the day. After a decade in start ups and now supporting a family, I'll always take salary over options.
> But if you're going to have to invest anyway, why not work for a company you believe in and have a chance at influencing the company's success as well as your own?
For one thing, it's fiscally unsound to have the majority of your net worth and your salary tied to a single investment.
I would like to point out that there is a practical third option given that some people say "Pay Employees A Market Salary", whereas some companies may not yet be able to afford it.
In practice when you're a technical founder (or cofounder with one), you might have three fantastic people you can't afford, great technical roles. They'd do great work for 40 hours per week, they believe in your vision and you, because your vision has a competitive advantage they can execute well with, and you can essentially generate equity value out of thin air together. They cost way less than the amount of value that could be generated, so they make sense from a business investment perspective.
But the company just might not have the funds yet.
So, besides giving out options as compensation, or giving out a market salary, the third, practical alternative, is not to hire any of the three persons, but instead work for 130 hours per week doing their 3 jobs and your job, and sleep 5.4 hours per day.
This divides to 32.5 hours per "job" (130 / (3+1)). In practice by not hiring these great engineers, you've also not hired their coffee breaks, lunches, not hired the time they spend reading Hacker News, reading about new technologies, trying various stuff such as a new framework they'd like to try, you've not hired the time they spend writing documentation or any kind of testing whatsoever, and you've not hired any downtime they spend waiting for anything whatsoever. In fact, with these concessions, the 130 hours turns out to be an exaggeration.
So, some people call the results of this "technical debt", which is a bit of a misnomer.
It's a misnomer because if the project doesn't start generating value, you can kill it and nobody has to clean up anything. So in this sense, rather than a "technical debt" - it's more of a technical option. Instead of generating employee stock options, you've created technical stock options, where if the technical results actually make it rain, then at that point the project is investable, people can be hired for a market salary, and they can rewrite all the code that you've optioned. In this very real sense it really is an option, rather than debt.
So, in practice a lot of silicon valley seems to work this way. A lot of successful people have succeeded using more or less this formula.
We've all heard lots of stories of seasoned developers being brought on to clean up spaghetti code written by a founder or cofounder, that proved the business case but was hideous, poorly documented, structured, tested, with even security and backup policies and redundancy policies making it a miracle that nothing melted down.
So when one wonders why some founders work so much - well, this is the reason.
The people who could have written all this properly from the start, weren't available given the finances the company had at the time.
Often other people aren't willing to share the vision, and if you want something built, regardless of its value, at times you just have to do it - before anyone has funded you.
So this is a very real third possibility that many people do not realize really is a kind of "option".
There is a downside to RSUs. Say you work for a private company with a high valuation, e.g. AirBnB at $25B, and you are granted 0.01% equity over 4 years. That means you are vesting $2.5m of RSUs over 4 years, and these RSUs are taxable at that amount. Typically for folks earning over $150k/year in base salary, particularly if married, even half as much will put you into AMT territory, and you will end up paying a significant chunk of cash each year in taxes (even if RSUs are withheld for taxes, because the withholding cannot account for things like AMT).
Options with extremely long exercise windows helps obviate this tax burden and allows the employee to decide when/if to improve their tax position by exercising ahead of a liquidity event.
I'm up in Canada, and the RSU structure for my employer is an initial grant of $3x, with $x vesting every year for three years. Only when I exercise the vested RSUs (flat exchange at fair market value - typically the average stock price over the past week) do I declare them as income, at which point it's taxed as per usual for employment income.
I was surprised to learn the post is referring to a type RSU that defers settlement and thus taxation to a liquidity event.
This is very intriguing. We may not be familiar with this because traditionally RSUs were issued by mature public companies, so they couldn't / wouldn't need to support that trigger.
Are there any startups using these single trigger settlement RSUs today? Any other drawbacks like from an accounting perspective?
You know the simple solution to this is that companies withhold the amount of RSUs from you that would be taxed, when they vest.
Its almost like so simple of a solution that reporters won't touch it.
edit: nevermind. even the company cant pay the tax with their illiquid RSUs so its still a problem, and a bigger problem if the share valuation increases, pre-IPO
This is very interesting. Options are really an unappealing mechanism to incentivize employees. I feel like they prey on people who really don't know any better, and don't understand the tax implications or the possibilities around future dilution.
As a rule of thumb I discount face value of options by as much as 70%, that generally doesn't go over very well with people trying to convince you to accept them in lieu of cash.
The single trigger RSU is a very hard sell though, as we can see from this example it hurts both Investor and Founder equity stakes, unless people start balking at options (which they should) it won't fly.
I value stock options at zero. There is potentially a huge upside if you are an early employee at a company that gets enormous. Even then, you have to be top 20 or 30 to get f-you money, and even then it might not even be that.
I had stock options (not RSUs) at BigCo where I worked for 2 years. At one point, had I been fully vested, I was sitting on about $240k worth of stock. After a 3x1 split and the company going back down to almost the strike price I was granted stock (and most of it was worthless because was given it as part of a raise at a high strike), after I parted ways with the company and sold my options (had to as part of the severance agreement), I walked away with $2000. Basically a $1k/yr bonus. I would have gladly taken extra salary instead of stock. Lesson learned.
Quick question. Do you work for a startup now with options? Or, have you in the past? I'm trying to work out if people who object to options would ever join startups. Or, if they're appetite for risk is too small to be a potential candidate.
Equity is one area where I would encourage YC to get more involved. We need someone to step in and lobby the government for tax treatment of options that reflects their economic reality to early stage employees. We also need to encourage companies to use a 'standard' stock option agreement which is well known by everyone so that equity offers can be compared across companies.
If you take equity from an early stage company that has also raised a ton of money with a liquidation preference, what are your chances of getting paid out, even on a big exit? That question is basically impossible for most people out here to answer.
Is the presumption that founders and investors are not trying to screw employees? I genuinely can't tell from the article. I thought it's just common knowledge that they will try to screw employees at every chance. With options it was different strike prices for management/ founders vs employees. With RSU's it is weird vesting schedules and forcing forfeiture situations.
>Is the presumption that founders and investors are not trying to screw employees?
I think the presumption is that all parties act in their own self-interest. For some founders that means compensating employees with equity, for others that means keeping equity to themselves and relying on cash compensation for employees. Without talking about specific situations I don't think you can ascribe malice to either choice.
The barrier to entry of this stock option tweak: it requires an informed populace, ie, us.
If you are a founder with reasonable engineer cred and announce differentiated stock option terms, ie, Adam D' Angelo at Quora, there's a reasonable chance that engineers considering joining your company will be encouraged by your effort on this.
If you're someone else, and your company offers this, many experienced engineers, not unreasonably, will value their equity packages at zero regardless of what you do. Many others, such as new grads, will not know enough about stock options to understand the distinction you're drawing.
If you do decide to offer RSUs for the reasons the authors cited, you may want to follow the example of Henry Ward at eShares and put together some good presentation materials to explain the benefits of this course. Otherwise, you're making an expensive choice for little benefit.
I have always thought that companies should work out the salary of a new employee in all cash then once the parties are happy allow the employee to trade in whatever percentage they liked for equity. If you value the equity at zero why should the company give it to you and if you value it very highly why should they give you cash?
Because startups are, effectively by definition, equity rich and cash poor. Trading $100k/yr in ISOs for $100k/yr in cash across 10 employees increases your cash burn by $1M/year, which is make-or-break for a lot of startups.
> 3 year employee tenure
> 100% loss of potential equity when employees leave the company ...
...
> You can also see that only the employees hired in year 8, 9, 10
> (the final 855) have any shares at the end of year 10. Quite bizarre!
I like the basic idea and it's nicely presented however conceptually I'd favor a model where the employee gains come primarily from the losses of later stage investors and not early stage investors (and founders).
"""Within the investor class the earlier investors lose more. Year one investors go from 3.2% to 2.3% about a 25% loss, pretty much the same as founders. Year ten investors go from 9.0% to 8.7% about a 3.5% hit."""
So basically I'd like to work from sort of the reverse of this but I assume it's not very likely due to the investment horizons etc.
Basically I suppose late stage investments should be a good chunk more expensive.
This is clearly a shot at Kupor's infamous A16Z post where he claims employees who stay suffer a LOT more dilution (80%) when employees who leave keep 100%.[1] But this poster's model puts it at just 5%.
There's clearly wildly different assumptions at play here. Can someone smarter than me spell them out? One that jumps out is the assumption here that no employee stays past 3 years. Isn't that a pretty high attrition rate for a pre-IPO startup?
Wouldn't RSUs open employees to a different and more punitive tax regime (income tax) than options (which would fall under capital gains if you exercised early enough)?
RSUs are simpler and can be planned for. For example, a company could grant RSUs with a mandatory buy back vesting schedule (basically 83b election) upon hire and include the taxes as part of the comp package.
Examples:
Junior Engineer Sally joins Company A and is offered 0.25% of the company in RSUs. Company A recent raised at a 20M post money with a preferred share price of $1 and a FMV of $0.20. She owes tax on $10k of RSU gains. Company A either: 1) Buys back $4000 of stock in order to cover taxes 2) Provides a $4000 signing bonus to cover taxes.
Senior Engineer Bill joins Company B and is offered 0.05% in RSUS. Company B recently raised at a $500M valuation with a preferred share price of $10 and FMV of $3. He owes tax on $75k of RSU gains. Company B either 1) Buys back $30k of stock or 2) provides a $30k signing bonus.
While the dialog around various equity-based incentive compensation mechanisms is good, this article is off base in SO many ways:
>>With an often high strike price,
Only an issue at the later stages of companies (note: this writeup argues RSUs "from the beginning").
>>a large tax burden on execution due to AMT,
Only if you are exercising later in the company stage, when the fair market value has (usually) gone up. If you are bullish on the company, it's generally best to exercise as you vest, for this very reason.
Also, exercising as you vest gets the timer going for (a) cap gains treatment (much better tax rates), AND, a possible Qualified Small Business Stock tax exclusion (5yr holding, significant tax break).
>>and a 90 day execution window after leaving the company many share options are left unexecuted.
This is MUCH less of an issue if you are exercising as you go along (see above).
If you you have just left a large unicorn private company, there are often secondary buyers for the stock. You could exercise and sell some stock to them to cover your exercise cost.
Regarding RSUs, you HAVE TO PAY TAX AS YOU VEST. For a private company, you're just replacing one potential problem (AMT with option exercises) with a very specific actual problem (steady tax liability as without liquidity).
RSUs are a very useful compensation tool, but you can't declare them unilaterally better. ALL equity compensation forms require some "user sophistication", including options and RSUs.
If you don't understand how to optimize your situation, get advice from someone who does!
Hold up. This post proposes using "single trigger RSUs" instead of options, claiming that taxes are deferrable to a liquidity event. But according to this[1], FICA taxes are still due on vesting. So RSUs would still have immediate tax consequences, potentially very expensive for unicorns.
Taking equity instead of cash is like asking the company to denominate your salary in Bison Dollars. Worth a lot IF the plan for world domination goes off without a hitch but until then...
The last startup I worked at went through a merger. In the process, they created a new company and gave all employees stock in the new company, on the same vesting schedule as the options had been on in the previous companies.
They organized things and provided help to ensure that all US employees were able to make a Section 83(b) election for our stock in the new company as soon as it was created. (This means we paid taxes early based on the current value (zero) instead of potentially paying much larger taxes in the future.)
reminded how 10 years ago upper class was trying to initiate grass roots and steer protests against options expensing. They failed and as a result we have RSU pretty much everywhere instead of options. The startups are the last bastion, and i think with the modern "who needs an IPO with such great C round (and related caching out for chosen ones)" approach, people will start to get the picture and the RSU will come there too.
The problem with startup RSUs is that you are taxed when the RSUs vest. If there is no liquidity (which is the case for most startups) then you're paying taxes on RSUs which you can't sell and may never be worth anything.
This is where having a lobbying group would be helpful -- this really needs to be fixed through policy.
We need to get the tax law changed so that RSUs are taxed on liquidity instead of vesting. Then you'll still avoid the corruption the tax is supposed to protect against (paying an executives millions in what was previously untaxed compensation through RSUs in the 80s) but still allowing them to be given as startup equity compensation.
Absolutely agree. ISOs should also be taxed on liquidity as well, instead of an AMT on exercise. There was a group, ReformAMT.org, opened in the wake of the 2000 tech crash, where many employees ended up owing massive amounts of AMT on now-devalued stock.
However, it seems that the employers' and investors' interests are against the employees' here - the investors want what few employee shares are lost to be returned so they are diluted less, employers want holden handcuffs to reduce mobility, and only the much-weaker at lobbying employees want more freedom/mobility.
Can you go into a bit more detail on what counts as liquidity? Can I sell on a secondary market? Can a bank let me guarantee a loan based on my current units? Can non-liquid units be transferred to my next of kin tax free?
I can imagine that there would be other consequences to the change. For example, I could see anyone on the edge around their 1 year vesting cliff would be fired to avoid parting with their equity. It would probably also push down the amount of equity offered because of the increase in value. Further, some companies are already doing this, vesting could be back loaded with the majority vesting in the later years.
There are companies that already let people go before their 1 year cliff (or do other types of restructuring that results in the vesting period to reset).
However, I think it would be appropriate to give fewer options as a consequence of this change, since the options would be a more realistic part of the compensation package when you have a longer-period of time to determine if you want to exercise them.
I could definitely see the 1 year cliff going away too, else you'd have people collecting 25% of their options at various places and moving on to other companies each year. Eventually one of those companies will do well and your "work" investment will pay off. You can do shotgun investing with your employee options.
But a lot of this misses the point that your company's growth is entirely reliant on a productive employee base. If you back load vesting or start firing people right before their cliff, or do any other practices such as this, why would anyone choose to work for you?
Is a single trigger RSU somehow different in trigger than single trigger options? I've always been told that single trigger, at least for the majority of engineering, means your company won't be purchased.
Single trigger makes sense for legal, accounting, etc who are likely gone in an acquisition.
If the premise is that employees can move the needle on the stock price through their contributions, then double trigger doesn't make sense either.
I recently went through an acquisition where all of our stock was converted into the acquiring company's stock. It was maddening to see our team continue to perform well but see the price of our equity tank along with the rest of the company.
There was a HN discussion ten days ago [1], where several people including myself were suggesting 83b rule RSUs as a possible solution. Nice to see this method quantified.
I have really never understood the confusion over why this doesn't get implemented. It has always seemed clear to me that there's not enough demand for change, and investors and founders want things to stay the way they are. It's a really, really good deal for them.
There are a wide range of financial products used around the world that would better fix the tech sectors compensation incentives and nobody is talking about them.
Think different didn't mean argue about false dichotomies.
It is a total charade for the venture firms to propel the notion that they are doing employees a favor by even offering stock. "How gracious of us to dilute our investment at all!"
Dilute the preferred shares with 8% dividend and liquidity preferences!
Offer convertible bonds or other hybrid products!
You can incentivize people in 101 ways, and you guys are debating about two of them under the assumption that the crowd is right
Either way it's a losing game, consider a company like Google - how would they attract new employees on either scheme given that the company has been around for 15+ years?
The only people who win are those who get in early, or invest big. Any IPO ultimately results in people earning money who don't "work" for that money - that means the actual workers lose out everytime.
So getting paid way above market and working at a place where software engineering talent is highly respected and valued is "losing out"?
I'm sorry but this entitled attitude just grates at me. If you are in SV getting paid 3-5 times the median household income you already are in the 1% and you already have all the advantages in terms of upward mobility. If you want to earn millions go out and start your own company, it is ridiculous to demand a high salary and a high equity payout. You are not entitled to anything except what you can negotiate.
There is nothing inherent in software engineering that makes it worth $100k minimum per head, it is only worth that much if it supports a business that can earn that much. The fact that SV is one of the bright spots in the economy of the last decade has really started to go to software engineers heads. If you believe you are worth more than what you are being offered, the only way to prove it is to go out and build a business yourself. You can't look at the 1% of the 1% who got a lucky windfall from being in the right place at the right time, and use that as your baseline for "fairness". Try facing the economic struggles that 50% of the country is dealing with, and then tell me how bad Google is screwing its employees.
> Any IPO ultimately results in people earning money who don't "work" for that money - that means the actual workers lose out everytime.
It is wrong to believe that people would invest large amounts of money randomly without spending significant amounts of their time to make sure the investment will create them some returns.
Also they have the risk to actually loose 100% of their investment, which some guy employed at Google with a 6 figure income doesn't have.
Of course they'll need more profit to cover for the risk.
Think about it this way: If there were no investors there wouldn't be a Google or Facebook as we know it today as these companies didn't make a dime for the first 5 or 6 years of their existence.
You can be critical of these two companies (I am) but there are thousands of other companies in the IT sector that just wouldn't exists if they had to make profit right from the start and grow organically.
chollida1|9 years ago
Their thesis was that
- startups would remain private longer.
- employee's lost their options when they leave
- longer periods to go public means more employees return options to the pool which means employee option pools can be smaller
- longer private periods leads to more rounds raised which benefits investors over employees as the former can participate on each round to keep from being diluted
- exits would come eventually and the investors would always have superior terms, I believe that they were working under the assumption that investors would never have mandatory black out periods after IPO so they could essentially participate in the opening day IPO pop.
This is one of the coolest and most maddening things about finance. Every time you think you've come to a big realization, usually you find out that someone else came to the same conclusion many years ago and has been making money "arbing" it out ever since.
wyman|9 years ago
This would totally solve the 90-day exercise period problem for the employees, without requiring company goodwill.
Some companies like ESOFund, 137 Ventures, EquityZen can do deals without company involvement, with a non-recourse loan with limited upside/downside, or a forward contract with cash delivered today, and the certificate held as collateral until IPO, when it is transferred.
There are increasingly share restrictions (which some consider unenforceable) on sales/transfers, loans, etc. First-hand knowledge online is scarce and lawyers give unclear answers due to the novelty of these deals. Can the company find out? Intervene? Sue? Are they likely to? Do we need a public case and TechCrunch headline in order to find out what the outcome is? How different is self-financing vs. a rich relative vs. angel vs. a marketplace investor?
Ask HN thread: https://news.ycombinator.com/item?id=12034716
Edit: It seems like I misunderstood, and the investors are investing in the company itself, not buying employee shares on the secondary market. The major point still stands though.
Jerry2|9 years ago
Can you (or someone else) please explain how you'd make money based on set of assumptions listed above?
hobbyjogger|9 years ago
Except I doubt the last bullet is accurate. I'd be very surprised to find that even 10% of tech IPOs have significant preferred investors not subject to a lock-up. Underwriters really, really don't like holders (even small ones, but especially big ones) being able to sell right off the bat. And if the market is flooded with VC investors dumping shares just after the offering, then there may well be no "pop" to participate in.
hkmurakami|9 years ago
I agree with the latter that the late stage market for startup growth capital likely did not price this advantage in, and that the PE fund had an edge. But even at that stage there are winners and losers, and I would think that a thesis would still need to resemble the kind that Series B investors must concoct, and be able to sift out the winners from the losers.
In any case I appreciate you sharing this info. It's enlightening.
mahyarm|9 years ago
shon|9 years ago
This seems crazy to me as I have watched many close friends cash out options from companies including Google, Yelp, Apple and Pandora and buy houses (some with cash), start companies, become investors and/or take long sabbaticals with the proceeds from their options. With salary there is a clear upper bound and the tax on W2 income is simply the worst. I would say that at least in the Bay Area, options are a good bet and much better bet based on what I've seen.
Startups are always a gamble for everyone involved. But outside of the financial industry, where 6 and 7 figure cash bonuses are common, I think options are superior to other forms of compensation if you're trying to optimize for gaining a "life changing amount of money" in less than say 10 years. High salary could only compare if you are very good at minimizing tax and maximizing the money making potential of your salary though investments (requiring additional work). But if you're going to have to invest anyway, why not work for a company you believe in and have a chance at influencing the company's success as well as your own?
rdtsc|9 years ago
I have watched friends get paid a smaller salary, hoping for a great exit only to find their options diluated or the company just simply failing.
Now you probably only have lucky and successful friends or that friends who didn't get enough cash to buy a house are probably not in the back of your mind, as nobody wants to advertise either their failure or failure of their friends.
It just get chucked to "oh well, startups are risky". But then the winner get famous and everyone talks about them, making it seem like joining a startup and accepting options instead of a good salary is a sure way to succeed.
Notice, this is the same process the lottery system uses. We make fun of those people, but it is the same idea. Lottery always havily publicizes their winners, that is not just random marketing but a very useful tactic -- make everyone believe they can win took -- "Look at him, they got a huge giant check, so can you". If they televised ever single lottery loser, nobody would buy the tickets.
bradleyjg|9 years ago
conistonwater|9 years ago
FussyZeus|9 years ago
Yeah, if you worked for Google back in the day, you could actually do this. Now? With the crowded landscape of tech companies competing to provide services, except for the few services who have one or MAYBE two companies that completely own the field? You'd be insane to take options.
thisone|9 years ago
You're one lucky person to know!
kriro|9 years ago
Additionally you can theoretically invest the extra money over your vesting period of the options at whatever $insert ETF produces as an annual return.
Setting all the monetary issues asside I'm not sure if I'd prefer more money or more options on a philosophical basis. I feel like I'd go for options because if you work at a startup you should share the vision and work there because you believe it's awesome stuff that will change the world. OTOH taking the salary might make you less prone to certain biases and more "objective" in everyday work (+not overinvested in one outcome). tl;dr: I think I'd take the options package if I'd work at a startup because if I wouldn't I'd have to question why I work there in the first place
powera|9 years ago
And with companies like Uber that seem to plan to never have an IPO, and also this meme that it's good to screw ex-employees out of their vested shares, it's not necessarily an unreasonable assumption.
justinlardinois|9 years ago
> the tax on W2 income is simply the worst
As opposed to getting taxed on what you eventually make from your options?
bogomipz|9 years ago
I'm mot even sure how you "optimize for gaining a "life changing amount of money"? That's like saying you are going to optimize for luck. There a substantial amount of luck involved in seriously "cashing out" on a startup.
marssaxman|9 years ago
For my own part, I've been at this for over 20 years and I've never come close to making any significant amount of money from options. They have lost all incentive power. Pay me cash money now, and I'll invest it however I please.
Retric|9 years ago
EpicEng|9 years ago
So, companies that exist in that tiny portion which are actually hugely profitable? Most companies aren't, and most options are worth little to nothing at the end of the day. After a decade in start ups and now supporting a family, I'll always take salary over options.
morgante|9 years ago
For one thing, it's fiscally unsound to have the majority of your net worth and your salary tied to a single investment.
logicallee|9 years ago
In practice when you're a technical founder (or cofounder with one), you might have three fantastic people you can't afford, great technical roles. They'd do great work for 40 hours per week, they believe in your vision and you, because your vision has a competitive advantage they can execute well with, and you can essentially generate equity value out of thin air together. They cost way less than the amount of value that could be generated, so they make sense from a business investment perspective.
But the company just might not have the funds yet.
So, besides giving out options as compensation, or giving out a market salary, the third, practical alternative, is not to hire any of the three persons, but instead work for 130 hours per week doing their 3 jobs and your job, and sleep 5.4 hours per day.
This divides to 32.5 hours per "job" (130 / (3+1)). In practice by not hiring these great engineers, you've also not hired their coffee breaks, lunches, not hired the time they spend reading Hacker News, reading about new technologies, trying various stuff such as a new framework they'd like to try, you've not hired the time they spend writing documentation or any kind of testing whatsoever, and you've not hired any downtime they spend waiting for anything whatsoever. In fact, with these concessions, the 130 hours turns out to be an exaggeration.
So, some people call the results of this "technical debt", which is a bit of a misnomer.
It's a misnomer because if the project doesn't start generating value, you can kill it and nobody has to clean up anything. So in this sense, rather than a "technical debt" - it's more of a technical option. Instead of generating employee stock options, you've created technical stock options, where if the technical results actually make it rain, then at that point the project is investable, people can be hired for a market salary, and they can rewrite all the code that you've optioned. In this very real sense it really is an option, rather than debt.
So, in practice a lot of silicon valley seems to work this way. A lot of successful people have succeeded using more or less this formula.
We've all heard lots of stories of seasoned developers being brought on to clean up spaghetti code written by a founder or cofounder, that proved the business case but was hideous, poorly documented, structured, tested, with even security and backup policies and redundancy policies making it a miracle that nothing melted down.
So when one wonders why some founders work so much - well, this is the reason.
The people who could have written all this properly from the start, weren't available given the finances the company had at the time.
Often other people aren't willing to share the vision, and if you want something built, regardless of its value, at times you just have to do it - before anyone has funded you.
So this is a very real third possibility that many people do not realize really is a kind of "option".
An essay on this is here:
http://higherorderlogic.com/2010/07/bad-code-isnt-technical-...
timcederman|9 years ago
Options with extremely long exercise windows helps obviate this tax burden and allows the employee to decide when/if to improve their tax position by exercising ahead of a liquidity event.
jamie_ca|9 years ago
I'm up in Canada, and the RSU structure for my employer is an initial grant of $3x, with $x vesting every year for three years. Only when I exercise the vested RSUs (flat exchange at fair market value - typically the average stock price over the past week) do I declare them as income, at which point it's taxed as per usual for employment income.
morgante|9 years ago
My understanding was that single-trigger RSUs aren't taxable until exit.
abalone|9 years ago
This is very intriguing. We may not be familiar with this because traditionally RSUs were issued by mature public companies, so they couldn't / wouldn't need to support that trigger.
Are there any startups using these single trigger settlement RSUs today? Any other drawbacks like from an accounting perspective?
harryh|9 years ago
cloudjacker|9 years ago
Its almost like so simple of a solution that reporters won't touch it.
edit: nevermind. even the company cant pay the tax with their illiquid RSUs so its still a problem, and a bigger problem if the share valuation increases, pre-IPO
home_boi|9 years ago
buttershakes|9 years ago
As a rule of thumb I discount face value of options by as much as 70%, that generally doesn't go over very well with people trying to convince you to accept them in lieu of cash.
The single trigger RSU is a very hard sell though, as we can see from this example it hurts both Investor and Founder equity stakes, unless people start balking at options (which they should) it won't fly.
dohertyjf|9 years ago
I had stock options (not RSUs) at BigCo where I worked for 2 years. At one point, had I been fully vested, I was sitting on about $240k worth of stock. After a 3x1 split and the company going back down to almost the strike price I was granted stock (and most of it was worthless because was given it as part of a raise at a high strike), after I parted ways with the company and sold my options (had to as part of the severance agreement), I walked away with $2000. Basically a $1k/yr bonus. I would have gladly taken extra salary instead of stock. Lesson learned.
jusben1369|9 years ago
wtvanhest|9 years ago
If you take equity from an early stage company that has also raised a ton of money with a liquidation preference, what are your chances of getting paid out, even on a big exit? That question is basically impossible for most people out here to answer.
cubano|9 years ago
I would think enough data now exists to allow such an analysis to have some idea of those numbers.
codeonfire|9 years ago
kevan|9 years ago
I think the presumption is that all parties act in their own self-interest. For some founders that means compensating employees with equity, for others that means keeping equity to themselves and relying on cash compensation for employees. Without talking about specific situations I don't think you can ascribe malice to either choice.
iaw|9 years ago
Some high-level valley participants are definitely bad actors but the bulk of them are just normal people in positions of power.
calcsam|9 years ago
If you are a founder with reasonable engineer cred and announce differentiated stock option terms, ie, Adam D' Angelo at Quora, there's a reasonable chance that engineers considering joining your company will be encouraged by your effort on this.
If you're someone else, and your company offers this, many experienced engineers, not unreasonably, will value their equity packages at zero regardless of what you do. Many others, such as new grads, will not know enough about stock options to understand the distinction you're drawing.
If you do decide to offer RSUs for the reasons the authors cited, you may want to follow the example of Henry Ward at eShares and put together some good presentation materials to explain the benefits of this course. Otherwise, you're making an expensive choice for little benefit.
a_small_island|9 years ago
Can you expand on this? Are you of the mind that engineers should only trust other engineers?
danieltillett|9 years ago
21echoes|9 years ago
powera|9 years ago
te|9 years ago
kriro|9 years ago
"""Within the investor class the earlier investors lose more. Year one investors go from 3.2% to 2.3% about a 25% loss, pretty much the same as founders. Year ten investors go from 9.0% to 8.7% about a 3.5% hit."""
So basically I'd like to work from sort of the reverse of this but I assume it's not very likely due to the investment horizons etc. Basically I suppose late stage investments should be a good chunk more expensive.
abalone|9 years ago
There's clearly wildly different assumptions at play here. Can someone smarter than me spell them out? One that jumps out is the assumption here that no employee stays past 3 years. Isn't that a pretty high attrition rate for a pre-IPO startup?
[1] http://a16z.com/2016/06/23/options-timing/
ktothemc|9 years ago
phamilton|9 years ago
Examples:
Junior Engineer Sally joins Company A and is offered 0.25% of the company in RSUs. Company A recent raised at a 20M post money with a preferred share price of $1 and a FMV of $0.20. She owes tax on $10k of RSU gains. Company A either: 1) Buys back $4000 of stock in order to cover taxes 2) Provides a $4000 signing bonus to cover taxes.
Senior Engineer Bill joins Company B and is offered 0.05% in RSUS. Company B recently raised at a $500M valuation with a preferred share price of $10 and FMV of $3. He owes tax on $75k of RSU gains. Company B either 1) Buys back $30k of stock or 2) provides a $30k signing bonus.
superuser2|9 years ago
I'm not a CPA.
payne92|9 years ago
>>With an often high strike price,
Only an issue at the later stages of companies (note: this writeup argues RSUs "from the beginning").
>>a large tax burden on execution due to AMT,
Only if you are exercising later in the company stage, when the fair market value has (usually) gone up. If you are bullish on the company, it's generally best to exercise as you vest, for this very reason.
Also, exercising as you vest gets the timer going for (a) cap gains treatment (much better tax rates), AND, a possible Qualified Small Business Stock tax exclusion (5yr holding, significant tax break).
>>and a 90 day execution window after leaving the company many share options are left unexecuted.
This is MUCH less of an issue if you are exercising as you go along (see above).
If you you have just left a large unicorn private company, there are often secondary buyers for the stock. You could exercise and sell some stock to them to cover your exercise cost.
Regarding RSUs, you HAVE TO PAY TAX AS YOU VEST. For a private company, you're just replacing one potential problem (AMT with option exercises) with a very specific actual problem (steady tax liability as without liquidity).
RSUs are a very useful compensation tool, but you can't declare them unilaterally better. ALL equity compensation forms require some "user sophistication", including options and RSUs.
If you don't understand how to optimize your situation, get advice from someone who does!
dman|9 years ago
abalone|9 years ago
Are there actually any startups offering RSUs?
[1] https://www.acc.com/chapters/wisc/upload/The-Rise-of-Restric...
bitwize|9 years ago
nfriedly|9 years ago
They organized things and provided help to ensure that all US employees were able to make a Section 83(b) election for our stock in the new company as soon as it was created. (This means we paid taxes early based on the current value (zero) instead of potentially paying much larger taxes in the future.)
trhway|9 years ago
mason55|9 years ago
jedberg|9 years ago
We need to get the tax law changed so that RSUs are taxed on liquidity instead of vesting. Then you'll still avoid the corruption the tax is supposed to protect against (paying an executives millions in what was previously untaxed compensation through RSUs in the 80s) but still allowing them to be given as startup equity compensation.
wyman|9 years ago
However, it seems that the employers' and investors' interests are against the employees' here - the investors want what few employee shares are lost to be returned so they are diluted less, employers want holden handcuffs to reduce mobility, and only the much-weaker at lobbying employees want more freedom/mobility.
iandanforth|9 years ago
spullara|9 years ago
delphinius81|9 years ago
However, I think it would be appropriate to give fewer options as a consequence of this change, since the options would be a more realistic part of the compensation package when you have a longer-period of time to determine if you want to exercise them.
I could definitely see the 1 year cliff going away too, else you'd have people collecting 25% of their options at various places and moving on to other companies each year. Eventually one of those companies will do well and your "work" investment will pay off. You can do shotgun investing with your employee options.
But a lot of this misses the point that your company's growth is entirely reliant on a productive employee base. If you back load vesting or start firing people right before their cliff, or do any other practices such as this, why would anyone choose to work for you?
hodgesrm|9 years ago
rdl|9 years ago
Single trigger makes sense for legal, accounting, etc who are likely gone in an acquisition.
Double trigger makes sense overall.
phamilton|9 years ago
I recently went through an acquisition where all of our stock was converted into the acquiring company's stock. It was maddening to see our team continue to perform well but see the price of our equity tank along with the rest of the company.
efoto|9 years ago
https://news.ycombinator.com/item?id=11963551
55555|9 years ago
kazinator|9 years ago
Is the following answer somehow too obvious to be true?
When you eventually sell the equity, the stock exchange will hook you up with counterparties who buy the stock. Those counterparties are who pays you.
cloudjacker|9 years ago
There are a wide range of financial products used around the world that would better fix the tech sectors compensation incentives and nobody is talking about them.
Think different didn't mean argue about false dichotomies.
It is a total charade for the venture firms to propel the notion that they are doing employees a favor by even offering stock. "How gracious of us to dilute our investment at all!"
Dilute the preferred shares with 8% dividend and liquidity preferences!
Offer convertible bonds or other hybrid products!
You can incentivize people in 101 ways, and you guys are debating about two of them under the assumption that the crowd is right
arrty88|9 years ago
https://www.nceo.org/articles/equity-incentives-limited-liab...
gringofyx|9 years ago
dasil003|9 years ago
I'm sorry but this entitled attitude just grates at me. If you are in SV getting paid 3-5 times the median household income you already are in the 1% and you already have all the advantages in terms of upward mobility. If you want to earn millions go out and start your own company, it is ridiculous to demand a high salary and a high equity payout. You are not entitled to anything except what you can negotiate.
There is nothing inherent in software engineering that makes it worth $100k minimum per head, it is only worth that much if it supports a business that can earn that much. The fact that SV is one of the bright spots in the economy of the last decade has really started to go to software engineers heads. If you believe you are worth more than what you are being offered, the only way to prove it is to go out and build a business yourself. You can't look at the 1% of the 1% who got a lucky windfall from being in the right place at the right time, and use that as your baseline for "fairness". Try facing the economic struggles that 50% of the country is dealing with, and then tell me how bad Google is screwing its employees.
DominikR|9 years ago
It is wrong to believe that people would invest large amounts of money randomly without spending significant amounts of their time to make sure the investment will create them some returns.
Also they have the risk to actually loose 100% of their investment, which some guy employed at Google with a 6 figure income doesn't have.
Of course they'll need more profit to cover for the risk.
Think about it this way: If there were no investors there wouldn't be a Google or Facebook as we know it today as these companies didn't make a dime for the first 5 or 6 years of their existence.
You can be critical of these two companies (I am) but there are thousands of other companies in the IT sector that just wouldn't exists if they had to make profit right from the start and grow organically.
morgante|9 years ago
Stock which is highly liquid and very valuable. I don't think they're having any trouble attracting talent.