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 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.
Unlike the lottery, knowledge and skill play a role here.
Startups are a lottery to a large degree, and for employees without significant equity, the odds don't seem great.
If you worked for 5 companies in 10 years, then you've got 50% of your options (likely) at each of those companies. Seems a decent-ish diversity.
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.
You're one lucky person to know!
Mainly I'm framing this in comparison to additional salary which is also unlikely to generate significant wealth unless you are very good or very lucky (Probobally both) at managing your money.
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
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.
> the tax on W2 income is simply the worst
As opposed to getting taxed on what you eventually make from your options?
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.
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.
Living in a cheap location is also not everyone's dream. It would be life changing for me to retire to Costa Rica, but it would not be a positive change. I live in a pretty expensive city (Seattle) because I like it here.
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.
For one thing, it's fiscally unsound to have the majority of your net worth and your salary tied to a single investment.
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-...
Working really hard and acquiring technical debt isn't really an alternative to hiring and compensating employees, it's (usually) a prerequisite. A single technical cofounder can be enough to get a company to Series A, but at some point you have to hire people.
If we wanted to discuss an actual alternative, it would be to hire people in other locations at far lower rates than those commanded in SV. But that comes with its own set of problems.
How awful do you think the original Facebook PHP codebase was? Or Google's original hacked together web crawler.
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.
My understanding was that single-trigger RSUs aren't taxable until exit.
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?
Most of the time, RSUs are taxable at the time of vesting, as most plans vest and release the shares simultaneously.
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
Edit: I think the parent poster was talking about RSUs (pre-IPO) that cannot be sold to pay off the required tax. My friends at companies in this pre-IPO stage hold the RSUs in the employees' names until the IPO permits the employees to sell RSUs to pay the tax. The companies also let employees recieve the RSUs and pay the tax themselves if they want to, but nobody I know has done this.
I may own illiquid RSUs, but only during the employee lockup period.
Fair and equitable are not often words used to describe the US tax code.
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 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.
But the options I've made the most money on was ironically from the only post-IPO company I've worked for (and where I joined years after the IPO), rather than the startups where I've had shares that have at some point or other had a paper-value magnitudes higher.
And the reason I did well there was that they clearly didn't value their options very highly - they threw a large options allocation after me to get me to accept a lower salary than I asked for for the first 6 months for political reasons (it would have put my salary above the salary of one of the higher ranked people who had to sign off on the hire, and they clearly didn't think that'd go down very well... so instead HR quietly promised me a "review" after 6 months and bumped up then).
That said, I am now co-founding a company and we plan to give future employees a long time period to decide whether they wish to exercise their options or not. If employees are willing to take lower salaries for equity for the sake of the company, companies should reward that sacrifice by letting the employee keep their equity options.
For example, I've got a friend who's been working at a startup for about eight years. They have a looming exit. If it goes through, he'll probably walk away with $1.5m. Had he gone the salaryman route, that'd be money in the bank.
if i'm going to work for someone else it's going to be the most stable situation possible, i.e. an established company with market or better salary and benefits and a reasonable workload.
In both cases, one of the defining factors in choosing the particular startups that I work for was that the founders were very employee-friendly.
In both cases, I was granted actual stock (ie. not options).
In my view, options (as typically offered) are basically useless as compensation. They have a strike price which isn't much lower than the price investors last bought stock at. Companies which offer these as a substantial component of compensation are essentially exploiting the naivety of employees and expecting them to value "ownership" more heavily than investors do, despite having much less favorable terms.
Risk appetite is not the issue.
If the startup stock doesn't, then it's extra stupid to work at that place unless they provide you with a special non-standard working arrangement.
Usually they don't, it's open offices in the bay area with a pretty similar organizational structure and work type. Not a flexible remote working situation at bay area salaries or similar.
I do work for a startup now, with options (and have in the past as well). I object to options in the sense that it takes a lot of luck for them to ever be worth anything. It's easy for companies to talk up their potential value (once we get our billion dollar valuation, your 0.05% is $500k!), but in order for the options to be worth the paper they're printed on, a lot of things have to happen in a specific order. One bump in the road, and your shares are wiped out.
Appetite for risk is a tricky way of putting it. I don't think the risk is that the company will fail and the options won't be worth anything; I think the real risk is that something will happen to cause the options to be worth less (or perhaps worthless). That's the sort of risk I'm not interesting in sacrificing much salary for, especially if the company isn't bootstrapping.
When the sum of the options pool allocated for employees is 5% or 10%, the risk/reward ratio is all out of whack. The risk of being diluted/preferenced/strong-armed out of your shares is fairly high. All it takes is one investor with preference to completely wreck the cap table.
As an employee, you need to know that you're absolutely last in line. Standing in front of you are: banks (loans generally come off the top), investors with preference, investors, founders (who will be fine, even if it means their shares are worth $0, but they get an incentive to stay worth $5m), C-level employees who might have preferred shares, and then finally, common stock holders.
So assuming everything to there goes really well, the shares convert to common and everything is looking up. You haven't been diluted into the ground, your company isn't Zynga and demanded your shares back and your company is now public. Congratulations! There are still more obstacles: you can't sell your shares for a certain lockup period, during which the share price could very well dive. If the stock is going up, you don't care, but if it dips, it's a race to your strike price. If the stock dips under your strike price, you have no reason to exercise your options, so you're left hoping that Wall Street likes your company.
And even then, let's say you exercise your options, sell the shares and make $500k. After taxes, you're going to walk away with a good chunk less than that. After taxes, let's say you have $330k. Say you worked at the company for 5 years before they went public, that's roughly $60k/year that your stock was worth.
So the real question then is how much salary is it worth deferring on the very long shot that you make $60k/year off of your stock? $330k isn't exactly life-changing money for most people: it's not enough to retire on, it's a nice down payment on a house someplace in reasonably high demand.
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.
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.
Can you (or someone else) please explain how you'd make money based on set of assumptions listed above?
What I don't understand is how you get around the fact that you would still have to "pick winners".
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.
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.
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.
2. Working somewhere that software engineering talent is highly respected is no measure of fiscal compensation
3. Those advantages of upward mobility are learnt, or acquired skills that people work at. There is no opportunity for them to be in the same position as a 1%er living off their parents money to invest and then continue to get rich(er)
4. You imply that employees have the ability to negotiate on-par with any investor
5. Your last point about $100k is odd, that's just supply and demand in a free market - and the sentiment is doubley-odd given that employee salaries have stagnated since the 70's, SV salaries have been proven to be (somewhat) rigged, also it is in any companies corporate interests to pay the lowest possible amount for any resource.
Lastly, your point about the 1% of the 1% is off-topic - and I agree that they're not necessarily to blame for the widening gap between rich and poor - but without proper incentives for the 99% to go to work, then that 1% of wealth could become worthless if society revolts because of the disproportionate distribution.
My point is simply that alternative vehicles for employee remuneration need to exist beyond the status-quo that's legally existed for decades.
[1] https://en.wikipedia.org/wiki/High-Tech_Employee_Antitrust_L...
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.
Stock which is highly liquid and very valuable. I don't think they're having any trouble attracting talent.
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.
I'm not a CPA.
Any gain post-vest can indeed be long-term cap gains, if you hold the shares > 1 year.
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.
Some high-level valley participants are definitely bad actors but the bulk of them are just normal people in positions of power.
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.
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 I sell on a secondary market?
Sure, and then you get taxed on the money you made, where your basis is $0.
> Can a bank let me guarantee a loan based on my current units?
That's tricky because it would be a way for people to work around the law. What if we made you pay tax if you took out a loan with the stock as collateral?
> Can non-liquid units be transferred to my next of kin tax free?
Seems like it would be reasonable to allow that. The value would still be $0, but when it became liquid, your next of kin would have to pay taxes on the value with a basis of $0, which would make it not a good workaround for estate tax since you would save money if you transferred it under the $5M lifetime limit.
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.
I would think enough data now exists to allow such an analysis to have some idea of those numbers.
A good example are T Rowe Price's 'unicorns': http://www.marketwatch.com/story/uber-airbnb-and-other-unico...
If UBER IPOs for any less than $12.5Bn, what will the early employees get? Probably not much compared with the value they helped create. Right now, that looks impossible, but who knows what will happen?
My point is that there is not a historic president for what has happened in the private markets and I would do anything I could to cash out of equity if I held it in a unicorn and I was liquid.
I would love to see YC step up and encourage founders to issue employee friendly stock options.
The nice thing about cashing out equity like this is it signals your true valuation of the company, both to yourself and the company. Just giving options on top of cash tells nothing.
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?
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.
Can you expand on this? Are you of the mind that engineers should only trust other engineers?
> 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!
Single trigger makes sense for legal, accounting, etc who are likely gone in an acquisition.
Double trigger makes sense overall.
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.
"""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.
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?
>>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!
Are there actually any startups offering RSUs?
[1] https://www.acc.com/chapters/wisc/upload/The-Rise-of-Restric...
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.)
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.
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
https://www.nceo.org/articles/equity-incentives-limited-liab...