> Not only does it not allow employees to sell their shares to secondary buyers, it also won’t allow them to use services like those offered by 137 Ventures, which makes loans to founders and early employees using their stock as collateral. (Snapchat, Dropbox, and Airbnb have similar policies.)
Does keeping early employees "handcuffed" essentially as indentured servants until IPO align with YC's ethics policy?
Sam Altman has commented on this before. Among other things, he advocates for much longer (10 years) exercise periods for equity grants.[0]
He also discusses the need for a change in tax treatment by the IRS. One of the fundamental issues is how options are taxed. Should you exercise an option, you will need to pay taxes on the spread (delta of strike price and current FMV, i.e. latest 409A valuation).
In many cases, the spread is so small or nonexistent, that the tax bill is irrelevant. But, in a few cases it's so large that most people can't possibly raise the capital to cover the tax bill.
I think the fundamental issue is the definition of FMV. When there's no public market, and employees are covenanting away any rights to sell their equity on secondary markets, is there really a fair market? I would say no.
"Should you exercise an option, you will need to pay taxes on the spread (delta of strike price and current FMV, i.e. latest 409A valuation)."
This isn't really true with ISOs (hence the point of them).
You may get an AMT gain which is ugly, but you don't owe regular taxes on the spread unlike Non-Quals where you would.
Yes, you're absolutely correct. That's a bad job on my part.
ISOs have a chance of pushing you into AMT land. If you exercise ISOs, and the FMV is different than the exercise price, then you should consult with a CPA to find out if you have a tax liability.
When I was in this situation I had a CPA project my taxes for the current year. It turned out that my taxes under the traditional system were more than under AMT, so I didn't have to worry. But this easily could not be the case if the spread is sufficiently large.
I early exercised at Twilio when the spread was pretty small.
The key is that you pay taxes on that spread. If you're early enough - I was roughly #25 - and do it early in your tenure, then you only have to come up with the cash to buy the shares and a minor tax bill. If I had waited until I left to execute, the spread would have been 12-15x. I know a few people who stayed 4 years to fully vest and then executed. I don't know detailed numbers but it sounded painful.
If/when Twilio eventually IPOs, then the ROI will be far better than any index fund.
(I don't know anything about the "if/when" as I haven't been inside in over 2 years.)
Okay; I don't know anything about Twilio in particular, but in the usual non-founder startup employee scenario, where you are busting your balls working crazy hours for less than you could get at a real company, you are already assuming a risk in the form of opportunity cost and job insecurity in exchange for equity; you would triple down on this risk by dumping your savings (or borrowings) into illiquid company stock at zero or nearly-zero discount?
How do you know there will ever be a spread? If your startup fails, your shares are worthless. Or better yet, your shares are diluted out of most of their value by several subsequent rounds of private equity, which generally you have no control over whatsoever, but which will certainly go to enrich the founders. Resulting in even more direct transfer of wealth of your investment, to the founders and venture capitalists.
I'm having trouble understanding why any startup employee would do this, as opposed to exercising stock options when they actually have value and ideally some liquidity. Yeah you have to pay taxes, but that's because you came out ahead.
I don't see anything other than a massive gamble. You've already staked enough of your future on one speculative start-up as an employee; why would you then put a big chunk of your own money at risk? An index fund has reliable long-term returns.
In my particular case, I had worked in the telecomm industry before and had a good understanding of the alternatives and felt that I understood where things were going and my prediction - still yet to be proven - was that they would win.
But you are right, it is yet another risk. At Twilio, the pay was awful but I felt the longer term risk/reward was worth it.
If I was with $startup and the strike price was $texas-sized, I wouldn't do it while the shares were still illiquid because executing would be so much.
I early exercised my CloudFlare stock as soon as I got it. As a result, I had 0 taxable gain at that point, and if the company eventually exits, my gains will be long term capital gains, AND they will be gains in whatever state I'm resident in at the time (exceedingly unlikely to be California -- Washington, for instance, has 0% income tax, no tax on capital gains, and no AMT, plus (outside Seattle) I can afford to buy a house.)
At some companies it is in the standard offer letter. Unless you are coming in very senior or very early (or both, really) you are unlikely to get a modified option grant, other than just number of shares negotiations.
IMO the gold standard here is to issue actual founder shares as long as possible (up to and possibly past series a) and then to do options with early exercise and extended validity, and of course complete transparency on all the numbers.
It may be that a company has done very well but hasn't raised more money to bump up the present market value of the stock. In this case you would want to exercise early so that the clock starts for capital gains in the event of liquidity.
"indentured servants"? That's ridiculous - startup tech workers are paid well compared to the average person, and they face no financial penalties for leaving their jobs if they do not exercise their stock options.
They do face the gnawing possibility that they could be rich, if only they could sell immediately, or keep the options for later, or or or ... if only!
But they can always just find another reasonably interesting job and get on with a pretty good life. I'm as interested in big success as the next guy, but let's be reasonable - these handcuffs are a lot more like "golden handcuffs" than actual handcuffs (or indentured servitude).
You disagree in terms of diction. It was an analogy, after all. History doesn't repeat itself. It rhymes.
Do you actually support the practice from an ethical standpoint? Employees are recruited to start-ups with equity. That's a core part of their compensation for their work (for which they likely could have received more salary from Google, Amazon, Facebook, etc). Then after they've already done the work, that compensation can be taken from them if they leave the company.
Options are inherently risky and should be accepted as compensation with the knowledge that there is a non-zero chance that they might turn out to be worth nothing. What's described in the article is an interesting way for those options to be effectively worthless, but it's not materially different (for an option-holding employee without unlimited means) from Uber going bankrupt or having all unvested options cancelled as part of an acquisition.
If an employee wants guaranteed compensation, they can negotiate for a cash-only package. If they want stock-based compensation that is not vulnerable to this particular loophole, they can go work for a publicly traded company that hands out RSUs.
The twist here is that the options end up worthless despite the hard work of the employee that leads the company to be successful. The options are supposed to incentivise this. Something about the incentive structure is wonky---in the case of Uber going bankrupt then the options "should" be worthless. But if Uber succeeds, then the incentive should pay out.
But options can end up (near) worthless anyway, for a number of other reasons. The company could go bankrupt. It could a new set of preferred shares that take priority over the current shares. It could get bought for a pittance. Granted, few of these probably apply to Uber, but they are all things that happen to companies in the broader space of start-ups.
The reason we're focusing on the 90-day clock for exercising options (and the attendant bill) is that it's something that happens to a single employee when he or she leaves the company, as opposed to something that affects all the employees all at once. But I'm not sure that changes the aggregate analysis. It feels different, but I'm not sure that it is different. When you an employee joins a start-up, he or she is taking a risk that part of their compensation could end up worthless. The corresponding reward for that risk is the chance for that compensation to be worth beyond their wildest imaginings. If that risk/reward ratio is not to their liking... well, Google is hiring, aren't they?
I agree. I think that extending the exercise period to something like seven years (as suggested elsewhere) would essentially fix this problem at the individual employee level. The employee shouldn't face risk that their option will end up worthless just because he or she makes the fairly reasonable decision to seek employment elsewhere.
As long as the employee's enter into the agreement with full transparency that this is how the compensation works then it's completely fair. This isn't the result of some kind of secret court deciding that it's how a company should pay employees. Adults are consenting to this arrangement.
There is only so much "fair" to be had in business. It's not like there aren't 1,000 other "mini ubers" that want to own the market Travis and Co built.
I don't think anyone believes that the issue with indentured servitude is that it was enforced by contract. As a society, we have decided that there are certain things you can't sign away (e.g., your freedom) and there are certain things you can (e.g., your right to exchange an illiquid asset for cash).
The GP's point is that calling this arrangement "indentured servitude" is more than a little dramatic.
I read it as hyperbole for the sake of making a point. I don't think the OP meant it literally.
But, debating that term seems to be getting away from the main point--that an employee could have an option on a sizable asset with no way to assert ownership of the asset, despite having fulfilled the vesting requirements set forth in the stock option agreement.
I'm not sure it is getting away from the main point. The OP's original assertion was that Uber is acting unethically, and calling the arrangement "indentured servitude" was meant to highlight how Uber's actions are morally wrong. I disagree.
The employees who are saddled with options they can't exercise are adults who agreed to the terms of their employment. They are free to quit Uber and work somewhere else if they want. There are a number of other ways options can become worthless while you're waiting for them to vest. The employees gambled on options and are finding out that there is yet another way to lose that bet.
And I do think it's unethical to exploit this particular corner-case. So we disagree.
I can't refute your second paragraph. You're totally correct on every assertion. I just happen to think it stinks, and I happen to think Uber is taking advantage of the situation. There are other companies who recognized this issue and chose to remediate it (to their employee's benefit), rather than exploit it.
So yeah, it's another way to lose the options lottery. I'm glad I know about it now. I'll add it to my list of things to look out for.
Finding one similar fact (which sounds strange so I would question without evidence anyway...) doesn't make a point correct. Horses and dogs both have 4 legs. It doesn't make them the same animal.
> As long as the employee's enter into the agreement with full transparency that this is how the compensation works then it's completely fair.
Fair carries with it a connotation of plain dealing, that is true; but one can consent to things which are not fair in the sense of "without unjust advantage".
As long as the employee's enter into the agreement with full transparency that this is how the compensation works then it's completely fair.
I expect that the vast majority of tech employees with agreements about stock options do not have full transparency about how they work. Thought experiment: ask random (US) employees with stock options "What is an 83(b) election" and "Should you make it, and why/why not," and see how many people have coherent answers.
This behavior is absolutely ethical. They have done some work, not all the work as you have implied. Part of the basis of paying employees with options is so that they stick around - early employees know this when excepting this form of payment. This is the small price they are paying for getting rich later.
The whole point of this article is that the employees have stuck around for the agreed vesting terms, the company has been successful, and the "later" has arrived now - but they are still prevented from exercising the promised gains and will be, potentially forever (e.g. if the major owners decide to keep the company private indefinitely under current terms).
That was not the initially accepted bargain. The bargain was that they take the risk of options becoming worthless or them not staying through the vesting period. Those risks didn't happen, this is the point where they would have earned the right to cash out, but now it turns out that the option isn't actually there.
that's not the unethical part. The unethical part is that exercising the options is a nontrivially confusing, in part, because of the legal and tax ramifications... And the startups don't complain too much because if the employee doesn't take part in the equity sharing scheme (often because of decision paralysis resulting) it is to their benefit.
The unethical part is that the startup uses the equity to lure the employee, but fails to adequately warn them about the trickiness coming down the pike when that time comes.
It's not a small price and it's not made clear in the beginning when they promise shares for service. The absurdity of allowing management to make slaves of men is no small thing.
No, there really is a pretty massive material difference between a startup employee and an indentured servant. It takes extreme naiveté or extreme privilege to confuse these two concepts.
Actual indentured servants were / are treated far far worse than the average startup employee. Besides that, no one forces employees to accept equity in lieu of decent salary. Comparing startup employees to indentured servants is a horrifyingly privileged way to frame the topic.
Certainly, golden handcuffs are a much less pressing concern than actual handcuffs that the less fortunate have to deal with. But this seems to highlight that no matter how much you're earning in Silicon Valley, you're still on the lesser side of the asymmetry against the founders, VCs, and management that run this town.
I appreciate this topic and am definitely in the proletariat camp.
I've made other people rich multiple times, with my ideas and effort, and gotten dick in return. I definitely would have been better off with a corporate job.
To my shame, I honestly don't understand the accounting behind all this. You'd think I'd learn. But each time I've been screwed a new way. Not knowing how to defend myself, I've mostly opted out. Which also doesn't seem like a good strategy.
Uber pays entry-level software engineers ~$110k [0], experienced engineers closer to $130k.
According to Glassdoor this is in the same ballpark as Facebook, Google, Twitter, etc [1].
You are not really making the startup "worse salary but potential equity" trade by working there, when the straight-out-of-college salaries are similar to the averages across all of Google.
130k for experienced engineers is very low by SF standards. That's average for senior positions in Dallas. 150k is the bare minimum for a senior dev unless you're getting a boatload of founders shares in a very early startup.
Google, Apple, and Facebook pay more. A lot more just in salary, more like 180-200k before options/RSUs.
Pinterest allows employees to hold onto their options for seven years after leaving (if they stay at the company for two years) to avoid this scenario. I think there are a few other companies that have done similar things.
I read the Pinterest policy last year and ask my CEO about doing something similar during a company meeting. He just laughed. Then he apologized the next meeting for misunderstanding the question and still said no.
Frankly institutional investors still have leverage over founding teams, and unless the company is a "darling" that has investors fighting for cap space, being "nonstandard" will be a possible liability.
Laughing at the question is obviously uncalled for, but there are legitimate cause for concern for adopting such policies.
Currently, late stage high growth companies and YC companies are the two segments best positioned to negotiate against VCs for these terms to become "standard".
At PlanGrid we (employees) pushed for a longer window. One of the founders explained that this "convert to NQO after X time" is not an IRS-tested policy as of yet. The lawyers are wary of it and the negative tax consequences will hit employees under the AMT line the hardest if the policy is wrong.
That said, they are working on it and intend to implement a similar policy if possible. Reputable founders and investors don't want to force people to stay just to keep their options, nor screw people out of compensation they earned.
YC could use their leverage to do so, if they were so inclined. The only other option is for tech employees not to take jobs at firms with less-than-ideal equity terms.
Employees have plenty of rights, you're talking about giving them additional privileges. No one forces people to take equity compensation instead of salary and as long as employees continue to do so the practice will continue.
It's horribly insensitive to even mention slavery in the same breath. There are actual slaves in the world and this is a completely different situation.
ISOs convert to NQOs once a certain amount of time has passed after leaving the organization, so there's not much difference there.
Having ISOs matters most when the underlying shares are illiquid, and you can defer the tax obligation until a sale event (provided you don't hit AMT). When you have a 7-10 year exercise window, the company will likely have IPO'ed or have failed. The tax benefit of ISOs are greatly diminished.
I think people downplay how easy it is to hit AMT. A single, no dependents, standard deduction filer making $120k will hit AMT after $26k of on paper gain for ISO exercise. Everything after that will be taxable. Filing jointly, 2 people who each earn $120k can absorb $18k in on paper gains from exercising ISOs. Add in a kid and it drops to $15k.
That's a paltry sum, basically breaking any advantage ISOs provide.
Yes but I believe you can (eventually) get the AMT difference back in offsets assuming there are later years when you are below the AMT limit. Fiendishly complicated and increasingly dumb though ...
What happens if they decide to keep the company private? Travis, the CEO of Uber, has stated many times he feels like going public isn't needed anymore because of all the extreme amounts of capital available in the private market.
And, they have found a spigot on the economy that can provide for returns for these private equity investors. So why even go public?
To me, this just seems like a well thought out plan to keep employees locked into the company while not allowing them to ever exercise their equity, and keep the return focused on those who have provided capital. The "capital class" if you will.
Carry on worker bee employees; one day you might see those options actually worth something and liquid.
> What happens if they decide to keep the company private?
The shares can still be sold, but it's limited to qualified investors. The primary issue is that obviously the same information of a public company isn't available & the SEC doesn't want Joe Smith getting scammed by fly-by-night operations.
It's also worth noting that once there are a certain number of shareholders, Uber has to publicly disclose its finances. That's even if they don't raise capitol & are not traded on the SEC.
Historically this was 500 shareholders, but Facebook got an exception from the SEC. I wouldn't be surprised if Uber did too.
I think you haven't read the article yet. The issue with Uber as opposed to a standard private company is that part of the charter prohibits employees from selling shares on secondary markets or to second party investors. The only viable exit for the employees to exercise their options is for an IPO.
I am currently dealing with this issue, though on a smaller scale.
The moral of the story is to forward exercise options if you can. Basically what this means is you pay to exercise on your start date. If you quit or get pink slipped before the standard one year cliff, the company does a buyback. Otherwise, the shares vest as per your vesting schedule. You can potentially avoid a lot of the AMT nastiness this way, and start the clock on long-term gains treatment on day one.
That said, companies really should scrap the 90 day exercise window. Uber et al want to avoid employees selling shares on side markets. If they just allow them to hold onto their options for years, most will sit on them rather than feel rushed to sell. I know they want to retain talent, but they should be doing that via rewards versus punitive measures.
In any case, its worth it to spend a couple hundred bucks on a tax expert to figure out in advance how to handle options so you don't get burned by taxes on fictional gains.
It's different with Uber in hindsight, but in general, employees at start-ups are already overinvested in the success of the start-up, and that success is unlikely. I don't recommend that most people also sink their cash into their employer.
Be careful, the company may not be required to buyback the shares. The company may have the option to accelerate the vesting schedule on the options. It's best to assume they'll choose to do this only when it's optimal for them, which likely means when it's suboptimal for you.
It's a real dilemma, as the company is doing well enough that the 409a value is not trivial, but its not clear that they will have a liquidity event in the near term. So on one hand I don't want to get screwed on a fictional profit on taxes, but on the other I don't want to forfeit the options as I earned them, and as far as I am concerned, that was part of my compensation for taking below market salary.
It bothers me that the terms are unnecessarily anti-employee. 90 days simply isn't enough time, especially when critical details related to the cap table and liquidation preferences are obfuscated. If they are not prepared to buy shares back at 409a value, they should allow an extended exercise window.
One thing to keep in mind is that you might not have until next April 15th to pay your taxes after exercise. If the exercise benefit is large enough compared to your typical income, you might owe estimated taxes that quarter.
This is a great point. Additionally, you're fine if you pay 110% of your prior year's tax bill. For most employees referred to in this article, this amount should be payable.
If the difference is less than $1000 or if you withheld more this year than you owed last year or if you withheld 90% of your total bill, there is no penalty.
This article is wrong. Option strike prices and taxation are based on the 409A "fair market" valuation, not private valuations achieved during fundraising. Move the decimal one place to the left and the numbers in the article get a bit more realistic.
Actually, it depends. In Uber's case yes it would be the 409A as there is no secondary market. If there were a secondary market, it would be the last sales price from the day you exercised, not 409A value.
The IRS guidelines say the spread between grant price and fair market valuation. If there's a secondary market, that's your fair market, not 409A (which is a joke anyway).
Also, most companies use the last public valuation as a basis for 409A valuation rather than hiring someone to do it in a separate process. The investors buying shares are the experts here. Of course there are considerations for preferred vs common stock and things like warrants, but they start at the top line number from the last round.
No, that's incorrect (speaking as a founder who's raised $35mm and sold shares on the private market). Private financings will trigger a new 409a valuation but won't influence it. 409A valuations are typically based on Black Scholes and have no connection to private funding valuations. Secondary sales only affect fair market if there's a functioning secondary market, and AFAIK there are no private startups with a FUNCTIONING secondary market.
You can do 409A however you want which is why I said it was a joke. I've worked in 2 places that based it off of last round after accounting for full dilution. You can use black Scholes, last round, or your finger in the air it doesn't matter. If it had to be accurate they wouldn't allow Black Scholes which has been all but disproven.
Also there are lots of secondary markets for private companies right now. What makes you think otherwise?
Okay thanks for confirming you don't know what you're talking about. Black scholes is options valuation and never used in 409A valuation. You can't just make stuff up, you have to justify it to your auditors.
> Black scholes is options valuation and never used in 409A valuation
'never' is wrong, depending on your meaning. It's definitely used in many 409A valuations. Typically a 409A will use a couple different approaches to come up with the initial valuation -- it will look at the discounted cash flow, the value of assets and liabilities, and generally will look at 'guideline companies' and their public valuations or cash value upon sale. Once one or more (often times all) of these methods are used for the initial valuation, the value is fed into a Black-Scholes model. That price (after applying discounts for non-marketability) is used as the fair market value for the common stock.
Black Scholes is used to value options, eg to set the strike price on options. So, it is used for this purpose by companies who need to set option strikes at fmv. I have no idea why he says it's been repudiated. As far as I know, it is still used in public market option pricing. Most people buying or selling options are not pricing them, but accepting the market makers price. How would you have any clue how they're coming to that value?
I previously wrote software at a major market maker. I can't say (NDA) what they use, but most professionals consider Black Scholes to be mickey mouse. If you're using it in the public market, you're not going to fare well on American style options.
As for real world proof of Black Scholes being garbage, it doesn't get any better than Long Term Capital Management.
Black-Scholes (and the Merton version) are useful as simple estimates of option prices. Of course it's not going to be accurate (it assumes a lognormal distribution for volatility, JFC) - but the model is public and easy to calculate, providing a stable basis for these kinds of prices.
Edit: people buying/selling options are of course performing their own pricing operations. They don't care how the market price is determined, since they believe their model is the best and gives more accurate prices than anyone else.
Edit 2: furthermore, to properly price startup options, you need to account for their 'random-expiration' nature: we have no idea when Uber will IPO. this makes it difficult to use traditional option pricing models which have fixed maturities (you can take integrals over the model's results at each possible maturity). additionally, choosing a discount rate is hard when realizing that most employees are not well-diversified, unlike the investors/funds that the traditional models are written for
There's not much difference between an American style public equity option and private equity option. Both can be exercised at any time. Perhaps you're thinking of European style options, that can only be exercised on a fixed date (expiry).
While neither are great, binomial is better for American style options than BS.
American options still have fixed expiration dates, and cannot be exercised after that. While that's closer to a startup's option structure, it still doesn't account for the uncertainty in when or if the startup will go public. Additionally, you never exercise dividend-less American options early, and startups generally don't offer dividends.
I guess you could choose an arbitrarily distant expiration date, but my bigger point was that while BS is clearly not going to give perfect results, the results are reasonable enough and transparent enough to justify their use for tax purposes in lieu of actual market prices.
I don't know. I read When Genius Failed. I'm quite sure it had little to do with Black Scholes. It was primarily an issue of trading illiquid positions that weren't hedged as well as they thought.
Options valuation is derived from your 409A valuation...and heyjon used Black Scholes to derive present option value. The two are related. Black Scholes is considered to be massively flawed by the larger public options market, but it's still used a lot in the private equity options side. Hence, why I said that it really could be whatever you wanted. If there were a legit requirement that it be an accurate valuation, you could never get away with Black Scholes. It's common knowledge that it's seriously flawed.
As for 409A valuation, I've never heard of an auditor seriously examining it or questioning its validity. It's mostly the "valuation expert" says, "What value do you want for 409A?" You tell them, they ask to see the books, and then say "OK I can sign off on that."
This is wrong information. 409A valuations are generally based on revenue models, profit models (not applicable for most startups) or comparatives. It's not done based on funding rounds because there's a lot of goodwill based in that.
Most companies push the 409A valuations as low as possible precisely because of income tax ramifications on exercise.
It depends on what the actual market value of your stock is upon exercise, not just 409A. Sure, it might be the 409A value, or it could be the last sales price on something like SecondMarket. If there's a secondary private market, that will trump whatever your company says the 409A value was.
If your company says the 409A is $1.50/share but people are selling on secondary markets for $4/share, you must use $4/share when computing your exercise benefit.
If there's no secondary market, it's the last 409A value.
This is an interesting conversation. I wish someone with readily verifiable credentials could weigh in. I'm not saying the parent, or GP do not have the credentials, just that they've not been established. I'd love to hear from an accountant or tax attorney on the topic.
From what I can tell, taxes will be based on the values in Form 3921 (for ISOs and ESPPs), which is delivered by the employer.[0]
Here's a sample 3921.[1] The FMV is delivered in Box 4. My question is where does that value come from? Is it the last 409A valuation, or is it required to use sale data from secondary markets?
I've received several of these forms over the years, and the FMV has always been the value from the last 409A. I have no idea if there was a secondary market for the shares.
If you get a 3921, use what's there; the burden of accuracy is on the company.
I worked at a place that didn't issue 3921's (in the .com go round). I had a hell of a time reaching someone still at the company who could give me that information almost a year later (and after several rounds of devastating layoffs). I really don't know what she based the figure on.
It's not a matter of if. Companies are required to issue a 3921 these days.[0] That was not the case in the dot-com days. I don't even know if Form 3921 existed then.
The market solution here seems to be the companies poaching those employees giving them, as a hiring bonus, enough cash to exercise their shares. Not sure what would make that workable, or if it's even a big enough problem to demand such a solution.
If you exercise upon getting hired, there is no tax bill, because there is no spread between FMV and your exercise price. There's only a tax bill later, upon liquidation.
Many (if not most) early stage companies won't allow you to do this. They claim that the "legal costs" are too high. When asked how much it is and offered to cover them, I've been met with blank stares.
I've been met with "but if you quit without having vested all your shares, we'll have to pay you back at FMV!" - and this was a CEO that said this. Staggering ignorance w.r.t. equity.
It's common for companies to have a 90-day window to exercise your options after leaving the company. There are some friendlier companies with longer exercise windows. See: https://github.com/holman/extended-exercise-windows
I've not been in the position of buying options before, but is that really how the tax system works? I understand you have to pay tax on income from shares, but if you're buying shares you haven't had any income from them at that point right? I would have thought you'd just pay tax on any money you received when you sold the shares. Curious to know if that's how it works in the UK as well as the US, anyone have any pointers?
Yes. It's a huge problem - the IRS demands liquid cash in order to pay tax on illiquid in-kind transfers.
The problem isn't just in startups with stock options; another big place it arises is closely held businesses. You receive the family business as an inheritance and suddenly you need to pay - in cash - 40% of the value of the business. Such a large cash hit can and does destroy many companies.
The solution is of course to require the IRS to allow payment in-kind (shares). Then you could exercise your options and hand over ~20% of your shares to the IRS. Or you could inherit the family business and give the IRS 40% of the the company (which suffers no cash flow hit and continues normal operations). This additionally would prevent the IRS from overvaluing in-kind earnings.
The problem isn't just in startups with stock options; another big place it arises is closely held businesses. You receive the family business as an inheritance and suddenly you need to pay - in cash - 40% of the value of the business. Such a large cash hit can and does destroy many companies.
Additionally, estate taxes are paid by the deceased's estate. In the US, inheritors do not pay federal tax on their inheritance, and only 8 states tax inheritors.
Your citation gets that number solely by defining "small business" extremely narrowly and in such a way as to mostly exclude businesses affected by estate taxes.
Well, let's have fun with the words you chose. Hobby Lobby is famously a "closely-held family business"... and it has 23,000 employees and $3.3bn in annual revenue. I'm not going to lose sleep over that being subject to taxation, and though someone could spin it as "mom and pop's family crafts store", it would be disingenuous to do so.
I'm surprised financial services have not popped up just to help people in such situations. The service could confirm the person has as much coming as they say, have him sign his life away to them, and then float him enough cash to buy the stock and pay the taxes on time. Then the employee pay some portion of his new wealth to the financial services company.
They do exist but are very expensive. Basically by the time you go to them they know you are screwed and in desperate IRS-caused need of liquidity. So while the actual estate tax may be 40%, you wind up paying 50% or more. This is usually a debt deal, not an equity one - who wants shares in a closely held family corporation?
For developers at unicorns I think services are somewhat better (e.g. secondmarket, elite crowdfunder).
They wouldn't, and the original poster isn't implying that they would.
I believe the argument here is that if the government wants to claim that these shares have a certain monetary value for tax purposes, then the government should stand behind that value and allow you to pay taxes with those shares at their claimed monetary value.
The end goal would be to prevent small business (or people with stock options) from going under because the government claims a piece of paper is worth $1m, but in reality it can't be sold at all, or couldn't be sold for such a high value. If the government claims "oh but we would lose 20% of the value in selling these shares" then they are essentially admitting that they overvalued them when taxing you.
Further, I believe that is an option (requirement?) when paying your renunciation tax on abandoning US citizenship. You're required to pay taxes on all your assets as though they were liquidated that day, and to cover the case of illiquid assets such as employee stock options. [1] In this case they will take 30% of the value of the shares at time of disposition. This is something employees holding ISO and NSO could be allowed to opt into on exercise when there is a spread between FMV and strike.
The problem isn't with the tax system, but the corporate system.
Companies are giving out time-limited stock buying privilege to employees instead of direct ownership. Additionally, some companies can even revoke the privilege through termination of employment agreements.
If employees were treated as full owners, there wouldn't be a problem.
I don't disagree with you that the problem is with the corporate system, but it's also made significantly worse by the unfavorable tax treatment.
If the IRS didn't require you to realize gains on the spread when exercising, then a lot of these issues would dissolve. That's not to say folks wouldn't find other ways to restrict employee ownership.
As someone who has been fired and given 90 days to cough up a few grand to exercise, it sucks. Unplanned change of employment is a turbulent financial event and the last thing you can wrap your head around is whether the lottery ticket is worth it. Add in the feeling of distrust that often follows getting fired and it's really hard to objectively evaluate the company and its position.
I ended up not exercising. Still not sure if it was the right call.
I recently got an offer from Uber (didn't accept for various reasons), so I have a couple of data points. In the last two years, they started offering RSUs, not options, that addressed this issue. And two years ago, they had roughly 200 engineers vs 2000+ engineers now. The issues they had 2 years ago are different, as was the business, it wasn't nearly as ubiquitous and now since they offer RSUs, there isn't the same level of problems.
So it's another hit piece on Uber that is completely unfounded.
But the stock will be considered income in the IPO year and subject to withholding, right?
So some employees will work for a negative potentially six figure salary (100% withholding + 5-6 figures owed to the IRS) with no way to pay the IRS until they can sell the stock in the next year?
You don't exercise RSUs. RSUs are taxable as they vest. At my company, a portion of your vesting RSUs are sold every time to pay the tax on them, unless you provide some cash to pay the tax.
Right, I am interested in whether they would do this during the lockup period. It would seem that if employees were contractually obligated to hold their positions, selling to cover taxes wouldn't be allowed.
You know, i've never really delved into the details of this, but i wonder if it's only required to be withheld, not sold.
That is, uber could withhold the right number of shares, and is selling them itself or repurchasing them and paying out the FMV.
In any case, Uber has to pay the withholding, and i suspect they have no magic way around this.
RSU's are only restricted until vest. Once they vest, they are unrestricted stock. Uber cannot control what you do with that stock (or at least, i'm not familiar with any company that has done so, and not sure that it's legal to do so)
As long as they are private, they can put lots of restrictions on what can be done with shares. That's the point of the whole article. Ultimately, people are allowed to exercise their ISO's and turn them into shares, they just can't do anything with those shares -- Uber won't buy them, and won't allow you to sell them to anyone else!
I think the sibling post answered the question -- RSU's don't vest until the company goes public. So, instead of getting illiquid comp, you just get none until Uber is public.
ISO != RSU.
They are different forms of restricted property, and when it comes to restricted stock, as i said, it's only restricted until vest. They can control when it vests, but even if they are private, they can't control what you do with restricted stock once it is vested, because it is then unrestricted stock, whether uber is private or not.
They actually can if they determine that you possess non-public information which could allow you to gain from the stock in a manner that can be considered "insider trading"
Typically this is only for short periods for higher-up people but it can affect "normal" engineers too (say you do a tech due diligence for an acquisition etc....)
>His ownership stake at the time would have been $300,000. Yet today, that same stake (undiluted) would now be worth $300 million
And at one point Elizabeth Holmes was worth billions, emphasizing that until you the have money in your bank account don't be tallying how much you're "worth".
Just another instance on why an employee shouldn't consider stock options as adequate equivalent to compensation.
In theory, those employees were promised to receive x shares of the company that now (partly due to their personal performance) are worth some significant amount.
In fact, that was a lie and they are not actually able to receive that part of their compensation despite having been promised and earned it, vested, etc.
Beware of scams (the legal details cause similar sized of equity options to have extremely different de facto value) and/or treat the offered equity as having near-zero value when comparing compensation offers from different employers.
Why is it the norm that employees even need to pay cash to buy their options? Why don't companies set the exercise price to zero?
Or if one must have a non-zero exercise price - why isn't there a way to do something like a "cashless exercise"? (i.e. buy your vested options by selling a small fraction of them back to the company).
In the past, when my wife has had options, we've always been able to use cash from the exercise and immediate sale to fund the transaction, with no cash out of pocket. Is this not an option available to Uber employees?
There's no liquid market for Uber shares. The article further states that Uber has taken measures to prevent a secondary market from developing. I wonder what those measures are. I imagine it's straightforward to prevent someone who wants to keep working at Uber from doing a secondary sale, but what sorts of contract terms can Uber put in place to prevent someone from quitting and then selling on the secondary market?
Rights of first refusal are common, but how can Uber prevent a non-employee from selling? I'd love to see the language they use in their options agreements.
I assume that in my wife's case, the company was buying the shares back (privately held firm and we weren't dealing in a secondary market). I guess I'm just surprised Uber doesn't do the same (actually, I'm not, given their C-suite's history of being all-around dicks).
> I guess I'm just surprised Uber doesn't do the same (actually, I'm not, given their C-suite's history of being all-around dicks).
I've never heard of this in the valley, it's standard practice to not allow shares to be traded and provide no option for liquidity until IPO. There can be occasional secondary offerings (Facebook and Square had these) but they are usually a one time deal. Definitely not a concept that Uber invented.
My understanding is, right of first refusal includes the option to render the equity worthless if this right is not honored. It's a threat I've seen made before by a CEO who did not want a secondary market to exist.
Can you expand on that? How would one be able to render the equity worthless?
My best understanding of a typical "right of first refusal" clause is that it gives the company the right to match any offer by a third-party buyer.
This would add some friction to the transaction, in that the company could have some specified period to consider the offer, leaving the pending transaction with a third-party buyer in limbo (or discourage the third-party from even considering the transaction). But if the company refuses to buy back the stock at the terms of the third-party offer or the period of time for the company to consider the offer expires, then you could go ahead with the sale to the third-party.
Every right of first refusal clause I've ever been subjected to or subjected others to has had a thirty day deadline, so I don't think this is accurate. It's unlikely that the set of companies I worked for / founded was that unrepresentative.
Mind you, when I did do a sale on the secondary market, it always took the full thirty days for the company to approve.
That depends on whether there is actually a market for Uber shares. In the few cases where I've had the ability to exercise options, the company was still entirely privately held and there was no general market for the shares. And nobody was really interested in buying mine, so there was nobody to sell to, even though on paper you could calculate a value.
There's no reason they have to find out. You just won the lottery or received an inheritance from a distant relative. How you acquire capital is none of their business.
They'll find out. You can't get an under the table loan for millions of dollars from a reputable organization. Plus, the IRS and everyone else will be looking into where the money came from.
When you exercise an option, you are paying the strike price for something that may be worth more. For example, you may have an option with a strike price of $1, but the shares are currently worth $10. That $9 is considered taxable income.
This is why what is happening with the digitization of private equity through blockchain technologies is going to make this kind of thing completely obsolete.
Sorry, my fault for not being clear. I didn't mean that digital equity would empower employees to circumvent company policies.
Rather digital equity and governance systems [1] that are currently being built around blockchain and decentralized projects simply take a much more egalitarian and healthy approach to distributing ownership in the first place. And, hey, if you want to use equity as an incentive for retaining employees, you still can do that using (for instance) a smart contract in a way that is fair and not concentrated as a power in the signature of a single person.
At the end of the day, traditional private equity whether it is an investment or as compensation has a lot of problems, as I'm sure HN readers on here know very well.
The existence of a distributed ownership mechanism isn't going to convince companies to use that mechanism.
Honestly, the best way to decentralize ownership is to lead by example and start a hundred-billion dollar company that distributes ownership. If the next Google has decentralized ownership, that would be a model for other companies to follow. Right now, there is no incentive for any company to do anything nontraditional here.
That's what I'm saying. The next generation of companies will have all of the tools and technologies to enable that distributed ownership. It's early days, but "decentralized Uber" Arcade City is doing precisely that.
(1) Okay, let's assume that. It's not exactly an outrageous assumption -- Bitcoin has been operating for 7 years. Ethereum has been around for 1 year, but even if it fails, there will be other smart contract platforms perhaps even on the Bitcoin chain (i.e. Rootstock).
(2) Sorry, not following you. I never said or implied anything of the sort. I don't see how that's a central issue to our discussion, but perhaps you can educate me.
Does keeping early employees "handcuffed" essentially as indentured servants until IPO align with YC's ethics policy?