Stock options are a big part of the startup dream but they are often not well understood, even by senior execs who derive much of their income from stock options. There is a small but necessary catch: This means that if you leave the company the week after you join, you lose your stock options. So, how long do you have to stay to keep your options? In most companies, they vest over four options. Details vary from company to company; some companies vest options over 5 years and some over other periods of time, and not all employers have the cliff. Why should you care about whether that guy who got fired after six months walked away with any options or not? Remember each share represents a piece of ownership of the company. The more shares there are, the less value each one represents. Lets say when you join the startup and get 5, shares, there are 25, total shares outstanding. You now make half as much for the same company value. That said, dilution is not necessarily bad. The reason the board approves any dilutive transaction raising money, buying a company, giving out stock options is that they believe it will make the shares worth more. If your company raises a lot of money, you may own a smaller percentage, but the hope is that the presence of that cash allows the company to execute a strategy which enhances the value of the enterprise enough to more than compensate for the dilution and the price per share goes up. This brings us to the number which is much more important though it is less impressive sounding than the number of shares — what portion of the company do you own. Regardless of units, this is the number that matters. Long ago Albert went to work at company A and Bob went to work at company B. Bob was very happy — he was granted 50, options at only 20 cents each. Who got the better deal? Lets say company A had 25, shares outstanding, and company B had , shares outstanding. So while Bob had more options at a lower strike price, he made less money when his company achieved the same outcome. This becomes clear when you look at ownership percentage. Albert had 2 basis points, Bob had one. Even though it was less shares, Albert had more stock in the only way that matters. At some level the number is totally arbitrary, but many VC funded companies tend to stay in a similar range which varies based on stage. As a company goes through more rounds of funding and hires more employees, it will tend to issue more shares. A normal mid-stage significant revenue and multiple funding rounds, lots of employees with a full exec team in place might have million shares outstanding. Late stage companies that are ready to Stock often have over million shares outstanding. I talked briefly about exercising options above. One important thing to keep in mind is that exercising your options costs money. Depending on the strike price and the number of options you have, it might cost quite a bit of money. In most private companies, there is no simple way to do the equivalent. The other really important thing to consider in exercising stock options are taxes, which I will discuss later. Why is the IRS involved and what is going on? One of the factors that the IRS uses to determine this is how the strike price compares to the fair market value. Options granted at below the fair market value cause taxable income, with a penalty, on vesting. Companies often options lower strike prices for the options — this makes the options more attractive to potential employees. In the case of startup stock options, they specify that a reasonable valuation method must be used which takes into account all available material information. The types of information they look at are asset values, cash flows, the readily determinable value of comparable entities, and discounts for lack of marketability of the shares. Most startups have both common and preferred shares. The common shares are startup the shares that are owned by the founders and employees and the preferred shares are the shares that are owned by the investors. There are often three major differences: What do these mean and why are they commonly included? The biggest difference in practice is the liquidation preference, which usually means that the first thing that happens with any proceeds from a sale of the company is that the investors get their money back. In some financing deals the investors get a 2x or 3x return before anyone else gets paid. Personally I try to avoid those, but they can make the investors willing to do the deal for less shares, so in some situations they can make sense. Investors often ask for a dividend similar to interest on their investment, and there are usually some provisions requiring investor consent to sell the company in certain situations. Employees typically get options on common stock without the dividends or liquidation preference. The shares are therefore not worth quite as much as the preferred shares the investors are buying. That is, of course, the big question. If your company has raised money recently, the price that the investors paid for the preferred shares can be an interesting reference point. The more likely that the company will be sold at a price low enough that the investors benefit from their preference the greater the difference between the value of the preferred shares and the common shares. So in effect, a smart investor is indirectly buying your common shares for around the price the VCs pay for preferred. Options typically expire after 10 years, which means that at that time they need to be exercised or they become worthless. Options also typically terminate 90 days after you leave your job. Even if they are vested, you need to exercise them or lose them at that point. The requirement to exercise within 90 days of termination is a very important point to consider in making financial and career plans. This is an area of asymmetry where senior executives have these provisions much more frequently than rank-and-file employees. There are three main types of acceleration: In this second case, I think a partial acceleration, double trigger is fair. In the first case, full acceleration may be called for, single trigger. In most other cases, I think executives should get paid when and how everyone else gets paid. Some executives think it is important to get some acceleration on termination. How many stock options you should get is largely determined by the market and varies quite a bit from position to position. This is based on my experience at two startups and one large company reviewing around a thousand options grants total, as well as talking to VCs and other executives and reviewing compensation surveys. I strongly believe that the most sensible way to think about grant sizes is by dollar value. While percent of company is better it varies enormously based on stage so it is hard to give broadly applicable advice: Dollar value helps account for all of this. What I would then look at is the value of the shares you are vesting each year, and how much they are worth if the stock does what the investors would like it to do — increases in value times. This is not a guaranteed outcome, nor is it a wild fantasy. What should these amounts be? This varies by job level:. Key early employees often wind up in this range as the company grows. VP, SVP, and CxO excluding CEO. For those reading this from afar and dreaming of silicon valley riches, this may sound disappointing. Remember, however, that most people will have roughly 10 jobs in a 40 year career in technology. Over the course of that career, 4 successes less than half at increasing levels of seniority will pay off your student loans, provide your downpayment, put a kid through college, and eventually pay off your mortgage. Your employer should be willing to answer this question. I would place no value on the stock options of an employer who would not answer this clearly and unambiguously. You should ask how much money the company has in the bank, how fast it is burning cash, and the next time they expect to fundraise. This will influence both how much dilution you should expect and your assessment of the risk of joining the company. You should ask what the strike price has been for recent grants. Nobody will be able to tell you the strike price for a future grant because that is based on the fair market value at the time of the grant after you start and when the board approves it ; I had a friend join a hot gaming company and the strike price increased 3x from the time he accepted the offer to the time he started. Changes are common, though 3x is somewhat unusual. You should ask if they have a notion of how the company would be valued today, but you might not get an answer. There are three reasons you might not get an answer: If you can get a sense of valuation for the company, you can use that to assess the value of your stock options as I described above. One feature some stock plans offer is early exercise. With early exercise, you can exercise options before they are vested. The downside of this is that it costs money to exercise them, and there may be tax due upon exercise. The upside is that if the company does well, you may pay far less taxes. If you do early exercise, you should carefully evaluate the tax consequences. By default, the IRS will consider you to have earned taxable income on the difference between the fair market value and the strike price as the stock vests. This can be disastrous if the stock does very well. In this case the taxes are calculated immediately, and they are based on the difference between the fair market value and the strike price at the time of exercise. If, for example, you exercise immediately after the stock is granted, that difference is probably zero and, provided you file the paperwork properly, no tax is due until you sell some of the shares. Be warned that the IRS is unforgiving about this paperwork. You have 30 days from when you exercise your options to file the paperwork, and the IRS is very clear that no exceptions are granted under any circumstances. I am a fan of early exercise programs, but be warned: What if you leave? The company has the right, but not the obligation, to buy back unvested shares at the price you paid for them. Taxes on stock options are complex. There are two different types of stock options, Incentive Stock Options ISOs and Non-Qualified Stock Options which are treated differently for stock purposes. There are three times taxes may be due at vesting, at exercise, and at sale. This is compounded by early exercise and potential 83b election as I discussed above. This section needs a disclaimer: I am not an attorney or a tax advisor. I will try to summarize the main points here but this is really an area where it pays to get professional advice that takes your specific situation into account. I will not be liable for more than what you paid for this advice, which is zero. NSO gains on exercise are taxed as ordinary income. When you sell the shares, you owe capital gains short or long term depending on your holding period on the difference between the value of the shares at exercise and when you sell them. Some people see a great benefit in exercising and holding to pay long term capital gains on a large portion of the appreciation. Be warned, many fortunes were lost doing this. What can go wrong? But, in an attempt to minimize taxes, you exercise and hold. But how do you pay your tax bill? The situation is a little different, but danger still lurks. In the best case, ISOs are tax free on exercise and taxed as capital gains on sale. However, that best case is very difficult to actually achieve. The situation becomes more complex with limits option value for ISO treatment, AMT credits, and having one tax basis in the shares for AMT purposes and one for other purposes. This is definitely one on which to consult a tax advisor. In the case of liquid stock options say, in a public companyin my opinion this is exactly as they are intended and a healthy dynamic: If you leave, you give up the opportunity to vest additional shares and make additional gains. But you get to keep your vested shares when you leave. In the case of illiquid options in successful private companies without a secondary marketyou can be trapped in a more insidious way: This is a relatively new effect which I believe is an unintended consequence of a combination of factors: Until then to adapt a phrase caveat faber. Private equity funded companies often have very different option agreements; recently there was quite a bit of publicity about a Skype employee who quit and lost his vested shares. The theory behind reclaiming vested shares is that you are signing up for the mission of helping sell the company and make the owners a profit; if you leave before completing that mission, you are not entitled to stock gains. In general, your vested options will be treated a lot like shares and you should expect them to carry forward in some useful way. Exactly how they carry forward will depend on the transaction. In the case of an acquisition, your entire employment not just your unvested options are a bit up in the are and where they land will depend on the terms of the transaction and whether the acquiring company wants to retain you. In an IPO, nothing happens to your options vested or unvested per se, but the shares you can buy with them are now easier to sell. In a cash acquisition, your vested shares are generally converted into cash at the acquisition price. In the case of a stock acquisition, your shares will likely be converted into stock in the acquiring company at a conversion ratio agreed as part of the transaction but you should expect your options to be treated similarly to common shares. That could actually be counterproductive for option holders. Lot of it depends including whether they keep the employees at all. But often they are converted to options in the new company. I got new options of the acquiring company at a SHITTY strike priceanything to do about that? Probably nothing to do about it besides quit though I am not a lawyer and you might ask one if there is a lot of money involved. How long did you work there without the options being granted? Up to a few months is normal, past that is unusual. I worked there for 6months part time and another 6months full-time. Did the board meet during the time after you accepted the offer and started and prior to the acquisition and how many times? Did it review your proposed grant at the meetimg and if not why not? If it reviewed your proposed grant why did it not approve it? On what basis was your new grant determined? Did they convert the grant in your offer letter based on the terms of the purchase or did they just give you stock in the acquiring company as a new employee of that company? This could have been ongoing from the time you joined, or started shortly afterwards but have been in progress at the first board meeting after you joined. If this was the case, the board may have been in a very hard situation with respect to valuing the stock options. If the acquisition discussion was credible enough, it would be material information that could force a re-evaluation of the fair market value of the shares. To avoid the risk of grantees you being liable for huge tax penalties, they would likely have wanted to retain a third party to do the valuation. Hiring the firm takes time, the valuation takes time, and board approval of the valuation takes time. During that time, the discussions might gave progressed — maybe they got a second higher offer. That could restart the clock. In any case, even if they were able to complete the valuation and grant the options, the valuation may well have been quite similar to the price offered by the acquirer and those options might have been converted to options in the acquiring company at a similar strike price to the price of your grant. If the value of the stock underlying your new grant number of shares times strike price is well in to the six figures or beyond, it may be worth consulting an attorney just in case, but my guess and I am not a lawyer is they are going to say that you just had bad timing. I too think that I should have gotten either an approval or decline of my optionsneither was delivered to me, hence I believe this is a direct violation of my employment agreement. My options never materialized, I basically got the buying company options at a strike price which is the share price in the day of the buyout which means zero profit! My guess is that you make some enemies with this post. It is clearly to the advantage of the company that the terms of stock options and vesting periods remain opaque. What if there were liquidity in options? That would be interesting, and wildly dangerous, I imagine, because such liquidity would be so predominantly speculative in the absence of knowledge of company fundamentals. A successful growing company grants millions of dollars worth of options each year, and I think it works to their advantage to have people understand their value and thus make rational decisions about them. That is certainly the case for well known private companies eg, Facebookand sometimes is the case for smaller companies as well; question is can you find an investor who wants to buy the shares. Often this will be restricted for current employees but more open for ex-employees. This can be very complex and the SEC has rules about shareholder counts, how the shares can be offered etc. Hello, I just received an employee stock option that would allow me to buy shares within five years. Do I have to buy the shares right away? If I buy the shares now and after 2 years I left the company or they fired me, do I still have the right for my shares? I really appreciate your advice. Really sorry for the delayed reply. Usually you have all 5 years. Usually you can buy some now and some later. Tax issues vary, research them carefully. Well written for sure. A small company was bought by a larger one and the employee was given her recalculated options. There are 2 years left on this employees vesting schedule. Without any prior negotiation at time of hire regarding acceleration of vesting, is there any way receive acceleration in case of termination? That means that their employer is under no obligation to keep them employed until the end of their vesting period or for any other reason. They can be fired because of a lack of work for them to do, a desire to hire someone less expensive to do the same job, a desire to restructure and eliminate their job, or because the company is unsatisfied with their work. By treating the terminated employees nicely, the remaining employees are less likely to panic. Normally one should expect to vest only as long as their employment continues. How do unvested options work post-IPO? Is an IPO an event that can trigger acceleration, or is this reserved for acquisition typically? Can unvested shares be canceled post-IPO? It is very unusual for an IPO to trigger acceleration. While it is easy to see an IPO as a destination for a startup, it is really the beginning of a much longer journey. An IPO means that a company is ready to have a broader base of shareholders — but it needs to continue to deliver to those shareholders, thus it needs to continue to retain its employees. Occasionally companies will give people the option to stay for reduced option grants but that is unusual. Family businesses and business that exist outside that ecosystem of startup investors, lawyers, etc may have different arrangements. What happens if you exercise pre-IPO stock options within 90 days of quitting and the company never goes public? Then you own shares that may be hard to sell. The company may be acquired and you might grt something for your shares, or in some circumsances you can sell shares of private companies. But the money you pay to exercise the shares is at risk. This entire article and your answer to my question has been the best write up on this topic that I could find on the Internet. I received the agreement, signed it, and got a copy of it back signed by the corporate secretary. I never received any other documentation since. Should I contact HR or a financial advisor? Just slightly concerned since the company seems a little secretive to me. I have been with them for over 6 years. Usually you have 90 days after leaving until you have to exercise the options, but this varies from plan to plan and the details should be in the paperwork you signed. One data point that you will need to finalize your decision is the FMV fair market value of the shares for tax purposes. The company should be willing to tell you this; if it is quite a bit more than a penny some taxes will be due on exercise but the shares are more likely to be worth something. Thanks Max, I really appreciate it. After reading your article and doing some research I found out I was looking at the par value, not the exercise price. So in my case, I would be severely underwater. Thanks again for sharing your knowledge! Max, thanks for the great info. I am considering joining a tech startup and wonder if there are enough benefits for both the company and myself for me to be brought on as an independent contractor vs. Any info you have or can refer me to would be helpful. Sorry for the delay. But even then, you will probably not get benefits or stock options. Good luck with your decision. The terms of preferred stock vary, not only from company to company but also across different series of preferred stock in a stock. I may not have time to answer but feel free to try me first initial last name at gmail. Hi Max — thanks for the insightful article. Half of my stock options have vested. I got them at a price of 3 and the current valuation is now at 4. What happens if I leave AFTER the IPO but BEFORE the employee lock-up ends. Do I get to leave with my vested as of departure date options or do I need to pay the company to buy them at the granted strike PLUS pay the tax on the gains etc. Putting aside any idiosyncrasies of your specific options agreement, typically you have 90 days after departure to exercise. So within that 90 days you need to pay the strike price and you incur a tax liability. Keep in mind the stock could decline before you can sell, so its not just acash flow exposure, you may wind up selling for less than you paid to exercise. Thanks for the help! Question — I purchased stock and then my company got purchased. My understanding is that the main investors lost money on their sale they sold below what they put into the company. Do you have any experience with seeing employees receive additional option grants with promotions? Is this common or only at key-level positions? I joined the sales team of a person startup at an entry level position about 2 years ago. Is it reasonable to ask? It is common but not universal to receive additional grants with significant promotions, but there is wide variety in how these are handled: I would ask your employer what the process is to ensure that your stock is commensurate with your current contribution to the company. For example, if when you joined an entry level employee received shares and an account exec receivedbut today an entry level employee receives shares and an account exec receives If this is the case, many companies would not give you additional shares to go with the promotion but would increase your salary. While this example may sound exaggerated, if the company has twice as many employees, grants may be half the size per employee — often the board will think about how much stock should go to all employees as a whole per year, and now there are twice as many to share the same number of shares. In any case whatever that value is, is it fair compensation for your time? How long do you have to stay to vest the options? And how much work are you expected to do? How does your stake compare to other participants and their contribution? I need your help! My company is a Green Sustainable clothes recycling company. I think 4 years is most common, maybe 5 next most, years is unusual. I am not sure what else you are asking. If you are asking about taxes on the equity, if it is options there is typically no tax on vesting if the plan is set up properly which will almost certainly require an attorney. How often should a company revalue their privatly held stock options? Any guidelines around that in the accounting standards? I am not a tax lawyer but I think for tax purposes options valuations are good for a year. If things change eg, financing, offer to buy the company, or other significant events you may want to do it more frequently, and for rapidly growing companies that might go public soon you may want to do it more frequently. With startups startup a global tendency, it becomes complicated to create one model that fits all. Any thoughts on adjusting vesting schedules, cliff periods and accelerations to ventures occurring in high-risk geographical areas? One thing that I do see adjusted globally is some of the details to fit local tax laws — even US-based companies have to administer their plans differently in different jurisdictions. Maybe a reader knows?? Great article, now for my question. Been working for a company 3 years, been vested, for example,shares, at 5 cents a share. Leaving company, It looks like the period to exerci se, buying the shares will have about 7 more years. When I leave, how long does one usually, questions to buy the shares, if they choose. I am a little confused about the 90days mentioned ealier in the article. Usually the option period is 10 years but only while you are employed. When you leave, the unvestef options go away and you have 90 days to exercise the vested options. Of course it depends on your specific option plan which may be completely different. I have some vested preferred shares. What are my options to liquidate them before any event? Your option may be to find someone who wants to buy the stock in a private transaction with limited data. Or it may be that the company has to give permission even if you find a buyer. Trading private stock is difficult. Also if you have options, typically you will have to exercise them before you can sell them. These stock options shall be deemed to have been granted January 31, and shall have a term of 3 years from the effective date granted. These stock options shall remain vested for a period of 24 months in which Employee remains in his current position with the Company. It sounds like you have between 2 and 3 years in which to exercise them. The vesting language is a bit unclear to me. You may want to get some legal advice, I cannot interpret that clearly. Let me elaborate on this as I am in the middle of an asset acquisition a division of the company is being bought that will close on Jan 31, I am still trying to understand the language above and below and what my options will be once the transaction is complete. The strike price above given seems startup bit high. How does this work in terms of an asset being acquired as opposed to the entire company? As Twitter is going public soon and I am in the last round of interview. If they offer me a job, will there be any impact to my equity offering if I questions before they go IPO or will it be the same after they go IPO? Which will be most beneficiary to me? Typically people expect the price to increase on I and thus try to get in prior. Predicting what actually happens is hard,for example Facebook went down. But generally joining before IPO is viewed as a better bet. On the day of my 7hrs in person interview conclusion, HR mentioned that they are not the highest paid company around, they come in like 60th percentile… But their RSU are at great offer. So I am guessing RSU is equal to Stock option they are referring to? I have been offered just over shares for. Our company is expecting to be acquired in the next 90 days so I could end up with no vested options… What happens if we get acquired before I am vested? The other thing that complicates it is that our company has a few different products we offer and the one stock is getting acquired is the one I work on. Does this make sense? Typically if the acquiring company does not want to keep you they can terminate you and your unvested options will not vest. If they want to keep you they would typically exchange your options for options in the new company. They will have some discretion in how to do this. Hopefully they will want to keep you and will treat you well. Now after 6 months the company is acquired by another company for cash buyout. Since I exercised my stock options just 4 months ago, will I be not considered for Long term Capital gain taxes? Or can I hold on to my share certificates for 9 more months and then will I eligible for Long term capital gain tax rate? Check with an attorney to be sure, it could depend on the details of that specific transaction but usually they close faster than that. We received an initial payout and had a subsequent release of the escrow amount withheld. This escrow payout was received over 1 year after the sale of the company. What is this payout considered? Is it a long term capital gains? Also, what about a milestone payout that falls under similar circumstance? I am not a tax attorney so I am not sure. If it came through regular payroll as a bonus my guess is that it is not long term capital gains. Hi Max — Great article! I have a question. I joined a company as one of the first 3 sales directors hired and was told in my offer letter I havestock options pending board approval. I have now been working for the company for 18 months and have not received any documentation regarding my options. I am continually told that they will be approved at the next board meeting but that has not happened and I was recently told they would be approved after the next round of funding but that did not happen either. What is happening here and what is your recommendation? Thank you in advance for your assistance. Something is not right. Sometimes the approval will be left out of a board meeting. With really bad luck you could be skipped twice. There is no good explanation for 18 months. But something is wrong with your company and I would be looking hard for something new. Sorry to be the bearer of bad news. If the CEO has an explanation that really makes sense feel free to share it and I will let you know what I think, maybe I have missed an innocent explanation but this does not sound right. Thanks so much for confirming what I was thinking, Max. To my knowledge the board has met several times and our CEO repeatedly states the valuation of our company is going up so I have not heard about a down round. We have had the same original investors for a few years and have recently had a new influx of cash in the form of loan but are still seeking that outside VC investment. I may have another start up offer coming soon and this information will help when I make the decision whether to accept the new position. Thank you again for your help!! You are commenting using your WordPress. You are commenting using your Twitter account. You are commenting using your Facebook account. Notify me of new comments via email. Enter your email address to subscribe to this blog and receive notifications of new posts by email. Email check failed, please try again Sorry, your blog cannot share posts by email. Max Schireson's blog Thoughts on technology and the tech business. Vesting There is a small but necessary catch: Ownership percentage This brings us to the number which is much more important though it is less impressive sounding than the number of shares — what portion of the company do you own. Exercise I talked briefly about exercising options above. Classes of stock Most startups have both common and preferred shares. How much are they worth That is, of course, the big question. Expiration and termination Options typically expire after 10 years, which means that at that time they need to be exercised or they become worthless. How many should you get How many stock options you should get is largely determined by the market and varies quite a bit from position to position. This varies by job level: Taxes Taxes on stock options are complex. What happens to my options if the company is bought or goes public? Max Schireson on August 23, PM on August 25, Max Schireson on August 31, What happens if the company is bought before I was granted my options? In my employment agreement the granting is subject to board approval and that never happened. Max Schireson on September 15, Max Schireson on September 16, I am assuming your options dated from joining full time, so it was a 6 month delay, not a year? Max Schireson on September 18, Benny on November 6, Max Schireson on May 17, How much would you pay to own an undisclosed percentage of my house? DMill-Tech on April 10, Martha on April 28, Max Schireson on April 28, Unfortunately for the subject of your story, probably not. CF73 on May 16, V on June 14, Max Schireson on June 14, Aleksandr Yampolskiy on June 14, Great summary Max, i found it very useful. Benny on June 16, Stephanie P on September 9, Max Schireson on September 10, Sorry for the delay in getting back to you. I hope this helps, — Max. Ken on September 19, Max Schireson on February 1, WhYSS62 on October 18, Taylor on November 7, Very informative post, thank you for sharing! May I contact you off-post for questions? Mrnanda on November 17, Max Schireson on November 17, Sam on January 4, Also, the purchaser then got purchased by a public company…how crappy. Alex on February 1, Max thank you for the terrific article. Options grants almost always have to be approved by the board. AB on February 5, Max Schireson on February 5, Yanna on March 15, Thank you soo much Yanna. Max Schireson on May 20, Rob Townend on April 16, Adriana Galue questions April 28, Terrific article thank you! Max Schireson on May 24, Max Zhang on August 20, Max Schireson on October 17, Mike on September 5, How would you explain this scenario? Mike on December 11, Andy on October 15, Andy on October 18, NY on November 6, Max Schireson on February 12, LJohn on February 12, LJohn on February 13, Leave a Reply Cancel reply Enter your comment here Fill in your details below or click an icon to log in: Email required Address never made public. Send to Email Address Your Name Your Email Address document. Post was not sent - check your email addresses! Sorry, your blog cannot share posts by email.
5 Tips on How to Grant Stock Options - Startup Tips
5 Tips on How to Grant Stock Options - Startup Tips
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Truly Truth. by sassyb Relationship is an enormous word and full with deep meaning.It could happen with everyone such as among friends, family and lover which is popular one.
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