Who pays when startup employees keep their equity?

There was a PE firm that came around about 4-5 years ago trying to raise money on this very premise.<p>Their thesis was that<p>- startups would remain private longer.<p>- employee&#x27;s lost their options when they leave<p>- longer periods to go public means more employees return options to the pool which means employee option pools can be smaller<p>- 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<p>- 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.<p>This is one of the coolest and most maddening things about finance. Every time you think you&#x27;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 &quot;arbing&quot; it out ever since.

It&#x27;s interesting to see the popular response to this thread being one where people think employees are better off with salary over options.<p>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&#x2F;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&#x27;ve seen.<p>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&#x27;re trying to optimize for gaining a &quot;life changing amount of money&quot; 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&#x27;re going to have to invest anyway, why not work for a company you believe in and have a chance at influencing the company&#x27;s success as well as your own?

There is a downside to RSUs. Say you work for a private company with a high valuation, e.g. AirBnB at $25B, and you are granted 0.01% equity over 4 years. That means you are vesting $2.5m of RSUs over 4 years, and these RSUs are taxable at that amount. Typically for folks earning over $150k&#x2F;year in base salary, particularly if married, even half as much will put you into AMT territory, and you will end up paying a significant chunk of cash each year in taxes (even if RSUs are withheld for taxes, because the withholding cannot account for things like AMT).<p>Options with extremely long exercise windows helps obviate this tax burden and allows the employee to decide when&#x2F;if to improve their tax position by exercising ahead of a liquidity event.

This is very interesting. Options are really an unappealing mechanism to incentivize employees. I feel like they prey on people who really don&#x27;t know any better, and don&#x27;t understand the tax implications or the possibilities around future dilution.<p>As a rule of thumb I discount face value of options by as much as 70%, that generally doesn&#x27;t go over very well with people trying to convince you to accept them in lieu of cash.<p>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&#x27;t fly.

Equity is one area where I would encourage YC to get more involved. We need someone to step in and lobby the government for tax treatment of options that reflects their economic reality to early stage employees. We also need to encourage companies to use a &#x27;standard&#x27; stock option agreement which is well known by everyone so that equity offers can be compared across companies.<p>If you take equity from an early stage company that has also raised a ton of money with a liquidation preference, what are your chances of getting paid out, even on a big exit? That question is basically impossible for most people out here to answer.

Is the presumption that founders and investors are not trying to screw employees? I genuinely can&#x27;t tell from the article. I thought it&#x27;s just common knowledge that they will try to screw employees at every chance. With options it was different strike prices for management&#x2F; founders vs employees. With RSU&#x27;s it is weird vesting schedules and forcing forfeiture situations.

The barrier to entry of this stock option tweak: it requires an informed populace, ie, us.<p>If you are a founder with reasonable engineer cred and announce differentiated stock option terms, ie, Adam D&#x27; Angelo at Quora, there&#x27;s a reasonable chance that engineers considering joining your company will be encouraged by your effort on this.<p>If you&#x27;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&#x27;re drawing.<p>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&#x27;re making an expensive choice for little benefit.

I have always thought that companies should work out the salary of a new employee in all cash then once the parties are happy allow the employee to trade in whatever percentage they liked for equity. If you value the equity at zero why should the company give it to you and if you value it very highly why should they give you cash?

The assumption that every employee leaves after 3 years and keeps none of their equity is absurd. I don&#x27;t see any value in that example at all.

I like the basic idea and it&#x27;s nicely presented however conceptually I&#x27;d favor a model where the employee gains come primarily from the losses of later stage investors and not early stage investors (and founders).<p>&quot;&quot;&quot;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.&quot;&quot;&quot;<p>So basically I&#x27;d like to work from sort of the reverse of this but I assume it&#x27;s not very likely due to the investment horizons etc. Basically I suppose late stage investments should be a good chunk more expensive.

This is clearly a shot at Kupor&#x27;s infamous A16Z post where he claims employees who stay suffer a LOT more dilution (80%) when employees who leave keep 100%.[1] But this poster&#x27;s model puts it at just 5%.<p>There&#x27;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&#x27;t that a pretty high attrition rate for a pre-IPO startup?<p>[1] <a href="http:&#x2F;&#x2F;a16z.com&#x2F;2016&#x2F;06&#x2F;23&#x2F;options-timing&#x2F;" rel="nofollow">http:&#x2F;&#x2F;a16z.com&#x2F;2016&#x2F;06&#x2F;23&#x2F;options-timing&#x2F;</a>

Wouldn&#x27;t RSUs open employees to a different and more punitive tax regime (income tax) than options (which would fall under capital gains if you exercised early enough)?

While the dialog around various equity-based incentive compensation mechanisms is good, this article is off base in SO many ways:<p>&gt;&gt;With an often high strike price,<p>Only an issue at the later stages of companies (note: this writeup argues RSUs &quot;from the beginning&quot;).<p>&gt;&gt;a large tax burden on execution due to AMT,<p>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&#x27;s generally best to exercise as you vest, for this very reason.<p>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).<p>&gt;&gt;and a 90 day execution window after leaving the company many share options are left unexecuted.<p>This is MUCH less of an issue if you are exercising as you go along (see above).<p>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.<p>Regarding RSUs, you <i></i>HAVE TO PAY TAX AS YOU VEST<i></i>. For a private company, you&#x27;re just replacing one potential problem (AMT with option exercises) with a very specific actual problem (steady tax liability as without liquidity).<p>RSUs are a very useful compensation tool, but you can&#x27;t declare them unilaterally better. ALL equity compensation forms require some &quot;user sophistication&quot;, including options and RSUs.<p>If you don&#x27;t understand how to optimize your situation, get advice from someone who does!

I wish companies adopt the same &quot;what have you done for me lately&quot; mindset to investors as they do to employees.

Hold up. This post proposes using &quot;single trigger RSUs&quot; instead of options, claiming that taxes are deferrable to a liquidity event. But according to this[1], FICA taxes are still due on vesting. So RSUs would still have immediate tax consequences, potentially very expensive for unicorns.<p>Are there actually any startups offering RSUs?<p>[1] <a href="https:&#x2F;&#x2F;www.acc.com&#x2F;chapters&#x2F;wisc&#x2F;upload&#x2F;The-Rise-of-Restricted-Stock-Units-1.pdf" rel="nofollow">https:&#x2F;&#x2F;www.acc.com&#x2F;chapters&#x2F;wisc&#x2F;upload&#x2F;The-Rise-of-Restric...</a>

Taking equity instead of cash is like asking the company to denominate your salary in Bison Dollars. Worth a lot IF the plan for world domination goes off without a hitch but until then...

The last startup I worked at went through a merger. In the process, they created a new company and gave all employees stock in the new company, on the same vesting schedule as the options had been on in the previous companies.<p>They organized things and provided help to ensure that all US employees were able to make a Section 83(b) election for our stock in the new company as soon as it was created. (This means we paid taxes early based on the current value (zero) instead of potentially paying much larger taxes in the future.)

reminded how 10 years ago upper class was trying to initiate grass roots and steer protests against options expensing. They failed and as a result we have RSU pretty much everywhere instead of options. The startups are the last bastion, and i think with the modern &quot;who needs an IPO with such great C round (and related caching out for chosen ones)&quot; approach, people will start to get the picture and the RSU will come there too.

This is where having a lobbying group would be helpful -- this really needs to be fixed through policy.<p>We need to get the tax law changed so that RSUs are taxed on liquidity instead of vesting. Then you&#x27;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.

I can imagine that there would be other consequences to the change. For example, I could see anyone on the edge around their 1 year vesting cliff would be fired to avoid parting with their equity. It would probably also push down the amount of equity offered because of the increase in value. Further, some companies are already doing this, vesting could be back loaded with the majority vesting in the later years.

Is a single trigger RSU somehow different in trigger than single trigger options? I&#x27;ve always been told that single trigger, at least for the majority of engineering, means your company won&#x27;t be purchased.<p>Single trigger makes sense for legal, accounting, etc who are likely gone in an acquisition.<p>Double trigger makes sense overall.

There was a HN discussion ten days ago [1], where several people including myself were suggesting 83b rule RSUs as a possible solution. Nice to see this method quantified.<p><a href="https:&#x2F;&#x2F;news.ycombinator.com&#x2F;item?id=11963551" rel="nofollow">https:&#x2F;&#x2F;news.ycombinator.com&#x2F;item?id=11963551</a>

I have really never understood the confusion over why this doesn&#x27;t get implemented. It has always seemed clear to me that there&#x27;s not enough demand for change, and investors and founders want things to stay the way they are. It&#x27;s a really, really good deal for them.

Who pays for this?<p>Is the following answer somehow too obvious to be true?<p>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.

Its not &quot;options&quot; vs &quot;RSUs&quot;<p>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.<p>Think different didn&#x27;t mean argue about false dichotomies.<p>It is a total charade for the venture firms to propel the notion that they are doing employees a favor by even offering stock. &quot;How gracious of us to dilute our investment at all!&quot;<p>Dilute the preferred shares with 8% dividend and liquidity preferences!<p>Offer convertible bonds or other hybrid products!<p>You can incentivize people in 101 ways, and you guys are debating about two of them under the assumption that the crowd is right

i really think Profit Interest Units are the best form of equity for both employees and employers<p><a href="https:&#x2F;&#x2F;www.nceo.org&#x2F;articles&#x2F;equity-incentives-limited-liability-company-llc" rel="nofollow">https:&#x2F;&#x2F;www.nceo.org&#x2F;articles&#x2F;equity-incentives-limited-liab...</a>

Either way it&#x27;s a losing game, consider a company like Google - how would they attract new employees on either scheme given that the company has been around for 15+ years? The only people who win are those who get in early, or invest big. Any IPO ultimately results in people earning money who don&#x27;t &quot;work&quot; for that money - that means the actual workers lose out everytime.