There was a PE firm that came around about 4-5 years ago trying to raise money on this very premise.
Their thesis was that
- startups would remain private longer.
- employee's lost their options when they leave
- longer periods to go public means more employees return options to the pool which means employee option pools can be smaller
- longer private periods leads to more rounds raised which benefits investors over employees as the former can participate on each round to keep from being diluted
- exits would come eventually and the investors would always have superior terms, I believe that they were working under the assumption that investors would never have mandatory black out periods after IPO so they could essentially participate in the opening day IPO pop.
This is one of the coolest and most maddening things about finance. Every time you think you've come to a big realization, usually you find out that someone else came to the same conclusion many years ago and has been making money "arbing" it out ever since.
Where are all these secondary market companies "arbing" it out on employee stock option liquidity? The market should be HUGE, both for locked-in employees, and for buyers who want a small discount on hot startups.
This would totally solve the 90-day exercise period problem for the employees, without requiring company goodwill.
Some companies like ESOFund, 137 Ventures, EquityZen can do deals without company involvement, with a non-recourse loan with limited upside/downside, or a forward contract with cash delivered today, and the certificate held as collateral until IPO, when it is transferred.
There are increasingly share restrictions (which some consider unenforceable) on sales/transfers, loans, etc. First-hand knowledge online is scarce and lawyers give unclear answers due to the novelty of these deals. Can the company find out? Intervene? Sue? Are they likely to? Do we need a public case and TechCrunch headline in order to find out what the outcome is? How different is self-financing vs. a rich relative vs. angel vs. a marketplace investor?
Edit: It seems like I misunderstood, and the investors are investing in the company itself, not buying employee shares on the secondary market. The major point still stands though.
Usually the major problem with buying employee shares on the secondary market is information asymmetry - the company is not going to provide the buyer with any information, therefore unless the buyer is intimately familiar with the inner workings of the company (I.e. An investor, or incredibly well plugged in) they really have no idea how the company is doing (despite being a "hot" company) which in turn makes it incredibly difficult to come up with market clearing prices
That's definitely true - so basically, the buyer is more averse to buying especially considering they are essentially investing in the dark, going off of public news or hearsay? For some of the most-fundraised private companies e.g. Uber, Airbnb, Stripe etc. I figure many would be satisfied with the last private round valuation or a small discount, and the loss/market inefficiency here (5-10%) would still allow most deals to work. However, as a seller, your pitch, especially for less-well-known companies, would be much more difficult.
Basically your thesis is that as an asset class, late stage private technology companies are underpriced, since the presumed employee option pool will be smaller than previously assumed, and thus dilution will be smaller than previously assumed. Thus you can bid a higher price than your competitors and still come out ahead in your investment in this asset class.
What I don't understand is how you get around the fact that you would still have to "pick winners".
> What I don't understand is how you get around the fact that you would still have to "pick winners".
If you didn't lead investments and instead diversified substantially amongst late-stage companies, you could probably get sufficient overall exposure to the class so as to not be driven by the performance of individual companies.
In reply to your other comment, VC investors tend to have a "thesis" about a particular market but PE firms can and do have a much broader thesis. "Changing conditions have led to late-stage equity being undervalued as an asset class" would definitely qualify.
>If you didn't lead investments and instead diversified substantially amongst late-stage companies, you could probably get sufficient overall exposure to the class so as to not be driven by the performance of individual companies.
Oh that was the missing link. I forgot that you can "not lead" a round, allowing you to avoid committing too much of the fund in a given company. Thanks for pointing this out.
My impressions is that late stage investors generally have lots of protection here, so that the company is forced to IPO by certain dates to avoid penalties, and if the IPO isn't at an agreed upon number, the company gives more shares to the investor to make up for it. IIRC square had such a clause, although I don't know how that turned out.
Picking the winners isn't so hard if you can protect your investment like this. The lower bounds on their expected returns isn't $0.
To make it a classic arbitrage you would hedge by shorting an "equivalent" asset. For example, if 1/1000th of JP Morgan Chase's assets are those also in your portfolio, then for every 1000 long shares you would short 1 share of JPM.
Since JPM is far from equivalent and most VC capital you don't have access to short, in practice I assume that a) you would assume that any startup receiving financing / investments at unicorn valuations is already a winner, and b) go long a sufficiently large and diverse basket to try to eliminate risk.
Unfortunately (a) is so far from true I'm not sure this would be an effective investment thesis.
Seems like a pretty good investment thesis (especially if they were truly ahead of the curve here).
Except I doubt the last bullet is accurate. I'd be very surprised to find that even 10% of tech IPOs have significant preferred investors not subject to a lock-up. Underwriters really, really don't like holders (even small ones, but especially big ones) being able to sell right off the bat. And if the market is flooded with VC investors dumping shares just after the offering, then there may well be no "pop" to participate in.
Maybe I'm missing something, but that doesn't really sound like a "thesis" but rather just an identifying mispriced securities ("arb opportunity" also works).
I agree with the latter that the late stage market for startup growth capital likely did not price this advantage in, and that the PE fund had an edge. But even at that stage there are winners and losers, and I would think that a thesis would still need to resemble the kind that Series B investors must concoct, and be able to sift out the winners from the losers.
In any case I appreciate you sharing this info. It's enlightening.
Well ESO fund has been around for 3 years-ish. VCs also do this ad-hoc sometimes too with employees. I think other older engineers have known this to be a 'problem' too for many years.
It's interesting to see the popular response to this thread being one where people think employees are better off with salary over options.
This seems crazy to me as I have watched many close friends cash out options from companies including Google, Yelp, Apple and Pandora and buy houses (some with cash), start companies, become investors and/or take long sabbaticals with the proceeds from their options. With salary there is a clear upper bound and the tax on W2 income is simply the worst. I would say that at least in the Bay Area, options are a good bet and much better bet based on what I've seen.
Startups are always a gamble for everyone involved. But outside of the financial industry, where 6 and 7 figure cash bonuses are common, I think options are superior to other forms of compensation if you're trying to optimize for gaining a "life changing amount of money" in less than say 10 years. High salary could only compare if you are very good at minimizing tax and maximizing the money making potential of your salary though investments (requiring additional work). But if you're going to have to invest anyway, why not work for a company you believe in and have a chance at influencing the company's success as well as your own?
> I have watched many close friends cash out options from companies including Google, Yelp, Apple and Pandora and buy houses (some with cash)
I have watched friends get paid a smaller salary, hoping for a great exit only to find their options diluated or the company just simply failing.
Now you probably only have lucky and successful friends or that friends who didn't get enough cash to buy a house are probably not in the back of your mind, as nobody wants to advertise either their failure or failure of their friends.
It just get chucked to "oh well, startups are risky". But then the winner get famous and everyone talks about them, making it seem like joining a startup and accepting options instead of a good salary is a sure way to succeed.
Notice, this is the same process the lottery system uses. We make fun of those people, but it is the same idea. Lottery always havily publicizes their winners, that is not just random marketing but a very useful tactic -- make everyone believe they can win took -- "Look at him, they got a huge giant check, so can you". If they televised ever single lottery loser, nobody would buy the tickets.
In my mind, startups are less like the lottery and more like blackjack. You are gambling either way (as with any investment) but, with blackjack and startups you can optimize.
Unlike the lottery, knowledge and skill play a role here.
> Unlike the lottery, knowledge and skill play a role here.
True, but that's not quite the analogy I was going for, the analogy was how survivorship bias is used in both cases for promoting the idea-- everyone picks the winners and remembers / tells / markets those while disregardign the losers. I do it too, it is just a natural human tendency.
In both cases, if every time someone heard about a successful startup they also heard about many failed ones, they might have a different perspective.
Considering that the biggest factor for turning a startup into a massive success is luck, I find that sentiment delusory.
The best you can do is to accept that you're not an expert in picking winners. (Just see how many hedge fund managers underperform the market. Even the supposed experts have problems doing any better than random decisions.)
You have no control unless you are part of the core management team and even then you don't have very much. Startup options really are a lottery, and just because other people sometimes win doesn't mean you can actually count on getting there yourself.
Or you start working for a company thinking their product(s) are cool, strong and survivable as its own thing, and then it turns out the plan was not to build a business but to cash out.
Actually it was only 7 months and I still got ripped in the deal. You can say "low risk, low reward," but in the big picture my reward was sorely out of scale to my contribution. Sorely.
This. And things are not really comparable to big finance jobs as the bonus is more or less expected to some degree or people leave to places where they will get the bonus.
Startups are a lottery to a large degree, and for employees without significant equity, the odds don't seem great.
The finance industry has its own risks. It's a tournament type structure where as long as you stay in the tournament you are doing very well, but if you fall out you can end up doing pretty poorly. Whereas the tech industry, at least for the last several years, has offered a soft landing to many of those that choose to enter the startup lottery and lost.
Probably the least risky choice among high paying jobs that exist in reasonably large numbers is to become a doctor.
Can you elaborate on the "tournament type structure?" Are you referring to those at a high enough level where the expectation is that they source deals? If so, then yes, because at that point it is sales, and if you don't deliver new business, you bomb out, same as any other sales job.
If you are low enough level though, that isn't necessarily a concern since you aren't expected to source deals.
In the investment banking industry you can't be a lifetime associate, it is up or out. If you make it to managing director you are doing very very well for yourself, but you still don't have any job security. That big pay packet is a ripe target when fortunes turn and the bank needs to cut costs. And if you get let go as an MD it is unlikely you will find another bank to take you in (the usual thing where it is harder to find a job without a job is even more so in the financial world.)
So it looks like we're in agreement that this primarily would apply to the upper levels of ibanking when there is an expectation of deal sourcing. But for junior analysts and such, there really isn't that stigma since their performance is not measured on a sales basis (and thus their mobility is not necessarily hindered by a down year).
Do you have any info or insights into how deal sourcing typically works at that level? Seems like a crazy thing to measure against when your annual deal volume would be relatively low given the size of the deals.
> So it looks like we're in agreement that this primarily would apply to the upper levels of ibanking when there is an expectation of deal sourcing.
I've never worked in finance, but I have a lot of friends who do.
From the day they entered (ie. as junior analysts), up or out has been the mantra. You simply cannot be in a position for more than a few years. If you're not promoted to the next level, you're fired (though most of them had the sense to switch industries when it became clear they weren't going to be promoted).
Deal sourcing comes in at higher levels, but the "tournament" structure is embedded throughout.
I think you mean lower expected value, no? The way you put it cash is strictly better in every way than options - both higher expectation and lower risk. According to you there's no upside to options relative to cash.
The main reason that options are handed out is to compensate for below-market salaries, and the main reason salaries are below market is that the company wants to increase its runway. Some specific valuations or offers warrant cynicism, but remember that any startup with negative cash flow (even successful ones with near-market salaries) should be giving out equity to keep their salaries costs down.
Yes, but most of these companies fail and the options thus worthless. I mean it's great when it works out, but like lottery tickets they usually aren't worth the paper they are printed on.
Right: startups give out options, and those options are likely to be worthless. Your previous comment, however, was also suggesting causation: startups give out options because they are likely to be worthless. That's certainly not the entire reason. Like I said, a startup doesn't want to pay market salary because it would effectively ~halve their cash runway versus shifting compensation towards equity.
Generally companies hand out options because their expected value is Less than cash. Put another way, they could also just hand out stock instead of stock options.
The upside is a non-zero chance of becoming filthy rich. Some people are willing to put up with a lower expected value in exchange for that chance. It's a fancy version of the lottery, which many people also play.
You shouldn't be able to influence a lottery outcome. Presumably, you can influence share prices if you work for a company that you have an ownership claim on.
Do you actually believe that as a non-founding employee you'll be able to make the difference between the company delivering "a life changing amount of money" to employees instead of the far more common outcome?
I guess the same type of mind that believes meritocracy really exists could believe such a thing...
> Or do you think employees are entirely fungible?
This is what every self-respecting capitalist believes and knows in their heart. Employees are resources. If a founder doesn't know that they will fail.
Maybe you thought startups were an exception and that startup employees are unique snowflakes but BigCo employees are drones?
> Does my last employer not have a large contract with Prudential, because of my work?
If that contract is what made the business viable, then the company must be completely fucked without you and be on their way to failure. If the contract didn't make a substantial difference in the company's outlook, then how does that relate to my point?
> If that contract is what made the business viable, then the company must be completely fucked without you and be on their way to failure.
In any startup with <5 employees if an early employee leaves it's a huge risk to the company that may result in bankruptcy or failure of the company. Engineer #1 is as important as a founder in the startups I've worked at.
If there are 3 founders and 2 non-founder employees, then typically each employee is doing (approximately) 20% of the work. Not many small companies can just shrug off losing 20% of their workforce.
> This is what every self-respecting capitalist believes and knows in their heart. Employees are resources. If a founder doesn't know that they will fail.
I hate to be rude but WTF are you talking about? I've known several successful startup CEOs and they keep good employees close and well taken care of. For one thing, startups usually fail, so you're going to have to keep your good employees open to working with you on your next attempt, and if you keep treating them like slaves/resources they won't come with you to your next venture. Second, how are you going to recruit new talent if your reputation as a founder is that you treat your employees like interchangeable "resources"?
It was a consulting firm trying to break in with a larger client, so they had to move to other projects. Last I saw, they were working on Android projects.
>Maybe you thought startups were an exception and that startup employees are unique snowflakes but BigCo employees are drones?
No, I just don't think anything can be done without people and that one person is not the same as another.
you are correct to point out the "flaw" in what s/he said.
I don't know the actual answer (and it would be difficult to convince me that anybody has all the data either) but many people "experienced" with startups believe that so many more options come out worthless that cash is strictly better, better expected return at lower risk.
however, in the same way that the freakonomics guys explain people playing state lotteries even thought they are "not worth it": state lotteries (and startups) offer some of the few chances that most people have to actually get rich, so even though they don't pay off on average, they are "the only way" and "worth it" to some people. Not claiming that these people have clear ideas about either expected values or risks involved, but they have clear ideas that "it's the only way". For workers at many skill levels, they may have a sense that in their industry they won't be too much worse off in the long run so why not take a shot.
Having a significant portion of your portfolio in options on one company, which also happens to be the company you work for, is overconcentrated. The usual (good) advice is that people should diversify their portfolio, and believing in your company is not a good reason to not do that. Maybe it'd help to think about it in reverse: if you had all your money in cash, would you then buy all those options in your company to get the same portfolio? (Note: perhaps you would, but it's generally considered to be a bad idea.)
This is like someone winning the lottery then telling you to liquidate your retirement fund and buy powerball tickets.
Yeah, if you worked for Google back in the day, you could actually do this. Now? With the crowded landscape of tech companies competing to provide services, except for the few services who have one or MAYBE two companies that completely own the field? You'd be insane to take options.
Of course I have seen people lose. I've personally lost on options as well. I didn't make the assertion that you can't lose. With options, you are betting that the company will not fail and that it will become much more valuable. Both are statistically unlikely. You are also betting that you won't leave or be otherwise eliminated before the exit.
Mainly I'm framing this in comparison to additional salary which is also unlikely to generate significant wealth unless you are very good or very lucky (Probobally both) at managing your money.
How much is needed for something to qualify as "significant wealth"? You seem to be dismissing differences in salary as unimportant, so it's fine to take a pay cut in exchange for even a small chance at significant wealth, because that's all that matters.
Let's say the salary difference is $50,000/year. Over 20 years, that's maybe half a million dollars, post tax, that you gain by ditching options. Maybe that's not significant to you, but it seems to me to be a pretty rational decision to prefer a relatively certain half million dollars over a low chance of some substantially higher payout.
In my experience the salary difference isn't usually that large. Sometimes it is, and some companies do pay unusually low salaries in exchange for options, obviously increasing risk, perhaps to an undesirable level.
I'm CEO and co-founder of a funded company. We pay competitive salaries + options. I don't begrudge someone who isn't interested in options. Options are actually expensive to me. We are still fairly early stage (Series A funded) so the founders own most of the company and the option pool primarily dilutes the founders. I want to give options to someone who wants them. I'm fine paying more salary in lieu of of options.
I think of options like a profit-sharing plan in a mature company. If the company does very well then the employees should share in that success. Some folks feel that paying very low salaries and heavy options breeds loyalty. I personally don't subscribe to that. I prefer to pay something competitive and have options as nice upside for the employee.
> In my experience the salary difference isn't usually that large.
Speaking as someone who recently did a round of interviewing with a mix of established companies and startups, $50k is a _very_ conservative guess. The difference between my Google offer and the highest startup one was ~$100K - if you drop to the average startup offer, it goes up to ~$150k. And that was at ~3.5 years of experience - it gets worse as you become more experienced.
It's hard for me to imagine how sure of a bet a startup would have to be for their equity to be worth $150k/year.
Interesting data point. Thanks for sharing. I'm no longer in SF so may be out of touch with current salary gaps.
That said, this is makes sense to me. Google's stock options aren't making employees wealthy these days. Yet it's still a fantastic company and obviously compensates with salary. On the other hand, no startup that I know of can pay 3-400K salaries for 3-4 years exp.
Also it should be said that the type of work you likely do and the culture at a large public company will likely be very different from a small startup. Culture, ability to influence direction, large potential upside (though unlikely) are reasons people continue to pick startups despite lower salaries.
For a new grad several years ago comparing offers between say Uber, Airbnb, Stripe, Google, and Facebook, the mid-stage private companies like Uber/Airbnb/Stripe are likely paying $100K, while Google/Facebook offer barely more at $120K or so.
However, the Google/FB overs likely include RSUs valued at $400K that vest over 4 years, while the private companies offer options (at the time) "worth" (at current company valuation) ~$300-400K, with incredibly low strike prices since the 409a can be much lower than the preferred valuation. It really depends on how well the company has down, but since the last 3 years those private companies have doubled to 8x in value (see Uber), and thus the Uber employee's shares would be worth $2.4M-$3.2M. Google also appreciated (+50%) making the RSUs worth $600K, but still has not appreciated as much. Of course, this is just one example, picking the most successful companies, but it is illustrative of the general principle: if 20-30% of the time you can get on a rocketship, you can be +EV but with higher variance.
I'm merely assuming that your working life is at least that long, and that the salary/options tradeoff is something you can make throughout, as you change jobs.
If you go hardcore for options, then you might take every job with a reduced salary and a chance of striking it rich. If you're totally against then you might take every job with a more established company (or unconventional startup) that pays better. The tradeoff of potential riches versus more certain earnings is as I described.
The idea of taking higher salary over options is basically summed up in the "why your dentist is rich" chapter in Fooled by Randomness. It's "safer" and you'll be relatively rich over all outcomes.
Additionally you can theoretically invest the extra money over your vesting period of the options at whatever $insert ETF produces as an annual return.
Setting all the monetary issues asside I'm not sure if I'd prefer more money or more options on a philosophical basis. I feel like I'd go for options because if you work at a startup you should share the vision and work there because you believe it's awesome stuff that will change the world. OTOH taking the salary might make you less prone to certain biases and more "objective" in everyday work (+not overinvested in one outcome).
tl;dr: I think I'd take the options package if I'd work at a startup because if I wouldn't I'd have to question why I work there in the first place
If you assume that you will be screwed out of your equity, it makes sense to be compensated entirely with cash up front.
And with companies like Uber that seem to plan to never have an IPO, and also this meme that it's good to screw ex-employees out of their vested shares, it's not necessarily an unreasonable assumption.
Are you talking about options being the entirety of one's financial compensation? Because I wonder how people who work without a salary manage to pay the bills every month.
> the tax on W2 income is simply the worst
As opposed to getting taxed on what you eventually make from your options?
It's hard to get substantial sums of money from options and have it all be taxable only at LTCG rates. ISOs are limited to $100K/yr when first exercisable and doing an 83b election (assuming your plan permits it) on unvested shares is fairly risky, to put it mildly.
Yes, it's possible to get such tax rates, but generally only for amounts under $100K.
That you have four close friends who have made significant windfalls is a bit of an anomaly. There are far more people that have lost on that gamble(trading salary for options) than there are that have won. Give it another ten years of working at startups and it won't look so crazy.
I'm mot even sure how you "optimize for gaining a "life changing amount of money"? That's like saying you are going to optimize for luck. There a substantial amount of luck involved in seriously "cashing out" on a startup.
My experience has been that you never get enough influence over the company's success to make a significant difference, and the options don't pay off frequently enough to rely on.
For my own part, I've been at this for over 20 years and I've never come close to making any significant amount of money from options. They have lost all incentive power. Pay me cash money now, and I'll invest it however I please.
I'm not sure why you think single is a positive if you're trying to save. It's far more cost effective to be married to another high-income earner.
Living in a cheap location is also not everyone's dream. It would be life changing for me to retire to Costa Rica, but it would not be a positive change. I live in a pretty expensive city (Seattle) because I like it here.
If X, says nothing about if not X. Dual income no kids @ 200+k can be a great way to save a lot of money. But, you have far less control over your spouses spending and willingness to relocate.
Also, even if you don't move having 500+k / person in the bank is life changing. The median bay area house is 635,000$ which becomes affordable while saving money. Dual income with a 1+ Million down payment and you can actually buy a nice place.
In general conversation, "if X" often says a lot about "if not X". "If you're a white male on America, you have entrenched institutional benefits" actually does imply something about non-white/non-males. It implies that non-white/non-males do not have the same entrenched institutional benefits. General conversations do not follow the rules of prepositional logic.
When you repeatedly refer to being single, you imply that it's the better way to save, whether you intend that or not. And when someone asks about it, brushing off the question by pretending they should have applied rigorous logic to the statement is somewhat... let's say silly. Ability to control a spouse's spending and willingness to relocate are legitimate answers that you make weaker with the attempted logical refutation.
Having 500k in the bank also isn't really life changing if your plan is to spend it on a house. With a high income, you could theoretically save for 10ish years and buy a pretty nice home outright. You could also just take a loan out immediately and live in the same home for those ten years, acquiring equity and tax benefits along the way.
Saving to buy outright or mostly outright only makes sense if you are either extremely risk averse or you believe that non-real assets will appreciate much faster than real assets over the medium term. Right now you can get a super jumbo loan at less than 4%. If you want buy a million dollar home and have a million dollars in cash, it's really not a given that you should buy the house in cash. That implies that you believe the stock market will do worse than, say, 3% (reduced due to tax advantages of mortgages and disadvantages of capital gains) for many years.
The glaring exception for dual incomes as I said was you can't control your partners behavior. That's a major caveat and derails the conversation. You go from stuff you can do, to some sort of theoretically ideal couple. In most areas the major savings is being socially acceptable to share a bedroom with someone and being a 1 car family. But, in SF you may already be sharing a bedroom limiting the savings.
Further a 100k income simply can't afford to buy a 900k place. 900k * .06 = 54k/year + taxes + repairs + insurance + utilities. Put a 500k down payment on that and suddenly it's a 400k place and much higher taxes. Now you might be able to swing 900k that with a roommates, but again not having them is a major life change.
> in SF you may already be sharing a bedroom limiting the savings.
I mentioned that in another fork of this thread but was being facetious. Adults do not generally share a bedroom unless they're in a sexual relationship. Sharing a bedroom platonically is not a reasonable thing to expect people to do to save money. Sharing an apartment, yes. A bedroom, no.
> Further a 100k income simply can't afford to buy a 900k place. 900k .06 = 54k/year + taxes + repairs + insurance + utilities. Put a 500k down payment on that and suddenly it's a 400k place and much higher taxes. Now you might be able to swing 900k that with a roommates, but again not having them is a major life change.*
Your numbers don't make sense. First, if you're paying 6% on your mortgage, you're overpaying by a ton. Assuming you even try to get a decent rate, you're looking closer to 3% once you factor in the tax advantages. Second, if you can save 500k in 10 years, you're saving close to 50k/year plus paying for housing. So it's a lie to claim you cannot afford 54k/year in house payments.
Interest is only part of the cost of a loan you also need to pay principle if you don't have a large down payment your interest rate increases. Feel free to calculate a 900k home w/ 0.8% property taxes and insurance. http://www.bankrate.com/calculators/mortgages/mortgage-payme...
You do get to deduct interest, but you lose out on the standard deduction you can also play a lot of games with savings. Things like not taking a car loan because use can pay with after tax money saving on the loan and paying less for the car. Financing your own credit card saves money where if your house poor debt is just a fact of life etc. You can also more safely have a high deductible health insurance.
Also, you get interest on savings so your not saving 50k per year to get 500k in 10 years.
I'm quite painfully aware of what a $1MM mortgage costs with taxes and insurance. The point is that if you can save enough to put down half of that in 10 years, you could swing the cost of the mortgage today. When you talk about saving, you have to remember that 1) you still have to live somewhere, and that's definitely not free, and 2) home prices are generally increasing over time so you probably need to save more than you think. On the subject of the standard deduction, you're right that you'd lose that, but with a jumbo mortgage, you'll still come out ahead for many years.
Interest on savings is negligible. If you take the highest money market rates, you'll get just north of 1%. If you stick the money in a 5-year CD, you'll get 2% and lower liquidity. Meanwhile the housing market is rising faster (how long that's sustainable is unknown).
I'm not sure what you're talking about with the car loan. If you think it's worth having a cushion of cash in the bank (I certainly think so) so that you can do things like buy your cars in cash, then saving for 10 years so that you can dump all the money into the house is a terrible idea because you've just lost your cash cushion. (Your best bet for saving on cars is to just buy fewer of them anyway.) For the high-deductible insurance, you only need a few thousand in the bank to take the risk out of that. You need enough cash on hand to cover your deductible. After that it basically looks like any other insurance plan. And certainly, a larger cash cushion makes copay/coinsurance easier to handle, but that's not specific to high-deductible insurance.
If you think you should live far beneath your means as a general rule, I can't argue with that. There's no compelling argument for why you should spend all your money if you have the option to save. It insulates you from risk and allows you to retire sooner if that's your goal. But if you are living far beneath your means so that you can just dump all your savings into a house in 10 years that you could afford today with the same income, I think you're wasting your time, especially in a market like SF where home prices are increasing so rapidly.
The car comment is people see 0% interest loans for a car and think they are not paying interest. However, if you have cash for the car out of pocket you can pay a lower purchase price. Because it's money saved you don't pay taxes on your 'earnings'. Which means it can be a very high ROI investment vs. that loan. Not that you should be buying a car but sometime over 10 years a new / used car is reasonable.
Also, I am basically assuming your going to get raises over time. So your initial 100k salary might be 150k in 10 years. Thus ~35k savings in your first year + 4% net interest (inducing things like that car loan) and cost dollar averaging etc and 4% more savings next year = 500k at the end.
As to housing prices, they might go up or stall. But, because your not in the market you can time things to buy when the market dips. Further, rent control means renting is divorced from increasing housing price changes so you gain a lot of the upside with fixed payments even if prices increase without the downside. Further, if prices fall you can rent somewhere else.
The truth is people are rarely going to do this, but people are also rarely going to hit big money from a startup.
> The car comment is people see 0% interest loans for a car and think they are not paying interest. However, if you have cash for the car out of pocket you can pay a lower purchase price.
This is all hypothetical and a really bad plan for increasing your overall wealth. Car manufacturers are the ones who subsidize the loans. If you see a 0% loan, it's not the dealer who's giving you that, so it's entirely likely that paying in cash will save you nothing. Those 0% loans are also for new cars (I've never seen them for used cars) and if you need to save a few dollars, buying used will do far more for you anyway.
> Thus ~35k savings in your first year + 4% net interest (inducing things like that car loan)
You can't just assert 4% interest and hand-wave it away with "things like that car loan". That's double the interest you'd get on the best 5-year CDs. So somewhere you need to account for that extra 2% interest and how it's going to compound for 10 years. You aren't buying a car every year even if that somehow would double your effective interest. Also, if you buy a car outright, it's presumably coming out of that 35k anyway. So no, your numbers still do not work.
> As to housing prices, they might go up or stall. But, because your not in the market you can time things to buy when the market dips.
Good luck with that. Timing the market is a really bad bet. There's no guarantee that the market will dip during the next 10 years. It could maintain growth for 15 years, or plateau after 5, or crash in 1 year (while you're still saving) but rebound and keep growing for another two decades after that. There's also no guarantee that it won't dip 20% as soon as you decide you're buying at the bottom.
> Further, rent control means renting is divorced from increasing housing price changes so you gain a lot of the upside with fixed payments even if prices increase without the downside. Further, if prices fall you can rent somewhere else.
Lots of places don't have rent control. Also, rent control might help your rent stay "low" (it's definitely not actually low in the bay) but it won't make buying more attainable. Again, if you want to rent because you think it's a better strategy than buying, go ahead. But renting while you try to save a half million in cash to buy a house seems like a really bad strategy. Saving aggressively is generally a good idea. If your goal is homeownership, though, saving to buy in cash has not looked like a good strategy since the government started incentivizing mortgage loans.
Nothing says you need to buy in exactly 10 years. If your in a rent controlled apartment you get to ratchet down if things get cheaper or stay out. Get a great offer somewhere else, move without the overhead of selling at a huge loss. It's effectivly a hedge.
As to ROI the car thing saves you around 6% meaning you need less than 4% from everything else to average out. Other options including dividend stocks are very likely to provide 4+% over 10 years ex Coca Cola. Is that 100% well no, but you can also make well over 4%. 450k or 650k is not a major issue vs. being yet another person who pasts on HN 10 years in startups and nothing to show for it.
Much like risking buying a house for the market to drop 40% in 10 years.
I think the core problem causing disagreement here is that you are not consistent or clear with what your goal is. Do you want flexibility? Low risk? Then rent. Do you want to own a home? Then buy. But decide what you want and then figure out how best to get there. You're starting with the assertion that the goal should be 500k in the bank but then abandoning that goal at some arbitrary point in the future when you'll suddenly dump that into a house. What do you actually want? Half a million in the bank as a safety cushion? Then you should not put that into a house at any time. Do you want a house? Then you probably shouldn't wait until you've saved an arbitrary half million dollars.
I don't know where you're getting the 6% number for buying a car in cash. That's definitely not going to happen. You could get a car loan at a better rate than that from a bank and pay the dealer in cash. Bankrate.com is showing me a rate below 3% for financing a new car over 5 years.
Your belief that you can do better than 4% in the market is exactly why it does not make sense to save and buy a house in cash. If you have 500k in cash and have the option to dump it into a house or dump it into the stock market, and you believe the stock market will perform significantly better than real estate, then you are wasting money by dumping it into the house. If you believe you can get, say, 6% in the stock market, then taking out a mortgage at 4% lets you earn 2% extra each year.
Reading though this thread I have been justifying my statements and backing into an odd corner.
Buying a house was an example of a life changing thing you could do with 500k even with a six figure job. And no you can't buy a house at 100k with zero savings in the bay.
Sure, that's true long before you randomly hit ~500k, but that was chosen as a 'good' return from joining a startup that does not become Google as a non founder.
PS: As to returns, if you can't get 4+% retirement get's a lot harder. 1.04 ^ 40 = 4.8x So, 10% is not even close to cutting it. At 2% forget about it. Best of luck.
You're right that you cannot buy a house with $0 in the bank, pretty much regardless of what you make. No one is likely to give you a mortgage with $0 down, and if they do, it's going to be a bad deal for you.
Back on topic, we did go down an odd path specifically about the house. My initial point really boils down to what you want to do with the money. It could be very life-changing to save $500k in ten years and retire somewhere cheap. If you're just going to buy a house, it's really not that life-changing, both because you can do that without 500k in cash, and because owning a house is really not that different day-to-day from renting.
I'm not clear what you mean when you say "10% is not even close to cutting it". If your retirement goals depend on a >10% return, you're likely to be disappointed. The S&P 500 has only been ~5%/year for the past 10 years, and that's before accounting for inflation. It wasn't doing so hot before that, either, with ~4%/year over the last 20.
You can still do remote work from a cheap location, or stay and have FU money.
Giving up 500k in salary for a chance to make 500k in stock is a terrible bet. Alternatively, only save up 100k in 10 years, go to Vegas and bet it all at slightly negative odds. You can set things up for a 20% chance of getting ~500k which is better odds than many startups while still having more day to day money.
Sure, though that only starts after pre-k and k, which tends to be much cheaper.
Anyway, if you compare starting a family with ~1M in the bank and 1 income at 50k vs. dual income 220k in the valley and no savings outside of home equity there are benefits on both sides.
This is an outlier and, in my opinion, not representative of any useful demographic for this discussion. The idea that you bank $100k a year (let's even through in compounding) is certainly feasible, but not common.
I don't know what housing costs you must be talking about then. $40k/year pre-tax is close to $2648/month after state and federal taxes, and you're saying that with Bay area housing prices, you're not starving? I'm guessing that's also with no school loans or trying to work and pay your way through school, which probably applies to a very small fraction of the population.
So, companies that exist in that tiny portion which are actually hugely profitable? Most companies aren't, and most options are worth little to nothing at the end of the day. After a decade in start ups and now supporting a family, I'll always take salary over options.
> But if you're going to have to invest anyway, why not work for a company you believe in and have a chance at influencing the company's success as well as your own?
For one thing, it's fiscally unsound to have the majority of your net worth and your salary tied to a single investment.
I would like to point out that there is a practical third option given that some people say "Pay Employees A Market Salary", whereas some companies may not yet be able to afford it.
In practice when you're a technical founder (or cofounder with one), you might have three fantastic people you can't afford, great technical roles. They'd do great work for 40 hours per week, they believe in your vision and you, because your vision has a competitive advantage they can execute well with, and you can essentially generate equity value out of thin air together. They cost way less than the amount of value that could be generated, so they make sense from a business investment perspective.
But the company just might not have the funds yet.
So, besides giving out options as compensation, or giving out a market salary, the third, practical alternative, is not to hire any of the three persons, but instead work for 130 hours per week doing their 3 jobs and your job, and sleep 5.4 hours per day.
This divides to 32.5 hours per "job" (130 / (3+1)). In practice by not hiring these great engineers, you've also not hired their coffee breaks, lunches, not hired the time they spend reading Hacker News, reading about new technologies, trying various stuff such as a new framework they'd like to try, you've not hired the time they spend writing documentation or any kind of testing whatsoever, and you've not hired any downtime they spend waiting for anything whatsoever. In fact, with these concessions, the 130 hours turns out to be an exaggeration.
So, some people call the results of this "technical debt", which is a bit of a misnomer.
It's a misnomer because if the project doesn't start generating value, you can kill it and nobody has to clean up anything. So in this sense, rather than a "technical debt" - it's more of a technical option. Instead of generating employee stock options, you've created technical stock options, where if the technical results actually make it rain, then at that point the project is investable, people can be hired for a market salary, and they can rewrite all the code that you've optioned. In this very real sense it really is an option, rather than debt.
So, in practice a lot of silicon valley seems to work this way. A lot of successful people have succeeded using more or less this formula.
We've all heard lots of stories of seasoned developers being brought on to clean up spaghetti code written by a founder or cofounder, that proved the business case but was hideous, poorly documented, structured, tested, with even security and backup policies and redundancy policies making it a miracle that nothing melted down.
So when one wonders why some founders work so much - well, this is the reason.
The people who could have written all this properly from the start, weren't available given the finances the company had at the time.
Often other people aren't willing to share the vision, and if you want something built, regardless of its value, at times you just have to do it - before anyone has funded you.
So this is a very real third possibility that many people do not realize really is a kind of "option".
I upvoted you because this is a fairly good comment, though I think it is fundamentally incorrect.
Working really hard and acquiring technical debt isn't really an alternative to hiring and compensating employees, it's (usually) a prerequisite. A single technical cofounder can be enough to get a company to Series A, but at some point you have to hire people.
If we wanted to discuss an actual alternative, it would be to hire people in other locations at far lower rates than those commanded in SV. But that comes with its own set of problems.
There is a downside to RSUs. Say you work for a private company with a high valuation, e.g. AirBnB at $25B, and you are granted 0.01% equity over 4 years. That means you are vesting $2.5m of RSUs over 4 years, and these RSUs are taxable at that amount. Typically for folks earning over $150k/year in base salary, particularly if married, even half as much will put you into AMT territory, and you will end up paying a significant chunk of cash each year in taxes (even if RSUs are withheld for taxes, because the withholding cannot account for things like AMT).
Options with extremely long exercise windows helps obviate this tax burden and allows the employee to decide when/if to improve their tax position by exercising ahead of a liquidity event.
I'm up in Canada, and the RSU structure for my employer is an initial grant of $3x, with $x vesting every year for three years. Only when I exercise the vested RSUs (flat exchange at fair market value - typically the average stock price over the past week) do I declare them as income, at which point it's taxed as per usual for employment income.
I was surprised to learn the post is referring to a type RSU that defers settlement and thus taxation to a liquidity event.
This is very intriguing. We may not be familiar with this because traditionally RSUs were issued by mature public companies, so they couldn't / wouldn't need to support that trigger.
Are there any startups using these single trigger settlement RSUs today? Any other drawbacks like from an accounting perspective?
Ya, what usaar333 said. I was talking about what is typical for private companies. Shares are generally held by the company until a liquidity event so that employees don't have a taxable event.
Vest but not release simply means that you've earned the right to those shares (vested), but that you don't actually have ownership of the shares (released) until some later time or event triggers the release.
You know the simple solution to this is that companies withhold the amount of RSUs from you that would be taxed, when they vest.
Its almost like so simple of a solution that reporters won't touch it.
edit: nevermind. even the company cant pay the tax with their illiquid RSUs so its still a problem, and a bigger problem if the share valuation increases, pre-IPO
The company I work for does this. The non-fanfare way it was described to me implies this is not rare across the industry.
Edit: I think the parent poster was talking about RSUs (pre-IPO) that cannot be sold to pay off the required tax. My friends at companies in this pre-IPO stage hold the RSUs in the employees' names until the IPO permits the employees to sell RSUs to pay the tax. The companies also let employees recieve the RSUs and pay the tax themselves if they want to, but nobody I know has done this.
yes the illiquid RSU dilemma: if the valuation of the RSUs have gone up by the time they vest, then you owe a boat load of tax but can't liquidate the RSUs to pay said tax.
I am curious what is the purpose of this withholding strategy then? I am not familiar with this. Doesn't sound great to me, at least with a quarterly vesting schedule you can generally go and sell them on the secondary market.
Because it's impossible to know each employee's tax situation, and better to withhold too little than too much. In most cases it works out, but early employees and executives can easily be affected.
My admittedly neophyte understanding is that a) RSUs are counted as income, b) if income exceeds some threshold the entirety of it is subject to a higher AMT rate.
Without AMT, if you got stock and paid taxes in stock, you wouldn't care about the effect on taxes if the stock price later tanked. With AMT, however, you get screwed.
However, I am unaware of a similar problem existing for RSUs. AFAIK, they are treated the same for AMT and the ordinary system meaning they shouldn't ever "push you into AMT"
If anything, it argues you are less likely to be in AMT with RSUs:
"In years when large blocks of RSUs vest, your ordinary income tax will usually exceed your AMT due to the additional ordinary income. As long as that’s the case—you’re not in AMT—you can use state income tax and property tax deductions to reduce your ordinary income tax liability. If you’re likely to be in AMT next year (say, because you’ll have fewer RSUs vesting), ...."
And it probably should - the IRS is in the business of collecting money from citizens and corporations. It should not be in the business of managing investments and RSUs in thousands of private entities.
Yes, typically there is withholding to help cover the taxes, but for four year grants in the range of $1m+, the default withholding doesn't fully cover the taxes.
This is very interesting. Options are really an unappealing mechanism to incentivize employees. I feel like they prey on people who really don't know any better, and don't understand the tax implications or the possibilities around future dilution.
As a rule of thumb I discount face value of options by as much as 70%, that generally doesn't go over very well with people trying to convince you to accept them in lieu of cash.
The single trigger RSU is a very hard sell though, as we can see from this example it hurts both Investor and Founder equity stakes, unless people start balking at options (which they should) it won't fly.
I value stock options at zero. There is potentially a huge upside if you are an early employee at a company that gets enormous. Even then, you have to be top 20 or 30 to get f-you money, and even then it might not even be that.
I had stock options (not RSUs) at BigCo where I worked for 2 years. At one point, had I been fully vested, I was sitting on about $240k worth of stock. After a 3x1 split and the company going back down to almost the strike price I was granted stock (and most of it was worthless because was given it as part of a raise at a high strike), after I parted ways with the company and sold my options (had to as part of the severance agreement), I walked away with $2000. Basically a $1k/yr bonus. I would have gladly taken extra salary instead of stock. Lesson learned.
Routine corporate actions will adjust the option count and strike price equitably. (A 2:1 split will typically double the number of option shares and halve the exercise price.)
Quick question. Do you work for a startup now with options? Or, have you in the past? I'm trying to work out if people who object to options would ever join startups. Or, if they're appetite for risk is too small to be a potential candidate.
I have started multiple startups, and joined others at various times. I've also professionally traded options. I have a huge appetite for risk, but the risk/reward isn't there for most early employees who are getting paid less cash in exchange for options. You just can't take them at face value. I would say many early stage employees aren't taking appreciably less risk than the founders themselves, but at a fraction of the upside.
I've been fairly successful at it. Most companies are willing to put up with some negotiation. I've gotten a lawyer to go over the options agreements on more than one occasion, usually money well spent if you don't understand all of the contract intricacies. I think how much people are willing to put up with is directly proportional to how valuable you would be to the company, your skill set, experience etc. If you are easily fungible or at least the perception is that you are than your ability to negotiate some of the finer points will suffer.
I think most early stage employees, especially ones who are ultimately going to be injecting the IP of the company on which it's future value will be based should be very aggressive about options and salary packages. Having seen both the bad and the good, I definitely gravitate towards being cautious when getting startup offers. I also think we need to educate people more about this. I recently asked a potential employer about the strike price, and he said I was the first person to ask that question. I think that says a lot about how weak the understanding of early employees is.
I have, several times, and I generally treat them as pretty much lottery tickets. That is: I expect at least market rate, often above in order to compensate for risk, and the options are an extra bonus if you're lucky. This is achievable. It's mostly younger people that "buy" the story of how you're going to get rich off the options so you should accept a lower salary. I did that too, a couple of times, before I "accidentally" learned that this is not an issue. Either you're important enough that they'll stretch, or you're in a junior enough position that the options allocation will be tiny anyway, in which case you're better off in a more stable company.
But the options I've made the most money on was ironically from the only post-IPO company I've worked for (and where I joined years after the IPO), rather than the startups where I've had shares that have at some point or other had a paper-value magnitudes higher.
And the reason I did well there was that they clearly didn't value their options very highly - they threw a large options allocation after me to get me to accept a lower salary than I asked for for the first 6 months for political reasons (it would have put my salary above the salary of one of the higher ranked people who had to sign off on the hire, and they clearly didn't think that'd go down very well... so instead HR quietly promised me a "review" after 6 months and bumped up then).
I worked at a startup for 2 years (left without exercising my options). I objected to options right from the start and during negotiations with the CEO said they should max out my salary in lieu of options. Options are funny money to trick potential employees into thinking their lower salary will pay-out in the end. But the reality is most start-ups do not have exits where rank and file employees get anything for their stock. Investors get paid first, then founders, followed by employees if anything is left - and usually there isn't unless the company has an IPO or was bought out because of superior growth.
That said, I am now co-founding a company and we plan to give future employees a long time period to decide whether they wish to exercise their options or not. If employees are willing to take lower salaries for equity for the sake of the company, companies should reward that sacrifice by letting the employee keep their equity options.
Discounting the value of options doesn't mean objecting to them completely, or not having an appetite for risk. But an option has to have a sufficiently large potential upside to take that risk. When you work for a startup, you take the risk that it'll fail, and that you get nothing except what you've already received. To compensate for that, the options need to provide a potentially huge upside, of the "never have to work again if I don't want to" size, not just "if this succeeds, the options might be worth what I could have easily made in a year or two at a non-startup".
Framing it as an appetite for risk is too simplistic. Risk adjusted returns matter.
For example, I've got a friend who's been working at a startup for about eight years. They have a looming exit. If it goes through, he'll probably walk away with $1.5m. Had he gone the salaryman route, that'd be money in the bank.
This is an important calculation that too many employees ignore. They get lured in by the stories of early Facebook and Google employees walking away with tens or in some cases hundreds of millions from their options, when in reality most start-ups fail and of those that succeed a sub-$100m exit is more likely than a blockbuster exit.
As an early employee you can probably negotiate 1-2%, which after dilution, tax and all the other fun things that come with options doesn't generate the returns to justify giving up the better part of a decade while arguably taking on just as much risk (if not more) than a founder. I've worked at several start-ups - including one where the founder plundered the employee option pool to offset his own dilution - and won't work at another unless it pays an above market salary or I am in a founder role.
i would only ever join a startup as a co-founder. i would never own less % than anyone else, i.e. at least one other founder should have the same equity as i do. that's my personal heuristic, ymmv.
if i'm going to work for someone else it's going to be the most stable situation possible, i.e. an established company with market or better salary and benefits and a reasonable workload.
In both cases, one of the defining factors in choosing the particular startups that I work for was that the founders were very employee-friendly.
In both cases, I was granted actual stock (ie. not options).
In my view, options (as typically offered) are basically useless as compensation. They have a strike price which isn't much lower than the price investors last bought stock at. Companies which offer these as a substantial component of compensation are essentially exploiting the naivety of employees and expecting them to value "ownership" more heavily than investors do, despite having much less favorable terms.
They have a strike price which isn't much
lower than the price investors last bought stock at.
Why is this so? I recently became aware of a case where the Fair Market Value of the common stock was only about 7% lower than what the last round of investors paid - preferred stock which, it was rumored in the press, came with a ratchet.
My impression was that the original thesis of the employee options were that common stock is marked down to a significantly lower price than the preferred stock.
I have. The basic issues with most options is will the %90 best case scenario of this risky reward mechanism beat working at FaceGooSoft by a significant margin? My %90 best case would be something like IPOing at $1 billion.
If the startup stock doesn't, then it's extra stupid to work at that place unless they provide you with a special non-standard working arrangement.
Usually they don't, it's open offices in the bay area with a pretty similar organizational structure and work type. Not a flexible remote working situation at bay area salaries or similar.
Let me flip that question. Is risk a positive quality for a startup employee? After all, the startup is already taking a risk in terms of its product/market fit, so it should not be taking risks in terms of technology or internal processes, and hiring employees who like risk means they will make professional choices that involve risk even in situations where they shouldn't.
You didn't address this at me, but I figured I'd chime in.
I do work for a startup now, with options (and have in the past as well). I object to options in the sense that it takes a lot of luck for them to ever be worth anything. It's easy for companies to talk up their potential value (once we get our billion dollar valuation, your 0.05% is $500k!), but in order for the options to be worth the paper they're printed on, a lot of things have to happen in a specific order. One bump in the road, and your shares are wiped out.
Appetite for risk is a tricky way of putting it. I don't think the risk is that the company will fail and the options won't be worth anything; I think the real risk is that something will happen to cause the options to be worth less (or perhaps worthless). That's the sort of risk I'm not interesting in sacrificing much salary for, especially if the company isn't bootstrapping.
When the sum of the options pool allocated for employees is 5% or 10%, the risk/reward ratio is all out of whack. The risk of being diluted/preferenced/strong-armed out of your shares is fairly high. All it takes is one investor with preference to completely wreck the cap table.
As an employee, you need to know that you're absolutely last in line. Standing in front of you are: banks (loans generally come off the top), investors with preference, investors, founders (who will be fine, even if it means their shares are worth $0, but they get an incentive to stay worth $5m), C-level employees who might have preferred shares, and then finally, common stock holders.
So assuming everything to there goes really well, the shares convert to common and everything is looking up. You haven't been diluted into the ground, your company isn't Zynga and demanded your shares back and your company is now public. Congratulations! There are still more obstacles: you can't sell your shares for a certain lockup period, during which the share price could very well dive. If the stock is going up, you don't care, but if it dips, it's a race to your strike price. If the stock dips under your strike price, you have no reason to exercise your options, so you're left hoping that Wall Street likes your company.
And even then, let's say you exercise your options, sell the shares and make $500k. After taxes, you're going to walk away with a good chunk less than that. After taxes, let's say you have $330k. Say you worked at the company for 5 years before they went public, that's roughly $60k/year that your stock was worth.
So the real question then is how much salary is it worth deferring on the very long shot that you make $60k/year off of your stock? $330k isn't exactly life-changing money for most people: it's not enough to retire on, it's a nice down payment on a house someplace in reasonably high demand.
Equity is one area where I would encourage YC to get more involved. We need someone to step in and lobby the government for tax treatment of options that reflects their economic reality to early stage employees. We also need to encourage companies to use a 'standard' stock option agreement which is well known by everyone so that equity offers can be compared across companies.
If you take equity from an early stage company that has also raised a ton of money with a liquidation preference, what are your chances of getting paid out, even on a big exit? That question is basically impossible for most people out here to answer.
If UBER IPOs for any less than $12.5Bn, what will the early employees get? Probably not much compared with the value they helped create. Right now, that looks impossible, but who knows what will happen?
My point is that there is not a historic president for what has happened in the private markets and I would do anything I could to cash out of equity if I held it in a unicorn and I was liquid.
I would love to see YC step up and encourage founders to issue employee friendly stock options.
Is the presumption that founders and investors are not trying to screw employees? I genuinely can't tell from the article. I thought it's just common knowledge that they will try to screw employees at every chance. With options it was different strike prices for management/ founders vs employees. With RSU's it is weird vesting schedules and forcing forfeiture situations.
>Is the presumption that founders and investors are not trying to screw employees?
I think the presumption is that all parties act in their own self-interest. For some founders that means compensating employees with equity, for others that means keeping equity to themselves and relying on cash compensation for employees. Without talking about specific situations I don't think you can ascribe malice to either choice.
Normal people that like money. If this article is about how equity compensation can be improved, then that is a fairly messed up world view and kind of insulting. Employee equity compensation is always designed to explode or have no value. Workers are sick of the schemes. Just pay cash. Companies don't want to and never will improve equity compensation. A better solution would be a law that requires a cash value of granted options or RSU's to be reported to workers which would require a look at sale-ability, strike price, volality, expected employee turnover, etc.
Actually there's a big movement to making options exercisable well after employees leave. So, no.
Startups don't have enough cash to compete in terms of pure salary with the leverage that the Googles of the world have. And stock can turn out very well for employees, I've seen it happen at a fairly good rate. You just need to make sure you're getting what you're worth, risk adjusted.
There's a "movement" in the sense that people are writing blog posts. Fewer than a handful of name-brand startups are putting any money where their mouth is. Any there's huge VCs trying to hold the line and keep anyone from changing the industry standard practice.
There is an argument going on in the VC world right now about how to properly structure employee compensation.
There is a side arguing for the status-quo and another side arguing for a change given the new-norm of long-delayed IPO/liquidity events.
I see where you're coming from, but the world isn't black-and-white and everyone with money isn't Art Carnegie hiring the Pinkertons. It's convenient to paint the VC industry in simplistic terms but it doesn't paint an accurate picture.
The barrier to entry of this stock option tweak: it requires an informed populace, ie, us.
If you are a founder with reasonable engineer cred and announce differentiated stock option terms, ie, Adam D' Angelo at Quora, there's a reasonable chance that engineers considering joining your company will be encouraged by your effort on this.
If you're someone else, and your company offers this, many experienced engineers, not unreasonably, will value their equity packages at zero regardless of what you do. Many others, such as new grads, will not know enough about stock options to understand the distinction you're drawing.
If you do decide to offer RSUs for the reasons the authors cited, you may want to follow the example of Henry Ward at eShares and put together some good presentation materials to explain the benefits of this course. Otherwise, you're making an expensive choice for little benefit.
I have always thought that companies should work out the salary of a new employee in all cash then once the parties are happy allow the employee to trade in whatever percentage they liked for equity. If you value the equity at zero why should the company give it to you and if you value it very highly why should they give you cash?
Because startups are, effectively by definition, equity rich and cash poor. Trading $100k/yr in ISOs for $100k/yr in cash across 10 employees increases your cash burn by $1M/year, which is make-or-break for a lot of startups.
But this doesn’t work if the employees doesn’t value the ISOs. If I want to hire you to come and work at my startup and you will only come if I pay you $200K then I either have to give you $200K cash or cash and some number of ISOs that you value at 200K as a package. If you don’t value the ISOs and I offer you 100K cash and ISOs that I consider are worth 100K then I have just offered you 100K. My value does not equal your value and me pretending is does not make it real.
The nice thing about cashing out equity like this is it signals your true valuation of the company, both to yourself and the company. Just giving options on top of cash tells nothing.
Of course, no one is saying that companies and employees have to value ISOs the same, but no one is saying employees who value ISOs at zero should be working at a startup either
> 3 year employee tenure
> 100% loss of potential equity when employees leave the company ...
...
> You can also see that only the employees hired in year 8, 9, 10
> (the final 855) have any shares at the end of year 10. Quite bizarre!
I like the basic idea and it's nicely presented however conceptually I'd favor a model where the employee gains come primarily from the losses of later stage investors and not early stage investors (and founders).
"""Within the investor class the earlier investors lose more. Year one investors go from 3.2% to 2.3% about a 25% loss, pretty much the same as founders. Year ten investors go from 9.0% to 8.7% about a 3.5% hit."""
So basically I'd like to work from sort of the reverse of this but I assume it's not very likely due to the investment horizons etc.
Basically I suppose late stage investments should be a good chunk more expensive.
This is clearly a shot at Kupor's infamous A16Z post where he claims employees who stay suffer a LOT more dilution (80%) when employees who leave keep 100%.[1] But this poster's model puts it at just 5%.
There's clearly wildly different assumptions at play here. Can someone smarter than me spell them out? One that jumps out is the assumption here that no employee stays past 3 years. Isn't that a pretty high attrition rate for a pre-IPO startup?
Wouldn't RSUs open employees to a different and more punitive tax regime (income tax) than options (which would fall under capital gains if you exercised early enough)?
RSUs are simpler and can be planned for. For example, a company could grant RSUs with a mandatory buy back vesting schedule (basically 83b election) upon hire and include the taxes as part of the comp package.
Examples:
Junior Engineer Sally joins Company A and is offered 0.25% of the company in RSUs. Company A recent raised at a 20M post money with a preferred share price of $1 and a FMV of $0.20. She owes tax on $10k of RSU gains. Company A either: 1) Buys back $4000 of stock in order to cover taxes 2) Provides a $4000 signing bonus to cover taxes.
Senior Engineer Bill joins Company B and is offered 0.05% in RSUS. Company B recently raised at a $500M valuation with a preferred share price of $10 and FMV of $3. He owes tax on $75k of RSU gains. Company B either 1) Buys back $30k of stock or 2) provides a $30k signing bonus.
But, you have to pay income tax on the value of the shares at the time when they vest, i.e. become non-restricted. You have zero control over that vesting schedule, and thus the tax bill, and you likely wouldn't have a liquid market for the shares before an IPO.
Any gain post-vest can indeed be long-term cap gains, if you hold the shares > 1 year.
While the dialog around various equity-based incentive compensation mechanisms is good, this article is off base in SO many ways:
>>With an often high strike price,
Only an issue at the later stages of companies (note: this writeup argues RSUs "from the beginning").
>>a large tax burden on execution due to AMT,
Only if you are exercising later in the company stage, when the fair market value has (usually) gone up. If you are bullish on the company, it's generally best to exercise as you vest, for this very reason.
Also, exercising as you vest gets the timer going for (a) cap gains treatment (much better tax rates), AND, a possible Qualified Small Business Stock tax exclusion (5yr holding, significant tax break).
>>and a 90 day execution window after leaving the company many share options are left unexecuted.
This is MUCH less of an issue if you are exercising as you go along (see above).
If you you have just left a large unicorn private company, there are often secondary buyers for the stock. You could exercise and sell some stock to them to cover your exercise cost.
Regarding RSUs, you HAVE TO PAY TAX AS YOU VEST. For a private company, you're just replacing one potential problem (AMT with option exercises) with a very specific actual problem (steady tax liability as without liquidity).
RSUs are a very useful compensation tool, but you can't declare them unilaterally better. ALL equity compensation forms require some "user sophistication", including options and RSUs.
If you don't understand how to optimize your situation, get advice from someone who does!
Hold up. This post proposes using "single trigger RSUs" instead of options, claiming that taxes are deferrable to a liquidity event. But according to this[1], FICA taxes are still due on vesting. So RSUs would still have immediate tax consequences, potentially very expensive for unicorns.
Taking equity instead of cash is like asking the company to denominate your salary in Bison Dollars. Worth a lot IF the plan for world domination goes off without a hitch but until then...
The last startup I worked at went through a merger. In the process, they created a new company and gave all employees stock in the new company, on the same vesting schedule as the options had been on in the previous companies.
They organized things and provided help to ensure that all US employees were able to make a Section 83(b) election for our stock in the new company as soon as it was created. (This means we paid taxes early based on the current value (zero) instead of potentially paying much larger taxes in the future.)
reminded how 10 years ago upper class was trying to initiate grass roots and steer protests against options expensing. They failed and as a result we have RSU pretty much everywhere instead of options. The startups are the last bastion, and i think with the modern "who needs an IPO with such great C round (and related caching out for chosen ones)" approach, people will start to get the picture and the RSU will come there too.
The problem with startup RSUs is that you are taxed when the RSUs vest. If there is no liquidity (which is the case for most startups) then you're paying taxes on RSUs which you can't sell and may never be worth anything.
This is not always the case. The grant may be structured such that you don't actually have the shares in your possession even after vesting, you just have a claim on them that will be honored at IPO or change of control. This though means you can't dump them on SharePost/SecondMarket etc. even after they vest.
This is where having a lobbying group would be helpful -- this really needs to be fixed through policy.
We need to get the tax law changed so that RSUs are taxed on liquidity instead of vesting. Then you'll still avoid the corruption the tax is supposed to protect against (paying an executives millions in what was previously untaxed compensation through RSUs in the 80s) but still allowing them to be given as startup equity compensation.
Absolutely agree. ISOs should also be taxed on liquidity as well, instead of an AMT on exercise. There was a group, ReformAMT.org, opened in the wake of the 2000 tech crash, where many employees ended up owing massive amounts of AMT on now-devalued stock.
However, it seems that the employers' and investors' interests are against the employees' here - the investors want what few employee shares are lost to be returned so they are diluted less, employers want holden handcuffs to reduce mobility, and only the much-weaker at lobbying employees want more freedom/mobility.
Can you go into a bit more detail on what counts as liquidity? Can I sell on a secondary market? Can a bank let me guarantee a loan based on my current units? Can non-liquid units be transferred to my next of kin tax free?
These are all details that would have to be worked out, but the gist of it would be that you shouldn't be taxed on it until you're able to sell it. But I'll give it a shot:
> Can I sell on a secondary market?
Sure, and then you get taxed on the money you made, where your basis is $0.
> Can a bank let me guarantee a loan based on my current units?
That's tricky because it would be a way for people to work around the law. What if we made you pay tax if you took out a loan with the stock as collateral?
> Can non-liquid units be transferred to my next of kin tax free?
Seems like it would be reasonable to allow that. The value would still be $0, but when it became liquid, your next of kin would have to pay taxes on the value with a basis of $0, which would make it not a good workaround for estate tax since you would save money if you transferred it under the $5M lifetime limit.
I can imagine that there would be other consequences to the change. For example, I could see anyone on the edge around their 1 year vesting cliff would be fired to avoid parting with their equity. It would probably also push down the amount of equity offered because of the increase in value. Further, some companies are already doing this, vesting could be back loaded with the majority vesting in the later years.
There are companies that already let people go before their 1 year cliff (or do other types of restructuring that results in the vesting period to reset).
However, I think it would be appropriate to give fewer options as a consequence of this change, since the options would be a more realistic part of the compensation package when you have a longer-period of time to determine if you want to exercise them.
I could definitely see the 1 year cliff going away too, else you'd have people collecting 25% of their options at various places and moving on to other companies each year. Eventually one of those companies will do well and your "work" investment will pay off. You can do shotgun investing with your employee options.
But a lot of this misses the point that your company's growth is entirely reliant on a productive employee base. If you back load vesting or start firing people right before their cliff, or do any other practices such as this, why would anyone choose to work for you?
Is a single trigger RSU somehow different in trigger than single trigger options? I've always been told that single trigger, at least for the majority of engineering, means your company won't be purchased.
Single trigger makes sense for legal, accounting, etc who are likely gone in an acquisition.
If the premise is that employees can move the needle on the stock price through their contributions, then double trigger doesn't make sense either.
I recently went through an acquisition where all of our stock was converted into the acquiring company's stock. It was maddening to see our team continue to perform well but see the price of our equity tank along with the rest of the company.
There was a HN discussion ten days ago [1], where several people including myself were suggesting 83b rule RSUs as a possible solution. Nice to see this method quantified.
I have really never understood the confusion over why this doesn't get implemented. It has always seemed clear to me that there's not enough demand for change, and investors and founders want things to stay the way they are. It's a really, really good deal for them.
There are a wide range of financial products used around the world that would better fix the tech sectors compensation incentives and nobody is talking about them.
Think different didn't mean argue about false dichotomies.
It is a total charade for the venture firms to propel the notion that they are doing employees a favor by even offering stock. "How gracious of us to dilute our investment at all!"
Dilute the preferred shares with 8% dividend and liquidity preferences!
Offer convertible bonds or other hybrid products!
You can incentivize people in 101 ways, and you guys are debating about two of them under the assumption that the crowd is right
Either way it's a losing game, consider a company like Google - how would they attract new employees on either scheme given that the company has been around for 15+ years?
The only people who win are those who get in early, or invest big. Any IPO ultimately results in people earning money who don't "work" for that money - that means the actual workers lose out everytime.
So getting paid way above market and working at a place where software engineering talent is highly respected and valued is "losing out"?
I'm sorry but this entitled attitude just grates at me. If you are in SV getting paid 3-5 times the median household income you already are in the 1% and you already have all the advantages in terms of upward mobility. If you want to earn millions go out and start your own company, it is ridiculous to demand a high salary and a high equity payout. You are not entitled to anything except what you can negotiate.
There is nothing inherent in software engineering that makes it worth $100k minimum per head, it is only worth that much if it supports a business that can earn that much. The fact that SV is one of the bright spots in the economy of the last decade has really started to go to software engineers heads. If you believe you are worth more than what you are being offered, the only way to prove it is to go out and build a business yourself. You can't look at the 1% of the 1% who got a lucky windfall from being in the right place at the right time, and use that as your baseline for "fairness". Try facing the economic struggles that 50% of the country is dealing with, and then tell me how bad Google is screwing its employees.
2. Working somewhere that software engineering talent is highly respected is no measure of fiscal compensation
3. Those advantages of upward mobility are learnt, or acquired skills that people work at. There is no opportunity for them to be in the same position as a 1%er living off their parents money to invest and then continue to get rich(er)
4. You imply that employees have the ability to negotiate on-par with any investor
5. Your last point about $100k is odd, that's just supply and demand in a free market - and the sentiment is doubley-odd given that employee salaries have stagnated since the 70's, SV salaries have been proven to be (somewhat) rigged, also it is in any companies corporate interests to pay the lowest possible amount for any resource.
Lastly, your point about the 1% of the 1% is off-topic - and I agree that they're not necessarily to blame for the widening gap between rich and poor - but without proper incentives for the 99% to go to work, then that 1% of wealth could become worthless if society revolts because of the disproportionate distribution.
My point is simply that alternative vehicles for employee remuneration need to exist beyond the status-quo that's legally existed for decades.
You specifically called out Google in your comment. As a result your arguments feel odd, since Google has a reputation for high salaries and high quality of life. If you specifically mention Google as a problem, you must hate the vast majority of the industry that both doesn't compensate as well and doesn't offer comparable quality of life. In other words, if you aren't happy as a software engineer at Google, where would you be happier?
I did not say Google is a problem, I said that either the current mechanism or the proposed mechanism would present a problem for companies (such as Google) when hiring new staff.
> Any IPO ultimately results in people earning money who don't "work" for that money - that means the actual workers lose out everytime.
It is wrong to believe that people would invest large amounts of money randomly without spending significant amounts of their time to make sure the investment will create them some returns.
Also they have the risk to actually loose 100% of their investment, which some guy employed at Google with a 6 figure income doesn't have.
Of course they'll need more profit to cover for the risk.
Think about it this way: If there were no investors there wouldn't be a Google or Facebook as we know it today as these companies didn't make a dime for the first 5 or 6 years of their existence.
You can be critical of these two companies (I am) but there are thousands of other companies in the IT sector that just wouldn't exists if they had to make profit right from the start and grow organically.
Your argument is surely moot because it assumes that startup employees take on no risk. Not to mention conflating IPO with startup options/shares. There are many companies out there that have never, nor will, take investment or IPO yet are still successful. There's also an argument to say that any company that isn't profitable from day one shouldn't exist in the first place.
Your argument also suggests that founders must go "cap in hand" to investors to beg for startup capital. In all scenarios I do not see a positive outcome for the employee, and it seems only more and more difficult to attract new talent
> Your argument is surely moot because it assumes that startup employees take on no risk
I wrote "which some guy employed at Google with a 6 figure income doesn't have." -> you are free to work at an established company and have no risk, I didn't say that startup employees have no risks.
Otherwise they wouldn't get equity, wouldn't they? So please don't twist my words.
> There are many companies out there that have never, nor will, take investment or IPO yet are still successful
Great, but how is this related to anything I wrote? My comment was about investors and companies that accept investors money, nothing else.
> There's also an argument to say that any company that isn't profitable from day one shouldn't exist in the first place.
Isn't Google or Facebook highly profitable? It's hard to imagine that a company can reach such a scale in such a short period of time without outside investment.
No society can have private property rights and freedoms without the right to private investment. If I am not allowed to decide for myself where I will invest the money I have earned then I have no money, the state owns it instead.
> Your argument also suggests that founders must go "cap in hand" to investors to beg for startup capital
No, not at all. I didn't suggest anything like that.
> In all scenarios I do not see a positive outcome for the employee, and it seems only more and more difficult to attract new talent
Sorry, but software development is one of the most privileged and highest paid professions. You make it sound as if we are all working in coal mines.
I think we're taking the extremes as the norm, and it is clouding the argument. Let's just say there is risk on both sides, nobody is entitled to anything except the chance to receive remuneration that is deemed fair, whether that's through investment or salary.
Your last point is the most interesting, though, coal-miners were paid very well and by contrast I know (good) developers that earn less than the national average. I am not arguing (in this case) about software developers, but all employees from all backgrounds.
> Let's just say there is risk on both sides, nobody is entitled to anything except the chance to receive remuneration that is deemed fair, whether that's through investment or salary.
See my previous comment to you (above) - also play out the proposal in the article over, say, 100 years, ultimately it could end up as an employee owned company.
Conflating political ideology with corporate structuring was not my point, nor my intent. Attracting staff after 100 years of operations was my point, to clarify; I said "could" (implying risk)... not "should" (implying ideology)
Their thesis was that
- startups would remain private longer.
- employee's lost their options when they leave
- longer periods to go public means more employees return options to the pool which means employee option pools can be smaller
- longer private periods leads to more rounds raised which benefits investors over employees as the former can participate on each round to keep from being diluted
- exits would come eventually and the investors would always have superior terms, I believe that they were working under the assumption that investors would never have mandatory black out periods after IPO so they could essentially participate in the opening day IPO pop.
This is one of the coolest and most maddening things about finance. Every time you think you've come to a big realization, usually you find out that someone else came to the same conclusion many years ago and has been making money "arbing" it out ever since.