Startup options, How to Make Startup Stock Options a Better Deal for Employees

Part of the problem is the sheer amount and complexity of information required to understand equity and ownership in the first place. For most people to understand how much of a company they actually own, all they really need is the fully diluted share count, the broader breakout of ownership among different classes of shareholders, and a couple other details.

There are lots of things that can increase the fully diluted share count over time — more options issued, acquisitions, subsequent financing terms, and startup options on — which in turn could decrease the ownership percentage. Of course, people may also benefit from increases in options startup options time through refresher or performance grants, but changes in the numerator will always mean corresponding changes in the denominator.

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This price tells us what various financial investors believe the value of the company was at various points in time. The conversion price is the price per share at which the preferred stock will convert into common stock. The exercise price of employee options — the price per share needed to actually own the shares — is often less than the original issue price paid by the most recent investor, who holds preferred stock.

Dilution Dilution is a loaded word and tricky concept.

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On the other hand, raising more money helps the company execute on its potential, which could mean that everyone owns slightly less, but of a higher-valued asset. After all, owning 0. While not all dilution is equal, there are cases where dilution is dilution — and it involves the anti-dilution protections that many startup options may have.

The basic idea here is that if the company were to raise money in a future round at a price less than the current round in which that investor is participating, the investor may be protected against the lower future price by being issued more startup options. The amount of additional shares varies depending on a formula. It also means the fully diluted share count goes up by an additional 10 million shares; all non-protected shareholders including employees are now truly diluted.

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Liquidation Preferences Some investors may also have liquidation preferences that attach to their shares. Simply put, a liquidation preference says that an investor gets its invested dollars back first — before other stockholders including most employees with options — in the case of a liquidity event such as the sale of the company.

It would, however, come into play under the following scenarios: Scenario 1. Scenario 2.

Understanding Startup Stock Options

When a company goes through several rounds of financing, each round includes a liquidation preference. Scenario 3. There are various flavors of liquidation preference that can come into play depending on the structure of the terms. But some investors do more than 1x — for instance, a 2x multiple would mean that the investor now gets 2x of their invested dollars off the top.

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The impact of this on other stockholders can be significant. This is the language that determines who gets to approve an IPO. In most cases, the preferred stockholders, voting as a single class of stock, get to approve an IPO: Add up all the preferred stockholders together and the majority wins. Sometimes, however, different investors can exercise control disproportionate to their actual economic ownership. This typically comes into play when a later-stage investor is concerned that the company might go public too soon for them to earn the type of financial return they need having entered late.

Types of startup stock options

In such cases, that investor may require that the company get its approval specifically for an IPO, or if the price of the IPO is less than some desired return multiple like x on its startup options.

How would they do this? By asking for more shares or lowering the conversion price at which its existing preferred shares convert into common. This increases the denominator in the fully diluted share count.

To be clear, none of this is to suggest nefarious behavior on the part of later-stage investors. ISOs vs non-quals and exercise periods Besides the financing and governance factors that could impact option value, there are also specific types of options that could affect the economic outcomes.

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Startup options general, the most favorable type of options are incentive stock options ISOs. Basically, ISOs mean that startup employees can defer those taxes until they sell the underlying stock and, if they hold it for 1 year from the exercise date and 2 years from the grant datecan qualify for capital gains tax treatment. Non-qualified options NQOs are less favorable in that someone must pay taxes at the time of exercise, regardless of whether they choose to hold the stock longer term.

Since the amount of those taxes is calculated on the exercise date, employees would still startup options taxes based on the historic, higher price of the stock — even if the stock price were to later fall in value.

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Below are some possible scenarios, assuming four years to fully vest but the company decides to sell itself startup options another company at year two: Scenario 1. Unvested options get assumed by the acquirer. This means that, if someone is given the option to stay with the acquirer and choose to stay on, their options continue to vest on the same schedule though now as part of the equity of the acquirer.

Unvested options get cancelled by the acquirer and employees get a new set of options with new startup options assuming they decide to stay with the acquirer. Unvested options get accelerated — they automatically become vested as if the employee already satisfied her remaining two years of service.

Part 1: Startup stock options 101

So people would get the benefit startup options full vesting whether or not they choose to stay with the new employer. In double trigger, the occurrence of the acquisition alone is not sufficient to accelerate vesting. Note, startup options are just general definitions. And double triggers give the acquirer a chance to hold on to strong talent. But how the money ultimately gets divided across these various buckets can sometimes diverge from what the initial option plan documents dictate as acquisition discussions evolve.

Which is great. But times have changed, and the requirements that were put into effect April have failed to keep pace.

Companies are now staying private longer and are therefore raising more capitaloften from new entrants to venture investing with startup options complicated terms. Rule should be updated to better reflect the information people need to understand options. Startup outcomes are, by definition, unpredictable. Every startup is unique, every situation has unknown variables, and new data will always change the economic outcomes.

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Working at a startup means getting in early for something that has yet to be proven, which means it could have great risks … and potentially, great rewards. August 24,