[dadkins]

There's a much simpler solution: early exercise. It's already possible and good companies offer it as an option. You exercise all of your options immediately upon joining. The difference between the fair market value and strike price is zero, so there's no tax due upon exercise. If you stay for at least a year, which is where the cliff is, you're now in long-term capital gains territory. And if you leave before all of your options have officially vested, the company is entitled to buy the shares back.

Now, let's address the problem in the article of employees not having enough cash to even exercise their options. If the company is truly concerned about this, then they can provide a signing bonus with which to exercise the options, plus a bit more to cover the taxes on that additional payment. Since the cash goes straight to purchase shares, which goes back into the company's bank account, it's a net zero on the books. The only expense here is the taxes.

Please, explain to me why this won't work. I'm genuinely curious.

[a_small_island]

This methodology isn't sound because of IRS treatment, I'm not an expert but I have these links bookmarked [0],[1]

From [0]: "I typically discourage companies from allowing option exercises by means of a promissory note. Promissory notes can provide employees a means of exercising options and starting their capital gains holding periods without coming up with cash. However, the promissory notes must be substantially full recourse to start the capital gains holding period, which creates a real obligation for the employee even if the stock eventually becomes worthless. A bankruptcy trustee might attempt to collect on a full recourse note in the event the company goes bankrupt. Full recourse means that the note is a general obligation of the employee, as opposed to recourse being limited to the stock purchased in the event of default."

[0]https://www.proformative.com/questions/exercise-stock-option... [1]http://www.jebachelder.com/articles/010321.html

[efoto]

I fully agree with you, with a small caveat though: the mechanism to use is called IRS section 83b election.

It is applicable when instead of the stock options companies offer restricted stock, in a similar way founder stock works. This should solve the problem for at least early employees, for whom the tax paid upfront will be almost negligible: while the company valuation is still low, the shares are inexpensive.

https://www.cooleygo.com/what-is-a-section-83b-election/

[csmeder]

Wouldn't this essentially just be the same as being an angel investor. This takes away all the value of getting options.

For example I am an early employee at a startup valued at 1M. If on day one I am given $10,000 worth of options and I buy all of them, how is this different than investing $10,000 worth of money for 1% of the company?

The value of options is that they are options. You get to wait and see if they are worth buying. If you have to buy them on day one, then they are not a compensation for taking a lower salary, they are simply an investment vehicle like a stock or a bond (a much riskier one).

> If the company is truly concerned about this, then they can provide a signing bonus with which to exercise the options

This is the only way it would make sense.

Say you can take a $150,000 salary with zero options. Or a $120,000 salary with $30,000 worth of stock options.

But if the company needs to give a $30,000 signing bonus to pay for the stock on day one, then they aren't saving any money for runway. Thus the main reason they want to compensate with stock is taken away. And a $30,000 bonus wouldn't do it, it would need to be $30,000 after taxes. The company would end up paying over $150,000 for this person's total salary.

Right? Or maybe I'm missing something?

[nwatson]

An Angel investor ends up with Series A stock which typically costs more per share and has extended rights. The early-exercising employee buys cheaper Common shares. In an IPO the classes may end up with the same value, meaning the employee got a better financial deal per share for their sweat-equity. In a non-IPO the employee may get a lot less per share often 0. Also, each employee has access to a very limited supply of cheap stock, whereas no founder/board will stop an Angel from buying more shares ... "wanna double your investment? come to the trough. "

[sk5t]

You are missing that the $30K bonus to buy the options would immediately flow back into the company's coffers. Perhaps a better scenario would be $30K of stock via grant and $15K in cash to pay the tax man... the company is out $15K net and the employee owns something putatively worth $30K.

[jamiequint]

The cost of the options is too high. Take a company valued at 90m pre-money for their Series B (a $10m investment). Their post-money valuation is $100m. Now assume the common is valued at 5x less than preferred. If the company wanted to do this and their hiring plan has them hiring 20 employees for a total of 5% of their options pool in options they now need to set aside $1m of their financing (5% * 20m) just to finance purchasing the options. That's unlikely to happen.

[dadkins]

I'm afraid I don't follow your math. The cash to exercise the options goes immediately back into the company's bank account. It's as if they were handing out shares instead of options. The only expense should be the tax on the fair market value of the shares, which should be considerably less than 100% of their value, no?

[jamiequint]

You're right, I somehow forgot who the money was going back to. I wonder if you could enforce this legally without the employee just having the ability to walk away with the current value of the options in cash. I also wonder what the tax implications of the purchase are to the company. I agree that this solution makes a lot of sense though.