[AndrewKemendo]

I read a lot about how employees get screwed over with stock options, so what we decided to do was to just give employees vesting stock straight up as a buy through.

Basically the way this works is that we give new employees an up front lump sum in the amount of how much it costs to purchase the shares of the company. The employee then purchases those shares from us in line with a vesting agreement. All warrants and conversions are exactly the same as the founders shares.

This means that they pay tax on this purchase as regular income rather than capital gains up front with the money we give them for it. This prevents a heavy tax bill at conversion and allows them to retain their vested shares regardless of if they work for us or not after the first 12 month vesting period.

We calculated that the up front taxes are magnitudes cheaper in the long run because the increased valuation will cover those differences handily and there is no waiting period like there is with capital gains tax.

In the end though our intention was to make a simple way for our employees to actually own the stock we give them as compensation and it not be something that they can lose or be restructured easily. If a VC or acquisition wanted to restructure that away for employees then they would be forced to restructure everyone's, so we are all in.

[cj]

Founders stock works well for early employees.

Since valuations of pre-series A companies is effectively $0, the cost for employees to buy their shares upfront is minimal (literally a few dollars for a few percent).

But as a company raises capital, it's legally required to have a "409a valuation", which establishes the "fair market value" of the stock. Once this happens, it can cost $x,xxx's of dollars for employees if they're given founders stock (restricted stock) upfront, compared to stock options that have no upfront cost.

One solution to this is to give employees a signing bonus to buy the restricted stock upfront, so it cancels out the amount they owe upfront. Alternatively, you could grant stock options, and sign something that says the company will give them a bonus equal to the exercise price of the options.

[AndrewKemendo]

100% correct. We hope that we will be able to float those amounts to the employees (as bonus) as we get to later stages of growth, but what I have discussed with our GC looks closer to the conversion bonus when and if that happens.

The boundary cases where there is a contentious firing will have to be taken case by case but then whatever that portion of the taxes are due for the percentage vested we would compensate the bonus as though it was 100% vested based on the agreement.

[hkmurakami]

I was thinking about the exact same model the other day (even to the point of paying new hires a signing bonus to cover the stock purchase + tax liability). The wall I ran into was how long I would be able to continue such a model -- how big of a bonus would I be willing to dole out? 20k? 50k? 100k?

If switching to a stock options at some point, what is the proper time? Post-A/B round? (obviously a nice problem to have if you have to worry about such things)

Would be keen on discussing it further sometime, since we seem to have arrived at the same conclusion independently.

[AndrewKemendo]

Like you, I don't have a good answer yet.

I think as long as we have the goal of equity = ownership instead of options to own we will figure out how to structure it. Sounds silly but it is fairly innovative/progressive stuff we are trying to do - which is our whole goal anyway to innovate and progress.

[ganeumann]

Remember, the part of the bonus used to buy the stock comes right back to the company, it's just one pocket to the other.

The tax piece is out the door (and is mostly a dead-weight loss if the company doesn't make it, one of the rationales behind options.)

[hkmurakami]

Wow I completely overlooked this fact.　Thanks!

[triplesec]

I wish more companies were so transparent and decent as yours. Why do others prefer not to do it this way, if it's not just sheer greed and obfuscation?

[ekanes]

This approach is awesome, but (I am not a lawyer, this is not advice!) one drawback is that the whole concept of an option is that it's optional. If the company succeeds, you exercise your option and spend that money to get a much larger return. If you must buy the option, and the company does not succeed, then you've spent the money and it's gone. You've lost the "option" aspect of an option.

And of course, yes, the company may say "we're spending our money to buy this for you, don't worry" the truth is money is money. Someone (company or you) is buying the option early, thus having less money to spend on other things.

Alternatives could be the company pays you that money, so it's yours to spend as you see fit. Including, someday, buying the option if you want.

Hope that helps!

[mblevin]

In my experience it's neither greed nor obfuscation, but rather along the spectrum of ignorance, cash conservation paranoia, and and/or a misplaced sense of justice.

Ignorance in the case of not knowing it can be done - many "startup" lawyers are operating with a playbook written in 1996.

Cash conservation in the sense of "holy schmoly I'd have to pay $X,XXX upfront in taxes to cover their option purchases???"

And "justice" in the sense of "well I'm taking a personal risk as a founder, so if you're not all in with me then suck it and your options will just go back in the pool when you quit."

[AndrewKemendo]

In 99% of cases my guess is they just don't know it is an option because it takes extra work on the company side and is not typically something that a GC or accountant would offer.

[joncalhoun]

I believe this is typically called "reverse vesting", and it isn't incredibly uncommon, but I have only seen it with small (pre-series A) companies.

My (very basic) understanding is that this works fine early on, but once a company reaches a certain size & valuation it becomes hard to continue.

[cj]

> Why do others prefer not to do it this way

Mostly because they don't have experience with option plans, and lawyers tend to recommend what's best for the company (not what's best for the employees).

I granted my early employee founder's stock (same as mine), mainly because I was screwed by stock options in the past. But I had to actively request this from our lawyer (the default is for lawyers to suggest stock options).

[harryh]

So what you're saying is if you give an employee say, 10k shares at $2/share strike price you give them a 20k signing bonus?

Then the idea is that they pay, say, 6k in taxes on the bonus. Then they write you a check for 20k to early exercise the options and file and 83b.

So they're out 6k in taxes but on the other hand they've early exercised so they actually own the stock (subject to 4 years of vesting).

1) What happens if they can't afford the 6k in taxes?

2) What if they don't want to early exercise? Can they just keep the bonus in cash?

3) What if they leave the company in less than 4 years. Do they have to pay the pro-rated portion of the bonus back?

[cj]

1) Company could offer more than exercise cost, so it also covers any tax liability. If I'm not mistaken, this is how [Google|Facebook|Apple] RSUs work.

2) Cash bonus would be dependent on employe exercising the grant.. it probably shouldn't be presented as a bonus, so the employee doesn't have to select between the bonus or the stock. If they prefer a cash heavy compensation package, that should probably be discussed in isolation from a stock purchase reimbursement / bonus.

3) This is a tough question. If an employee leaves before 4 years, the company has to buy the restricted stock back from the employee. Perhaps there's a way to legally require the employee to return the buyback check to the company.

[spinlock]

It used to be common to loan the employee the money to purchase the stock. This avoids both the tax and early termination problems.

[AndrewKemendo]

Well this is exactly what we are doing! In our case however we are probably going to sequentially forgive the debt, which would look like real income and as long as we space it out the tax burden is slow. All of the transactions are paper anyway so this also keeps our cash flow the same.

What good is equity as compensation if you have to purchase the stock after all?!

[SeoxyS]

A loan of the exercise price + 40% to cover taxes sounds like the best of all worlds to me.

[prostoalex]

> If I'm not mistaken, this is how [Google|Facebook|Apple] RSUs work.

For FB specifically, they just pre-sell 40% of issued RSUs. The amount then shows up on paystub as income tax withheld.

There's no extra money to be had on top of the RSU grant - for a global company it would be unfair to treat employees at high tax burden locations differently from employees in low tax burden countries.

[leroy_masochist]

>Basically the way this works is that we give new employees an up front lump sum in the amount of how much it costs to purchase the shares of the company.

Interesting. Can you provide more detail on this? Do you just pay the lump sum outright as a hiring bonus? Obviously this works at early stages when the stock is like $0.001/share, but what happens after you've raised a few rounds and the current fair value of the stock is in the 6-7 digit range?

[SeoxyS]

One way to avoid the whole stock option / RSU mess is to structure your company as a C-corp that is wholly owned by an LLC, and give your employees membership units in the LLC. This is a very unusual setup and it'll take a good lawyer to help you get it right; but the benefits are huge for employees who own stock, because there are zero tax liability and zero purchasing price until the ownership produces a return.

[mooredinty]

In some states LLC members are not allowed to take salaries. They can only take guaranteed payments, which have other tax implications

[walterbell]

Are there any published references on this technique, or a law firm that is well-versed in it?

[SeoxyS]

I don't know of any public resources on the topic, or of any law firms that are particularly adept at this. However, I have seen it done in practice.

I'd recommend talking to a law firm that's well versed in startup corporate law. The big firms Cooley and Orrick come to mind.

[simonebrunozzi]

Andrew, it would be great if you write a detailed blog post about this. I bet that quite a few startups would love to follow you here.

[prostoalex]

Do you cover the purchase and tax liability, or just the purchase?

Also, are you not worried about reporting requirements once you reach a certain number of shareholders?

[sliverstorm]

As someone trying to understand the various stock incentive plans, can you explain the difference between this and RSUs with an 83b election?

[choppaface]

Does this system effectively make employees do 83b early exercises? or is it more like a custom RSU program?

[AndrewKemendo]

Yes, an 83b election is required.