Startup Equity Standards - A Guide for Employees

Learn the three standards that define Startup Equity and three questions to ask to know if you have the real thing. 

1. Ownership - “Can the company take back my vested shares?”

2. Risk/Reward - “What information can you provide to help me evaluate the offer?”

3. Tax Benefits - “Is this equity designed for capital gains tax rates and tax deferral?”

Attorney Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers and post-acquisition employment agreements, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

Links - Best web content on startup employee stock

Here's links to the best web content on startup employee stock:

1. Valuing Your Opportunity

Calculating percentage ownership and understanding fully diluted capital, #1-2 of The 14 Crucial Questions About Stock Options, Andy Rachleff, the Wealthfront Blog

How to value an offer, Right to Value How-To, Stock Option Counsel Blog

How to use the company's VC valuation to evaluate your equity offer, Video, Stock Option Counsel Blog

How to calculate the future value of your equity by estimating dilution and valuation, John Greathouse's Blog

How to ask about valuation, #11-13 of The 14 Crucial Questions About Stock Options, Andy Rachleff, the Wealthfront Blog

How preferred stock rights make common stock less valuable, Stock Option Counsel Blog

Knowing your market rate with regards to startup equity, #3-4 of The 14 Crucial Questions About Stock Options, Andy Rachleff, the Wealthfront Blog

How to know how much is enough equity for a pre-Series A startup, Stock Option Counsel Blog

Four factors of how startups decide your salary and equity Mary Russell & Boris Esptein on the Stock Option Counsel Blog

Four factors of how startup decide your equity offer VIDEO Mary Russell & Boris Esptein on the Stock Option Counsel Blog

Negotiating Compensation An Engineer's Guide to Silicon Valley Startups

2. Understanding Your Vesting

Acceleration upon change of control, Gil Silberman on Quora

When acceleration upon change of control does not make sense, Gil Silberman on Quora

What is vesting; what is acceleration upon change of control? #5 & #8 of 14 Crucial Questions about Stock Options, Andy Rachleff, Wealthfront Blog

Does my vesting make sense? Stock Option Counsel Blog

3. Identifying Company' Repurchase Rights Over Vested Shares

Can the company take back my vested shares if I leave?, #6 of The 14 Crucial Questions About Stock Options, Andy Rachleff, the Wealthfront Blog

How Skype's repurchase rights gave certain employees $0 of $8.5 billion acquisition payouts, Felix Salmon on Reuters Blog

4. Understanding Your Tax Benefits

Three Ways to Avoid Tax Problems When You Exercise Options, Bob Guenley, Wealthfront Blog

Ensuring company compliance with tax rules - and your tax rights - when negotiating an offer, #9-10 of 14 Crucial Questions About Stock Options, Andy Rachleff on the Wealthfront Blog

Incentive stock options, Michael Gray, CPA

Non-qualified employee stock options Michael Gray, CPA

5. Overview

The 14 Crucial Questions About Stock Options, Andy Rachleff, the Wealthfront Blog

How to Value Startup Employee Stock

Attorney Mary Russell, Stock Option Counsel, counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers and post-acquisition employment agreements, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

 

PART I: VALUATION

If the startup has sold preferred stock, you may be able to calculate the most recent investor valuation of your percentage ownership in the company ($X) for a rough understanding of the value of your percentage ownership in the company. For example: 

1.      You could ask the company to provide the number of shares in your grant (“Your Number of Shares”), the company’s post-money valuation in a recent financing (“Post-Money Valuation”) and the current number of shares outstanding on a fully diluted basis (“Fully Diluted Capital”) to calculate: $X = (Your Number of Shares/Fully Diluted Capital) * Post-Money Valuation                                                                                                   

2.    Or you could ask the company to provide Your Number of Shares and ask a professional to research the most recent price paid by investors for shares of the company’s stock (“Preferred Stock Price Per Share”). $X  =  My Number of Shares   *  Preferred Stock Price Per Share

3.    If you want to go further, you could estimate a discount on the recent valuation of your ownership percentage because your common stock is less valuable than the Preferred Stock Price Per Share. To understand liquidation preferences and participation rights and how they reduce the value of common stock, seeStartup Negotiations: How Preferred Stock Makes Employee Stock Less Valuable. You can also follow the how-to below on company estimates. The difference in your payout between a company exit at 1X the current VC valuation v. your payout between a company exit at 2X or 10X the current VC valuation will show you how the liquidation preference affects the value of your shares in an acquisition. [Note I: Preferences do not affect your value if there is an IPO and you can sell your shares on the public market.] [Note 2: The most recent “fair market value of common stock” from the company is not a good way to estimate the value of startup stock. It’s created for tax purposes, not for valuation purposes.]

If the startup has not sold preferred stock, you may be able to compare your percentage ownership in the company to the founders’ and other employee’s percentage ownership to determine if you are being compensated appropriately for your relative contribution to the team. You could calculate your percentage ownership (Your Number of Shares / Fully Diluted Capital) by asking the company to provide:

  1. Your Number of Shares; and
  2. The current number of shares outstanding on a fully diluted basis (“Fully Diluted Capital”):                                              
  • Founders’ shares outstanding (vested and unvested shares)
  • Investor shares outstanding; 
  • Employee equity pool (reserved and issued); and
  • Estimated shares to be issued upon conversion of convertible notes and exercise of warrants.

PART II: ESTIMATING EXIT VALUE

1. You could calculate your percentage ownership (My Number of Shares / Fully Diluted Capital) by asking the company to provide:

a. Your Number of Shares; and

b. The current number of shares outstanding on a fully diluted basis (“Fully Diluted Capital”):

i.     Founders’ shares outstanding (vested and unvested shares);

ii.     Investor shares outstanding;

iii.     Employee equity pool (reserved and issued); and

iv.    Estimated shares to be issued upon conversion of convertible notes and exercise of warrants

2.     You could also ask the company to provide calculations of your equity value in possible exit scenarios, such as:

a. What would the shares to be worth at an acquisition or IPO at the most recent Post-Money Valuation? At 2X the most recent Post-Money Valuation? At 10X the most recent Post-Money Valuation?

b. What would the shares to be worth in the company’s estimations of the three most likely exit scenarios? 
 

 

3. You could also make your own estimations of future dilution and future valuation to calculate your potential exit payout. The calculations could follow this logic, provided by John Greathouse on his blog [Click to look at colored image with calculation. I haven't gotten his permission to use it here, and it's great.]

 

4.     After you join the company, you can continually reevaluate your equity based on changes in company progress, valuation, liquidation preferences and your percentage ownership in the company on a fully diluted basis.

 5.    These equity evaluations are designed to help you negotiate for the right number of shares when you accept an offer and after you have joined the company. As time passes, you can continually reevaluate your equity comp based on changes to the company’s capitalization and valuation, your performance and your competitive scenarios on the market. 

For more information on joining an early stage startup before there is a VC valuation, see Joining An Early Stage Startup? Negotiate Your Salary and Equity with Stock Option Counsel Tips.

Attorney Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers and post-acquisition employment agreements, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

For Employees: Checklist for Evaluating Employee Equity

Attorney Mary Russell, Stock Option Counsel, counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers and post-acquisition employment agreements, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

1. Evaluating the Equity. Before we accept an offer and throughout our time at the company, we calculate the percentage ownership our shares represent, educate ourselves on the most recent valuation of our percentage ownership and estimate the value and probability of potential company exit scenarios. We compare our company's equity compensation to our other market opportunities and negotiate for the right salary and equity to earn our market value and contribution to the company’s value.

Why? – True Story – An employee was planning to take a $60,000 per year cut in pay and benefits to join a startup. She was offered 4% of a company vesting over four years, but was not told the most recent valuation of the company. She did her homework and found out that she was being asked to sacrifice $240,000 in pay and benefits over four years for a percentage ownership in the company that had been valued by VCs at only $100,000. (She figured it out and negotiated for a raise in salary to make up for the difference.)

Why? – Hypothetical – An employee is comparing offers between two startups, each with similar valuations. Both positions have similar salaries and offer 10,000 RSUs vesting over four years. The first startup has 10,000,000 shares outstanding and the second has 100,000,000 shares outstanding. What is 10,000? It is 1.00% of 1,000,000 shares, 0.1% of 10,000,000 shares or 0.01% of 100,000,000 shares. If the employee has 10,000, what does she have? Without knowing the company’s number of outstanding shares (calculated on a fully diluted basis to be most accurate), she would have no way of comparing the value of the two offers and negotiating for the right number of shares from either company.

2. Understanding Your VestingWhen we join a startup, we learn how our shares vest and if the vesting schedule will accelerate if we are terminated after an acquisition of the company. We negotiate the vesting timeline, vesting contingencies and acceleration upon change of control terms that make sense for our expected role and future with the company.

Why? – Vesting Timing – True Story – A senior engineer was brought into a Series A startup to make a big push toward efficient operations. He was so successful at his job that the startup was "finished" with him after 6 months when the operations could be managed by junior engineers. He was on a four-year vesting schedule with a one-year cliff. He earned zero shares for doing an amazing job at exactly what he was hired to do.

Vesting Contingencies – True Story – An early sales employee was brought into an early-stage startup with a 100% commission-based vesting schedule for his equity. The product wasn’t ready to be sold for two years, so he earned zero shares in his first two years.

3. Identify Repurchase Rights. Before we accept an equity package, we confirmed that we have full rights to our vested shares if we leave the company or are terminated by the company before or after an exit event.

Why? – Repurchase Rights – True Story – Employees who left or were terminated by Skype before its acquisition by Microsoft thought they owned their vested shares and would share in the $8.5 billion purchase price. But under their stock option agreements, the company had the right to repurchase the shares from the employees at the exercise price. This gave those former employees $0 of the $8.5 billion purchase price.

No Merger Rights – True Story – An early employee of a startup left the company ownership of his vested shares. When the company was acquired three years later, he discovered in the fine print that he had no right to his share of the merger proceeds because he was no longer with the company. In other words, his vesting was infinite because he had to stay with the company to have any right to value.

4. Understand Your Tax Benefits. We learn how we will be taxed on our employee equity, the tax benefits that may be available to us and the actions we must take to secure those benefits. We confirm that the company’s design and management of its equity plan make those benefits available to us.  

5. Overview. We ask for the information and counsel we need to secure our rights before we accept an equity offer and at each stage of the negotiation of the company financings, our acquisition payouts and our post-acquisition employment terms. We share our knowledge of the Bill of Rights and our company’s status with regards to these rights with one another. If we do not have access to the documents or counsel necessary to know our rights, we share ask the company to certify that our equity conforms to the Bill of Rights. 

 

Attorney Mary Russell, Stock Option Counsel, counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers and post-acquisition employment agreements, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

March 14 Event: Startup Employee Equity *Bill of Rights*

Attorney Mary Russell, Stock Option Counsel, counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers and post-acquisition employment agreements, making stock option exercise and tax decisions and 

Thanks to the 300 people who joined Chris Zaharias, Startup Equity Freedom Fighter @SearchQuant, and Mary Russell, Attorney Counsel to Individuals @StockOptionCnsl, for this event in Palo Alto on March 14, 2014! 

Here's the draft we created for the event. Thanks for the great discussion!

Startup Employee Equity "Bill of Rights"

Right to Know. Company information on capitalization and valuation, being necessary to the employee’s negotiation of a fair compensation package, shall be provided to the employee with his or her equity offer and after each dilution and valuation event.

Right to Value. The right of the employee to earn the full value of his or her grant shall not be limited by unreasonable vesting terms.

Right to Hold Earned Equity. The right of the employee to hold vested equity up to an acquisition or public offering shall not be violated, and no forfeiture, repurchase or other provisions shall allow the company to seize vested equity of current or former employees.

Right to Tax Benefits. The employee shall enjoy the right to all tax benefits available from state and federal governments, and shall not be subjected to tax penalties due to company negligence, at grant, at vesting or settlement and at company acquisition or sale of stock.

Right to Enforce. The right to enforce this Bill of Rights shall not be violated by company limits on access to information or legal counsel necessary for such enforcement.

Chris Zaharias, SearchQuant LLC

Chris is a startup veteran and advocate for startup employee equity rights. chris@searchquant.net (415) 832-0089.

Mary Russell, Attorney @ Stock Option Counsel - Legal Services for Individuals - www.stockoptioncounsel.com

Mary counsels individual employees in negotiating startup equity and employment agreements, tax and exercise planning, and sales of startup employee stock. mary@stockoptioncounsel.com (650) 326-3412.

Q: How much acceleration of vesting upon a change in control do Series-A startups typically offer?

Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. She is an attorney and the founder of Stock Option Counsel.

A: Startup would not likely offer accelerated vesting upon change of control without you asking for it. But acceleration is usually a negotiable term for anyone in mid to senior roles. 

If you frame this negotiation as a discussion of your role and what you are being brought on to accomplish, it will get to the truth of the matter - What vesting makes sense for your position in the enterprise's future? All compensation - and especially vesting schedules - should make sense for what you are there to do. But startups might not take the time to look at it in that way. 

For example, a senior engineer was brought into a Series A startup to make a big push toward efficient operations. He was so successful at his job that the startup was "finished" with him after 6 months when the operations could be managed by junior engineers. He was on a four year vesting schedule with a one year cliff. Did it make sense that he would receive zero equity for doing an amazing job at exactly the job he was hired to do? No.

If the comapny wont agree to acceleration, ask for more shares to make up for the fact that you don't expect to earn the full number of shares in your grant.

Good luck. And watch out for the precise terms of your acceleration language to be sure they make sense as well.

Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. She is an attorney and the founder of Stock Option Counsel.

Tax Deduction Reminder & Stock Option Counsel Updates

 

Stock Option Counsel

Legal Services for Individuals

Thanks for a great year with Stock Option Counsel.

Reminder - Tax Deduction for Legal Fees

Your legal fees may be deductible on your tax return. Check with your tax advisor for more information. 

Update - Stock Option Counsel Services for Employees & Founders

Please keep us in mind as a resource for yourself and your friends and colleagues for guidance on:

  • Job offers, equity grants and employment agreements
  • Stock option exercise and tax choices
  • Sales of employee stock on the secondary market
  • Post-acquisition employment agreements
  • Founders' interests at incorporation, financings, and exits
  • Dispute resolution among founders and employees on startup equity

Our Blog - Articles and Videos on Employee Equity

We use the Stock Option Counsel Blog to share information on negotiating job offers and selling startup stock. Please send us any requests for additions to the blog. Here's some links to our most popular posts:

Joining An Early Stage Startup? Equity Tips

Bull's Eye - Negotiating the Right Job Offer

RSUs - Startup Restricted Stock Units

MARY RUSSELL • ATTORNEY-AT-LAW 

125 UNIVERSITY AVENUE, SUITE 220 • PALO ALTO, CALIFORNIA 94301

INFO@STOCKOPTIONCOUNSEL.COM • (650) 326-3412

©2014 STOCK OPTION COUNSEL • DISCLAIMER

Startup Negotiations: How Preferred Stock Makes Employee Stock Less Valuable

Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. She is an attorney and the founder of Stock Option Counsel.

If you have a job offer from a startup with an option to purchase shares representing 1% of the company, you may want to consider the Preferred Stock "Liquidation Preference" to see if your 1% would really be 1% if the company is acquired. If the Liquidation Preference is high, you might want to negotiate for more shares to make up for the loss in value you can expect when the company is acquired.

Common Stock v. Preferred Stock

As a startup employee, you'll be getting Common Stock (as options, RSUs or restricted stock). When venture capitalists invest in startups, they receive Preferred Stock. Preferred Stock comes with the right to preferential treatment in merger payouts, voting rights, and dividends. If the company / founders have caved and given venture capitalists a lot of preferred rights - like a 3X Liquidation Preference or Participating Preferred Stock , those rights will dramatically reduce your payouts in an acquisition.

Liquidation Preference & How It Makes Employee Stock Less Valuable

One Preferred Stock right is a "Liquidation Preference." Without a Liquidation Preference, each stockholder – preferred or common – would receive a percentage of the acquisition price equal to the stockholder's percentage ownership in the company. If the company were acquired for $15 million, and an employee owned 1% of the company, the employee would be paid out $150,000.

With a Liquidation Preference, preferred stockholders are guaranteed to be paid a set dollar amount of the acquisition price, even if that guaranteed payout is greater than their percentage ownership in the company.

Here’s an example of the difference. An investor buys 5 million shares of Preferred Stock for $1 per share for a total of $5 million. After the financing, there are 20 million shares of common stock and 5 million shares of Preferred Stock outstanding. The company is then acquired for $15 million.                                                                                                                           

Without a Liquidation Preference, each stockholder (common or preferred) would receive $0.60 per share. That’s $15 million / 25 million shares. A hypothetical employee who held 1% of the company or 250000 shares) would receive $150,000 (that’s 1% of $15 million).

If the preferred stockholders had a 1X Liquidation Preference and Non-Participating Preferred Stock, they would receive 1X their investment ($5 million) before any Common Stock is paid in an acquisition. They would receive the first $5 million of the acquisition price, and the remaining $10 million would be divided among the 20 million shares of common stock outstanding ($10 million / 20 million shares of common stock). Each common stockholder would be paid $0.50 per share, and hypothetical employee who held 1% of the company would receive $125,000.

Ugly, Non-Standard Rights That Diminish Employee Stock Value

The standard Liquidation Preference is 1X. This makes sense, as the investors expect to receive their investment dollars back before employees and founders are rewarded for creating value. But some company founders give preferred stockholders multiple Liquidation Preferences or Participation Rights that cut more dramatically into employee stock payouts in an acquisition.

If preferred stockholders had a 3X Liquidation Preference, they would be paid 3X their original investment before common stock was paid out. In this example, preferred would be paid 3X their $5 million investment for a total of $15 million, and the common stockholders would receive $0. ($15 million acquisition price – $15 million Liquidation Preference = $0 paid to common stockholders)

Preferred stock may also have "Participation Rights," which would change our first example above to give preferred stockholders an even larger portion of the acquisition price.

Without Participation Rights, Preferred Stockholders must choose to either receive their Liquidation Preference or participate in the division of the full acquisition price among the all stockholders. In the first example above, the preferred stockholders held 20% of the company and had a $5 million Liquidation Preference. When the company was acquired for $15 million, the preferred stockholders had the choice to receive their $5 million liquidation preference or to participate in an equal distribution of the proceeds to all stockholders. The equal distribution would have given them $3 million (20% of $15 million acquisition price), so they chose to take their $5 million liquidation preference, and the remaining $10 million was divided among 20 million shares of common stock.

If the Preferred Stock also had Participation Rights, (which is called Participating Preferred Stock), they would receive their Liquidation Preference and participate in the distribution of the remaining proceeds.

In our example with a 1X Liquidation Preference but adding a Participation Right, the Participating Preferred Stock would receive their $5 million Liquidation Preference AND a portion of the remaining $10 million of the acquisition price equal to their % ownership in the company.

$5 million Liquidation Preference + ((5 million shares / 25 million shares outstanding) * $10 million) = $7 million

Common stockholders would receive (20 million shares common stock / 25 million shares outstanding) * $10 million = $8 million.

Our hypothetical employee who held 1% of the company would receive $100,000 (.01 * $10 million) or 0.67% of the acquisition price.

Employee Focus – Calculating Your Payout

If you are an employee of a startup, you can use Liquidation Preference as shorthand for the minimum price the company would have to be acquired for before any employees would be paid out. 

If the acquisition price is less than the Liquidation Preference, common stockholders will get $0 in the acquisition.

If you want to go further and understand what you would be paid out if the acquisition price is more than the Liquidation Preference, consider these three scenarios:

If the preferred stockholders have Participating Preferred Stock, Your Payout = (Acquisition Price – Liquidation Preference) * Your % of All Outstanding Stock

If the preferred stockholders have Non-Participating Preferred Stock, you will receive the lower of:

Your Payout = (Acquisition Price – Liquidation Preference) * Your % of Common Stock OR

Your Payout = Acquisition Price * Your % Ownership

Employee Focus – What to Ask the Company

These calculations are complicated, so if you are evaluating a job offer you might want to stay out of these details leave it up to the company to tell you how the Liquidation Preference would affect you in an acquisition. Use these questions to understand how the Liquidation Preference would reduce the value of your common stock in an acquisition. Simply ask the CFO these questions:

1. What is the total Liquidation Preference? Do the investors have Participation Rights?

2. If the company were purchased today at the most recent VC valuation, what would my shares be worth?

3. If the company were purchased today at 2X the most recent VC valuation, what would my shares be worth? 

3. If the company were purchased today at 10X the most recent VC valuation, what would my shares be worth?

This will give you a good feel for how heavy the VC Liquidation Preferences are and how they would weigh down the growth in value of the common stock.

Founder Focus – Negotiating Your Acquisition Payout

If you are a founder and are negotiating with an acquiror, consider renegotiating your investors’ Liquidation Preference payout. Everything is negotiable in an acquisition, including the division of the acquisition price among founders, investors and employees. Do not get pushed around by your investors here, as their rights in the documents do not have to determine their payout.

If your investors are pushing to receive the full Liquidation Preference and leaving you and/or your employees with a small cut of the payout, address this with your investment bankers. They may be able to help you play your acquiror against the investors so that you are not cut out of the wealth of the deal, as most acquirors want the founders and employees to receive enough of the acquisition price to inspire them to stay with the company after acquisition.

Mary Russell is an attorney and the founder of Stock Option Counsel. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers and post-acquisition employment agreements, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

Thanks to investment banker Michael Barker for his comments on founder merger negotiations. Michael is a Managing Director at Shea & Company, LLC,  a technology-focused investment bank and leading strategic advisor to the software industry.

Would a sale of private company /startup common stock by a former employee trigger a change in 409A / fair market value?

Short answer:

Not in all cases. It comes down to logic. How significant is the market for this company's stock? Is it enough to really show there is a market? Or that there is a clear value? Probably not, unless it is a company-sponsored sale or a Facebook-type frenzy. But companies do use this as an excuse to prohibit secondary sales or drag their feet on allowing their employees to do them.

Lawyer answer:

Based on the tax code rules, the Board needs to change the fair market value price at which they grant options / employee stock any time a major change has occurred that either reduces risk or materially changes company forecasts. Is a secondary sale of private company stock a material change that would have to be seen by the Board as a sign that the risk of investment in common stock has changed?

There are arguments on both sides of this question.

One one side, the secondary sale of shares of common stock shows that common stock is "liquid," or convertible into cash. The lack of liquidity is a big factor in the riskiness of stock and in the logic of discounting common stock value compared to preferred stock value, so liquidity for common stock would raise the "market" price of common stock. Also, the investor who invested has clearly signaled that he/she thinks the stock is less risky than the prior 409A valuation if he/she pays more than that valuation.

However, there are good arguments on the other side as well. The basic argument is that a one-off sale of common stock does not a market make. When you look at the FMV of publicly traded stock, it is based on many sales and the presumption that anyone who holds common stock can trade at any time. Small sales of private company common stock do not mean that any shareholder could find a buyer or that any shareholder could sell at that price. Another argument is that a single buyer or even group of buyers who do not have access to inside company information do not have enough information to know if the stock is more or less risky than the Board has determined it to be in setting the FMV. So one buyer or small group of buyers acting with limited information would not be the appropriate group to define the risk of the stock and, therefore, its fair market value.

Many thanks to Aranca for the following additions to this analysis:

In addition to 2 key points (# of sale points for the price paid, and profile of buyer + seller) that have been mentioned for assessing reasonability of price paid as reflection of FMV, I would like to add 2 more angles that would need to be evaluated while making the determination:

How many different buyers participated at the price that has been paid for the security: If there have been lets say a couple of parties that have transacted, the applicability for the price paid to be considered as reflection of FMV would be weak. However, if there are several buyers who bought from the seller, the applicability of price paid as a FMV can be high.

What has been the valuation range (if any) / bid-ask spread offered by buyers: If the available buyers give a valuation range which is wide and significantly different from the transacted price, then again the applicability of price paid as reflection of FMV becomes questionable. However, if there are sizable number of buyers providing a tight valuation range, then the applicability of price paid as an FMV can be a good indicator.

Mary Russell is an attorney and the founder of Stock Option Counsel. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers and post-acquisition employment agreements, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

Many thanks for the contributions of Dylan Gittleman, Vice-President, ARANCA US and Manpreet Singh, ASA, Manager, Valuation Services, ARANCA US. Aranca is a leading provider of 409A valuation services.

Alternatives to Stock Option Exercise Loans

Attorney Mary Russell, Stock Option Counsel, counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers and post-acquisition employment agreements, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

Looking for cash to exercise startup stock options and pay your tax bill? If you take a loan from one of the Silicon Valley/San Francisco funds that are set up for this purpose (such as from ESO Fund, SharesPost or 137 Ventures), you can expect to give up a significant portion of the "upside" in exchange for the "loan" funds. In other words, you are essentially selling a portion of your shares for a low price. Don't be fooled by the name "loan."

The advisability of doing this deal depends on how much "upside" you give up, and from what I've seen you have to give up a LOT to make a deal with one of these funds.

You do have other choices for raising the funds for exercising stock options and paying taxes at exercise:

1. Get a regular loan secured by the shares. You'll pay interest on the loan, but not give up the "upside" at an exit. In other words, it's a real loan not a disguised sale. I have recently seen startup employees get these loans from specialized banks at reasonable interest rates.

2. Sell a portion of your shares and use those funds to pay the exercise price and tax bill. I have seen an increase in these deals in recent months as there are many investors who want to buy a piece of startup companies. Employees find buyers through their personal networks/family or through Silicon Valley financial advisors who specialize in serving entrepreneurs and tech employees. You can also use an online forum such as SharesPost or EquityZEN to find buyers and make the sale. The structure and feasibility of the sale will depend on how strict your company has been in restricting sales of employee stock.

Mary Russell provides legal services to individuals who need guidance on their stock options. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

Employees Selling Startup Stock: TWO WORLDS

Want to get some cash for your startup stock before an IPO or acquisition? This is a hot topic with much mystery around it.

So here's the deal, as we see it. For employees and former employees who want to sell their startup stock, there are two worlds. In the first, you can just wait for your company to make the $ flow to you. In the second, it's not so simple. But it can be done and Stock Option Counsel is here to guide you.

One: Company-Sponsored Sales

First are company-sponsored sales. These have been much in the news lately as execs at Square, SpaceX, Evernote, SurveyMonkey and Automattic have made efforts to hook their employees up with big $ buyers for their stock. Since the deals are supported by the company, it's just a matter of ensuring you are one of the employees who are eligible to participate (which is up to the company to decide). The eligibility criteria and terms for eligible employees vary. In one example, The Information reported that Evernote CEO Phil Libin  allowed employees who have been at the company for at least two years to cash out up to 10% of their holdings. 

Two: Free-Wheeling Deals

Second are free-wheeling deals you have to set up yourself. They must be designed to comply with or get around company restrictions and securities laws. We have guided employee stockholders through this process both independently and through funds and platforms designed to streamline these deals. 

Here's a quick guide to the process of free-wheeling deals:

1. Put a legal eye to your documents. We can tell you if and how the company's approval can be obtained and what steps you and/or your lawyer will need to follow to finish the transaction. If your documents prohibit sale, don't stop there. There are creative deal structures available that may help you around those restrictions.

2. Find a buyer. We suggest word of mouth - there are brokers and buyers who want to do these deals, but it's just a matter of finding a match. EquityZEN, SharesPost and some Silicon Valley financial advisors are serving as matchmakers for employees and investors. 

3. Close the deal. This takes time. Depending on the company's rules and the legal structure of the sale, your company may have a right of first refusal (window to buy the shares to stop you from selling them outside the company) which takes at least a month to satisfy. The company may also hold up or restrict the sale by other means such as requiring a legal opinion.

Good luck. We're available to employees who need guidance through this process. Contact us through our website or call us at (650) 326-3412.

Mary Russell is an attorney and the founder of Stock Option Counsel. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers, making stock option exercise and tax decisions and identifying your rights and opportunities to sell startup stock. 

Bull’s Eye: Negotiating the Right Job Offer

Bulls Eye: Negotiating the Right Job Offer.jpg

Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. She is an attorney and the founder of Stock Option Counsel.

Boris Epstein is the founder of BINC Search, a next-generation recruiting startup that helps Silicon Valley companies hire technical talent at the scale they need.

You’re negotiating your salary and equity. You know there is a right answer – a bull’s eye where the final offer should land. But where is it?

The company is deciding what to offer you. They know there is a right answer, and they’ll get there using these four factors:

1.     Past Comp – your salary and equity in current and past jobs

2.     Peer Comp – the salary and equity of others in your peer group within this company

3.     Desired Comp – what you want to get paid, regardless of other indicators

4.     Market Comp – your competitive offers in the market

The right offer for you is the bull’s eye at the center of these possible offers. You can maximize your final offer by thoughtfully using these factors in your negotiation.

Past Comp

The company may ask you to disclose your compensation in your previous positions – your Past Comp.

If you disclose these numbers, be sure to include detail or “color” on the numbers to show the true value of your Past Comp. Do you believe your salary was lower than it should have been because of difficult financial circumstance at the company? Are you overdue for a review and raise? Does your company have valuable equity or a bonus structure that should be included to accurately describe your Past Comp? Are you expecting to continue vesting or receive additional stock option grants that you would forfeit by leaving your company?

A thoughtful discussion of your Past Comp may be more effective than following the lore that you should never disclose this information. You can use your answer to the question to guide the company to the right offer.

Peer Comp

The company also considers your Peer Comp – the range this company is already paying employees in similar positions. You start shaping this number during your interview as you discuss roles, levels and opportunities and present information to help the company understand where you fit to add the most value to the team.

For a company with a thoughtful system of leveling, there will be names or labels for each position and a range of salaries and equity packages they offer within each level. Your negotiation work is to distinguish yourself and show that you are a peer of those being paid at the highest end of the range for your level based on your unique skill set or experience.

The more unique your position, the less experience a startup will have in defining your Peer Comp. If you are a first-hire designer, physician or other leadership or expert role, you may have to help the company understand who your peers will be.  This is especially important in early-stage startups, where the hiring team might not understand that your new role should be considered a peer of, for example, vice presidents rather than junior engineers.

Desired Comp

The company also considers your Desired Comp – what you want to get paid. This is highly relevant to the right offer.

Desired Comp is especially important in equity packages, where your evaluation of the company’s equity may vary greatly from another candidate’s evaluation of that package. If you’ve been hoping for a home run exit during your career, you’ll be looking for an equity package that could get you there. If you’re strapped for cash and looking to maximize salary, you will have less desire for an equity-heavy final offer.   

There may be some tradeoffs, of course, but the right offer will be centered on your Desired Comp. So do your self-reflection homework and know what you want.

Market Comp

Companies take into account Market Comp and need to know what they will have to offer to stay competitive. While companies have a general idea of what is “market” for each position, your personal Market Comp is unique and driven by your efforts to identify alternative offers. The only way to use the right Market Comp in your negotiation is to go out to the market, derive that information and communicate it to the company.  

Once you have competitive offers, evaluate the equity packages and make thoughtful comparisons between them. For example, based on your appetite for risk and financial considerations, would you prefer options to purchase 1% of a Series A startup with a company valuation of $5 million or 5,000 RSUs of a public company with a current market price per share of $10? How many more stock options would the Series A startup have to offer you to equate to the public company offer? The company cannot make this estimation for you any more than they can decide which company is the best fit for your personality. When you own this process, you can confidently and effectively communicate to your company what is “market” for your equity offer.

Market Comp is also relevant after hire, as the startup job market can shift dramatically over time and new opportunities are always surfacing. As you continually find new information about opportunities, you can continually communicate with your company about what is “market” in defining the right salary and equity for your position. 

Bull’s Eye: The Right Offer

With thoughtful attention to these four factors, you can use your negotiation to guide the company to the bull’s eye – the right offer for you. If you see the company using the wrong data, you can bring the conversation back to the truth as you see it and work toward the right outcome. 

For more help on these preparations, you are welcome to read the full text of our interview here: The Right Offer – Long Form Q&A Between Stock Option Counsel and BINC Search

Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. She is an attorney and the founder of Stock Option Counsel. You are invited to contact Stock Option Counsel for help in negotiating and evaluating your job offers, making stock option exercise and tax decisions and identifying your rights to sell startup stock. 

Boris Epstein is the founder of BINC Search, a next-generation recruiting startup that helps Silicon Valley companies hire technical talent at the scale they need.

Negotiating the Right Job Offer – Long Form Q&A Between Stock Option Counsel and BINC Search

Thanks for reading our shorter blog post: Bull's Eye - Negotiating the Right Job Offer. This is the full Q&A between Mary Russell and Boris Epstein. It’s long, but it’s full of lots of insights on how to negotiate the right compensation offer from a company.

Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. She is an attorney and the founder of Stock Option Counsel.

Boris Epstein is the founder of BINC Search, a next-generation recruiting startup that helps Silicon Valley companies hire technical talent at the scale they need.

Mary Russell, Attorney @ Stock Option Counsel: Welcome, Boris. I’ve always enjoyed our discussions on compensation negotiations because you seem to believe that a candidate and a company can discover a “right offer.” Employees who come to me for Stock Option Counsel want to get to that “right offer” for salary and equity, and I’m happy you’ve joined us to share your perspective on how to get there.

Boris Epstein, Founder @ BINC Search: Thank you. I think there is a right offer in a compensation negotiation, and companies and candidates arrive there by identifying four data points:

1.     The candidate’s Past Comp

2.     The Peer Comp of the candidate’s level within the company

3.     The candidate’s Desired Comp and

4.     The Market Comp or competitive scenarios in the market

The epicenter of all the different data points would be what they would arrive at to get a right offer. So if all four numbers align, it’s really easy. If the four numbers are divergent in some way, then someone’s going to have to make tradeoffs and concessions. If the person’s making $100,000 but then they want $200,000, and market’s $150,000, someone’s going to have to make a tradeoff somewhere to arrive at the right package.

READ LOTS MORE ...

Read More