Negotiation Rhythms #1: Zone of Possible Agreement

Each party will enter a negotiation with the knowledge of their limits and the desire to make as favorable a deal as possible.

We begin our illustration of the basic negotiation rhythms with the fundamental negotiation question from Harvard Negotiation Project’s classic Getting to Yes[1]: Is there a Zone of Possible Agreement (“ZOPA”) between the limits set by each party?

An agreement is possible if the seller's limit is lower than the buyer's limit. Here's an example:

If an engineer is willing to work for a salary of $100K and a company recruiting that engineer is willing to pay $120K, there would be a ZOPA between $100K and $120K.

However, there would be no ZOPA if the amounts were reversed and the company would not offer more than $100K and the engineer would not accept less than $120K.

Capturing the ZOPA

Presuming that there is a ZOPA, the seller will want to sell for as much over the seller’s minimum as possible, and the buyer will want to buy for as much below the buyer’s maximum as possible.

It would be best for the seller to settle on a price at buyer’s maximum and for buyer to settle on a price at seller’s minimum.

Each is free to try to capture as much of the amount within the ZOPA as possible, especially if they do not know one another’s limits.

Hiding the ZOPA

The danger comes when one or more parties push so hard to settle on an agreement well above their minimum or below their maximum that they fail to discover that there is a ZOPA between the parties.

For example, the engineer would be at an advantage in the first example above if she convinced the company that she would not accept a salary below $120K. By pushing for $120K, she might end up with the maximum possible salary available from the company. However, she would end up with no deal at all – and have missed the chance to make a desirable agreement at somewhere between $100K and $120K – if she convinced the company she would take no less than $125K.

The opposite is also true. If the company convinced the engineer that they could offer no more than $95K, they would have convinced the engineer that there was no ZOPA and killed the deal.

ZOPA Conclusion

Each party has two conflicting goals in a negotiation:

1.     Transparency: To discover a possible point of agreement, if one exists. This requires each party to be transparent enough about their limits that the parties can identify whether there is a ZOPA. If the parties kill the deal, they will have sacrificed the value of a beneficial agreement.

2.     Ambiguity: To settle on a price that is as close to the other party’s limit as possible. This requires each party to be ambiguous in communicating their limits to encourage the opposing party to believe the ZOPA and their potential gain are smaller than they actually are. If a party settles at their limit, they will have sacrificed the benefit they could have captured by pushing to settle closer to the other party's limit.

Our next post, #2: Best Alternatives to Negotiated Agreement, illustrates how negotiators set their limits. Post #3: Sales & Threats shows the flexibility of the pattern by illustrating how negotiators use sales techniques to change the other party’s limit.

[1] Roger Fisher, William Ury and Bruce Patton, Getting to Yes: Negotiating Agreement Without Giving In.

Negotiation Rhythms

We’ve all heard plenty of advice about negotiating.

The business world directs us to stay rationally focused, rely on exhaustive preparation, think through alternatives, spend less time talking and more time listening and asking questions, and let the other side make the first offer.[1]

The psych world counsels us to listen first, sit down, find common ground, move in, keep cool, be brief, forget neutrality, avoid empty threats, and don’t yield.[2]

These tips don’t have much meaning without knowing the underlying principles of negotiations, and studying tips alone is about as meaningful as learning dance steps without ever hearing the music.

The following three-part series presents the rhythm of negotiations as described in the Harvard Negotiation Project’s Getting to Yes: Negotiating Agreement Without Giving In.[3] It should be useful for those first learning to hear this rhythm and for those who have been dancing since the bazaars of their youth who may need to go back to basics to learn some tricky new steps.

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 welcome to contact Stock Option Counsel at info@stockoptioncounsel or (650) 326-3412.

Read on!

#1: Zone of Possible Agreement

#2: Best Alternatives to Negotiated Agreement

#3: Sales & Threats

[1] Take It Or Leave It: The Only Guide to Negotiating You Will Ever Need http://www.inc.com/magazine/20030801/negotiation.html via @Inc

[2] The Art of Negotiation | Psychology Today http://www.psychologytoday.com/articles/200701/the-art-negotiation

[3] Roger Fisher, William Ury and Bruce Patton, Getting to Yes: Negotiating Agreement Without Giving In. 

Funding Options for Exercising Options

Quora is awesome. Today it provided me a real softball question for a blog post:

"How am I supposed to afford my stock options?"

Here's my answer:

When your options "vest," they "become exercisable." At that time you have the choice to exercise them or wait to exercise them later (or never).

When you decide to exercise, you may have more choices than simply paying cash. These will depend on the terms of your options (as described in your option agreement and the company's option plan), your company's policies, your ability to negotiate for favorable terms, and the existence of a public or private market for your company's stock. 

Here are the basics of each alternative:

1. Pay with a Promissory Note.

If the company allows you to pay the exercise price with a promissory note, you'll make an official promise to pay the company the exercise price and they will issue you the stock. This is not common, as it requires some thoughtful planning by the company to comply with the law. But I have seen it used for executives of private companies to exercise or even early exercise very valuable option grants.

2. Take Out a Loan.

If the company is promising enough to inspire you to exercise your options, it may also inspire a friend, a bank, or a special fund to loan you the money to make the exercise. The terms of such a loan would vary from a standard signature loan from a bank (much like borrowing on a credit card) to the non-recourse loans offered by specialized Silicon Valley funds. These special funds, such as The Employee Stock Option Fund (esofund.com), loan you the cash to exercise your options (and even to cover any tax liabilities at exercise). At a liquidity event, the funds are repaid and also participate in the upside of the stock. However, they do not require repayment if the stock later becomes valueless.

3. Cashless Exercise.

There are three steps in an exercise and sale -- pay cash for exercise, receive stock, sell stock. You may be able to cut out the "pay cash" portion by using a twist on the "Take Out a Loan" option above. Using a brokerage, you would borrow the money to exercise the options and immediately sell at least enough of the stock issued on exercise to repay the loan from the brokerage. This depends, of course, on having a buyer / market for the company stock.

4. Pay the Exercise Price in Stock.

If you already hold stock in the company, you may be able to use that stock to "pay" the exercise price. You would transfer your stock back to the company, and the current FMV of the transferred stock would be applied toward the exercise price of the options as if you were paying the exercise price in cash.

ESPP How-To #4: Tax Basics

To save you from reading too many words about tax, I've presented this final ESPP How-To in a visual / audio form. You can download the presentation here>. But all you need to know about tax when enrolling in your ESPP is in the first two slides. This is what they say:

1. Enrollment: The payroll deduction percentage you choose during Open Enrollment is calculated on pre-tax income but taken after taxes. Therefore:

a. If your salary and bonuses equal $100,000, a 10% contribution percentage will result in a $10,000 investment in the ESPP.

b. You will pay income and payroll taxes on the $10,000 investment, so your take-home pay will be reduced by the $10,000 as well as the tax on the $10,000

2. Purchase Date: The Purchase Date is not a taxable event, so you do not pay taxes at purchase. However, discount on the Purchase Price is a benefit to you from the company, so you will pay taxes on that discount as if it were compensation when you sell or transfer the ESPP stock.

3. Sale of ESPP Stock: If you sell your ESPP stock before the expiration of a 1-2 year Holding Period following the Purchase Date (this early sale is called a Disqualifying Disposition), you are likely to pay more in taxes than if you sell after the Holding Period because:

a. Taxable Income: Your taxable income on a Disqualifying Disposition may be greater than you Gain on Sale and 

b. Tax Rates: Your tax rates on your taxable income may be higher because a greater portion of your taxable income is likely to be taxed as Ordinary Income rather than Capital Gains.

Really. That's all you need to know to enroll. But if you want to plan for the sale of your ESPP stock, you can download the presentation here> or watch the slideshow (with audio!) above or at my sweet new youtube channel>.

More in the ESPP How-To Series:

Intro To ESPPs

Timeline the ESPP

Know the Discount

Calendar Your Bets & Play to Win

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