Negotiation Rhythms #2: Best Alternative to Negotiated Agreement

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.

We know we want to push beyond our limits to capture as much value as possible in a negotiation. But how do we define those limits? It takes a five-word phrase to bring this concept into focus: Best Alternative to Negotiated Agreement (“BATNA”).

The BATNA for a car buyer might be the same car at a nearby dealership for $20,000. The BATNA for a home seller might be an offer from another party for $1 million. The BATNA for a child trading baseball cards might be to hold onto his favorite cards and enjoy looking at them rather than to trade them away.

 

BATNA Slide.jpg

Any agreement below (or, for a maximum limit, above) a BATNA would leave the negotiator worse off than in the absence of that particular agreement. Said another way, the negotiator would be better off with some other option – their BATNA – than accepting an agreement on those terms.

 

BATNAexamples.jpg

To properly identify a BATNA, we must do a lot of calculating, daydreaming, and going out in the world to test alternatives. But this creative process is necessary. When we believe that the only alternative is the one at hand, our negotiation position is dangerously weak. It is also dangerously ineffective because it leads to an arrangement that does not, in fact, make the negotiator better off than without it. And any deal that is not in both parties’ best interests is unstable and likely to collapse after it is made.

Countless factors go into naming and ranking one’s alternatives to arrive at a BATNA, and even then it is impossible to do so clearly as those factors cannot all be outlined in numerical format. A better offer might be less certain of being completed, so it might be more advantageous to make an agreement on less favorable terms today. For example, the other job offer might not be certain even though it appears it would be more advantageous if it were finalized. This is the old saying that a bird in the hand is better than two in the bush, and this can be dangerous for those who optimistically negotiate as if their imaginary alternatives are already in the hand. In the other extreme, this is very limiting for those who are very fearful of uncertainty, as they will accept disadvantageous terms for the simple purpose of having certain terms when a bit of risk in pursuit of a better alternative could have led to greater results.

Timing is important in other ways as well, as a negotiator with more time to come to an agreement will have more chances to find alternatives to the agreement at hand. "Wait and see" becomes a BATNA in itself. The opposite of this would be a party who must have resolution today, which would, of course, limit the alternatives.

Beyond hard limits on time, some people do not enjoy the back and forth process of negotiating. They might prefer to take this deal, and even to accept much less of the middle than is possible to capture, than to continue to seek alternatives or negotiate deals. For these people, the process itself inhibits the growth of BATNAs.

We’ll see in the next post – Negotiation Rhythms #3: Sales & Threats – how brainstorming or eliminating BATNAs changes the ZOPA and improves or weakens our force in negotiation.

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.

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

***

Stock Option Counsel

We serve as Stock Option Counsel to employees and executives who want to maximize their stock compensation, including stock options, RSUs and restricted stock.

ESPP How-To #3: Calendar Your Bets & Play to Win

Imagine a casino game that allowed you to bet once to get in the game and then withdraw your bet after you had more information and saw that you no longer wanted to take the bet.

To maximize your ESPP benefits, know your rights to make changes and withdrawals under your ESPP and calendar the key decision dates for those changes and withdrawals.

Changing Your Bets

The right to wait to make a final decision is always an advantage in a game, as the risk of loss or chances of winning change over time. In legal contracts, people often pay more for the right to make changes at a later time.

Your ESPP game may allow you to change your bets after the Offering Period has begun without charging you for the right to make this change. This gives you the opportunity to strategize for your purchases based on changes in the company’s stock price.

For example, if you’re following the stock price and find that the likely discount on the next Purchase Date will not be not high enough to make you want to make the purchase, you would want to cancel your bet and get a refund if your plan would allow it. If you’re following the stock price and decide you want to bet more to take advantage of an attractive Look Back discount (because of a low Offering Date market price), you would want to increase your payroll deduction percentage.

Even if your plan allows these changes, it will have very strict deadlines for each change. Calendar your decision dates for each possible change, follow the company’s stock price throughout each Purchase Period, and reconsider your bets as each Purchase Date approaches.   

Cisco Bet Change Opportunities

This timeline shows the timing of bet choices during a sample Cisco Offering Period.

Transient

Bet #1: Open Enrollment

Open Enrollment is the first phase of betting, as employees sign up to have a percentage of their income (1% to 10%) deducted at each pay period during the Offering Period (Contributions). This locks in their right to (automatically) purchase stock on each Purchase Date with a maximum Purchase Price of 85% of the market price on the first day of the Offering Period.

The only entrance time for playing an Offering Period is Open Enrollment, which takes place in the months before the start of an Offering Period. If employees don’t enroll and later find that the Offering Date market price was low and the Look Back discount is attractive, they’re out of luck as it’s too late to join that Offering Period.

Bet #2: Withdrawal During Purchase Period

Cisco’s ESPP includes the right to withdraw from the Offering Period (subject, of course, to strict timing deadlines). Withdrawing employees have the choice to (1) have all the Contributions accumulated during the current Purchase Period refunded (“withdraw-with-refund”) or (2) have those Contributions used for purchase on the next Purchase Date but cease all further payroll deductions (“withdraw-with-purchase”). Of course, purchases made on prior Purchase Dates are already final, and those funds will not be refunded.

The right to withdraw-with-refund makes it possible to monitor the stock price, predict the Purchase Price for upcoming Purchase Dates and choose not to make the purchase if the Purchase Price is unappealing.

For example, if an employee is not impressed with only a 15% discount, he or she could monitor the stock price and withdraw-with-refund during a Purchase Period in which he or she expects the market price on the Purchase Date to be less than the market price on the Offering Date.

However, withdrawal during a Purchase Period permanently removes an employee from the remainder of the Offering Period.

Bet #3: Decrease Payroll Deduction Percentage

Cisco allows employees to decrease their payroll deduction percentages, subject to strict deadlines. They can choose to have the decrease effective during the current Purchase Period or starting in the next Purchase Period.

Bet #4: Increase Payroll Deduction Percentage

Cisco allows employees to increase their payroll deduction percentages, subject to strict deadlines. However, payroll deduction percentage increases will not become effective until the following Purchase Period.

For example, an employee who is enrolled in an Offering Period during which the market price is rising above the Offering Date market price might want to increase his or her Contributions for the remaining Purchase Periods within that Offering Period to take advantage of an attractive Look Back discount.

Bet #5: Change Payroll Deduction Percentage for Next Offering Period

If an employee is still enrolled in the Cisco ESPP at the end of the Offering Period, he or she is automatically enrolled in the next Offering Period, which starts immediately after Purchase Date #4. If the employee chooses not to participate in the next Offering Period, or wants to increase or decrease the payroll deduction percentage for the next Offering Period, those changes should be made during Purchase Period #4.

Calendar to Win

Even if your plan allows these Cisco-style bet changes, like Cisco it will have very strict deadlines for each change. To take advantage of this flexibility and maximize your benefits:

Calendar your decision deadlines for each bet – open enrollment, withdrawal, decrease payroll deduction %, or increase payroll deduction %; Follow the company’s stock price throughout each Purchase Period; Make changes in your bets by the deadlines; and Be glad you played to win.

More in the ESPP How-To Series:

Intro To ESPPs

Timeline the ESPP

Know the Discount

Calendar Your Bets & Play to Win

Tax Basics

***

Stock Option Counsel

We serve as Stock Option Counsel to employees and executives who want to maximize their stock compensation, including stock options, RSUs and restricted stock. 

ESPP How-To #2: Know the Discount

The discount is the “win” of an ESPP because it allows you to buy stock for less than the market price. Most ESPPs use a discount percentage of 5-15% off of the market price.

Big Win = Look Back Discount

The best ESPPs “look back” in time to calculate an even better discount for employees.

On the date of each purchase, an ESPP with a Look Back will calculate the purchase price by applying the discount percentage to the lesser of (1) the market price on a date months or even years before the Purchase Date (for Cisco, the Offering Date) or (2) the market price on the Purchase Date.

A Look Back is valuable if the market price of the company’s stock is rising during an Offering Period, as purchase prices during that Offering Period would be calculated using the low market price of the first day of the Offering Period (Offering Date).  For example, if the market price goes up from $10 to $20 over a tw0-year Offering Period and a company uses a 15% discount percentage, the purchase price on the last day of the Offering Period would be $8.50. That would be a discount of $11.50 off of the market price on that day.

Cisco’s Purchase Price Calculation

Cisco’s ESPP has a 15% discount and a two-year Look Back. Therefore, joining a Cisco Offering Period locks in the right to buy stock with a maximum price of 85% of the market price on the first day of that Offering Period. Even if the market price of the stock rises dramatically over the two years of the Offering Period, the employee’s maximum purchase price on each Purchase Date in that Offering Period is 85% of market price on the first day of that Offering Period.

Cisco’s Purchase Price on any Purchase Date is the LOWEST OF:

1. 85% of the market value of the stock on the Offering Date OR

2. 85% of the market value of the stock on the Purchase Date.

Transient

Cisco Up Market Example: If the market price on the Offering Date is $15 and the market price on the Purchase Date is $25, the Purchase Price for that Purchase Date would be $12.75 – 85% of $15. That would be a discount of 49% off of the market price on the Purchase Date. If the employee sold the stock immediately after the Purchase Date, he or she would have a gain (winnings) of $12.25 per share.

Cisco Down Market Example: If the market price on the Offering Date is $15 and the price has dropped to $10 on the Purchase Date, the Purchase Price for that Purchase Date would be $8.50 – 85% of $10. That would be a discount of 15% off of the market price on the Purchase Date. If the employee sold the stock immediately after the Purchase Date, he or she would have a gain (winnings) of $1.50 per share.

Cisco Reset Feature

Since the goal of an Offering Period game is to lock in the lowest possible Purchase Price, the Cisco ESPP automatically cancels any Offering Period after any Purchase Date on which the market price is less than the market price on the Offering Date. New Offering Periods start every six months, so participants are automatically enrolled in a new Offering Period starting after that Purchase Date. This lets employees take advantage of the lower maximum Purchase Price of the new Offering Period as the market price on the new Offering Date will be less than the market price on the cancelled Offering Period’s Offering Date. 

 

More in the ESPP How-To Series:

Intro To ESPPs

Timeline the ESPP

Know the Discount

Calendar Your Bets & Play to Win

Tax Basics

***

Stock Option Counsel

We serve as Stock Option Counsel to employees and executives who want to maximize their stock compensation, including stock options, RSUs and restricted stock.

ESPP How-To #1: Timeline the ESPP

Playing and winning the ESPP game is not as simple as writing a check to the company and receiving discounted stock. To maximize ESPP benefits, the first step is to understand the timeline of important events in your ESPP game.

In most ESPPs, the timeline flows like this: (1) employee enrolls to participate in an Offering Period and agrees to have the company deduct a percentage of his or her income to hold for later purchase of the company’s stock; (2) payroll deductions continue throughout the Offering Period; (3) the company holds onto the employee’s payroll deduction funds until special Purchase Dates; and (4) on each Purchase Date, the employee’s accumulated funds are automatically used to purchase discounted company stock for the employee.

Cisco ESPP Timeline

Cisco starts two games (Offering Periods) per year. Each Offering Period lasts for two years and has four six-month rounds (Purchase Periods) within it.

Transient

If a Cisco employee signs up for an Offering Period during Open Enrollment, he or she authorizes the company to take a percentage of his or her income at every pay period during the Offering Period (Contributions).

Cisco holds the employee’s Contributions on his or her behalf to purchase stock at the end of each Purchase Period within the Offering Period. The dates on which the purchases are made are called Purchase Dates.

Transient

Contributions accumulate during each Purchase Period. On the last day of each Purchase Period (the Purchase Dates), the employee’s Contributions are used to purchase Cisco stock at a discount. The company creates a special brokerage account for each employee and deposits the stock into that account after each Purchase Date.

More in the ESPP How-To Series:

Intro To ESPPs

Know the Discount

Calendar Your Bets & Play to Win

Tax Basics

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.

Startup Negotiation: Know the Game

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.

Craps is the best game in a casino. The house odds are very low at around 0.6%. When you’re rolling and you’re hot you can make big money for everyone at the table. And when you’re cold it doesn’t take long for your turn to end and the dice to move to someone who might get hot!

The same is true for Silicon Valley. It is arguably the only place where employees can strike it rich. Employees become rollers here, making the enterprise happen and enjoying some of the upside of the business through employee equity.

But the odds in craps can be even worse than double zero roulette if you don’t choose the right bets. There are about 120 to choose from, and the people who win know the game and know the risks they’re taking with each bet.

This is a list of casino-style descriptions of a bet on stock options, RSUs or ESPPs. We’ll give each a more thorough look (and pay attention to the great casino king Uncle Sam’s take) in later posts. To keep it simple, these presume that the vesting time/terms have been met by the player.

Stock Options: Player wins cash if (1) player pays cash exercise price to company before/when leaving the company and before the expiration date of the option; (2) company gives permission for or requires player to sell shares (on secondary market, at IPO, at sale of company, etc.); and (3) player sells shares at a price greater than the exercise price. Player loses the exercise price cash if (2) and (3) are not met.

RSUs (“Restricted Stock Units”): Player wins cash when (1) company settles the RSUs in shares of common stock (aka company gives player common stock) and (2) player sells the shares.

ESPPs (“Employee Stock Purchase Plans”): Player wins cash if (1) player makes cash payroll contribution; (2) company converts player’s cash to shares on purchase date (# of shares = cash/conversion price); (3) player sells shares at a price greater than the conversion price. Player loses cash if player sells shares below the conversion price.

Of course, this post does not include the 1000 disclaimers that would be necessary to cover every possible Stock Option/RSU/ESPP plan or equity compensation bet. But it should be a good place to start for employees trying to know the game.

 

Startup Stock: Particles and Waves. Casinos and Creativity.

Photo: Bobby Mikul

Photo: Bobby Mikul

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.

What is a corporation? Finance pros and justice types present two very different answers to that question.

On the finance side, a corporation is a casino-style financial arrangement between those who own stock. It divides up the rights to a financial return on capital. It emphasizes balance sheets and stock prices and risk and return to support the view that each corporation is a table in a casino that investors approach to place their investment bets and seek a financial return.

On the human advocacy side, a corporation is a living body made up of creative individuals. The liveliness of the group – defined to include investors, managers, employees, and, perhaps, the community or the earth – is the purpose of the corporation. They make comparisons to slavery, define externalities and articulate their values to support their view that a corporation is a living body that could not be owned.

Like a ray of light, which is at once a wave and a group of particles, the corporation is both a casino game for investors and a living, creative body. Evidence will always appear on both sides of this truth.

In choosing a career path and negotiating compensation, we use both perspectives. We find a place that has some life to it, to which our creative contribution can add life. But we tune into the casino view as well and seek compensation for the risk we take in joining the enterprise. This requires the eye of an investor who would look at the risks of the bet and the size of the possible return from every angle with the help of professionals in law, finance, technology, etc.

It would be distasteful to take this view of our work every day, but it must be done at some time. And it is best done with Stock Option Counsel. This blog will introduce the Stock Option Counsel perspective on the risk / investment that employees take / make in accepting stock options or other equity as compensation. It should be helpful to those evaluating their compensation and also reveal the points in time in which Stock Option Counsel can add value in this process.

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 her at info@stockoptioncounsel or at (650) 326-3412.

Who is Mark Zuckerberg's Daddy?

Who is Mark Zuckerberg’s daddy? In a traditional public company, the CEO’s daddy is the board of directors who hire him, and the board’s daddy is the stockholder who can vote out the board. But Mr. Zuckerberg has voting control over the board and the power to define his own priorities.

So, who IS Mr. Zuckerberg’s daddy? He answered that question in yesterday’s interview with TechCrunch founder Mike Arrington with a subtle message to employees: The employee equity we grant you today, at today’s low prices/strike price with a four-year vesting schedule, will “pop” at the end of the vesting schedule.

Well, he didn’t say that exactly. But he led with that very clear (and obviously carefully crafted) message to employees by defining a remarkably specific timeline for stock price increase (remember, he always references vague future goals such as “build value over the long term” and “making the world more open and connected”):

“Over the next three to five years, I think the biggest question that is on everyone’s minds that will determine at least our performance over that period, is really going to be how well we do with mobile. … I think it’s easy for a lot of folks, without us being out there talking about the stuff we’re doing, to really underestimate how fundamentally good mobile is for us.”

Did someone ask him about the next three to five years? Not the interviewer. Not the public markets. Who cares about three to five years? Employees care about three to five years because they will receive grants of options or RSUs that will become fully vested in three to five years.

So Mr. Zuckerberg’s message to employees is this:

1. I know you care about the Facebook stock price in three to five years, because its delta over that time is your chance to build a fortune in compensation. If you’re not expecting a delta, you’ll place your bets (work) elsewhere.

2. I am thinking about the stock price in three to five years, because that is what you care about. I care about you. I have a plan, and it is going to benefit you directly.

3. The plan is mobile. Facebook is going to have a higher stock price in three to five years because of mobile.

4. Your employee equity is not worthless. It is going to gain value in the exact time frame in which you want it to gain value. And you will be rich.

So, Mr. Zuckerberg has declared what employees are betting on if they bet their workdays on Facebook employee equity. Will the best and brightest take the bet?