In the News: Startup Employees in the Dark on Equity

“Mary Russell, an attorney who founded Stock Option Counsel to help employees evaluate their equity compensation, says the first step is for employees to make sure any equity is theirs to keep. Some companies have repurchase rights in their equity agreements that give them a right to buy back shares and options from any employee who leaves; and some give founders or investors broad latitude to change the terms.

“If the company can take back employee shares it dramatically limits the value of those shares,” says Ms. Russell. “It’s the sort of thing an employee needs to know about when they go into a job.” She says it’s as simple as asking whether the company can take back vested shares.”

— Katie Benner, The Information

See Katie Benner's full article, Startup Employees in the Dark on Equity. The Information is a subscription publication for professionals who need the inside scoop on technology news and trends. 

RSUs - Startup Restricted Stock Units - What You Need to Know

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. 

Restricted Stock Units ("RSUs") are not stock. They are not restricted stock. They are not stock options. RSUs are a company's promise to give you shares of the company's stock or the cash value of the company's stock. Every company designs RSUs differently, so be sure to find out the following to understand what you're getting and when you will pay taxes. There are a lot of variables with startups and RSUs, so don't take this blog post as fact or advice for your situation. Read your own fine print or contact Stock Option Counsel for guidance on the details for your negotiation or evaluation of startup stock.

1. How many RSUs are in my grant? Will I be granted more RSUs yearly or after upcoming financings?

One RSU = the right to receive one share of the company's common stock at a later time, or the right to receive the cash value of one share of the company's common stock at a later time. The number of RSUs you are granted tells you how many shares of stock (or the number of shares of stock used to determine your cash payment) you will receive when they are "settled" (see #5 below).

You should also find out when and if you will receive more RSU grants. If you are evaluating a job offer, there is a big difference in the value of your offer between a company that grants you RSUs only at hire and a company that plans to make additional grants each year ("Annual Grants") or after more shares are issued in financings to make up in part for dilution ("Refresh Grants"). 

2. Of course there is no precise "value" for startup RSUs, but it makes sense to gather some relevant details to evaluate the offer. For example: What is the most recent VC price per share of preferred stock? What is the current number of fully diluted shares in the company or my percentage ownership in the company? Can you give me some guidance on the company's expected dilution, exit scenarios, exit timing and future valuation?

When evaluating the number of RSUs in your grant, consider using one of the following methods to value the grant:

A. Current Valuation Method (Fact-Based): For startup stock, you don't have access to a public market for the stock. Therefore, there is no precise method for finding today's value of your RSUs. Instead, use the price per share paid by venture capitalists for one share of preferred stock in the most recent financing. This is the closest number you can find for today's value. It tells you that X Venture Capitalist paid $Y for one share of the company's stock on Z date.

You can find this in one of three ways: (1) Ask your attorney (Stock Option Counsel = legal services available to individual employees to guide them on their negotiation and sale of startup stock) to order the certificate of incorporation from the State of Delaware and interpret it to tell you the most recent price per share paid for the company's preferred stock. (2) Ask the company the price per share paid by VCs in the most recent round of financing. (3) Ask the company for the most recent VC post-money valuation of the company and the number of shares of fully diluted capital at that round; VC post money valuation / fully diluted capital = price per share paid by VCs in the last financing. For more on this approach, see Venture Hacks' post on startup job offers.

B. Future Valuation Method (Guesstimate Based): To look forward and define a future payout for your RSUs, you have to do some guesswork. If you could guess the startup's value at exit and dilution prior to exit, you would know how much the stock will be worth when you receive it. You can make these guesses in one of three ways: (1) Ask the company to estimate different exit scenarios for you. (2) Make these guesses yourself (see John Greathouse's What the Heck Are My Startup Stock Options Worth for his guidance on how to estimate wisely). (3) Find online commentary on future value of your company, if it is close to IPO and discussed in the news. 

3. What is my vesting schedule? Will any portion of my RSUs be accelerated upon change of control?

You will most likely not earn the full number of RSUs simply by joining the company. They will "vest" over time, meaning that you will earn them over a set period of time (called the "Vesting Period"). If you leave the company before the end of the Vesting Period, you will not earn the full number of RSUs.

The most common vesting period = "Four Year Vesting With a One Year Cliff": (1) After one full year, 1/4 of the RSUs will vest. This is called a "One Year Cliff." (2) After one full year, 1/48 of the total grant of RSUs will vest each month. 

Some startups require more than simply time to fully vest your RSUs. After you have "earned" them by meeting the cliff and monthly vesting during the Vesting Period, you may also have to wait until the company has an exit before they officially "vest." 

"Acceleration Upon Change of Control" is an employee-favorable modification of standard vesting. A portion of your unvested RSUs would vest before the end of the Vesting Period if certain conditions are met. The most common acceleration language is "Double Trigger Acceleration," which provides that you vest a portion of your unvested shares if two conditions are met: (1) the company is acquired and (2) you lose your position within one year of the acquisition. If you have acceleration language, contact an attorney to help you negotiate the most favorable language. The devil is in the details. (Stock Option Counsel = legal services available to individual employees to guide them on their negotiation and sale of startup stock.)

4. Will I forfeit or otherwise lose my vested RSUs if I leave the company?

For stock and stock issued upon exercise of stock options, some companies keep the right to repurchase your stock when you leave the company even if it is already vested ("Repurchase Rights"). Some companies have similar restrictions on RSUs, so watch out. This greatly reduces the value of your grant because it is not really "yours" even after the vesting period if, for example, you are no longer at the company when it is acquired or goes public. For RSUs it may be called "Double Trigger Vesting," which should not be confused with the employee-friendly Double Trigger Acceleration (see #3 above).

5. When will the RSUs be settled? Will the RSUs be settled in cash or stock?

A company "settles" its RSUs when it gives you either cash or stock. Unlike stock options, you may not receive anything for the RSUs at the time they vest. In other words, the company may delay "settling" the RSUs. The company's Stock Plan will tell you whether you will receive the RSUs at vesting, at an IPO  or sale of the company, or some other deferred time. The deferral is usually in your best interests, as it prevents you from paying tax before a liquidity event. However, it can prevent you from selling your startup stock before your company goes public or is acquired.

The company's Stock Plan will also tell you whether the company plans to "settle" the RSUs with (aka "give you") company stock or the cash value of the company's stock.

Knowing when and how the company settles your RSUs will help you with your tax planning.

6. When the company settles the RSUs and income tax is due, how will that be handled? Will I pay payroll ("FICA Taxes") taxes when the shares vest or when they are settled?

Fortunately, you will not pay taxes on RSUs at the time they are granted to you. Taxes are deferred until actual or constructive receipt of the stock or cash settlement.

Unfortunately, RSUs do not have the capital gains tax advantages of restricted stock or stock options. They are simply compensation income to you when you receive them (either at vesting or settlement). That means you owe ordinary income taxes and FICA taxes for their value as if you had received cash. Ugh.

In most cases, you will not pay income tax or FICA Taxes on RSUs until they are "settled." The company can make arrangements so that you do not have to pay these in cash out of pocket, but you will be responsible for the tax in some way. For example, the company may sell a portion of your stock for you to cover the income taxes. It's best to know the company's plan on this so that you are not caught by surprise in your tax planning. 

7. Questions? Contact Stock Option Counsel

Stock Option Counsel legal services are available to guide individual employees and founders on their startup stock. We specialize in helping employees who are evaluating and negotiating job offers with startup stock. Contact us with any questions at (650) 326-3412 or at http://stockoptioncounsel.com/contact/. 

VIDEO Startup Stock Options: Startup Valuation

Stock Option Counsel for individual employees and founders in all matters relating to startup stock options or other employee stock. This video describes startup valuation for employees in a thoughtful, accessible way. Call us when you want to evaluate, maximize or monetize your stock options or other startup stock. (650) 326-3412. www.stockoptioncounsel.com. info@stockoptioncounsel.com.

VIDEO Startup Stock Options: Exercise Price Basics

Stock Option Counsel for individual employees and founders in all matters relating to startup stock options or other employee stock. This video describes stock options in a simple, accessible way. Call us when you want to evaluate, maximize or monetize your stock options or other startup stock. (650) 326-3412. www.stockoptioncounsel.com. info@stockoptioncounsel.com.

Negotiation Rhythms #3: Sales & Threats

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.

There are two ways to increase or decrease another party’s limit in a negotiation – sales and threats.[1] The picture above takes some of the mystery out of the salesman and the thug -- they're both just working as negotiators to change the perception of the current offer in comparison to the other party's BATNA – Best Alternative to Negotiated Agreement.

Selling improves the perception of the quality of the present offer so that the outside alternatives are unattractive by comparison. Threats decrease the attractiveness of outside offers or the possibility of making no deal and sticking with the status quo.

Threats

An ongoing employment lawsuit over no-hire agreements among Silicon Valley companies featuring Steve Jobs provides a strangely relevant example of the power of threats. 

Edward Colligan, former CEO of Palm, has said in a statement that Jobs was concerned about Palm’s hiring of Apple employees and that Jobs “proposed an arrangement between Palm and Apple“ [2] to prohibit either party from recruiting the others' employees.

That would have been a simple offer of an agreement (however illegal that arrangement might have been) if Colligan had access to the undisturbed alternative of not participating and keeping the status quo.

But Colligan has said that Jobs’ next negotiation move was to make the alternative of nonparticipation very unappealing with the threat of patent lawsuits that would cost Palm and Apple a great deal of money. Jobs followed this threat with a reminder of just how unpleasant such litigation would be for Palm, considering the fact that Apple had vast resources to endlessly pursue the lawsuits: "I’m sure you realize the asymmetry in the financial resources of our respective companies …."[2]

Even though most of us don’t use threats in a negotiation, it’s part of the logic of negotiation rhythms. 

Selling

Selling is the more common (and generally legal) way to address the fact that the other party has choices outside the present negotiation. As we discussed in the prior posts, a party's price or terms limits are defined by his or her best alternative outside of making an agreement in the present negotiation. Selling moves the limit when it can make the present offer more appealing than what had been perceived as an outside alternative.

Many people resist “selling themselves” in a salary negotiation because they are embarrassed to discuss their “value.” The logic of BATNA and negotiations provides some relief from this embarrassment, for it reframes “selling” from bluffing and puffing to describing and distinguishing one’s past experience and intended role in the organization.

Since the employer’s limit is not defined by an individual’s value, but by the employee’s differentiation from the field of candidates, the task of negotiating becomes more fact-based and less fear-driven. This logic encourages progress from the attitude of “Oh, they see who I am and hate me,” toward the sales approach of “Oh, it seems they need more information about what I offer in terms of my past experience and my role going forward.”

As an employee’s offer of services becomes distinguishable from the employer’s alternatives, the employer’s perception of the BATNA will change.

Consider an employer who believes there’s an equal candidate available for $120,000 and is entertaining another’s proposal to perform the role for $140,000. Without “selling” the offer of one’s services, the employer has no information with which to make a distinction between the two alternatives. The process of selling oneself to the employer is not to prove one’s inner worthiness at $140,000, but to show and tell that the employer is choosing between two distinguishable candidates. 

(For those still interested in threats, distinguishing one’s skills is a form of a threat when it comes to negotiating with a current employer. Every element of the description one’s current performance and ongoing role is a threat of what the employer would have to work without or try to replace.)

What an employer would have once considered a better alternative – such as another equal offer for $120,000 – loses its appeal in light of the truth (sales pitch) of the $140,000 offer. If they are no longer equal in the mind of the employer, he or she must consciously decide if the other candidate at the lower price is still a better alternative. While there is no guarantee that the employer will prefer to pay more, the process of selling pushes the employer to the choice based on the true distinctions in the qualities of the candidates.

Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their salary, 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.

[1] Roger Fisher, William Ury and Bruce Patton, Getting to Yes: Negotiating Agreement Without Giving In. Gerald B. Wetlaufer, The Rhetorics of Negotiation (posted to SSRI).

[2] http://vrge.co/USNorq