Silicon Valley Wins Big With Tax Break Aimed at Small Businesses: An eight-figure IPO windfall can mean a zero-digit tax bill
"If you planned well, you ended up with a phenomenal result," says Mary Russell, an attorney at Stock Option Counsel in Palo Alto, Calif., who advises tech employees on their compensation. "If you didn’t, you were in a really tight, messy spot." Photo by Mikhail Nilov.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Startup equity and Stock Option Counsel, P.C. in Bloomberg Business this week:
“While venture investors and founders, who can afford top-notch tax advice, are using [the Qualified Small Business Stock tax provision to take advantage of 0% tax rates on startup gains], tech workers might not be as lucky. The rules are complicated, and it can be easy to miss out. For example, early employees needed to have exercised options at a time when their startup was still under $50 million in assets. ‘If you planned well, you ended up with a phenomenal result,’ says Mary Russell, an attorney at Stock Option Counsel in Palo Alto, Calif., who advises tech employees on their compensation. ‘If you didn’t, you were in a really tight, messy spot.’”
For more information about planning for option exercises, see The Menu of Stock Option Exercise Strategies. Happy strategizing!
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Uber IPO - Lessons for Negotiating Startup Equity Offers - Spring 2019 Newsletter - Stock Option Counsel, P.C. - Legal Services for Individuals
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Hello Startup Community!
Uber's IPO is a great lesson for startup employees on negotiating their startup equity. Unicorn startup recruiters have been telling hires for the past few years to value the offered RSUs at many multiples, even 10X, of the most recent investor valuation in negotiating their compensation offers. Since Uber's value has not risen even 2X in that time, any hires who accepted offers based on this calculus have lost significant value compared to their opportunity cost.
Individuals need negotiate for enough shares in a startup to balance their risk. The calculation for the right number of RSUs at a late-stage startup with a public-company-size valuation is the current investor value per share, not the potentialfuture value.
Shira Ovide explored this issue in Bloomberg Opinion last week with input from Stock Option Counsel:
Uber's example shows that employees at startups – particularly those who come aboard when the company is more mature – often don't get rich, even when the companies are successful. Many workers are at the bottom rung of stock holders and tend to have less information about their company's value and prospects than just about anyone else who holds shares. ... Mary Russell of Stock Option Counsel, which advises employees on compensation at startups, said people evaluating job offers at more mature startups should analyze only what the proposed equity is worth at the time of negotiation, not what it could possibly be worth in a dreamy future. That’s not always easy, because Russell said startup recruiters sometimes suggest that a 10-fold increase in valuation in the past is an indication of what prospective employees can expect from their wealth.
For more on using current value to evaluate startup equity offers, see this video from the Stock Option Counsel blog.
Stock Option Counsel, P.C. - Legal Services for Individuals. Thank you for your enthusiasm for my practice and for the Stock Option Counsel Blog! I will continue to send quarterly updates on important topics in the market for startup equity for individual founders, executives and employees. Please keep in touch.
Best,
Mary
Mary Russell | Attorney and Founder
Stock Option Counsel, P.C. | Legal Services for Individuals
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Seed Stage Startup Job Offer - Equity Negotiation Checklist
Working for a Startup? Seed Stage Startup Job Offer Equity Compensation Negotiation Checklist. Image from rawpixel.com.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Have a job offer from a seed stage startup? Individuals work for equity at seed stage startups (otherwise known as early stage startups) with the expectation that they will have great financial success if the company itself is successful. That dream can come true, but it depends on taking care of a few key details of the option or restricted stock at the offer negotiation stage. Here’s the Stock Option Counsel negotiation checklist for seed stage startup offer negotiations.
Percentage Ownership. The lore of Silicon Valley is that anyone who joins an early stage startup that is later a huge success will become rich. But if they fail to negotiate a significant number of shares at hire, they cannot expect that the value of their interest at the time of an acquisition or IPO will be impressive. Since being one of the first startup employees is extremely risky, there needs to be enough equity in the offer to balance that risk. I have seen individuals who are disappointed (to say the least) in these situations when they have accepted a below-market equity percentage and assumed that the founders would “take care of them” in the future. With these points in mind, I recommend taking the following steps before agreeing to join a startup:
Negotiate for enough shares up-front to balance the risk in joining the company. This is based on market norms, so do plenty of research among colleagues and advisors to confidently set market-based expectations.
Insist on time-based, not performance or milestone, vesting.
Expect that the equity interest will be significantly diluted and negotiate for enough shares to cover that expectation.
Making it Official. At the earliest stage startups, employees and founders often work for promises of future equity without signing the necessary paperwork to ensure that they have the legal right to that equity. They often start working with vague promises of future grants and “trust” that their business partners will “take care of them” in the future. This is misguided, as the purpose of a stock option grant or any written agreement is to not have to rely solely on the trust you have in any individual person. Since changes in leadership, investors, direction, etc. are guaranteed to happen at some point in time, you need protection from the company not promises from the current leaders. Before signing an Offer Letter or beginning work, I suggest to first:
Ask for a copy of the Form of Stock Option Grant or Restricted Stock Purchase Agreement, along with any other documents referenced therein. Review the terms and negotiate any issues.
Ask the company to confirm that the board will officially make the equity grant promptly after hire.
Board Approval Timing. Early stage startup companies often delay officially making grants to the detriment of their employees. This is due to administrative disorganization, a desire to delay the legal and valuation expenses of making the grant, or even a disagreement among executives and investors about how much equity should be allocated for employee grants. After starting in the role, take the following steps:
Follow up to be sure the grant is made by the board promptly. This should not take more than a couple of months.
Compare the terms of the grant to be sure they are as-agreed during the offer negotiation stage.
Tax Planning. The potential tax benefits to receiving equity in an early stage startup are unparallelled. The structure may allow for tax deferral until sale of stock - which avoids the problem of paying taxes on option exercise before liquidity - and lower capital gains tax rates or even 0% QSBS tax rates on gains. Achieving these tax benefits requires precise design by the company - such as restricted stock or early exercised stock options - and effective execution by the individual - such as the timely delivery of the purchase price and filing of the Section 83(b) election with the IRS. Early tax planning action items are:
Negotiate the tax structure during the offer negotiation stage. The right structure will depend on the stage of the company, so work with advisors if necessary to determine the most desirable structure for your grant.
Take care of the required follow-through to take advantage of the most desirable tax structures.
Legal Terms. Startup employees are sometimes very surprised by the legal terms in their grant years after they have accepted its terms. They might have assumed that they have the right to hold the shares that they have purchased and vested and find out that the company can forcibly repurchase the shares at their termination. Or they might assume that they have the right to earn their unvested shares following an acquisition but find out that they can be cancelled as part of the deal without payment. To avoid these and other unpleasant surprises regarding the legal terms of a grant, take the following steps during negotiation:
Ask for a copy of the Form of Stock Option Grant or Restricted Stock Purchase Agreement, along with any other documents referenced therein.
Review the terms and negotiate any issues before committing to joining.
If the legal terms have unexpected risks, negotiate for more shares or more cash compensation to balance the risk.
Have an offer from a seed stage startup? Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Winter 2019 Newsletter - Stock Option Counsel® - Startup Offer Letter? The Equity Issues Hidden Between the Lines
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Hello Startup Community!
If you have an Offer Letter from a startup, you may notice that it’s light on information about stock options or other equity. See this new post on the Stock Option Counsel Blog to learn the key issues hidden between the lines. It covers:
Grant Timing. The exercise price is not negotiable, but you will want to follow up after your start date to be sure that the board grants the options promptly. Delays are common and can increase the exercise price dramatically and reduce the value of your stock options.
Protection for Unvested Shares. The standard vesting schedule will not protect unvested shares in an acquisition. Consider negotiating for double trigger acceleration upon change of control.
Clawbacks and Other Red Flags. The equity incentive plan and stock option agreement are usually not provided with the Offer Letter. However, it makes sense to request and review those documents before signing the Offer Letter to identify clawbacks for vested shares or any other red flag terms
Tax Structure. The right tax structure will balance your interests in total value, low tax rates, tax deferral, limited tax risks and investment deferral.
You can see the full post on the Stock Option Counsel Blog, along with other great information on startup equity negotiations. Happy reading.
Stock Option Counsel, P.C. - Legal Services for Individuals. Thank you for your enthusiasm for my practice and for the Stock Option Counsel Blog! I will continue to send quarterly updates on important topics in the market for startup equity for individual founders, executives and employees. Please keep in touch.
Best,
Mary
Mary Russell | Attorney and Founder
Stock Option Counsel, P.C. | Legal Services for Individuals
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Have an Offer Letter from a Startup? The Equity Issues are Between the Lines
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Working for a startup? Learn more about the fine print terms of an offer letter. Plan ahead to protect your equity stake.
If you have an Offer Letter from a startup, you may notice that it’s light on information about stock options. You may see a few sentences noting that (1) the company will recommend to the board that the grant be made at the first market value on the date of grant; (2) the option will vest monthly over four years with a one-year cliff; and (3) the option will be governed by the company’s equity incentive plan and your stock option agreement. It sounds simple. But the key issues are hidden between the lines.
Change of Control Protections for Unvested Shares
A standard vesting schedule does not provide protection for unvested shares in the event the company is acquired. If you are joining in a senior position or as an early stage employee, consider negotiating for a double trigger acceleration upon change of control to protect the right to earn unvested shares. The most robust double trigger language would provide that 100% of unvested shares will accelerate if you are terminated or constructively terminated as part of or at any time following a change of control. See this blog post for more information on change of control terms for startup equity offers.
Clawbacks for Vested Shares
The equity incentive plan and stock option agreement are usually not provided with the Offer Letter unless requested, as the official equity grant is not made until after the start date. However, these agreements contain important details about the grant, so it makes sense to review them before agreeing to the number of shares or signing the Offer Letter.
For example, the equity incentive plan and stock option agreement may give the company the right to forcibly repurchase shares from the employee after termination of employment, even if they are vested shares of restricted stock or vested shares issued upon exercise of options. See this post for some examples of how those clawbacks may be drafted. Clawbacks dramatically limit the value of the equity, as the most significant increase in the value of startups has historically been at the time of an exit event. If this term, or any other red flag term, appears in the form documents, it makes sense to negotiate these out of the deal or provide for alternative compensation to make up for the potential loss in value before signing the Offer Letter.
Tax Structure
The Offer Letter may not include the terms of the tax structure, but if you have any leverage on those terms the Offer Letter negotiation is the time to address them. The right tax structure will balance your interests in total value, low tax rates, tax deferral, limited tax risks and investment deferral. This balance is different at each company stage. For example, at the earliest stage startups you may be able to meet all those goals with the purchase of Restricted Stock for a de minimis purchase price. At mid-stage startups you might prefer to have Incentive Stock Options with an extended post-termination exercise period to defer the investment until a liquidity event. At late-stage startups you might prefer Restricted Stock Units for a full value grant. See this blog post on Examples of Good Startup Equity Design by Company Stage and this blog post on The Menu of Stock Option Exercise Strategies.
Grant Timing
The company will set the exercise price at the fair market value ("FMV") on the date the board grants the options to you. This price is not negotiable, but to protect your interests you want to follow up after your start date to be sure that the board makes the grant of the options soon after your start date. If they delay granting you the options until after a financing or other important event, the FMV and the exercise price will go up. This would reduce the value of your stock options by the increase in value of the company’s common stock during that time.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Fall 2018 Newsletter - Stock Option Counsel®
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Hello Startup Community!
Here's the big news in the world of startup equity.
Leaked Compensation Data for Startup Executives from Andreessen Horowitz. Business Insider has published a database of startup executive compensation data leaked from Andreessen Horowitz. It was sourced from executive search firms and is searchable by fundraising stage. This data may be valuable to startup executives negotiating their compensation and interesting to anyone curious to know how much executives in the startup world earn in cash and equity.
How to Use the Data. The data reveals that the level defined for a role can dramatically affect the compensation offer. For example, the difference between the compensation for a CMO and a VP of Marketing at a Series A company would be significant in both cash and equity. In counseling individuals on their compensation negotiations, I see the most significant increases in cash and equity from successful re-leveling arguments. Read more on my blog about how to use leveling to negotiate the right startup offer or contact me for information on my services.
Pay Gap for Startup Equity. I was recently interviewed by Bloomberg for an article on the gender pay gap for startup equity. They featured a study by Carta which found that women "make up 35 percent of equity-holding employees, but hold only 20 percent of the employee equity," and, further, that women make up "13 percent of founders but hold 6 percent of founder equity." I noted that one reason for the gap may be a lack of willingness to push for information necessary to evaluate a startup equity offer: "Equity is information asymmetry squared. You have to have the confidence to put the responsibility on the company to give you enough information."
Closing the Information Gap. It's up to individuals to educate themselves on equity and negotiate for the right number of shares to balance the risk of joining a startup. The purpose of my practice is to be available to those who need guidance in this process. See my website for more information.
Stock Option Counsel, P.C. - Legal Services for Individuals. Thank you for your enthusiasm for my practice and for the Stock Option Counsel Blog! I will continue to send quarterly updates on important topics in the market for startup equity for individual founders, executives and employees. Please keep in touch.
Best,
Mary
Mary Russell | Attorney and Founder
Stock Option Counsel, P.C. | Legal Services for Individuals
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
New Blog on Change of Control Terms - New Videos - Summer 2018 Newsletter - Stock Option Counsel, P.C
New video for individuals negotiating startup equity offers explaining the difference between startup valuation and 409A valuation.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.Hello Startup Community!
Here's the latest on startup equity for individual founders, executives and employees.
Negotiating Change of Control Protections for Unvested Shares. See my newest post on the four categories of change of control terms, from the worst of the worst - cancellation plans - to the best of the best - single trigger acceleration. It also provides current market info on which terms executives, employees and founders can reasonably expect to negotiate in their offers.
Liquidation Preferences Make the News. FanDuel's $465 million acquisition deal reported by Legal Sports Report shows the power of liquidation preferences. Ordinary shares will receive $0 in the deal because of preferred shares' $543 million liquidation preference. See this post for more info on liquidation preferences and this post on how startup executives consider these in negotiating their offers.
New Videos! Check out new videos on:
Stock Option Counsel, P.C. - Legal Services for Individuals. Thank you for your enthusiasm for my practice and for the Stock Option Counsel Blog! I will continue to send quarterly updates on important topics in the market for startup equity for individual founders, executives and employees. Please keep in touch.
Best,
Mary
Mary Russell | Attorney and Founder
Stock Option Counsel, P.C. | Legal Services for Individuals
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
VIDEO: Founder Restricted Stock Purchase Agreements
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Are you a founder with a restricted stock purchase agreement (RSPA)? Protect your equity stake with change of control vesting acceleration, Section 83(b) election and fine print details.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
VIDEO Startup Stock Options: Exercise Price Basics
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Tax Changes for Startup Executives and Employees - Tax Cuts and Jobs Act of 2017 - Q1 2018 Newsletter - Stock Option Counsel, P.C.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Here's our Q1 2018 Newsletter. Sign up for our mailing list to receive these quarterly updates!
Hello Startup Community!
The final Tax Cuts and Jobs Act of 2017 is already affecting startup equity holders. Check out my recent blog posts on Tax-Deferred Option Exercises Under the New Section 83(i) and Incentive Stock Options & Changes to the Alternative Minimum Tax. Here's the short version.
Tax Deferral for Option Exercise - New Section 83(i) Election. The new Section 83(i) was designed to defer taxation from a stock option exercise until the shares become liquid. Unfortunately, the details of the new Section 83(i) make it unlikely to work for most startup option holders. But where it does apply it will defer taxation for up to five years from the date of option exercise with the use of the new Section 83(i) Election. These are the key details of the new Section 83(i).
Tax Relief for ISO Exercise - New AMT Limits. Dramatic increases to the exemption amounts and phase out thresholds of the Alternative Minimum Tax (AMT) will allow many more startup employees to exercise Incentive Stock Options (ISOs) tax-free. This allows for more planning opportunities to take advantage of the potential ISO tax benefits of capital gains tax rates on all gains. These are the key details of the AMT changes as they relate to ISO exercise.
Startup Offer Negotiation Tips. What does this mean for our clients negotiating new stock option offers? First, the new Section 83(i) will not provide wide relief from pre-liquidity tax burdens for stock option exercise. So it still makes sense to negotiate for a tax-deferred structure such as early exercise or an extended post-termination exercise period. Second, since the revised AMT limits make the ISO benefits even more appealing than ever, ISOs are far more appealing than NSOs for most people (unless the options will be early exercised.)
Stock Option Counsel, P.C. - Legal Services for Individuals. Thank you for your enthusiasm for my practice and for the Stock Option Counsel Blog! I will continue to send quarterly updates on important topics in the market for startup equity for individual founders, executives and employees. Please keep in touch.
Best,
Mary
Mary Russell | Attorney and Founder
Stock Option Counsel, P.C. | Legal Services for Individuals
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Tax-Deferred Option Exercises Under The New Section 83(i) - Tax Cuts and Jobs Act of 2017
Update December 2024: I still have not seen anyone take advantage of Section 83(i). Sigh. It’s just not drafted in a way that can be helpful. Mostly I just see people confusing it with 83(b).
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
The final Tax Cuts and Jobs Act of 2017 added a new Section 83(i) to the Code intending to allow holders of RSUs and options to defer tax on those benefits until they are able to sell the shares to cover their tax bills. Its drafting makes it unlikely to apply in practice at most startups, but where it applies it can defer taxation for up to five years from the date of option exercise or RSU vesting.
Many issues related to the Section 83(i) Election are unclear from the legislation and will need to be clarified by IRS guidance. So this is the best of my understanding as of today. This is not tax advice for readers, so please consult with your own accountant or CPA.
Update December 2024: I still have not seen anyone take advantage of Section 83(i). Sigh. It’s just not drafted in a way that can be helpful. Mostly I just see people confusing it with 83(b).
Option Exercises & Section 83(i) Election
Because well-designed startup RSUs are already structured to defer taxation until liquidity, the benefits of tax deferral under Section 83(i) are most needed for option exercises.
For eligible option exercises, a timely election under Section 83(i) will defer income at exercise until the earlier of the (i) IPO; (ii) the first date the stock becomes transferable (including to the employer), (iii) five years from exercise, (iv) the first date the employee becomes an “excluded employee,” or (v) the date the election is revoked. The 83(i) Election must be made within a 30-day period after exercise.
These are some of the eligibility requirements:
1. The company must have offered stock options on terms that provide the same rights and privileges (other than the number of shares) in the calendar year of grant to at least 80% of its U.S. employees. Since most startups do not make annual grants of stock options, this would be unlikely to apply except in years of very high growth in staff size, or to the occasional startup that gives broad-based annual refresh grants.
2. The individual must not be a significant owner or executive of the company. The ownership test is met by 1% ownership. The executive test relates to role, such as CEO and CFO, as well as total compensation, as it applies to the four most highly compensated officers of the company. Both definitions have historical applicability, such as a 10-year look back, as well as future applicability, so that if one of the definitions is met after the Section 83(i) Election, the individual becomes an “excluded employee” and the tax deferral ends.
Section 83(i) Notice
Companies are required to provide a Section 83(i) Notice to eligible employees at the time (or a reasonable period before) they become eligible to make the Section 83(i) Election. However, not all eligible employees will be aware of their eligibility, as some companies may still be in the process of assessing eligibility. Therefore, those considering option exercises at private companies may want to inquire as follows:
I understand that the new tax bill created a Section 83(i) Election to allow deferral of taxation at option exercise until the earlier of 5 years from exercise or liquidity. But there are certain rules that have to be met for an option to be eligible, including related to the company’s option grant practices, my own ownership percentage and other requirements. Can you please confirm whether, if I exercise this option, I will be eligible to make a Section 83(i) Election on the stock I purchase?
Making the Section 83(i) Election Decision
Individuals who are eligible to make the Section 83(i) Election will want to consider the pros and cons based on the tax consequences and their investment plans. For example, exercising options and filing the Section 83(i) Election will not solve the pre-liquidity taxation problem if there is not a liquidity event before the five-year (or earlier) deadline. And the Section 83(i) Election converts ISOs into NQSO, so any favorable tax treatment associated with ISOs would be lost. Since the alternative minimum tax exemptions have increased so dramatically, ISOs are more likely to be AMT-free at exercise. Such an ISO exercise may ultimately result in more favorable tax treatment than the Section 83(i) Election, if the shares are held for the full ISO holding periods. And, as in any option exercise, paying the exercise price itself is an investment risk and having a tax-deferred exercise does not make the exercise risk-free.
Negotiating New Offers
All well-negotiated startup equity offers include planning for investment timing, tax timing and tax rates. While the Section 83(i) Election is a new tool in that toolbox, it is not likely to be the most advantageous planning method for new grants. See this post for some examples of my favorite structures for equity offer negotiations.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Incentive Stock Options and the Alternative Minimum Tax - Changes under the Tax Cuts and Jobs Act of 2017
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
The final Tax Cuts and Jobs Act of 2017 will reduce Alternative Minimum Tax ("AMT") bills for many who exercise Incentive Stock Options ("ISOs") in two ways - one direct and one indirect.
First, the bill increased exemption amounts and phase-out thresholds for the AMT as follows:
The increased AMT exemption decreases the likelihood of triggering AMT at exercise of ISOs. For those ISO exercises that do trigger AMT, the increased AMT phase-out threshold may reduce the amount of AMT due. The result of these changes is a maximum savings of $18,000 for an individual exercising ISOs.
Second, the bill reduced or repealed several triggers of the prior AMT, such as state and local tax deductions. This reduces the number of taxpayers who will need to use their AMT exemption amount for non-ISO AMT items. According to Joe Rosenberg of the Tax Policy Center, as quoted in the Wall Street Journal, only about 200,000 returns will be subject to AMT in 2018 down from approximately five million in 2017. So starting in 2018 most taxpayers will not have “used up” the AMT exemption amount on non-ISO related items and therefore will be able to use the entire AMT exemption amount to offset gains at exercise of options. In addition, these new thresholds may trigger the release of AMT credit carryovers.
“These changes are somewhat anticlimactic after legislators almost repealed the entire Alternative Minimum Tax, which would have made all ISO exercises tax-free. But they may result in savings of up to approximately $18,000 in AMT for a ISO exercise.”
What does this mean for existing ISO grants?
These changes are somewhat anticlimactic after legislators almost repealed the entire Alternative Minimum Tax, which would have made all ISO exercises tax-free. But they may result in savings of up to approximately $18,000 in AMT for a ISO exercise. So it makes sense to work with your tax advisor and/or financial planner to decide if/when to exercise to take advantage of the benefits of the new rules. Here are some choices on ISO exercise:
1. Early exercise some ISOs prior to vesting (if allowed under grant documents);
This is a tax planning maneuver to start your capital gains holding period and avoid paying taxes at exercise. (If you have ISOs you are considering for early exercise, you might prefer to have them converted into NSOs before early exercising. See more on this issue here.)
2. Exercise some ISOs after vesting and prior to liquidity; or
Precisely planning your ISO exercises can allow you to take advantage of the ISO benefits, which will be more favorable under the revised AMT limits. Work with your accountant or financial advisor to determine precisely how many ISOs can be exercised per year to fall within the AMT exemption amount for your phase-out threshold status.
3. Wait to exercise all ISOs until the shares will be sold to pay the taxes due at liquidity and the exercise price.
This is likely to have the highest tax rates but the lowest investment risk. However, if the ISOs expire early at employment termination, leaving your job may make this impossible. More on this issue here.
What does this mean for negotiating a new stock option offer?
ISOs are more favorable than NSOs (unless you are early exercising while the exercise price is equal to the FMV). The revised AMT limits make their benefits even more appealing. So, if you are negotiating a stock option offer, make sure the grant will qualify as ISOs up to the limits under the law.
I would be happy to hear from you if you are navigating an existing option grant or negotiating a new offer. For more information, please see this FAQ or contact me at (650) 326-3412 or by email.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Watching the Tax Bill - Fall 2017 Newsletter - Stock Option Counsel, P.C.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
This is our Fall 2017 Newsletter. Sign up for our mailing list to receive these quarterly updates!
Please note: This is an update on the bill as it was in process. Please see our later posts for the final outcomes on these points!
Hello Startup Community!
The Senate and House have each passed tax reform bills that include provisions related to startup equity. When they pass a final bill, I will send an update on how it affects individuals in the startup community. As of today:
Final Deal Before Christmas? Congress is working to reconcile the Senate and House versions before Christmas. The Wall Street Journal reported today that House and Senate Republicans have agreed on the final version and expect to vote next week.
Tax-Deferral for Stock Option Exercise? Both the Senate and House versions include a tax-deferral opportunity for certain startup employees who exercise stock options or settle RSUs before they have liquidity for the shares. However, the rules are quite restrictive and not well-aligned with the current practices of most startups, so this is not likely to be a benefit for most startup employees who have outstanding stock options.
Eliminate AMT? The House bill would eliminate the Alternative Minimum Tax for individuals. If this is part of the final bill, it would allow for tax-free exercise of Incentive Stock Options. The House bill also modifies the timing for use of existing AMT tax credits.
Restrictions on Sale of Stock? The Senate's bill also included a first-in, first-out rule for stock sales. This would affect startup stockholders who participate in secondary sales or tender offers and those who sell stock after an IPO. It could limit their planning opportunities for tax-deferral and Qualified Small Business Stock exclusions.
Stock Option Counsel, P.C. - Legal Services for Individuals
Thank you for your enthusiasm for my practice and the Stock Option Counsel Blog. I will continue to send quarterly updates on important topics in the market for startup equity for individual founders, executives and employees. Please keep in touch.
Best,
Mary
Mary Russell | Attorney and Founder
Stock Option Counsel, P.C. | Legal Services for Individuals
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Welcome East Bay BioNetwork!
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
This is a "handout" for an event on October 12, 2017 for the East Bay BioNetwork.
I’m Mary Russell and the founder of Stock Option Counsel, P.C. – Legal Services for Individuals. I serve as attorney counsel to individuals on their personal interests in startup equity including job offers, equity grants and employment agreements, founder interests at incorporation, financings, and exits, and executive compensation design.
Evaluating Startup Equity Offers
I regularly counsel individuals who are evaluating equity offers from venture capital backed startups. In our conversation today, we will discuss key factors in these evaluations. You can use this blog post to follow along and use the links below for further information.
1. How can I evaluate the number of shares in a startup equity offer?
Early Stage (Seed): Percentage Ownership + Relative Ownership
Mid-Stage: Percentage Ownership + Recent Investor Value/Share + Leveling
Late-Stage (Unicorn): Recent Investor Value/Share + Public Company Comps
2. What equity documentation requires review?
Equity Incentive Plan
Forms of Stock Option Grant Notice, Stock Option Agreement and Exercise Notice
Any other documents referenced therein
3. What happens to my shares when I leave the company?
Assuming you own vested shares (i.e. you have exercised your stock options) or have time-vested RSUs:
Standard: You have the right to hold your shares or RSU rights until company acquisition or IPO
Value-Limiting: Company can force repurchase or forfeiture at termination (aka clawbacks)
4. What happens to the unvested equity at company acquisition?
Best: Single Trigger Acceleration
Good: Double Trigger Acceleration
Neutral: Continued vesting of value of unvested equity if you stay in service after closing
5. Is this a favorable design for tax rates and tax and investment timing?
Early Stage: Restricted Stock or Early Exercise Stock Options
Mid-Stage: Stock Options with Extended Exercise Period
Late Stage: Restricted Stock Units
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
The Good Stuff - Continuation Plans - How To Avoid the Juno Drivers' Fate of Cancelled RSUs in a $200 Million Acquisition
If you're negotiating a startup equity offer, ask for the good stuff - a Continuation Plan - or even more favorable single or double trigger acceleration terms. Photo by Erik Mclean.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Bloomberg reported on startup Juno's rescission of driver’s RSU awards in its $200 acquisition by Gett. They reported that Juno promised 50% of founders shares to drivers, but that it appears that the maximum portion of the acquisition price they could have received was 1.5%.
What was the disconnect? A type of startup equity plan - a Cancellation Plan - that can dramatically limit the value of employee equity grants.
Some startup stock plans allow companies to cancel unvested equity in an acquisition without payment for the shares, even if the employees holding that unvested equity stay in service after the closing of the deal. We'll call these Cancellation Plans. (You can read more on all the variations of change of control terms in startup equity offers here.)
The standard for startup stock plans has historically been that unvested employee equity must be continued or substituted in an acquisition rather than cancelled without payment. We'll call these Continuation Plans. This means they must be replaced with either cash or equity awards with the same value as the deal consideration for the shares being cancelled. If they are not replaced for the deal value, their vesting will be immediately accelerated at the acquisition and paid the entire deal price for the vested and unvested shares. The replacement still must be earned over the original vesting schedule, so there's no guarantee of earning the unvested shares without also having single or double acceleration upon change of control protections. However, this traditional requirement offered protection of value for employees. Those who stay at the acquiring company under a Continuation Plan will continue to earn the deal consideration for their shares in some other form.
The Cancellation Plans that allow cancellation of in-the-money unvested equity without payment are grabbing value from employee shares. Unvested equity - RSUs, options, etc. - can be cancelled and replaced with $0. For example, if an employee's total number of RSUs were worth $200,000 at the acquisition price, and only 50% had vested at the acquisition, the employee would be paid $100,000 and the remaining $100,000 in value of RSUs would be cancelled without payment, continuation or substitution even if the employee stays as an employee after the acquisition.
In a Continuation Plan, an employee would receive the $100,000 deal consideration for the vested shares and a substitution or continuation award in exchange for the $100,000 in unvested value. That might be in the form of cash to vest over time, continuing awards in the acquired company if it survives the merger, or substitute value of the acquiring company's equity, such as RSUs worth $100,000 in value of the acquiring company. Any such replacements would continue to vest over the original remaining vesting schedule.
When Juno, a ride-sharing app which promised 50% of its founders shares to drivers in the form of RSUs, was acquired by Gett for $200 million, they cancelled without payment all RSUs it had awarded and promised to drivers. The merger terms were not made public, but it appears that Juno had a Cancellation Plan allowing the company the right - which they exercised - to cancel unvested RSUs. All RSUs would have been unvested as the drivers reportedly had to work for 30 months to time-vest any of their RSUs and less than a year had passed between the grants and the acquisition.
The drivers instead received a one-time payment, which appears to be dramatically lower than the RSUs would have been valued in the acquisition. It was reported that the maximum portion of the acquisition price they could have received was 1.5%. It's not entirely clear that this is the case, as drivers report that they were never notified of their percentage ownership in the company at the time of the acquisition. But if the paltry payouts - one example was $250 to a driver - were actually at the deal consideration for the deal, it would mean that the original awards were such a low percentage of the company that they would have crossed into absurdity. Therefore, it safe to assume that Juno had a Cancellation Plan and it used it to cut its drivers out of a $200 million acquisition, less than a year after promising its drivers 50% of the company's equity. Ouch.
So if you're negotiating a startup equity offer, ask for the good stuff - a Continuation Plan - or even more favorable single or double trigger acceleration terms. More on those variations here.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.