Faux Golden Handcuffs: A Tale of Startup Stock Options

When you join a startup as a full-time employee, part of the package includes stock options. It is actually kind of funny how these are presented, as most employees choose to work for a startup for a lower salary than what they’d make at any large business, and in exchange for this lower salary they get some number of options. That sounds fancy, but really what it means is that when you join the company, you’re provided the right to buy X number of shares at their current strike price.

Now, if you join a company very early on, this strike price could be extremely low. For instance, if you get options valued at 5 cents per share as one of the first 10 employees of a company, and one day the company sells for $5 a share or IPOs at this rate and holds it value for a 6-month no-sell period, you have a sizable profit per share, even after taxes. So if you had 1000 shares you’d make $5000 minus the $50 you’d have to pay to buy the stock options. Minus your tax rate, or if you exercise early (will explain below), a lower tax rate. Not bad, you did pretty well for yourself. Especially if you negotiated many more than 1000 options, say, 100,000, or 200,000. Suddenly a $5 sale price could be worth millions. Hence, the golden handcuffs.

But these handcuffs are fuzzy. Because besides the company having to be successful against very tough odds, there are so many other variables that go into the value of the options that few startup employees understand. Executives use this to their advantage in hiring talent on the cheap, and employees get to dream of being part of building something that could contribute to their financial freedom, or at least financial flexibility. Usually, this is just a dream. And you don’t know what those options are worth until an event many years into the future, possibly after you left the company.

Stock options are designed to keep employees around when they can go off and get a better salary some place else. They are not really designed to the benefit of the employee, though in the rare occasion when a company does well they can make the employees wealthy. There are a lot of companies that fail, very few that are huge successes like a Google or Facebook, and many more that quietly get acquired for cents on the dollar, with employees lucky if they see any increase in value on their shares. Sometimes these acquisitions are considered a success for the business, and the executives and investors profit from them, but common employees with their common stock are screwed over.

I witnessed this first hand at my last startup where, in an acquisition, I was provided the option to either sell back my handful of shares for $3 per share, or trade them in for shares of the acquiring company which were then valued at $16 per share. However, due to the acquisition terms, only accredited investors were legally able to accept the second option. Basically, you needed $1M in networth in order to trade your options in for the $16 per share opportunity. The deal that was struck was clearly designed to benefit the executives (all who were already millionaires) and not the common employee.

I didn’t complain here, however, as I had few shares and wasn’t planning on buying them – they were a gift to me upon my layoff. I walked away with a small bonus that got me through until my next job, but what I gained was the learning that options are never ever worth what they should be, and executives will do whatever it takes to bullshit you into believing their potential so you work your life away to help make them rich. Yes, the executives usually get rich well before the company sells, between their larger salary and cashing out a little in each round. But the common employee, who thinks he has this great opportunity to one day see some form of wealth, is largely deluded.

The Problem with Stock Options

  1. You have to buy them. You are given the right to buy stock options at a specific strike price. If you are a very early employee, this strike price may actually be pennies on the dollar and cheap enough to buy up front.
  2. If you don’t buy them up front (exercise early) then you have a big problem. The price of the stock will likely go up and when you do decide to buy the shares, you have to pay taxes on any interest between your strike price and the cost of the shares.
  3. You can wait until the company gets acquired or goes IPO to sell the shares, but then you have to pay alternative minimum tax on the difference. So you might pay 15% on the gains if you exercise early and 45% if you don’t. That could be a huge amount, if your company happens to be one of the few to hit it out of the park.
  4. But, if you exercise early, you don’t actually have all of your options if the company were to sell tomorrow. Most companies offer a vesting schedule. That’s a fancy term for, you don’t actually get all of your stock until you’ve worked for us for 4 years. In fact, the typical vesting schedule requires you to work for a year before accessing any of the stock, and you’ll get 25% of your shares up front and then vest the rest monthly over the next three years.
  5. If the company sells before those four years, you won’t have all the shares you were promised, even if you exercised / bought them early, unless the executive team is able to negotiate this into the contract. This would be rare for the executive team to care about their employees this much.
  6. For very early employees, this is less of a risk because it takes a while for startups to get acquired or IPO – but four years is still a long time in startup years. Instagram was acquired by Facebook for $1B when in business for under a year. So it happens. But is rare. It’s more of an issue with later stage startup employees who come in when the strike price is higher (it typically goes up with every round of funding, which is a good thing for the business, but bad for the later-stage employee) and then the cost to exercise shares is too high while they are still stuck in their deluded golden handcuffs.
  7. Later stage startup employees figure out that their options aren’t worth that much. They don’t get as many as the earlier employees because the earlier employees are given more as part of taking a risk on the young company. This makes sense to motivate early employees, but there comes a time in every startup where they are still limited on cash but aren’t able to give away as much low-price stock options, and hiring becomes a huge challenge. What’s more, later stage employees are less loyal because they know their chances of achieving any sort of wealth from the company are lower than going off and joining another startup as an earlier employee.
  8. All the time I hear people say at various startups “I’m waiting until my 1 year to leave.” This doesn’t make a lot of sense and shows just how little startup employees understand options. Stock options must be purchased within a few months of leaving the company, or they disappear. So if you decide to leave after a year, you will have a right to purchase 25% of the stock you were promised, for the strike price you were promised, and you have to pay taxes on the difference.
  9. However, if you stay at the company until an event, you don’t have to buy the options, you can wait until the event. So once the price of the options goes above the strike price you have to decide — is it worth paying for the options (which could be worthless in the future) and tax on their supposed current value that you aren’t allowed to sell them for? This is where options get really shady in my opinion.
  10. What’s worse is sometimes the value of the stock goes down. For example, an employee may join a company and be offered stock options with a strike price of $2 per share. She may decide to wait a year to be able to purchase 25% of the options and then leave the company. But after a year, it’s possible the stock price went down to $1.50. She now has options that cost $2 a share to buy but she’d only actually be getting stock worth $1.50 a share. This means she’s underwater and has a really tough decision to make. After staying out her year, does she exercise the options with the hope that one day they will at least be worth $2 per share or more in the future? And if she believe that they will be worth a lot more in the future, why is she leaving the company? Now she gets to vest monthly, so it’s easy to think “I’ll stay just another month” to obtain more shares. But this doesn’t change the fact that the shares are worth less than she would have to pay for them today, so she actually can’t leave the company. She’s seriously handcuffed.
  11. If you got in early and have a lot of shares to vest, you may actually be able to see some profit from them if the company is doing well, but this isn’t a sure thing. What you give up for this chance is flexibility in your career. If you love your job at the startup and have opportunities for growth then life is perfect. However, you are pretty much stuck in your job for four years to have access to all of your options. As I mentioned, four years in startup time is a very long time. A company you once loved working for will change. This is a natural part of business and change can be good. When you were part of a 1-20 person company the experience maybe was challenging but it likely felt amazing being part of a small team. If your company is doing well, then you may find that suddenly you look around and you’re working for something that looks exactly like the corporate culture you were trying to get away from. And you have to stay there for the 4 years to access your options.
  12. In addition to this, if you got in early and have a lot of options, you’re going to inevitably run into a big problem, especially if you’re not a VP. New management will be brought in above you and while they may have negotiated a package with a sizable amount of options as well, chances are their strike price will be higher than yours. So, if the company is doing well, your manager will ultimately be jealous that you have a lot of stock at a low strike price. If the company is doing poorly, the manager can hold the fact that you have a lot of stock over your head instead of giving you a raise, saying that you have more stock than other people in the company do and you should be grateful for that. No matter what, even if the stock options might be worthless one day, the options you received early as a risk for joining a pre-funding company or Series A company are seen as part of your total pay package… which means you probably will never make the salary you deserve, and your stock options may still be worth nothing in the end.
  13. Besides the culture challenge, the larger issue is if you’re giving up opportunities for professional growth in exchange for the hope that the stock options may one day be worth something. Again, if you like your job and can negotiate enough in terms of raises to be making near what you’re worth, then by all means, stay. But startups are unlikely to give you raises to meet what you’re worth in the market. Especially after two or three years, you’ve gained a lot of experience and that experience is more valued in another company. So you’re faced with the conundrum: stay where you are, or use this experience when the company is doing well to land another position.
  14. You can always go land another position and start over, getting stock in another company, but then this whole thing repeats itself. Maybe one day you’ll get lucky. Maybe you won’t. But you continue to be deluded into giving up the benefits that larger companies offer, like 401k match, healthcare (most startups don’t get health packages until they’ve grown to a certain number of employees, and they will not be the best health packages), opportunities for growth, etc.
  15. After you’ve been at a startup for a few years, you start playing the numbers game. For example, when you are 2 years vested, say, of 100,000 shares, and say you exercised early, you own 50,000 shares. If you stay two more years, you will own 50,000 more shares. For the sake of simplicity, let’s say you paid $.10 per share, so you paid $10,000 to purchase the shares. If you leave today, you actually get $5k back because those shares are not vested. You officially own the 50k shares. Let’s say the company does ok, but it isn’t a runaway success. The company sells for $3 a share. This isn’t bad at all and is a pretty good case scenario. You’ve made a $2 per share profit. So your 50,000 shares are now worth $100,000. But at your two years vesting mark, you look at the next two years don’t know if the company will sell for $3 per share, or $5 per share, or $20 per share, or $0 per share. If you think the company is doing well and that there’s a chance it will sell for $3 per share, then you must determine is $100k for the next two years worth it in exchange for the opportunity to move into a more senior position at another startup or to move into a larger company where the $100k difference will quickly be made up with increased salary and opportunities for growth.
  16. Still, in the back of your mind, you see that there is still a chance, albeit a tiny, tiny, tiny chance, that the stock will be one day worth more. Even though you also know there’s just as much of a chance, probably a better chance, that it will be worth $0, which at this point you actually lose all the money you paid to exercise early to buy the stock. Because even though stock options are part of your pay package, they are still an investment. This is not a big deal for the executives who likely are already millionaires, where putting down $50k on a startup is not a huge deal. But for the common employee, she may pay $5k or $10k or $20k to obtain these options, if she negotiated for a lot of options and the strike price is higher that price goes up.
  17. Employees may receive additional stock grants but just like later-stage employees they get the grant at the price the stock is valued at when they receive the stock. And these grants are usually subject to the same vesting schedule as the earlier stock, so you have to stay one year to earn the right to buy 25% of the total offer.
  18. What’s worse is what stock options do to motivation within a startup company. Later-stage employees, after the first 25, are not offered as much in terms of stock options unless they are a very key strategic hire. If the employees are talented, they quickly realize they could be paid more or get more stock options in another organization. If they aren’t talented or motivated, they may not think about this or care. But the best employees are smart, and they know that their offer of 5000 shares and below-industry pay is not worth trading in for the opportunity to advance their careers elsewhere. So unless your startup culture is amazing and your product is selling like hot cakes, people start to leave. And once the good people start to leave, it’s a trickle effect. Retention becomes a huge issue — and you can’t do anything to stop the bleeding because you’re hoarding your cash in case the business needs it, and options are now too expensive to benefit the employee.

There’s more to the problems with stock options, but these are just a few of the issues which few employees know until it is too late. It’s important, then, to always be true to yourself, and don’t fixate on the dream of wealth as a startup employee. Make sure to join a company that you believe in because of its mission, it’s executive team, and the role you will get to take on.

But I have less advice for someone who is an early employee and somewhere in the middle of vesting. What makes me saddest of all is the death of the company culture. I could work for lower salary than I’m worth with a sizable amount of stock options when I felt like I was part of growing something from nothing with a small team. As hard as it was, I loved it. I loved coming to work and knowing that the people I worked with were all as passionate as I was to build a business. When the company gets larger, even past 50 employees, that culture dies. People join the business at this point because they hear it’s a hot startup or the salary offers went up. They are less devoted to the business. It becomes just a business, no longer a dysfunctional family, and often times a dysfunctional business – natural for a company with growing pains, but uncomfortable.

As of August 1, I am 31 months of 48 months vested. I see other employees who joined around the time I did starting to pack their bags. This shows me that others — who probably know more than I do — don’t have the same faith they once did in the company. What the executive team has to tell its minions and the truth are often two very separate realities. What was a transparent, small culture, is now one filled with corporate politics, back stabbing, and other traditional business practices. It makes me uncomfortable and unhappy. I miss being in a smaller company. It’s worth the smaller salary to be part of that culture. But now, I face my own conundrum: do I stay and if I do stay why am I staying?

Reasons to Stay or Not Stay…

  1. Stock Options: At this point, I try to not be too deluded into thinking the shares will be worth a lot. At a conservative pricing I would estimate my remaining shares could be worth anywhere from $0 –  $335k. Now, $335k may be reason to stay for another 1.5 years, as it would be impossible to obtain another offer where in 1.5 years I would make that much. But the $0k and everything in between is very much a possibility. So one must ask herself, what are the odds of that, and are the odds better to trade back the remaining shares and move to another startup where this risk can be better diversified? Meanwhile, there is always the very, very, very small chance that the remaining stock options could be worth $335k+. No one knows what they’ll be worth.
  2. Opportunities for Growth: Which are pretty much non-existent. Even if they were existent, I’ve discovered that my current field is not the one I’d like to stay in for my career. I’ve been able to gain some experience in other areas in this role, but I still worry that I’m trading years of experience when I could be working in more junior positions in product management or pmm or digital strategy for time building myself up to be a VP of communications, which I don’t want to be. The real opportunities for growth at a startup are in engaging with projects that you don’t have experience with that no one else wants to do. But my boss doesn’t like it when I get involved in things outside of my basic tasks — which I understand, that is my first priority — but the opportunity to learn new skills and make myself more flexible for future roles is one of the best reasons to stay. It takes a lot of energy and careful wording to be allowed to work on projects that are not directly benefiting my department’s goals.
  3. People You Work With: This is the hard one. There are still many people I work with who I like a lot. While the small family culture has died, it’s still fun to be part of the early kids club, and to share this with other employees. But the early kids club is slowing leaving and the new kids club has taken over. I like the new kids too, but it’s just, different. And I like working with the crazies that are drawn to early-stage startups. I don’t mesh well with corporate executive types. I don’t play that game well. I could put all of my energy into playing that game, but honestly, I’d rather just be good at my job and get shit done. It takes too much energy to handle the bullshit that is the typical business.
  4. Corporate Culture: It may be asking for too much, but my company once had quarterly events where we’d do fun things and really bond together. Coming to work everyday, while we all worked very hard and were exhausted by all the work, felt a bit like coming to a camp where we were teaming on working on an exciting project. I was very insecure at the time in what I could offer the business, but even that made me work harder, and for the most part, I loved it. We were all in the same boat together on an exciting adventure. It wasn’t perfect either, but it was a true startup, and it was a place where we could all be ourselves without worrying if something we say or do looks unprofessional and will haunt us later on when it comes time to determine promotions and raises. Meanwhile, what makes me the most unhappy is how once a company grows each department feels like it works within a silo. Everyone is working towards the same goal but it doesn’t always feel this way.
  5. Industry/Company: Do you like the industry you’re in, and the opportunities for the company? Do you believe in the product? Do you think you are part of something that is changing the face of something? Well, it’s pretty exciting to be part of a business that is working with many other businesses. I’m learning a lot overall, but limited in opportunities to interact with our customers. It’s still an exciting industry, although at this point in my life I’d like to work for a company in the wellness or education space, that is designed to help people vs just to make money. Though making money is good too.
  6. Salary: In my current role, I’m confident in another business, even another startup at our stage, I could be making $20k – $30k more per year. So I’m not staying for salary.
  7. Loyalty: Loyalty is overrated. It’s overrated because you can be let go any day, and no one would bat an eye. You may think you’re doing just fine and suddenly your company’s board of directors decides that it doesn’t need your role, or it wants to replace you with someone else, and you’re gone. If your company doesn’t show signs of loyalty, you shouldn’t be expected to either.
  8. Flexibility & Benefits: Does the job enable a flexible work schedule that fits your life? Are the benefits pretty good or unique (do you get to take a yoga class in the middle of the day that you wouldn’t be able to do at another job?) I don’t see any major benefits at my current company that would make me want to not leave.
  9. Feeling Successful: Ultimately, the largest question is, “are you set up for success?” In a startup this is a challenge because hiring is always on the lean side. You are expected to work harder and longer hours than if you were at a regular company, this comes with being part of a startup. But there also is a point where you step back and have to analyze if you’re set up for success. Much of this is outside of your own control. Maybe your management doesn’t understand how to help support your success, or they do, but their hands are tied because of their own corporate politics or sheer realities of the business’s bank account. After years of feeling like you can never quite achieve success, it takes a toll on you. I get bored when my job is easy, but I’m not sure how much longer I can handle it being so hard, just without the right resources to feel successful.
  10. The 5 Year Question: does staying in this job now get you where you want to be in 5 years vs other options? In 5 years, I’ll be approaching 35. Where on earth do I want to be in my career or life at this point? The reality is, I’m not sure. If I stay for 1.5 more years in my current role, work my ass off, help the company grow, and ideally be rewarded for this in some form in a company acquisition or IPO where the stock options are worth more than I paid for them, does this help me get to where I want to be in 5 years or not? My biggest concern of all is that the quality of my work suffers when I’m burnt out. I don’t get burnt out from working all the time, I get burnt out from feeling the need to spend energy engaging in corporate politics vs just getting work done. But worst case scenario my work suffers because I’m caught up in this, and suddenly the positive sentiment held about my work is gone. While my job encompasses a lot of tasks that I’m sure no one sees or understands (ghostwriting an unlimited number of contributed articles to secure press coverage because most publications don’t actually pay enough reporters anymore to create their own content, website creation and management, lead generation via web marketing, web advertising, brand strategy, award applications, speaking applications, coordination with customers and partners around their communications strategies and collaborating to this effect, customer communications, et al)  I know that “all I need to do” is secure dozens of press hits with the help of my PR firm with an occasional piece in a tier 1 publication, and everyone will think I have my act together. But that in itself is very challenging. It requires a great deal of coordination between our customers, strategy, and ultimately luck in that reporters are still interested in covering the industry. I’m sure some brilliant PR strategist could figure out how to land the front page of the NYT, but I’m not a brilliant PR strategist. I want to build great products.

So… this all leaves me with… no answer. I think the answer comes in every time I watch a colleague of mine leave the business. But ultimately I believe that my work on a day-to-day basis has a direct impact on the success of the business. Every article my team lands makes us more attractive in the eyes of future stockholders or acquirers. At the same time, would leaving to make room for someone more seasoned at this stage company and PR strategy enable even better success in this area, helping lift share price while also enabling me to pursue my dreams of being somehow involved in product strategy and design? Who knows. I doubt there is anyone out there willing to work for the price I do and do all the jobs I do and care as much as I do. But there probably is. There’s always someone smarter and better and willing to work for the same or less. The question is, will my company be able to find that person. And, should I care?

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