Pre-IPO › Basics

Investors often ask for a dividend similar to interest on their investment, and there are usually some provisions requiring investor consent to sell the company in certain situations. In some financing deals the investors get a 2x or 3x return before anyone else gets paid. There may be several reasons. Mature private companies with no exit strategy have no liquidity options. There are often three major differences: She would share the potential upside growth potential with the founders and other shareholders. The repurchase right can be based on

Sometimes stock options can be “golden handcuffs”. In the case of liquid stock options (say, in a public company), in my opinion this is exactly as they are intended and a healthy dynamic: if you have a bunch of “in-the-money” options (where the strike price is lower than the current market price), you have strong incentive to stay.

Selected Articles

As privately held companies prepare for their market debuts, they make changes in their equity compensation programs beyond just stock options. This article looks at some of the shifts you can expect in your stock grants from the startup stage through the IPO and the post-IPO periods. Their Stock Option Tax Dilemma Bruce Brumberg The biggest surprise for employees with stock options at pre-IPO companies is often the amount of taxes they need to pay when their company goes public or is acquired.

When they exercise their options after the IPO or as part of the acquisition, selling the stock at the same time, a large chunk of their proceeds goes to pay federal and state taxes. This article looks at ways to reduce this tax burden.

However, these options can have negative tax consequences in a disqualifying disposition e. This article reviews the tax effects of early-exercise incentive stock options and compares the tax results to those of early-exercise nonqualified stock options. Employees in startup companies often have misconceptions about their stock options and restricted stock.

Understand what could happen to your stock options or restricted stock in venture capital financings, in an acquisition, or in an IPO. This is simply a selection of the many articles in this section. Use the navigation to the left to explore all of the categories in this section. Has there been a tax-law change for stock options and restricted stock units RSUs in privately held companies?

Yes, starting in Basics What are the top 10 questions I should ask about equity awards I receive at a privately held company? Once you know the size of your grant, you must find out the following before you Basics How do I value options and stock in a privately held company?

Different methods can be used. The valuation of options and stock issued by private companies is more art than science. At least in the context of valuations for estate and gift tax purposes, the IRS has admitted How do stock grants in privately held companies differ from those in publicly traded companies? It is an incentive and an investment, not an entitlement.

The stock option holder is motivated to see the company turn a profit. Success generates potential dividends and stock value gains but is balanced with the risks associated with any investment. We are all in this together. A typical start-up grants stock options to all employees, not just the top executives. Share the risk, share the upside. Granting stock options is in line with prevailing market pay practices. Stock options are competitive practice for start-up companies because they align employees, management and shareholders alike with the goal of creating value.

Potential for growth and value realization. There is potential for tremendous upside for all levels of employees upon a liquidity event. Consider a private tender offer. As companies stay private longer and valuations increase, the demand to provide partial liquidity to employees has grown [3].

These repurchases typically are limited to owners i. Consider other forms of equity depending on stage of business While a minority practice at start-up companies, other forms of long-term incentives could be considered depending on the stage of business: High-valuation late stage start-ups have less emphasis on growth. RSUs provide immediate equity as opposed to an option to purchase equity and are particularly effective at late state pre-IPO companies with valuations not likely to increase dramatically.

RSUs emphasize retention by preserving the value of equity i. However, RSUs do not have the same emphasis on stock price growth and have an immediate tax implication to employees upon vesting.

Mature private companies with no exit strategy have no liquidity options. Long-term incentive cash plans are the most prevalent [4] form of long-term incentive for mature private companies, used exclusively for executives. Freed from the direct tie to company valuation, these incentives are paid in cash based on the achievement of multi-year operating performance measures such as profitability and revenues.

Long-term incentive cash plans allow for immediate cash flow to the participant and flexibility to focus on near-to-long term often years operating objectives. However, many companies find it difficult to set multi-year performance goals and to distribute the amount of cash needed for market-competitive payouts.

Frequent regular grants of long-term incentives to executives emphasize retention. While it is common for start-up companies to provide a one-time grant upon hire, many mature private companies provide regular cyclical long-term incentive grants to executives [5] in order to retain high value employees. My guess is that you make some enemies with this post. It is clearly to the advantage of the company that the terms of stock options and vesting periods remain opaque. What if there were liquidity in options?

That would be interesting, and wildly dangerous, I imagine, because such liquidity would be so predominantly speculative in the absence of knowledge of company fundamentals. A successful growing company grants millions of dollars worth of options each year, and I think it works to their advantage to have people understand their value and thus make rational decisions about them.

That is certainly the case for well known private companies eg, Facebook , and sometimes is the case for smaller companies as well; question is can you find an investor who wants to buy the shares.

Often this will be restricted for current employees but more open for ex-employees. This can be very complex and the SEC has rules about shareholder counts, how the shares can be offered etc. Hello, I just received an employee stock option that would allow me to buy shares within five years. Do I have to buy the shares right away? If I buy the shares now and after 2 years I left the company or they fired me, do I still have the right for my shares? I really appreciate your advice. Really sorry for the delayed reply.

Usually you have all 5 years. Usually you can buy some now and some later. Tax issues vary, research them carefully. Well written for sure. A small company was bought by a larger one and the employee was given her recalculated options. There are 2 years left on this employees vesting schedule. Without any prior negotiation at time of hire regarding acceleration of vesting, is there any way receive acceleration in case of termination?

That means that their employer is under no obligation to keep them employed until the end of their vesting period or for any other reason. They can be fired because of a lack of work for them to do, a desire to hire someone less expensive to do the same job, a desire to restructure and eliminate their job, or because the company is unsatisfied with their work.

By treating the terminated employees nicely, the remaining employees are less likely to panic. Normally one should expect to vest only as long as their employment continues. How do unvested options work post-IPO? Is an IPO an event that can trigger acceleration, or is this reserved for acquisition typically? Can unvested shares be canceled post-IPO? It is very unusual for an IPO to trigger acceleration. While it is easy to see an IPO as a destination for a startup, it is really the beginning of a much longer journey.

An IPO means that a company is ready to have a broader base of shareholders — but it needs to continue to deliver to those shareholders, thus it needs to continue to retain its employees. Occasionally companies will give people the option to stay for reduced option grants but that is unusual. Family businesses and business that exist outside that ecosystem of startup investors, lawyers, etc may have different arrangements.

What happens if you exercise pre-IPO stock options within 90 days of quitting and the company never goes public? Then you own shares that may be hard to sell. The company may be acquired and you might grt something for your shares, or in some circumsances you can sell shares of private companies. But the money you pay to exercise the shares is at risk. This entire article and your answer to my question has been the best write up on this topic that I could find on the Internet.

I received the agreement, signed it, and got a copy of it back signed by the corporate secretary. I never received any other documentation since. Should I contact HR or a financial advisor?

Just slightly concerned since the company seems a little secretive to me. I have been with them for over 6 years. Usually you have 90 days after leaving until you have to exercise the options, but this varies from plan to plan and the details should be in the paperwork you signed. One data point that you will need to finalize your decision is the FMV fair market value of the shares for tax purposes.

The company should be willing to tell you this; if it is quite a bit more than a penny some taxes will be due on exercise but the shares are more likely to be worth something. Thanks Max, I really appreciate it. After reading your article and doing some research I found out I was looking at the par value, not the exercise price.

So in my case, I would be severely underwater. Thanks again for sharing your knowledge! Max, thanks for the great info. I am considering joining a tech startup and wonder if there are enough benefits for both the company and myself for me to be brought on as an independent contractor vs.

Any info you have or can refer me to would be helpful. Sorry for the delay. But even then, you will probably not get benefits or stock options. Good luck with your decision. The terms of preferred stock vary, not only from company to company but also across different series of preferred stock in a company.

I may not have time to answer but feel free to try me first initial last name at gmail. Hi Max — thanks for the insightful article. Half of my stock options have vested. I got them at a price of 3 and the current valuation is now at 4. Do I get to leave with my vested as of departure date options or do I need to pay the company to buy them at the granted strike PLUS pay the tax on the gains etc. Putting aside any idiosyncrasies of your specific options agreement, typically you have 90 days after departure to exercise.

So within that 90 days you need to pay the strike price and you incur a tax liability. Keep in mind the stock could decline before you can sell, so its not just acash flow exposure, you may wind up selling for less than you paid to exercise. Thanks for the help! Question — I purchased stock and then my company got purchased. My understanding is that the main investors lost money on their sale they sold below what they put into the company.

Do you have any experience with seeing employees receive additional option grants with promotions? Is this common or only at key-level positions? I joined the sales team of a person startup at an entry level position about 2 years ago. Is it reasonable to ask? It is common but not universal to receive additional grants with significant promotions, but there is wide variety in how these are handled: I would ask your employer what the process is to ensure that your stock is commensurate with your current contribution to the company.

For example, if when you joined an entry level employee received shares and an account exec received , but today an entry level employee receives shares and an account exec receives If this is the case, many companies would not give you additional shares to go with the promotion but would increase your salary. While this example may sound exaggerated, if the company has twice as many employees, grants may be half the size per employee — often the board will think about how much stock should go to all employees as a whole per year, and now there are twice as many to share the same number of shares.

In any case whatever that value is, is it fair compensation for your time? How long do you have to stay to vest the options?

And how much work are you expected to do? How does your stake compare to other participants and their contribution? I need your help! My company is a Green Sustainable clothes recycling company..

I think 4 years is most common, maybe 5 next most, years is unusual. I am not sure what else you are asking. If you are asking about taxes on the equity, if it is options there is typically no tax on vesting if the plan is set up properly which will almost certainly require an attorney.

How often should a company revalue their privatly held stock options? Any guidelines around that in the accounting standards? I am not a tax lawyer but I think for tax purposes the valuations are good for a year. If things change eg, financing, offer to buy the company, or other significant events you may want to do it more frequently, and for rapidly growing companies that might go public soon you may want to do it more frequently. With startups becoming a global tendency, it becomes complicated to create one model that fits all.

Any thoughts on adjusting vesting schedules, cliff periods and accelerations to ventures occurring in high-risk geographical areas? One thing that I do see adjusted globally is some of the details to fit local tax laws — even US-based companies have to administer their plans differently in different jurisdictions.

Maybe a reader knows?? Great article, now for my question. Been working for a company 3 years, been vested, for example, , shares, at 5 cents a share. Leaving company, It looks like the period to exerci se, buying the shares will have about 7 more years. When I leave, how long does one usually, have to buy the shares, if they choose. I am a little confused about the 90days mentioned ealier in the article. Usually the option period is 10 years but only while you are employed.

When you leave, the unvestef options go away and you have 90 days to exercise the vested options. Of course it depends on your specific option plan which may be completely different. I have some vested preferred shares. What are my options to liquidate them before any event? Your option may be to find someone who wants to buy the stock in a private transaction with limited data. Or it may be that the company has to give permission even if you find a buyer. Trading private stock is difficult.

Also if you have options, typically you will have to exercise them before you can sell them. These stock options shall be deemed to have been granted January 31, and shall have a term of 3 years from the effective date granted.

These stock options shall remain vested for a period of 24 months in which Employee remains in his current position with the Company. It sounds like you have between 2 and 3 years in which to exercise them. The vesting language is a bit unclear to me. You may want to get some legal advice, I cannot interpret that clearly. Let me elaborate on this as I am in the middle of an asset acquisition a division of the company is being bought that will close on Jan 31, I am still trying to understand the language above and below and what my options will be once the transaction is complete.

The strike price above given seems a bit high. How does this work in terms of an asset being acquired as opposed to the entire company? As Twitter is going public soon and I am in the last round of interview. If they offer me a job, will there be any impact to my equity offering if I join before they go IPO or will it be the same after they go IPO?

Which will be most beneficiary to me? Typically people expect the price to increase on I and thus try to get in prior. Predicting what actually happens is hard,for example Facebook went down. But generally joining before IPO is viewed as a better bet. On the day of my 7hrs in person interview conclusion, HR mentioned that they are not the highest paid company around, they come in like 60th percentile… But their RSU are at great offer.

I have been offered just over shares for. Our company is expecting to be acquired in the next 90 days so I could end up with no vested options… What happens if we get acquired before I am vested?

The other thing that complicates it is that our company has a few different products we offer and the one that is getting acquired is the one I work on.. Does this make sense? Typically if the acquiring company does not want to keep you they can terminate you and your unvested options will not vest.

If they want to keep you they would typically exchange your options for options in the new company. They will have some discretion in how to do this. Hopefully they will want to keep you and will treat you well. Now after 6 months the company is acquired by another company for cash buyout.

Selected FAQs

Stock options and RSUs are popular at startups and late-stage pre-IPO companies. However, shares in privately held companies typically lack liquidity and thus cannot be sold, creating difficulty when taxes are owed on the income recognized. Understand what could happen to your stock options or restricted stock in venture capital financings, in an acquisition, or in an IPO. Part 1 looks at M&A deals; Part 2 analyzes IPOs. This is simply a selection of the many articles in this section. The initial public offering (ipo) process: learn the important distinction binary option company between pre-money and post-money valuation and understanding pre-ipo stock options how (ipo) explained. stock option counsel. this article series explains the basic facts of rsus. if you’re understanding pre-ipo stock options understanding pre-ipo stock options right, buying a call option forex.