This is an inadequate overview of options issues for startup employees. The major issues are probably:
1. Acceleration on change of control (the article covers this). 1 year acceleration is fairly common it seems. There should be something here. But fully acceleration of granted options is probably more than you realistically can hope for. After all, you didn't need to work for that year to get the options. There should be some balance here.
2. Rule 83b electoins. Particularly relevant for pre-funding startups and especially for founders. It allows you to pay all the tax on options up front rather than be hit by yearly AMT bills;
3. Clawback agreements. This is a nasty one that was most publicly brought to light with Skype (the second time around). A bunch of executives were fired before the acquisition went through, allegedly for performance reasons. Their options could be bought back at issue price, resulting in a windfall for SilverLake of possibly several hundred million. Want to sue? Well the company was incorporated overseas. Good luck with that.
The moral of the story is watch out for any rights the company has to repurchase your options and at what price.
Repurchases in general aren't necessarily evil. It's good to avoid having a lot of shareholders for early stage companies (due to SEC limits on number of shareholders for non-public companies) but such repurchases need to be fair.
4. You're taxed on options based on their fair market value when they're issued barring a Rule 83b election;
5. Liquidation preferences. VCs generally have some form of preferential treatment on how they're repaid in the event of a buyout. This can take a number of forms.
The most reasonable is that they're simply guaranteed to get their money back. Meaning if they paid $10M for a 40% stake in a company that gets bought for $15M they're going to get their $10M back instead of 40% * $15M = $6M. That's not unreasonable.
But what's not reasonable (IMHO) is "participating preferred" liquidation preferences. What this means in the above scenario is the VC will get $10M of the $15M back and then 40% of the remaining $5M. So the other 60% are divvying up $3M. That's a lot less attractive.
6. Bonuses in lieu of acquisition. You may see a headline that says your company has been bought for $100M and you own 1%. Great! You're now a millionaire! Not so fast...
It may turn out the VC owns 40% participating preferred with $20M funding and the company is actually only being bought for $50M. The other $50M is incentives in the new company paid to the founders and possibly key executives.
So you're only getting 1% of $30M.
7. Dilution. Your 1% may not be 1%. You may have been told something like "there are 1M shares outstanding and we're granting you 10,000 options over 4 years with 1 year cliff". So you own 1% right? Well, maybe you do and maybe you don't.
The company may be reporting outstanding shares rather than outstanding shares plus any obligations it's made. It really needs to report on a fully diluted basis. There may be convertible notes and rights of existing VCs to buy in in future funding rounds, etc.
1. Acceleration on change of control (the article covers this). 1 year acceleration is fairly common it seems. There should be something here. But fully acceleration of granted options is probably more than you realistically can hope for. After all, you didn't need to work for that year to get the options. There should be some balance here.
2. Rule 83b electoins. Particularly relevant for pre-funding startups and especially for founders. It allows you to pay all the tax on options up front rather than be hit by yearly AMT bills;
3. Clawback agreements. This is a nasty one that was most publicly brought to light with Skype (the second time around). A bunch of executives were fired before the acquisition went through, allegedly for performance reasons. Their options could be bought back at issue price, resulting in a windfall for SilverLake of possibly several hundred million. Want to sue? Well the company was incorporated overseas. Good luck with that.
The moral of the story is watch out for any rights the company has to repurchase your options and at what price.
Repurchases in general aren't necessarily evil. It's good to avoid having a lot of shareholders for early stage companies (due to SEC limits on number of shareholders for non-public companies) but such repurchases need to be fair.
4. You're taxed on options based on their fair market value when they're issued barring a Rule 83b election;
5. Liquidation preferences. VCs generally have some form of preferential treatment on how they're repaid in the event of a buyout. This can take a number of forms.
The most reasonable is that they're simply guaranteed to get their money back. Meaning if they paid $10M for a 40% stake in a company that gets bought for $15M they're going to get their $10M back instead of 40% * $15M = $6M. That's not unreasonable.
But what's not reasonable (IMHO) is "participating preferred" liquidation preferences. What this means in the above scenario is the VC will get $10M of the $15M back and then 40% of the remaining $5M. So the other 60% are divvying up $3M. That's a lot less attractive.
6. Bonuses in lieu of acquisition. You may see a headline that says your company has been bought for $100M and you own 1%. Great! You're now a millionaire! Not so fast...
It may turn out the VC owns 40% participating preferred with $20M funding and the company is actually only being bought for $50M. The other $50M is incentives in the new company paid to the founders and possibly key executives.
So you're only getting 1% of $30M.
7. Dilution. Your 1% may not be 1%. You may have been told something like "there are 1M shares outstanding and we're granting you 10,000 options over 4 years with 1 year cliff". So you own 1% right? Well, maybe you do and maybe you don't.
The company may be reporting outstanding shares rather than outstanding shares plus any obligations it's made. It really needs to report on a fully diluted basis. There may be convertible notes and rights of existing VCs to buy in in future funding rounds, etc.
So anyway there are a lot of potential traps.