Has this approach held up in court or survived an audit? Do you actually transfer the money to the employee's account? How do how do you prevent them from having a program to immediately wire the money to Zurich and run off, given that you have a non-recourse note for the stock that never got purchased?
[edit] I say small business because we do not yet have the 10-15% weekly growth required to be called a startup. Until you are expanding like a airbag, you are just fooling yourself that you matter by calling your company a startup.
Yes, it's actually a very old way to do things that fell out of favor in the 80s in favor of options. This way of doing it is more complex and more risk for the employer, so it makes no sense to do it over options if your goal is to just give tokens to employees.
>Do you actually transfer the money to the employee's account?
No, it's all papered
If a the time of a liquidity event the stock is worth less than an employee's strike price, they'll still be underwater. They'll either owe the loan back (the difference between the strike price and exit valuation) or the loan is forgiven and they owe income taxes on the forgiven debt. So there's still risk of owing tax on equity worth less than the current valuation at the time of their offer, right?
So there's still risk of owing tax on equity worth less than the current valuation at the time of their offer, right?
Nope. Because of the 83b election, they pay no tax as the shares vest and pay no tax until they sell their shares.
There's no doubt that you've created a generous plan for your team. The description of your plan was certainly helpful and illuminating. But this thread seems like an odd place for a recruiting ad.
I'm curious what advantages options give employees over a system like ours. I don't see any, and the whole point of our structure was to give employees lower risk and more comfort that they actually owned equity, not a promise of it.
Stock is so much better for employees on almost every possible dimension and it's a real shame that more companies don't give it out, even when it's quite possible to do so (ex. early stage companies who have only raised convertible notes).
Thanks for sharing this. Thinking on how to do equity compensation right when you have no real profit to share was one of the barriers for me starting a startup.
It used to be standard practice until a bunch of executives used it in the 80s to cheat the system.
I should note that this plan cannot apply to executives, for that reason.
Also, before a 409a valuation wouldn't you just be better off granting the shares outright and having employees write a check for $20 or whatever?
Yes that's definitely easier, but if you have had a round of financing even before filing a 409a the "valuation" can be determined as far as the IRS in concerned.
When the liquidity event happens, the tax from a forgiven loan is very miniscule compared the standard situation.
Do you want to be an investor? No? then why would you pay for stock out of your own money?
At our startup everyone gets the same stock, not options, through our Equity Incentive Plan. Here's how it works.
1. We lend new employees the amount of money it would take to buy common stock on a non-recourse promissory note the collateral in this case is the stock itself.
2. The employee then buys the shares from the company with the loan.
3. The employee then files an 83b election so that when it comes time to cash out, they only pay taxes at the strike price of when the shares were bought.
4. At a liquidity event, the promissory note goes away and they own the shares outright
5. They only pay taxes when they sell their shares not when they buy them
Now there are other provisions like if they want to sell prior to a liquidity event, we get rights to buy them back first if we choose to - in which case we just write off whatever the unvested portion from the note and take those shares back.
In the end it gives the employee actual rights to the same class of stock as the founders, so we can't fudge our employees out of stock benefits without hurting our own shares. This also prevents them for having to lay out any money until there is an actual no kidding liquidity event, so they take no risk of paying taxes on something which might be worthless. Even then they will only ever have to pay taxes on the shares, the promissory note goes away, so in effect looks like a equity grant at the time of sale.