Preferences are a trap (for everyone in the company, founders included): if the company takes money at an ambitious valuation, their investors probably have terms that claw back their money if the company sells for an unspectacular number.
Vesting and cliffs are pretty straightforward. You get no equity unless you last a year. You get get your equity in pieces over 4 years. That's pretty much the only sane way for a company to operate, and it's how every well-managed company runs.
I'm not sure what you mean by "vesting resets". How do you reset someone's vesting schedule?
What is the difference between the following two compensation strategies: (1) You get 100 options, that vest at 1/4 after one year and 1/4 after every following year. (2) You don't get any options now. You will get 25 options, which can be exercised immediately (or whatever the equivalent status is of vested options), after one year. And similarly three more times.
I assume it's 30% (a) taxes, 65% (b) psychology, and 5% (c) something that happens if there's an IPO or other exciting event?
In short, where can I read about what startup compensation is, why it is the way it is, and the math behind how much it's worth?
Example: assume the valuations each year are 0.10, 0.20, 0.30, 0.40, 0.50 and the sale price is $1 at year 5.
In option 1 your strike price will be $0.10 for all 100 options so should you choose to exercise you have to pay $10, netting you $90. You can choose to exercise these as they vest, paying $2.50 each year. If you choose to exercise on vest, your cost is the same, although you potentially will owe AMT.
This means that if you make enough money you essentially have to declare the difference between strike price and current value as income. This means you will have to potentially pay taxes on an extra $25 over the four years.
In option 2, exercising the options will require $5.00, $7.50, $10, $12.50 for a total of $35. This means you only make $65 in the sale.
EDIT: to be clear, 1 and 2 refer to the original differences in the first post. If we are comparing different exercise time with the same strike price, then the taxes are nominally the same (Because the income tax % you pay depends on your income, you might be able to save money by exercising in a year when your income is low).
(I assume I should look up "409a", the magic keyword to answer my questions?)
The normal way it works: you get 1/48th of your allocation every month you work there, EXCEPT that you don't get the first 12 months worth until you stay for a whole year --- the first 12 months are "all or nothing".
Alternatively, why aren't salary offers phrased as "you will get $640,000, which vests at 1/48 per month"? (Usually you'll hear "your salary is $160,000 per year and we do payroll monthly.)
When the accounting and law professions catch up with the tech I think we'll see this all being much simpler, as with government and driving licenses and all the other pointless bureaucracy. But judging by how slowly bureaucracy moves, don't hold your breath.
Replacing vesting with options artificially discounted to the FMV of the company at hire might not be different fundamentally from vesting, but it seems like there's lots of ways to abuse the capability of issuing discounted options.
Options at the money are also incredibly valuable, and even more so when they're for a startup (hence their usage in compensation). It's instructive to look at the prices for at-the-money options on, say, GOOG 1--2 years out to see how much they're worth on the open market (easily 10% of the current stock price).
As far as I understand, granting an option now with a currently "fair" strike price which "vests" in the future (but only if the person is still employed), does not create a taxable event at the time of vesting. However, granting an option in the future at the exact same strike price at the exact same time, creates a taxable event.
So my understanding is that option vesting is "simply" tax-preferred.
Let's say that the employee has 0.4% (after dilution) of BuzzFlop with a 4-year vesting cycle. After 2.5 years, BuzzFlop is bought by Hooli for $100M in Hooli stock. The employee doesn't get $250k in walk-away cash, but $250k in Hooli stock, subject itself to a vesting schedule (and possibly a "refresher"). If that employee gets cliffed (which can happen in a merger) then none of that stock ever vests.
Are you saying: the vesting schedule on your as-yet unvested stock might reset when the company is acquired?
How often does that happen? How often does the exact opposite thing happen --- accelerated vesting on change of control? Because that other thing also happens.
I think Michael has a very legitimate position here, and one that is not well understood at all.
As a side note, I think Netflix' strategy of paying people a lot of money with no stock/rsu's/options is the right one.
The difference is that Wall Street has profits to share. A standard company has much less profits than Wall Street, and a startup loses money. Find a way to create a company that creates a positive value for the society while having Wall Street like profits, and I can guarantee you will become rich.
a crazy concept in silicon valley
VC-istan: you can get dicked out of your bonus for reasons you don't understand (liquidation preferences, vesting resets and cliffing) or that are purely political and lose 6 years' worth of expected bonus.
Wall Street: you can get dicked out of your bonus for reasons you don't understand or that are purely political and lose 11.9 months' worth of expected bonus.
I'd rather have the losses be limited, and have more opportunities for negotiation and revision. Wall Street's system is just better. We may not like that industry, but the facts are clear.