Understanding Your Share Options Letter
Shortly after joining a startup you should receive a letter that explains how your share options – or stock – from your employer will work.
For anyone not familiar with the world of finance and investing then the letter may be quite tricky to understand with lots of technical terms and jargon.
Glossary of terms
Accelerated Vesting is when your Vesting period is made shorter. See Vesting.
Or Capital Table. This is a table that details who owns what in the company. It will include founders, senior management, staff (often via the options pool), and investors.
Vesting often has a Cliff or other dynamics where you have to wait a minimum length of time before you are eligible to receive something, such as working for 12 months at the startup. This can create an all-or-nothing situation.
When new investors invest, new shares are issued so they can take a stake in the company. This means that existing shares owned by staff, founders and other investors make up a lower overall percentage of the total value of the company. The flip side to this is that the company valuation should go up and the overall value in your shares should increase. – unless you have a Down Round.
If the valuation of the company in an investment round is lower than a prior round, this is known as a Down Round. This usually happens because your company has lost some momentum, missed targets, or due to a wider economic downturn. Your stake in the business will be diluted and worth less.
Incentive Stock Options
These are the type of stock options you want. Any profit made on them will be treated as capital gains for tax purposes, rather than income which is eligible for a higher rate.
This happens when the startup IPOs (lists on the public stock market) or is acquired. You can sell your shares and finally get some money!
Often equity investments in startups are complex. Some investors will be promised a return and a liquidity preference sets out a hierarchy of who gets what. This is when things can get complicated and your shares might not be worth what you thought there were, particularly if there has been a Down Round.
Non-Qualified Stock Options
Try to avoid these if you can. You will end up paying income tax before you can sell the shares as you will need to say what the current value of those stocks will be.
These are usually what employees of startups receive and they are usually share options. They are different from direct shares in a company. Instead you get an Option to buy the stock at a later date at a pre-agreed price, or Strike Price, which is very low. It’s better to have Options than straight stock as you don’t have the headache of dealing with income and capital gains. You only want to own the stock at a Liquidity Event when you can sell your stake in the business for real money.
The value of the company before an investment round
The value of a company after an investment round
The price at which your stock Options are able to switch, or buy, company stock. The Strike Price is often set to a super low value such as £0.01 a share.
The time it takes before you can formally earn Options, or the right to buy shares in the company.
In almost all cases share options should be set up so that there aren’t any tax implications under tax rules designed to help employees take small partial ownerships of the businesses they work for, and hold that ownership for a period of time, usually 3 years or longer.
The main thing to watch out for non-qualified stock options as we have heard of startup employees being hit with large tax bills they can’t afford as well as losing government benrits such as childcare
What if I'm not offered share options?
There may be times when employers may choose not offer stock reasons. Valid reasons include:
- The company is a startup but is profitable and is paying market rate wages.
- The company isn’t a startup but a small or medium sized business. There is an argument that employee ownership helps reduce staff turnover and increases company profits and many larger companies offer employee share schemes.
- There is a high sales commission structure or other forms of bonuses.
- The company is offering a very high level or training and opportunity, essentially trading pay for other employee benefits.
- Stock options are only offered after you have worked at the copy for a period of time, say 12 months. However, this shouldn’t be too long, and you could ask your employer to waive this period and issue stock options with vesting periods. Ideally you want your stock options as early as possible when the company has a low valuation.
If you have any more questions about your share options or you work for a startup that isn’t offering any then please get in touch at firstname.lastname@example.org.
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