employee equity compensation in tech startups
July 19, 2021
May 12, 2020
July 19, 2021
May 12, 2020
The impact of COVID-19 is being felt by businesses across the globe, including startups. Whether the company that you work for has been directly impacted by the current crisis or not, the long-term economic fallout of COVID-19 will have repercussions on all of our lives as we move towards an uncertain future. Startup employees with equity are understandably concerned about what impact this will have on their future, which is why we’ve put together a guide to help you navigate these uncertain times so that you can maximize the value of your options.
After reading this guide you’ll be armed with a better understanding of how COVID-19 could impact your equity, and what you can do to maximize your value in the face of a global recession.
In this guide you will learn:
It doesn’t take an economist to tell you that there is financial uncertainty in the market. Companies are cutting costs, laying off employees, and taking other drastic measures in order to weather the storm caused by COVID-19.
That’s bad news for the economy, but particularly for the startup ecosystem. Cash is king in the startup world and many venture-backed companies simply won’t have the reserves to make it through to the other side of this pandemic. Add to this the fact VC funding was in decline even before COVID-19 began to hit, and the future looks uncertain at best for startups moving forward.
Even startups fortunate enough to receive the investment they need to stay afloat, may have to do so at lower valuations and less preferred structures. According to one survey of venture firms, investors are expecting to see valuations of early stage companies to decrease significantly.
These are unprecedented circumstances and both employees and founders will have to plan for the potential fallout from COVID-19. Wherever your organization falls on the spectrum however, it’s important to understand how the current economic climate impacts any equity that you hold.
For better or worse, COVID-19 will have an impact on the valuation of your company. This will in turn have repercussions for your equity and you will need to plan accordingly.
409A valuations take into account a number of factors including growth, financials, and other metrics. Companies with decreased revenue and/or growth due to COVID-19 will likely result in lower 409A valuation. On the flip side, companies doing well in this environment will likely see an increased 409A valuation.
If you are unsure about the latest 409A situation for your company then you should ask your management team, who will be able to tell you when a valuation will be put in place and estimate what they think it will increase or decrease in the short-term.
If your company has taken a large hit due to the COVID-19 situation, you can likely expect the 409A price to drop at the next valuation.
That might sound like bad news, but a lower valuation of your equity is not the disaster that you might think it is. A lower valuation creates opportunities for your options and could help you to save money when it comes to taxes.
A lower 409A valuation means it will be cheaper to exercise your options as you will pay tax on the difference between your 409A and strike price of the options. This means that you can wait until the lower valuation is put in place which will allow you to exercise more options with less cash. If you were looking to exercise, consider the impact of waiting until the new 409A is set at a lower price.
On the other hand, if your company is doing exceedingly well during these times, its 409A valuation may increase in the next few months. If you have been looking to exercise your options, this could be a great time to do so. Employees who act quickly and exercise with a lower 409A will likely have a lower tax bill out of pocket today and take more home down the road.
Use our free Exercise Tax Calculator to find out what this would cost.
For those employees who hold restricted stock units (RSUs), you may want to consider filing a 83(b) election to pay tax now on your shares if you are bullish on your company’s shares. If you think the company’s value will continue to rise, then filing a 83(b) election allows you to pay less tax now than you would when the company grows. On the flip side, if you think the valuation will drop in the short-term but recover, you should consider filing a 83(b) election when the 409A price drops.
Whether the valuation of your company increases or decreases, employees need to be aware of potential changes in their company’s equity in order to make informed decisions. Those that plan ahead will be able to take advantage of the current situation most effectively and maximize their equity’s value.
In light of the economic slowdown many companies have begun to cut costs. Reduced pay or furloughing employees has become the new norm as businesses of all sizes struggle to navigate these changing times.
It can obviously be concerning if you find yourself in this situation. But for startup employees the COVID-19 crisis could provide an opportunity to negotiate your compensation package to make up for this decrease, and even set yourself up to prosper in the future.
Startups typically offer equity as a means of deferred compensation and as a way to incentivize employees to own a piece of the company they are building. The compensation is deferred as most startups are cash-strapped and cannot afford to pay you what a larger company may be able to.
If your company is now asking you to take a paycut, or even take no pay during this time, you should consider asking for additional equity to make up for the lost compensation. While not all companies may be amenable to offering more equity, there is no cash outlay from the company’s standpoint so it’s an efficient way for your company to compensate you for your sacrifice while preserving their cash.
In addition, offering more equity shows a commitment from management to their employees during this difficult time. It may be a win-win scenario for your company and yourself in the long-run so it’s worth having the conversation with management to discuss if this is available for you.
Layoffs have become part and parcel of the current economic crisis with unemployment figures skyrocketing to record highs as a result of COVID-19. From multinational conglomerates to Ma and Pa stores, everyone is feeling the impact and the startup sector is no different.
Despite difficult circumstances, the silver lining for employees is that we have seen management teams go the extra mile to help their teams especially when it comes to equity. Compared to traditional layoff situations, companies in the COVID-19 era are offering generous extensions and accelerated vesting on their options, which is undeniably good news for employees with equity.
Typically equity plans come with a 90-day exercise window after employment termination. That means that if you leave the company, you will have to exercise your options within 90 days or they go back to the company. However lots of management teams have decided to extend these deadlines to many years out given the circumstances of the layoffs.
In addition, we have seen many companies offering accelerated vesting. This means that even if your options or shares are not fully vested, you will be able to exercise them or keep them despite the layoff.
While layoffs are not easy, it’s been great to see management teams doing the right thing when it comes to equity for their employees who have been laid off. Offering extensions and accelerating vesting is a benefit that employers should be offering their employees who have helped build the company.
If your company is not offering either option, consider negotiating and asking for an accelerated vest and an extension on your options. This is the right thing to do for employees who are now out of work and a paycheck for the foreseeable future. Both options do not require the company to pay cash at the moment so there are few reasons a company should deny this request in this environment.
Even if you are granted an extension to exercise your options, employees that hold incentive stock options (ISOs) should look into exercising their options now to maximize their equity’s value.
Many companies are offering extensions for option exercises. While this is great in that it gives employees more time to figure out their exercise situation, waiting past the 90 day window may have much bigger tax consequences that employees need to consider.
ISOs are much more tax advantageous compared to non-qualified stock options (NSOs). They are not taxed under standard income tax, and if you sell the stock two years after grant date and one year after exercise date, you sell them as part of a qualifying disposition. In short, this allows you to effectively convert everything north of your strike price to preferential long-term capital gain rates.
As part of offering these tax advantages, the tax code allows limitations on ISOs. Most relevant to us at this point is that the fact that you cannot have ISOs past 90 days after you are no longer an employee. This means that even if your company allows an extension on your stock options past the typical 90 day expiration window, your ISOs will convert to NSOs and lose their tax benefit.
This creates a potential planning opportunity that employees who have been laid off need to consider. If you feel good about the upside of the company, then you should consider exercising your ISOs today to capture the potential tax benefits rather than letting them convert to NSOs. Employees who wait risk putting themselves in the same difficult situation once the extension ends at typically less favorable conditions due to an increased 409A valuation.
If you want to take action on your equity but don’t know where to start, now is a good time to brush up on how your stock options work. Our Stock Option Starter Guide helps you to quickly brush up on the basics, so that you can understand how your options work and what you should do to navigate the uncertainty of the current crisis.
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