Working for a startup is an attractive proposition for many people and comes with apparently excellent stock options attached. But what if you decide to leave after a few years – is it easy to exercise the options? Hillary Reilly says no.
Going to work for an investment-backed startup can be a really exciting career move. Your co-workers are hip, leadership is accessible and graphic tees are acceptable attire for 95% of your work days. Working remotely is the norm, and the company’s product may be one that you really believe to be innovative and exciting. You’re motivated not only by the job opportunity, but for a new compensation package that includes base pay, perhaps a bonus or commission structure and an incentive offered ubiquitously by private companies: the opportunity for equity.
Being offered equity in a startup is being presented with the opportunity to own a part of it. And startup ownership comes in the form of stock options. A stock option can be defined as the right to buy or sell stock at an agreed upon price and date. Your HR representative may have briefly explained things like the strike price and the vesting schedule to you. They may have even given you a hypothetical dollar amount for what your stock options are worth.
What most new employees gather from these conversations is that the options will vest (or officially be made available to them) over time, and that if there is a liquidity event they have the potential to turn that stock into money. Despite this fact, employees rarely think of their options as something that holds actual monetary value.
Your CEO wants you to value your stock options, to feel motivated to work hard, to build a company that will someday be valuable to another company, or in the public market. You and your company share a common goal: to achieve success so that you can reap the rewards.
Employee share ownership
Fast forward a few years. You have accepted a role with a new company. In your exit interview, your HR manager covers buying your vested stock options. You’ll learn that your deadline to purchase your options – at your strike price – is 90 days. When you receive an email with stock option paperwork, it explains the convoluted process for exercising your options. You see a six digit number that you will have to spend and realise that your equity may never actually be yours.
Purchasing stock options
More than 55% of startup employees in the US a don’t exercise their options, and of that group, 25% don’t have the finances to spend on something that feels like a gamble.
Maybe you can borrow the money from your parents. But what if your family doesn’t have enough to give you?
Another possible route would be taking out a loan, the way one might when applying for a home mortgage. This, like a home loan, comes with its own set of challenges to the borrower – like interest – which can be considerable, depending on the size of the loan.
The bottom line is, if you’re unable to come up with the money to exercise your options, you’ll miss out on the potential for financial gains from your hard work. In short, that hardly seems fair. Overwhelmingly, the people who buy their vested options during or after their employment are executives and other highly compensated employees. And they have the ability to access and exercise earned equity that is affordable only to them. Those who can borrow the money from family round out this contingent. Everyone else goes without or goes into debt, despite the fact that they worked just as hard as those with more means.
Overwhelmingly, the people who buy their vested options during or after their employment are executives and other highly compensated employees. And they have the ability to access and exercise earned equity that is affordable only to them.”
Startups have systemic issues of race and economics that can be traced all the way back to their investors. The majority of people who work for startups come from middle to upper socioeconomic backgrounds. They can afford to take a job for slightly less than a market rate with stock options as an upside because if their startup closes its doors, they have a soft place to land. Those who do not have that type of financial cushion often shy away from roles at startups because it involves more risk than they are willing to take.
Similar to the US market, in the UK, tax considerations play a significant role in the outcome of how much earned equity will actually be received. Selling shares can be costly. Options are taxed when they’re granted or when they vest. But capital gains tax will be applied when an employee exercises them. There can be a large gulf between the strike price and the share price; and as with US startup employees, in nearly all instances purchasing one’s options requires a lump-sum of liquid cash to cover the options and pay the taxes.
Lower strike prices (a fixed price at which the owner of the option can buy, or sell, the underlying security or commodity) can broaden the opportunity for employees who leave their startup to exercise their options upon departure, and to become shareholders. However, higher strike prices, as is customary in many European countries, mean that only wealthy employees can afford to exercise the options that they are entitled to – which underscores the inequitable nature of startup equity for startup workers around the world.
If equity were equitable, more employees would have a way to purchase their options. For some, acquiring their earned equity becomes life changing money. For most though, it’s paperwork that they are forced to ignore because they cannot access what’s theirs on paper only. In this respect, working in the private market can perpetuate the haves and have nots among us. Equity shouldn’t be an option; it should be a right.