A not yet incorporated startup offer me stock options instead of common stocks. Should I do it?

Vincent Leung Senior Software Engineer / Technical Lead / Architecture

October 29th, 2015

I am a software engineer / architect helping a technology startups full time. The company is NOT incorporated yet but will do it soon in couple months. The founders are offering me 2% stock options? Is this better than common stocks since I don't have to worry about the tax implication right now until I exercise it?

Neil Gordon Board Member, Corporate Finance Advisor and Strategy Consultant

October 29th, 2015

Two replies so far, each offering unsolicited advice and neither answering your question.

As to stock vs. options: A stock grant (without vesting or with an election to be taxed now) creates taxable income now, but based on the likely startup value that's a low number. Any future sale would result in a capital gain or loss. An option would only be taxed on exercise; aside from the ordinary income tax rate, you'd owe the tax whether you could afford to pay it of not and without regard to whether there's a market for what might be non-public shares.

I'd opt for taking stock now if you can get it.

MaxBlox/Founder Institute Director, Chennai Area at The Founder Institute

October 29th, 2015

I dont think you can actually offer 'options' on stock, when such stock does not actually exist. Without incorporation there is no stock to offer. It maybe a promise to offer stock options WHEN they incorporate, but they may vest the period between now and incorporation. I am assuming they are offering a 1 to 4 year vesting period on the options as well.

There are multiple things to consider.
At this stage of the company, everyone should be getting shares not options. If it is options then everyone should also be on options and should have vesting plans.

if you are within the first five people of the company, you are not getting enough of the company. Assuming you are the fifth, i would still expect more than 5%. I dont think this deal is particularly fair, even if you get some kind of a salary.

I am concerned as to why they dont incorporate. It literally takes $150 and a week to incorporate and authorize 10Million shares. There are at least 5 companies that i know of that can do this virtually.

Hope this helps.

Stas Khirman SVOD Conference CoChair

October 29th, 2015

Considering that fair market value of this company right now is close to $0, getting stock vs options makes no difference from tax perspective right NOW, but may be a huge difference once company is successful: If you get stock now, all future profit ( at moment of sale) will be taxed as "long capital gain". With options, you have to convert them into stock just before sale, so profit will be taxed as "short term capital gain"..
So, rule of thumb - get stock whenever you can do it. For non-incorporated company it is no brainer: Founders have to incorporate it anyway (eventually) and set initial capital to , let say $100 . It is a company fair market value. Now you have to PURCHASE 2% for $2 ( do it with a check and keep copy). So you have no tax as you got no gain ( at this moment).. If you have vesting schedule, it is the same, but don't forget to file 83b form with IRS...

Benjamin Olding Co-founder, Board Member at Jana

October 31st, 2015

Wow - I don't think anyone read your posts, Vincent. 2% fully vested for a couple *months* of work in a company you believe in? How is this not a generous offer? I can't believe how many people are telling you this is a bad deal when you are stating you already know it's a good one.

Anyway, let's address your actual question: If they are offering common versus options, take the common; it's a bit cleaner.

If they are only offering options, ask the following questions before you ask for anything else:

1) When will the option grant occur by (date)?

2) What will the strike price be?

3) How many shares will 2% be?

4) What is your compensation if you do not receive the option grant on or before that date and at that strike price or below?

Make sure you get the answers as part of the contract. Then, you can do the math of multiplying the strike price by the number of shares. Since you'll be fully vested immediately, you can write a check for this amount back to them and you will own common shares instead of options instantly.

So, assuming this is a real small number and you can get all this in writing, I don't see there being much of a practical difference here. Basically you're just going to get paid a little less since they'll write you a check for your work, then you'll write one back for the equity. The only risk I see is that they do not make the grant in a reasonable time frame - but as long as your contract explicitly explains your compensation in that event (and you're happy with the alternative), that should be covered.

Since it seems like unsolicited advice is the norm for this thread, here's mine: try to only work with people you like and try to treat them generously when you do.

Michael Barnathan

October 29th, 2015

Stock with an 83(b) will by far be the better option if the company's just starting out, since your cost basis (and thus your taxation at grant) is essentially nothing. You just pay taxes on the capital gains over that basis when you sell, which if you hold for more than a year are at the long-term rate.

As others have said, 2% in a company that's just incorporating is very little.

Jacob Kojfman Experienced technology and corporate lawyer, focusing on SAAS

October 29th, 2015

I don't know where you live Vincent. In Canada, stock options are more favourable than common stocks because of the tax implications. Keep in mind, options do not give you an ownership stake, only the right to acquire

Vincent Leung Senior Software Engineer / Technical Lead / Architecture

November 2nd, 2015

Thanks for all the feedback. They are very helpful. Sounds like common stock is the way to go.

Pam Founder Founder at tilt365.com

November 3rd, 2015

Our startup has a law firm that specializes in startups and conducts a survey each year that tells you what the average salaries and equity amounts should be for various roles in startups. At this stage, being considered a co-founder vs. not being a co-founder matters too. According to the last survey they conducted, 2% is a super offer for a software engineer. So, do your homework and don't just trust opinions on this thread. Benjamin is the only one that seems to know that you have to ask more questions about the exchange to know if it's fair. By the way, the law firm I mention is here http://www.hutchlaw.com/ Contact them and see if they will share the last study with you. Then go for it if you believe in the idea and like the people you'll work with.

Hoofar Pourzand

November 4th, 2015

I don't think you can offer someone something that doesn't exist. If it is not incorporated there is nothing to offer. However, it's a nice gesture and deserves a "thank you".

Jacob Kojfman Experienced technology and corporate lawyer, focusing on SAAS

November 5th, 2015

You can have pre-incorporation contracts. They'd need to be ratified by the board of directors after incorporation. So while in theory, yes you cannot offer something that does not exist yet, you can do it legally if all the right steps are taken. This is not legal advice. This is for legal information only. Jacob Kojfman 604 318 4539