Contract negotiation · Deal Structure

How to structure options in a company

Sapir Sosnovsky Innovator and Entrepreneur

December 18th, 2018

Hey,

I recently started to offer my expertise as a product developer to new startups.

One of the companies that I recently started to work with has given me a few options to be paid with:

1. Options

2. Equity

3. Direct payment for my service


I really believe in this product, I would like to get a stake in it and possibly continue to work with this company.

I am an engineering student, I never knew what options in a company are until recently.

From my research I understand that my service is would have a value which will act as debt against the company, and at some point I will have the option to convert this debt into share in the company.


Can someone confirm my definition of this and how do I go by structuring an options deal? Would it be wroth it? or should I just stick to equity if I believe in this product?


Thanks in advance for your knowledge and help!

Kevin Carney Content Marketing works, but needs better tools.

December 18th, 2018

That's generally not how options are defined, but it's possible in this case they are.


An option is nothing more than the right to purchase a stock at a future date for a price that is agreed upon now. This price is called the strike price.


Let's say they've valued their stock at $1 a share. If at a future date, the stock can be sold at $20 a share, you of course will exercise the option.


Whether or not your current contributions are recorded as a debt to you is a different issue, although there is nothing sketchy or shady about that.


Then whether or not the debt they owe you for your contributions is eliminated if and when you exercise your options is also a different issue.


K. Robbins Head Moose at Moose WorldWide Digital

December 18th, 2018

My advice is get direct payment. Startups offering rev share deals to developers are notorious for having no acquisition strategy or marketing plan, which equates to a great product with no customers and no revenue.

Dane Madsen Organizational and Operational Strategy Consultant

December 19th, 2018

Fundamental considerations:


1)Taxes are an issue. In the US:

a) Direct payment is just what it sounds like. You get cash and have taxes due, but have the cash to pay the taxes.

b) Equity: You get stock with a value established by the company that you may or may not be able to sell, but taxes (at payroll tax rates, not cap gains) are due on the vesting of that equity regardless if you have cash to pay them (in listed companies, typically the company gives you the shares then some are sold immediately to pay the taxes).

c) Options: You get the "right" to a share of equity upon vesting of the options, but no equity until you exercise the options. As you vest there is no taxable event unless you exercise. When you exercise, the taxes are due based on the difference in the grant price and the value at exercise. If the company is still private, they will establish the value at exercise at which time the taxes are due regardless if you have cash to pay the taxes.


2) Ownership. In the US

a) Direct payment, obviously has no ownership.

b) Equity is ownership. If you leave the company you own the vested and received shares regardless and have the rights of a shareholder. You also own any gain or loss.

c) Options: You have no rights of ownership until you exercise the options. Prior to exercise, the company may change the rights of options, cancel them, change the terms, among other acts with you having little to no recourse. Further, the value of the company shares (as established by the company if not public) can and will vary, often down. You may find you hold options at a price higher than the value of the shares they represent, making owning them without value. Occasionally, because there is usually a limited window (often 4 to 12 weeks) to exercise options, if you have a significant option grant and it is very valuable, unless you can arrange the capital to acquire the shares at the agreed exercise price, you will lose the value should you not be able to pay for them.


Direct payment is attractive because you have the cash and you pay the taxes. To your point, however, you have no upside.


Payment with equity is typically something a more mature company (Amazon does this, for example) as part of the compensation. They are paying your compensation, part in cash, part in equity, for your total compensation. As shares are vested, the rights of those shares are equal to the rights of any shareholder of an equal class of shares.


Options are more for younger companies where a roughly market rate of compensation is paid with options granted to employees they want to incentivize and retain but they know will not have the cash to pay the taxes or will not exercise the options until they have to (at a liquidity event or when leaving the company).


Sapir Sosnovsky Innovator and Entrepreneur

December 19th, 2018

Thanks for all the answers!


I live in Canada so I don't think the rules on taxes and such are much different.

This project is under $10 K project, however its also my way of paying for university. But, I do believe in this project and my gut is telling me that if I do not take ownership in it I will regret it.


I am probably going to aim for an options deal. From the way many of you explain it, it will give me a chance to work with the company while also having the option to own a share of it. The only thing I am assuming is that I may need to give up some of my upfront payment.

Eric Kaufman Managing Director, Acumen Business Advisors,llc, Startegic Advisor to startups and small businesses

December 20th, 2018

Sapir.

If I understand your situation, while still a student, you have succeeded in convincing this startup of your "expertise."


If, as you want/need to pay for your education, it makes sense to receive immediate payment for your services. Should your expertise be required further by this new company, you can join it later as an employee. As such, you may be entitled to receive the equity or options you desire.


But by going the "option" route, you are expecting that this particular startup won't fail. Do you know enough about the founders, the needs and desires of the customer/market segment they're marketing to and the existing (and potential)competitors to assure yourself that this startup has what it takes to become a sustainable business?


Most startups fail. They do so despite offering innovative products, employing smart people and having the best of intentions.

Although you may regret a lost opportunity in the short term, when your expertise and experience grow, you will be in a better position to gamble the potential to pay down your education debt or defer receiving income for other future cash requirements.


Sorry if this seems too practical, but it comes from experience.

Good luck.

Andrew Chalk Co-Founder of a startup. CEO of a startup. CTO of a Hedge Fund. Quantitative Researcher. Superb COO.

December 19th, 2018

How much is at stake? If more than a $50k/labor, contact an attorney experienced in equity compensation issues. The upside will pay the likely cost.


One you may want to consider is Walker Corporate Law https://walkercorporatelaw.com/tag/this-week-in-startups/

, according to Jason Calacanis. They offer some fixed-price contracts (obviously, I have no connection with them. I also have not used them). Others in this group may have personal experience with an attorney that they would recommend.