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5 Things I Wish I Knew About Startup Equity - YouTube
Channel: Uprise - Finance For Young Professionals
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hey guys jessica here today i'm going to
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be talking about startup equity you know
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that super complicated options thing
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that you get as part of your comp
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package when you join a startup that may
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or may not be worth a ton of money in
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the future so i'm going to be talking
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today about how the options work about
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taxes isos nsos
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early exercise 83b elections and more so
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if you're curious about any of those
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things or if you've never heard of any
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of those things but you have options you
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work at a startup then stay tuned
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so this topic actually brings up a lot
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of emotions
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i know that sounds super weird but
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basically my first experience working at
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a startup was when i joined a small
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london startup called wise it was called
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transfize back then and it does
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international money transfer and over
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the course of three years working at the
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company
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i had an amazing time an amazing time
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building product an amazing time making
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friends and a few weeks ago
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transferwise finally went public
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so before i start i want to say congrats
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to the founders congrats to the
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employees and to the alumni
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this is a culmination of a lot of hard
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work a lot of doing the right things for
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customers all along the way
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so kudos to everybody and so i thought
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this would also be a really great time
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to talk about startup equity because now
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i've seen that journey all the way
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through to completion from not knowing
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anything about startup options to now
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seeing those shares actually become
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public and liquid and finally worth
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something and so here it is five things
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that i wish i knew about startup equity
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when i first joined a startup okay so
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really quickly high level overview first
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of how options work so say you're given
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a thousand
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options
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as part of your comp package when you
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start um and let's say that there is a
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strike price or an exercise price of ten
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dollars
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and most startups have vesting schedules
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um over four years so that means they'll
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tell you you know a big number of
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options you get you know that a thousand
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options but those options only become
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yours in small drips a little bit at a
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time that best over the course of four
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years um investing schedules are
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normally 25
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at the end of year one than a
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proportional amount each month
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afterwards
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so let me draw this out for you really
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quickly
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so let's say you joined the company on
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january 1st 2021
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that's when you start
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then on january 1st
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2022
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250 options become yours
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and then on february 1st
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2022
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um an additional 20.83
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options become yours
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and so on on a monthly basis until
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january 1st
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2025
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um then you get
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all 1000 options now all of those shares
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are or all of those options are yours
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and so if you were to
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leave the company say at
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on june 30th 2021 you would get to keep
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none of your options if you were to
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leave the company on you know sometime
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in january of 2022 you would get to keep
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250 options and if you were to stay all
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the way until january 1st 2025 you get
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to keep all 1000 of those options so
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that's basically how investing works
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and whenever you decide to exercise the
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options um some point down the road that
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means the options you're going to pay
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this exercise price of ten dollars and
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then those options turn into shares and
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now you own those shares
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so let's say you do this at the end of
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you know four years when you have now a
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thousand options say also you know like
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the value of those shares now um
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have become a hundred dollars you know
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it's grown from ten dollars when you
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join the company now it's worth a
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hundred dollars that means that you know
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over the course of four years
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you've gotten
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uh pretty much
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ninety dollars of value you know times a
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thousand uh a thousand options or a
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thousand shares and so the irs irs is
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going to want its share of that ninety
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dollars but we'll touch more on that in
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a little bit
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so getting back to it five things that i
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wish i knew about startup equity a lot
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earlier
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number one negotiate harder for startup
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equity at the start i covered this in
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another video where i talk about
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negotiating startup comp um i'll link to
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that up here
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but basically the point is that startup
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comp is broken down into two parts the
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cash part and the equity part and the
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thing about the cash part is that this
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will hopefully go up over time
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you know as you get performance reviews
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as you do better and you get raises um
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things like that
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there isn't really that same opportunity
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for equity
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equity is kind of fixed or it's a lot
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more fixed in the cash piece and so
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don't waste that opportunity at the
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start to ask for more equity
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number two options aren't all the same
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so prior to joining wise i had heard a
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little bit about options um mostly from
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friends who had been working at startups
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and i heard this thing that hey
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you need to exercise your options within
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90 days upon leaving a company
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and so after three years at wise you
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know i had taken a new role and was on
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my way out and i remember hearing
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nothing about needing to exercise my
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shares and i was getting kind of
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concerned and
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you know writing to hr all responsible
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and on top of my stuff and i get the
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feedback
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read your options contract
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okay
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so maybe recommendation number 2.5
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is to
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read your options contract anyway there
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are actually two types of options
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incentive stock options or isos and
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non-qualified stock options or nsos
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i had nsos and those friends i've been
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talking to had isos there are a bunch of
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differences between these uh tax
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treatment with the irs holding periods
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when you need to exercise by
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the eligibility
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all of these things can get pretty
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complex and so i won't go into too much
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detail here and also because actually as
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an employee you
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most likely don't have the option to
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pick which one you want
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you get what the company has and what
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they'll give you also they both have
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pros and cons it's not like one is
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inherently better than the other it
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really depends on the situation
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but if there's one learning here it's
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that you should know which one you have
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because knowing which one you have will
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allow you to look ahead to plan ahead to
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know the specific rules around that type
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of stock option and then to be able to
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optimize for that type for the rest of
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this video i'm mainly going to be
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talking about nsos because that's the
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one that i had
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um that's not to say that the things i'm
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going to say
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don't apply to isos they just have
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very specific requirements and so really
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keep that in mind if you have nsos uh
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and hey if you guys want a video about
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isos um please leave a comment and let
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me know number three the final tax bill
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is hefty
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uh so the way wise had set up its
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options i actually couldn't exercise
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until there was a liquidity event an ipo
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or sale or something like that
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even if i wanted to exercise earlier so
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going back to our example remember how
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the shares are now worth a hundred
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dollars the exercise price or the value
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of the shares when i received them was
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ten dollars and so the difference
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between a hundred dollars and ten
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dollars i just made 90 bucks yay
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the irs is going to want its cut for
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nsos you pay taxes upon the exercise of
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your shares it doesn't matter if you
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sell them afterwards or not
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but basically
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you'll be taxed on the value of the
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shares so that hundred dollars less the
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exercise price the ten dollars so
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basically they'll um taxes will be
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applied on that ninety dollars and
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um
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the tax rate that will be used is the
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income tax rate which is the highest tax
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rate um for federal the highest tax
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bracket is
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37.7 percent and if you live in a high
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tax state like california that could
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even be up to an additional 13.3 percent
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on top of that and so
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you know over 50 percent
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for most most people um it's probably
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gonna come out to something below that
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however
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definitely expect a big chunk of money
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to go out pretty much straight away and
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you won't even see that money the
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company is legally obligated to withhold
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taxes from the proceeds um you know
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before before they pay it out to you and
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they do something called sell to cover
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sell the cover basically means that the
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company will go out and sell a bunch of
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your shares in order to pay the taxes
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and then give you over the rest
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um and the company is even legally
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obligated to use a very conservative tax
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rate which means that the company will
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likely sell more of your shares um than
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you needed to have sold
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and then it's up to you to sort of claw
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back that money when you file your taxes
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in april um it kind of sucks number four
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early exercising could potentially save
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you a boatload of taxes
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so this one i didn't find out about
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while at wise and only afterwards
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realized that some companies were
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offering this amazing thing um
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but if i had known about it i would have
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asked about it and so should you
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so again quick caveat this is more
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relevant for nsos you can also early
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exercise isos but there's a bit of
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trickiness related to that so please
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keep that in mind basically early
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exercising means that you exercise your
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options you pay that exercise price and
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those shares become yours even before
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they vest and
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what happens then is that if you are
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able to do this early enough like at the
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point at which the options are granted
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to you then the fair market value of the
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shares and the exercise price are
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very close or even the same and then you
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would be paying income tax on a very
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small number or even zero if you do this
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make sure to file the 83b election
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within 30 days if you don't do this
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there are potentially some ongoing very
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painful tax consequences um into the
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future so
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file the 83b election but basically by
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exercising when the value of the shares
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are low and by filing that 83b election
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you are able to eventually when you um
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sell in the future to pay capital gains
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tax rates instead of income tax rates
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and capital gains tax rates are
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significantly lower number five
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there's even the possibility to pay no
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federal tax this one didn't apply to me
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at wise because wise is not a us company
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and so it wasn't eligible but i do want
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to call this out because it could be
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huge
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it's called qsbs or qualified small
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business stock so qsbs basically says
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that if you are an early shareholder in
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a company meaning that the company
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hasn't yet reached 50 million dollars in
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assets when you became a shareholder
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then those shares that you bought um if
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you hold on to them for five years at
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least
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when you sell um
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you're able to pay no tax on the gains
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of those shares um up to 10 million
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dollars again there are a lot more
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specifics around this but if you're at a
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startup it's worth asking the company if
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they qualify um you know as a qualified
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small business and that's it it's been a
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crazy ride for me and i hope sharing you
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know a little bit of the learnings is
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helpful for you guys at least in terms
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of you know what to be looking out for
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as you're working at a startup
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as your you know negotiating comp if you
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want us to take a look at your specific
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situation and how to optimize please
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feel free to sign up on our website i've
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linked to it in the description below we
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are a startup that is on a mission to
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take the tax and financial optimization
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strategies of the rich and make it
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completely free
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other than that if you got value out of
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thanks
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