Startups and Equity?

[Table 5]

I'm curious if anyone here is/was involved with startups, and has some insight into the whole issue around being paid in equity?

I've done a couple of projects down in California for some startups, that are offering to partially pay in some form of equity (ie, stock options, convertible notes etc.). The idea of having some equity is always intriguing, but honestly I'm pretty uninformed about the whole thing.

In your view what is the best form of equity payment? Both in terms of maximizing profits, as well as any tax implications. Is there anything I need to look out for? Is there a good resource to learn about the ins and outs of this stuff for the non-MBA/Finance major?

[photon]

Not much to say in terms of maximizing profits or tax implications, but I've got a shoe box full of equity from various startups in a closet somewhere..

[Table 5]

Originally Posted by photon

Not much to say in terms of maximizing profits or tax implications, but I've got a shoe box full of equity from various startups in a closet somewhere..

Hah, yeah, I'm fully aware that it's a giant crapshoot, which is why I only do it if there's some sort of cash as well...but some of these ventures do seem to have some promise, so I don't mind the risk. I do have a few colleagues/friends who seemed to have benefited quite nicely from playing the game.

[photon]

Yeah same with me, I only got involved if there was some cash involved too, and how much one buys into the product can make a huge difference.

And the most recent one, the one that I bought into the most, the one that had actual customers and a validated plan, strung the employees along after bouncing paycheques for a few months, so I don't really trust my judgment lol.

[Phanuthier]

Check to see what round of funding they are at and who are backing them (VC's, etc). 95% of the startups fails on the business side, rarely do they ever fail on the idea. If you have a good VC backing you, it goes a long way. Especially here. Check out Quora for information and some Q&A.

Equity is a great way to hit it big, but I wouldn't really count on it. More than a few people here think we're headed in the same direction of the dot com crash..... when it crashes, who knows, but its coming for sure.

[Kybosh]

I'd be checking out their balance sheets and other banking/accounting information if possible. Run the various options over with your accountant.

[Fozzie_DeBear]

People who do this for a living (VC's) fail 90% of the time...and the ventures they invest in are typically relatively far along with customers, revenue etc. So their investments are de-risked more than the ones you are talking about.

You know its going to be a crapshoot...my advice is to value the equity as worth nothing and assess the project from there.

[Wormius]

Had stock options in two companies. The first one actually got bought out. I saw nothing. Unless you're getting a decent percentage of the stock, your options will probably be so diluted by the time anything interesting happens that you might make a small amount, maybe enough for a nice vacation, but nothing life altering like early retirement at the age of 30.

[photon]

Oh yeah forgot about that, I was in a situation where I had some ownership, they got bought out but the buyout was structured such that the class of shares I had got very little.

[Sr. Mints]

About a week ago, I ran into this piece, which really shined some light on how complicated the issue of equity can be:

Startup Employees Think They Are Going To Get Rich — Then A Horror Story Like This Happens

( . . .)

Among other special rights, the owners of preferred stock get "liquidation preferences."

What that means is that when the startup sells, or liquidates, the owners of preferred stock get a guaranteed amount of money from the sale.

Often, the owner of preferred stock gets a guaranteed return of 1X their investment.

Imagine a VC that buys 50% of a company for $50 million, for a $100 million post-money valuation. If that company then sells for $75 million, the VC gets more than 50% of the $75 million. The VC gets his or her $50 million out first, and then half of the remaining $25 million ($12.5 million) for a total return of $62.5 million. The common stock holders split the remaining $12.5 million.

( . . . )

Read more: http://www.businessinsider.com/how-l...#ixzz2x5gRQAxz

Waaay over my head. But I know my dad issued stock once upon a time, the company went nowhere, he died, and my mom was sued by one of the investors. She had a lawyer draft a '#### off letter', and the issue was dropped. </coolstorybro>

[Phanuthier]

To not fully put a damper on Table's lottery ticket, I know a lot of success stories down here of people who do have a lot of success with equity from startups...... so its not that bad of an option.

[Locke]

Walk into the Elbow River casino and put it all on Black. You'll have better odds.

Plus the dealer might at least have the common courtesy to offer a reach around after he takes your cash.

[Regular_John]

At the end of the day I'd look at my time/compensation as an investment, separate of the work being asked of you. If this same group approached you and said "hey, here's our idea, here's our company, are you interested in investing?" what would the answer be?

To me equity like this is kind of an all or nothing partnership, either you're all in with what the company is doing and want a piece of it, or you're only interested as an employee/vendor. You want them to succeed, but it's not your skin the game.

[Wormius]

Originally Posted by jaydorn

At the end of the day I'd look at my time/compensation as an investment, separate of the work being asked of you. If this same group approached you and said "hey, here's our idea, here's our company, are you interested in investing?" what would the answer be?

To me equity like this is kind of an all or nothing partnership, either you're all in with what the company is doing and want a piece of it, or you're only interested as an employee/vendor. You want them to succeed, but it's not your skin the game.

If you're going to look at it from that perspective, I would then ask for stocks, and not stock options in-lieu of direct salary compensation. Stock options are too variable in value and at the whim of the directors. Stocks do have financial/tax implications, but they are at least a known quantity. Stock options are the vaporware of the investment world.

[Regular_John]

Originally Posted by Wormius

If you're going to look at it from that perspective, I would then ask for stocks, and not stock options in-lieu of direct salary compensation. Stock options are too variable in value and at the whim of the directors. Stocks do have financial/tax implications, but they are at least a known quantity. Stock options are the vaporware of the investment world.

Absolutely true, I had stock options once in the past with an established company, but they were on top of my base salary & bonuses. So if you're looking at taking a cut in salary/compensation then options don't really fill that void. Full stock shares on the other hand are a different matter.

[Table 5]

Thanks for the feedback guys.

For me, this is more of a bonus situation, not something that's in lieu of regular payment. I still charge pretty much my regular rate (maybe a little less), and the equity portion is more of a bonus. So even if the company doesn't go anywhere, I typically have 90% of my usual fee anyway.

I guess I'm just trying to see what the most ideal position is for someone to have. I usually come in at an early stage (since I do identity/branding/naming), so there probably is typically the option to negotiate for something more ideal...I just don't know what that is. In California, where a lot of my clients are, this stuff is pretty common, but Im just not as familiar with the terminology and what means what.

Originally Posted by Wormius

If you're going to look at it from that perspective, I would then ask for stocks, and not stock options in-lieu of direct salary compensation. Stock options are too variable in value and at the whim of the directors. Stocks do have financial/tax implications, but they are at least a known quantity. Stock options are the vaporware of the investment world.

That makes sense. Do you have an idea of what the tax implications are? if you get say 5% ownership, and there's a certain value attached to it, does that mean you have to pay taxes right away, or only when there's some sort of profit made?

What Im trying to avoid is having to pay taxes before there's actually any sort of money in my pocket, because obviously you never know if it will arrive.

[Regular_John]

Originally Posted by Table 5

Thanks for the feedback guys.

For me, this is more of a bonus situation, not something that's in lieu of regular payment. I still charge pretty much my regular rate (maybe a little less), and the equity portion is more of a bonus. So even if the company doesn't go anywhere, I typically have 90% of my usual fee anyway.

I guess I'm just trying to see what the most ideal position is for someone to have. I usually come in at an early stage (since I do identity/branding/naming), so there probably is typically the option to negotiate for something more ideal...I just don't know what that is. In California, where a lot of my clients are, this stuff is pretty common, but Im just not as familiar with the terminology and what means what.



That makes sense. Do you have an idea of what the tax implications are? if you get say 5% ownership, and there's a certain value attached to it, does that mean you have to pay taxes right away, or only when there's some sort of profit made?

What Im trying to avoid is having to pay taxes before there's actually any sort of money in my pocket, because obviously you never know if it will arrive.

Honestly, you'd have to give an accountant/book keeper a call. I worked for company that did employee stock plan administration in the past and there is a whole slew of "equity" plans out there, tax deferred, dividend payouts, options, stocks, RSU's, vested, unvested, etc.

Basically the short version is that no two companies are the same, and no two stock holders are the same. Some companies even offered plans where the employees would have the option of paying tax immediately or doing tax deferred payout and only paying tax on income collected.

The rules regulating public VS private companies also varied quite a bit.

[calf]

Up front, you'd have to pay tax on the value of the shares you receive as compensation is. How that value is determined, for a startup that I'm assuming isn't public, is a little bit tricky. It could be based on what that 10% would be for your charge-out, or a set formula for the company, it's tough to say.

Any gain in value would be a capital gain when you sold, of which only 50% is taxable. And if it's a private company and the gain is worth it, you could apply it against your lifetime capital gains exemption and pay no tax.

[Table 5]

There's a lifetime capital gains exemption? Interesting...any idea how much?

[calf]

Yes - only for private companies though. For a total gain of $750,000 (changing to $800 I believe), or $375k/$400k for the taxable part.

Some T&C's though: http://www.cra-arc.gc.ca/tx/ndvdls/t.../lgbl-eng.html