Can A Business Owner Offer You Stock Options Instead of a Salary?

Discussion in 'Growing and Managing a Business' started by cesspadilla, Oct 11, 2012.

  1. cesspadilla

    cesspadilla
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    Hey guys!

    I just want to ask. A friend of mine just recently have this part-time job from a starting company although they are really famous in another city here in PH but she's still a little skeptic because it is her first time being offered a stock options rather than salary. Actually I'm not really sure if there are no salary included but the employer just keeps on going on with stock options. He also gave my friend a NDA (Non-Disclosure Agreement).

    My questions are:

    Do startup businesses offer stock options?
    What are the Pros and Cons of a stock options?
    How do you open up to the owner about the salary without having a negative assumption to you?
    Does this deal really have an NDA?

    Thanks in advance!
     
  2. ArcSine

    ArcSine
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    •1 Startups are famous (infamous?) for using equity options as a significant component of the compensation mix. On paper, it makes sense: "We won't be generating much cash in the early going---typical of startups---but we expect to be a high-flying growth company soon enough. So if you'll accept a lower cash salary at first, we'll more than make it up to you by giving you a piece of this hi-growth pie, such that you'll have much greater total wealth later on, than you'd have had if you simply received and invested a normal cash salary from the start."

    The other motivation for the employer isn't usually trumpeted quite as loudly, but it goes something like, "As a startup we realize that it's vitally important to our continued existence for our employees to be 1,000% motivated to give their all. With stock options in your hands, dear employee, we have more confidence that our success will be your Priority No. 1, since the value of that paper you're holding will move up, down, or sideways, in direct proportion to that of the company itself."

    •2 Whether it's a good or bad deal to the employee-recipient depends, as you can imagine, on the particulars of the situation. Cash is nice (you can't pay your grocery bill with a stock option), and so an option is a winning deal for an employee IF the option is eventually cashed out for an amount that more than compensates for the wait. Plus, every employee will have a unique "utility" of current cash, so any given option might be good for one employee but not so great for another, depending on their respective current cash needs and utility curve. In assessing the pros and cons, though, the employee must consider the likely growth trajectory of the firm (or a spread of reasonable scenario expectations), the likelihood of the company actually having the legs to make good on the options at maturity, and of course the specific terms of the contract.

    Side note: The income tax ramifications are frequently both a pro and a con. Under many tax codes options enjoy certain tax advantages if they meet certain criteria (governments like to encourage employee ownership in their employers, more often than not). But the tax rules can be very complex, and your friend would be well advised to have his particular arrangement vetted by his tax advisor.

    •3 Bring up the subject after he's had two or four martinis? Seriously, that's really a matter of the ambiance of the whole scene. If the employee would like to discuss a possibility of opting out of the option scheme in favor of plain ol' cash, s/he'll just have to proceed based on a feel for the situation. The boss of Company A might be completely understanding of an employee's need for current cash (medical bills, whatever), whereas a different boss might see this request as indicating someone who's not a team player.

    •4 Likely, especially if the firm's biz model is based on some proprietary process or technology. In general, startups are more vulnerable to competition than are established companies (haven't had time to erect those barriers to entry) and so they're rather keen on keeping folks from stealing the ideas from the playbook. Whether or not it's an enforceable NDA depends on its terms. Personally, if I were receiving stock options as an employee---and (of course) I had no plans for launching a competing operation---I'd have a preference for the NDA being ironclad and bulletproof; the tighter the better. After all, if I'm holding equity in this little operation the last thing I want is for it to get torpedoed by some former employee who found a loophole in the NDA.
     
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  3. cesspadilla

    cesspadilla
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    Thanks for the detailed explanation arcsine. It's a startup company but I see a lot of potential in it. I, too, was really overwhelmed by the idea of having stock options as a my salary. I already told my friend about what you said and she's very thankful to you. Honestly we're not really used to offers like that here in PH. Especially for a regular employee like her. Anyway, just a follow up question, will it be a good proposal if my friend told her employer that she likes to have a salary while still having the stock options? What percentage can she say?
     
  4. ArcSine

    ArcSine
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    It's certainly not unreasonable that an individual might be in circumstances for which cash would be more valuable than options. Everybody's circumstances are different and vary widely. A reasonable employer will certainly understand that.

    First, what is the cash / options mix being offered to your friend? In other words, how much of her compensation are they proposing to pay her with a traditional paycheck, and how much of her compensation is to be in the form of options?

    Having addressed that one, the next question is, how much of an adjustment to that mix would your friend require? That is, how much more cash, over the amount being offered, would she require to meet her needs?

    The reason for these two questions is that it identifies the magnitude of the gap between the employer's proposal, and your friend's needs. The narrower the gap, the more likely her chances of successfully negotiating for a more-salary-less-options arrangement.

    The employer usually has bona-fide reasons for wanting employees to take at least part of their pay in the form of options. As I mentioned earlier, one of the common reasons is that a start-up frequently has a desperate need to conserve cash in the early stages. Then there's the "alignment" motive: some employers subscribe to the school of thought that employees who hold stock in the company will perform better (the employees' financial interests are "aligned" with those of the owners), with the end result that both the owners and the employees wind up making more money.

    The extent to which one or both of these motivations underlie your friend's employer's thinking, will probably play a role in how flexible they'll be willing to be to make an adjustment to your friend's cash-vs-options compensation mix.

    On a separate tack, does your friend's reticence about taking options arise from • (1) simply a need for current cash, due to present circumstances; or • (2) misgivings about whether or not these options will end up being worth the forgone cash?

    All of my foregoing blathering assumes (1), but (2) is a different matter. If she has valid reason to doubt the potential value of the options, she'll need to give serious thought to the matter. First and foremost, if she could put all the details of the proposed option plan in front of her tax or financial advisor, it'd be helpful.

    Ultimately, options involve uncertainty (especially in the context of a startup), and there's no getting around it. There are a lot of old-time Microsoft employees who ended up very wealthy thanks to options, and there are also plenty of failure stories out there. Even talking with a financial advisor is no guarantee of landing on the right decision, but it would improve her odds. The more details she could furnish to the advisor, the better.

    Sorry for rambling so long without ever getting to a succinct and direct answer to your question. It's just unfortunately the case that with equity options in a startup company, nearly every question has a "it depends" element to it.
     
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  5. cesspadilla

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    I understand ArcSine. Thank you so much because you have answered the question in the most elaborate detail you can. My friend already talked to her employer and the reason of her doubt comes in two things you already said (1) simply a need for current cash, due to present circumstances which is she have a current work and looking for another job; • (2) misgivings about whether or not these options will end up being worth the forgone cash? Because it is her first time to all of this. Another is that (3) she haven't been informed fully about the salary option which leaves her thinking that she was only given a stock option. They already agreed on something as of now but then she will be a contractual worker for them in the meantime to still support her other expenses. I think they already meet in the middle. :)

    Thanks for being so helpful again!
     
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