Turn ISOs from Confusion into an Asset & Compete with the Googles of the World for Top Talent

“I was extremely uncertain about the value of the options in my grant and consequently didn’t even practically consider them as part of the total comp in my offer letter”

~ a 27 year old male at a later-stage, private startup in San Francisco.

In today’s competitive job market, startups face an uphill battle when competing for top talent against the Googles of the world who can pay top dollar. For instance, the median total compensation at Facebook was recently announced to be north of $240K.

Want to get better at attracting and retaining talent? Do a better job at communicating and helping visualize the value of your company’s stock options to prospective hires and current employees. ISOs and NSOs are the most under-valued, misunderstood, and stressful part of startup compensation.

Here at Pave, we’ve conducted extensive research with employees at private startups of varying stages. 3 key problems have emerged as a very consistent pattern during these interviews:

1. Stock options are an extremely under-appreciated and vague aspect of job offers.
2. Once hired, employees are almost unanimously uncertain or misinformed about their exact exercise and tax implications.
3. Stock options feel extremely illiquid and thus worth “nothing”.

1: Stock options are an extremely under-appreciated and vague aspect of job offers

Surprisingly, at Pave we’ve learned that most startups have completely different ways of communicating equity compensation details to candidates after they receive their offer letters. Unfortunately, all approaches consistently leave candidates feeling confused, uncertain, or skeptical to varying degrees.

Here are some approaches that startups commonly use:

• “Keep it Vague” — simply mention the number of options and maybe the predicted strike price in the offer letter and say nothing more.
• “Chat with our CFO” — at smaller startups (usually under 50 employees), some of Pave’s interviewees mentioned that the CFO offered to sit down with them for a 30 minute meeting to explain their options.
• “Here’s a packet with more info” — sometimes, candidates receive a powerpoint or additional PDF with explanations and some static visualizations of how vesting and exercising works.

Unfortunately, none of these approaches have proven to be effective among the cohort of interviewed startup employees.

Pitfalls of Current Approaches Used to Inform Candidates with Offers About their Stock Option Grants:

2: Once employed, employees are almost unanimously uncertain or misinformed about the exact exercise and tax implications

The most consistent point of frustration for employees is understanding the tax implications. Even employees who have a finance background or have invested heavily in their own personal research to understand how ISOs work consistently mention that they don’t know how much they’ll possibly be expected to pay due to the AMT tax liability if they decide to exercise. Here are some quotes:

• “I really wish the company had a crash course about ISOs and the tax implications. Something like sexual harassment training but for stock options.”
• “The day I decided to exercise was the most stressful day of my life. I had to ask my parents if they’d lend me money the following April in case I was going to owe extra taxes because I decided to exercise.”
• “I was super stressed about the tax implications of exercising. And this was the main reason I decided not to exercise.”

Overall, there are two key layers of ISO tax comprehension:

1. The high-level difference between long-term and short-term capital gains taxes and why exercising earlier will enable you to qualify for long-term capital gains taxation treatment.
2. How the AMT tax can affect you even if you’ve qualified for long-term capital gains taxation.

Roughly two-thirds of the interviewed employees have directionally known about point #1. That’s good. But almost nobody has known exactly how the AMT works. And not one interviewee has even loosely known how many shares they could exercise without tapping into an AMT obligation.

This is broken. There should be a simple way for every employee to know exactly how much they’ll owe in taxes with different strategies:

1. Strategy 1: wait until a liquidation event before exercising and pay the ordinary income tax rather than long-term capital gains tax as a “tradeoff penalty” for the decreased risk.
2. Strategy 2: exercise as many shares as early as possible without tapping into the AMT tax. Then, exercise the rest of the shares when there’s a liquidation event.
3. Strategy 3: exercise as many shares as early as possible even if it taps into the AMT tax liability and then try and “recover” the AMT costs in future years.

Current Approaches Used to Inform Employees About their Options

3: Stock options feel extremely illiquid and thus worth “nothing”

This is the biggest problem of all. A driving reason why startup employees undervalue their stock options is due to a (mostly accurate) perception that it’s unlikely they’ll ever see any cash for them. Additionally, the average time that startups take to have an IPO is on the rise. And most startups have a perception that startups are inherently risky ventures.

Here’s a quote from a software engineer at a company that recently went public:

“These days, most of my friends and I don’t really value startup stock options as worth anything, because we’re skeptical of liquidation events ever happening.”

A key ingredient to giving stock options more power and providing employees with more control is to give employees more certainty or capabilities to control their shares’ future liquidity. But this is no easy problem to solve overnight!

A View of Pave’s Total Rewards Portal

Pave enables your talent to treat equity as a valuable asset, not Monopoly money.

Pave is a suite of compensation tools that helps companies plan and communicate total compensation. Eliminate the confusion around equity and help candidates and employees dream big about their futures at your company. Learn more at www.pave.com.