Reasonable Option Policies are not Scary
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Gusto’s legal department responded to my previous post, so make sure to read that first if you haven’t.
For the benefit of current and former employees, I’ll clarify a few misleading parts of their response (reproduced here.)
No such thing as a free discount.
Let’s start with the portion on why allowing you to sell shares you own would supposedly hurt you.
Currently, the common stock price at which the options are issued (the 409A price) to employees is 30% of the preferred stock price. In other words, you’re getting a significant discount.
This is not true.
The IRS has many rules, but a basic principle is that you cannot give an employee compensation and then arbitrarily tax it at a lower value. That is tax fraud. Of course, that isn’t what Gusto is doing here.
A discount is when you get the same item for a lesser price. You are not getting a “discount” on preferred stock; you are getting common stock (i.e. preferred stock minus rights) which is less valuable. To say common stock is discounted preferred stock is to say a Jetta is a discounted Mercedes Benz. Yes it is cheaper, but you’re not getting the same thing.
But that doesn’t tell us why I can’t sell my Jetta after I own it.
…if our common stockholders start selling their shares at a price of the preferred, $5.02, then this suggests to the IRS that the 409A price is wrong and that the options that we are issuing are undervalued. In sum, the discount that our current employees would be getting would diminish greatly, impacting our new grants as well as our recruiting efforts.
Employees losing a discount sounds bad, but by now we know that is not actually what is happening. You wouldn’t “lose your discount”; the shares you have would simply be worth more.
On the other hand, employees are giving the company a free loan.
When I started at Gusto (then ZenPayroll) three years ago, I exercised my options immediately. This means I bought them up front, for a cost of over $27,000 at the time.
That money was an investment, and a risky one at that. Startups have a high failure rate, but I believed in Gusto’s mission so I invested considerable time and personal savings. Over three years later, they still hold my money —minus the unvested shares they repurchased when I quit—but, apparently, I have no option of getting that money back.
In essence, every employee that has exercised options has given their company an interest-free loan with no timeline of when they get that money back. If Gusto stays private for a decade, well that’s just too bad. And the silly part is that, while tens of thousands of dollars means a lot to employees, Gusto has raised hundreds of millions of dollars. The money means little to them, yet they will “exercise all legal options” if I try to sell the shares that I earned.
It’s like sitting down at a poker table, but you can’t leave until the House says you can.
Transparency does not hurt recruiting.
The part about recruiting efforts is interesting.
Being transparent about the terms in your options agreement shows maturity and a willingness to have difficult conversations. I would encourage you to ask for a copy of Gusto’s full Bylaws—not just parts of it—so you know what is in there.
But if you care about your mission and want to recruit those who live by it, the first step is to hold yourself to the same standard.
Doing the right thing is not the same as doing what you can get away with.
This approach is standard practice. During my time at Fenwick, virtually every startup I helped incorporate decided to structure themselves in this way.
Doing the right thing is not the same as doing what you can get away with because everyone else is doing it. Often, doing the right thing means having the courage to stand against the tide. It means finding a just solution, instead of pointing at others and saying, “They do it too”.
Our company, Seneca Systems, neither has such a provision nor was advised by our lawyers to include one. However, if it is the case that these terms are standard then this is even more surprising. Employees in startups across the world are receiving equity promises that do not match up with their expectations.
Whether willingly leaving out information or simply forgetting to inform employees, companies are slipping in unfriendly provisions without notifying those they hire.
The SEC is not out to get you.
Another reason is the SEC, which has started to https://corpgov.law.harvard.edu/2016/04/25/sec-scrutiny-of-secondary-market-trading/
That’s an excellent article to link to. Given the rest of the email, you may think that Mary Jo White, Chair of the SEC, comes out against secondary markets. In fact, she advises how companies can responsibly monitor secondary transfers:
If their shares trade in the secondary market, companies should develop procedures to monitor and review company disclosures or other publicly available information that may impact trading, as well as monitoring what material, nonpublic information is available to directors, employees and others who may be selling shares in the secondary market.
She also lists a number of questions as advice for corporate governance. As an employee of Gusto, I would go through these four questions yourself.
Does your board include outsiders with public company or large company experience?
Do you have board members with regulatory and financial experience?
Does your board have expertise in the industry so that you can analyze different viewpoints and spot critical issues?
Is the company run and governed for the benefit of all of its investors?
You should ask for the terms of all previous investment rounds.
If the Gusto board is going to assert rights to protect you, you should have an understanding of how the board actually operates. As we have learned the hard way with employee equity, those terms are not always what you think.
Gusto can still go public when it wants.
If we allowed people to sell their shares to outsiders, we would then have to make company disclosures like a public company, even though we don’t have access to the public markets yet. That would be unnecessarily burdensome, negatively affecting our ability to operate.
This is also highly misleading. No employee, current or former, has said they would be unwilling to sell shares to current shareholders. In fact a few of us proactively offered to arrange such a deal. This means no cap table management, no regulatory burden, and no additional reporting requirements. Needless to say, Gusto turned this down.
Conclusion
You have worked hard for your stock and are now being told that you do not actually own it; at least not in any meaningful way. To be clear, this isn’t some conspiracy, but does represent a large chasm between what is practiced and preached at Gusto.
Hopefully they’re willing to do the right thing for their employees. Until then, at the very least, I hope employees can feel informed about the decisions made on their behalf.
Chris
