[Learning Equity] Why You Should Think About Compensating Employees, Freelancers in Exit-Vested RSUs

Note: This is an updated version of a piece written by Mike Mills for Quidli earlier this year.

Most startups use incentive stock options as a way to compensate workers. But the process of setting up, distributing, and benefiting from incentive stock options is complicated, painful, and risky. If something goes wrong or the price of the stock fluctuates, workers can end up with nothing but a large tax bill. We think there’s a better way, however, and it’s called the Restricted Stock Unit, or RSU. And we’ve added a twist to it to make it even better, vesting at exit.

Finding the right way to compensate workers is difficult.

As the founder of a startup, you need to think about several things in how you compensate workers with equity:

You want to save on cash: You live and die on your company’s cash runway. The more you can pay in equity, the longer your lifecycle.

You want to align incentives: Early workers are critical to your success, but only if they stick around. Even if they eventually leave, you want them to have an incentive to work toward long-term success, not just up until the day their shares vest.

You want to protect your control: Each time you give a piece of your company away, that’s less control you have from that day which means more complexity for future fundraising.

You want to give everyone a fair chance to share in success: Startup workers take on extra risk to help you. They should have commensurate rewards with the company’s success, and not with fluctuations in the company’s price.

You want it to be simple and easy: You and your workers don’t have the time to build a complicated financial plan to best optimize stock options. You don’t want people to pay unnecessary taxes or end up with something that costs them money.

Traditional incentive equity is complicated and risky for workers.

Traditionally, startups have offered stock and stock options to workers to incentivize them. But these create a mess of problems for them.

Difficult Accounting Choices: Workers receiving traditional stock options have to make difficult and irreversible choices at the moment they receive a stock option to optimize their taxes. They must choose whether to be taxed at the moment the stock option is granted, before it even vests. If the worker chooses to pay taxes at that moment, they now face the risk that they have paid taxes on something that may never vest or may never be worth something. Most don’t understand that they need to make this decision, and even if they do, they must seek out help from accountants. It’s hard to incentivize people if they don’t understand what they’re getting.

Difficult Timing: Most stock option plans offer only a small window for a worker to exercise. If the timing is wrong, the worker loses out on everything.

Downside Risk: Stock options are risky bets. A worker could pay for stock options that end up worthless. This pushes workers to act like gamblers, working only to push the price up in time to exercise.

Lack of Transparency: It’s hard for a worker to understand exactly what they own and what they will get without an accountant and a lot of work.

Traditional incentive equity is difficult for you to maintain.

Not only is it complicated for workers, it’s complicated for you.

An Army of Lawyers and Accountants: To set up incentive equity requires costly meetings with lawyers and accountants just to set things up.

Regular Valuations: To price incentive equity and stock options, your company regularly has to seek corporate valuations. This costs money and time.

Securities Regulations: Once you have a certain number of owners, you have to start filing more complex reports with the SEC. This can scare off all of your stakeholders.

You want to use an RSU that has exit vesting.

An RSU is a conditional promise of future equity or cash equivalent. The RSU will convert into shares of stock or cash at a specified moment in time. Large public companies make this conversion after a certain amount of time working at the company, or after certain performance goals are met. This method is not effective for small, private companies. So we’ve added a twist to RSUs, Exit Vesting.

We think the best way is to set RSUs to convert into real shares at the moment the company has an exit event, that is, it goes public or is bought out. This way, workers share in your company’s success. By setting the conditional promise of conversion at an exit event, you unlock several features:

• An RSU owner does not have any ownership rights to underlying stock until conversion. This protects your control, and avoids complicated registration requirements with the SEC.
• Until the moment of conversion, the RSU owner pays no taxes. Not coincidentally, this is the same moment that the owner will have something liquid with which to pay those taxes.
• The RSU owner does not have to make any filings or declarations, or make difficult decisions about when or how to exercise.
• The stock a worker receives at conversion is always worth something.

You can use Exit-Vested RSUs now. We can help.

Do you believe RSUs are right for your company? The good news is you can now use Quidli to generate Exit-Vested RSUs to give your workers. Drop us a line at hey@quid.li if you’re interested in getting a demo!

We spend a lot of time thinking about equity but we’ll be the first to admit it isn’t the most intuitive part of building a business. ‘Learning Equity’ is a series of notes prepared by Quidli based on the most common questions we get from clients and prospective users. If there’s anything you don’t understand, we highly recommend seeking professional legal counsel.