Stock options aren’t the only option
Stock options are as ubiquitous as ping pong tables in the startup world. Many founders and employees probably don’t even question the type of equity they offer employees, or understand the implications on both the business bottom line and employee’s pocket books and morale.
Stock options used to be standard for companies wanting to incentivize top talent — but unfortunately they come with significant (and hidden) downsides, both for workers and employers. In an article from April 2019, Steve Blank in the Harvard Business Review called stock options “a good deal gone bad.”
Because Fortune 1000 firms have greater resources, they were the first to innovate on equity systems. After the mid-2000s and scandals such as Enron and WorldCom, companies began offering Restricted Stock Units as executive compensation instead of stock options. Eventually RSUs became adopted as the gold standard for top-tier companies, almost replacing stock options entirely.
Unfortunately, this wasn’t the case for small- to medium-sized businesses, because of the significant cost of setting up RSU-based legal contracts (often over a million dollars.)
RSUs are vastly preferable to traditional stock options for workers, because they reduce taxation and reporting requirements. RSUs are also better for employers, because they do not affect cap tables or grant shareholders’ rights, allowing greater flexibility and more streamlined decision-making.
Until recently,, RSUs were by and large inaccessible to small- and medium-sized businesses, due to the prohibitive cost of bespoke RSU document creation. Upstock was founded on the belief that RSU-based equity programs should no longer be restricted only to companies like Google, Apple, and Facebook, who can afford millions of dollars in legal fees.
Upstock’s mission is to create a world where fair company ownership can be enjoyed by every team, everywhere. Within the US, RSUs are a huge part of making that possible. We rely on the world’s top equity lawyers to advise us regarding the preferred equity units in each market we enter.
The major benefits of RSUs (when compared to stock options) for businesses include:
Stock Options Have to Be Purchased
Many employees don’t realize that within a short time after vesting, or termination of employment, (usually 90 days) they have to produce the money to purchase those stock options or forfeit them back to the company. This financial burden becomes an emotional one as well, at a moment when the employee is least ready to manage it. If the options are vesting, it creates a shadow over what should be a moment of celebration. In the case of termination, it’s asking someone to invest in a company they they just quit or were fired from. In neither case is the employee given the space to make this investment with the best emotional and mental state possible. If they do decide to forfeit the stock, the stock usually returns to the company and the founders and the company benefit, while the employee is disadvantaged.
Investment without Complete Information
In addition, this cash investment into the company an employee works for comes without the visibility normally present when someone makes such a significant investment. Does the worker know what the current valuation of the business is? Do they know the financial stability of the company? Do they know the trajectory? Are they given all the information they would need to make an informed investment decision? In vast majority of cases, the answer is a resounding no.
RSUs Offer Preferable Taxation
Many workers may not be aware that an increase in stock value is a taxable event in and of itself. If the value of the stock has risen since the stock options were issued, workers must pay tax on the price differential as well. (And in some cases, an additional tax vehicle also applies when options are exercised, called the Alternative Minimum Tax or AMT.)
When workers are granted RSUs, taxation is timed to occur with a landmark event (IPO or sale of the company) and the shares can be sold to cover the cost of the tax bill, also known as “sell to cover.” As a result, RSUs allow workers to avoid paying tax on stock until there’s money available.
Stock options are as ubiquitous as ping pong tables in the startup world. Many founders and employees probably don’t even question the type of equity they offer employees, or understand the implications on both the business bottom line and employee’s pocket books and morale.
Stock options used to be standard for companies wanting to incentivize top talent — but unfortunately they come with significant (and hidden) downsides, both for workers and employers. In an article from April 2019, Steve Blank in the Harvard Business Review called stock options “a good deal gone bad.”
Because Fortune 1000 firms have greater resources, they were the first to innovate on equity systems. After the mid-2000s and scandals such as Enron and WorldCom, companies began offering Restricted Stock Units as executive compensation instead of stock options. Eventually RSUs became adopted as the gold standard for top-tier companies, almost replacing stock options entirely.
Unfortunately, this wasn’t the case for small- to medium-sized businesses, because of the significant cost of setting up RSU-based legal contracts (often over a million dollars.)
RSUs are vastly preferable to traditional stock options for workers, because they reduce taxation and reporting requirements. RSUs are also better for employers, because they do not affect cap tables or grant shareholders’ rights, allowing greater flexibility and more streamlined decision-making.
Until recently,, RSUs were by and large inaccessible to small- and medium-sized businesses, due to the prohibitive cost of bespoke RSU document creation. Upstock was founded on the belief that RSU-based equity programs should no longer be restricted only to companies like Google, Apple, and Facebook, who can afford millions of dollars in legal fees.
Upstock’s mission is to create a world where fair company ownership can be enjoyed by every team, everywhere. Within the US, RSUs are a huge part of making that possible. We rely on the world’s top equity lawyers to advise us regarding the preferred equity units in each market we enter.
The major benefits of RSUs (when compared to stock options) for businesses include:
Stock Options Have to Be Purchased
Many employees don’t realize that within a short time after vesting, or termination of employment, (usually 90 days) they have to produce the money to purchase those stock options or forfeit them back to the company. This financial burden becomes an emotional one as well, at a moment when the employee is least ready to manage it. If the options are vesting, it creates a shadow over what should be a moment of celebration. In the case of termination, it’s asking someone to invest in a company they they just quit or were fired from. In neither case is the employee given the space to make this investment with the best emotional and mental state possible. If they do decide to forfeit the stock, the stock usually returns to the company and the founders and the company benefit, while the employee is disadvantaged.
Investment without Complete Information
In addition, this cash investment into the company an employee works for comes without the visibility normally present when someone makes such a significant investment. Does the worker know what the current valuation of the business is? Do they know the financial stability of the company? Do they know the trajectory? Are they given all the information they would need to make an informed investment decision? In vast majority of cases, the answer is a resounding no.
RSUs Offer Preferable Taxation
Many workers may not be aware that an increase in stock value is a taxable event in and of itself. If the value of the stock has risen since the stock options were issued, workers must pay tax on the price differential as well. (And in some cases, an additional tax vehicle also applies when options are exercised, called the Alternative Minimum Tax or AMT.)
When workers are granted RSUs, taxation is timed to occur with a landmark event (IPO or sale of the company) and the shares can be sold to cover the cost of the tax bill, also known as “sell to cover.” As a result, RSUs allow workers to avoid paying tax on stock until there’s money available.
RSUs Are More Fair to Early-Stage Workers
Early-stage workers take on disproportionate risk in accepting stock options than do later-stage workers. Due to the rapid increase in company valuation, the tax bills for early stage workers are often significantly larger than later stage employees. Again, these taxes are often due before the stock can be transferred, sold, or liquidated in any way.
Increased Cap Table Flexibility
Because stock options are managed via a cap table, each new worker added to the option pool requires an entry on the cap table. This incurs additional lawyer and administrative fees for each new worker added, as well as relative hassle and fears activist workers delaying the company due to their shareholder rights.
Unlike traditional stock options, Upstock eliminates the need to adjust the cap table after every new stock option grant, as well as to get board approval for each new worker being added.
Streamlined Company Voting
Stock options require an amendment to the organization’s cap table with each new hire, which could eventually grant workers shareholders’ rights if they exercise the option. This issue creates uncertainty and even hiring and firing paralysis for owners and investors.
With RSUs, workers can receive a stake in the company without being added onto a cap table or granted shareholders’ rights.
Reduces 409A Valuation Costs
Because companies who issue stock options must constantly be able to quote a fair exercise price to be able to issue new options to workers, they are required to pay for a 409A valuation. These need to be renewed every 6 to 12 months and third-party vendors must be paid for each time. This can cost one to ten thousand dollars or more each year.
Because RSUs gain their value only at a landmark event, 409A valuations are generally not required, due to the fact that the market rate for the company will have already been established by the sale or IPO of the company. Thus, employers issuing Upstock RSUs can usually avoid paying $1,000 to $14,000 or more each year for 409A valuations.
Stock is like anything else — ripe for disruption. In a world that is increasingly flat, it’s about time the luxury equity available to the richest among us- the Fortune 1000s- be available to every business, whether its a tech startup or a brick and mortar business.
We believe that businesses of all sizes, stages, and budgets deserve access to top-of-the-line equity that provides favorable conditions for workers and employers alike. This is why I founded Upstock and brought together a team as passionate about disrupting stock options as I am.
Upstock’s system is based on a tried-and-true formula within the equity ecosystem — Restricted Stock Units (RSUs), the same unit of equity in use at most Fortune 1000 companies. If you have questions about getting the best equity for your organization, contact our team.
Please Note: The information contained within this section is specifically tailored to businesses incorporated within the United States. While RSUs are the most frequently used type of equity on the Upstock equity platform, Upstock does use different units of equity when regionally and jurisdictionally prudent. Please contact our team if you would like to know how our documents work in other locales.
