Employee Equity AMA - The Total, Uncensored Q&A

Hey Val! How do you handle equity questions when an employee is terminated? Does that change if they're based outside of the US?

It's a complicated topic, and it involves a lot of questions around how vested the employee's stock options are and what you, as the employer, are willing and able to provide.

For instance, you might be able to waive the cliff (most vesting schedules start with a 1 year "cliff" that you have to pass before your options start to vest), accelerate the vesting schedule (allow anyone at any stage who hasn't fully vested to buy in to the company further) or even extend the length of time after the employee has left for them to be able to take advantage of the stock options they have already accrued (known as the post-termination exercise period or PTEP).

There are tax considerations to take into account too if the employee decides to exercise within the PTEP. In the US it's quite simple, but when your employee is based abroad you need to think about whether you still have the obligation to withhold something even though the employee has left the company (how should you notify the tax authorities, should equity be treated as part of the severance package, etc.). It all depends on how your plan is structured and on what the local laws say.

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I went through a funding round where I raised almost totally via SAFE notes. I have quite a few of them now, and now I need to be able to issue options to my employees. The problem is that because some are pre-money, some are post-money, and the valuation cap is different each time, I don't know how to calculate my price per share … which means I can't put a dollar value on the equity grants I plan to make. What's the best way to figure this out?

It can be tricky to simulate the conversion of multiple SAFE notes and get a proper understanding of the company's valuation, the company's latest price per share or one's ownership percentage.

At Easop, we always advise our clients to aim for the highest level of transparency when it comes to communicating equity value. If you, as a founder, want your team to be in the same boat, you need a proper understanding of what you have. Because even if your employees can be fooled by improperly representing company's valuation, that lack of transparency will always come back to bite you.

You could for instance take the highest or the latest valuation cap as a proxy of your company's valuation but keep in mind that you'll have to take into account the dilution impact of these SAFEs when calculating the "SAFE price". There are other more conservative methods too, such as not taking into account the SAFE (or other convertible notes) at all when sizing your grants.

This matter can be quite complex. Feel free to contact me in DM if you want us to go through the numbers together!

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Hi Val, Are they any specific considerations that I need to make when I issue options to Canadian employees, at the time I issue them?

Not at the time of issuance itself. However, there are some tax benefits that may be available at the time of exercise of the options (such as a 50% tax reduction) so long as we're talking about an employee (not a contractor/advisor).To be more specific regarding the 50% tax reduction: The grantee may be able to benefit from a 50% reduction in the taxed amount of the spread. To qualify for this tax benefit, these conditions should be met:

1. The shares acquired as a result of the exercise of the stock options are shares of common stock ("prescribed shares") (this will generally be the case when grants are made through Easop)
2. The strike price is at least equal to the fair market value of the shares at the time of grant (this will be the case when grants are made through Easop, unless you've opted for a lower strike price)
3. The grantee is an employee of a subsidiary which is controlled by the parent company (a “qualifying person” )
4. The grantee dealt at arm's length with the qualifying persons right after the agreement was made (Unless the grantee is already a significant shareholder, they will almost invariably be considered to have dealt at arm's length with the grantor. In general terms, an individual will not be considered to deal at "arm's length" with the grantor if the individual controls the grantor through voting shares or is otherwise able to control the grantor through other means).

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Val, thank you for this answer! Does the type of equity matter to give our future employee the biggest tax advantage? For our America-based employees, RSAs make the most sense, as they can file 83(b)s. In our case, this person is a US citizen living in Canada.

Yes the type of equity matters. Generally, it can be influenced by several factors such as the type of work relationship you have with the person (employee, employee via EoR, contractor). RSAs often make sense if you are not in a position to benefit from the 50% tax reduction I mentioned. Another way to come to the same result would be to grant stock options with early exercise. We do a pretty deep dive into early exercise here

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I've never issued equity to any international employees, but as we keep growing I'm wondering... are there standard rules/regulations across the EU? Or does each country have specific laws to follow?

Unfortunately, there are no standard rules/regulations across EU countries. Each country has their own set of rules and/or exemptions.

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We're a startup incorporated in Delaware, but most of our team is abroad. Some in Europe, others in South Asia, etc. Obviously, being a company in this phase, we want to be able to provide equity to our employees, but we haven't gotten there yet. It's honestly confusing to figure out whose laws apply here. Is it the US because that's where the business is? Or abroad in the country of each employee? Really hoping for the former, as it would make life easier…

Sorry to break your heart, but I have to tell you what you don't want to hear … The laws are mostly based on the place where the person receiving the shares is living. So if you have an employee in Portugal, you'll need to make sure that the shares you're providing to them are aligned with Portuguese law (same goes for any other country). And by the way, that includes taking taxation into consideration, as that can make a huge difference when it comes to whether you've actually incentivized your employee or just made their life harder.

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We're still pretty small, but I'm wondering, what's the biggest mistake you see small companies make? Talking Pre-seed and seed-level startups.

Great one! Here's what I see: 409A valuations. This is the fair market value of your company, as evaluated by a third party. And for any company that either issues equity or is considering doing so, the fact is that most early stage startups don't take a serious enough look at their valuation early on. And this can result in some possibly harmful effects on the current team when you take on new funding. Specifically, the IRS could attach some extremely harmful fines and penalties to your company AND your equity holders.

And one more point I'd like to address (even though you didn't directly ask this) is the international aspect here. Because a 409A is an IRS code (aka a US regulation). But how does that apply outside the United States? Well, it doesn't directly. But if foreign tax authorities are looking for a valuation, they may take it into account. And since it's a very complete document, it's still worth having done even in an international context.

So, there you go. I would strongly suggest you have a 409A valuation done even when equity isn't necessarily top of mind!

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I'm working on launching an ESOP for my employees, but I don't really want to provide a 1-year cliff for many of them. They've been with me long enough that I'd like them to start vesting right away. Is there any problem with this? Can I change the vesting schedule for some employees?

There's nothing that says you're required to follow the 1 year cliff / 4 year vesting schedule that most scale ups use. That's just an industry standard. So if you're comfortable, change away! That said, from a practical perspective, you should be aware that any policy-level changes could benefit new employees in a way you didn't expect (e.g. a brand new employee vesting options after their first month on the job).

Still have questions?  Reach out, we’d be happy to talk Let’s Chat

It's been a tough year and a lot of my employees' option grants have an exercise price per share higher than the current actual fair market value of one share (effectively - they're underwater). I'm considering some sort of repricing to get their options back to FMV and motivate them. What's the best way to handle this?

First off, I'm sorry you're going through this. It can definitely be a tough thing to incentivize employees when you're upside down. But you're on the right track thinking about a repricing. Let me see if I can break this down for you:

Typically, repricing happens by either reducing the strike price option holders have to pay to get them back in line with fair market value (FMV). But it comes with a few legal hurdles you'll need to be aware of. If you're in the US, you have ISO status, and you want the favorable tax treatment that comes with it, then the repricing means two things.

First, the value of the repriced stock can't exceed a $100,000 FMV, and second, your clock resets. Any company that wants to take advantage of their ISO status always has to hold those shares for a 2 year period. When the repricing occurs, that clock will start over again.

If you're NOT in the US, then depending on where your employees are, you could be subject them to taxes. The reason is that a repricing in places like Belgium, Ireland, and Canada could amount to a new grant, and these countries tax at the time of grant in certain circumstances.

There isn't a clear path to tell you to take, but hopefully this will help you understand your options. Best of luck!

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Hey Val! Thanks for the great tidbits here. I have one for you: I've had a buyer approach my company (about 2 years old) and I'm considering an early exit. The thing is, a lot of my employees haven't hit their 1-year cliff yet, so they haven't vested any shares. I'm considering allowing early exercise so they can take part in the acquisition. What are your thoughts on this?

Congratulations! I hope your exit talks go smoothly and you get what you want out of it. But to start, I want to clarify something. You've actually mixed up two concepts, and they're different enough that I need to nitpick before I go further.

You've said that you want to early exercise so that people with unvested shares can take part in the sale, but early exercise and vesting acceleration aren't the same thing. If I want to make sure someone has vested shares prior to the sale, I can perform a vesting acceleration. That would then give them the ability to buy more shares (aka exercise) when the timing is right.

An early exercise, on the other hand, just lets the employee take those vested shares (aka the ones they currently have the right to buy) and buy whether or not there's a liquidity event on the horizon.

So, a situation like yours is actually one in which you might want to consider a vesting acceleration due to the potential buyout. But if you didn't have a buyer on the horizon and just wanted to incentivize your employees by letting them have a true ownership interest in the company even without any upcoming liquidity event, then early exercise is for you.

Hope that helps!

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I hope I'm not too late to ask, but have a question that is likely up your alley.  We've just hired our first international employee in Ecuador to handle customer service issues, and we did it through Remote as the employer of record. I wanted to make an NSO grant to her, but I'm not sure what the legal requirements are. We're in California if that matters.

Hi, Cheryl!  No problem, happy to answer still - great question! And I'll be honest, there are really only two options. The first is probably the harder option, because it involves hiring lawyers that can bridge the gap between the US and Ecuador. That really means finding and hiring a lawyer in Ecuador that understand how to apply US tax law to the Ecuadorian legal environment. Remote can help a bit, and they do provide some of that assistance as part of their service, but it isn't their specialty.

The second option, while a little self promotional, is Easop. We make this process really quick and transparent by allowing you to create those same documents in almost real time. We've basically hired the lawyers and do the grunt work for most of the world's countries ourselves. Ok, that's enough self promotion.

Still have questions?  Reach out, we’d be happy to talk Let’s Chat

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