January 25, 2022
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 pocketbooks 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 went bad.”
Because Fortune 1000 firms have more significant 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, due to the high 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. They were an expensive stock to choose though, with the price tag for a single document costing upwards of a million dollars.
Until recently, RSUs were by and largely inaccessible to small- and medium-sized businesses, due to prohibitive costs. Upstock was founded on the belief that RSU-based equity programs should no longer be restricted to companies like Google, Apple, and Facebook, which can afford millions of dollars in legal fees. Upstock developed a Dynamic Equity system based on the best RSU legal documents in the world.
Our mission at Upstock is to create a world where proper company ownership can be enjoyed by every team everywhere. We rely on the world’s top equity lawyers to advise us regarding the preferred equity units in each market we enter.
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, often coming 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 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 to the company's benefit, while the employee is left disadvantaged.
This cash investment into the company an employee works for comes without the visibility usually 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 the vast majority of cases, the answer is a resounding no.
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. Worker-issued stock options are taxed in two main ways. First as ordinary income for the value delta between the option grant and the option exercise. Second, on the delta between the exercise and the final sale of the stock. In some cases, an Alternative Minimum Tax or AMT is applied.
When workers are awarded Dynamic Equity, 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, Dynamic Equity allows workers to avoid paying tax on the stock until there’s money available.
Early-stage workers take on a disproportionate risk in accepting stock options than 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 usually due before the stock can be transferred, sold, or liquidated in any way.
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.
Unlike traditional stock options, Upstock eliminates the need to adjust the cap table after every new stock option grant, as well as the need to get board approval for each new worker added.
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.
Because companies who issue stock options must continuously be able to quote a fair exercise price to be able to issue new opportunities 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 each time. This can cost one to ten thousand dollars, or more, each year.
Because RSUs fully vest to 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 an increasingly flat world, it’s about time the luxury equity available to the richest among us- the Fortune 1000s- becomes available to every business, whether it's 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 — Dynamic Equity, based on 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.