Start-up Equity. Suppose I were offered 1% equity in restricted shares and 1% in non-qualified stock options (NSOs) as part of a compensation package at an early stage startup, where the shares and options are subject to a 4-year vesting schedule with a 1-year cliff. The current FMV is very low.
1. Is the following correct? I could take an 83(b) Election and pay ordinary income tax on the restricted share grant now. I would owe no further taxes on the restricted shares until the time of their sale, at which time I would only pay long-term capital gains (LTCG) as long as I've held the shares for more than 1 year.
2. If I have a choice, is it correct that it would be more beneficial to have the restricted shares vest before the NSOs? My concern is having to potentially exercise NSOs at a high FMV in the case of a termination of service (e.g., 2 years into my employment), which would leave me with a huge tax burden for that year.
3. Finally, the company has claimed that their attorneys advised them not provide more than half the equity as restricted shares, and that this is their rationale for offering half as NSOs. I see the NSOs as a large risk primary because if there were a termination of service for any reason prior to an exit event which would allow me to liquidate my vested options, I would be faced with taking on a large tax burden for that year in order to exercise the vested options.
Would it make sense to attempt to negotiate a combination of restricted shares and ISOs totaling 1.9% or 1.8% if I think the expected exit price will be sufficiently high? Is it more favorable to have restricted shares or ISOs in this case?
I'm sorry but your question is unclear to me, Are you asking how each of the options work?
I believe I understand the basics of ISO vs. NSO vs. restricted shares. However, I have three specific questions.
The first is to check my understanding of the 1% equity which has been offered as restricted shares. (See 1.) I need to rephrase the second questions, but I would like to know what would happen if I accepted the offer as is, with 1% equity as restricted shares and 1% as NSOs. They both have a 4-year vesting schedule. Would the restricted shares and the NSOs vest at the same time over the course of 4-years?
Primarily, I am afraid of the possibility of being laid off or fired before my NSOs fully vest. In that cast, my understanding is that I would have two options: 1) walk away and not exercise my NSOs or 2) exercise my NSOs, in which case I would have to pay ordinary income tax on the difference between the fair market value and exercise price at that time. Currently, the FMV of shares is very, very low. In 12 months, it might be 10-100 times higher. So if, hypothetically, I were fired in 12 months, exercising my NSOs might mean having hundreds of thousands of dollars in ordinary income tax.
Finally, my third question has to do with some counteroffers I am considering making. Because NSOs seem like a risky asset to me, I would prefer to have all of my equity in the form of restricted shares or incentive stock options (ISOs). I am considering giving up some equity (asking for a total of 1.8 - 1.9% instead of 2.0%) to make this happen. Should I ask for 1.8 - 1.9% in restricted shares? Or 1% in restricted shares and 1% in ISOs? What combination would the employer be more likely to accept?
I will be on my computer tonight so please let me know if I can clarify any points further.
I want you to have the best answer you can possibly have
I'm sorry -- I typed out a long reply to your initial question but I am no longer seeing. Were you able to see the reply I sent to you?
and I have another expert in mind that I think could REALLY look at this and give you a great answer
he's not in the forum at the moment, but I can send him an email
would that be ok with you?
Oh........and I did see your reply
would waiting until tomorrow after I send this expert an email be ok with you?
Yes, but I haven't used this site before and want to repost my question as an urgent one. What should I do in the meantime?
I can "opt out" which will put this question back on the open board, and any other experts currently online will have access to it
Perfect. That would be great. I will edit my question for clarity and if you could direct the expert to my question I would greatly appreciate it.
ok........I will opt out and send this expert an email
Anne, were you able to opt out of this question?
Thank you for your answer.
To follow up on my second question, is it possible that both the restricted shares and NSO would vest simultaneously (so that each vests over the 4-year time period)?
I would be happy to leave a positive rating, but I still am struggling to understand some of the details.
If I accept standing offer of 1% restricted shares and 1% NSOs, will they both vest over the 4-year time period unless I negotiate a different vesting schedule? This is what I meant to ask with my last question to you.
Also, why is the employer unwilling to issue more restricted shares or ISOs to me instead of NSOs? In my specific scenario, isn't the only advantage of NSOs to the employer that they can deduct the spread when I exercise them? Or is there something I am missing?
I see -- thank you for that detailed explanation. I did not think that NSOs might be issued to discourage employees from exercising. (And yes, I would be an early employee).
I am going to leave you a positive answer. Also, are you available for phone consultation / document review at an hourly rate? (And if so, do you have any U.S. tax or legal credentials? I wasn't clear from the site).