One of my longtime college buddies – Henry – took the plunge and joined a healthcare startup. He’s awesome – the kind of person that continually grows on you. He can talk to you for hours about anything and everything and make you feel so comfortable and laugh all at the same time.
Henry is the CTO and the company is raising a seed round. He wants to know how to best organize his equity – startup shares ownership or stock options – so he can get the most out of it. The conversation that I had with him can be useful to you as you are evaluating equity in your startup.
Do You Believe in Your Startup?
If you do, it’s better to own the shares outright. First, you must own the shares! Second, you purchase them for the lowest valuation they will ever be. Third, as long as the company qualifies for Qualified Small Business Stock (QSBS), it’s better for taxes. You will have to own the shares when the company meets QSBS and this will have to be properly documented.
The biggest concern with startup share ownership is – can you afford them? Typically, the cost can be in the 5 and 6 figure range. This ownership is structured as restricted stock awards and you must wire the money right away to buy them.
If you leave the startup before the shares are vested, the company can buy the shares from you. It’s best to discern this purchase price upfront. However, sometimes the company may not do this because of the extra legal expenses.
Not So Sure about the Company?
If you are not so sure about the startup, options are a better choice for you. Then you have to decide between NSOs and ISOs. Here’s an article explaining the difference.
Regardless of the options, push for a “post termination window” as long as possible. This is the amount of time you have to use the options in the event you leave the company. A ten year post termination window is the longest period and it is becoming more common, so ask for it.
Remember, as a high level employee at your company, the leadership, board of directors, and investors want you to stick around. So use this position and framework to best make your decisions. If you would like to get down to the nitty gritty and get the show on the road, let’s talk.