Ask HN: buying options in a privately-held company
5 comments
First, let me be "FIRST LAWYER POST" and tell you that you have to have counsel check this.
Second, it's actually likely that your friend cannot sell options in the company; typical boilerplate employee stock option agreements prevent this. Without that agreement, a competitor can buy options from a former employee and wind up with common stock.
Third, once your friend left the company, a clock probably started ticking on those options; they'll either expire or the company will automatically get the option to buy them back at their strike price (or some other nominal price). They may not be worth anything at all.
Fourth, it may not be lawful for the private company to have non-employee shareholders; private companies are typically only allowed to sell shares to SEC accredited investors, who (simplifying) have more than $1MM in the bank or $300k+/yr in salary.
Fifth, you want to seriously consider whether you even want to hold shares in a private company. Your friend was an employee, is probably last in line for liquidity, and probably has no meaningful voting rights. I have several friends who wound up paying for their employee options only to have them become worthless due to restructuring (companies can restructure, terribly dilute existing options, but issue new options to current employees to make up for them) or M&A terms.
Second, it's actually likely that your friend cannot sell options in the company; typical boilerplate employee stock option agreements prevent this. Without that agreement, a competitor can buy options from a former employee and wind up with common stock.
Third, once your friend left the company, a clock probably started ticking on those options; they'll either expire or the company will automatically get the option to buy them back at their strike price (or some other nominal price). They may not be worth anything at all.
Fourth, it may not be lawful for the private company to have non-employee shareholders; private companies are typically only allowed to sell shares to SEC accredited investors, who (simplifying) have more than $1MM in the bank or $300k+/yr in salary.
Fifth, you want to seriously consider whether you even want to hold shares in a private company. Your friend was an employee, is probably last in line for liquidity, and probably has no meaningful voting rights. I have several friends who wound up paying for their employee options only to have them become worthless due to restructuring (companies can restructure, terribly dilute existing options, but issue new options to current employees to make up for them) or M&A terms.
The main issue here is: does the company allow the early employee to sell shares from an executed option when there is no public market for the shares. Most companies don't allow these shares to be sold (or have right of first refusal on a sale), so in this case the early employee would have to hold the shares.
If you are going to approach the CFO and let him know what you are thinking, this is the main issue to bring up. If the company will allow the early employee to sell the shares, than I would structure the $10,000 as a short term loan with tangible property as collateral (such as his car). The loan can either be paid back in 30 days or a set number of shares can be delivered at a set price. The $10,000 would be subtracted from YOUR_PRICE * SHARES_SOLD when the shares are delivered. You would write a check to the early employee for the difference. If no cash or shares are delivered you would get title to the car.
If a liquidity event is required to sell the shares to a third party, you could simply extend the loan period long enough for a liquidly event to emerge. This is more risky as the time frame is unknown, and would bring in concepts such as interest on the $10,000, etc.
The CFO should know the share price the board set at the last meeting. These prices tend to be low, but in general I think you should pay less than this amount for the shares. A discount of 50% is not unreasonable.
The other issue is taxes. The early employee will be incurring taxes at exercise on non-qualified options and at sale on incentive options, so in either case this needs to be factored in. The early employee will pay ( BOARD_SET_PRICE – EXERCISE_PRICE ) * NUMBER_OF_SHARES * MARGINAL_TAX_RATE for NQO at exercise and (YOUR_PRICE - EXERCISE_PRICE) * NUMBER_OF_SHARES * MARGINAL_TAX_RATE for ISO when he sells them to you. As long as the tax amount is greater than (YOUR_PRICE – EXERCISE_PRICE) * SHARES_SOLD he will be covered. His profit would be the shares he retains from the deal.
Good luck.
If you are going to approach the CFO and let him know what you are thinking, this is the main issue to bring up. If the company will allow the early employee to sell the shares, than I would structure the $10,000 as a short term loan with tangible property as collateral (such as his car). The loan can either be paid back in 30 days or a set number of shares can be delivered at a set price. The $10,000 would be subtracted from YOUR_PRICE * SHARES_SOLD when the shares are delivered. You would write a check to the early employee for the difference. If no cash or shares are delivered you would get title to the car.
If a liquidity event is required to sell the shares to a third party, you could simply extend the loan period long enough for a liquidly event to emerge. This is more risky as the time frame is unknown, and would bring in concepts such as interest on the $10,000, etc.
The CFO should know the share price the board set at the last meeting. These prices tend to be low, but in general I think you should pay less than this amount for the shares. A discount of 50% is not unreasonable.
The other issue is taxes. The early employee will be incurring taxes at exercise on non-qualified options and at sale on incentive options, so in either case this needs to be factored in. The early employee will pay ( BOARD_SET_PRICE – EXERCISE_PRICE ) * NUMBER_OF_SHARES * MARGINAL_TAX_RATE for NQO at exercise and (YOUR_PRICE - EXERCISE_PRICE) * NUMBER_OF_SHARES * MARGINAL_TAX_RATE for ISO when he sells them to you. As long as the tax amount is greater than (YOUR_PRICE – EXERCISE_PRICE) * SHARES_SOLD he will be covered. His profit would be the shares he retains from the deal.
Good luck.
See other advice above, ie: it's very unlikely that you can actually execute this arrangement.
Supposing that you can, however, I would recommend that you either purchase shares outright, or now. Stock is not really a good thing to have joint ownership of (excepting cases of spouses, etc.).
I would never "purchase" (I'm using the term loosely here) stock that I didn't have ultimate control over. If the ex-employee wants to make some money, you could agree to purchase his options at a price between their current value and his strike price.
If you don't follow the above, you'd need a fairly rigid contract outlining how and when either party could force the sale of the stock (price, criteria, RFR, etc.).
Supposing that you can, however, I would recommend that you either purchase shares outright, or now. Stock is not really a good thing to have joint ownership of (excepting cases of spouses, etc.).
I would never "purchase" (I'm using the term loosely here) stock that I didn't have ultimate control over. If the ex-employee wants to make some money, you could agree to purchase his options at a price between their current value and his strike price.
If you don't follow the above, you'd need a fairly rigid contract outlining how and when either party could force the sale of the stock (price, criteria, RFR, etc.).
If it's a great deal, and the option-holder's only problem is liquidity, loan him the money at an interest rate that's attractive to you and should be easy for him to pay if the shares ever have the expected value. Make the principal and interest due if the shares are ever sold (or when dividends are paid).
tptacek's forth point is probably correct. You also may need to bring in someone with a series 7 license to close the sale. It's just the government looking after you for your own good.
tptacek's third point is moot as you will be getting shares in the company, not options, since the $1 per share is an exercise price.
tptacek's third point is moot as you will be getting shares in the company, not options, since the $1 per share is an exercise price.
[deleted]
a) what kind of contract would I create to set up this deal (he would hold the shares in his name, I presume) b) what kinds of questions should I ask the CFO in order to come up with a fair 'meta-market' price.
Assuming the options are worth more than a dollar, I presume that a pool of people would come up with $10,000, and each person would get a proportionate quantity of options, and the ex-employee would get a quantity "for free". Does anyone have any insight into how I might do this and how the deal can be contractually structured, without getting too complicated?