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IPOs - Page 6

post #76 of 87
2/4/12 at 7:48am
Quote:
Originally Posted by Saturdays View Post

Again, really not too hard to understand the difference between a company that has to file publicly, and a company that shares trade publicly.

Um. Yeah. You've pretty much invented a definition. In a dozen years in finance, I've never understood "public" and "private" to mean anything other than whether or not the equity of the company is traded in a public exchange (from the pink sheets to the NYSE). Public companies are traded, private companies are not. A company whose shares are not traded in the public market is, by definition, private.

Secondly, you've totally confused employees and shareholders in your analysis above. These two groups of people are definitively not the same (though they often overlap, especially in private companies). It is true that a company with 500 shareholders must report its financials to the SEC, and is subject to much of the same scrutiny as a public company. This DOES NOT make them a public company. Most companies look at this rule and conclude that if they're going to have to deal with all of the negatives of being public, they might as well get all of the benefits as well, so they open their trading to the public. But until they start to trade, they're not public companies (see CH2M Hill, or Publix).

By your definition, there are *no* private companies in the UK, because all companies must report their financials to Companies House.

In sum, "Public" and "Private" have nothing to do with availability of information, and only refer to the equity ownership structure.
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post #77 of 87
2/4/12 at 10:00am
yes, i understand its not termed 'public' - that point was clear, i never disputed that. Again my point was not in the definitions but just that you have the choice of doing an IPO and not doing the IPO.

I agree, most companies sort of say 'fuck it' and do the IPO once they reach that limit, and I only used employees because in the cases we were discussing most employees were awarded stock as a way to bring them in to work at Facebook, Google and other companies like Gilt and Twitter are doing the same thingetc..

But yeah, I think i grasp the terminology - I sort of assumed it was classified as public in a certain sense - but i guess its more like 'privately held but filing with the SEC'
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post #78 of 87
2/4/12 at 11:51am
Quote:
Originally Posted by Saturdays View Post

I only used employees because in the cases we were discussing most employees were awarded stock as a way to bring them in to work at Facebook, Google and other companies like Gilt and Twitter are doing the same thingetc.

Just a minor point of clarification, because it's a pretty complex topic. Former employees are likely to be shareholders (and thus counted against the 500 shareholder limit), current employees are probably mostly optionholders (who are not counted against the limit). Since options (usually) have to be exercised when an employee leaves the company, most people will only become shareholders when they become former employees.
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post #79 of 87
2/4/12 at 1:37pm
Quote:
Originally Posted by tj100 View Post

Just a minor point of clarification, because it's a pretty complex topic. Former employees are likely to be shareholders (and thus counted against the 500 shareholder limit), current employees are probably mostly optionholders (who are not counted against the limit). Since options (usually) have to be exercised when an employee leaves the company, most people will only become shareholders when they become former employees.

interesting didn't think about that. I know my father generally gets paid in a combination of stock and options - he exercises the options once in a while when he has a reason to.
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post #80 of 87
2/5/12 at 7:37am
Quote:
Originally Posted by Saturdays View Post

interesting didn't think about that. I know my father generally gets paid in a combination of stock and options - he exercises the options once in a while when he has a reason to.

It depends a lot on the strike price. Really early employees are likely to have options with really low strike prices ($0.10 - 0.50 a share), and for them, it often makes sense for them to exercise as they can afford to in order to hit the two year waiting period for LTCG tax treatment (so they can subsequently be ridiculed if they run for President...). For later employees, where the strike price is higher ($1+ per share), it gets more difficult to do this.

Quick example:

One of the first twenty employees is awarded 1 million options with a strike price of $0.10. You estimate that the shares are currently worth $2/share, but in the next two years, will easily be worth $10/share. If you exercise now, you're going to spend $100,000 of cash (which most people, especially young employees who jumped into startups, don't have) and then you're going to get your ass kicked by the AMT to the tune of $500K come next April. So you really need to have $600,000 of cash lying around to exercise your options. BUT if you wait it out, it's a good deal, because in two years when the IPO happens, your gain of $9,400,000 is taxed at 15%, so you come out of it with ~$8M. If you hadn't spent the $600K two years earlier, an the IPO those shares would have been taxed as Ordinary Income and you would have netted out somewhere around $5.5 - $6M depending on what state you live in. So your $600K investment created savings of $2.0 - $2.5M, which is a pretty good deal.

Now, take a later employee, who also gets 1 million options, but his are at $1.50/share. At the same point in time, he could spend $1.5 million to exercise, plus an AMT hit of ~$150K for a total of $1.65M. After the IPO he would come out of it with an after tax payment of $7.1M. If he hadn't spent the $1.65M to qualify for LTCG, he'd come out with $5.1M at the IPO. So he spent $1.65M to save $2.0M, which is a 25% return (over two years) with quite a lot of risk.

The reality is that the strike price keeps people from exercising in most cases. Most startup employees don't have a couple million lying around to exercise their options. And it's one of the seedy underbellies of options - take employee #2 above, say he did a great job and took a low salary in exchange for options, but the company outgrew his skill set (this is a very common situation). Fire him. The newly jobless employee isn't going to spend $1.65M exercising the options that he earned, and they're going to expire 90 days after he leaves the company. You got a great employee who did great things for your company, and you barely had to pay him....
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post #81 of 87
2/5/12 at 10:35am
Quote:
Originally Posted by tj100 View Post

It depends a lot on the strike price. Really early employees are likely to have options with really low strike prices ($0.10 - 0.50 a share), and for them, it often makes sense for them to exercise as they can afford to in order to hit the two year waiting period for LTCG tax treatment (so they can subsequently be ridiculed if they run for President...). For later employees, where the strike price is higher ($1+ per share), it gets more difficult to do this.
Quick example:
One of the first twenty employees is awarded 1 million options with a strike price of $0.10. You estimate that the shares are currently worth $2/share, but in the next two years, will easily be worth $10/share. If you exercise now, you're going to spend $100,000 of cash (which most people, especially young employees who jumped into startups, don't have) and then you're going to get your ass kicked by the AMT to the tune of $500K come next April. So you really need to have $600,000 of cash lying around to exercise your options. BUT if you wait it out, it's a good deal, because in two years when the IPO happens, your gain of $9,400,000 is taxed at 15%, so you come out of it with ~$8M. If you hadn't spent the $600K two years earlier, an the IPO those shares would have been taxed as Ordinary Income and you would have netted out somewhere around $5.5 - $6M depending on what state you live in. So your $600K investment created savings of $2.0 - $2.5M, which is a pretty good deal.
Now, take a later employee, who also gets 1 million options, but his are at $1.50/share. At the same point in time, he could spend $1.5 million to exercise, plus an AMT hit of ~$150K for a total of $1.65M. After the IPO he would come out of it with an after tax payment of $7.1M. If he hadn't spent the $1.65M to qualify for LTCG, he'd come out with $5.1M at the IPO. So he spent $1.65M to save $2.0M, which is a 25% return (over two years) with quite a lot of risk.
The reality is that the strike price keeps people from exercising in most cases. Most startup employees don't have a couple million lying around to exercise their options. And it's one of the seedy underbellies of options - take employee #2 above, say he did a great job and took a low salary in exchange for options, but the company outgrew his skill set (this is a very common situation). Fire him. The newly jobless employee isn't going to spend $1.65M exercising the options that he earned, and they're going to expire 90 days after he leaves the company. You got a great employee who did great things for your company, and you barely had to pay him....

I imagine employee 2 would be able to find quite a few buyers for those options who are willing to trade cash for immediate leverage.
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post #82 of 87
2/5/12 at 2:28pm
Quote:
Originally Posted by Nereis View Post

I imagine employee 2 would be able to find quite a few buyers for those options who are willing to trade cash for immediate leverage.

Unlikely. Assuming the company doesn't have a right of first refusal on the options/shares at the strike price (which almost all do), it's a huge risk (unless we're talking Facebook) to buy options (or shares) as a minority position in a privately held company. The only times I've ever seen that work out is where employee #2 sells his shares to another insider (usually one of the VC investors). People do sometimes take big loans to exercise when they leave, but I've seen that end badly as well - I know a guy who lost his house on that move.
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post #83 of 87
2/5/12 at 3:02pm
Quote:
Originally Posted by tj100 View Post

Unlikely. Assuming the company doesn't have a right of first refusal on the options/shares at the strike price (which almost all do), it's a huge risk (unless we're talking Facebook) to buy options (or shares) as a minority position in a privately held company. The only times I've ever seen that work out is where employee #2 sells his shares to another insider (usually one of the VC investors). People do sometimes take big loans to exercise when they leave, but I've seen that end badly as well - I know a guy who lost his house on that move.

Ah, so they've fired him long before the IPO. In that case he's in a situation where he can either make some money or make none. I'd eat some face value loss on that sucker and sell it at a discount if I didn't have the liquidity to exercise the position. Isn't it due to the incentive for management to game financials for short term gains to push the market value up to exercise those options and gtfo right after the reason we now mostly have share rights distributions over the course of several years as opposed to options nowadays?
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post #84 of 87
2/5/12 at 6:46pm
Quote:
Originally Posted by Nereis View Post

Ah, so they've fired him long before the IPO. In that case he's in a situation where he can either make some money or make none. I'd eat some face value loss on that sucker and sell it at a discount if I didn't have the liquidity to exercise the position. Isn't it due to the incentive for management to game financials for short term gains to push the market value up to exercise those options and gtfo right after the reason we now mostly have share rights distributions over the course of several years as opposed to options nowadays?

Very different situations for public companies and pre-IPO private companies. For the pre-IPO private company, employee #2 is just screwed (if the company wants). There's really zero opportunity for them to sell their position before exit (because the company has a right of first refusal on the shares, at a very low value), and they have no way to know when that will happen. So the only option is to tie up a pile of cash for an undetermined amount of time and an undetermined exit value.
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post #85 of 87
2/5/12 at 8:41pm
I agree, in that situation it would royally suck to be the guy who gets forced out before the real paycheck comes in. Did that happen to a close friend of yours? From what I hear the work culture in tech startups usually encourages loyalty among the founders/original employees. It's in that middle phase after VC comes in but before the IPO that people start getting screwed over.

The only people I've known who've worked for startups straight out of school were the founders of the firm/s and had been entrepreneurs/real estate flippers since teenagers and as such, had plenty of liquidity on hand even if their family wasn't willing to pitch in (and they would've been).
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post #86 of 87
2/5/12 at 9:00pm
Quote:
Originally Posted by tj100 View Post

Unlikely. Assuming the company doesn't have a right of first refusal on the options/shares at the strike price (which almost all do), it's a huge risk (unless we're talking Facebook) to buy options (or shares) as a minority position in a privately held company. The only times I've ever seen that work out is where employee #2 sells his shares to another insider (usually one of the VC investors). People do sometimes take big loans to exercise when they leave, but I've seen that end badly as well - I know a guy who lost his house on that move.

I always played that scenario in my head, if ever I acquired options, but not having the capital - would I go out and get a loan to exercise the options? In my head I would- if i was 100% sure it would go down as planned and I was way in the money.
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post #87 of 87
2/6/12 at 8:30am
Quote:
Originally Posted by Nereis View Post

I agree, in that situation it would royally suck to be the guy who gets forced out before the real paycheck comes in. Did that happen to a close friend of yours? From what I hear the work culture in tech startups usually encourages loyalty among the founders/original employees. It's in that middle phase after VC comes in but before the IPO that people start getting screwed over.

Not to friends, but I've seen it happen a few times to colleagues/peers. My career has mostly been in the growth equity phase where valuations become more certain and people begin to start bickering about how to divide the pie (even if they previously agreed on what size slice everybody would get). In the startup phase, everybody is just trying to bake the pie and it works pretty well.

In the cases where I've seen it happen, there's usually a wide gulf between what Employee #2 thinks he brought to the table and what the CEO/Board thinks he's brought to the table. I've never been in a situation where the CEO outright screwed somebody, but I have seen several where the CEO rationalized his screwing somebody pretty well ("the guy doesn't deserve all that $$$ for these reasons"). But I am aware of a few straight up "thanks for your hard work, you were awesome, but if I fire you I get to take all of your equity, so I'm going to do that" situations.

In fairness, I've also been in an investment where the opposite happened - one of our execs was barely in the money, simply because of timing, and he was doing phenomenal work. At the exit, his payoff was only going to be ~$500K, but the Board gave him a $5M bonus to top him up.

As far as borrowing $$$ to exercise deep in the money options, it's definitely a case-by-case basis. I've seen it work out for people, and I've seen people pretty much lose everything - it all depends on your risk tolerance.
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