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How do you protect your employees financially?

This story on Good Technologies is interesting. For example:

""It's not unusual for employees to be wiped out while venture capitalists make money," said Dennis J. White, a partner in Boston at the law firm Verrill Dana, who has studied deals like Good's."

How do you protect your employees? If your company runs out of money, or gets sold for less than its valuation, anyone without protected stock can be instantly wiped out, or go into serious debt. (This is not to worry about people who just make thousands instead of suddenly make millions in windfall; they're fine.)

And how do you protect yourself?

"The odds that the unicorns will all reap riches if they are sold or go public are slim. Over the last five years, at least 22 companies backed by venture capital sold for the same amount as or less than what they had raised from investors, according to a data company, Mattermark. This means investors did not reap many returns - but there was even less left over for employees."

3 Replies

Neil Gordon
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Neil Gordon Advisor
Board Member, Corporate Finance Advisor and Strategy Consultant
The mechanics of protection are easy, but liquidation is a zero sum game. Less risk for employees translates into lower portfolio returns for investors. All else being equal, you get lower valuations, i.e., the "insurance premium" is paid by the common shareholders, primarily the founders.
Faisal Memon
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Faisal Memon Entrepreneur
iOS Department Technical Lead at Citrix ShareFile Quick Edit
If getting stock means having to pay tax due to a valuation event, how do the employees of silicon valley startups manage to pay their tax bills before the company they work for has a liquidation event? Do they take big loans or what?
Michael Brill
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Michael Brill Entrepreneur
Technology startup exec focused on AI-driven products
Faisal, assumedly all of these employees made the decision to exercise their options/purchase restricted stock. They did this to lock in long term capital gains tax treatment, sell shares, etc. Nobody made them do it... they could sit on their option grants and exercise only when there was a liquidity event. That eliminates the risk... OTOH, they're paying taxes on ordinary income which will be much higher than on long term capital gains.

They got caught up in the excitement of skyrocketing valuations and made grown-up decisions to liquidate their kids' 529 plans to get more upside. Decent chance they're buying a meh 2 bedroom house in San Francisco for $1.3 million. That looks like a good idea today. It could play out well or it might not.

One thing's likely though... we're going to see a whole lot more of this during the 2016 (and 2017?) Writedownpalooza. I'm not smart enough to put a number on it, but I'd wager that 80% of those who have joined a Bay Area tech startup in the past 2 years will find all of their equity (options) worth nearly zero.

Having said that, this tips the scales in favor of starting your own company!


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