## Introduction Silicon Valley often attracts workers with the promise of an equity component in its compensation packages. Employees get to own a piece of the company so that if the company does well, they get a chance to participate in the upside. But a deeper examination reveals a more nuanced reality. This essay delves into the lesser-discussed aspects of stock options in startups, revealing why they might not be everything they are made out to be for Silicon Valley workers. ## Low Salary, High Equity: A Double-Edged Sword Startups commonly compensate their employees with a combination of lower salaries and high equity. It allows the company to hire employees while conserving one of its most precious resources - cash. Young, ambitious talent is often attracted to such offers, as they are willing to sacrifice cash compensation in the short run for the prospect of significant equity appreciation in the future. The problem is that the way Silicon Valley equity compensation is structured creates significant financial challenges, especially for those early in their careers. With the cost of living in Silicon Valley being what it is, a lower salary at a startup often translates to little to no savings after paying off taxes, rent, and other liabilities, making it difficult for employees to benefit from their equity due to prohibitive strike prices. ## The Burden of Strike Prices Equity in startups is awarded in the form of stock options - a contract awarding the employee **the right to buy the company's shares at a specific price by a specific time**. The idea is that the price paid to own the stock (the strike price) will be much lower compared to the external valuation of the company when it eventually raises new funding rounds, goes public, or gets acquired, thereby allowing the employee to keep the difference (more on this later). The first problem with this is that the total cost the employee has to pay just to own the stock can be *very high* - from tens of thousands to over a hundred thousand dollars (you can calculate the total amount you would have to pay by multiplying your strike price by the total number of shares you have vested). Most workers even in their 40s - their peak earning period - cannot afford to shell out that kind of money just to own shares in a private company that they cannot sell for years to come, much less workers in their twenties, who make up a large portion of the talent in Silicon Valley startups. This financial barrier means that even vested stock options remain unexercised, as employees simply cannot afford the upfront exercise cost. The alternative is to leave the options unexercised until you have the opportunity to sell (in a tender offer, IPO, etc.) That brings us to the second problem. ## Alternative Minimum Tax (AMT) If employees do somehow find the money to exercise those options, they often trigger tax implications that add another layer of complexity. Incentive Stock Options (ISOs), for instance, can trigger an Alternative Minimum Tax (AMT) at the time of exercise. This means that employees who exercise their options but do not sell their stock in the same year (maybe there was no tender offer or the company has not gone public yet) are potentially required to pay AMT on the difference between the fair market value (FMV) and the strike price, along with the long-term capital gains tax that is due when they do eventually sell their stocks. If they choose to sell their stock the same year, the difference between FMV and strike price will be taxed as income instead of capital gains. On the other hand, if they decide to not exercise the options and wait, the fair market value of the company (and the difference between the FMV and strike price) will continue to increase as the company grows its revenues and profits, increasing the potential AMT employees may have to pay when they do eventually exercise. ## The 90-Day Exercise Window Upon Leaving the Firm (PTEP) If, for some reason, employees decide to leave the firm while still having unexercised options, they will typically have only 90 days after leaving to decide whether to exercise their vested options. This 90-day window is called the post-termination exercise period, or PTEP (some firms offer a PTEP higher than 90 days, but most do not). This means employees have only 90 days to pull together the money they need to exercise the vested options (and to pay the AMT if the stocks won't be sold the same year), something that might not be possible for a lot of workers. If employees are not able to find the money to exercise the options within 90 days, the unexercised options go back into the company’s option pool to be reissued to other employees. If they do exercise the options and own the stock, they have now locked up a significant amount of cash for an indefinite amount of time until the firm issues a tender offer (which is completely its prerogative and not necessarily offered to everyone), goes public, or gets acquired. And ex-employees are unlikely to get any opportunity to sell their vested stock in tender offers the way present employees are. ## Employee Lockups During IPOs Let's say the employees wait patiently until the firm decides to go public. Most traditional IPOs involve bringing in an investment bank to underwrite the IPO. The firm going public offers up 10-20% of the firm in the IPO, which will be sold to large fund houses, family offices, and institutional investors who are interested in an allocation. When the firm goes public, these new shareholders are free to sell their stake in the public markets immediately. Employees, on the other hand, are forced into a 6-12 month holding period even after the firm goes public. So, the people who believed in the company the least (institutions who bought an allocation just before the IPO) have fewer restrictions on their stake than those who believed in the company the most (employees who joined the firm at its nascent stages). Moreover, companies are often encouraged to under-price their equity when going public to get a jump or a "pop" in the stock price on IPO day. This underpricing essentially creates a wealth transfer from existing shareholders (founders, employees, early investors) to new shareholders (large fund houses and financial institutions). So when the stock "pops" on the first day when the firm goes public, the new "investors" can immediately sell their stock and make a quick profit, while employees are forced to wait until the lockup period expires, by which time the pop might have normalized or even reversed, potentially reducing the gains employees can realize from their shares. This waiting period can expose employees to greater market volatility and the risk that the stock's value may decrease from its initial post-IPO highs. As a result, the lockup period creates a situation where those who have been with the company longest and contributed significantly to its growth may not benefit as much from the IPO's immediate aftermath as newer, institutional investors. ## Conclusion The allure of Silicon Valley equity is undeniable, and equity has made some of the participants extremely wealthy, but it's crucial to also be aware of the challenges it poses for employees. The combination of low salaries, substantial strike prices, and complex tax scenarios, coupled with limited liquidity and strict exercise timelines, paints a less favorable picture of what is often considered a golden opportunity.