Ask HN: My startup has concealed from me that it raised funding. What to do?
I did my best to keep my story within 2000 words but I couldn't shorten it anymore without leaving off important details so I posted the full text here: http://pastebin.com/xLLNUF0H
I feel so disgusted and cheated right now. I had worked for this company for almost 3 years doing everything possible to maximize its chance of success: from working overtime to meet deadlines to answering support emails on weekends, and now I find out that they've kept this investment (and the tax implications that go along with it) hidden from me for over a year. I'm left thinking that they concealed it so they wouldn't have to give me a raise, but I am more concerned about the tax implications of these shares. I had to leave work early yesterday when I found out about this and I don't think I'll be able to come in to work today. What should I do? Should I confront the founders about this? Is there any use in contacting a lawyer?
116 comments
[ 2.0 ms ] story [ 104 ms ] threadAnother problem, however, is that even if you do confront them and get to claim what's rightfully yours, you're probably going to be asked to leave the company. It's worth noting this as you plan ahead.
Anyway, I'm very sorry to hear this. That's disastrous.
I think this is moot. Such a disaster would indicate bad shit is happening. Lawyer up asap.
When joining a company if you are a founder always insure the titles are correct as they do make a difference even if you are a founder. If you are not a C-Level executive, apart of the board or an investor the groups under them will always be the last to find out what is going on. If your in the C-Club you are always in the mailing group list for all the important meetings and are expected/invited to all of them. To be honest though, it appears you were left out because you were not family and they probably just considered you as just an engineer that they gave some stock too and not really privileged to the company inner workings or financial activities.
Sorry to hear this.
You should definitely talk to a lawyer and an accountant. I could see an argument where your gains would be based on the company's 409A valuation, which can be significantly lower than what the last investors put in.
Based on what you wrote, I am not seeing a bad intention from the founders. seems like talking to them might be helpful.
This works because stock is considered an investment where as options are not considered investments (according to the tax code) and by holding the stock for more than a year it's considered "long term" and thus it gets classified as capital gains.
Ultimately I think it's a very smart thing to do especially if the company says that the stock is valued at $0.0001/share meaning that he can exercise 1000 shares per $1. The only time there's ever a downside to exercising early is if your strike price is substantially above $0/share meaning that it might cost a sizable sum. If it's free -- or nearly free -- to exercise, there's really no reason not to.
Unless of course you end up in a situation like this person has.
Second: Yes, consult a tax attorney. Your own attorney, not theirs. Don't talk to the founders. You need to know where you're at first. Legal500 could be a decent starting point: http://www.legal500.com/c/canada/tax.
It could very well be that they disregarded some security rule (i.e. notification of a capital increase or something like that) and can now be sued for your situation (in the event it's too late to fix things).
One thing to consider if you get a capital gains tax loss is that you usually can offset it against other gains. Do you know if you can carry that loss forward in Canada, or do you need to use it in the same year?
Given an S&P fund tends to return around 7% (averaged) per annum, you can actually use it over several years if you can carry forward the loss indefinitely.
Third: Time to look for a new job.
"You can use a net capital loss to reduce your taxable capital gain in any of the three preceding years or in any future year."
http://www.cra-arc.gc.ca/E/pub/tg/t4037/t4037-e.html#P2313_1...
I'd speak with the founders and enquire why they never executed the agreement, that is the raise that was conditional on getting funded. From a contract point of you, you should be eligible to receive that money.
From a trust point of view you can no longer trust these individuals. Without trust in a small organization I don't see the point in sticking around.
The amount of people I know that were employee #1-3 and exercised all there options cause they were cheap and then found out about capital gains they owed I can count on 3 hands if I had them.
However, you are right, if this company succeeds, he saves some money on taxes by owning stock early.
You might be thinking of this for more established companies where the exercise might require tens or hundreds of thousands of dollars. That's a very different situation.
1. You avoid the tax issues the OP faced if you exercise at a lower valuation.
2. It's also more tax efficient if you plan to hold the shares or wait a few years to sell.
It sounds like your bosses are ethically challenged. With 3%, you are an employee and not a cofounder.
Instead of suing them, consider writing it off as a loss and learning experience and move on. As a minority shareholder, they can dilute you out of your shares and you would have no recourse.
In any case, it certainly seems worth talking to a lawyer to see if there's a case, and if there is a case it's absolutely worth pursuing. If you let people get away with this behavior, you just encourage more of it.
A lawsuit is a lot of stress.
There's no guarantee he'd win.
The corporation can be bankrupt when/if he wins.
You can't keep working there after you sue them or your lawyer sends them a threat letter.
There's no point continuing to work with dishonest people. Given their dishonesty, the shares are probably worthless.
If that is correct, at this point nobody wins. At best from his viewpoint, the company covers his tax bill (or I suppose establishes a new investment price a lot lower through bankruptcy or whatever). Much more likely is that he's going to have to weigh whether suing them and the likely payoff of that will be higher than the tax bill; hmmm, he'd better get a reading on whether he can pierce the corporate veil and go after them directly. Heck, he also needs to see if he can arrange a payment plan with the tax authorities, as others have mentioned; that bill will be due very soon, whatever the final outcome of a lawsuit is.
They're indeed snakes, the shares are indeed almost certainly worthless, but not for the purposes of his 2014 personal tax year :(. ADDED: unless, as others have pointed out, the investment was structured as debt instead of equity.
Yet another example why non-founder options/stock is frequently a negative.
Even if he can afford everything, it still may not be worth it, even if his goal is just to prove a point/stick it to the dishonest cofounders.
You can usually negotiate a payment plan. Plus, he gets a credit when he sells or writes off the shares,
Better to seek legal counsel and have them talk to the founders.
He needs to know what his choices are before he talks to the founders so he knows if what they're saying is bullshit or not.
Act normal, and continue to work and essentially collect as much as evidence you can. You can drop hints, talk to people to find out what they know, etc.
The more you know, you can start to build a timeline and the implications that the company was effectively doing this behind your back for nefarious reasons. The more you have documented, the more you strengthen your case so when its time to actually threaten them with legal recourse, you'll have all the evidence you need while they'll be scrambling to build a defense.
Hope this turns out well for you!
Since you have been exercising your options - you are a shareholder in the company (or a member depending on the structure) and I would imagine that the company's operating agreement would require them to disclose any funding rounds to you. I'd get a hold of that if you can.
It sounds like you're working with amateurs, so I'd pass it by a lawyer to determine the real impact on you - but I wouldn't flip out until you get the entire picture. They may be planning on diluting the hell out of you or they may just not know what the hell they're doing.
I'd say it's too early to tell.
That's not exactly accurate in the US. You need to pay income tax - not capital gains - on the spread between the strike price and the fair market value. Since the company is not publicly traded, the fair market value needs to be assessed. The IRS has rules on how to do this, but many companies use independent third party auditors to do this, though an early stage company probably would not do this.
Once an investment has been made, a fair market value has been established, and you need to report the difference between the strike price and the investment price as income when you exercise options. Capital gains applies when you later sell the stock for a gain.
Edit: Though I should point out, this is only for non-qualified stock options. If the options are tied to performance metrics, for instance, this may not apply.
Edit 2: See here for a discussion of this: http://www.investopedia.com/articles/optioninvestor/07/esoab...
"I will be left with a tax bill on $10,000s of additional "income" that I never received"
His paper gains are taxed. It's not quite "income" but it's taxed that way.
If he's really a founding engineer though he should have filed an IRS 83B election and basically paid close to zero tax on all this
In a private corporation where an employee is issued stock options, a taxable benefit exists ONLY when you sell the shares for a profit. Unless this is a public company or a non-Canadian controlled company, you will not face a tax liability. Just make sure both owners and any majority investor is a Canadian resident.
Now - there is another question - when you were given the options, were they in the money at the time. This is to say, were the options priced below the FMV at the time of the option being given to you? If they were not, or there was likely no way to tell at that time (they were worthless, and were priced accordingly which it appears), then you will be eligible for an additional tax credit on the gain (it is approximately 50% of the capital gain, it is substantial). Please do your own research in this regard. Also keep in mind selling shares of a QSBC (Qualified small business corporation) means you get up to $800K in TAX FREE gains, once in your life. This is called the life time capital gains exemption. Please do your research here. You likely will pay no tax at all on the capital gain.
I really don't think so. There are many cases in Canada of people getting screwed by buying and selling at the wrong time.
If you buy options and immediately sell them, you have the cash to pay the taxes.
If you buy and hold, you are likely to have tax owing. i.e. buy a share at $0.01, where it's FMV is $1.00. You have $9.99 of either capital gains or income, and you have to pay taxes on that.
If the shares later go to $0.00 in value, well, you might have a non-refundable tax credit. But that doesn't matter when you've paid taxes on value which is valueless.
For example: 1) Your share is worth 0.0001. 2) The company goes bankrupt/insolvent/no longer carries on business 3) You include $10-0.0001 * 50% in your income as employment income for the benefit you recieved from options. The tax base of the shares is now $10. 4) You claim a business investment loss of $10 per share. This can be deducted against all income. This in effect negatives 2x the tax you would have had to pay.
Please keep in mind this does not apply to public companies or large non-small business companies. Only to this example he has proposed. Again i suggest approaching a tax accountant.
That's not quite correct with regards to US tax law at least. You can get taxed on the spread between the price you pay and the "fair market value" of the shares received.
It's quite possible to get nailed with an insane tax bill in situations like this. You can end up in a situation where a company raises money at high valuations, and that spread is high, generating a tax bill of hundreds of thousands of dollars on a supposed million dollar spread, and then the company implodes and the shares are worthless, but that tax bill is still there -- leading to a horror story of being taxed on a percentage of the millions of dollars you supposedly got but never realized a dime from. This has happened to real people and is "a very bad thing" to say the least.
If the shares a complete loss and liquidated that way, you also have a capital loss for the millions of dollars which can be applied against income for tax purposes; this may end up somewhat less than offsetting the tax bill depending on your other income because of tax rates; you do end up paying (for employer-provided options) the payroll tax for the spread in any case, but then, the main part of that is limited by the annual cap on SS taxes, so for most of anything in the millions, you'll only be paying, on the payroll tax side, the Medicare portion.
But, in any case, that risk (plus the long term capital gains benefit) is why, if you have confidence in the company, you exercise options as early as possible; you only delay exercise if your confidence in other uses of the money vs. the company's stock is such that the risk that you'll exercise at a point where the tax burden is higher is a cost worth paying for the other use of the money.
(Note also that if you get equity directly instead of in the form of options, you pay taxes -- payroll and income -- on the fair market value at the time you get the equity, too; which is equivalent to an option with a $0 strike price. So, its not like options that you choose whether and when to exercise are any worse in that respect.)
EDIT: other people have pointed out that capital loss is capped, which makes sense. So while it may be true that you can claim capital loss, my understanding has been that it never compensates for the tax you're already liable for when you exercised.
This depends on the tax jurisdiction; as the OP indicated, in Canada capital losses cannot be deducted against ordinary income, which the difference of (FMV - strike) would be assessed as. (I believe in the US, up to $3,000 of losses can be deducted against ordinary income)
Also, we have AMT (alternative minimum tax) which gets triggered by this kind of scenario--exercise and hold--and really ends up screwing you due to outdated but not updated calculations that assume anyone making over 150k or so is "rich".
I looked around to find a overview of how this works with some case study examples, and this is the best I could come up with in 5 minutes of googling: https://www.sharespost.com/docs/the_stock_option_tax_dilemma...
As an employee, if I buy shares of a company at a discount then that discount is taxable income -- not capital gains. Buying the shares as they vest is a way to minimize this tax. The adjusted cost base of the stock is changed to become the fair market value (on which the tax has already been paid) so that when they're eventually sold, the difference between ACB and sale price is a capital gain which only pays half the tax.
In his case he could end up paying taxes at full marginal rate on an inflated amount, and if the company goes under, gets a capital loss that a) doesn't offset the taxes paid earlier and b) is not usable until he gets capital gains elsewhere.
The CRA lets you carry the taxable benefit forward until you sell the stocks. I'd suggest talking to an accountant, not a lawyer. Also see http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/...
In the US this is a completely false statement.
As the FMV increases of your exercised options, you are responsible for paying taxes at the /time of exercise/ between the strike price and the FMV of that stock.
Once you pay those taxes, you do not need to continue to pay taxes as the FMV increases. The reason you pay at exercise is because you are exercising options that are already "in the money" even though you obviously have not yet realized that actual gain since you didn't sell the stock.
Sucks, but it's the way it is.
ISO's were specifically designed to get around this issue (but you may still get hit w/AMT on the spread)
Not sure it applies to capital gains with options/alternative minimum tax, but a tax lawyer might know.
If the tax bill does turn out to be like the price of a car, aside from taking some form of legal action, or if it fails or is not possible, then you can make payment arrangements, so that in theory, paying off the tax over time will maintain your ability to keep hold of the asset of the options.
> "contingent on raising target angel round of financing".
My English is not good enough, so I'm not sure what this means, in particular "target".
If their "target" was $100.000 and they "only" raised $99.000, are they forced to give you the raise?
[Also, as other said, with a 3% you are not a "engineer founder", you are only a "engineer first employed". In any case, talk to a lawyer.]
It's quite possible, nee probable, that they are just disorganized and genuinely thought you already knew, or that it didn't matter, or otherwise were clueless or inexperienced enough to not really understand what had happened.
I think it would be a mistake to get into it with them on a war footing. Early stage companies like this make mistakes of this kind all the time, and it's not necessarily a sign that the whole ship is doomed. If they have the ability to get revenue and investment and pay salaries and whatnot it's possible that there's a positive outcome in the future.
I would schedule an initial consultation with a lawyer who deals with these kinds of things. Get a referral and schedule an hour or so to go over it with them. They'll probably charge you a few hundred bucks, or even waive it if you have a close friend or existing client of theirs refer you.
Sit down with a lawyer, bring the docs, and explain what happened and get some sense of the implications. Then approach the founders with the attitude that it must be an administrative mistake or misunderstanding. If they are evasive or otherwise shady that should become clear quickly. If they are genuinely concerned and want to help fix the problem then great. But personally I wouldn't blow up your relationship with everyone until you have a better idea which of those two scenarios is more descriptive.
[0] http://en.wikipedia.org/wiki/Hanlon's_razor
Unless you're in the room when the chips are (re)divvied up, you have to trust someone else to advocate for you. And after tolling away for a few years, trading your life for the promise of a better future through being acquired, ultimately you end up in a shitty position.
Don't be diluted in thinking the founders will "take care of everyone".
Your only leverage in the end is to walk away (and try and blow up the deal or company, if you're that critical). And if you do walk and they don't stop you and counter offer, you probably weren't going to get anything anyway.
Never do that. Not only does it create bad blood, which could only be bad for you in the long run, it may also leave you open to a lawsuit.
The business world is often about shoveling shit. People who always get their revenge tend to have no friends and lots of burned bridges.
that's a bit offtopic though.
"Don't burn your bridges" implies that these are bridges worth preserving--sometimes they aren't, and you're doing others a favor by letting them know.
Don't buy this fud. There's nothing illegal about walking away from a shitty deal. Whatever your motives just plainly state "this deal no longer makes sense for me".
If you're a great engineer, then have some self respect, and walk away from a shitty deal. Go somewhere else where they respect the people that build value.
And if you aren't a great engineer, you weren't going to get anything anyways, so go somewhere that will raise your game and better positions you for the future.
>People who always get their revenge tend to have no friends and lots of burned bridges
There's a big difference between being bitter on a daily basis vs coming to terms with your past three years that are basically only going to net you an extra 100K (which you could easily get hustling in a few months consulting in SV).
Think deliberately about what you're toiling away for. An extra 20K? An extra 100K? REALLY? All the extra weekends for years is worth that? Get mad at yourself. Demand more. And if they deny you, walk, and position yourself better next time.
Second, you seem not to understand the difference between "breaking the law" and "getting sued". Intentionally screwing over a company can be both legal and lead to a lawsuit that you end up losing.
2) They don't want to compensate you to your liking..
3) So you walk. Yes, this is meant to intentionally hurt the company with the only lever that you have (your skill set and institutional knowledge).
You working for this company costs you opportunities elsewhere.
You're convincing yourself to stay because it "doesn't solve any problems and certainly could create some." Your vague fears are holding you back.
But if we get rid of these vague fears, here's what we know is certain:
1) You're critical to the success of the company.
2) But you're not going to be compensated to your liking
3) And you're costing yourself other opportunities by sticking around.
Quit being scared, look them straight in the eye, and say "I am walking unless I get X,Y,Z." If they say no, then kindly resign and don't look back. Bring on the lawsuit (highly doubtful).
At one point I was at a company that had built a web product for another company. The external party decided they weren't going to pay their bill, and at the time we'd been covering the cost of hosting several of their servers for months. Obviously our first reaction was that we'd just turn them off but our lawyers told us in no uncertain terms that we couldn't. It would be obstruction of business and we would definitely be found to be in the wrong. (This was in the uk)
Was the external party eventually forced to pay the bill for hosting their service during the time it was being disputed since you couldn't just turn it off?
They tricked us into signing up to some sort of gentleman's agreement where they folded the company and re-launched as a charity (or something weird like that). Basically, they said, if you chase us for the money, you'll take us down, then you won't get any money. If you let us do this our way you'll get your money if it all works out. So they fairly well held us to ransom.
I don't recall how it all worked out in the end but we definitely got some (all?) of the money - I recall my boss telling me we'd received a payment a good year or two later!
I was pretty amazed at how few rights and options we had in the situation. We had the lawyers talking us through our options at every step and they said there wasn't a lot else we could do.
That was one of a catalogue of mischievous plays I witnessed there. We were a company that were very honest and ethically sound so it was always sort of shocking to see others acting dishonestly.
The whole situation ended up being somewhat overshadowed by the accountant nicking £50k from the company savings!
I've definitely learnt to make sure you're covered as much as possible in business. Always get everything in writing and be aware that sometimes people don't act in good faith. At my current startup, my co-founder and I have a fairly all guns blazing approach to people not paying their invoices on time (we start chasing before it's even late).
I think that smt88 was referring to trying to blow up the company, which I agree is bad juju.
That doesn't mean OP shouldn't walk (as fast as possible) out of there if he or she isn't taken care of.
I meant this in the context of you're a critical engineer, and by leaving, you leave the company handicapped. You're critical to their success, but yet you don't feel like they're looking out for you. Walk.
Walking away from a bad deal isn't about getting revenge, it's about looking out for yourself (because no one else is).
The normal phrase is "...deluded in thinking...", but in this case, "diluted" is probably appropriate.
I am amused.
Staying on topic...
If you've got any significant stake in the company, you do have an interest in any deals being made. Sometimes it is the case that the current shares will be diluted so that the new investment can be accepted. It depends on how much was reserved at the start.
So you may have been holding stock that was worth 5% of the company, but after the investment it could now be less. It really depends on how the deal was structured (how much for how much basically).
You may not (as a non-founder) have a say in the terms of the deal, but you need to be kept informed.
I've seen cases where the founders will dilute themselves, but not the smaller holders, to try to be fair to them, but that doesn't always happen.
Maybe its time to read up on your corporations by-laws, which may spell out how and when they have to notify you of these sorts of changes.
I very much agree with you, likely not malicious.
vs
"...quite possible, nay, probable, that"
I always thought it was the latter. Are these the same? i don't think so, but i'm not great with language rules.
"nay" was the word that was almost certainly intended in GP.
He's in Canada. As others have pointed out, at the very least he needs to engage an accountant to find out exactly what the tax implication are.
You are upset about something that might not be an issue. You haven't mentioned what type of stock options you have (in the US there are ISO and NQSO, and - upon a quick check - it appears there are different types in Canada as well, with differing tax treatment). Omitting that detail in addition to the ... unusual way in which you exercised them makes me think you may have more of an academic familiarity with the process.
It would have been nice if the founders told you about the investment, but your reaction is completely out of proportion with what happened. Lawyering up [edit: distinct from a consultation] will be the equivalent of ending your career track with them and burning your bridges entirely.
And really, if the market value of your options has increased, consider the positive side of that news if you own 3%.
1. Stop going in to work (at least without a good reason such as health). 2. Confront anyone, at all. 3. Degrade your work (in as much as you can help yourself). 4. Talk about it, even here or elsewhere.
All of these things will likely be brought up if this goes to court. Don't damage your image.
Recognize you cannot trust your employer, so no point in confronting them or asking anything. Try to be all smiles and don't give anything away. You don't want them to start digging for information on their side.
Get a lawyer. I hope you can afford that. It will be hard to find one but persist.
Write down all details you can remember right away with dates and times, including overtime hours, special projects, extras you performed, reviews of your work and performance, comments that may matter, copies of your email, etc.
Good luck sir... Apologies this happened.
On the financial front, the decision is easy to remedy, if the other founders are willing. Ideal scenario is (a) Your 3% equity is fully-vested (b) 3% equity cannot be further diluted (c) you get retrospective compensation and (d) You get another good raise.
Morally, you have been wronged. It is tempting to take the high ground and take full offensive on principal alone (fight) or cut all ties (flight). But a moral victory won't last long when you need to find a new job, when you realise your stake is gone or if the company gets a big exit 2 years down.
Emotionally, you have every right to be upset and you'll need to find a way to deal with it. My own two cents is, "don't be a wuss" or anywhere near that frame of mind--you'll come out stronger and smarter, whatever happens.
In terms of making a value-judgement business decision, your best outcome is that things get reconciled and you put this all behind yourselves, they apologise, you build a rapport with them and have discussions on how this can be avoided in the future. You may need to highlight to them all that you have given to this company and you are willing to reconcile if they are. You should probably not go in to work for 3-4 days (I am presuming they know you are upset and why) and wait for them to contact you during this time. If they contact you and are showing any signed of reconciliation your conversation should be about (a) how they can make things right financially (all 4 points above) and (b) how to avoid this in the future so that the company can have a strong moral standing. During this time, you should prepare for the worst and talk to a lawyer with the correct expertise.