We're in the process of hiring our first employee and trying to figure out logistics given that we're making the employment offer in parallel with our seed funding. All of our current funding up to this point has come from angels on convertible notes, but we're currently waiting to hear whether the term sheet we signed with a VC will close. We only plan to hire this employee if that funding comes good, but the terms we're offering are "pre-funding", i.e. the equity he's getting will be diluted shortly after he comes on board when the round closes. The round will not close immediately when the term sheet does as we still need to close a bit more angel funding.
The prospective hire has come back with a few concerns on the offer:
1) The employee wants stock rather than options, with a re-purchase right that vests away over 4 years, which he says gives better tax treatment. What would be the effect of this and what is the ideal way to handle this before a priced round?
2) He wants to know the exercise price of the options. Would this be based on the pre-money valuation the VC has assigned to us, or should we base it on a lower valuation since the round will not have closed?
We'd like to give this guy a fair and straightforward deal with terms that are advantageous both to him and to the company. Any insights on how to think about this?
Give the equity now, before the next funding round results in a higher per-share valuation.
If you issue options, the price that the employee would have to pay for the options (when the employee exercises the options) would be the fair market value at the date of grant...so go ahead and have your board grant the options now, before the closing of the next funding round.
If you issue shares directly to the employee now, the employee may need to pay tax on whatever the value of the shares now is, and so do that now as well if you're going to.
Either way, if the VC has given you a pre-money valuation, it's kind of tough to argue that the fair market value of the shares (and thus the strike price of the options) is lower than that. Has your company done a recent valuation that is lower? If so, you may be able to use it instead, but it's tricky.
Odd that the person would rather pay tax now than pay a strike price of options later.