stock options or convertible notes?


2

I will be joining as a senior developer on a startup and I will be working 20 hours a week remotely. I have a day job which pays my bills now.

The company is not funded yet so we will not be given any cash now. I've been given two choices. Get stock options or Convertible notes:

Could you help me choosing the best for me based on the details given below:

1- There are lots of chances that the company will be funded in 2-3 months and I will be paid some cash after that.

2- There are chances that the application starts generating in 12-14 months.

Could you give me the differences between stock options and convertible notes and in my situation which choice will get me the max money if the company is a success? Thank you.

Independent Contractor Stock Options Convertible Note

asked Apr 5 '12 at 01:59
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Java Mouse
113 points

4 Answers


4

  1. Do realize that "There are lots of chances that the company will be funded in 2-3 months" should really be "there is a good chance that the company will not get any funding until another year of hard work, if ever"
  2. I'm not sure what they mean by convertible note. It's usually for investors who sign a check to the company, but instead of getting stock right away, it's considered a loan that can convert into stock later (when another round of funding happens). As an unpaid employee, you should not be required to invest cash, you are already taking a huge risk. Stock options look fine to me, the only point is that I would refuse a one-year cliff, it's abusive when you are not getting any salary at all. Think of it this way: after 11 months of hard, successful work, the product is looking good, but the company could fire you and you would receive absolutely nothing for your work: no cash and no stock.
answered Apr 5 '12 at 02:48
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Alain Raynaud
10,927 points
  • Thank you. Its valuable. – Java Mouse 9 years ago

1

Let's start from definitions:

If you are given an option of Convertible Bond or a Stock Option I would get Convertible Bond. Convertible Bond being a bond carries interest albeit lower then a regular bond but interest nontheless which the company will have to pay depending on how they will set this up.
answered Apr 5 '12 at 02:16
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Karlson
1,779 points
  • Thanks for the details. – Java Mouse 9 years ago

1

(1) Beware of tax issues. If the company gives you something, including a convertible note, as compensation for your services, and that thing has an ascertainable value, you will be taxed on it. Not really what you want -- nothing like getting a $20K convertible note that you can't sell, and then having to pay $5,600 in taxes on it. (Also check into problems with section 409A of the tax code, which imposes a significant penalty for messing up deferred compensation arrangements.)

(2) You should consider getting restricted stock, subject to vesting. This has the advantage of starting the clock for capital gains treatment (assuming you file an 83(b) election within the right timeframe.) If the per-share value is minimal, you won't incur much in the way of immediate tax when the shares are awarded. Options do not generate tax immediately, but can get worse tax treatment when you exercise them and promptly sell the shares.

(3) In answer to your question, it depends on the number of options and the value of the notes. When the notes convert, they will do so for fewer shares than you'd get if you spent the same amount on stock today.

answered Apr 5 '12 at 03:24
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Chris Fulmer
2,849 points
  • Thanks for the details, and suggestions. – Java Mouse 9 years ago
  • Yes, go with restricted stock and file your 83(b) within 30 days, that's the best deal around. – Alain Raynaud 9 years ago

1

A convertible note suggests that the company will consider your deferred compensation as a debt the company owes you. You would be in the same position as an investor who contributed cash to the company in exchange for a convertible note. Typically, a holder of debt is considered to be in a more favorable position than a holder of equity, because a creditor has a right to be paid before any equity holder. Debt is an obligation that cannot be escaped except thorough bankruptcy. Equity is not an obligation of the company; it's value is determined by the market. Without more information, I think you might break down your choice to look something like this (suppose the amount due is $100): (i) A $100 note you can cash in at a later date for $100 cash; (ii) A $100 note you can convert to equity of the company at a later date (and presumably at the then-current valuation); (iii) The right to buy $100 in equity of the company at a future date, at today's valuation (stock options). Contrary to what is stated above, a note may or may not pay interest on the principal owed.

answered Oct 7 '12 at 01:23
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Sam Iam
11 points

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Independent Contractor Stock Options Convertible Note