Founder Vesting, RSU’s and 83(b) Elections – Making Sense of the Mess

0:00 Last week we talked about the importance of a founders agreement when you have more than one founder.

0:05 And what was critical about it was the vesting component, making sure that you agreed over what period of time you owned your equity and what happens if someone leaves before that.

0:14 They only take the portion they've owned. And so the question I want to address today is what are the mechanics? How do you actually facilitate this vesting over time?

0:23 Many of you are familiar with the concept of stock options, which is what people typically get when they go work for a startup and they say,

0:29 up and they say hey i got some equity i used air quotes because they don't actually have equity

0:33 what they have is an option to buy equity and the reason that distinction is really important is for

0:39 tax purposes you see if the company gave you a bunch let's say one percent of the company is what

0:44 you got as part of your employment agreement if they gave that to you in stock then you would own

0:49 that and you would owe income tax on the value of that maybe it's a company that's doing well

0:56 maybe it's worth 10 million dollars you have one percent you now owe income tax on a hundred

1:00 thousand dollars that you never got cash for you just got a piece of paper that wouldn't fly very

1:05 well so instead what they do is they give you a piece of paper or note a stock option an option

1:12 to buy the stock at the current valued price so in this case you may have the option to buy stock

1:17 at a hundred thousand dollars what that means is if the company becomes worth ten times as much and

1:22 your portion is worth a million at the time of the exit you get to buy it for a hundred thousand

1:29 sell it for a million you net nine hundred thousand dollars and you only pay tax when

1:36 you execute that transaction and it's a much simpler solution much less paperwork so that's

1:43 what we do for more normal uh employees however what if the stock isn't worth anything then when

1:51 I give it to you there'd be no tax right so when we form the company let's say there's three of us

1:55 who form the company we could each get a third of the company in stock and have no tax implication

2:01 because it's not worth anything that's true but I told you last week you need to have vesting over

2:07 time and when you put that vesting agreement in on the stock they become what are called restricted

2:12 stock units you're restricted from selling them because you don't really own them all until they

2:17 vest and the irs treats that as though you don't actually own them at all until they vest and the

2:23 irs says when they vest you owe tax on the value of them as they vest if you're building a great

2:31 company four years from now when your last stock options when your last restricted stock units

2:36 sorry vest you're gonna owe a lot of tax and again not have the cash to cover it

2:42 So that's a problem.

2:44 So the IRS has created a form called an 83(b).

2:49 And the reason they created the 83(b) is so that you can declare,

2:53 listen, I know I may never vest all of these shares of stock.

2:57 I may leave before they're all vested.

2:59 But IRS, I'm going to pay you all of the tax I owe on all of it right now.

3:03 And I'll never get anything back.

3:05 Sounds like a bad deal until you realize all of the tax you owe right now is zero.

3:10 So when you form your company and your stock is worth nothing, you do it and divide up the equity

3:17 with stock, not options, restricted stock units. You each file an 83(b) declaring that you're doing

3:24 it and you're paying all the tax you owe, which is nothing. And now you don't owe any tax until

3:29 you sell those shares of stock in a transaction. And here's the big bonus. When you do sell the

3:36 shares of stock, assuming you've held them for a long enough period of time, it's capital gains tax,

3:42 which today is 15 to 20 percent, depending on your tax bracket, versus stock options,

3:48 that gain is ordinary income, which today could be as much as 35 percent. Big savings in tax.

3:54 That's why you want to do it as restricted stock units. That 83(b) we talked about, it is super

4:00 important. You have to file it within 30 days of the transaction. If you file it on day 31,

4:06 the IRS tears it up and doesn't pay any attention to it. There are no second chances. It is very,

4:11 very, very important. It's a simple page, one page form. You have to file it, mail it into the IRS,

4:18 make sure you do it certified mail, you have a receipt, etc. But do that. If you have a great

4:25 founders agreement, you have restricted stock units so that you'll get capital gains treatment

4:30 on your gains when you do sell the company,

4:34 and you remember to file your 83(b) within 30 days,

4:37 you have an amazing foundation,

4:39 and you're off to the races.