Understanding equity at tech companies, with Billy Gallagher of Prospect

Patrick and Billy discuss how equivalent equity promises result in vastly different outcomes based on employee sophistication. Employees from advantaged backgrounds (Stanford grads, second-time unicorn employees) make better decisions on time-sensitive equity choices, while less-connected employees lose hundreds of thousands due to clicking wrong buttons or missing deadlines. HR cannot provide useful advice due to legal constraints.

• •Equity decisions have expiry dates starting the day you sign your offer letter
• •Information asymmetry correlates with sociopolitical advantages—Stanford grads vs first-time tech workers
• •HR gives carefully rehearsed non-advice due to legal liability concerns
• •Wrong decisions can cost employees hundreds of thousands to millions of dollars
• •The system punishes less-sophisticated employees despite equal work contribution

Overview of how startups structure equity grants, distinguishing between options (right to buy stock at strike price) and RSUs (direct stock grants with higher taxes). Standard vesting is four years with one-year cliff—no equity for first year, then 25% on day 365, remaining 75% over 36 months. The 20% employee equity pool typically dilutes to 10% by IPO.

• •Options are tax-advantaged but require paying strike price; RSUs are direct grants with higher taxes
• •Standard vesting: 4 years with 1-year cliff (25% year 1, then monthly over 36 months)
• •Employee equity pool starts at ~20% of company, dilutes to ~10% by IPO
• •Equity value is non-deterministic unlike salary—could be $0 or millions
• •Earlier employees get options; later-stage employees typically get RSUs

Early exercise allows employees to buy unvested options immediately, locking in lowest tax basis when strike price equals fair market value (often zero tax burden). The tradeoff: increases variance—best case is minimal taxes on huge gains, worst case is losing the exercise cash if company fails. Waiting to exercise can result in massive tax bills as the 'bargain element' (spread between strike and FMV) gets taxed at ordinary income rates.

• •Early exercise locks in tax basis at lowest point—often zero spread means zero taxes
• •Money spent on early exercise is gone forever if company fails—no bankruptcy claim
• •Waiting 3 years at a successful company can create 20x higher tax burden
• •Tax burden often grows faster than company valuation due to FMV/preferred price dynamics
• •Series A employee might pay $1,000 to exercise; Series C employee might need $300,000

The 83(b) election must be filed within 30 days of early exercise to lock in tax treatment and qualify for QSBS (up to $10M in tax-free gains). Missing this deadline has no remedy—the IRS will tax vesting events at ordinary income rates. Founders have been personally bankrupted by missing this filing, owing $1.4M+ in taxes on illiquid stock. Even Stripe had to build automated systems to ensure founders file this critical document.

• •Must be filed on paper within 30 days of exercise—no exceptions or extensions
• •Enables QSBS tax break: up to $10M in gains tax-free (phased: 50% at 3yrs, 75% at 4yrs, 100% at 5yrs)
• •Missing deadline can create $1M+ tax bills on illiquid stock with no recourse
• •IRS has no statutory authority to grant relief for missed 83(b) elections
• •30 days passes quickly when you're focused on actual work—easy to forget

Incentive Stock Options (ISOs) use Alternative Minimum Tax (AMT) system with lower rates (26-28%) versus ordinary income (up to 37%) for Non-Qualified Stock Options (NSOs). AMT requires calculating taxes under both regular and AMT systems, paying whichever is higher. Small ISO exercises can sometimes incur zero AMT. Exercising ISOs generates AMT credits usable in future years, adding another layer of complexity.

• •ISOs taxed under AMT at 26-28% vs NSOs at ordinary income up to 37%
• •Must calculate full tax burden under both systems, pay the greater amount
• •Can sometimes exercise small amounts of ISOs annually without triggering AMT
• •AMT exercise generates tax credits for future years
• •IRS makes this intentionally complex—requires sophisticated tax planning

Attending a conference in Illinois for one week while vesting $4M creates Illinois tax liability on that week's portion. High-flying companies maintain spreadsheets tracking employee days in various states. Digital nomads face worst-case scenarios where highest-tax jurisdiction claims full residency. Establishing residence requires lease, driver's license, and putting down roots—Airbnbs can trigger residency claims. Patrick personally pays taxes to states he doesn't live in due to work travel.

• •Vesting equity while traveling creates pro-rata tax liability in that state
• •Companies track days-per-state for high-value employees to manage tax compliance
• •Digital nomads risk highest-tax state claiming them as full-time resident
• •Airbnb rentals can establish residency unlike hotels—major tax trap
• •Need lease, driver's license, and demonstrated roots to establish clear residency

Companies clam up on equity advice because unsophisticated employees aren't accredited investors—giving advice creates 'put rights' where employees can demand money back if advice proves wrong. If Bob in HR tells you to spend $300k exercising and company fails, you can sue Bob personally for $300k. Securities regulations protect unsophisticated investors, and equity grants fall under these rules. This forces employees to rely on 'bootleg spreadsheets' passed around by veteran employees.

• •Employees aren't accredited investors—companies face securities law liability for advice
• •Bad advice creates 'put rights'—employees can sue for money back personally
• •HR/CFO individuals can be personally liable, not just the company
• •This is why HR gives carefully rehearsed non-answers to equity questions
• •Employees resort to 'bootleg spreadsheets' from veteran coworkers—highly variable quality

Tender offers now happen earlier and more frequently—sometimes multiple times per year at rapidly growing companies. Employees face complex decisions: sell now at known price vs. hold for potential 2x in 6 months, but no guarantee of future tender offers. Companies never promise future liquidity. Must balance desire to hold concentrated position in employer vs. need for cash for house, family, or diversification. Adds complexity of which specific lots to sell for tax optimization.

• •Tender offers happening at Series A/B stage now, not just late-stage companies
• •Some companies doing 2+ tender offers per year as valuations rapidly increase
• •Companies never promise future tender offers—each might be the last chance for years
• •Typically capped at selling 10-20% of holdings to maintain employee alignment
• •Requires sophisticated lot selection strategy—which grants to sell for optimal taxes

Companies give refresh grants to prevent cliff-vesting employees from leaving after year 4. These have much more variable structures than initial grants—some are stacking 1-year quarterly vests, others are new 4-year vests, some are back-weighted. After 7 years at a successful company, employees have waterfall of grants at different strike prices, partial exercises, partial sales in tenders—creating combinatorial complexity that bootleg spreadsheets can't handle.

• •Refresh grants prevent mass exodus after initial 4-year vest completes
• •Much more structural variety than initial grants—no standard template
• •Long-tenured employees accumulate complex waterfall of overlapping grants
• •Each grant has different strike price, exercise status, and sale history
• •Requires modeling which specific lots to exercise/sell across multiple dimensions

Early employees face liquidity crunch for exercising options—might need $25k-$300k cash. Options range from family loans, 401(k) loans, home equity, credit cards, to specialized equity loan companies (which employers hate). As employees become wealthier, private banking unlocks bespoke solutions, but early decisions made without these tools create permanent tax consequences. Banks use internal wealth scales ($1-$5 signs) to determine service level—most startup employees start at $1, some reach $3.

• •Early exercise requires significant cash: $25k-$300k depending on stage and grant size
• •Liquidity options: family loans, 401(k) loans, home equity, credit cards, equity-specific lenders
• •Companies strongly discourage equity-backed loans for various legal/structural reasons
• •Private banking becomes available at higher wealth levels with bespoke loan structures
• •Early-career decisions made without sophisticated tools create permanent tax impacts