Stock options have long been the driver of top talent within technology-based startups.

These startup lottery tickets of sorts have served as the single-biggest asset that young, cash-strapped companies have leveraged to cover the delta between market-value salaries and below-market compensation.

To put it in plain English, stock options are the reason why a veteran software engineer would chose to bypass a six-figure salary and plush 401k at a Fortune 500 to work for 5-person startup at a 50 percent reduction in pay and stale bagels.

But that could all change on January 1, 2018 if the current draft of the Senate Tax Reform Bill passes as written.

The proposed bill would dramatically change the way stock options are treated, by taxing them when they vest rather than when they're exercised.

In a recent article in Axios, Greg Grogan, a compensation and employee benefits attorney with Simpson Thacher and Bartlett, stated:

"For startup employees, this is equivalent to the government taxing a lottery ticket because the first two ping pong balls match your ticket. Employees will owe taxes on 'potential' value on the vesting date of their options before they know whether the option will ever really be worth anything and before there is any cash available to pay taxes."

Under the current law, employees who are given stock options are only taxed when they exercise (or sell) their shares. Most often, this option is only available when the company goes public or gets acquired.

The new proposed bill would require employees to pay taxes on their options when they vest (or when they have the option to exercise).

The problem is that while startup stock options have a paper value associated to them upon vesting, they are illiquid -- worth nothing more than the paper they're printed on.

This new change, if it should come to pass, could have devastating effects on the technology industry and startup ecosystem as a whole.

Startups would lose their ability to hire top talent.

Without stock options to offset lower salaries, high-growth startups will have a difficult time luring top talent away from more lucrative opportunities.

With no upside potential to mitigate risk, the most talented potential hires will likely opt for a higher salary with a bigger technology company.

Less investment capital would re-enter the market.

With fewer employees earning big pay days from equity cash-outs, there will invariably be less money circulating back into funding the next wave of startups.

This could also lead to less people taking the leap from employee to entrepreneurship as the earnings to risk ratio shifts.

More startups would shutter due to lack of capital.

Without equity incentives, startups will be forced to use bonuses and increased cash compensation to attract, or even just maintain, key hires.

For pre-revenue or pre-profit companies, this will require more capital from institutional investors. The increased demand could lead to a strain on available funds within the market, leaving companies with no other option than to close their doors.

Since the proposed changes have gone public, many opponents have voiced their concerns.

Thomas Korte, an ex-Google employee and founder of startup accelerator, AngelPad, told me this: 

"Employee stock options are a pillar of compensation in tech startups. Startups often underpay employees but offer a potentially huge upside if the company succeeds. Taxing the unrealized gains of stock options is like taxing a person who is buying a lottery ticket for the potential lottery win -- it makes no sense and will destroy the high risk/high reward attitude of Silicon Valley."

Rather than waiting to see how the bill plays out, Korte has called on others to sign his petition and asked that those who oppose the bill reach out to their Senators to express their opposition. 

Korte issued a warning: "We have to move fast -- this may be decided in days, not in weeks."

Published on: Nov 15, 2017
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