Hi there, Justin here. The ongoing allegations against Flutterwave have, over the past few weeks, given The Flip Notes the opportunity to further discuss some of the important topics in question. Part of the story has been about stock options - something that I realized I didn’t know enough about. So I reached out to a few friends of The Flip to better understand this topic, in general, and what we need to know in the African context, in particular. Here’s what I learned…
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My primary takeaway from a week in the employee stock option rabbit hole is that this stuff is (overly) complicated. There are different strategies to implement, all with their own nuanced details, and all dependent upon a company’s underlying culture and objectives. And that’s just in one tax jurisdiction. Add to that multiple tax jurisdictions in markets with uncertain regulation, unpredictable regulators, and run by governments that need to tax anything they can to increase revenues. That’s what we’re dealing with here.
In The Flip’s endeavor to share contextually relevant insights, it becomes clear in the stock option context, that much of what’s been shared in the Silicon Valley discourse simply don’t apply to many African startups. I aim to write about topics in the local context, and as a result, I don’t typically write about general topics where there is better information available, written by people who are greater subject matter experts than I am. So at the end of this newsletter edition, I’ve linked to a handful of useful resources from the global punditry that provide much more detail than what we’ll discuss here. But a massive caveat applies that a lot of what’s written about from a US-centric lens doesn’t necessarily apply everywhere, and much of this varies on a country-by-country basis.
Then, my second takeaway is that I’m surprised this topic isn’t being talked about more, considering the role equity plays in startup culture and its compounding complexity as one peels back layers of the onion. Today’s edition, I surmise, will be the beginning of an ongoing discussion about that which needs to be discussed and explored further. But first, let’s start with the basics.
Employee ownership is, of course, a defining element of startup culture and is both an important talent attraction and retention tool. What was once more of an executive perk has now become an expected part of employee compensation. It is, on one hand, a tool that enables startups to recruit top talent early in their lifecycle, with a promise of a sizable payday upon exit. It is also a means by which companies build their “familial” culture. Everyone is part of the team/family, sharing in the gains. And on the retention side, cliffs, vesting schedules, and grants - which we define below - incentive employees to build with the company over the long term.
Generally, the primary shareholders are the founders, as well as early team members who are issued shares when they join the company. As startups raise outside capital - seed stage and beyond - their fundraising rounds will typically include an employee pool, which allocates another percentage of company ownership for the employees that will join post-raise.
Meanwhile, a stock has a value and is subject to capital gains taxes. As a result, companies don’t give stocks to their employees but instead offer stock options.1 An option is the right to purchase a stock at a set price for a fixed period of time.
How much equity employees are offered, in terms of dollar amount, and which employees are offered options - whether certain types of employees or employees at a certain seniority level - depends on the organization and its culture/strategy. But employees are typically issued stock options at a multiple of their salary (e.g., 0.5x their annual salary). The number of shares is generally determined by the dollar value of the equity divided by the current share price, as determined by the most recent pricing round.
Then, the price that an employee must pay for a share is called the strike price. Although the employee has to buy these shares, the general idea is that when it is time to exercise the options, the share price will be significantly greater than the strike price that was locked in when the employee first joined the company. And the earlier an employee joins, the lower the strike price and/or the greater the number of shares that employee will be offered. It is also at this point in time, when options are exercised, that there are tax implications.
The strike price is based on the “fair market value” of the company. In the US, private companies must determine FMV with a 409A valuation, which is typically assessed by a third-party valuation provider, and is different from (and less than) the valuation that investors set during a funding round.
To protect the company, employees earn their options per a vesting schedule - usually four years. And most vesting schedules include a cliff period, typically a year, in which no vesting occurs. After a year, the employee’s options vest on a monthly basis, upon which they take ownership of their options. Thereafter, companies often offer retention grants to further incentive employees whose options have fully vested2.
And finally, if an employee chooses to leave a company after one year, they have the right to purchase their options from the company although they have left. This is called the post-termination exercise and is typically a 90-day window in which employees have to pay up or lose their options. However, the 90-day window is particular to US taxes, where after 90 days the tax treatment of the options is different.3 While some US companies have implemented new ways to structure to give their former employees more time to exercise their options after they leave. The decision to do so, in theory, may have implications on how much equity is available at a later date for either existing or new employees, so is also a part of the company's larger recruitment and retention strategy.
Meanwhile, African startups can give their employees a longer window, as well, considering the US tax implications don’t apply. But African startups’ decision to do so - and indeed their decisions around employee stock options in its entirety - largely comes down to tax policies and culture.
The African Context
The initial challenge, in the local context, is the uncertainty around taxes.
In Kenya, for example, tax law only allows for public companies to issue stock options and, as a result, it is unclear how these options will be treated from a tax perspective. There have been instances and indications of tax authorities taxing options when they vest, not when employees exercise their options, meaning that employees have a tax burden on the options before they even exercise their right to purchase them from the company.
The concern with issuing stock options in such an uncertain environment is the risk of employees facing significant tax obligations, especially for unrealized gains, and before they have the liquidity to meet their obligations. This concern is exacerbated in an environment where employees might not even value employee ownership.
This is where culture comes into play. Anecdotally, employees may value equity more in Nigeria, for example, where they’ve seen rising valuations and/or a handful of exits, as opposed to in other African markets. Undoubtedly, employee perceptions about equity are shaped by exits and representative examples of equity ownership being worth something in these markets.
In general, in a context with lower incomes, many employees in African markets may prefer the certainty of cash today to the uncertainty of the future value of options. And the challenge with options, in this context, is that they also require the employee to have the liquidity to exercise their shares and to pay their tax obligations, as well.
On the other hand, a strictly cash-based compensation structure may also make it difficult for startups to compete with larger corporates, as we have seen in markets like Kenya, and in an increasingly remote-friendly environment globally. It also gives companies less of a retention lever than they would otherwise have with option pools and vesting schedules.4
All of this raises an important question: what does it mean to try to build a (Silicon Valley-style) company culture, leveraging employee stock options, in an environment with unclear tax implications and/or with mild interest in equity amongst employees in the first place?
This, in my opinion, underscores the importance of shifting our collective attention to this topic. Even if stock options are less useful of a tool in this context, they are no less important. Particularly when we look at the national and racial inequities of venture capital raised in select markets - with the lion’s share of funding coming from overseas - employee ownership is vital in advancing the ecosystem for the benefit of local employees. The next cycle of startups should be funded by the employees and founders of this current round, which potentially widens the scope of founders funded. This evolution can only happen with employee ownership.
So, much like other regulated industries, here’s another scenario in which startups ought to work with governments to create clarity and reach agreeable resolutions, to create outcomes that promote ownership without also creating undue tax burdens for employees. Likewise, it’s incumbent upon startups and founders to educate their employees and explain why this is important for them, and for startup employees to get better informed and share their expectations with their management, as well.
Accion’s presentation on ESOPs
Stripe's equity for employees guide
Fred Wilson’s series on employee equity:
A series of blog posts from Carta on:
- Ryan Breslow's thread on Bolt's stock option program. Please read responses and quote tweets for both sides of the discourse on employee loans.
- Google, Uber, Coinbase, Stripe and other tech firms are shaking up their stock plans, and employees are getting their money sooner
- Better Tomorrow Venture's Sheel Mohnot on why this is bad for employees
- Why stock vesting periods are getting smaller
Thanks to Raise’s Marvin Coleby and Shara’s Jordan Solomon for reviewing and providing feedback on today’s newsletter edition, and to various members of the Stitch team for answering all of my questions at lunch on Friday.
Many companies also offer Restricted Stock Units, but RSUs are generally issued after a private company goes public. Like stock options, RSUs vest over time, but unlike stock options, you don’t have to buy them. As soon as they vest, they are no longer restricted and are treated exactly the same as if you had bought your company’s shares in the open market. For more on RSUs vs. stock options, see here. ↩
This is where things get even more complex. For more on options strategy, I suggest reading the resources at the end of this piece for more on these details.. ↩
There are, of course, other means of retention - non-financial perks, employee training and development, opportunities for upward mobility, and being a place of employment that people actually enjoy. ↩