This is exactly what we do at my startup: our options are early-exercisable, we pay a bonus equal to the strike price, and we set up the 83(b) paperwork for you. (We don't gross up the bonus, so you will owe taxes on the strike price, but so far that hasn't been a problem for anyone; early-stage strike prices are manageable.) Are other companies doing this as well? It does seem like the sane approach.

Thanks for validating that this scheme is not crazy!

I have a follow-up question though. Every time a new employee joins, you are essentially shelling out the cash equivalent of their equity's FMV. This way, the offered equity is twice as expensive for you - once as equity itself, but then again as the cash bonus. Has this caused problems for your cash position? Is it sustainable as Scalyr grows into higher valuations?

It's cash-neutral for us. Suppose a new hire gets 10,000 options with a strike price of $1.00. (These are not real numbers.) They will pay $10,000 up front to early-exercise the options. We give them a bonus of $10,000. Net cash impact to us: zero. (As I noted, there is some cash impact to the new hire, as they will have to report $10,000 income and pay taxes on it.)

We've lost the opportunity to earn a little money from the new hire by selling them stock at a nonzero price. But that's not an opportunity we want.

As we grow into higher valuations, the tax impact may become an issue. We might have to start grossing up the bonus. Also, if someone leaves before they're fully vested, all this has to be unwound and I'm not certain of the tax implications there. We haven't worried much about that because at this stage no one is leaving. :)

This is unrelated to anything but just wanted to say how awesome your Topcoder results were, you are a legend!

Thanks! I wish this becomes the industry standard.

IANAL, but I do not believe you can file an 83(b) election for options. You can only file an 83(b) for NSOs or restricted stock. I am not sure if, post-exercise, the options become "owned options" or "restricted stock" and how the IRS views the difference between the two.

Some companies allow you to "early exercise" your options before they vest. If you do that, you'll certainly want to file an 83(b) election for that exercise, when the spread between strike price and fair market value (FMV) is $0. If you don't file the 83(b) and the FMV goes up, each future vesting period will be subject to taxation.

And all startup employees are expected to know all these rules? Before I joined a startup I spent days researching all the rules about options and I still didn't quite understand all the nuance.

But wait, there's more... Let's say that you decide it's too risky to early exercise in year 1, but by year 3 things are looking pretty good and you early exercise all your options.

Let's say your strike price is $0.20, and now the FMV is $0.75, and you're exercising all 10,000 of your shares, including 2,500 that haven't vested yet. When you exercise, you file an 83(b) so that you get taxed (AMT) on the full $5,500 spread in year 3, even though you don't technically own those year 4 shares yet.

Then, you leave or get fired 3 months later. Pursuant to the early exercise agreement, the company can repurchase 1,875 shares at your $0.20 strike price, giving you $375 back. Unfortunately, AFAICT, there's no way for you to reclaim the tax you paid on the $1,031.25 spread for those 1,875 shares; you just eat it.

Yeah, this stuff is complicated, and sadly it seems to fall to each startup employee to educate themselves.

Err, are you sure you can't take a capital loss on the $1,031.25 spread?

Not that I would benefit personally. I am still burning through years of capital loss carryover from ZNGA.

Section 4.03 of IRS bulletin 2012-28 (https://www.irs.gov/irb/2012-28_IRB/ar12.html) states, "If property for which a § 83(b) election was filed is forfeited while substantially nonvested, § 83(b)(1) provides that no deduction shall be allowed with respect to such forfeiture. Section 1.83-2(a) further provides that such forfeiture shall be treated as a sale or exchange upon which there is realized a loss equal to the excess (if any) of (1) the amount paid (if any) for such property, over (2) the amount realized (if any) upon such forfeiture. If such property is a capital asset in the hands of the taxpayer, such loss shall be a capital loss."

I'm not an accountant nor a tax expert. My layman's understanding of that clause is that (1) the amount paid was $375, and (2) the amount realized was $375, so the buyback nets $0.

Could the nonvested shares somehow be defined as "a capital asset in the hands of the taxpayer" with a cost basis of the FMV at exercise time, even though they're not technically property of the taxpayer yet? Perhaps it depends on the specific terms of the early exercise and the buyback?

Yeah, it's a little annoying to read all of these context-dependent details from people calling those who don't know them "naive."

It is also important to evaluate the likelihood of liquidity events and vesting schedules on the decision (if available) to file an 83(b) election. You may be paying tax on something you never get.

It's still tough from a liability standpoint as the loan needs to be 100% recourse for tax reasons, so you have to pay it all back even if the company goes under. With high valuations this might be a lot of money. You are therefore investing more in an underversified portfolio increasing an already high startup risk.

I may be wrong, but I think that in order to early exercise the underlying Option Plan has to allow for it which isn't always a given these days for some reason.