What Does Working at a Successful Startup Look Like Financially?

or…how it cost me $1,000,000 to sell startup shares on the secondary market.

After joining 3 startups, I was fortunate enough to help found a company that grew from 0 to single-digit billions in valuation in just 4 years. My role during much of that time was leading the engineering team. While I don't know the exact percentage of the company I originally owned, my current shares amount to approximately 0.002% of the company, worth about $X,000,000. The million-dollar question is: when converted to cash, how much money do I actually receive?

Why Sell Some Shares?

$X,000,000 is an unfathomable sum for someone who never really imagined making $100K/year. I grew up in a relatively modest rural area to well-educated parents. I attended public school without tutors or extensive extracurricular activities. Sundays were spent cutting coupons from the newspaper, and it took years after college to feel comfortable ordering an appetizer at a restaurant. I feel extremely fortunate about my upbringing and the resources I had access to. However, my world growing up differs significantly from NYC in 2021.

I chose to sell a portion of my shares because the money would be transformative. I also believe having 95%+ of my net worth in a single company represents significant risk.

What Happens When Selling Shares on the Secondary Market?

Selling shares on the secondary market is quite involved. End-to-end, it took 16 weeks from contacting the secondary sales company to receiving funds.

After leaving the startup I helped found, I contacted my long-time tax advisor about potentially selling some shares of the company I had worked at for the past 4.5 years. I asked whether there were any tax implications I needed to be aware of when selling shares on the secondary market. He confirmed that since I had early exercised and completed an 83(b) election, the shares would qualify for long-term capital gains. Great!

On April 15th, I signed agreements to sell a portion of my shares totaling $2,000,000 on the secondary market (Note: this is not the actual amount). I believed this approach would preserve significant upside potential while immediately helping me live more flexibly and assist my mother in retiring. (This was pre-tomato plants)

For transactions of my size, the facilitators take their maximum fee of 5%, which in this case is $100,000. Here is how I calculated my anticipated net proceeds:

2,000,000 - 100,000 
Total after placement fee = $1,900,000

1,900,000 * 0.2 (federal long term capital gains) + 1,900,000 * 0.12 (NYC state + local)
Total taxes = $608,000

1,900,000 - 608,000
Total take home = $1,292,000

(608,000 + 100,000) / 2,000,000
Taxes and fees as a percent of takehome: 35%

On April 28th, President Biden announced a tax plan where capital gains over $1,000,000 would be taxed as ordinary income, with the changes retroactive to April 28th, 2021. Unfortunately for me, the taxable event date for my sale is not when I signed the transfer agreement (April 15th) but when I receive the funds. This means my transaction, despite being initiated without knowledge of this potential policy change, would be subject to this new tax rate. With this new rate, my total taxes and fees would be:

2,000,000 - 100,000
Total after placement fee = $1,900,000 

1,000,000 * 0.2 (federal) + 900,000 * 0.4 (federal under Biden plan) + 1,900,000 * 0.12 (state)
Total taxes = $788,000 

1,900,000 - 788,000 
Total take home = $1,112,000

(788,000 + 100,000) / 2,000,000 
Taxes and fees as a percent of takehome: 44%

This reduces the net proceeds on a sale of $2,000,000 in stock to $1,112,000. 44% of the total is consumed by taxes and fees. However, there was nothing I could do, so the process continued.

In mid-July, approximately 14 weeks after signing the transfer agreements with the buyer, the funds from the secondary sale arrived in my account. This transfer occurred 4 years and 10 months after the options were initially granted to me, which I had early exercised with the 83(b) election. After the sale was complete, the company voided my prior stock grants and issued me a new grant with my remaining shares.

Minor note: The cost basis of my shares was $0.01, so my calculations rounded down to $0.00 for calculating capital gains. State taxes are also deductible on your federal taxes up to a maximum of $10,000. Both of these factors would provide a few thousand dollars in savings.

Note 2: I am validating these calculations with multiple CPAs.

Exemption!

Around this time, a financial advisor from a large investment bank reached out via LinkedIn about helping startup employees manage their new wealth. I responded, and they informed me that my shares might be eligible for a 'QSBS tax exemption'. Despite having researched extensively about taxes relating to startup shares and consulting my tax advisor prior to the sale, I had never heard of a 'qualified small business' tax exemption.

The QSBS exemption means that if you owned shares of a 'qualified small business' while the business had less than $50 million in assets and held those shares for 5 years, then up to $10,000,000 in profits are completely exempt from federal taxes.

The concept that there are additional tax exemptions beyond long-term capital gains was astonishing to me. I never anticipated the federal government would create a 100% tax exemption, so I never investigated this possibility.

While the QSBS exemption benefits early-stage employees/founders, it is particularly advantageous for early-stage startup investors. It also allows individuals to roll funds into other investments before the 5-year mark and maintain tax exemption. For example, if you invest in an early-stage startup and sell those shares after 3 years, you can invest your money in another early-stage startup within 6 months and sell after 2 years (5 years total invested in a QSBS). These investments now avoid any federal taxes on profits up to $10,000,000 per year, allowing you to stagger sales to further minimize taxes.

Note: There are apparently also more controversial tax saving methods where you purchase shares with your ROTH IRA.

How Does QSBS Apply to My Situation?

After conducting research, I found that the startup appears to qualify as a 'qualified small business' and that approximately half of my shares were vested while the company had less than $50 million in assets. However, given that I sold some shares, complications arise.

• If I sold half of my shares, did I sell the first half (those that would qualify for QSBS in the future) or the last half? How would I determine this?
• Given that I now have a completely new stock grant with a new date, can any of my shares be considered as having been held while the company had < $50 million in assets?

My current understanding is that one or both of these factors disqualify me. This means none of the shares I currently own will be eligible for the QSBS exemption in the future.

A Stacked Game

In summary, I made one decision that cost me either $X00,000 (at the current tax rate) or $1,000,000+ (under proposed capital gains changes) in taxes. Given that none of my shares qualify for QSBS in the future and that taxes on my shares are 35%-44% of $X,000,000, that cost equates to approximately 1/4-1/3 of my personal wealth.

How does that feel? I have mixed emotions—I'm doing well financially yet feeling somewhat disappointed. It reminds me of playing a board game with someone who didn't explain all the rules beforehand. They suddenly announce, "boom, I win; game over," revealing some previously unmentioned rule. Had I known about this hidden rule, I would have adopted a different strategy, but the moves have already been made.

With one move, I simultaneously encountered two hidden rules—a retroactive tax change and an obscure tax exemption. Had I known about either one, I would have waited or sold fewer shares.

What's Next?

I was relatively advantaged in this situation and still experienced significant financial impact. I've worked at many startups and learned about the AMT exemption and the 83(b) election, which few startup employees both know about and can afford. The 83(b) election requires paying to exercise options covering 4 years within 30 days of starting a new job. In most cases, this costs tens of thousands of dollars. Even fewer understand how the AMT exemption applies to exercising startup options (consult your CPA about this). By early exercising all my shares when their value was $0.01, I was able to "hold" my shares as long as possible and get closer to the QSBS exemption.

Is all this fair? I'm not certain. Many individuals have accumulated significantly more wealth by utilizing AMT, QSBS, and their ROTH IRAs in ways few understand. Complexity inherently benefits those with knowledge and resources.

What I do know is that I now have both more knowledge and more financial resources than before.