Guide to Your Equity
There are currently 4,662,658 shares of Clef common stock outstanding.
Our 409A Valuation Report, which discusses the price per share of employee shares, is available (to employees only) here. Any employee with questions about the report, our share price, or valuation should ask B.
This guide is meant to help you understand the piece of Clef that you’re going to own! Its goal is to be more straightforward than the full Stock Incentive Plan and Award Agreement, which both go into the full legal details. You should consult an employment attorney if you have any questions about navigating your stock options and before you make important decisions.
Owning stock in Clef gives you a stake in our success. As Clef grows and increases in value, you will own a piece of that growth and increased value. Clef is pretty small today, but if things go well, your stock could be worth many times more. However, you are gambling with this portion of your compensation -- if Clef decreases in value, then your options won’t be worth anything.
At Clef, we give equity grants in the form of Incentive Stock Options (ISOs). It’s called an option because you have the option to buy Clef stock later at the same price it was worth when the option was granted. So if a share of Clef stock is worth $1 today and we grow so it’s worth $20 in a few years, you’ll still be able to buy it for $1 (and then sell it immediately for a profit of $19).
The reason we give stock options instead of straight stock is that it keeps you from being taxed on the stock until you actually use it.
If we gave you $10,000 worth of Clef stock today, you would have to pay thousands of dollars in taxes this year. If we give you options for $10,000 worth of stock, you don’t have to pay any taxes until you exercise them (more on exercising later).
Instead of giving you all of your options on day one, you get them over time. This process is called vesting and different companies offer vesting schedules of different lengths. If you had a basic 2 year vesting period, you would own a quarter of your stock after 6 months, half of your stock after a year, and all of it after 2 years.
The industry standard right now is 4 years, but at Clef, employees’ stock vests over 6 years. We offer much higher equity grants than the industry standard (about 2x in most cases), but it takes longer to earn them. This works out so that employees always come out ahead, even if they leave before their stock has fully vested, but helps us communicate that we’re looking for employees who want to build longer careers at Clef.
Vesting happens on a monthly basis (so you vest 1/72 of your options each month), but many vesting schedules include a cliff.
A cliff is a period at the beginning of the vesting period where your equity does not vest monthly, but instead vests at the end. At most companies, including Clef, this cliff happens at one year. This means that if you leave your job before you’ve worked for a whole year, none of your options will be vested. At the end of that year, you’ll vest the entire year’s worth of equity all at once. This helps keep the ownership of Clef stock to folks who have worked at the company for a meaningful amount of time.
When Clef raises money from outside investors, it needs to create new stock to sell those investors. You will own the same number of shares as you did before, but there will be more total shares of Clef available, so you will own a smaller percent of the company -- this is called dilution.
If we get a fair valuation for the company, then the value of your options stay the same when we raise outside money because the company’s new valuation will be equal to the old value of the company + the new capital raised. For example, if Clef is worth $20m and we raise $5m, we are now worth $25m. If you owned 5% of $20m before, you now own 4% of $25m (we sold 20% of the company, or, said differently, diluted you by 20%). The 5% stake was worth $1m before the fundraise and the 4% stake is now worth $1m.
You can also be diluted as we give equity to employees. Clef gives stock option grants to new employees out of an option pool, or a group of options that the Clef board of directors creates all at once. This means that you will not be diluted each time we hire a new employee, but only when we need to create a new option pool. Clef’s current option pool is intended to cover the first 10 hires (after the three founders) before it needs to be refreshed. For some high-level executive hires, the board might approve stock option grants outside of the equity pool. In both cases, the hope is that employees add more value to the company than the equity they receive.
Investor dilution won’t affect the value of your stock, but the valuation that we raise money at definitely will. Valuations (how much a company is worth) in private markets are highly unpredictable and subjective -- a share of Clef stock is worth whatever someone will pay for it. Competition between investors, general market performance, perceived future value, and our negotiation skills all play into that valuation and the value of your options will be affected by those forces.
Exercising Your Options
"Exercising your options" means buying the stock guaranteed by your options. You pay the exercise price that was set when the options were first granted and you get stock certificates back. You can only exercise stock that has vested, but you can do it at any time by filling out a form and paying the cash amount for the stock.
You will usually only want to exercise the stock when you have the opportunity to sell it for a higher price than you are buying it for or when it is expiring.
Your stock options expire 10 years after they were issued. You have 7 years to exercise your options after you stop working at Clef, but by law the options only count as ISOs for 90 days after you stop working. Once those 90 days are up, the options count as non-qualified stock options, so they count as income and are subject to income tax when you exercise them.
Traditionally, employers have made options expire quickly after employees stop working at the company because the company also has to pay tax on the options when they are non-qualified and considered income. However, this means that many cannot afford to exercise their options and so either a) leave the company and lose the equity they worked hard for or b) stay at the company until they can afford it (this situation is often referred to as "golden handcuffs"). At Clef, we want our employees to keep the equity they earn, and we don't want to keep anyone working here if they're not happy, so we give employees the option to exercise their options up to 7 years after they leave Clef.
However, there is a very significant increase in the tax burden of exercising options 90 days after leaving Clef that we cannot control. This means that while you have more options regarding your equity, you will lose a significant amount of your options' value if you wait. In weighing your different options, you should consult a tax attorney to help decide what path makes the most sense for you.
Exercise Prices and 409a Valuations
The exercise price is how much Clef stock was worth when you received the stock option grant. Figuring out the right number for this (one that keeps the IRS happy, but also helps make option grants valuable) is important. Investors in Clef get Preferred Stock with some special privileges (more on that below) so we don’t want to use the same valuation they paid to price your Common Stock.
The lower the exercise price for Common Stock, the more money your options will earn you, so it’s in our best interest to make this price really low. Traditionally, companies would divide the Preferred Stock price by 10 or more and use that price, but the IRS decided that was unfair, so now private companies are required to undergo something called a 409a valuation to determine the exercise price of our stock. The valuation is good for a whole year or until we raise more money. (We are currently in the process of getting our 409A Valuation)
Tax law is complex and you should consult a tax attorney who is familiar with startup stock options before making any decisions.
With Incentive Stock Options (ISOs), you aren’t taxed when you exercise your options, and the profit you make between the exercise price and the price you sell your stock for is taxed as capital gains (much lower than income tax). However, because you’re not paying income tax on this gain, this money is counted as a "tax preference" towards the Alternative Minimum Tax limit.
This changes if you exercise stock less than 2 years after the grant was made because then the options are automatically treated as Non-qualified Stock Options (NSOs) instead of Incentive Stock Options (ISOs). NSOs are treated much less favorably under tax law because they can be given to people who don’t work at Clef. This complicates the tax law and is beyond the current scope of this document.
Classes of Stock
When Clef raises outside capital, investors will buy a form of Preferred Stock that gives them special rights on top of their ownership of the business. Each subsequent round of funding will create a new class of stock with its own rights -- these are usually named by the rounds of funding (ex. Series A Preferred Stock, Series B Preferred Stock, etc.). Here are a few example rights that preferred stock may have.
Board seats: A class of Preferred Stock may elect, independent of the other shareholders, a certain number of board seats. For instance, the Series A Preferred Stock holders may be able to elect one person to Clef’s board of directors.
Liquidation preferences: In a liquidation event (Clef is sold or goes public), investors with liquidation preferences get paid back first. These favor the investor and lower the value of the stock. They usually cascade from the later rounds backwards, and can be a multiple of the money raised. For instance, if our Series A investors invested $5m with a 2x liquidation preference and Clef was bought, then $10m would go back to the Series A investors before anyone else got any money back. If Clef was sold for $10m or less, that would mean that everyone with common stock (founders and employees) would get nothing. If Clef sold for $15m, then $5m would be distributed among the common stockholders.
Outstanding Convertible Notes
Clef has raised $1,858,555 to date, all as convertible notes.
A convertible note is a popular way for startups to raise money because it lets us delay picking a valuation for a company. Instead of selling equity for a fixed price, we borrow the money as debt. Then, next time we raise money, that debt converts to equity at a discount. The discount rewards the initial investors for investing in the company early, and usually comes in 2 forms: a discount and a cap.
The discount is a fixed percentage (20% for Clef) that the investors will get when the debt is converted into equity. The cap is a maximum valuation that the first investors will have to pay for the stock. The debt converts to stock at whichever is lower: 80% of the price of the next round or the valuation cap.
For Clef’s fundraise:
$175,000 was raised on notes with a cap of $5m
$1,683,555 was raised on notes with a cap of $6m
Anyone is always welcome to ask B, our CEO, any questions they have about their options, Clef’s fundraising, or anything else related to equity at Clef. However, everyone should also consult a lawyer before making important financial decisions, especially regarding their equity because there are complex legal and tax requirements that may apply.