Should You Accept Stock Compensation from Startup Businesses?

Almost all entrepreneurs that discuss their business plans with their friends and family will hear all about the risks involved with starting up a new business.  Most successful entrepreneurs will take this to heart and will take any steps necessary to help them reduce their risks.  Then, there are the entrepreneurs out there that simply say “bring it on.”  Most startup entrepreneurs are leaving behind their full time jobs to get away from the confinement of the office.  Some people are prepared for this, while others may not be.

If you are considering loaning services or money to a startup company, you may find that you will not get any form of cash repayment anytime in the near future.  Take a look at why this is the case.

Investors usually don’t want to put their money into something that is just paying off existing liabilities.  They would much rather put money into projects that will bring more to the value of a business, thus bringing them a return on their investment.  Some of the expenses that they like to invest in would include product development, patents, and marketing endeavors.  Investors will like to see that the owners of a business, as well as the employees, are putting themselves into the company as well.

Investors that invest in businesses that are just starting up will usually force the debts that are due to the founders of the company or the employees.  They do tend to make exceptions from time to time, but that doesn’t happen very often.  Another problem is the fact that they will be earning income for services from the business, and even though they are not going to see the money right then they are still held liable for the taxes on the money.  So, if you receive stock compensation, you may find yourself out of pocket when it comes tax time.  Most people call this phantom income taxation.

Most employees that work for a startup business will get compensation from stock options instead of just common stock.  Stock options are usually priced at the current market value, and the taxes can be delayed.  Stock options can also have other advantages, including tax breaks.

With all this in mind, there can sometimes be a few potholes along the way.  The biggest risk that startup company employees have is the fact that stock options can sometimes expire before they are able to get the cash for them.  This is why most employees will want to make sure that they negotiate long terms when it comes to receiving stock options.  It is good to consider a term of 5 or 10 years instead of a shorter term of 2 or 4 years.

The amount of stock that you should request will be based on the amount of work required when it comes to starting up the business.  You will want to make sure that helping with the startup of a business is not going to drag you down financially.