One roadblock, I think, is that the IRS requires 409(a) valuations every year to set a value for common stocks and thus the strike price for options. During those valuations, most startups strive to paint their value as being very low: “Seriously, folks, the market could dry up and leave common shareholders with nothing.” The resulting common share value is often pegged at 1/10 to 1/3 of the preferred share value implied by the most frequent fundraising round. Lower strike prices make it easier for employees to exercise their options and provide more upside.
My understanding is that a sufficient volume of equity sales can force new 409(a) valuations. These would require more payments to an external accounting firm, and 4x the work to do it quarterly, work that often consumes leadership cycles. Moreover, these valuations would likely have the effect of narrowing the gap between common and preferred share values, elevating the strike price and squeezing potential profits out of employee equity.
It’s probably different once a company is large enough that it’s granting RSUs. For companies at the ISO stage, I’m not sure the upsides outweigh the downsides.
My understanding is that a sufficient volume of equity sales can force new 409(a) valuations. These would require more payments to an external accounting firm, and 4x the work to do it quarterly, work that often consumes leadership cycles. Moreover, these valuations would likely have the effect of narrowing the gap between common and preferred share values, elevating the strike price and squeezing potential profits out of employee equity.
It’s probably different once a company is large enough that it’s granting RSUs. For companies at the ISO stage, I’m not sure the upsides outweigh the downsides.