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Seed equity is a great retirement plan, if you can pull it off

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Nearly two years ago, Trevor Ford quit a job at LendingTree that gave him a 401(k) plan and a generous employer match to work at Yotta, an online banking app.

When Mr. Ford started working there, Yotta, like many start-ups, did not offer 401(k) plans to its employees. Instead, Mr. Ford received equity compensation in the form of incentive stock options, which give him the right to buy company stock at a discount. He believes owning stocks early on offers a better opportunity to accumulate wealth than an employer-sponsored 401(k) plan with matching contributions.

“The net worth could be well into the seven figures, hopefully, and maybe more,” said Mr. Ford, who is 33 and lives in Austin, Texas. “That’s more than enough to retire.” But Mr. Ford’s equity will only have value if Yotta becomes a successful public company. (Yotta recently gave employees access to a 401(k) but doesn’t match their contributions; Mr. Ford makes a small contribution.)

Swapping a job at a company with a traditional 401(k) plan for a job at a startup that offers equity gives employees a rare opportunity to receive a large payout at a young age. Although the potential gain may be far greater than that of a traditional pension plan, equity is worth nothing until someone buys it or the company goes public.

“In terms of building wealth, investing in a 401(k) is like running a marathon, whereas investing in equity in a business is like running a sprint,” said Jake Northrup, certified financial planner at Experience your heritage in Bristol, RI, which specializes in helping millennials manage their equity compensation. “If a start-up hits a home run, you may be able to achieve financial independence at a very young age with your company’s equity,” Northrup added. He estimates that about 20% of his clients have received some sort of equity payment.

Mr. Ford is betting on equity in part because he watched his friend Andy Josuweit, founder and managing director of Student Loan Hero, receive a huge payout when LendingTree acquired the startup for $60 million in cash in 2018. “At 31, he walked away with a life-changing sum of money,” Mr Ford said.

Not all start-ups are successful, of course. A analysis conducted this year by CB Insights, a company that studies venture capital and start-ups, found that 70% of start-ups fail.

“You have to keep in mind that it might not work,” said Chris Chen, certified financial planner at Insight Financial Strategists in Lincoln, Mass. “When you’re in your 20s or 30s working in a start-up, time seems endless, but at some point you’ll have to retire,” Chen said.

Annie Fennewald was one of the first dozen employees at a fast-growing technology company in Missouri, and she worked there for almost seven years. In May, after selling her shares through a private equity sale, Ms Fennewald, 44, was able to retire about eight years earlier than she had planned.

Although she received a seven-figure payout, Ms Fennewald said she was not relying on her equity as her only retirement plan.

“I’ve always treated stocks like a lottery ticket,” she said. “It could be valuable, but I haven’t really staked my retirement on it.” When the company started offering a 401(k) plan four years ago, it paid out the maximum amount. Often, as start-ups move out of seed funding and reach 50 or more employees, they offer a 401(k).

But not everyone is able to sell their shares.

Danielle Harrison, a certified financial planner in Columbia, Mo., has a client who wants to retire but is waiting for her business to go public so she can raise nearly $2 million in equity. “It’s hard to completely depend on something like this,” said Ms Harrison, owner of Harrison Financial Planning.

If you’re a start-up employee and are considering forgoing a more traditional path of retirement savings in favor of equity, here’s what you need to know.

Stock-paid employees typically receive several thousand shares that they can purchase at a discounted price before the company goes public. If they leave the company, they usually have 90 days to purchase their options. For example, one of Mr. Northrup’s clients worked at a start-up company and had 65,000 stock options which were granted at 13 cents per share. His client paid $8,450 to exercise these options.

Shares in the company are now valued at more than $25, making those shares worth $1,625,000, whether the company makes an initial public offering or is acquired, Mr. Northrup said.

“The option you have when you leave is to buy the equity and hope that at some point something will happen,” said Jessica Little, 32. She and her husband, Matt Little, 40, worked on several early starts. -ups and usually buy their shares when they leave. This investment has paid off many times over, Ms Little said.

However, exercising stocks and buying stocks is not without risk. There is no guarantee that you will ever see this money again or that you will receive any gain from your investment, and the value of the stock may fluctuate.

The exercise of options also has tax consequences. “One of the reasons people don’t exercise their options is that it could cost millions of dollars in taxes,” said Jordan Gonen, co-founder and chief executive of Compound, a wealth management platform that helps people with equity manage their long-term financial health. These taxes must be paid even before the income from the investment is realized, Mr. Gonen said.

The need to have money to buy stock options and pay taxes on that purchase is why many people who work in start-ups are reluctant to tie up their money in vehicles. traditional retirement funds such as a 401(k) or a Roth IRA – neither. which can be fully accessed without penalties until later in life, Mr. Northrup said.

The mistake some people make is to become so attached to the company they work for and its stock that they don’t want to give up their capital, fearing they’ll miss a big payment, Chen said. “When you have equity and your salary is tied to the same company, you already have too many eggs in one basket,” Ms. Fennewald said. For some, this concern has taken on new urgency, given the recent plunge in start-up sales and IPOs, which fell more than 80% in the first half of this year, according to figures released this week. .

Both Mr. Chen and Ms. Harrison recommend saving money in multiple accounts, including a Roth IRA and a health savings account.

Many start-ups have high-deductible healthcare plans, so opening an HSA is a great way to have a triple tax advantage, Ms. Harrison said. The money is paid into the account tax-free. Money held there is not taxed, and when you withdraw money to pay for a health care expense, it is also not taxed.

Once employees have maxed out a Roth IRA and HSA, Mr. Chen and Ms. Harrison recommend that they open a taxable brokerage account that allows them to invest in stocks and bonds.

“If you are young and 20 to 30 years old before you need this money, you can invest in the stock market,” Chen said. A brokerage account might be a better investment plan if you’re young, he said, because if you take money out of a 401(k) or Roth IRA before the age of 59.5 years, it will be taxed as income (with some exceptions). But if you put money in an S&P 500 index fund and withdraw the money after a year or more, it will be taxed as capital gains, which at a rate of 15% is generally lower. at the income tax rate, he said. .

Mr. Ford worked at Student Loan Hero when it was acquired in 2018, and because he had equity, he received almost $200,000. After paying off his student loans and opening a Roth IRA, he opened a brokerage account.

After Ms Little and her husband used some of their capital to pay off student loans, they spent the rest buying property, including a lakeside house in Maine. “We see it as a retirement investment that we actively benefit from today,” said Ms Little, who is chief of staff at To catch, an app that helps users save for retirement by depositing a percentage of their earnings into an IRA “The return on these investments will be much more valuable in the long run than if we had funds wrapped up in a 401(k)”, said Ms. Little said. Her husband also works at Catch, and both contribute to 401(k) Catch offerings — although they don’t want to put all their money into it until retirement.

“Most young people don’t think about retirement or benefits the way their parents and grandparents did,” Ms Little said. Mr Ford admitted he doesn’t often think about retirement and neither do most of the people he interviews for jobs at Yotta. “Retirement benefits are not a deciding factor,” he said.