Gilt Groupe Is a Cautionary Tale for Startup Employees Banking on Stock Options

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A $250 million acquisition probably sounds like a lot to many employees of privately held companies. But for startups backed by big venture capitalist money, even a deal that big can be a financial bloodbath for employees.

Case in point: Re/code spoke to a half dozen former employees of flash sale site Gilt Groupe in the two weeks since its $250 million acquisition by Hudson's Bay Company was announced. And at least three of them lost more than $10,000 as a result of the deal.

The outcome is a stark reminder that buying shares in a startup you work for is often a riskier financial bet than it may seem, even at a company as hot as Gilt once was. The story of Gilt, which was once valued by investors at more than $1 billion, also serves as a cautionary tale for the 100-plus startups with valuations of $1 billion or more today: That number on paper can vanish in, essentially, a flash. Gilt spokeswoman Jennifer Miller, who is leaving the company in March, declined to comment.

By early last year, when Gilt raised a last-ditch $46 million investment, Gilt employees Re/code spoke to assumed the company's eventual outcome would be financially disappointing, but not as bad as it actually turned out.

Hudson's Bay is paying $2.17 for each common share of Gilt, according to documents Gilt provided to shareholders. About $1.71 is going to be paid up front, while the remainder is paid out over time because it is held in an escrow account in case of unforeseen liabilities on the part of the seller.

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Since its founding in 2007, Gilt has regularly awarded employees stock options when they are hired and sometimes when they are promoted. Stock options give the holders the right to purchase stock in the company in the future at a pre-determined price per share — called a strike price.

I spoke to employees who joined in 2009 and 2010, some only a little more than a year after Gilt was founded and when it still had fewer than 100 employees. While employees who joined prior to 2009 received a strike price that turned out to be below the $2.17-per-share sale price, all Gilt employees who joined in 2009 or later received a strike price that turned out to be more than the sale price.

For example, people who started working at Gilt in the first half of 2009 received options with a strike price of $2.24, according to documents. That strike price later rose to at least as high as $25 a share at the height of Gilt's growth and popularity.

Why does this matter? When these former employees left Gilt after several years, they had three months to decide whether or not they wanted to exercise their right to buy the stock. Some didn't, either because they didn't have the money or didn't trust the company was in a good spot.

But several former employees told me that it was common for peers and some managers to talk about this decision as a no-brainer in 2012 and 2013, though the company's senior leadership and HR group were careful never to express an opinion one way or the other.

"On a good sales day, managers on the business side would say things like, 'Your shares are going to get you a house someday,'" one former employee said.

This environment had an impact on several employees, who were dealing with stock options for the first time, and who chose to buy their shares at a strike price of $2.24 a pop or higher. While that may not have been an exorbitant sum for those who only held a few hundred shares, it was for many when you factor in taxes that had to be paid at the time.

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Employees typically pay taxes when they exercise their options, based on the difference between their strike price and the value of the stock at the time of their decision to exercise.

It's also likely that there were some more experienced employees who sold their shares years ago on the secondary market for a profit. Still, that's not any solace for the first-timers who didn't know any better and held onto the stock hoping for a good sale.

Since some Gilt employees Re/code spoke to left when the company was valued at as much as $25 a share, they recorded a profit on paper of more than $20 a share. This led to tax bills in the thousands, or tens of thousands for some employees, they said. Or as one put it, more than they spent on their house down payment. Some employees took out loans from friends to pay for their tax bill, others from banks.

All of these former employees requested anonymity for one of two reasons: They are embarrassed by what they see as their naivete in believing such an outcome wasn't possible, or they still work in the industry and fear retribution for speaking out on a topic that is currently a sore spot at Gilt.

Gilt, for its part, has tried at times to do right by its employees. Starting in 2011, the company began giving out restricted stock units to manager-level employees. Employees don't have to pay any per-share price to acquire these stock units, only stay employed at the company for a certain period of time to get them converted into actual shares.

CEO Michelle Peluso also worked to lower the strike price of stock twice since 2013, in an effort to make the stock more attractive to employees. However, the strike price was still around $7 as recently as a few months ago, according to sources.

Lastly, when the company raised $46 million in early 2015, its early investors had their shares converted from preferred shares to common shares, eliminating the protection they originally had that guaranteed they get their investment back in the event of a sale. Without this change, employees would have been left with considerably less money after Gilt's sale. Multiple sources said Peluso lobbied hard for this change. For some, it still wasn't enough.

CNBC's parent NBC Universal is an investor in Re/code's parent Revere Digital, and the companies have a content-sharing arrangement.