
How much startup stock options are worth - danshapiro
http://www.danshapiro.com/blog/2010/11/how-much-are-startup-options-worth/
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tptacek
This is a fabulous article and I only want to add a tiny little bit of
additional context:

* Exits north of $100MM are rare, and a $400MM exit is rare indeed; virtually any such exit will be from a famous company. Valuations are at least somehow tethered to sales, and companies that justify mid- 9-figure exits can usually consider IPO... as an example of how rare that event is.

* In most sectors of the industry there are rule-of-thumb valuations based on multiples on sales. An enterprise software company aiming for a $150MM acquisition is expecting 4-8x, and needs to be achieving 18MM (optimistically) to 40MM (conservatively) sales to do that. You can reconcile this estimate by asking for current sales, this year's "number" (in a well-run company, everyone knows the number), and then asking "what's going to happen to scale the number up".

* Last time I had to think pragmatically about VC, a round that took participating preferred shares (in which the VC takes their money off the table, _then_ takes their percentage off the table) was an indication of a weak round; if they're shooting for the moon, you're entitled to hold that against them.

* Finally, remember that _if you quit, the equation changes again_. When you leave, you can execute your vested options, but that costs money. Perhaps nobody in the company is less protected than _former employees_ : investors have contractual provisions to protect their money, and employees are given retention grants, but former employees can be written right out of the deal. I've seen it happen.

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lemming
Great comment, thanks.

 _former employees can be written right out of the deal_

Can you elaborate on this? How does this work? As a holder of a lot of common
stock in an increasingly VC-dominated company, this is interesting to me -
surely if I buy my shares, I have that proportion of the company with the same
rights as any other common stock holder? What about a "normal" acquisition
deal could change that?

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URSpider94
Key phrase: tyranny of the majority.

You can bet that the founders and VC's (or other institutional investors) own
a super-majority of the shares. Therefore, they can simply write the rules to
give themselves whatever they want. For even more fun, sub-groups of VC's can
team up to force out founders or other VC's.

One way this is typically done is to increase the share count by 10X, then
sell these new shares for 10 cents on the dollar to a sub-group of new
investors.

As an existing shareholder, you MAY have the right to buy into such a deal,
but only if you are a "qualified investor", meaning that you have substantial
liquid wealth. Otherwise, you'll be left sitting on the sidelines.

Even in a "normal" acquisition, the current shareholders will have to vote on
the deal, so it's not uncommon for the large shareholders to cut lucrative
side deals with the buyer that give them much more profit than the average
shareholder.

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danshapiro
One mistake in the above: the right to participate in future financing rounds
has nothing to do with qualified investor status, and everything to do with
whether your agreement guarantees it. Good CEOs will often make sure all their
investors are given a chance to participate (because it's the right thing to
do and reduces the chance of one class of lawsuits) but it's only a guarantee
if your documents say it is.

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tptacek
I was locked out of an investment round at one company because of
qualification status. I'm pretty sure being meeting the accredited investor
standard actually does matter, at least if you're not an employee and the
round involves an exchange of money for financial instruments.

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danshapiro
If your agreement had guaranteed you investment rights you would have had
them. Since it didn't, it was at their discretion, and they could have used
many different criteria to make that decision. Now as a general rule, when you
have an option in the matter, you don't want non-accredited investors in your
deal. But assuming that accredited status grants follow-on investment rights
(or that lack of them prevents it) as a rule is wrong.

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danshapiro
I didn't want to clog the article with an explanation of each of the
heuristics I provided, so here it is in the comments.

#1 is pretty self-explanatory.

#2 is the expected value, halved because an awesome startup with every chance
of success still fails half the time. If you're swinging for the fences
(shooting for IPO), you're way more likely to either fail or get so much
preference ahead of the common that you never see anything.

#3 is because everyone underestimates the amount they'll need to raise.

#5 The huge penalty is for two reasons. One, because it's tremendously bad for
the common. Two, because it often means something worse: the company's up
against a wall, the CEO's a bad negotiator, everyone's expecting the common to
be worthless so they have to make it up in preferences, etc.

#6 Again, the direct impact isn't as bad as this makes it out to be, but a CEO
who does a good job negotiating preferences is a leading indicator of other
good things: s/he knows how to generate demand for the company, has leverage,
knows how to squeeze every ounce out of a deal, etc. This is basically a proxy
for if the CEO will do well during negotiations to sell the company.

#7 A common-dominated board will tend towards common-friendly exits, and
indicates a CEO who does well in negotiations. Again, this is all guesswork,
particularly trying to figure out the all important "will the CEO do a good
job selling the company" factor. But I think it's a decent swag.

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abeppu
Does anyone have any advice on how you're supposed to tactfully get all the
info required to do this computation?

During my recent job search, I received offers with options from companies who
refused to tell me what the count of fully diluted shares was. No one was
particularly comfortable answering questions about expected exit. When I tried
to ask various questions to estimate some kind of ballpark value for the
equity being offered, one company took this as a signal that I wasn't
sufficiently enthusiastic about the offer or optimistic about their chances
for success. They then started saying things like "We want to hire someone
who's really excited to join our team..."

Ultimately the I had to use the "assume the options are worthless" stance, but
then, with cash compensation being the only consideration, I ended up
accepting an offer with a significantly more mature company.

How are you supposed to get this information while not giving the prospective
employer the impression that you're either (a) too skeptical of the company's
prospects or (b) too motivated by the money?

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mikebo
If they won't even tell you the # of fully diluted shares, I'd run away fast.
Sounds like you made the right move.

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tptacek
I might not _run_ (this is unfortunately a common practice), but I would be
explicit in negotiation that you value an options grant without that
information at $0.00. You can say that politely, or even apologetically, but
make it clear that you'd give some flexibility on salary or paid vacation days
in exchange for more information ( _don't_ be specific about this though).

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donaldc
_make it clear that you'd give some flexibility on salary or paid vacation
days in exchange for more information_

I disagree. You shouldn't trade anything for the information. A company should
make the information available if they want the value of the options to be
considered greater than $0. You are _already_ considering trading some salary
for the options, but the onus is on the offering company to make enough
information available to convince you that the options are worth it.

~~~
tptacek
Your argument is principled but not very pragmatic.

When a potential employer gives you anything they consider "significant"
equity (ie, worth mentioning as a major part of your comp plan), they are
implicitly discounting your salary to make up for it. If you accept their
offer, you have _given_ them salary flexibility without receiving
consideration.

In reality, information is very much something that negotiating parties
exchange. But, I agree that you should reasonably expect enough information to
value your equity if equity is a major part of your comp. All I'm _really_
saying is, make it clear to your counterparty that the lack of information
about your equity is raising your negotiating floor. Which, logically, it
must.

But I am also specifically _not_ saying, "offer 5k off your salary in exchange
for valuation information".

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ax0n
I generally assume they're worth exactly zero million dollars a piece, because
that's what they're actually worth. A few places I've been have tried to pass
off this whole "half your salary in stock options" rubbish while still giving
me an acceptable wage in real money. This put a phantom value on stock
options. At best, they're an exit bonus, which is an incentive to do your best
to make your company thrive. It gives you a token that could be worth real
money if everyone pulls together.

Don't expect anything from stock options.

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yoak
I really appreciate this article. Unimaginably, most programmers I interview
to this day in late 2010, react primarily to number of shares an offer
includes option to buy. I've written offers with (made up numbers) option to
purchase 10,000 shares at a strike price of $0.10 and had candidates, asking
no questions, attempt to negotiate for 20,000 shares which is something that
they'd be more comfortable with.

In my admittedly limited experience, just realizing that there are a number of
shares out there (fully diluted or not!) and that this grant translates to a
percentage of the company and that the strike price implies a valuation is
beyond a solid majority of people I've seen receive stock option grants.
Articles like this one are certainly needed to improve education on these
matters.

~~~
kevinpet
I don't see what's so horrible about that. By the time you get to the offer,
you have an idea of the current valuation of the company. The price * options
= $1000 already tells you if the company can grow 25x, you'll make on the
order of $25k.

Or maybe you're just saying who the hell bothers to negotiate over $1000 over
4 years. I guess that's a valid point.

~~~
yoak
As the other commenter pointed out, that's not my point. If I issue a billion
shares and offer you stock options at a $0.10 strike price you can't really
expect the company to grow that 25x . It's an entirely different matter if
there are 50,000 shares.

You may be assuming that the strike price is fairly pegged at a real value of
the company and thus you can make assumptions about real growth of the company
in terms of multiple. Short of public markets, this is always a questionable
assumption, but in the case of new startups it is almost completely arbitrary.
When you start a new one, there is no reason to differentiate between choices
in the number of shares varying by a factor of 10,000x or more, and strike
prices are almost as flexible.

Perhaps the best reason to pick any number is to pick a large one because of
the (irrational) psychological impact that your large absolute number of
shares will have in option grants.

I suppose this emerges out of people's naive appreciation of public markets.
Smaller companies often have stock prices in the teens. Mature, stable
companies tend to hold prices closer to a hundred. Blockbusters like Google go
to 400! Etc. These prices are managed with splits and have little to do with
the return captured by owners of the stock, but people looking at it from the
outside sometimes miss this. That's why I appreciated the article so much. It
goes beyond these simple matters.

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jcdreads
I'm at a startup (that I otherwise like) where the CEO refuses to disclose the
total number of outstanding shares. You can bet that I compute the expectation
value of my options to be exactly zero.

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gamble
Employees should consider their options to have an expected value of $0. (With
a not insignificant variance...)

There are so many ways things can fail to pan out or you can get screwed, and
employees simply can't protect themselves in the way an investor or founder
can. If significant participation in an exit is important to you, the only
logical option is to be a founder yourself. Trying to get a payoff as an
employee is little better than gambling.

My rule of thumb is that if the options influence your behavior at all, you're
over-valuing them.

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cageface
In the first .com boom I worked for a company that had a 60 million funding
round. By the time I left I decided not to bother exercising my options for
pennies a share. The company never went public. None of the many people I knew
working for startups at the time saw a dime of profit from their options
either.

The stock I got from the much larger, already public company I worked for next
turned out to be worth a nice chunk of change though.

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URSpider94
What you REALLY want to know are things that you're not likely to find out in
your offer:

* How does your share allocation compare to your peers, superiors and subordinates? In other words, are you getting an equitable share in the company for your position?

* What is the board's strategy for maintaining employee ownership in the face of dilution? Regardless of what you start with, it can be made irrelevant as the number of outstanding shares goes up in future financing rounds. It is natural to expect your ownership share to go down over time as the company grows, but additional share grants can mitigate that effect.

~~~
tptacek
It is simply irrational to value an offer of employment relative to what
existing employees received.

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stefanweitz
When people ask me this, I always run away crying. Finally I can point them
somewhere.

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tungwaiyip
With all due respect on this formula, it is only one instance of many
possibities. There are numerous assumption being made. The range of outcome
can easily be 10x different (with the mode being 0 obviously).

Could it gives a more reprentative picture if we can do a survey on successful
exit? Something like glassdoor.com?

Also i've heard really good story happened to the talents in talent
acquisition situations. I wonder if the number can turn out better in those
cases, especially for non-founder and non-exec.

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jlgosse
The frustrating thing about this is that you rarely ever hear about early
employees getting filthy rich, even in HUGE companies.

This is why starting your own company and going for broke seems much more
appealing, as having 10-20x what your first employees might have is really a
game changer. Couple this with the fact that many first employees may end up
doing much more work than the founders, and things can get really perplexing.

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jaekwon
This could be a course for high school students -- like a 1 semester AP
course. Understanding stock to me is like a multidisciplinary life skill.

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hanula
Sometimes it's not worth to work for stock options.
<http://www.youtube.com/watch?v=hyM3HVdH1Kw>

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TheIronYuppie
Love the simple equation - really calls into clarity what is a very fuzzy
subject.

