
Do the math on your stock options - jackgavigan
http://jvns.ca/blog/2015/12/30/do-the-math-on-your-stock-options/
======
jvns
I'm really interested in other people's experiences with understanding how
their stock options work.

It seems really easy to misunderstand something serious, even if you know
quite a lot about equity.

~~~
millstone
I got an offer from a late-stage (not sure if that's the right term, but they
had a shipping product) non-public startup that included 10,000 stock options.
That sounded like a lot, but I had problems evaluating that number without
knowing the shares outstanding. I asked for that figure, and was told it was
privileged and confidential.

I decided to value the options at $0, and instead think of them like a non-
monetary perk: "free lotto ticket Wednesday". I ended up turning down the
offer.

Was that experience normal? Did I have a right to know the shares outstanding?

~~~
Gibbon1
If they told you that the number of outstanding shares was privileged and
confidential they are crooks in nice suits.

Also at this point in time there is so much shady stuff going on with options
that you should always always value options at zero. Frankly if all you are
offering is your labor in return for options you don't have the pull to get a
particularly good deal. (Example: Friend worked three years at a startup.
Friend is smart. Friend got ~$50,000... whoop dee doo dah day)

Only other advice I have is, if you are considering exercising any stock
options you need to talk with a tax accountant before you pull the trigger. No
exceptions.

~~~
jackgavigan
_> If they told you that the number of outstanding shares was privileged and
confidential they are crooks in nice suits._

Never attribute to malice that which is adequately explained by stupidity.

Getting a seed round doesn't magically confer the founders/C*Os with an
comprehensive understanding of how company equity works. Or common sense.

~~~
lazaroclapp
In all fairness, anyone who doesn't get that the expression c/x where c is
known and x is unknown can match any given rational number - or the
implication that this makes c convey zero information - is pretty much
definitionally unfit for running a tech company. So malice might actually be
the charitable explanation here.

I mean, imagine if someone followed the same practice for the salary part of
compensation: "We will pay you money!" "Eh... how much?" "Some. The actual
number is privileged and confidential."

~~~
brianwawok
^^ At least in that case you would see in 2 weeks what your actual salary is
;)

~~~
Namrog84
Oh but this company pays annually and you got hired in January. Sorry ;)

~~~
bkeroack
There's a vesting cliff so you only get 25% of your salary the first year.

------
AndrewKemendo
Options are for suckers.

Do you want to be an investor? No? then why would you pay for stock out of
your own money?

At our startup everyone gets the same stock, not options, through our Equity
Incentive Plan. Here's how it works.

1\. We lend new employees the amount of money it would take to buy common
stock on a non-recourse promissory note the collateral in this case is the
stock itself.

2\. The employee then buys the shares from the company with the loan.

3\. The employee then files an 83b election so that when it comes time to cash
out, they only pay taxes at the strike price of when the shares were bought.

4\. At a liquidity event, the promissory note goes away and they own the
shares outright

5\. They only pay taxes when they sell their shares not when they buy them

Now there are other provisions like if they want to sell prior to a liquidity
event, we get rights to buy them back first if we choose to - in which case we
just write off whatever the unvested portion from the note and take those
shares back.

In the end it gives the employee actual rights to the same class of stock as
the founders, so we can't fudge our employees out of stock benefits without
hurting our own shares. This also prevents them for having to lay out any
money until there is an actual no kidding liquidity event, so they take no
risk of paying taxes on something which might be worthless. Even then they
will only ever have to pay taxes on the shares, the promissory note goes away,
so in effect looks like a equity grant at the time of sale.

~~~
relkor
This is exactly what I was looking for. As a first time founder at a small
private business I was looking for a nicer way to compensate the employees
other than sticking them with a huge tax bill as thanks for our success.

Has this approach held up in court or survived an audit? Do you actually
transfer the money to the employee's account? How do how do you prevent them
from having a program to immediately wire the money to Zurich and run off,
given that you have a non-recourse note for the stock that never got
purchased?

[edit] I say small business because we do not yet have the 10-15% weekly
growth required to be called a startup. Until you are expanding like a airbag,
you are just fooling yourself that you matter by calling your company a
startup.

~~~
AndrewKemendo
>Has this approach held up in court or survived an audit?

Yes, it's actually a very old way to do things that fell out of favor in the
80s in favor of options. This way of doing it is more complex and more risk
for the employer, so it makes no sense to do it over options if your goal is
to just give tokens to employees.

>Do you actually transfer the money to the employee's account?

No, it's all papered

------
JumpCrisscross
Always ask for:

1\. TRANSFERABILITY. If you are given options to buy privately-held common
stock in lieu of compensation, you must demand transferability. Rights of
first refusal (ROFRs) are fine. "Board approval" is not. "Board approval"
means "you may not sell your shares until we go public, except to us, if and
when we feel like it, and at a price we get to unilaterally decide".

2\. CASHLESS EXERCISABILITY. Always ask for cashless exercisability. In the
public market, if you ask your broker to "cashlessly exercise" in-the-money
options, here is what happens. First, your broker lends you the money to
exercise the options. Then, the broker sells some of the resulting stock.
Finally, the broker pays herself back, plus a pre-disclosed fee, and returns
the rest to you.

This also works with private stock. (Unless you forgot Rule No. 1; if your
shares aren't transferable you've already been screwed.) But you may not
require a broker. Some companies allow for direct cashless exercise. Suppose
you hold options for 100 shares struck at $100 per share. You need $10,000 to
exercise. The company figures its stock's "fair market value" is $110. You
check with outside sources, _e.g._ a private-stock broker, and conclude this
is not much less than what you could sell your stock for in the market. Your
stock is worth $11,000 to the company; it is $1,000 in the money. After
cashlessly exercising with the company you would get $1,000 of stock, _i.e._ 9
shares. (Fractions of shares are usually lopped off in these calculations.)

Plus: you got shares without putting up capital. Minus: you lost the upside
(and downside) on ninety-one shares. That said, 9 shares is better than 0
because you had no capital to exercise upon termination.

~~~
inthewoods
I've never seen the ability to customize these kind of things because they
generally are, in my experience, part of the core options agreement for the
entire company and would require BoD approval. Thus, you're asking a lot -
works if your a key employee but probably not for the average employee. Would
love to hear if people have been able to get these terms.

~~~
mpdehaan2
Righto, and asking a lot of demands/questions means the company is not going
to like you as much and will influence your relationship after the offer is
accepted. The info you get will be standard and there is certain info they are
not going to want to share.

Basically a casual ask for "can you share how many options are outstanding?"
is about as good as you are going to get. Totally good. Non-stand demands? Not
so good.

If the VC has preferential shares (they do) just realize that's ok - and
probably fair. Don't join the company if you don't think it can exit above
it's funding amounts if you are in for the stock - but hopefully you're in it
because you really will love the position and the stock is just a bonus if it
makes it.

That's the most important thing :) You don't want to be in a job you don't
like just because it's profitable IMHO.

~~~
pc86
There is absolutely no reason not to disclose the number of outstanding
shares. Failure to do so means the denominator in the equation can be
anything. One or one billion. At that point you have to value the entire
option nonsense at $0 total, or even negative given the tax implications. It
takes all the truth out of the statement "our cash compensation is below
market because of our generous option grants." If I can't figure out the
monetary value of the options at the given strike price, I have no way of
knowing if they're generous or not.

~~~
mpdehaan2
Reasons exist.... One reason is likely that they want to keep the valuation
confidential outside of the company (people talk), because as a private
company that information doesn't have to be public. It's not a great reason
for the employees - but it's there, nonetheless.

It's tricky to share that with employees and not have it get out.

That being said, if it were all public, I think that would be fine, I'm not
sure what results that would cause if every company did that, and it might be
cool if every company were required to by law (hint, hint, congress!).

~~~
s73v3r
"Reasons exist"

And absolutely none of them are valid. If you're going to have this person
work on the core of your company, there is absolutely no reason to not be up
front with them.

~~~
mpdehaan2
It's quite valid and exists as a reason, you just don't agree with it :)

~~~
s73v3r
No, it's not valid. The only reason it would be done is for deceitful reasons.
Therefore, not valid.

~~~
mpdehaan2
Keeping it private here means private from external companies that should not
have access to that data, not employees. This includes competitors, M&A
targets, and investors who have not yet invested and should not have access to
the books.

I do however strongly believe in tempering expectations, it's wrong to try to
retain people by thinking they have more than they do.

------
encoderer
Stories of equity working out well are rare in these comments. I think in part
this is because contentment is silent, so I'll share a bit. I joined a private
company with over $100M in revenue about 3 months before IPO. They couldn't
say they were in the process when I took the job, but it was hinted at
strongly. I got an options grant with normal 4 year vest that amounted to an
actual face value of about $50k. Being successful, I imagined they could be
worth $100k, or a $25k/year bonus on top of my salary. All of my actual
negotiation was of the salary component, and I was very happy with the
outcome.

The company went public, and the following year there were a couple events --
a nice earnings beat, some positive news, etc -- that pushed the stock up.
Around that time I hit my 1 year cliff so I had 25% of my grant vested. I sold
every vested share and used that as a down payment on a house in the bay area.
I had a very large tax bill the following year that I paid by selling a bit
more equity. But, I have a house that has appreciated since I purchased it,
not to mention a nice place to live.

In year 2 I started receiving add'l RSU grants, and I usually sell them as
they vest. Here's the test: If they gave you a cash bonus would you BUY stock?
If not, sell it.

In the end, my initial option grant will end up worth $300-400k, adding almost
an entire extra salary to our household income.

We've been fortunate, have given back a lot to charity and especially to
family. Oh, and I've truly enjoyed working there.

What I've learned is that there is a probability curve. I chose an offer that
had a high liklihood of buying me a down payment on a house but zero chance of
buying me a whole house. In the end, this is a pattern I would repeat and I
think if you can do go work for Uber, Pinterest, Airbnb, etc, where an IPO is
very likely, go do it.

~~~
tariqr
thanks for sharing! :)

------
geertj
In my experience and understanding, investors (almost) always get preferred
shares with a liquidation preference. So unless you know what the preferences
are, any such calculations are completely bogus. But even if you know them
(and note that full cap tables are not commonly shared with employees in my
experience) such calculations are still mostly bogus, because:

* You don't know what the preferences of future rounds will be. Your founders may say that they will never go above 1x or whatever, but the company may enter difficult waters and be forced to accept less beneficial terms.

* If you hold common shares in the presence of preferred shares with a liquidation preference, the payout function at acquisition/IPO will depend non-linearly on the selling price. There are steps and there will be a price below you will be 100% wiped out. So the incentives are not aligned. Preferred normally has all the voting rights, and for them 5% more or less on the acquisition price might not be a deal breaker. For for the common, 5% may be the difference between a nice down payment on a home or a 100% wipe out.

Based on this I would always negotiate a market rate salary at a startup
company and value the options at $0, with 4 exceptions:

* You're offered to be a co-founder or one of the very first employee (< 3), with significant (~5%) equity. This is a risk that I personally might take.

* You're joining a late stage company and based on your industry knowledge you expect the company will do a successful IPO within 12 months. In essence you become a late stage investor in this scenario and your investment is your time.

* You're not in it for the money but instead want to change the world (and you don't mind someone else will make money based on your work if successful). For me personally a company like SpaceX could be in this category.

* You "trust" the founders to have your back and make sure your efforts will be rewarded whatever happens. This is a thin justification, but I could imagine doing it if you have been in business with the same team of founders for multiple times already.

------
corford
If you're being offered options in an early stage startup you need to ask at a
minimum (and any half decent founder should answer):

1\. How many shares of the same class are in circulation

2\. What is the price per share at current company valuation

3\. How many shares of other classes are in circulation and whether these come
with liquidation preferences

4\. If you will be required to exercise your options in the event of leaving
the company and, if yes, how long you have to do it

5\. If you have the right to transfer your options (and later shares) to a
third party. Unusual to have this right (unless you're transferring to
immediate family) but good to know if you do have it.

6\. Ask to see a copy of the company's articles and/or shareholder agreement
(to check how voting rights work, tag along & drag along rights, entitlement
to quarterly management accounts, right to first refusal, what power the board
has on deciding sales/transfers etc.)

That's in addition to being very clear on what the vesting terms are (assuming
you are not being given all your options in one go).

------
fiachamp
There actually IS a way to exercise after you leave without laying out cash +
tax dollars today. Consider esofund.com, its a fund that will pay your
exercise price and tax liability for a proportion of your upside in a good
financial outcome. If it doesn't work out, well at least you didn't throw away
your own cash. They're basically a vc that takes common stock in companies by
getting rights to employee shares.

~~~
rpedela
Only possible if you are able to sell your private shares without a
liquidation event (IPO, acquisition) which is often not the case.

~~~
steven2012
Not true. They don't own the shares, but you owe them a percentage of the
upside, plus the money you borrowed to exercise and pay taxes. Not a bad deal
if you're talking about a huge amount of money, and if you were in a
questionable company like Square, etc.

------
inthewoods
Great thread here and the original article has some excellent points.

I recently left a company and explored executing my options via a vehicle
called ESO Fund (www.esofund.com). In the end I did not use them for different
reasons, but their offer was reasonable.

Two general comments on stock options: \- Remember that bad things happen in
companies in raising money. Your company could raise another round after
you've executed your shares, and in addition to the dilution, you could also
have an onerous term in that round - like a 2 or 3x liquidation preference -
that will mean you are very, very unlikely to see any money.

\- Remember that companies don't have to have a liquidation event. I executed
shares in a company I worked for in 2006. That tied up money in the company -
and then nothing happened with the company for the last 9 years until this
year I got a buy out offer on my shares at about 50% higher than I paid.
Sounds great, except if you consider time. 50% return over a period of 9 years
is certainly not a fail, but it also isn't a big win over putting that money
into the general stock market.

~~~
finance-geek
Seems like almost a total fail for me...50% over 9 years is about 5.5% return
a year for a VERY risky asset. Something that risky warrants more. Also
curious if that 50% return considers the upfront outlay, taxes upon grant,
capital gains taxes, and the works...

~~~
inthewoods
It's 50% on top of initial investment and net of capital gains. But you're
right - it's more or less a total fail. It was a small amount of stock, but
right after I sold it I realized I probably should have just held it to see if
they went public.

------
chubot
It definitely seems like a bug that it's so difficult to realize any benefit
until the company goes public, and when that happens -- if it happens at all
-- is under the sole discretion of management. I guess there is a reason
they're called golden handcuffs.

This problem was described well here:

[http://blog.samaltman.com/employee-
equity](http://blog.samaltman.com/employee-equity)

and there are some interesting solutions. I wonder if any companies have taken
this advice in the 20 months since it was given.

------
Teodolfo
I'm surprised people don't take the time to figure out what the options
actually mean and negotiate some of the terms. When I have negotiated with
startups I have paid for legal advice to help me figure out what language I
needed in the option agreement (for example, a pinterest-style clause that
prevents me from having to exercise within 3 months of leaving) and negotiated
for the terms I felt were important. Just because the agreement is written to
give you ISOs doesn't mean they will qualify for ISO tax treatment when you
eventually exercise, so it is better to let you give up ISO treatment and
convert to NSOs in order to avoid having to effectively forfeit vested options
upon departure from the firm or face massive tax consequences. The pinterest-
style structure should be standard.

~~~
ap22213
Just curious, how difficult was it for you to find a qualified attorney, and
how much did you spend? (I tried this approach once, but the legal advice was
low quality and very basic.)

~~~
gkop
A friend referred me to an attorney at a well-known SV firm. She gave me a
free consultation back and forth over email. By my own judgement as well as
that of the founders and attorneys of my new company, the advice was good. It
covered both my negotiation with the company as well as my personal tax
planning and accounted for various possible outcomes. Following the advice, I
learned more of the nitty gritty financial details of the company, got a
calculated split of ISOs and NSOs (to early exercise), and also a decent cash
bonus.

------
drglitch
I am considering an offer from an early stage startup. Salary is being dragged
down ~40% under market due to stock options. The role is being a 'first key
engineer' hire after the three co-founders. What kind of common-stock equity
offer is 'average' in this case? 1%? 2%? 5%?

~~~
ryanSrich
In my experience it's never a good idea to take a pay cut in lue of equity.
Taking a pay cut because you like the product, the role, etc. are infinity
better reasons than equity.

In my opinion a 40% pay cut and being one of the first 5 engineers warrants
co-founder status.

~~~
Ixiaus
It does not warrant cofounder status at all. So much more goes into being a
cofounder than simply being one of the first x employees.

~~~
ryanSrich
Well when someone is offered a 'key' engineering role it's basically a fancy
way of saying 'you'll be building pretty much everything'. Couple that with
the fact that it requires a 40% pay cut and you've got a situation that
definitely warrants co-founder status.

~~~
Ixiaus
Most founders go with no pay for quite some time. You can still be a co-
founder and receive pay but being a co-founder conveys far more risk and
responsibility than being one of the first x employees in the company. Even if
you happen to be the person "building pretty much everything", it still does
not justify being a co-founder.

If you wish to be a co-founder, you typically have to be willing to take more
than 40% pay cut for much longer. You must be willing to defer your paycheck
so that your other employees (who are usually on a paycut too) can get paid if
funds get tight - this is even expected of most C _O employees in the company
but the first ones to go are always the founder 's. You are usually involved
in most fundraising activity _in addition to your other duties, whatever they
may be* and customer support early on.

The list is quite long, I was once a highly entitled "engineer" until I built
a few of my own companies. The dynamics are so much more complicated and
tailored to each individual situation that it's disingenuous to lay out
blanket statements the way most people in these comment threads have been
doing.

Being a founder is brutal.

I'm not saying key engineers aren't entitled to good or fair treatment or that
it is impossible to become a co-founder if you're #3 or #4 or #5, but I do not
believe you're entitled to _founder_ status just because you're an early hire.
Sometimes it can happen that way if you choose to take on those
responsibilities and risk and negotiate that dynamic with the other founders -
setting up achievement milestones and what-not.

Similarly: Just because you're a founder doesn't mean you're actually entitled
to the role of C*O (though you may hold that position early on as it needs to
be "filled" it can quickly out-grow you). Some can become those roles and some
simply aren't capable of scaling with the needs of the company.

~~~
dmitrygr
You're totally right! Without that guy who builds everything your company will
do just fine...doing nothing and having nothing to sell....

just wow

...

Also, what risk? There has never in history of history been easier access to
money than now, and never better terms. Hell, tell a stranger in palo alto
you're an MIT dropout, and have a Stanford dropout friend, and they will
practically write you a blank check.

~~~
Ixiaus
Your thinking is clearly very black and white, also highly entitled - quite
common with engineers. There is no doubt that a product would not exist
without the people to build it but an organization would not exist without the
people to organize it.

Many roles in the company are invaluable. Not just the engineer.

It sounds like you've had a bad experience and I'm sorry if you have, but not
all companies are "pointy haired bosses that take advantage of the
underlings".

> Also, what risk?

You clearly have no idea.

> There has never in history of history been easier access to money than now,
> and never better terms.

You still have no idea. I'm not even going to try.

> Hell, tell a stranger in palo alto you're an MIT dropout, and have a
> Stanford dropout friend, and they will practically write you a blank check.

This is a pretty offensive statement and you've lost me entirely, your
perspective is so far detached from reality that it makes a lot of sense why
you're so upset, sarcastic, and frustrated. Instead of a self-righteous
attitude, go build your own startup if it really is that easy and low risk.

If you have built your own startup and received a blank check and performed
the feat [of building a startup] with no risk to yourself or your peers then I
call bullshit or you're just internet trolling.

~~~
dmitrygr
[https://medium.com/@tikhon/founders-it-s-not-1990-stop-
treat...](https://medium.com/@tikhon/founders-it-s-not-1990-stop-treating-
your-employees-like-it-is-523f48fe90cb#.ws2e25qra)

------
Anderkent
You don't have to hold the stock until IPO. If the company is doing good,
finding a private buyer through a stock broker shouldn't be _that_ hard. Sure,
you won't get the best deal, but it lets you cash out.

Also, if a private company grants you options and never gives you any options
for liquidity (like buying the stock back when taking new investment etc) you
should be really careful about overvaluing the options. Clearly the company
wants to chain you down, not reward you.

~~~
jvns
Have you found a private buyer for stock? What was the experience like?

~~~
mavelikara
I have sold stock (exercised options) to a private buyer. I found them via
sharespost. The experience was good. I paid 5% of the proceeds to sharespost.

------
xiaoma
Another variable I once saw was options (subject to board approval) in the
offer letter and then several _months_ later an approval of the options grant
that had to be signed. In this second document, there was a clause saying they
could fire the employee and take back the options à la Zynga, Skype, etc.

In that case, immediately discounting the value of my options by a quarter is
reasonable since those kinds of terms being used for clawbacks is getting more
common.

------
DanielShir
As a founder who's been through a liquidation event, I have to say that stock
options are a terrible way to reward employees. The tax issues alone (not to
mention all the other stuff mentioned in this thread) are a huge pain for most
ordinary people. The only reason companies use this is that there's no better
alternative... Anyone ever encounter some other financial instrument that's
possible to use in this situation?

~~~
maneesh
Bonuses based on how well the company does.

I.e. $1,500 bonus per $MM in revenue, each year

~~~
yasth
These cause huge cyclical attrition and mess with everything every
vest/payout. Also if that is written to the contract as a formula it is a huge
reason to lay off old employees, because as the company grows one expects the
MM to grow larger. If it isn't written into the contract it is a crappy way to
reward the initial brave few as initial revenue will be negligible and their
share will decrease as the company grows.

------
jakozaur
It would be so much easier for everyone, if companies would IPO earlier.
Evaluation of your option value would be straightforward, there is liquid
market, no need to worry about investors preferences, ratchets, etc. Also the
whole market gains a lot of efficiency if basic financials are public.

Not so long ago, companies used to IPO way earlier... Microsoft, Apple,
Amazon...

~~~
x0x0
Unfortunately, it appears that many startups have gotten their valuation ahead
of their economics, so IPOing isn't an easy option for them because it would
be a large down round. IIRC, most of the large tech ipos in the last year went
public below their final private valuations. Though to be fair, the last
investors often got ratchets.

This is a good read too

[http://thomasgr.tumblr.com/post/135710601255/the-pre-ipo-
dip...](http://thomasgr.tumblr.com/post/135710601255/the-pre-ipo-dip-the-
opposite-of-the-burst-of)

~~~
maneesh
Yea not to mention the sarbanes oxley act, post-enron, that makes public
company regulations obscenely difficult.

------
peteretep
Even when the maths is simple, few people seem to do the maths. The number of
reasonably bright friends I have who say "I've got some equity, so if it goes
big I'll make great money", but haven't actually sat down and calculated that
"great money" is a one-off £50k astounds me.

~~~
Anderkent
The more common problem I see is the reverse: people do the math for the
optimal scenario, see big numbers, and then assume that's how much the options
are worth.

~~~
rphlx
I agree. Stock options are a well-engineered exploit of employee optimism.

------
krschultz
Math is good. Philosophy is better.

Your salary is what you live on. Everything else is a bonus. As a salaried
engineer I have received basically every 'extra' there is. Cash bonus. Equity
bonus. Options. Restricted Stock Units. Overtime pay by the hour (seriously!)

In all cases I do not plan to get that money. I don't use it to pay rent or a
mortgage. I don't use it to buy clothes or food. You might argue that is a
luxury, but honestly if you can't afford your lifestyle _without_ the bonus,
then what happens when there are bad times and you don't get the bonus?

I set this up so explicitly that I have a separate bank account for that money
and when a bonus comes in it gets transferred away from the day to day
account. This years vacation is paid for with last years bonus.

------
crabasa
One mistake I see people make quite often is failing to adequately research
the reputation of a prospective employer and their executives. I've seen
people accept offers because the option grant was marginally better at company
A than company B.

There are so many things that can effect the outcome of an employee with
options (subsequent funding rounds, liquidation preference, if and how the
exit happens) that it often boils down to whether or not you believe you will
be treated fairly.

------
shubhamjain
One thing I wish to know is whether it is possible to negotiate the terms so
you have preference of liquidating some of your shares when company raises a
round. Surely, the possibility of an IPO or an acquisition might be uncertain
but another funding round seems a very plausible event.

One company, Atlassian, did raise one round solely to allow employees to vest
their shares but I am not sure how common this is in Silicon Valley's Tech
Culture.

------
amichal
I've been through this before (15 years ago). As a "first engineer" as well. I
was fully-vested in a fair deal. The start-up had been acquired outright by a
large private co which gave a nice real world known valuation for the company
and the new owners were entering a pre-IPO quiet period (we were told it would
happen with few months). Exercising my options would net a 7 figure stake for
at a cost of about six-months salary. I hadn't understood all the options
complexities at the start but learned fast about this time thinking of selling
some. Engineer #2 got a loan in order to exercise their similar options and
got totally screwed as things slowly imploded. I never did exercise them
thankfully. In another case my options as a early engineer (again fair enough
terms) ended up actually worth actual money after a few rounds of dilution and
conversions and sales ultimately to a public company. However it was a few K
worth after 5 years of work on paper it had been variously valued up to high
six figures. I know now that options are, as someone said elsewhere in the
comments, "a variable odds lottery ticket".

------
slyall
I've currently got around 60 days to exercise some options with a company. But
I have not been told how many shares there are out there or anything about the
company finances so I have no way to judge how much they might be worth even
in the best case.

In the end though the amount that I can buy is so low that even if they are
worth 10x what I'm paying for them it is not worth the paperwork and trouble.

~~~
ewindisch
The easiest thing to do is find out what the current strike price is and
compare it to the strike price of your options. This will tell you ONE key
metric for determining the stock's value and will help assist in estimating
your tax liability.

The same is true at time of negotiation. You don't really need to know how
many shares are outstanding if you have the strike price and an estimate for
the company's growth. That is, you're investing $X dollars and expect it to
raise by a multiple of Y.

------
diziet
This covers a lot of the more important things -- certainly to the individual.
But one thing that you need to keep in mind in terms of predicting the actual
value of the options, which is outlined in the "More ambitious questions"
section is things like overhanging liquidation preferences, participation
rights, downside protection for investors, etc. Ask these questions.

------
jlas
> which pays me a SF salary despite me living in Montreal

I'm not sure what cost of living in Montreal is, but I'd be surprised that
jvns is making less than 100k in SF. If Stripe were smart they'd increase her
salary stat. Just based on her excellent blog posts and her insatiable
curiosity, this is not an employee you want to lose.

~~~
jvns
(my after-tax salary -- I pay 40% income taxes or something? basically I'm
saying my salary is less than 150k USD)

------
zurn
Why is it so hard to convert these to cash the same instant you exercise them?
If there are some special terms attached to your share of the company that
prevent you selling the shares directly, you could just make a (transferrable)
derivatives contract with interested investor(s) where you pay them the
dividends from the stock?

~~~
x0x0
Every private company I've gotten an offer from includes, at minimum, a right
of first refusal on selling shares. Some allow the company to prevent you from
selling period. This isn't, afaik, entirely evil -- there are SEC regulations
controlling the allowable number of shareholders for a company to stay
private. I've also seen it mentioned that Etsy, amongst others, has fucked
employees trying to leave by preventing them from selling shares.

------
bankim
Elaborating on early exercise. Employee can choose to pre-exercise ISOs soon
after starting job (before vesting) and file 83b. In this case, the difference
between strike price and FMV is $0 and hence tax realized is also $0. This
also starts ticker for capital gains sooner and if the company gets sold/IPO
after 1 year from date of exercise and 2 year from date of grant then long
term capital gains will apply and not short-term capital gains which is taxed
as ordinary income.

This obviously depends on the strike price on joining the company and how much
money employee is okay to lose in case company goes bust. If not all, some
ISOs can be early exercised.

In my case, I early exercised around 25% of ISOs soon after joining. In hind-
sight I should have early exercised more as the company did go IPO around 2
years after I started...

~~~
jypepin
"the difference between strike price and FMV is $0 and hence tax realized is
also $0"

well, this is assuming your company's value hasn't increased since then. But I
do agree it's usually an interesting move if you believe in the company since
you'll pay taxes earlier.

------
jason_s
I'd rather have the RSUs
([https://en.wikipedia.org/wiki/Restricted_stock](https://en.wikipedia.org/wiki/Restricted_stock))
that my company gives us, than stock options. A chunk of them vests each
quarter, they allocate an appropriate fraction of that chunk to cover taxes,
and the resulting shares are ours to hold or sell. No dilemma of when to
exercise or whatever, no risk of being underwater.

My father once got stock options from Nortel Networks right before the dot-com
bubble bust (sometime between 2000 and 2002). He exercised them, sold some to
buy a car, but held onto the rest, had to pay a hefty tax bill, and then when
the price nose-dived, they were worth less than what it had cost him in taxes.

------
jfountain2015
If you are considering a job that offers options/stock I think this is the
most important thing to consider.

1\. Do the founders have a history of successful exits? 2\. If so, did all
employees with stock get paid?

If either is no, you should consider options/stock worth $0

~~~
harryh
Some of the most successful exits in the tech industry were started by first
time founders. I don't think that's a very good criterion.

------
discordianfish
Is it really that hard to find a buyer for private shares in a "good looking"
startup? It almost sounds impossible, yet I talked to some people who said
it's not that hard. I guess I have to find out..

~~~
vidarh
There are tons of brokers that makes their living doing this. It's not
necessarily hard, depending on how good price you want to hold out for, but it
can take a lot of time and be unpredictable, because the buyers are not
necessarily sitting around waiting and so it can depend on finding a broker
that have the right kind of potential buyer on the books that they can
contact.

I've sold shares same day in an unlisted company, and then a few weeks later
called the broker to sell more and ended up taking several months to find a
buyer, but on my end it wasn't "hard" \- it was just a matter of waiting it
out.

~~~
mavelikara
I also had the same experience. Because there is no real market making entity,
finding the two parties needed to make a trade can take unpredictable amount
of time.

------
steven2012
There are some funds that some of my former coworkers talked to that will
front all of the money to exercise your options, plus pay the taxes, in return
for paying the money back for the above, plus 30% of the profits. You're
basically borrowing the money to exercise and pay your taxes and then giving
up 30% of the upside. It's seems like a good deal to me since you take on zero
risk, especially if you're in that situation described in the blog post.

I won't advertise their name, but they seem legit and know several people that
took them up on their offer.

------
Smaug123
I have a single peeve with this otherwise excellent article: "My after-tax
salary is less than $100,000 USD/year, so by definition it is impossible for
me to exercise my options without borrowing money."

This fact isn't true "by definition". It's true "by arithmetic". We say a fact
is true "by definition" if it isn't true for any other reason. [1]

[1]:
[http://lesswrong.com/lw/nz/arguing_by_definition/](http://lesswrong.com/lw/nz/arguing_by_definition/)

~~~
Rapzid
Last I had options there were companies(etrade in my case IIRC) that will do
the whole buy/sell for you; they flip them instantly and give you the cash. I
suppose that depends on the type of options and how the company has it setup?

------
pmorici
Every offer I've ever gotten that included an equity/options component omitted
key information that I would have needed to have even a fuzzy understanding of
the offers value. When I asked for details it was like pulling teeth to get
the information if they would disclose it at all and often they would only do
so verbally and not in writing. I turned them all down because that sort of
thing leaves a bad taste in my mouth.

------
primemod3
Evaluating the value of stock options can also be done using the Black-Scholes
model. Here's a blog post that explains more as it applies to startups:
[http://cdixon.org/2009/08/18/options-on-early-stage-
companie...](http://cdixon.org/2009/08/18/options-on-early-stage-companies/) .

------
swingbridge
Most people don't have a clue how options really work, but are thrilled to get
them... until they try to excise them.

Truth is companies give options to low level employees because it's cheaper
than paying cash. Most employees don't do their homework to realize that in
the vast majority of cases they'd probably be better off demanding cash.

------
superuser2
My first equity experience is going to be RSUs. They seem better in every way:
you don't owe taxes in cash (they're withheld), you can't go upside down (zero
strike price), and you don't need capital to begin with so your compensation
does not depend on how wealthy you already are.

Why would anyone take options if they could get RSUs?

~~~
jedberg
You have much higher leverage on options, and you don't take a tax hit until
you sell them. That's assuming the price goes up significantly. That's
basically the tradeoff.

------
takeda
This is a bit ridiculous.

Why do you need to pay taxes when exercising the options? At that point one
did not made any profit and in fact you made an investment (you spent money
and there's still high chance you might lose to that investment).

It would make much sense to be taxed when you sell the stock (and use the
original option price you paid for the shares).

~~~
harryh
Just because you don't have cash doesn't mean you don't have an asset that has
value. If I give you a house, you don't have cash, but you still have to pay
taxes on the gift.

I do agree that there is some degree of ridiculosity and there should probably
be some tax reform here, but that is the reasoning behind the current rules.

~~~
takeda
Sigh... it really needs to be reformed, you essentially can lose money twice
on such investment.

------
lifeisstillgood
Is this a sensible approach:

You have offered me X ordinary shares which is y % of total outstanding.

I want a contract that guarantees me the same % of this class of shares, and
the same % of any other more privileged class of shares, and I am given an
opportunity to participate in every liquidation event pre public offering

Seems to cover many of the horrors people have hit?

~~~
sokoloff
Unless you're an irreplaceable employee, you won't get that. In particular,
it's unreasonable to take the initial percentage and demand the same
percentage of preferred shares (or venture debt convertible into shares at the
lender option).

Many of these "horrors" are a reality of the angels and VCs protections that
enable and are essential to the company financing. IOW, attempting to tunnel
under those protections for employee benefit runs counter to the investor
interests, sometimes to a degree that it would preclude investments entirely.

Even the liquidity provision is problematic. Suppose investor A wants to sell
their stake to investor N in a private negotiated deal. Maybe fund A is
collapsing. Are they obligated to tell you the terms of their negotiations?
Obligated to also purchase some of your shares at your sole discretion? How
would they even _know_ that you have such a provision?

~~~
lifeisstillgood
VCs get dilution protection, why can't other "investors" who invest time and
effort.

If that dilution protection is some other form than stated, well I need to
read up on it.

But my general approach is that just because you are an employee not a capital
investor does not mean you should just take whatever shit is doled out.
Especially not these days.

That whole thread is about finding better terms and protection to take options
on.

"They won't let you" is close to "shut up and take it". (Not the same but a
bit too close for my ckmfort

~~~
sokoloff
I don't view it as "shut up and take it", but rather "here's what we're
offering; would you like to take it?"

The most common form of dilution protection is the right to invest more cash
in future rounds pro-rata. (So you can pay to stop being diluted.) That you
_might_ be able to get if you hold shares, but you're going to need to pay
cash at each round to avoid dilution. You won't realistically be able to get
it as an option holder in the employee option pool, and as a non-accredited
person (by the meaning of CFR Title 17.II§230.501), I'm not sure of the
legality of investing cash to protect existing holdings from dilution. (I'm
not saying it's not legal; I'm just not sure as I meet at least one of those
tests.)

As both an employee of startups (in the past) and an angel investor
(dabbler/dilettante), I can see both sides, but when I contemplate writing a
check to "2 founders, an idea, and a powerpoint deck", you can imagine that
many provisions of convertible/venture debt exist to make that make a tiny bit
more sense and provide some limited downside protection for the "indefinitely
horizontal" company trajectory.

Once I invest, I have very limited input into how the CEO runs the company,
but I'd advise a CEO to pass on a mid or late stage employee who is too much
of a troublemaker about their options terms. Realistically, the company should
not be negotiating and drafting custom options terms per employee and an
employee who demands such is probably a better fit for someplace else. Quite
literally, the terms of the company option plan are (often) set and modifying
them is nowhere near the same as giving a signing bonus, flexible hours, a few
extra vacation days, work from home on Wednesdays, or a different salary/bonus
amount.

~~~
lifeisstillgood
I may have been more ... Assertive .. than I meant.

Interesting. The right to invest as dilution protection I had not remembered
(Is it stripe that surprised everyone by giving investors right to invest at
the previous round prices?)

I suppose that what I am trying to protect against is to not see dilution
occur worse than that of founders. But then if you don't trust the founders
that much at the outset, don't join.

So, perhaps better advice is take the money not the options, and if you want a
lottery ticket, start your own company.

I think I will give up and form a co-operative.

------
stats_lly
This is very useful! I accepted an offer with few options and low salary at a
start up after I graduated from my masters, and only realised what I have
missed out on a couple of years later. I left with fewer options than people
who joined years after me. Wish I knew a bit more about startups and their
options earlier.

------
nbevans
What protects the stock from being diluted since presumably it has no or
insufficient voting rights?

~~~
diziet
Nothing. Stock will get diluted. Typically every 'Series' fundraise will add
10-20% option pool and dilute the company by another 10-20% of preferred
shares. The 'idea' is you have a smaller piece of a larger pie.

Very incredible companies will raise at better terms and valuations and dilute
more. This is very rare.

~~~
nbevans
Indeed. In other, perhaps less "SV" companies, I've seen it happen where the
CEO wants to bring in an associate as perhaps the COO, CTO, CFO or some other
high level position. Obviously such a person won't just leave their "megacorp"
job without some shares being offered to join the riskier venture. So they end
up diluting the company just so that a certain % can be given to this new
"super experienced and respected head". It is sold to the rest of the company
that he will bring in new customers. What actually happens is almost nothing.
No real value is created. Just expectations are created.

This can be the same with "fund raising". Just because the company has diluted
itself and now has a few million in the bank... it still has to spend that
money wisely and correctly in order to realise a genuine "the pie is now
bigger than before" that the shareholders were expecting.

------
calcsam
This is an excellent article. Thank you.

The thing that is missing from all of these articles is, unfortunately, a tool
to actually do these calculations. I am building such a tool. Happy to share
(privately!) an early version. If you're interested, email is in my profile.

------
dghughes
I wonder what your company would do if you chose a short position with your
options.

But I guess what you're given pretty much assume a long position.

The little I know of options (and how no human can never ever guess the strike
price!).

------
sytelus
Silly question: Why startups insist on stock options? Why not just give out
stock themselves in same quantities? I think doing that might make them more
attractive if they are competing for talent.

------
Denzel
What prevents a company from issuing vested stock options with an anti-
dilution clause to early employees? Has any company set the precedent? Would
it scare investors away?

I'm very curious.

------
retube
Why do firms offer options as opposed to actual equity?

The way these options are structured plus US tax law basically means a lose -
lose scenario for the employee.

~~~
brianwawok
I think some of it has to do with giving you either X stock or 2-4x Options...

If your company is growing every year, and the stock is liquid, Options are
great. I know a fortune 1000 company that used to give people a bunch of
options at bonus time, people loved it - bought houses, etc. Then the stock
turned sideways, so they switched to 50% options, 50% shares (with the actual
share count being option count / 4, to approximately take into account that
shares are worth a lot more than options). The next year they flipped to 100%
shares. No one would get mega rich with a small pile of shares, but everyone
would have some money in the bank...

------
tylercubell
What's are the pros and cons of setting the strike price as $1? Is it
intentional to inhibit employees from exercising their options?

~~~
mrmcd
In the US at least, the strike price for options in a private company is set
at whatever price the last 409A valuation was. How this is done is a bit
technical, and typically something done by a specialized professional
accountant type.

At any rate, the younger and riskier a company is, the lower the 409A usually
is, and the more legal wiggle room they have to keep it low so common stock
option grants are worth more later on.

For public companies it's whatever the stock price is on the date the option
grant is made. If it goes up, the options are worth money. In general, for
public companies options are vastly more easy to understand and actually cash
out.

------
webo
I have always just asked this one simple question:

\- What is the price per share at current valuation?

I don't think it's has to be that complicated...

~~~
rahimnathwani
It's not that simple if there are multiple classes of shares, particularly if
some have liquidation preferences attached.

~~~
mikeyouse
Yep, quick example -- company valued at $300M, 150M shares outstanding,
options should be worth $2/share, right?

Except if that company raised $100M to get that valuation, the preferred
shares will certainly have at least a 1x preference. If they are fully-
participating, the new math world make the shares worth ($300-$100) / 150M or
$1.33/share.

In round numbers, I worked for a similar company but they had to take a
terrible down round post-GFC with 3x participating preferred. In that case the
common options would literally be worth $0.

------
jroseattle
As I compete to hire engineers, I've found myself in the role of providing
counsel to many younger candidates we see about alternative opportunities
they're considering. Outside the large tech-cos, they're usually considering
joining a startup with a lower salary and some number of options for equity.

Our company is a wholly-owned subsidiary of a private holding company and does
not offer equity ownership. As an alternative to equity options, we have bonus
plans based on performance, both annual as well as long-term. We make
estimations about overall company performance on a few metrics in order to
provide what amounts to a range of values for how those plans apply to a
specific candidate's role with us.

But I get a lot of questions about how to compare an offer from us to an offer
from a startup that includes equity options as part of compensation. It's
simple to compare salary, benefits, etc. But invariably, we get into
conversations where candidates ask me how to value equity options they've
received from another company.

First, I'm totally upfront about the fact that I'm: 1) not an expert, and 2)
biased. But I am always honest with a candidate, and do everything I can to
put myself in the shoes of an advisor.

Without looking at any offer details they have, I point them to the equation
inputs: # of outstanding shares, preferred percentages, any liquidation
preferences in play (need the multiple too), and the valuation. I'm sure there
are other data points that could apply, but this information seems like table
stakes. Nonetheless, if they have this information, they could at least gauge
the value of their own equity options with exit scenarios at different levels.

But converting those scenarios to present-day value? This is the part where I
always check myself, but I express that those equity options are almost
certainly zero value. The outcome of a significant positive exit is always an
outlier on the distribution curve, so appropriate discounting applies. That's
the math part, which is as good as your assumptions and estimates allow.

The hardest part of those conversations is understanding how to justify
assumptions in those calculations, such as how high profile a startup may be
(and how that affects those assumptions.) I've been around long enough to have
friends who were employees with numbers less than 30 at some very high-profile
startups who had significant public exits, yet those employees made little to
nothing. And to say nothing of those companies that simply didn't make it.

As creatives, our natural instincts drive us to believe we can create the
value necessary for us to derive positive outcomes and ultimately benefit in
these situations. The historical numbers simply don't represent that fact, and
indeed show that outcome to be a rare occurrence. Good on you if that happens,
but the odds are simply not in your favor.

As I conclude with most candidates, I tell them their mileage may vary and
that they should absolutely seek the advice of someone entirely independent.
Maybe as luck would have it, we have had a few candidates join us that were
strongly leaning to accepting their startup offer. Several told me their
reasoning -- they trusted my honesty with them. Who knows, maybe that's the
_real value_ in equity options. :-)

