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Do the math on your stock options (jvns.ca)
445 points by jackgavigan on Dec 31, 2015 | hide | past | favorite | 247 comments

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.

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?

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.

In addition to the # of outstanding shares, you want the valuation, the # of preferred shares, their liquidation preferences and multiples, and a couple more things I'm probably forgetting.

You can never get this information even as an employee. You ask directly, and nothing. They don't want to give it to you.

Your company could be sold for 100's of millions, paying off the investors at 2x investment, and the common stock holders get nothing.

> 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.

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."

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

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

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

It is also a signal -- "Can this person be persuaded to work for magic-big-number options but half the salary without too many question? If yes, then he's a believer and want him to work for us. He'll probably stay up on weekends and work for the cause." If he's asking too many questions, he'll probably question our decision making down the road as well, and will be hard to fool.

This can be seen in recruiting stagee as well, it is usually presented as the take home question. Give them a take home interview problem that takes two days to solve. Those that go for it, will be dedicated and desperate enough to be good workers.

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

I honestly strongly dislike this quote, because at the end of they day just about every malicious activity could be wrongly attributed to stupidity.

Exactly! Plausible deniability is a very low hurdle to jump over. If it's your only hurdle, you're in big trouble.

Crooks, or dumber than a baked potato. Either way, run fast and far.

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

So what is the lesson here? I hear this saying over and over, always with the implication of "Give them a pass". Who cares if they are being crooked, or are too dumb to do division. Either way, the employee loses.

There's no lesson. I'm just pointing out that many founders are more focused on tech or product than they are in options and cap tables. And many startups employ staff who are also unfamiliar with such things.

Given my experience of advising early stage startup founders on equity investment, dilution, cap tables, etc., I believe that ignorance is at least as likely as malice in situations where they seem unwilling to disclose all the information the potential employee needs to fully evaluate the potential value of any equity options being offered.

Stupidity is very dangerous in this situation because the CEO may completely believe that he's doing the best for the employees, but then get hoodwinked by institutional investors who will make the deal sweet enough for the CEO so he can be the one to tell you your options are worthless when the liquidation preferences come home to roost.

I would never join a startup where the founder wasn't razor sharp and forthcoming on all these details.

That's fine. I don't care if the Cxo is lying or stupid. The conclusion is the same: I don't trust them to deliver value on my shares.

It's like a doctor who opens up your gut to remove your appendix, but it turns out he doesn't know what an appendix looks like and has never performed surgery before. The distinction between stupidity and malice has kind of disappeared.

If they were that dumb they would have just coughed up a number. So let's trade aphorisms:

"A witty saying proves nothing." - Voltaire

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

Does that really change anything, if your C-suite is too stupid to understand how companies work?

Even if you knew the number of shares outstanding at the time of the option grant, it would still be useless. The company can issue new shares at any time leading to dilution. Also at some future liquidity event (acquisition, IPO), a significant number of new shares can be issued leading to more dilution.

So yes, options are somewhat of a lottery ticket with ever changing odds. If the company does extraordinarily well, you will do well also. If you truly believe the company has a very good chance at financial success, you should stay irrespective of the number of options. If you are making a significant contribution to that success, a rational company will want to reward you and incent you to stay with more options. If both those things are not true, it is best to seek your fortune elsewhere.

"The company can issue new shares at any time leading to dilution."

Yes, but the directors of the company are obligated to act in the best interest of shareholders, so hopefully they would do that iff it increases the value of existing shares. (OK, there are many things wrong with this, including the fact that option holders are not shareholders.)

"If the company does extraordinarily well, you will do well also."

Yes, but if the company does very (but not extraordinarily) well, you might end up with nothing.

"If you are making a significant contribution to that success, a rational company will want to reward you and incent you to stay with more options."

But your contribution may not be constant. An early engineer who took a risk (low salary, high chance of being laid off) and built the prototype may not fit in when the company grows, so there may be little rational incentive to treat her fairly.

"obligated to act in the best interest of shareholders". Obligated how specifically?

Also, all shareholders, or the majority?

Obligated by law: deliberately acting against (some) shareholders interest is a criminal offense.

So my interpretation is: this is good for shareholders.

Can you give me examples of people in jail for this 'crime'? At worst people saw social network, and it seemed a ok.

My understanding is that options for common shares, such as terms at YC, have not even anti dilution protection. So the # you have is a snap shot, and nothing to do what that % would be when you fully vest.

people holding options are not shareholders until they exercise those options.

Excellent point, but equally important is the fact that even if you purchase your < 1% of shared, if you are a regular middle class person, you will probably have no real legal recourse to sue if you get screwed. The investors who are most likely behind it will cover their asses and so far outgun you legally that it is probably hopeless to try to fight even if you have the means.

This is where the GGGP (davidwihl) is both right and wrong—knowledge of the cap table at signing won't guarantee anything, but that combined with a good judgement of character is the best you can do. In the end you can get screwed either way, but if there is any caginess up front then run don't walk away.

They can issue new shares but they would have to notify you. You should have a clause in your agreement that any new grant you have the ability to get more options to stay at leat less dilluted or you can walk.

What does "walk" mean in this context? My (naive) reading is that you can cut all ties and run because they've essentially broken a contract; that's trivially true, but doesn't help with the actual goal of getting money from those options.

You did the right thing. The situation is analogous to someone telling you the numerical amount of your proposed salary, but not telling you the currency and/or frequency. You don't have a right to know the details, but without the details it's hard to evaluate them as worth more than 0.

If you are signing a contract, why don't you have the right to know? If I tried to defend the fact that I never specified paying in US currency in some contract and instead used what ever the new hyper-inflated currency is, a judge would kick me out of the court room. Only if it was explicitly stated would a judge uphold such a contract.

You don't have a right to know, because you weren't born with the right and nothing grants you that right. Your option, if you don't like not being given the information you request, is to not sign the contract.

This is a case where you have the right if you insist on it.

Your BATNA is to walk away from a deal where the counterparty refuses to give you the information needed to make a rational decision.

Years ago I did this same thing for a startup that wanted me to move to another more expensive city, and take a significant pay cut. They offered a bunch of options, but would not answer any of my questions to help me value them. I told them to me they have zero value and I'll operate from that premise. We never could come to terms on pay so I passed on the offer. Less than a year later they were out of business.

I can almost guess the company from the number of stock options offered. I was in a similar situation, but I accepted the offer and these articles a bit too late :(

I like the experience of working here, but now I totally realize I have lost a significant amount just by not negotiating anything.

What would you have done differently if you had known at that point what you know now?

1. Would've interviewed with other companies - I interviewed with one startup, cleared it and joined it. Never knew that stock options carried so much detail.

2. Would've asked for a better base salary citing all the "ifs" stock options carried with them.

You made the right choice. If they are going to hide this information from you, you have to assume they are dishonest, or the number of total shares is very large.

While the interview was confidential, I don't think the offer was. I'm going to chicken out, but it was a top 5 YC startup, and they did that. Either options or RSUs, I can't remember which, but you have no way to value them beyond the value they tell you. I ended up turning them down which was probably stupid of me.

Why was it stupid to turn down something which you couldn't value, yet had to buy (in way of lower salary or more hours or whatever it was) ?

because (based on future performance that obv I couldn't have known at the time) it would have worked out for me

Your experience is not normal, and you did the right thing. If someone offers you stock options as part of a compensation package, they ought to give you enough information to ascertain the current and potential value of these options. The fact that they're secretive about this makes the deal feel sketchy.

Issuing 10,000 options and not telling you how many options are outstanding is very very common for startups, unfortunately. I don't know how many times I've joined companies that listed 10,000 options and I was too dumb to question it.

In many cases, it's because they don't want non-executive employees to be able to know certain financial details, including the valuation of the company. I wish this wasn't the case, but the reasons for it seem logical and in fact fair - it's just that many people assume this is a lot when it probably isn't.

The downside is many people are apt to accept, thinking 10,000 in options is a "lot", and I've made that mistake in the past. In an A round startup, this number could easily be in the several millions of shares outstanding, and likely is. If it's gone through several funding rounds, it's likely even less. 10,000 in a C round is significantly less if they have divided the stock by 10x or more in the previous rounds.

Executives could be pulling in whole percentages of the company, or multiples thereof, and one of the first few members of technical staff could basically be looking at a year's salary or less in payout if the company would sell in 5-8 years.

The percentage of the companys that make it is also a factor. While the article focused on needing to stay at a company, it's fair to consider that the great majority of startups are going to fail or be very small acquisitions (asset deals, acqui-hiring, etc). In these positions, the VCs will get paid first, and there may not be much if anything left.

Another possibility is the company is sold for small prices but the CEO could secure a very very nice deal to join the new company (plus bonuses), which has happened on more than one occasion.

A VC only needs a small fraction of his portfolio to do big exits, so they make lots of bets.

Stock is a huge gamble. I don't recommend "no stock, just cash", but don't ever let someone underpay you on hopes the stock event will happen.

Stock is being used as a retention tool, and that's the design of it, unfortunately.

I'd be much more in favor of equitable profit sharing as a retention tool - suppose a company decides to give away X% of it's profits back to employees forever, and this is done in a way where it isn't the CEO/leaders making all the money. Instead say in a 50 person company, 10% of the profits always go back to the people, and each person gets 1/50th.

This also eliminates sales commission on large deals and makes everyone part of the deal (the whole company) profits - also no quarterly targets, personal bonus tiers, executive bonuses, or anything like that. As the company becomes more efficient, those numbers go up, and it keeps things simple.

In this "growth above all else" ecosystem, do you think profit sharing could possibly be just as bad? I'm not sure how those deals are usually set up, but unless you set aside a portion of revenue to share I could see people losing out here too.

Do you know of good examples of this working? I'm interested in how it might work with a typical startup.

I don't know of any examples, it just seems like it would be a good way to structure things. I also can't see it being bad if it did not differentiate by position - I've heard a lot about how much, say, enterprise sales pays itself (because effectively it sees the money first and controls who sees the money) and I'd be very wanting to make sure everyone - admin assistants, everyone, who made the organization great had a chance.

I think you would want to calculate a % early in the year, and then award that percentage at the end of the year.

If you wanted to taper that somewhat by employee reviews I guess you could, but it shouldn't be on quota - and ideally you'd just not continue to employ those people you didn't want to be there.

Yes, everybody would lose out if there were no profits. And a lot of startups aren't profitable. But (IMHO) I think that's also where SV investment gets it wrong -- they value growth above profitability sometimes, and this desire for rapid scaling makes or breaks companies, when in the end, I think a greater percentage could be BOTH happy and moderately successful at the same time, rather trying to bust themselves and "go big or go home".

This model is probably a LOT easier to adopt in a bootstrapped company, where there's less likely a board to say no to it -- and yeah, if you're not profitable, you wouldn't do it... and you also would be unlikely to have stock anyway.

It helps to understand the company's situation and progress, and to make sure you get the "right" type of options and are aware of any vesting periods or other conditions that might apply. Try to have access to the latest balance (could be feasible, depending on the role you are joining with) and growth figures. Personally, I would not value them at zero but rather as something closer to a performance based bonus with an extra risk.

If they could not share the numbers when giving an offer, I would be surprised and suspicious. Did you ask the founders?

At least they should be able to tell you the common strike price and ideally the fair market value of preferred shares. This would let you benchmark things fairly well.

What does late stage mean? How many employees? How much funding raised?

I had pretty much the same situation. I think you handled it exactly right.

Yes, and yes.

I've had ISOs in a couple of startup employers, non-qualified options in a startup customer, and RSUs in a couple of public employers.

The only book I've read on stock options is _Consider Your Options_ by Kaye Thomas, which I thought was good. I do my own taxes, and there was enough detail in that book to let me figure out the tax implications of my options. (Including AMT the one time I had to pay it.)

The actual mechanics when you already have options are straightforward. You either exercise speculatively (pay real cash to turn options into shares, then hold the shares), or exercise risklessly (pay cash to turn options into shares which you sell immediately for more cash than it cost to exercise). Exercising speculatively has risks -- you pay real money for shares that then go down in value, possibly to less than the strike price, possibly leaving you with a tax bill even though you made a loss. Exercising risklessly is safe.

I don't like to speculate with meaningful amounts of money. If in doubt, sell the stock and diversify. Think of the worst case (the company crashes and you lose both your job and the value you thought the stock had). Better to not have all your eggs in one basket and sleep well. I suspect this is not a popular sentiment there, though.

The real question with options is when you're considering multiple job offers. Company A offers $100k and 3000 options. Company B offers $110k and 5000 options. How do you value the options? For a startup, the usual answer is that you can't, because there's no anti-dilution protection. If the founders want to hose you, they can hose you, by diluting your shares or by firing you right before a vesting date. So I value them at zero and take the job I like better, or the job that pays more actual cash.

(RSUs in a healthy public company are a bit different, since they have an actual immediate cash value. I value them at 75% of the current value of the stock. The 25% discount is because of vesting periods.)

>Exercising risklessly is safe

It may be safe, but it isn't free. As with most other things, you pay a risk premium -- in this case, in the form of failure to qualify for capital gains tax treatment on the resulting gain, because you didn't exercise in time to hold the underlying stock for more than one year. Depending on the amount, this difference can be quite significant.

You do your own taxes so probably know all this already, but here's a simple example[1] anyway. Let's say you "risklessly" exercise options with a strike price of 100 and a FMV (tax-lawyer speak for fair market value) of 1000. You have immediate gain of 900 -- and because you didn't hold the shares for >1 year, all 900 is Ordinary Income, generally taxed at higher rates than capital gains. (Top federal OI rate is something like 39% last time I checked vs something like 17% for cap gains.) Assuming the OI rate is 39% and the CG rate is 17%, you pay tax of .39 * 900 = 351, for total post-tax cash of 900 - 351 = 549.

What if, instead, you had exercised speculatively, more than 1 year prior? You'd still have taxable gain on 900, but because you'd have held the stock for more than one year (and met some other qualifying factors I won't bother explaining here), your tax bill would be 17% -- meaning that you'd pay .17 * 900 = 153 in taxes, and keep cash of 900-153 = 847.

Not a huge difference when we're talking about gain in the hundreds, but adds up quickly if you're in line for tens or hundreds of thousands or more.

It's really just a question of how you evaluate different kinds of risks, and what you want to pay to hedge them. If you want to balance your tax bite against the risk that your company goes under or otherwise fails to deliver, you may still want to exercise early, but only partially.

[1] I'm eliding a few things and making some assumptions. Not legal advice, talk to a real tax attorney before making decisions, etc.

A number of people got screwed six or seven figures in the early 200s dot.crash waiting the year for LTGC tax rates or during the sales lockout. There were a lot IPOs in the late 1990s and a lot of worthless stock a year or two after that.

In the US, do you pay taxes when you exercise your option to buy the stock?

For you example, say I exercise my option to by 1 at strike price of $100 in 2015. I hold on to it and sell it in 2017 for the FMV of $1000. Do you only pay the capital gains tax of the $900 gain?

Ignore state rules, just at the fed.

Lets say the fmv in 2015 is $500, and your strike price $100. If they are ISO, in 2015 you own no regular tax on it(thats the Incentivized). In 2017 you owe capital gains on $900.

However, AMT(alternative minimum tax) doesnt recognize ISO. So in 2015, you have to calculate AMT, which $400 counts towards. This is basically a no-deduction(except a high standard deduction) flat tax, you potentially owe 26-35% on that 400. Even though you didnt sell anything - this is where people get screwed.

So lets say you paid $100 in AMT. In 2017, you still owe capital gains tax on the whole $900, but you calculate AMT and claim the difference, up to $100, as a credit - the difference should be >100. You can actually claim this credit every year until previously paid AMT runs out, but most likely the difference wont be sizable enough until you sell.

For completeness, on ewams' question: if the options are non-qualified (NQSO instead of ISO) and FMV at the time of exercise was $500, you would owe ordinary income tax on $400 ($500-$100) of income in 2015 tax year and long-term capital gains on $500 ($1000-$500) in 2017 tax year.

Not a tax pro; this is not tax advice; yada yada.

Do companies actually change the type of options to NSO, ISO, RSA, RSU, etc? Or are they usually stagnant and non-negotiable?

Thanks for responding folks.

ISOs have a set of specific qualities that must be present to be treated as ISOs. Most established companies issuing options will be NQSOs. RSUs are a lower volatility version, but with less flexibility in terms of timing (I can't delay "exercising" my RSUs in terms of timing when I recognize the income).

You can make ISOs be treated approximately as NQSOs, but otherwise, you're generally getting from an established program and within a company, you don't have to be prepped to negotiate one type vs the other. Over time, the company will no longer be able to issue ISOs and may implement other programs, but they will tend to be "one type fits all" in general.

its always fun when the company issues you a boatload of options when raising money to offset the dilution... But they give the last round of investors a huge multiple, which effectively makes all the options worthless.

If the company isn't public, presumably you can't exercise risklessly, right?

Mostly true but sometimes you can sell on a secondary market or through a tender offer.

At least for one of my previous employers, the secondary market was not interested. I personally wouldn't count on it unless one is working for a highly visible startup ;)

Definitely true, and many times there are clauses preventing you from selling to a 3rd party before IPO anyway.

Usually those providers don't "buy" it from you.

They do fun things like giving you a loan with the options as a collateral. You would then default on the loan at the point of IPO.

So theoretically you don't sell them anything.

Interesting, I had never heard of that.

Did you get the cash and options the wrong way round in your example ($100k + 5000 options / $110k + 3000 options)? That bit confused me for a while. Or maybe I'm missing something about how they work!

Actually, his example works either way. Imagine this:

- $110k + 5k options, with 5M shares outstanding, at a strike price of $1 / share.

- $100k + 3k options, with 1M shares outstanding, at a strike price of $0.01 / share

Both are realistic scenarios for an early-stage startup. The 3k options in the second deal are worth much more than the 5k options in the first deal, on paper. (This is without even brining in valuation in question.)

My understanding is that strike price can be virtually unboundedly below current valuation of the share, given particular circumstances of a company, which makes this calculation quite sensitive to the valuation.

A call option on a share of Google with a strike price of $50 is worth a heck of a lot more than a call option on "name any startup" with a strike price of a tenth of a penny.

There are, naturally, cash flow implications to this.

Why would you assume 3000 options at Startup A are worth less than 5000 at Startup B?

I did that on purpose. Options in company A are completely different than options in company B, and assuming that more is better is just silly. 3000 out of 100000 is 3%; 5000 out of 500000 is 1%. But you can't just compare percentages either, because a percentage of a more valuable company is worth more than a percentage of a less valuable company.

As an employee, you just don't know. So value them at zero. Or, if you want to be fancy, epsilon. And take the cash.

I got offered a job 4 years ago at a very early stage company with really generous stock options. I didn't know what options meant, I didn't know that I had to exercise. That was pretty silly on my part but in my defense I was getting my visa, moving across the world, and working as the first employee trying to keep up with insane growth.

When the time came to raise our second round, I got intrested in how it would affect my shares and sat down to understand this whole shares thing. And to my dismay it turns out I have to pay for my compensation! I was pretty disappointed, even felt a little bit of resentment that no one took the time to explain things to me. But the reality is that your employer is not obliged to explain how your compensation works -- after all it's all in the contract (except it's written in awful legalese).

2 years later when I quit my job I was broke and barely had enough money to get by until my next paying job. Anyways I hustled to borrow money and exercise my options, all the while I still haven't understood the tax implications (I still don't!). My CPA told me that I can delay paying taxes on this until a liquidation event, and my coworkers who quit at the same time got similar advice. Now and after talking to others who exercised their options, that advice seems out of place and flat out wrong. I'm now trying to figure out what to do next, most likely getting a new CPA or a tax attorney. The whole thing is really stressful and I feel like startups can do better by their employees. At the very least substantially extending the exercise time and making it a standard in SV.

There are also issues around your employer offering you specific tax/legal advice. It opens them up to liability. They can say "here are how options work in general" but they'll always follow it with "but for your situation, you should talk to a CPA/attorney."

I also made the mistake of not working through the implications until a year or so in. Luckily, I joined early enough that my strike price (and valuation) was still low enough that I could exercise pretty easily.

Disclosure: It appears that my former employer has filed their S-1 in the last couple weeks.

Assuming you followed a professional’s advice I would really not worry about this stuff. Unless you make a lot of money or do something really strange your unlikely to get audited. Also, they don't generally go back very far even with an audit.

As to stock options they are best treated as lotto tickets. Unless you think the company is very likely to get sold or go public at a high valuation you’re generally better off ignoring them.

This is bad advice. You do not have to get audited to get yourself in trouble here. When you exercise options, that is reported to the IRS and their automated systems will ding you if you fail to report them correctly.

[Citaion needed] for public compaines or high value stock that's one thing, but this is private companies and small amounts of money which have very different rules.

PS: https://www.irs.gov/taxtopics/tc427.html

Statutory Stock Options If your employer grants you a statutory stock option, you generally do not include any amount in your gross income when you receive or exercise the option. However, you may be subject to alternative minimum tax in the year you exercise an ISO. For more information, refer to the Form 6251 Instructions (PDF). You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you do not meet special holding period requirements, you will have to treat income from the sale as ordinary income. Add these amounts, which are treated as wages, to the basis of the stock in determining the gain or loss on the stock's disposition. Refer to Publication 525 for specific details on the type of stock option, as well as rules for when income is reported and how income is reported for income tax purposes.


Not Readily Determined Fair Market Value - Most nonstatutory options do not have a readily determinable fair market value. For nonstatutory options without a readily determinable fair market value, there is no taxable event when the option is granted but you must include in income the fair market value of the stock received on exercise, less the amount paid, when you exercise the option. You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss. For specific information and reporting requirements, refer to Publication 525.

I recommend hiring an independent financial advisor, they probably cost $100-200 per hour in your area. (Banks will do it for free but they will also recommend that you buy garbage.) Ask them about options up front and see what they say. And also get an accountant to do your taxes. The cost is peanuts compared to the amount of capital you're dealing with. Just because you can learn how to do something doesn't mean it's worth it.

Unfortunately, not telling people the total number of shares outstanding is more common than it should be (10% of companies? heavily weighted toward the crappy ones, but some decent ones, including at least one of the top YC investments).

This is probably something which should be fixed by regulation.

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.

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.

>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

If it's a small private business, restricted share grants are pretty easy / cheap. Until you have a good basis for a fair market valuation (409a, raising an equity round, etc) employees can just pay the strike price for the shares, file an 83b election, and avoid most of the options calculus.

> so they take no risk of paying taxes on something which might be worthless

If a the time of a liquidity event the stock is worth less than an employee's strike price, they'll still be underwater. They'll either owe the loan back (the difference between the strike price and exit valuation) or the loan is forgiven and they owe income taxes on the forgiven debt. So there's still risk of owing tax on equity worth less than the current valuation at the time of their offer, right?

There is no underwater because employees don't pay anything for their shares.

So there's still risk of owing tax on equity worth less than the current valuation at the time of their offer, right?

Nope. Because of the 83b election, they pay no tax as the shares vest and pay no tax until they sell their shares.

I'm sure that "options are for suckers" has a powerful effect in your recruiting materials but I don't think it adds any value to this discussion. Options have real advantages, you don't have to exercise them "out of your own money", and you ignore that a ton of feathers weighs the same as a ton of bricks. (eg, you're not giving me more money just because you're giving me a promissory note).

There's no doubt that you've created a generous plan for your team. The description of your plan was certainly helpful and illuminating. But this thread seems like an odd place for a recruiting ad.

Definitely isn't a recruiting tool or an ad - in fact I don't even really go into the details of the plan when I do my recruiting because most employees don't really know the difference at that point. If it was an ad it certainly wasn't effective as nobody has contacted me :p.

I'm curious what advantages options give employees over a system like ours. I don't see any, and the whole point of our structure was to give employees lower risk and more comfort that they actually owned equity, not a promise of it.

It's not that options beat your system, it's that options are what's available and the point of this article is: do the math and understand your equity.

Right, and my point is that options aren't the only thing possible.

To the job candidate they really are. A rare company like yours notwithstanding. Happy new year.

I'm not sure about the specifics of your plan, but I have to commend you for figuring out how to give your employees actual equity (instead of options).

Stock is so much better for employees on almost every possible dimension and it's a real shame that more companies don't give it out, even when it's quite possible to do so (ex. early stage companies who have only raised convertible notes).

This is how to do your equity compensation founders. It would be the recruiting tool you need to hire people who won't work at most startups due to research or being burned in the past.

Thanks for sharing this. Thinking on how to do equity compensation right when you have no real profit to share was one of the barriers for me starting a startup.

At some point I will write it up with templates and all on our blog, but we need to focus on growth right now.

This is clever. Who put the plan together? #4 seems like something the IRS would look on unfavorably. Also, before a 409a valuation wouldn't you just be better off granting the shares outright and having employees write a check for $20 or whatever?

Our lawyer put it all together.

It used to be standard practice until a bunch of executives used it in the 80s to cheat the system.

I should note that this plan cannot apply to executives, for that reason.

Also, before a 409a valuation wouldn't you just be better off granting the shares outright and having employees write a check for $20 or whatever?

Yes that's definitely easier, but if you have had a round of financing even before filing a 409a the "valuation" can be determined as far as the IRS in concerned.

#4 is actually pretty clever. This way the employees are only taxed at the strike price of the grant as income vs. being taxed at the full value of the stock at the liquidity event. And all the profit from the liquidity event is taxed as long term capital gains. By being a loan vs. income, the stock given to the employee is not taxable until they actually sell.

When the liquidity event happens, the tax from a forgiven loan is very miniscule compared the standard situation.

If the company goes bankrupt, though, can't a bankruptcy trustee go after the employee to try to collect on that loan?

No, the non-recourse note is collateralized with the stock.

Hm, I thought IRS treated stock purchased with a non-recourse note as an option (since there's no risk to the employee). If that's true, then you can't take the 83b election. That is, unless you convert to a full recourse note, but then you're back to the employee cash liability thing again.

Interesting discussion here (for some definition of "interesting"): http://www.proformative.com/questions/exercise-stock-option-...

How does vesting work with this system?

Standard 4 year vest. Vesting doesn't really change.

Tax fraud is a hell of a drug.

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.

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.

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.

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.

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!).

"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.

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

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

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.

> will influence your relationship after the offer is accepted.

It will influence your relationship, positively.

Executives and managers always pay attention to these details and negotiate them when joining a company. The fact that you're paying attention signals that you actually understand what's going on and demands respect.

Some companies will refuse to give you this info and resent you for asking, but you should automatically reject such offers.

Err, no. Not always.

If a "rank and file" developer goes back and forth grilling them over offer terms, and is exceptionally picky above his peer group, this DOES make it back upstream in negative ways.

Some companies will not give you this as a matter of policy - , if you are ok with the salary, you could still enjoy working there - and may also make a great deal of money (or you might not).

> Some companies will not give you this as a matter of policy

Then don't work for those companies.

Ones goal in life should not be to get exploited at shitty startups as a "rank and file" developer (aka chump).

Some parts of companies can be corporate and still have some other very good parts.

All being said, if at that stage of a job offer, you don't want to be looking like the most important thing to you are your options. If you get a decent salary and like the work, you are not being exploited.

If everyone asks for such things, then boards will get the message and make this standard to compete.

Or you know, the board might not be a dick. Some of us founders are less outright hostile to employees and we are definitely on the board (usually with majority when the first 20-50 employees are coming on).


The approach you imply is the approach I've taken. Work with founders that I trust, verify the details of the deal to the best of my ability and assume that good people do the right thing for other good people.

Right. A CTO could negotiate these terms. Everyone else should value their options properly at 0

Restrictions on transferability is standard for a private company. Kudos if you are able to negotiate this but I think a small company would be crazy to agree to this. It opens the door to a whole list of potential burdens for the company.

> Restrictions on transferability is standard for a private company

A right of first refusal (ROFR) is a reasonable transfer restriction. So is a lock-up period, e.g. you may not sell these shares within N years of getting them. Bans, on the other hand, are not. For a common stockholder, requiring board approval is a cutesy way of saying "ban".

You're basing this on what? Not saying your wrong but what is the basis of this opinion ?

Employees usually get restricted stock until there is a liquidity event.

"Restricted stock" means the securities are un-registered [1]. The minimum holding time is 6 months. All stock issued by a privately-held company is "restricted stock". Practically all other transfer restrictions are at the company's discretion.

ROFRs are the only restriction I've seen widely enough to merit calling "standard". Everything else exists in different forms in different companies, all the way up to being wholly non-existent for some combination of employees, executives and institutional shareholders.

My work involves helping private companies raise capital and investors (mostly institutions) sell privately-held positions.

[1] http://www.sec.gov/investor/pubs/rule144.htm

What I meant by "restricted" is that it's a restricted class of common stock. i.e. you don't have the same voting rights as the owner or investors in the company.

Your experience is working with investors. Your advice makes more sense from that point of view. Employees are rarely (read Never) afforded the same privileges as the investors.

I think that this is a reasonable right to hope for.

No need for us to boot-lick and perpetuate a minor injustice against employees and labor here...especially one that is causing long-term harm to the ecosystem.

You are a lot more likely to just get conversion from ISO to NSO and 7-10 year window for exercise, than either of these (which I've never seen).

You could also get early exercise. That, personally, is what matters the most to me in a company with common valuation <$100mm. I have very very little interest in holding options; shares (either directly via grant, or via early exercise), or RSUs (which are even flimsier than options, but at least come in public companies.)

I imagine cashless exercise is only valuable for ISO options that expire 90 days after leaving?

Generally, you'll want to hold your options until the company is public or acquired, so you wouldn't need to worry about this.

If you are receiving NSOs, it is best to be at a company where they expire 7 years after leaving.

Even if you cashlessly exercise, you are still going to have a tax-bill problem, which can be a huge problem if current FMV is far higher than strike.

Is it common for engineers to be granted these terms if requested, even if they're not already baked into the company's existing documentation?

If the company hadn't done this before, they'd need to think through the implications for their processes, and probably get a legal stamp of approval. They might not be willing to do this, and instead pass on even a potentially great employee.

With an early-stage company, i.e one having not yet raised its Series B, a high-value employee should be able to negotiate almost everything. The earlier-stage and higher-valued the employee, the likelier the company is to budge.

I wouldn't encourage anyone to turn down an offer for its lack of cashless exercisability. The lack thereof, however, causes pain. That should be compensated for. On transferability, I would mark down non-transferable stock to zero in any salary-or-equity trade-off calculation.

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.

thanks for sharing! :)

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.

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).

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.

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

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.

This doesn't seem to be a requirement with esofund

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.

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...

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.

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:


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

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.

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.)

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.

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%?

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.

Co-founder? You could call me "Company Wizard and Lord of Space and Time" and I still wouldn't take a 40% pay cut. That's outrageous.

And you are not the kind of person who would ever want to leave a corporate job to work at a very early stage startup. And that's fine.

But a 40% pay cut is within the the norms for that sort of transition. It can be a good move for some people.

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.

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.

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 CO 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.

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.

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.

> but I do not believe you're entitled to founder status just because you're an early hire

That's not what I said at all.

Early employees that are paid a fair market salary are absolutely not entitled to founder status, and in some cases not even substantial equity.

Then find yourself another key engineer. :) Or perhaps you do not know what "key" means?

It is rude to lie to people about the value of their options to hire them. ("Your options are 0.866% of the company"). But to try to defend that practice in public is just hilarious.

Heh, at least now we know what it does take to be a cofounder :)

Sarcasm is a crude tool for communicating your point, it also causes me to have less empathy for you.

> It is rude to lie to people about the value of their options to hire them. ("Your options are 0.866% of the company"). But to try to defend that practice in public is just hilarious.

I never once stated that one should lie to employees about the value of their options. Those conversations are always highly specific to the situation, the negotiated contract with the person, and how fluid the actual current "valuation" is. It's very difficult to pin-point a true value for a set of options in a private company - sometimes you can come close, particularly once major funding events and milestones have been hit, but it is still difficult. I usually do my best to have a candid conversation with prospectives or currents about that value. A lot of founders do.

If all you care about is the financial upside in joining a startup, then I will always say that you should not join one. The risk is very high and it takes an enormous amount of cooperative collaboration from numerous people that are willing to be "in it together" - it also takes many years before you have something valuable enough to make those early options worth it. If you get in before the Series A and you really give it your all and it's a good product that people want and you're surrounded by peers who are the top of their game and you've got excellent leadership: Hang on because it will be a rocket ride. If not, then it might not be worth it.

The other reasons to join a small startup are numerous. In the early stages it's mostly intangible and the later stages are usually very tangible. The "option" for a financial upside is there and should factor into how much risk you're taking as an early employee, but unless that is all you care about then it should not be the only factor in your censure of an organization.

Figure out what's important to you and act accordingly.

> Heh, at least now we know what it does take to be a cofounder :)

Become one. You'll find out. I've been unable to accurately convey it to people it seems; most think it's glamorous. It is not. Most think they're entitled to it. They most likely are not. Most think founders have the upper-hand. Very few ever do (hint: the board and the investors control the strings more than most think).

>Most think founders have the upper-hand. Very few ever do

Upper hand, n: having better knowledge, information, or otherwise situation than the rest. Compared to the employees founders most definitely do. Eg: how many startups will give you the answers to the listed questions easily? Founders have them.

I am not saying founders are above all, but they definitely have the upper hand when compared to those pesky employees who want to know the value of monopoly money they are claimed to be paid with.

You've clearly been burned in the past and I'm sorry that was your experience. Not all founders, executives, or organizations are like that though. You will always have to grapple with sociology, hierarchy, and power structures but that's a fact of human life - not all are "bad" though.

It's also on you to be clear about what you want and to vet orgs and people. If an org will not share sensitive information with you in order to make a sound decision, then I certainly would not join it. If the leadership won't go to bat for their own people or honor their word, I will not work for them.

> unless that [money] is all you care about

It is. If i wanted to change the world, I'd join the red cross. Attempting to make someone feel bad for only caring about pay, as a way to get them to work for worthless options only works on some people. :)

Again, there you go with saying I've said something I did not. I never once said you should feel bad for only caring about money, I said if that's all you care about, I would go do something else that's more lucrative and predictable (work in the fintech sector or defense sector, lots of money there).

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

As someone who has been the first employee at two different startups, it doesn't warrant co-founder status.

Yes, it's going to be a lot of work. But you never go without salary and never have the same stress level or expectations as founders. At the end of the day, you're still an employee—a key one, who should be compensated with single digit equity, but an employee nonetheless.

Can anyone justify the down-voting here?

Are they offering options for stock, or stock? Make sure it's real equity.

If it was me, I would start at 5-6% and negotiate from there.

Assuming that this opportunity could turn into something huge, I highly recommend taking some negotiating training, if you have the time. Back when I was an executive, I was given a week-long negotiating training session. It was seriously the best, most useful training that I'd ever had in my career.

What kind of training was this, can I look it up? Or perhaps the training isn't available, but it's derived from somekind of methodology. In that case, what methodology was it?

I tried to look up the team that they brought in to give the training, but I couldn't find them. It was several years ago, but I remember that the main guy was one of the more popular authors. He had a series of books written that ranged from basic to advanced skills. I wish I could remember his name.

The books are probably useful (there are a ton of them), but the live sessions are likely much more effective because you get to practice the techniques, see the subtleties, and experience the results directly. For me, seeing the results really helped train my brain.

Honestly, I went into the training dragging my feet and expecting the worst, but it's given me a huge edge. The results have been amazing - especially when negotiating with unskilled negotiators. I've gone into negotiations expecting X and consistently getting 2X, sometimes even 10X.

In order to answer your question there are a couple of important data points that need answering:

1) Are any of the three co-founders engineers? Or are you expected to run engineering?

2) How senior are you? Will you be expected to take on a leadership role or, after they hire a couple more folks, will you just be one of the team?

3) What is the fundraising situation for the company?

4) Has the company released a product to the market? If so, how much traction is there?

The first two questions go towards answering how important you might be to the organization. Obviously more important -> more equity. The last two questions go towards evaluating how much success has been achieved already. More success -> less equity. Though less isn't necessarily a bad thing here as you'll be joining a company with a greater chance of success.

> The role is being a 'first key engineer' hire after the three co-founders.

I've been in that role for two different companies.

First of all, you should never accept a ~40% under market pay cut (at least if your "market" is mid-to-senior developer). A 10% cut is reasonable, but you should absolutely never accept less than ex. $130k in SF.

In terms of the equity grant, you can find some average here: https://angel.co/salaries

It should absolutely be at least 1%, but the specific percentage is going to vary a lot based on your perception of the company's value. Put yourself in the shoes of an angel investor and try to imagine what valuation you would invest at. This can include factors like (a) what did other investors invest at, (b) founder history/background, (c) market potential/size. Then take whatever annual salary you're giving up, multiply by 8, and ask for that percentage.

40% is a _dramatic_ cut. You are not gonna see raises no money ifor years till options vest. Say three years. Now stack 40% of your gross yearly rate times 3 and ask yourself: what are the chanches those options will be worth that much?

First step, put on your negative nancy glasses and deep dig. What is the chance of success? Are they shipping? Profitable? Do they have a bunch of big competitors to try and overcome? A kind of stupid idea that probably won't work? The founders will sell you on the dream, you need to dig into the other side.

For me - I would cofound for 40% less pay(and say get 10-30% of the company), but not be engineer #1 for <5%. At the end of the day, a job is a job, why work for less than you are worth?

Think of it from another perspective. If you were just an investor, would you take pay 40% of your salary, per year, for those options?

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.

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

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.

I haven't, but a coworker has. I'm not sure what the brokers cut was - but as far as I know it was pretty straightforward, with the broker handling all legalese/paperwork.

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.

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?

How about exceptional 401k contributions? I believe the employer / employee contribution limit is around 50K / year, as an employee I feel like it'd be much clearer cut & less arduous if an employer just dumped extra money into a retirement vehicle, it's tax deductible by the business and the tax ramifications for employees is much clearer.

Perhaps issue a interest bearing senior bond to the employee in return for services rendered?

Bonuses based on how well the company does.

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

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.

RSUs are far better, especially for a later stage company.

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...

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


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

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.

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.

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

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.

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.

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.

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".

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.

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.

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.

> 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.

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

> My after-tax salary is less than $100,000 USD/year

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?

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.

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...

"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.

I'd rather have the RSUs (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.

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

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.

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..

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.

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.

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.

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/

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?

It's not even a fact - she can exercise the options more slowly than she is given them and still exercise all of them.

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.

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... .

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.

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?

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.

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).

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.

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

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?

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?

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

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.

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.

Right. A "contract" like that will restrict their ability to raise money. They'll just move on to the next guy who knows nothing about options (most of us) and isn't so demanding.

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.

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

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.

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.

The Social Network movie shows some classic screwings in this case.

In theory, the company has a legal fiduciary duty to act in the best interest of the shareholders. If they try to rob the shareholders by unreasonably diluting, you could sue for breach of that responsibility.

In practice, nothing really prevents it completely. However, the founders will generally be getting diluted the same amount as you so their interests are somewhat aligned with yours to negotiate a reasonable dilution amount. If they make some deal in which other shareholders get diluted much worse than themselves, it's often strong grounds for a legal suit.

Real life extreme dilution example:

How Mark Zuckerberg Booted His Co-Founder Out Of The Company http://www.businessinsider.com/how-mark-zuckerberg-booted-hi...


Dilution isn't so much a bad thing, as long the company value goes up enough to compensate.

Nothing - and it leads you to an even more difficult place. Imagine a late stage startup that has raised, say, $40m. You leave and execute your shares. Now they do another raise, but the company situation has changed and the next round is a down round, or maybe it's an up round, but the money has a 2 or 3x liquidation preference on it. Ugly.

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.

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!).

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.

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.

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.

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...

I have an extraordinarily limited understanding of these things, but I always thought it was because if you were gifted equity you had to pay taxes on it immediately, based on the current valuation, which is a major bummer.

The employee has to pay for the shares and any taxes up front. In the very early stages, this is ideal because the shares are worth nothing. Eventually the shares are valued high enough that the upfront costs are prohibitive.

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

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.

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...

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

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.

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. :-)

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