Fielding offers from start ups who are urging you to trade cash for equity? Do your due diligence and learn what the true value is of stock options offered to you.
3. Hypothetical
You are making $200K/year today
The start-up offers you $100K/year + discretionary 10%
bonus + $100K in equity
The $100K in equity will be paid over a four-year period
after you have been employed for one year (a “one year
cliff”)
Over those five years of your employment, you will
receive $20K in equity per year
Does the company expect the value of the equity to
double by year two, triple by year four?
Then you will have exchanged $100,000 in compensation
every year in exchange for $40K/year by year two and
$60K/year by year four.
You have still not made up for your $500K investment
4. Willyouhitthejackpot?
In 2019, the failure rate of startups was around 90%.
21.5% of startups fail in the first year, 30% in the
second year, 50% in the fifth year, and 70% in their
10th year.
6. Howthestart-upvalues
itsequity
The company hires an independent appraiser to
provide a 409A valuation that represents the market
value of all shares of the company’s equity.
When the company tells you the value of your stock
options, it is generally referring to that valuation.
That valuation is not the value of the stock options to
you.
When your options “vest” (usually after your first year of
employment) you can purchase the option at the strike
price.
If the “strike price” is $10/share and the trading value at
the time the company is acquired or “goes public” is
$15/share, the value of the option to you is only $5/share,
not $15/share.
Your options only have value when they are worth more
than the strike price.
7. Canyoucashinoptions
andselltheequitywhen
theoptions vest?
You can exercise your options after they vest, i.e., you
can buy the vested portion of your equity
But there is no market for the sale of the equity you
acquire unless:
The company has been acquired;
The company has “gone public” and its shares are now
trading on a stock exchange;
The company has agreed to buy the shares back from you
at their then fair market value when you exit the
company before acquisition or IPO; or,
You can find an outside purchaser
Most such investors tend to buy stock in Series C companies
or later and that have strong revenues (more than $30M
per year).
In addition to finding a willing buyer, you will have to seek
the company’s approval to sell pre-IPO or pre-acquisition
shares
8. Willthevalueofmy
equitybedilutedin
futurefundingrounds?
Unless you have a non-dilution clause in your stock
option contract, the value of your stock may well be
lessened when the company raises additional round of
venture capital
Of course, additional rounds of venture capital should
also raise the fair market value of your shares
The difference can be minimal or devastating (see The
Social Network)
9. Aretheretax
consequences
Yes! But you’ll need to ask your accountant
The consequences vary whether your option is
classified as NSO (non-qualified stock options) or ISO
(incentive stock options)