how to evaluate startup stock options

^{Here is a step-by-step guide to calculating the value of your options as precisely as possible:}

• Use the last investment round as a baseline. What was the amount raised in the last round, for what % of the company, and how many outstanding shares are tehre? ...
• Discount invested funds spent. Assume the last round was intended to last 18 months. ...
• Discount that amount for your class of stock. If you're being offered an underprivileged common stock class, where a significant participating-preferred class gets a 1x or more liquidation preference, you ...
• Subtract the exercise price. As in the exercise above, if the exercise price is $0.20 per share, subtract that from the intrinsic value of your options relative to the share ...
Do the Math. Taking the most aggressive $0.50 per-share value, $0.50 x 100,000 = $50,000, or $12,500 per year of value to you as a benefit.
Other considerations. Consider things like future dilution vs growth prospects of the company. More than likely, the company will have to raise 1-2 more rounds before all your options vest. ...

Full Answer

How do you calculate stock options?

You calculate the compensation element by subtracting the exercise price from the market value. The market value of the stock is the stock price on the day you exercise your options to buy the stock. You can use the average of the high and low prices that the stock trades for on that day.

How do employee stock options work in startup companies?

Private company stock option grants: a founder's guide to who gets what, when

• Size of the option pool. After the formation of a startup and prior to any significant financing, companies should and often do consider establishing a pool for providing equity grants ...
• Grant size. ...
• Vesting. ...
• Pricing. ...

How to understand private company stock options?

Stock options have an exercise or "strike price," which is the price you must pay to actually become an owner of the underlying share of stock. In private companies, valuations are often far more subjective and lack the higher valuation or premium associated with public companies. As a result, you may have more success negotiating a larger ...

What is the intrinsic value of stock options?

The intrinsic value of stock options is one of the factors – along with time value – that contribute to the value of a stock option. For an in-the- money stock option, intrinsic value is the difference between the strike price and the price of the underlying stock. For an option that is at-the- money or out-of-the- money, the intrinsic value is zero.

How do you evaluate a stock option offer?

10 Tips About Stock Option Agreements When Evaluating a Job OfferExactly what is a stock option? ... How many shares will my option allow me to purchase? ... What's the exercise price of my initial options? ... What is the company's total capitalization? ... How many other options will be authorized?More items...

What is a normal amount of stock options in a startup?

Understanding how option pools work and why they've been growing is critical, as they will affect dilution. Employee option pools can range from 5% to 30% of a startup's equity, according to Carta data. Steinberg recommends establishing a pool of about 10% for early key hires and 10% for future employees.

Do startups offer stock options?

Most startups give employees Incentive Stock Options (ISOs), though some use Non-qualified Stock Options (NSOs). For this post we'll assume that we're only dealing with ISOs, but you can read about the difference here. There are a few key components to an equity offer that you should always look for.

How do startups negotiate stock options?

Many startup employees give up part of their salary for a share in the company's long-term success. Here's how to negotiate your equity package.Keep an eye on your vest length. ... Watch out for the cliff edge. ... Keep strike prices down. ... Spread the load equally. ... Need for speed. ... Have one eye on the door.

Is 1% equity in a startup good?

Q: Is 1% the standard equity offer? 1% may make sense for an employee joining after a Series A financing, but do not make the mistake of thinking that an early-stage employee is the same as a post-Series A employee. First, your ownership percentage will be significantly diluted at the Series A financing.

How much equity should a CTO get in a startup?

Companies that are public or have over 10k+ employees typically offer their employees the least equity as most. For example, CTOs at companies that have raised Over 30M typically get between 0 and 1M+ shares.

Should I buy options in my startup?

High Certainty Of Growth. Startups are usually loss making. But if there is a high certainty of growth with a proven business model that will allow the company to eventually make a profit, then it's probably a good idea to buy your options. You should know better than most how well your company is doing.

How much stock options should I ask?

You typically can ask for 0.25% to 2.0%. The company has NOT issued a stock option during its last fundraising: Then it's a little trickier again. You will be promised stock options that will happen in the next fundraising.

What should I ask for in a startup package?

Things to ask for: Remember to tie all asks back to your productivity and impact.Salary. ... Summer support. ... Moving costs. ... Tech, grant, and/or teaching support.Travel and development. ... Reduced teaching load. ... TA or RA support.

What are the challenges of evaluating incentive stock options?

One of the biggest challenges people face when evaluating job offers that include Incentive Stock Options is understanding the current -and potential future value- of their ISO stock option grant. In order to do that, you have to know how many shares you have, how many shares there are total, and a rough estimate for how much the shares are worth now. Let’s take a look at why, before we delve into how to find those numbers.

How to find the future value of a grant?

To find the future value, you have to have a ballpark figure for the percentage of the company that you have been granted. If you know how much of the company you own, you can guestimate the valuation of the company at IPO or acquisition, then simply multiply by your ownership percentage to get a future valuation for your shares.

Why is the strike price important?

Because of that, you want the share price to be as low as possible when you get your grant, and as high as possible when you end up selling your shares. When people join later stage startups with higher valuations and (generally) higher grant dollar values, it becomes even more important to know the value per share so you know your cost to purchase. It doesn’t matter if your stock is worth $1,000,000 if you have to pay $999,999 to buy it.

Do you need to figure out the share price of a grant?

Now we know that we have to figure out the share price and total number of shares to understand the present and future value of the grant, it’s pretty clear that we’ll need to do some research. In some cases, you can just ask for those numbers, but companies can be secretive if they are raising funding or don’t want to disclose their valuation. Either way, we’ll assume for the purposes of this post that you need to find some of this information on your own.

Does Uber have diluted shares?

Shares get diluted: Uber has had about 10 funding rounds since 2011, each one of which created more shares, causing your shares to be diluted. In plain English, there are more shares in the total pool but you didn’t get any more, so you own less of the total. More than likely, another 500m-1b shares have been created, causing your .09% equity stake to fall to .04% or worse.

What is stock option?

Stock options are not stock. If you were given stock outright, you would have to pay tax on its value immediately. This would require you to have a large mattress containing a lot of cash that you didn’t mind spending, risking and probably losing. Instead, stock options represent the right to purchase stock from the company at a fixed price (the “strike price” - see below), regardless of its market value. If the company is sold for $10/share, you can buy your stock at $1/share (or whatever your strike price is), sell it immediately and trouser the difference. All being well.

How to calculate the value of options?

The quick way of calculating the value of your options is to take the value of the company as given by the TechCrunch announcement of its latest funding round, divide by the number of outstanding shares and multiply by the number of options you have.

How is TechCrunch valuation set?

Of course, the TechCrunch valuation is set by investors who pay a fraction of the tax rate that you pay. Knock the real value of your options down another peg or two.

How long do you have to vest your options?

When you are granted a chunk of options, they will probably come with a 1 year cliff, 4 year vest. This means that the entirety of the grant will “vest” (or “become yours”) over a 4 year period, with a quarter vesting after the first year “cliff”, and an additional forty-eighth vesting each month after that. If you leave within the first year, before reaching the cliff, you forfeit the entire grant. If you leave before the 4 years are up, you do so with a proportional fraction of your options. You should note that if you leave before the company is sold, you will probably have about 3 months to purchase your options before they vanish forever. This can be prohibitively expensive. More details below.

What happens when you own options?

As already mentioned, when you own options, what you actually own is the right to purchase shares at a set “strike price”. The strike price is set by a 409a valuation report that determines the “Fair Market Value” when the options are granted. Suppose your options have a strike price of $1/share, and the company eventually IPOs for $10/share. Your actual payoff per share is the $10 you sell it for, minus the $1 that you have to pay to actually buy it in the first place.

How long do you have to buy options if you leave a company?

You should note that if you leave before the company is sold, you will probably have about 3 months to purchase your options before they vanish forever. This can be prohibitively expensive. More details below.

What happens if a VC buys shares?

Assuming they are neither morons nor terminally unlucky, this diversification reduces their relative risk . Of course they are also investing money that doesn’t belong to them and getting paid fee-plus-carry, so their personal risk is already zero, but that is another story. As a wholly undiversified lottery ticket holder, you are extremely vulnerable to the whims of variance. If your company goes bust then your entire “portfolio” is wiped out. Unless you are a financial adrenaline junky, you would much, much rather just have some actual cash that will definitely still be there tomorrow. If you have options with an expected but extremely risky value of $200,000, but you would actually sell them for $50,000 just to get some certainty in your life, then they are only worth $50,000 to you and you should value them as such when calculating your total compensation. The delta between these two figures is the risk discount.

How to get shares of options?

In order for your “options” to become “shares”, you need to “exercise” your options. That means you need to write a check. If you have 10,000 options, and the strike price is $0.10, you’ll be writing a check for $1,000 to your company to get those shares.

How long do you have to work to get an option?

This means that you actually have to work for the company for some period of time in order to earn the options. A common vesting period is 3 years for employees.

How to find ownership percentage?

To find your ownership percentage, divide your number of shares by the total shares outstanding. Here is a table showing the relative ownership percentage for an employee with 10,000 options in a few different scenarios.

How long do you have to exercise your options after leaving a company?

If you decide to leave the company, you normally only have 90 days to exercise your options. That means you’ll be quitting, and writing your boss a big fat check on the way out the door. Lots of employees don’t exercise their options upon leaving the company, which means those options were essentially worth $0 to the employee. (So much for making up for a lower salary!)

What does preferred share mean for VCs?

When VCs invest in companies, they almost always get “preferred shares”, which come with a few extra features. One of these features is a “liquidation preference”. This means that, if the company is acquired, the preferred share holders each get their initial investment back before any other share holders get a dollar.

Do privately held companies have an advertised share price?

But privately-held companies don’t really have an advertised share price, so knowing how much your shares will be worth is tricky. You need to know both the number of shares you have options to buy, as well as the total number of shares that have been issued for the company.

Is common stock worthless?

If a company doesn’t sell for more money than it has raised from investors, common stock is basically worthless.

What is a startup stock option?

Stock options aren’t actual shares of stock—they’re the right to buy a set number of company shares at a fixed price, usually called a grant price, strike price, or exercise price. Because your purchase price stays the same, if the value of the stock goes up, you could make money on the difference.

What are employee stock options?

There are two types of employee stock options: incentive stock options (ISOs) and non-qualified stock options (NSOs). These mainly differ by how and when they’re taxed—ISOs could qualify for special tax treatment. Note: Instead of stock options, some companies offer restricted stock, such as RSAs or RSUs.

What does vesting mean in stock?

Vesting means you have to earn your employee stock options over time. Companies do this to encourage you to stay with them and contribute to the company’s success over many years.

What is a stock option grant?

Stock option grants are how your company awards stock options. This document usually includes details like the type of stock options you get, how many shares you get, your strike price, and your vesting schedule (we’ll get to this in the vesting section ).

How long do stock options last?

Your stock option agreement should also specify its expiration date. In general, ISOs expire 10 years from the date you’re granted them. However, your grant can also expire after you leave the company—you may only have a short window of time to exercise your options (buy the shares) after you leave.

What happens to your shares when you leave a company?

Termination. If you leave the company, your shares will stop vesting immediately and you can only buy shares that have vested as of that date. And you only maintain this right for a set window of time, called a post-termination exercise (PTE) period. Historically, many companies made this period three months.

What happens if you don't get a cliff on your option grant?

If your option grant includes a cliff, it prevents that.

What information is provided when you receive an option grant?

Typically, very little information is provided when you receive an option grant in an offer letter. You are usually just shown the number of options you will receive and potentially the vesting schedule. If part of your compensation package involves an option grant you need to ask the following four questions so you fully understand what you are getting.

How does vesting work?

A standard vesting schedule is 25% vested after the first year and then monthly vesting for another three years until you are fully vested after four years. You should also confirm that the vesting will start on your first day, not when the option is finally approved by the board because this can make a material difference if you have “standard” vesting schedule.

When should startups offer stock options?

So those are a couple of broad outlines of “how.” Now let’s talk about “when.” James says that for the first five employees , restricted stock makes sense.

What are the advantages of startup stock options?

Before we dive into the “how,” let’s talk about the “why.” Considering the fact that most founders aren’t financial experts and many have never founded a company before, why add the headache of figuring out startup stock options ?

How to assign stock options based on percentage?

Assigning stock options based on percentage is relatively simple. You say “You, employee, own X% of this company.” So, if we throw some numbers in there, you could give an employee 1% of your company. If your company exits for $100 million, they would make $1 million. Pretty clear, right?

Why are stock options good for employees?

Stocks are relatively low-risk for employees. “Stock options are great because employees participate in the upside without taking on any downside risk ,” James Seely, head of Marketing at the ownership management platform Carta tells Startups.co.

How long should stock options be covered?

Experts recommend that this gap be covered for generally around two years — but each company’s mileage may vary.

What does it mean to be a partial owner of a stock?

A stock is a portion of ownership in a company and, for some people, being a partial owner is a great motivator for working even harder. People feel a greater sense of investment and pride in anything — a house, a business, a car — when they own it.

What is equity in accounting?

Equity: the value of shares being issued by a company; “one’s degree of ownership in any asset after all debts associated with that asset are paid off.”

How much equity do you give to a contractor?

If giving it away to contractors and service providers, or exchanging it for good and services, be very stingy, and plan to give no more than 3-5% in aggregate. If you have to give a bigger lot to a single individual for their services, you may be looking at a co-founder or a first employee, rather a service provider. If they are truly a co-founder, convince them to come onboard with your mission and vision, and use existing frameworks to split equity (such as our own Co-founder Equity Split ). If they are an early employee, use industry benchmarks to arrive at their equity compensation (and make sure they have vesting).

How to derive value in the absence of trading data?

In the absence of trading data, there are generally two ways to derive value: Compare the thing that you want to value to similar things with quoted prices in active markets or identical things in inactive markets, or things which can be priced by taking into account non-price inputs.

What is the value of a pre-investment?

In reality, a pre-investment, unpriced, pre-revenue, early stage startup should be considered as having a value near $0.

What is valuation in finance?

In its simplest terms, the value of a “thing” (or security) is the price (in cash or cash equivalent) that two people (a buyer and a seller) agree upon during a transaction.

Do pre seed companies have real assets?

Few pre-seed startups have any real assets. What investors will eventually base the startup’s value on is its team: startups have people with ideas and ambitions and know-how, which is why the investor believes it will be successful, but these people are (of course) not owned by the startup and can walk away.