how to value stock options in a startup

^{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. ...

How much are Startup stock options worth?

Those shares could be worth $.10 per share, or $1000 per share. All that’s necessary to calculate the value of startup stock options is A) the number of shares in the grant and the current price per share or B) the number of shares in the grant, the total number of shares, and the total valuation of the company.

How do you assign Startup stock options?

The other way of assigning startup stock options is “to think of equity in terms of dollar amount,” according to James. “For example, ’I own 2,000 shares in Meetly, and investors paid $50/share in the most recent round of funding, so my equity is worth roughly $100,000 today,’” James says.

What do you need to know to value a stock option?

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. Why do we need so much information to value a stock option grant?

What is an options Option in a startup company?

Options in a startup company do a great job of aligning investor, manager, and employee incentives. They can also return life-changing sums of money for employees when things go well.

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.

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.

How long do you have to stay with a firm to vest?

Vest: “Employees might be given equity in a firm but they must stay with the firm for a number of years before they are entitled to the full equity. This is a vesting provision .”

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 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.

Is it exciting to get a grant for stock options?

There’s not too many things more exciting than landing a big stock option grant in a hot new startup. However, the potential future value of a grant hinges on many factors. Make sure to take all of them into account!

Can you get excited about stock options?

It’s easy to get overly excited about stock options, so there are some caveats I wanted to mention that help me keep an even keel as I consider the potential value of my options.

Is there a criminal lack of understanding about startup stock options?

If you follow me fairly regularly, then you know I feel there is a criminal lack of understanding about startup stock option compensation. With the rapid growth of technology and venture capital, stock compensation has become increasingly common. Unfortunately, most people know little to nothing about what an ISO stock option is, when to exercise them, when to sell them, or how they are taxed.

Can you sell stock options if the company is public?

The shares will not have value unless they can be sold: Keep in mind that it is nearly impossible to sell startup stock options unless the company is public, or it’s acquired. There are companies that intermediate transactions in private company stock, like Sharespost, but not all companies allow their stock to be sold in secondary transactions. Some companies will allow employees to sell shares during financing rounds (Uber and other late stage companies have done this), but it’s uncommon.

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.

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).

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.

Types of startup equity

Any competitive startup's pay package includes equity. Equity is usually in the form of stock options (ISOs and NSOs) or Restricted Stock Units (RSUs). For early-stage startups, stock options are far more common than RSUs.

Valuing your stock options (i.e., what is my startup equity worth)

Whenever we work with a client who is negotiating startup offers, we will ask how many stock options they'll be receiving in their offer, the strike price of those options, and the latest preferred price. Sometimes recruiters try to withhold this information.

How much equity should you expect from a startup?

Data on compensation is extremely situational. What an employee receives in terms of stock, cash, and bonuses is determined by their role (i.e., technical vs. non-technical), the industry they work in, where the startup is located, and of course, seniority. On top of that, perhaps the largest factor is what stage the startup is at.

How to negotiate your startup offer and specifically more stock options

It should be no surprise that cross offers will enhance your chances of receiving a better offer. Leveraging the range associated with preferred prices when comparing between two offers is a tactic we see work quite consistently.