A company offers you a job that comes with options. You’re excited and you’re a bit overwhelmed. How valuable is this offer, exactly?
The big thing is knowing what percent ownership you have in the company. This is even more important than how many actual options you get. You can figure out your percentage by dividing your number of options by the total number of shares outstanding. Those outstanding shares include shares issued to the founders, options reserved for employees, and shares sold to investors. Typically, the amount of options reserved for you and your colleagues (and future colleagues) is around 10-20%.
Also check your option grant letter itself for your strike price, which is the cost to turn your option into a share in the company. At the time of your offer, your strike price will be the current Fair Market Value (FMV) of a share, which is determined by a 409a valuation. If things go well for the company, the FMV will increase, while your strike price doesn’t change. The difference between the FMV and your strike price is what you stand to profit. Where can you find the FMV? Try a company-sponsored tool like Solium Shareworks or Carta.
But this is just the beginning of your sleuthing. You want to validate that your ownership percentage is accurate and understand how your offer stacks up to other companies. We know who can help you. (Hint: It starts with ‘vest’ and ends with “ed,” as in education.) Our database shows you how ‘fair’ your offer is depending on your role and the stage of your company. For example, you might find out that the average percent ownership for a VP of Product for a Series C company is .002% and you’re only at .001%. It’s good to know your options, so to speak.
As more people get hired, the pool gets refreshed as new options or shares are created and that causes dilution.
Dilution happens because each owner then owns a smaller percentage of the pie (and each share is worth less). This is inevitable as new investors get onboard, so don’t get too fixated on your ownership percentage.
Sure you own a smaller percentage, but it’s a smaller percentage of a more valuable thing. That’s the trade everyone makes.
OK, so now you’ve done your research and you find — gasp — that your equity percentage is below our benchmarks. Don’t panic just yet. There are a few things to consider if this is the case.
Do they offer performance-based equity grants?
This is a way for companies to provide further incentive for employees to meet company goals. Usually these grants are contingent on you adding value in some way to the company. For example, you come up with a new product feature or you rank in the top 10% of performers or you beat 50% of your deadlines, and in exchange, you get additional options or shares.
Do they give you more salary to compensate?
Some startups will bump up your salary if they are unable to offer something competitively attractive for equity ownership. This is important to consider as most employees actually leave after two years (when they would likely only be 50% vested). You want to think about how much money you need now and how much you believe in the company. (Keep in mind that venture capitalists (VCs) invest in 100 companies to make it big on one or two.)
Do they reward you for staying longer?
The average tenure at startups is two years. Part of the lure of hanging on is that you get more vested as you go. Yet some companies realize that after you’re fully vested (typically four years), you might lose motivation because you aren’t earning any new equity. The dangling carrot? Offering additional options in year 3 or 4.
Contrary to popular opinion, you don’t need to wait for your company to IPO (Initial Public Offering, essentially when it goes public) or be acquired to cash in on your options.
Sell your options to outside investors
Companies are staying private for longer than they ever have. There’s now more access to capital than 10 or 15 years ago, so they don’t need to resort to going public to keep themselves well funded. And now outside investors are angling to get in on the growth of these private companies. One way to do it? Buy employee shares.
There are a number of platforms, such as EquityZen or SharesPost, that match accredited investors with employees looking to sell their shares. And you can do this whenever you have some, or all, of your shares vested. Simply let them know how many you want to sell and your desired price and they will try to make magic happen.
It’s tricky, though. Investors are cautious because information is harder to come by for private companies. They can’t easily figure out the value of the company and the shares can’t simply be traded on the stock exchange. Plus, private companies have rules about who can buy the shares, and how and when they can do it.
Get a loan from outside investors
The other way investors can get exposure to stocks at private companies is by making loans to employees like you so that you actually have the money to convert your options to shares. So what’s in it for them? The chance to get paid back when your company goes public or gets acquired. And, you guessed it, to get paid back more. Because they receive the principle that they loaned you plus some percentage of the profit.
Things that affect the value of your options and when you buy them:
There are NSOs, or Non-Statutory Stock Options, and ISOs, or Incentive Stock Options, and the primary difference is taxes. For NSOs, you pay ordinary income tax on your bargain element — the difference between your strike price and the current share price — when you buy your options. For ISOs, the taxes might be seen as more favorable because you don’t pay this ordinary income tax when you exercise. However, something called Alternative Minimum Tax (AMT) is often triggered when you exercise ISOs and you need to make a payment similar to what you would with an NSO anyway.
Regardless if you have ISOs or NSOs, you will have to pay tax when you sell your shares, assuming, of course, that you make a profit. If you keep your shares for at least one year after exercising your options and two years after the grant date (e.g., your start date), your profits will be taxed as long-term capital gains, ranging from 0 to 23.8% depending on your income. If you don’t wait that long, you pay short-term gains, taxed as ordinary income, ranging from 10 to 37%.
There are different types of loans, so be aware of what you’re getting into. A recourse loan means that you need to pay it back whether or not the company actually goes public or gets acquired. Non-recourse loans do not have to be repaid if the company goes belly up — if the shares are worthless, you owe nothing.
Many employees wonder this. You might be leary of even mentioning for fear of looking like you don’t believe in the company anymore. But secondary stock transactions are actually quite common. Your management team understands that people have different needs — maybe you’re remodeling your kitchen, trying to pay for a Master’s or buy a car. Selling some of your shares to reach your goals might be right for you.
Yes. And that’s because private companies almost always have a right of first refusal when an employee wants to sell shares. Which means if you find a qualified buyer for your shares, your company will likely have the right to refuse that offer and match it themselves instead. This allows private companies to better control who is at the capitalization table.