Options

Alex McCaw wrote an excellent blog explaining stock options - http://blog.alexmaccaw.com/an-engineers-guide-to-stock-options.  Everyone getting options (an engineer or not) should read this - especially the tax implications of converting your options.

I thought there were several common issues that could use some further explanation using an example.

For our example, lets say a VC investment made of $10 M at a valuation of $50M.

Pre Money and Post Money Valuation.  Since people like big numbers, so this is usually expressed as post-money. So the company was valued at $40M before the investment, but now that they have another $10M in the bank, they are now worth $50M.

Dilution.  Before the investment there were 4,000 shares/options, each worth $10, and each representing 1/4,000th of the company.  For the investment another 1,000 shares were created and sold to the investors at $10 each.  Each share/option each employee had was worth $10 before and $10 after - so there was no economic dilution.  Each share/option is no representing 1/5,000th of the company - so there is a % ownership dilution.

Dilution can be an emotional topic.  For founders as they go thru rounds they drop from 60% ownership to 30% to 15% and feel a loss of control of the company. But this is the deal for getting those financial resources into the company. Dilution for most employees does not impact "control", but a feeling of "worth".  They may start with 1% but at the end be at .2%. The fact that each round was needed and valued "fairly" means it was just part of growing the company. Just like adding another superstar developer or VP of Sales. 

The point I would like to make is that company leadership should explain this during the growth stages and when new investment comes in.  It is a simple fact and should be treated as such. Don't wait to sell the company and people think they have 1% and they actually have .2% - too much heartache when there should be celebrations.

Option Valuation. In our example the valuation is $50M, but that valuation is for Preferred Shares. The reality is that Common shares (which options are tied to) are NOT worth that much. The reason is covered in Alex' blog. Boards will try to get a valuation done for the company at the lowest possible price.  These days that is about 20% (and it seems to have gone up over the past 10 years and continuing to head upward). Boards have a reason to try to get the minimum valuation because it is an incentive to hiring people, so in this case boards are definitely on the side of the employees!

So that means if you are issued options around the time of this funding, your options will be priced at $10 * .2 = $2. So, if the next week the company is sold at $50M, you are in luck because your options will be worth almost $10 a piece! (it is "almost" because some preferences may wind up giving some of that first $50M to the preferred shareholders).  Of course if the company sells for $10M in a year, then the preferred shareholders get all $10M and you get nothing - hence the reason for the decreased value of your options.

Who Deserves How Much? This is one thing I have learned - no one gets what they feel they deserve. At some very successful IPO's and Exits I have been a part of I have seen unhappy people from the founder to the CEO to the Exec team to developers to sales people - well, everyone. It seems some people always have a high opinion of themselves! 

The fact is that there are four key things that determine how much you get:
  • When you join. The earlier the better.
  • How much appreciation to the value of the company happens after you join.
  • Accepted Market Practices. All the VC's will have a chart for what % each type of job function gets they will share with their CEO's. That provides ranges, like .7-1.5% for a VP Marketing. The interesting thing about most that I have seen really focus on the people that report to the CEO, so the typical % going to a developer will be much below 0.1%.
  • How critical the open spot is and how good you are. 
So negotiate the best you can, but the big wins come from being part of a company that grows really fast and increases their valuation 10X while you are part of the team. Good luck on finding that opportunity. 

In the mean time, enjoy your job and live within your existing compensation!

Comments

Post a Comment

Popular posts from this blog

Ringside Winding Down

A year ago, a group of us met in a pizza parlor to discuss how we could bring the social web to every website and business. In January, we launched Ringside Networks with seed funding from Matrix Partners, one of the best VC firms in the country. By the end of March we released into open source an initial beta of our Social Application Server – a very ambitious project. We got some very positive reviews on our approach, our implementation and the need in the marketplace for every website to become social. We were ready for our Series A round of funding, and in late May we received a number of term sheet offers from the very best VC firms. As we were about to finalize our funding, one of the biggest non-evil Internet companies asked if we would have interest in being acquired instead. After a lot of thought and debate, we decided that the larger company would enable us to get our technology to market sooner and with more impact. The story sounds almost too good to be true. And it w...
Read more

Capitalism vs. the Three Legged Stool

Image
Wikipedia defines: " Capitalism  is an  economic system  in which trade, industry and the  means of production  are controlled by private owners with the goal of making  profits  in a  market economy ." This definition has always bothered me. I prefer a different model where there is equal recognition of the three primary drivers behind the success of a company: Owners Employees Customers I like to think of it as a three legged stool, where each leg is as important as the other.  One gets too large or small and the stool tips over. The free market is supposed to take care of Employees and Customers.  Employees because the Owners will create so many jobs that due to supply and demand, employees will receive competitive pay.  Customers because if the owners are not building the right thing, then they can go elsewhere. As someone who has helped to build about 10 startup companies now, I have seen the power in mak...
Read more

Galbraith Revisited

Image
To follow up on my post from a while ago, Galbraith sited 5 key reasons for the 1929 crash and following depression: 1. The bad distribution of income. 2. The bad corporate structure. 3. The bad banking structure. 4. The dubious state of the foreign balance. 5. The poor state of economic intelligence. To compare this to today: 1. Bad income distribution. 1929 - Top 5% received about 33% of all personal income. 1929 - Top 1% held 44% of all wealth. 2000 - Top 1% received about 20% of all personal income. 2004 - Top 1% held 34% of all wealth. Here is a picture of the real income gains between 1979 and 2005 by percentage. It is clear that the top income groups are gaining ground faster than lower income groups - creating an income distribution that approaches 1929. 2. Bad corporate structure. In the 1929 era there had been a large rise in a "vast structure of holding companies and investment trusts... In particular the dividends from the operating companies paid the interest on t...
Read more