How to Evaluate and Negotiate Your Stock Option Package

Congratulations! You just got off a call in which you were offered to join a hot new startup! Base salary is in-line with your expectations, benefits look good, and there’s even an annual bonus. The last thing left to do is negotiate your stock option package. How many options should you get? What percentage ownership in the company? What should you optimize for? And how do you evaluate the package and compare it with other offers?

Before we go there, make sure you have option basics covered right here. Parts 2 and 3 are coming in the next few weeks, so be on the lookout.

Now that we have that covered, let’s go back to the negotiation table…

When assessing a stock option package, one must focus on two key parameters:

  1. The value of the package
  2. The vesting schedule (i.e. when do I actually get that value?)

Assessing Value

Let’s assume your offer includes 5,000 options. How do you put a value on that?

Here are a few approaches.

Negotiate Your Stock Option Package

In an ideal scenario, the company provides you with its most recent valuation and the ownership percentage (fully diluted[1]) your options represent assuming they are all exercised and converted into actual shares. Multiply these two figures, and you’ll get a general understanding of how much your options are currently worth.

For example, if the company is valued at $100M based on the most recent equity round and your 5,000 options make 0.04% of the company’s shares, you can use $40,000 ($100M x 0.04%) as a good current value estimate. Don’t forget to deduct the cost of exercise from this figure to get your net value number. For example, if your exercise cost is $0.50 per option then you must pay $2,500 (5,000 options x $0.50) to convert your options into shares, bringing the net value to a slightly lower $37,500[2].

As the company grows and raises additional money, two things will happen: its valuation will change (hopefully will increase over time), and your ownership stake will decrease (as the company issues additional shares to new investors). This means that the value of your options will change over time, but if the company’s doing well, that change should be overall positive.

The challenge with the first approach is that many companies don’t like to share their valuation with candidates (or even employees). If that’s the case, you can ask for other pieces of information that will help you put the puzzle together. For example, you can ask the company for its last equity round price-per-share. Companies are more open to sharing this piece of information since it does not reveal their valuation. Once you have that price handy you can calculate your net value by multiplying the number of options offered and the difference between this price-per-share and your exercise price. Using our example above (and a price-per-share of $8), the calculation would be 5,000 x ($8-$0.50) = $37,500.

It’s important to understand that this value is an estimate, many things could have changed since the last time the company raised money and many things will change in the future as it continues to raise funds. Plus there are other variables that must be considered (like the preference venture capital investors may have over other shareholders). However, we believe that the output this approach delivers is solid given its simplicity and its practicality.

The final approach we will discuss is useful if the company is not willing to provide any information beyond what is absolutely required: the number of options and the exercise price per option. In this case, and assuming you still want to work there (red flag anybody?) use this 2-step approach:  first, multiply the number of options and the exercise price, sometimes referred as strike price. In our case, you will multiply 5,000 and $0.50 to get $2,500. Then, further multiply 2,500 to get close to the “real” value. For early stage companies, that multiplier can be as high as 10x or even more. As the company matures, that multiplier becomes lower (for example, post series B companies will have a multiplier of 4-5). We’ll explain the multiplier concept and why it exists in future posts.

Vesting (Or, How Long Until I Actually Get This Value?)

On the day you join this hot new startup or shortly thereafter, the options will be granted (or awarded/issued) to you. However, you cannot exercise them and make them into actual shares quite yet… you have to wait until they vest.

Options vest over time and only at the end of your vesting period will own 100% of the options you were granted. Companies use a vesting schedule to incentivize employees to stay with them long-term and so they don’t give the company away to people who barely worked for it. A typical vesting schedule is four years long, with 25% of the options vesting after the first year (referred to as a “cliff”) and the remainder vesting monthly or quarterly over the following three years.

These terms are usually fixed company-wide, but can be negotiated in some cases. You should also ask if there’s an early exercise option and inquire if your options would vest faster if the company is acquired or goes public (accelerated vesting). For example, if your vesting schedule is four years, but the company exits after three years, acceleration ensures that you get the options that would have vested in year four immediately upon exit or shortly thereafter. Note, however, that in most cases only executives get to enjoy acceleration.

Evaluation and Negotiation.

Now that you have a general idea of value in mind and you know how long it will take you to earn this value, you can evaluate your offer as a whole and see if it’s competitive enough for you.

The first thing you can do is sum your offered annual base salary, annual bonus and annual option value (total value over number of years it takes to vest, or in our case $37,500 divided by 4) and compare it with your expectations, what you made previously, and other offers you are considering. When comparing different offers, always compare the value of the options and not the option count. 10,000 options in one company could be worth much less than 1,000 options with another.

You can also use this tool offered by Index Ventures to see where you are vs. market. It offers a simple calculator to estimate exactly that. What we like about this tool is that it’s based on real data from a broad range of companies, so it can be a reliable source of information to use when negotiating an offer.

Finally, you have to decide what’s most important to you. If you personally place less value on options since the company may or may not succeed or because you just bought a house and have a mortgage to pay so cash is more important for you, you can ask for a higher base+bonus and fewer options. If you feel like this company is going to hit a home run and you can live with less cash for a few years, ask for more equity and be flexible on base and bonus. This is about trade-offs at the end of the day.

It’s important to keep in mind that the option exercise price is generally non-negotiable since there are rules that companies have to follow when setting it, so really your focus should be on optimizing the number of options awarded to you. 

Final words

Options are important. Negotiating the right package on day one can have a massive impact on your bottom line when the company exits. It’s important to understand their value and mechanics and ensure you get what you deserve. But at the end of the day, the most important thing is betting on the right company. Your time is limited, and so is the number of companies you can work for. Before signing the offer letter to join your next company, ask yourself: Do I believe in the company? Do I believe in the team? Can I imagine them winning their market in few years? If the answer is no, all the optimization in the world does not matter and you should keep looking for the right opportunity.

Good luck!

 

[1] A fully diluted view assumes that all outstanding options are granted, vested, and exercised, and that all other instruments that can be converted into shares are converted.

[2] Without getting too technical – this calculation assumes that corporate investors (angel+VCs) that hold preferred shares convert them into common shares (which will happen if the company’s doing great and it makes sense for them to do so). If they don’t, you’ll have to take liquidation preference into account when calculating value. But who joins a company thinking it won’t hit it out of the park.

 

All information provided herein is for informational purposes only and should not be relied upon to make an investment decision and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. Readers are recommended to consult with a financial adviser, attorney, accountant, and any other professional that can help you understand and assess the risks associated with any investment opportunity. Private investments are highly illiquid and are not suitable for all investors.  Securities on the EquityBee platform are offered through North Capital Private Securities, member FINRA/SIPC. 

5 thoughts on “How to Evaluate and Negotiate Your Stock Option Package

  1. Pingback: When Should I Exercise My Stock Options? – EquityBee Blog

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EquityBee helps employees get the money they need to exercise their stock options by connecting them to investors who want to invest in their companies. We do this by executing SOFAs (Simple Options Financing Agreements). Entering into this agreement with an investor will allow him or her a percentage claim to a liquidation event, with no guarantee of such an event, and is subject to the terms of your company options agreement. Securities offered through North Capital Private Securities Corporation, member FINRA/SIPC.