"Stocking" Up on Information (Get it??)

December 5, 2007 1:40 PM

What do I need to know about employee stock options at a small, private tech start-up?

I recently joined a very small (~15 people total) tech startup. I've been here about three months and I'll have my first performance-related meeting with the company heads in the next month-ish. We'll (hopefully) be discussing some increase in compensation. I was hired at the low-end of my expected salary and all parties agreed that this would be adjusted after the latest round of venture capital came in, which it has.

As part of this compensation increase, I will be offered employee stock options. To prepare, I read this, this and this. While useful, most of these seem to assume (I think) that your company is publicly traded.

What do stock options mean if your company is private? If you exercise your options and then later want to sell your stock, who do you sell it to? Back to the company itself? How is the stock price set if the company is private?

Also, I'm not sure if I'm going to be at this company for years and years. If I leave in a year or two, what happens to my options, especially if the company is still private? Will I have a chance to exercise my options before I leave? If I do, do I have to sell the stock as well? Obviously, the vesting period will come into pay in determining what % of options I can actually exercise.

Finally, if the company is purchased by another company, what happens to the stock options? Would we be asked to exercise our options and then sell them to the purchasing company?

Obviously, I'll discuss the full details of this with an accountant at some point as well, I'm just trying to establish a basic understanding at this point, especially if this is going to be part of my future compensation. Thanks!

posted by Nelsormensch to work & money (5 comments total)

Stock options are (effectively) no different for a privately-held company.

The first thing you need to understand is the number of outstanding shares (so you can calculate what % equity you have).

You need to ask about their vesting schedule. Depending on how the options are structured, you may not get your "allotment" for some period of time, you should know what this schedule is (and then try to understand what that might mean with regard to how and when the company might get acquired) to assess their value.

You might also ask about how many different classes of stock currently exist. If there are VCs involved, you can bet they have a "preferred stock" and you will get "common stock". You need to understand what level of preference and liquidation ratios are available for the preferred stock to further assess the "compensation" they are giving you.

You should have the opportunity to exercise them if you leave the company.

When the company is acquired, typically all stock is purchased by the acquiring company as a provision in the acquisition agreement. This is also the document that will "value" the stock (or options).

Exercising the options, then selling them back does not really happen so much, mostly because exercising early would negate any additional vesting you might have had. the idea in that type of company is that you hold on to the options til you leave or until they are acquired.

If you have any further questions, you can PM me. Also, you can probably wikipedia any terms here that you are unclear on, that should clear things up.

Best of luck, take 'em for all they've got!
posted by milqman at 2:02 PM on December 5, 2007

second milqman

Also, make sure the company has some sort of plan for how the options are granted. If the company does not agree to a plan of how many shares of pre-IPO stock they will issue, they can just issue massive amounts of them, making your options worthless.

Also, keep in mind that something like 9 in 10 tech startups go bankrupt, so the chances of your options being worth anything ever is fairly slim. It's basically like getting paid in lottery tickets.
posted by burnmp3s at 2:06 PM on December 5, 2007 [1 favorite]

Okay, first off you'll want to divorce options from compensation, especially at a startup. If the company is purchased, sometimes it's outright and sometimes it's for stock. In the former you'll get a check when the deal goes through and that will zap your options, in the latter case there will be a conversion factor determining how many shares in the new parent you will receive.

If the company is private, then you can vest your options just as though you would if the company were public. This just means there's no market around the shares and you'll likely only be able to sell them to your coworkers or other informed person (as a practical matter, but you can probably sell to whomever you can find).

Typically, the odds are low that a particular startup will be acquired. It's also not the wisest investment to have shares in a company that don't move in price and are only known about to initiates. This is why thinking
All of this is highly unlikely for any given startup, so this is why options should not be factored into your sense of what a fair rate is. Additionally, your newbieness fairly removes any ability you have to negotiate on this point, so you'll probably just be given a piece of paper to sign with whatever raises and grants you get.

If you've never had options before, I'd understand if you're a bit starry-eyed. The real-world landscape, however, invites a bit more skepticism. Options in a small company rarely turn out as profit, so treat them as gravy. You might think of it in terms of "salary+benefits = future performance" & "options = rewards for past performance."
posted by rhizome at 2:35 PM on December 5, 2007

In a startup, unlisted and unprofitable, options are lottery tickets. Obviously you want to have as many tickets as you can, but they are not cash.

If the company is private, you may have problems exercising your options, because you need someone else who wants to buy them, and without a liquid market, that someone may be hard to find.
posted by i_am_joe's_spleen at 2:48 PM on December 5, 2007

Do not assume too much concerning your percentage share in the company at this stage. If your company goes public or if VC people invest, your shares could be highly diluted, by a factor of 10 or 20 or more. You have no control over this so don't count your chickens before they hatch.

Generally your options are worthless unless the company goes public or is acquired. Generally there is no market for them so they have no value.

The wild days of the 90s are over and there is no guarantee that your options will ever have value. Even if your shares do become liquid, they may only be worth hundreds or a few thousand dollars. So don't give up your wages for a long shot that may never pay off. It is the few founders and the VC people who will make out, but they try to get some employees to work for a pittance for a very tiny share of the business using dreams of another Microsoft.
posted by JackFlash at 6:23 PM on December 5, 2007