How can I tell how much my pre-IPO stock options might be worth?
December 20, 2009 12:34 AM   Subscribe

How can I tell how much my pre-IPO stock options might be worth?

I have a few bits of data: I know the exercise price of the options now and a couple years ago. I also know roughly how much money has been invested by VC's in the company. And I can make estimates as to how much the company will be worth in 5 years.
posted by cman to Work & Money (15 answers total) 4 users marked this as a favorite
 
Well, strictly speaking, your shares are currently worth the current strike price (that is the price at which they would be transacted). The strike price fundamentally represents a current valuation of the company.

I assume that you are asking how much they would be worth at some time in the future based on the information you have. that is a much more difficult question that no one out here in mefi land or even those people running your company from the highest level knows for sure.

A couple things to think about regarding future value:
-It may not be an IPO, many startups achieve liquidity through a more direct acquisition from another company (so the value would be determined by a deal and a contract, not by the free market)
-The best way to guesstimate what might happen is to look for other businesses in your industry segment and see how much they sold for in terms of revenue ratio. The number is probably in the neighborhood of 3. That means that the value of the company is roughly 3 times the annual revenue. From that point, you would determine what percentage of existing shares you own/have-rights-to to determine how large the windfall might be to you (don't forget to subtract the strike price from the final share price to determine the winnings!)

A lot of things can happen in 5 years, a lot. Unfortunately, the amount that VCs have invested, and the current and past strike prices have very little to do with what could occur in the future.

If I did not answer your exact question, let me know and maybe I can resolve the exact query you are pondering. This whole area is pretty fuzzy, and there can be a lot of variables...
posted by milqman at 12:51 AM on December 20, 2009


You may have already seen these, but this page has some things to consider, and this page offers a seemingly reasonable formula along with some decent comments. The safe bet is to view your stock options as a bonus. They might provide a considerable windfall if handled correctly and everything goes according to plan, but it is just as likely that you will end up with little to no profit in the end. Treat any claims made by your employer regarding to stock options as supplemental to your salary with extreme skepticism.
posted by sophist at 1:09 AM on December 20, 2009


Treat any claims made by your employer regarding to stock options as supplemental to your salary with extreme skepticism.

This is absolutely vitally true.

There is often very little incentive to go public with a company, even after years and years of sucking at the VC teat. My last employer told us every year, "This is the year we're going public." And everybody would get all excited every year. And now, two years after I've left, they still haven't gone public.

That's the second company I've had that experience with. And many other people I know have been promised stock options, "worth a hundred k, easy", that they never found any value in. Either they left before the company went public, the company folded before it went public, or the company decided it was going to remain privately held permanently. As a rank-and-file employee, there's precious little you can do to influence this.

So, in my experience, the actual value of a pre-IPO stock option is usually $0.00.

Don't let them tell you that part of your salary will be paid in options. The options should be a bonus on top of a decent wage.
posted by Netzapper at 1:45 AM on December 20, 2009 [2 favorites]


That's the second company I've had that experience with. And many other people I know have been promised stock options, "worth a hundred k, easy", that they never found any value in. Either they left before the company went public, the company folded before it went public, or the company decided it was going to remain privately held permanently.

Yeah, this happened at my first employer too, except rather then going IPO they talked about getting bought out. It was a pretty small company. I think that kind of thing is pretty common.
posted by delmoi at 1:59 AM on December 20, 2009


I resigned just this past Friday. At this start-up (about 100 people strong) options were touted and an IPO was in the picture depending on the market.

But I have no idea what % of the company my shares represented, nor the valuation of the company even after several rounds of financing. Even with this information, there are too many variables as mentioned above.

I was paid well, so there were no illusions about the real possibility that these options would be worthless. I'll be in the position to see what actually happens in the next year or two - this past year, to project some $20M in sales and then come in about 1/5th that amount doesn't bode well. And of course now I realize that for the 'true believers' in the company one can become delusional about being on the verge of turning the corner etc.

Being able to resign with an offer in hand was a great feeling. I've had it with working in the start-up environment - I don't have any problem with the lack of resources or many other aspects of a small company's difficulties, but when I lose confidence in the ability of the principals to understand the company's products, market and customers, it is certainly time to move on.
posted by scooterdog at 3:51 AM on December 20, 2009


If we are not talking about your options as a part of salary, but as a separate fin. instruments then here is how to evaluate the value.

1) You might need some help form your friend, who knows a little bit of financial theory.

2) The price is always a suggestion. Don't trust on it blindly.

3) Logic

Price of an option can be evaluated by knowing

a) underlying stock price (S),
b) volatility of the stock price (sigma),
c) strike price (K) at the maturity (if S at maturity is higher then your call option is in the money)
d) time to maturity (t)
e) risk-free interest rate (r)
f) dividend rate of underlying stock (d)

Then knowing that your option is most often European (must be executed at a certain given moment) / American (can be executed whenever), you can estimate the value of the option.
Sigma is sometimes estimated from the historic prices, but as you don't have them it can be derived from the market (so called implied volatility). As you do not have S price yet, you have to make some sort of estimate either by

a) relative valuation (compare to similar listed companies, and notice that the number of shares issued affect the price) or
b) some sort of discounted cash flow estimation (i.e. trying to evaluate the value of the stock by relying on the fundamentals)

4) Evaluation of parameters

- company valuation is a form of art, NOT a form of science. Thus, the price you estimate will by highly unreliable. Many young IPO-companies nowadays rely on non-tangible assets, which are difficult to estimate.
- implicit volatility estimation is more reliable, if made carefully, but you will need help with this. There are so many issues you have to know that I cannot explain it here thoroughly.
- most young growth companies do not pay dividends, and also r & t are easy

5) Option price

As a consequence your estimation can give you some hints about your option value. If you have finance background, read Hull's derivative bible (Options, futures and other derivatives), which shows you the theory. The book does not show you how to estimate sigma or S, and you have to ask help from some professional or aspiring professional. From Hull's homepage you can download his freeware Derivagem program, which works as an extension to your Windows Excel. Then, when you have the afore-mentioned estimates, you can easily make the program calculate the value of your call option.

6) Problems

There are to potential further problems:
- in order the price to be reliable, the market must be relatively efficient (e.g. no small or unreliable developing markets).
- the price of an option is most oft he time for bunch of stocks. Thus, multiply the call price above with number of stocks mentioned in the contract, in order to get the value of the whole contract.

7) Why?

Does this seem difficult? I explain all this, bec. if you are about to deal with options, you should lean how they work. Read your Hull and improve your understanding, and you get to know the risks and caveats better. Less sleepless nights.

Hope this helps.

DB
posted by Doggiebreath at 4:11 AM on December 20, 2009 [2 favorites]


A few further ideas, which might help you forward

- use a local T-bill of the same maturity as option maturity as your r
- t is expressed as years
- K is at the maturity
- d as a decimal (if 5% then 0.05)

The most tricky estimates are

Current stock price (S)
- your company's estimated market value in 5 years must be divided by the number of stocks and then discounted continuously by r to current time (Se^-r*5)

Implied volatility (Sigma)
- Once you now current S search for other similar companies to yours, which have a similar situation. (out of the money, at the money, in the money), as the volatility is different in different situations.
- Search all the other parameters for the new stock you have found, and have a random guess as a volatility (e.g. 0.43). Set the option price box equal to the market price of an option. Then tick Derivagem's "implied volatility" box, and the program estimates your implied volatility.
- Repeat the process a few times for different companies, which are as closely as possible to yours. Then, compare the created implied volatilities you have calculated and try to come up with the best possible guess of implied volatility to your own company, based on those.
- calculate the price of your option, by using the implied volatility you have estimated.

In the end

Think if your result is believable. You can make a sensitivity analysis, by changing the values a little bit and repeating the estimation with those changed values. If the result is not believable, make sure your stock price was created by dividing the right number of stocks issued, and that you are comparing the option prices either as per one option contract or per one stock (contract value divided by number of stocks included in the contracts) etc.

Best

DB
posted by Doggiebreath at 4:57 AM on December 20, 2009


One more definition:

"Once you now current S search for other similar companies to yours, which have a similar situation. (out of the money, at the money, in the money), as the volatility is different in different situations."

This means, search identical options to yours (t,K, Amer/Eur etc.), which are written on a company similar to yours as closely as possible. Once you have found them, choose only those options for further studies, which are out of/at/in the money the same way as yours. This is because of the phenomenon called "volatility smile". See Hull for further information.

DB
posted by Doggiebreath at 5:25 AM on December 20, 2009


How can I tell how much my pre-IPO stock options might be worth?

Pick one:
(a) You can't.
(b) $0.00

All the math in the world isn't going to tell you how many more funding rounds are going to occur, whether they will be up-rounds or down-rounds, or how much dilution they will create. You can't predict whether Goldman will be running the IPO or some third-rate IB. You can't predict whether Goldman will be a 3rd rate IB in five years (though I wouldn't bet on it).

Your options probably have some non-zero value, but you should treat it as zero until an investment bank (IB) has been retained to run the IPO and you are in the blackout period. Once the IPO is priced, you still don't know the value - the initial auction could open at the IPO price, or it could open up or down. You will probably have a lock-in period, so you won't even know the value of your options on IPO day - you will need to wait the three months until you are no longer prohibited from selling, and see what the underlying stock price is then.
posted by b1tr0t at 7:55 AM on December 20, 2009


So mainly what I want to know is what percentage of the company are my shares. I can make assumptions and I know any number I come up with will NOT be exact. But I just want to get an order of magnitude calculation. I want to know whether, if all goes well, they may be in the range 10,000-100,000, 100,000-1,000,000, or 1,000,000+.

Thanks
posted by cman at 10:00 AM on December 20, 2009


So mainly what I want to know is what percentage of the company are my shares.

You need to ask your boss what the number of shares outstanding is. This is information they should be willing to share with you. But that number could go up over time, if the company gets more funding.

I've been working for a startup for about half a year. When I joined, I asked the CEO to include the number of outstanding shares in my offer letter so that I could have concrete information about what my options represented, and he was happy to do that. But that's with the understanding that the company might issue many more shares in the future to get more funding. I didn't join the company with the expectation that it would be a success; I joined it because I liked the people and the product is interesting.

Do you have any hint that your company will be able to turn a profit? If so, the conventional thinking is that the IPO or private sale will garner some multiple of that profit, say 10x. But I know nothing about your company, so I couldn't guess what that multiple might be. (And I am not a financial advisor, etc.)

Other indications that your options will be worth something:
- The product is good.
- The sales and marketing people are experienced and there is a reasonable plan for selling the thing or otherwise making money off it.
- Similar products currently on the market are doing well. But your product is better in some significant way.
- The CEO has an established record of founding companies that have either gone public or been sold. If so:
- The CEO has brought in former coworkers from previous companies that have gone public/been successfully sold.
- If the product is publicly available, people are blogging/tweeting about it positively.

If profitability is still a big question, then you're better off not even worrying about this. There are many ways that your options could become worthless. The most valuable thing you can do is to learn as much as you can, establish a reputation as a good worker, and try to work on interesting things, so that if you need to change jobs, you can impress your interviewers with all the cool things you've done and the positive references from your current coworkers.
posted by A dead Quaker at 11:43 AM on December 20, 2009 [1 favorite]


This is information that your CEO should be able to share with you. You should know the number of options you have been granted, and you will just ask how many outstanding shares there are. then you just divide. If you are unclear on the most of this in the first place, then you probably have less than a percent (probably less than half a percent).

That isn't a dig against you, it's just that normally the stock goes out according to rank. Any folks that have something in the neighborhood of a percent usually know it (and their title starts with C** or VP of *********).

Good luck with the monies!
posted by milqman at 3:44 PM on December 20, 2009


There are two cases:

1) What are these theoretically worth - I can't answer that one.
2) What are these actually worth if I wanted to convert them to cash now, in which read on:

Your options are worth whatever someone is willing to pay for them. You company might buy them back from you for what you paid for them (assuming you've exercised them). So they are either worth that or $0 (because nobody else will buy them from you).

In certain uncommon cases where the company is very HOT property and there are lots VC's (who can't get in on a financing round) looking to get some of the action, they will try to buy common shares from employees that have them. Usually this only works for founders & execs because they have a reasonable amount of stock to sell. In this case the value is a negotiation but will be tied to the most recent valuation of the company, which will have been determined as part of the last finance round.

For background, in many start-ups (at least in Silicon Valley) the employees will potentially own about 15~25% of the company (this is called the option pool). Of that pool the CEO will have about 1/3, the executive staff will have another 1/3 between them and the rest of the employees will share the last 1/3. This means a VP level or C-level guy will have 1~2% of the company. A senior developer might have 0.2~0.5% of the company. These are very general guidelines, but they're what I've seen to ballpark employee equity here.
posted by Long Way To Go at 5:17 PM on December 20, 2009


Second Market (www.secondmarket.com) is a marketplace connecting pre-IPO and other illiquid asset sellers and buyers. If you work for high-profile start-up (think Facebook, etc.), they might be able to help.

My wife got some estimations for stock she's had with a company that might (or might not) have IPO 2010.
posted by zeikka at 5:45 PM on December 20, 2009


a) "(b) $0.00"

The option always have time value. Thus, it's price cannot be zero ever before maturity.

b) "Second Market (www.secondmarket.com)"

Your own calculations are always unreliable. Thus, if any liquid market is available for reference, use it -- one way or another.

c) You should be able to figure out, how many stocks will be issued in the IPO. If yes, calculations are possible. The market price will change of course depending on the success of IPO, but I thought that current price was what the person was after...

d) Normally, IPOs are underpriced to make sure investors are interested, and consequently the stock value will increase somewhat.

DB
posted by Doggiebreath at 9:24 AM on December 21, 2009


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